Readers Question: On Jan 2009 I asked a question on the greek current account deficit, the fixed EUR rate, the lack of competitiveness and the debt load and you expanded brilliantly on the dangers of the twin deficits and the deteriorating Greek credit quality. Now I just need to make a comment that all the analysts, all the policymakers and all the technocrats are talking about all the possible solutions on the Greek saga with one huge undisclosed assumption in the back of their minds which is a relic of the past: that there won’t be another global recession any time soon. I believe that the bus. cycle will be much more volatile than it used to be and all projections are off if we slow down meaningfully again (politics will be unpredictable). I have been thinking about the possible consequences on such a scenario and they are just horrible. I would therefore like to ask your opinion on the probability of such a recession and your view on how quickly Europe will debacle in such a scenario. Thanks
Unfortunately, it hard to see any optimism about the Greek economy.
At the end of 2010, unemployment stood at 14% (OECD) Private consumption is falling and the economy is stuck in recession. (despite growth of 0.8% in the Q1 of 2011) the overall trend is downward in
Trading economics [Greece]
Despite the fall in consumer spending, the current account deficit has barely fallen, remaining at just under 10% of GDP – indicating a continued lack of competitiveness.
Unfortunately, the main objective of the ECB, EU and Greek government is avoiding debt default. There is no real target or effective policies for reducing unemployment or boosting economic growth.
Therefore, although the economic outlook is dire, there will be greater efforts to force through more tax rises, spending cuts and austerity measures.
These austerity measures are exactly what the economy doesn’t need. The battered consumer and economy will only suffer further. Spending cuts will mean lower income for government workers and less money for investment projects. Therefore there will be less spending contributing to rising unemployment.
There is an underlying lack of demand and spare capacity. In this situation, there needs to be some kind of stimulus.
- Fall in exchange rate to make exports more competitive
- Looser monetary policy
- Expansionary fiscal policy
But, Greece is facing the opposite – a strong Euro, prospect of higher interest rates and higher taxes and lower spending. There is sometimes talk of supply side policies to make the economy more efficient. There is nothing wrong with trying supply side policies, but they can’t solve the fundamental lack of aggregate demand.
Even with this next round of austerity there is still no guarantee that Greece will avoid a debt default (currently put around 50%). Long term interest rates on Greek bonds recently rose to 16% – showing how much investors feared Greek’s ability to repay. (Greek austerity plan)
It is an unfortunate situation, the macro economic management of Greece is hurting not helping. To a large extent it is a consequence of being in the Euro which removes independence of monetary policy and exchange rate. It means Greece is being pushed into a corner
There is a good case for the ECB to pursue more expansionary monetary policy to help the EU periphery, but there is no chance of this happening. The German dominated ECB are already talking of higher interest rates to meet the threat of (oil-push) inflation.
Leaving the Euro is not without serious consequences for Greece, but increasingly may look like least worst option. If nothing else it would mean they wouldn’t have to go through another economic crisis like the current one. But, that is another post.