Blog Post

Filling Europe’s bottomless pit

After so many packages, the Greek parliament passed another round of austerity measures on Wednesday night. As reported by the Financial Times, the new measures include cuts of between 5 and 35 per cent in pensions and public sector salaries, tax increases on fuel and cigarettes, and higher charges for state healthcare. The retirement age […]

By: Date: November 9, 2012 Topic: Macroeconomic policy

After so many packages, the Greek parliament passed another round of austerity measures on Wednesday night. As reported by the Financial Times, the new measures include cuts of between 5 and 35 per cent in pensions and public sector salaries, tax increases on fuel and cigarettes, and higher charges for state healthcare. The retirement age will rise from 65 to 67 for recent entrants to the workforce.

Yet this will not at all solve the budget gap, which may seem like a bottomless pit from the eyes of euro-area partners. Greece has been granted two financial assistance programmes by euro-area partners and the IMF (the first in May 2010 and the second in March 2012), totalling almost €240 billion. But this amount will not be enough, as I concluded in a paper on the maths of the Greek public debt.

While policy slippages have also contributed to the bottomless budget gap, the ever-worsening economic outlook has had a decisive role. The perceived unsustainability of Greek public debt has likely contributed to the much deeper than expected GDP contraction and indeed the largest forecasting errors were made for Greece.

There are no easy solutions for the Greek public debt overhang: a small reduction in the interest rate on bilateral loans to Greece, the exchange of European Central Bank Greek bond holdings, buy-back of privately-held Greek debt, and frontloading of some privatisation receipts would not be sufficient. Policymakers have to recognise that their three refusals are inconsistent: no additional funding, no restructuring of official loans, and no default and exit from the euro.

Let’s keep exit excluded, for various reasons. A credible resolution is needed, which should involve the reduction of the official lending rate to zero until 2020 and indexing the notional amount of official loans to Greek GDP. Thereby, the debt ratio would fall below 100 percent of GDP by 2020, and if the economy deteriorates further, there will not be a need for new arrangements. But if growth is better than expected, official creditors will also benefit.

Yet in later years (realistically, beyond 2030), Greece should try to pay back the debt relief provided by the zero-interest lending, using an extended privatisation plan and future budget surpluses.


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