The Brazilian expression “Greek Present” (Presente de Grego) means unwelcome gift, an obvious reference to the infamous Trojan Horse. The current crisis in Greece might show that the euro was just one of those presents. If the European Union (EU) does not provide sufficient resources to preclude not just a default, but also and more importantly a profound recession, then the advantages of the euro for Greece and other countries in the periphery of Europe should be seriously questioned.
The Greek financial crisis is an exemplar case of the perils of macroeconomic orthodoxy, and of the exceedingly narrow measure of the changes that have taken place since the global financial crisis started. The same conventional ideas about fiscal adjustment are repeated, no matter that their record in the past has been dismal. The price tag of learning, once again, about the limitations of conventional wisdom is the staggering human suffering, in this case of the people in Greece, that European authorities are demanding.
In many respects the crisis seems like a conventional one, with a significant fiscal and current account deficits on the order of 13% and 12.5% of GDP respectively. The conventional wisdom is that excessive public spending led to increasing lack of confidence and to the balance of payments problems. As Greece cannot devalue its currency (the euro), and the possibilities for Greek workers to move to other European countries in the numbers that would be required to reduce unemployment (at around 9.8%) are limited, the only solution would be to adjust, by reducing the fiscal deficit from 13% to 3%, or default. According to Niall Ferguson this shows that there is no Keynesian free lunch.
In line with the adjustment perspective and the pressures of the European Union and the European Central Bank (ECB), the Prime Minister George Papandreou announced severe spending cuts that will freeze salaries and cut bonuses of public workers, increase the average retirement age, and raise the burden of taxation. Europe would grudgingly provide resources conditioned on a draconian adjustment. As correctly pointed out by Thomas Palley: “the ECB would act as an analogue International Monetary Fund for euro member countries.”
It is important to note, however, that this is not a fiscal crisis, as conventional wisdom would have it, but a euro crisis. If the EU had a degree of fiscal centralization compatible with the monetary union, federal transfers would cover the needs of a sub-national unit, without enforcing huge spending cuts. That is what the federal government does (or at least tries) in the US, transferring resources to the States in a recession so that spending can be maintained. In such a situation the risk of higher interest rates associated with the large fiscal deficits are minimal, since the Federal government that has a larger revenue base and the ability to monetize debt carries the burden of debt. Monetization should not lead to inflation, unless the economy is at full employment. So there is a third solution, despite Mr. Ferguson’s arguments, and that would be a Keynesian one.
In other words, the EU should issue Union debt and should transfer to Greece enough funds to deal with the crisis, large enough to completely offset the contractionary effects of the announced cuts. The euro arrangement precludes the Keynesian solution, and essentially forces the country with a current account deficit to reduce imports, and to generate a higher export surplus to pay for the accumulated debt. Even in a terrible recession the economy is forced to contract to reduce imports. The euro, thus, imposes a harsh balance of payments constraint on the Greek economy.
There should be no doubt about the fundamental mistakes and the negative consequences of the pro-cyclical policies being imposed on Greece. Argentina also faced a similar situation in the late 1990s, and fiscal adjustment was clearly incapable of reversing the crisis. Of course Argentina was not part of a Union that could transfer resources. But, in hindsight, devaluation and a well-managed default proved to be a better solution. Maybe the Greeks should question how much the euro is really worth.
Matías Vernengo is Assistant Professor at the Economics Department and the Latin American Studies Program of the University of Utah. This article was first published in Triple Crisis on 15 February 2010; it is reproduced here for non-profit educational purposes.