Blog Post

Reactions to the Greek deal

What’s at stake: By any standard, Sunday’s loans announcements on Greece and the emergency moves by the European Central Bank on Monday on its collateral rules were bold and unprecedented. The IMF-Eurogroup rescue package for Greece is heavy on core macroeconomic austerity measures and lighter on the kind of structural that won the fund opprobrium […]

By: Date: May 3, 2010 Topic: European Macroeconomics & Governance

What’s at stake: By any standard, Sunday’s loans announcements on Greece and the emergency moves by the European Central Bank on Monday on its collateral rules were bold and unprecedented. The IMF-Eurogroup rescue package for Greece is heavy on core macroeconomic austerity measures and lighter on the kind of structural that won the fund opprobrium during the Asian financial crisis of 1997-1998. The core of the three-year programme is a huge fiscal tightening equal to 16 per cent of gross domestic product – an extra 11 per cent on top of the 5 per cent already announced.

An IMF study points that more than twenty advanced economies have achieved improvements in their structural primary balances of at least 5 percent of GDP at least once in the last four decades; ten of them have achieved improvements in excess of 10 percent of GDP in that period. So history suggests the adjustment is doable. Greece has actually done it before (by 12% between 1989 and 1995), but this time they have to do it with 1) a shrinking economy, 2) poor demographics (aging population), and 3) no exchange rate depreciation.

Erik Nielsen argues that Greece will have to engineer a decline in private sector nominal wages of 15 per cent if it is to restore its international competitiveness.  A decline of up to 20 per cent will be required to generate the current account surpluses needed to continue making interest payments to foreign creditors. This would be a colossal challenge for any government – let alone a socialist government in Greece.

Felix Salmon says the Greek bail-out won’t work. The fact is that the bailout package really doesn’t address the problem, which is one of solvency rather than liquidity. The European loans are being extended at about 5%, which while much lower than market rates is still not low enough to make anything approaching a dent in Greece’s debt dynamics. And by the time the bailout package is exhausted, if Greece even gets that far, its debt-to-GDP ratio will be significantly higher than it is right now, thanks to both a rising numerator and a declining denominator.

Mohamed El-Erian  argues that as the programme does little to address the debt overhang Greece faces the risk of a “lost decade” similar to what Latin America experienced in the 1980s. He also notes that the programme assumes no new financing from the private sector until 2013. But can it keep existing creditors from trying to exit in mass? The problem here is that Greece needs a quick transition in the composition of its investor base: from those that mistakenly bought bonds on the basis that Greece is a mature European government (“interest rate risk”) to those that are comfortable with more volatile credit risk. Given how over-exposed the first group is, the transition in investor base will entail continuous net selling pressure.

Jacob Funk Kirkegaard argues that even if successful the joint Europe/IMF/Greek government aid program only postpones an inevitable Greek debt restructuring by a few years. In that context, it is scandalous that German lawmakers are asked to put NEW German taxpayer money behind that of private bondholders in the line-up of potential creditors. In other words, German parliamentarians are being asked to bail out both Greece AND bankers and financial speculators (or “locusts” as the latter they are known in Germany).

Models and Agents does not think there will be any debt restructuring. Any haircut decision – and savings thereof – would have to be weighed against the new debt that would need to be issued to cover the losses of Greek financial institutions; and the much higher interest rates that Greece would be charged for its debt in the future (which would be higher the lower the recovery values and the higher the perceived probability of default). Add to that the possibility of bank runs, collapse of confidence and the ensuing disruption in people’s daily routines, and you kill all incentives for reform by transforming an economic emergency into a national calamity.

*Bruegel Economic Blogs Review is an information service that surveys external blogs. It does not survey Bruegel’s own publications, nor does it include comments by Bruegel authors.


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