Blog Post

Europe must offer Greece a post-election prospect

The euro might survive. But a cooperative Greek government, a real European programme to support Greek economic growth and a resolution of the Greek public debt overhang are minimal conditions for the short term. The euro's deeper flaws should also be addressed soon if a disorderly and destructive dissolution of the euro area is to be avoided.

By: Date: June 8, 2012 Topic: Macroeconomic policy

The euro might survive. But a cooperative Greek government, a real European programme to support Greek economic growth and a resolution of the Greek public debt overhang are minimal conditions for the short term. The euro’s deeper flaws should also be addressed soon if a disorderly and destructive dissolution of the euro area is to be avoided.

The Greek people will vote on 17 June 2012 – or might not if the announced strike by Greek municipal employees wrecks the parliamentary elections. Post-election, three main scenarios could emerge: 1. Government led by the centre-right New Democracy – the party regarded as “pro-bail-out” with a wish to renegotiate the conditions; 2. Government led by the Coalition of the Radical Left (Syriza) – an “anti-bail-out” formation, but with the intention to keep Greece in the euro area; and 3. No government.

The no-government option would likely lead to political chaos and make the Greek exit from the euro a real possibility. A Syriza government would be a dark horse – the many measures they wish to reverse would be clearly unacceptable for the European lenders and the IMF, so either their campaign promises or their wish to stay inside the euro could remain unfulfilled. A New Democracy-led government might be able renegotiate the conditions of the bail-out programme and keep Greece inside the euro, at least for some time. But that wouldn’t be enough. The situation in the country is getting worse and worse and Europe must offer a prospect for Greece after the elections if a cooperative government is elected.

Commentators, especially from North America, take it for granted that Greece will exit the euro area and will be followed by others. As Peter Boone and Simon Johnson lucidly explained recently, “it is already nearly impossible to save Greek membership in the euro area: depositors flee banks, taxpayers delay tax payments, and companies postpone paying their suppliers. … With IMF leaders, EC officials, and financial journalists floating the idea of a “Greek exit” from the euro, who can now invest in or sign long-term contracts in Greece? Greece’s economy can only get worse.

They are right in the diagnosis and also right in concluding that after a Greek exit the Germans and the European Central Bank would be reluctant to see a massive rise in ECB lending to other struggling southern euro-area countries. Europe is not prepared for an eventual Greek exit: the lending programme for Spain that is needed anyway could be put together, but an accelerated capital flight out of several southern euro-area countries cannot really be stopped. That could lead to a disorderly and destructive dissolution of the euro area, unless the United States of Euro is introduced immediately, which does not seem politically feasible.

But is a Greek exit really inevitable? There are very strong economic and political reasons for not letting this happen. Greek output would collapse massively and unemployment would skyrocket. The best way to prevent the acceleration of capital flight from other struggling euro-area members is to demonstrate the euro area’s integrity. And the euro is not just about economics but has major historical and political roots.

In the short term much will depend on the results of the Greek elections. It is up to the Greek municipal employees to cancel the strike and up to the Greek people to decide the ‘Irish way’. Irish people voted yes for the fiscal compact on 31 May 2012 not because the fiscal compact will solve Ireland’s problems; it won’t. But Irish voters realised that a yes vote is a quid pro quo for many other issues. In fact, Greek choices now are pretty much the same as they were last November when former Prime Minister George Papandreou called for a referendum.

But even if the new government, irrespective of which party leads it, is able to agree with its creditors on amending the current programme somewhat, thus abating the short-term risk of a Greek exit and rallying markets, it still will not be enough. The very poor performance of the Greek economy must be reversed.

If we look at the export performance of EU15 countries since 2008, Spain is the best, followed by Germany, Ireland and Portugal – they outperform even the UK and Sweden, the only two EU15 countries which benefitted from sizeable nominal exchange rate depreciations. Therefore, even if the unemployment situation is miserable in Spain, Ireland and Portugal, their export sectors show signs of hope. But Greek exports look hopeless. The badly needed structural reforms will help, but not in the short term. In addition, the goal of reducing Greek public debt to about 120 percent of GDP by 2020 is not appropriate.

Consequently, euro-area partners should recognise two major issues and act on them decisively if a cooperative government is elected in Greece:

1.       Greece’s economic outlook is hopeless. A real programme for supporting Greek growth should be put together with very significant investment from Europe. One of the two obvious instruments, better use of the structural and cohesion funds, should be employed but has limitations. But the other, European Investment Bank (EIB) investment, could be implemented disproportionally in Greece if the EIB’s shareholders decide that way. Other instruments could also be envisioned.

2.       Greece’s public debt is still too high. The Greek fortune cannot be turned to good without properly addressing the public debt overhang. Greeks were irresponsible in accumulating such a huge debt, but it was a major mistake of official lenders to start the first programme in 2010 without a sizeable debt reduction. Even in summer 2011 they insisted that no debt reduction is needed. As a consequence, they ‘socialised’ Greek public debt, but because of this, further significant public debt reduction cannot be accomplished without a kind of official sector involvement.

So Greeks should vote first. If a cooperative government is elected, but Europe fails to offer a prospect for Greece, the country will likely subsequently fall back to its current state. Then the scenario of Greek exit and the disorderly and destructive dissolution of the euro area could follow, unless all of the flaws in the euro’s design are corrected promptly, which does not seem to be realistic.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More by this author
 

Blog Post

Fiscal arithmetic and risk of sovereign insolvency

The record-high debt levels in advanced economies increase the risk of sovereign insolvency. Governments should start fiscal consolidation soon in an environment of low nominal and real interest rates and post-COVID growth.

By: Marek Dabrowski Topic: Global economy and trade, Macroeconomic policy Date: November 18, 2021
Read about event More on this topic
 

Past Event

Past Event

European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Petra Geraats, Wolfgang Lemke, Francesco Papadia and Massimo Rostagno Topic: Macroeconomic policy Date: November 4, 2021
Read about event
 

Past Event

Past Event

Microchips and Europe's strategic autonomy

Per microchips ad strategic autonomy.

Speakers: Piotr Arak, Alicia García-Herrero, Jay Lewis, Stefan Mengel and Niclas Poitiers Topic: Digital economy and innovation, European governance Date: November 2, 2021
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Unboxing the State of the Union 2021

In this Sound of Economics Live episode, Bruegel experts look at the State of the Union address delivered by Ursula von der Leyen, President of the European Commission.

By: The Sound of Economics Topic: Macroeconomic policy Date: September 15, 2021
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live: Unboxing the State of the Union 2021

In this Sound of Economics Live episode, we look at the State of the Union address delivered by Ursula von der Leyen, President of the European Commission.

Speakers: Grégory Claeys, Maria Demertzis, Alicia García-Herrero and Giuseppe Porcaro Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 15, 2021
Read article More on this topic More by this author
 

Opinion

EU climate plan should involve taxing pollution, not borders

Climate change and taxes may be some of the only true certainties in life. To protect ourselves better, we should make careful choices on how they interact.

By: Rebecca Christie Topic: Green economy Date: September 6, 2021
Read article More on this topic
 

Blog Post

How have the European Central Bank’s negative rates been passed on?

Negative rate cuts are not that different from ‘standard’ rate cuts. Like them, they reduce banks’ margins, but this effect does not appear to be amplified below 0%.

By: Grégory Claeys and Lionel Guetta-Jeanrenaud Topic: Macroeconomic policy Date: July 7, 2021
Read article More on this topic More by this author
 

Blog Post

Inflation!? Germany, the euro area and the European Central Bank

There is concern in Germany about rising prices, but expectations and wage data show no sign of excess pressures; German inflation should exceed 2% to support euro-area rebalancing but is unlikely to do so on sustained basis.

By: Guntram B. Wolff Topic: Macroeconomic policy Date: June 9, 2021
Read article
 

Blog Post

European governance

Emergency Liquidity Assistance: A new lease of life or kiss of death?

Use of Emergency Liquidity Assistance to prop up euro-area banks needs to be more transparent; available evidence suggests its use has not always been within the rules.

By: Francesco Papadia and Leonardo Cadamuro Topic: European governance, Macroeconomic policy Date: May 28, 2021
Read article More by this author
 

Opinion

European governance

Europe must fix its fiscal rules

The pandemic has shown that the EU’s spending framework reflects an outdated economic orthodoxy.

By: Maria Demertzis Topic: European governance, Macroeconomic policy Date: May 27, 2021
Load more posts