The financial ministers of 19 EU nations agreed to keep the EU bailout funds flowing to Greece. Bloomberg reports that the government in Athens may run out of cash as early as next month. Yesterday, Germany rejected a Greek proposal for a six-month extension of loan agreement, arguing it was “not a substantial solution”. Along with other European creditors, Germany has been reluctant to risk its taxpayer money by lending it to Greece. After much heated debates and negotiations, Germany finally accorded to extend Greece’s bailout for another four months. The loan will help temporarily stem flights of deposits from the Greek banks, but many doubt it will resolve the essential economic and financial troubles of the nation.
At the same time, Greek politicians face serious domestic backlash. Alexis Tsipras, the newly elected prime minister of anti-austerity party Syriza, is at the greatest risk. During his campaign, he promised the mass “No more bailouts, no more submission, no more blackmailing”. As a condition for its bailout loans, IMF had required the Greek government to adopt severe austerity measures including tax increase and cut in government spending. While unemployment rate in Greece has long surpassed 25%, the safety nets for jobless workers continue to diminish. Many critics worry that IMF’s policy recommendation will adversely affect the Greek economy in a long run.These policies is in discordance with Keynesian method of overcoming economic recession through fiscal expansion.
Starting next week, the Greek government must show a list of overhaul measures, which EC, ECB,and IMF will review. It will be interesting how this decision will unfold in Greece and rest of the Europe.
References: Articles from Bloomberg, CNN, Reuters, and NYTimes
Graphs inserted by the Prof. Note the extraordinary rise in interest rates, which are rising again, and the collapse of employment, down roughly 20% over 4 years (from 2009Q3 to 2013Q3). See comments as well.
One Comment
Germany is trying to bully a brand new government into an agreement, even before Prime Minister Tsipras has assembled his economic team. The only reason not to offer an extension is in the hopes that this power play works. (Whether the targets for which Germany is aiming are feasible or for that matter desirable from a more careful calculation of Germany’s economic interests is a different matter.) However, as long as loans are repaid there’s no budgetary cost to Germany and since the interest rates they will charge are high, it could be profitable. Furthermore, that’s an issue only on German loans. If these are from the EU as a whole or the European Central Bank, then there’s even less reason for concern by German taxpayers.
All of this begs the question of the source of Greece’s problems. The short story is that when Greece adopted the Euro, interest rates fell sharply — Greece had a low credit rating, but post-accession rates equalized to those elsewhere within the Euro Zone. Low rates set off a housing boom, targeted at German tourists and financed by loans from German banks. (I don’t know whether the developers were also German.) All of this led to a rise in real wages and a trade deficit, accentuated by tight fiscal policy in Germany that made exporting even harder for Greece. When the Lehman Shock spread to the EU, all this real estate development came to a sudden halt, and the Greek economy crashed. Since Germany also slowed, it still wasn’t possible for Greece to export enough to earn Euros to cover its debt. Finally, markets panicked. Greece with 10 million people is a very small slice of the European economy. So is Greek debt, denominated in Euros. Hence if you were a money manager, you could dump Greek bonds, even if you had to book a modest loss, because they were a small share of your portfolio. Bondholders had an exit, Greek workers didn’t because labor mobility within the EU is low. The final insult was that the panic pushed interest rates to over 25%. While long-term bonds provided some insulation, it became extraordinarily costly for Greece to roll over the bonds that matured, and with the depressed economy tax revenues plummeted while (as above) exports to Germany and elsewhere didn’t rise to make up the difference.
Can Greece via austerity cut their way to health? Even a small multiplier suggests that it not help growth and will thus not do much to increase net tax receipts. In the short run it may be hard to cut expenditures, since unemployment and early retirement will push up social insurance outlays. Cuts won’t help exports, either, as long as Germany is also in austerity mode. Is the only option Grexit, to (i) exit the Euro and (ii) default on Euro debt? That will impose horrific costs on the entire Euro Zone, and ultimately on Germany.
To sum, Germany had a large hand in Greece’s boom, and another large hand in the bust. German politicians want to wash their hands of Greece. In the process they may well set off a recession that will be far more costly to the citizens of Germany than would bailing out Greece from all of their problems.
Comments are closed.