Is Greece turning the corner? Michael G. Arghyrou

Is Greece turning the corner?
A theory-based assessment of recent Greek macro-policy
Michael G. Arghyrou
INTECO Workshop on Economic Integration
University of Valencia, 27 November 2014
Introduction
• In recent years Greece has experienced an
unprecedented economic crisis
• Greek authorities have resisted GREXIT calls
• They pursue maintenance of euro-participation
through policies determined in close cooperation with EC, ECB and IMF
• Ultimate objective: Sustainable long-run growth
and employment within euro area
2
This paper:
• Provides a theory-based map aiming to
enhance understanding of:
- The factors underlying the success /failure of past
Greek economic policies
- The current policy’s potential in delivering its stated
objectives
- Ultimately, the desirability of Greece’s continued euro
participation
3
Central question in macroeconomics
• Causes of economic fluctuations, i.e. changes in:
- National output
- Level of employment
• Key distinction between:
- Observed (market) output
- Natural (equilibrium/trend) output
4
Neoclassical school
• Rational firms and households
• Flexible prices and wages
• Free competition causes optimal resources
allocation and full employment
• Market output equal to natural output
• Natural output determined by labour supply,
capital stock and productivity
• Productivity determined by exogenous
technological progress
5
Neoclassical school – Policy implications
• State intervention is harmful, as it distorts the
optimal outcome achieved by free competition
• Given constant labour supply, increases in
production only possible through higher capital
stock or technological progress.
• Economic fluctuations caused by changes in
natural output
6
Neoclassical economics and single currency
• Monetary policy does not affect production
(money neutrality)
• Hence, single currency is neither beneficial,
nor harmful: it is indifferent.
7
Keynes (1936)
• Price/wage rigidities and shifts in “animal spirits”
cause deviations of output from natural output
(negative output gaps = unemployment)
• Government intervention necessary to close output
gaps
• Fiscal policy more effective than monetary policy
(multiplier effects versus liquidity trap)
• Great Crash of 1930s due to wrong fiscal policy
8
Monetarism: Friedman (1964)
• Very strong correlation between money
supply and output growth
• Great Crash due to wrong monetary policy
• Keynesian multiplier effect overstated
(permanent income hypothesis)
• State intervention cannot prevent economic
fluctuations
• Friedman rule: Fixed growth for money supply
9
Neoclassical synthesis – Samuelson (1968)
• Government activism (fiscal and monetary)
necessary to achieve natural output
• Keynesian model special case applying under
price stability
• Inflation explained through Philips curve,
extensively used for policy purposes
10
Neoclassical synthesis and single currency
• Theory of optimum currency areas: Mundell
(1961), McKinnon (1963), Kennen (1969)
• Single currency beneficial only under:
- Symmetric economic fluctuations
- Fully flexible markets
11
Rational expectations – I
• Stagflation following first oil shock incompatible
with PC predictions
• Demand management policies failed, resulting in
excessive public debt and inflation
• Macroeconomics in major crisis
12
Rational expectations – II
- Lucas critique
- Economic performance determined by strategic
interaction between rational government and
private sector
- Phillips Curve does not exist in the long run
- Discretionary monetary policy is timeinconsistent, leading to harmful inflation
13
New classical economics
• Real business cycle theory
- Methodological innovations: Rational agents and
micro-foundations (profit/utility maximisation)
- Economic fluctuations due to changes in natural
output (fully flexible markets)
- New growth theory: human capital, institutional
performance, financial development, R&D
14
Rational expectations, new classical
economics and single currency
• Discretionary monetary policy leads to harmful
inflation
• Single currency beneficial for countries with high
inflation tradition via policy credibility and
improved institutional performance
• Basis for:
- Central bank independence
- Fiscal rules in MT and S&G Pact
15
New Keynesian economics – I
• Adopts new classical methodological approach
(rationality and micro-foundations)
• Maintain market rigidities due to
asymmetric/imperfect information, credit
rationing, nominal rigidities, habit formation etc.
16
New Keynesian economics – II
• Market imperfections/price rigidities cause
output gaps
• Demand management useful to manage
fluctuations.
• Monetary policy superior to fiscal policy
(unlike traditional Keynesian view)
• Monetary activism effective only as long as it
does not destabilise inflation expectations.
17
New classical/New Keynesian synthesis – I
• Current macro-mainstream
• Incorporates micro-foundations, rational
expectations (NC) and market imperfections
(NK)
• DSGE models
18
NC/NK synthesis: Consensus points
• Some economic fluctuations due to market imperfections;
others due to changes in the level of natural output.
• Optimal macro-management presupposes knowledge of
the source of the shocks (demand v supply)
• Monetary policy can only affect output in the short run.
• In the medium-run excessive money growth causes
harmful inflation.
• Higher budget deficits may increase output temporarily
but excessive deficits hurt output (even in the short-run)
• Expectations, competition, institutions and human capital
are vital for sustainable economic growth.
19
NC/NK synthesis and single currency – I
• In the short-run, abolition of national currency
may involve costs (loss of stabilisation tool)
• Hence, real convergence and market flexibility are
important, as suggested by the TOCA
• In the long run, abolishing the national currency
does not entail economic costs, as money is (at
best) neutral.
• For high inflation/high-debt countries joining a
low-inflation monetary union can increase natural
output through improved expectations
20
NC/NK synthesis and single currency – II
• Joining euro the result of a comparison between:
-
Benefits of increased natural output due to improved
expectations
Welfare losses due to higher output volatility caused by less
stabilisation
• Classic trade-off problem subject to the constraints
set by society’s preferences between:
- Consumption and leisure
- Current and future consumption
21
A theoretical mapping of modern
Greek macroeconomic policy
• Post WWII, 1950-1980:
• Mid- and late-Metapolitefsis , 1981 – 2011
• The end of the Metapolitefsis: 2012 onwards
22
Post WWII and Early Metapolitefsis:
1950 – 1980
• 1950-1973: Successful neoclassical synthesis
- Breton Woods participation
- Fiscal activism (significant public investment)
• 1974-1980: Early Metapolitefsis
- Collapse of neoclassical synthesis
- Unsuccessful fiscal/monetary activism
23
Mid Metapolitefsis: 1981-89
• Old-school Keynesianism
• Redistribution-oriented fiscal activism
• Discretionary monetary policies leading to
high inflation-devaluation spirals
• Increased government intervention
• Result: Low growth, high deficits, inflation,
unemployment.
• By 1989 Greece at the brink of bankruptcy
24
Mid Metapolitefsis: 1990-2000
• Partial return towards macro mainstream,
driven by:
- Failure of the policies of the 1980s
- Greece’s bid to join the euro
• Progress in reducing inflation and stabilising
fiscal dynamics (macro-improvement)
25
Mid Metapolitefsis: 1990-2000
• Limited progress in:
- Promoting competition/flexibility
- Institutional performance
• Adequate nominal but not enough real
convergence
• Greek experience similar to other euro-periphery
countries
• Highlights failure of MT to meet prerequisites of
TOCA
26
Late Metapolitefsis: 2001 -2011
• Return to traditional Keynesianism:
- Significant increase in public-sector
employment
- Increase in wages, to levels much higher than
average productivity growth
- Lack of structural reforms to improve supply
side and institutional performance
27
Late Metapolitefsis: 2001 -2011
• Overall:
- Significant loss of competitiveness
- Unsustainably high levels of public and external
debt
- Demand bubble: Positive cumulative output gap
over 2001-2010 equal to 40% of GDP
28
Employment in Greek public sector
(excluding SOE and armed forces)
1200
1000
800
600
400
200
0
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
29
General government revenue and expenditure
55
53
51
49
47
45
43
41
39
37
35
2001
2002
2003
2004
2005
2006
2007
Revenue
2008
2009
2010
2011
2012
2013
2014
Exprenditure
30
General government deficit measures
20
15
10
5
0
-5
2001
2002
2003
2004
2005
2006
Headline
2007
2008
Primary
2009
2010
2011
2012
2013
2014
Structural
31
Public debt to GDP ratio
180
160
140
120
100
80
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
32
Table 1: Excess nominal compensation growth, 2001-2009 and 2001-2013
(a)
Nominal
compensation
per employee
growth
(b)
Harmonised
Consumer price
index (HCPI)
growth
(c)
Person-based
labour
productivity
growth
(d)
Sum of labour
productivity
and CPI growth,
(b) + (c)
(e)
Excess
compensation
growth,
(a) - (d)
47.0
42.9
33.8
28.5
27.9
26.1
25.4
25.0
22.7
20.1
19.3
7.2
27.1
28.8
22.0
25.9
20.3
13.3
23.3
16.5
16.1
17.2
15.5
20.0
13.9
19.4
8.8
9.3
3.6
5.2
5.1
-3.8
5.4
4.9
4.3
5.4
-5.8
1.9
3.7
37.6
31.2
29.5
25.5
18.4
19.5
21.9
21.0
21.5
20.9
14.2
15.8
23.1
9.4
11.6
4.2
2.9
9.5
6.5
3.5
4.0
1.2
-0.8
5.1
-8.6
4.0
41.8
39.5
36.3
36.1
36.0
35.1
33.8
32.0
29.4
25.2
24.5
18.3
32.3
25.5
37.6
24.8
28.7
24.4
37.7
27.0
30.4
27.4
31.2
39.3
22.5
29.7
9.0
-5.6
9.1
6.4
14.9
12.7
6.8
12.0
6.5
-5.2
6.3
6.9
6.6
34.5
32.0
33.9
35.1
39.3
50.4
33.8
42.4
33.9
26.0
45.6
29.4
36.4
7.3
7.5
2.4
0.9
-3.3
-15.3
0.0
-10.4
-4.4
-0.9
-21.1
-11.1
-4.0
Panel A: 2001-2009
Greece
Ireland
Spain
Portugal
Finland
Luxembourg
Netherlands
France
Belgium
Austria
Italy
Germany
EMU12 Average
Panel B: 2001-2013
Finland
Luxembourg
France
Belgium
Ireland
Spain
Netherlands
Portugal
Austria
Italy
Greece
Germany
Average EMU12
Real exchange rate
v current account deficit
110
16
14
105
12
100
10
8
95
6
90
4
2
85
0
80
-2
2001
2002
2003
2004
2005
2006
REER
2007
2008
CA deficit
2009
2010
2011
2012
2013
Output gap
12
8
4
0
-4
-8
-12
2001
2002
2003
2004
2005
2006
2007
Greece
2008
Eurozone
2009
2010
2011
2012
2013
2014
Background of Greek debt crisis
• Major internal policy errors - large deviation from
lessons of NC/NK synthesis
• Greek policy errors greatly enhanced by:
- Lack of a credible European monitoring/prevention (eurogovernance failure)
- Private expectations that no euro zone country would be
left to default (market misconception)
• Both due to lack of credibility of S&G pact as a
credible mechanism ensuring fiscal discipline
36
Greek debt crisis/economic recession
• Equilibrium phenomenon restoring output to its
natural level
• But recession made worse due to fast-deteriorating
expectations/uncertainty caused by:
- Major policy errors of Greek authorities in 2009-2011
- Lack of credible European plan to deal with crisis, i.e.
failure to provide credible commitment that Greece
would remain part of the euro-area.
37
The end of the Metapolitefsis: 2012+
• Major turning point: second part of 2012
- General election of June 2012 returned proeuro, pro-reform broad coalition
- EMU members delivered credible commitment
to help Greece stay in the euro zone (November
2012)
- Significant improvement in external
environment (OMT, September 2012)
38
Greek return to the NC/NK mainstream – I
• Current Greek macro policy consistent with NC/NK
mainstream macro approach:
• Pursues increases in natural output through:
- Structural reforms enhancing competition and flexibility
- Improved institutional performance
• Supports demand through increasing liquidity
- Bank restructuring programme
- European finance to Greek firms
39
Greece’s return to the NC/NK mainstream – II
• Greek/European economic policy firmly anchored
in political centre.
• A purely new classical (neoliberal) policy would
not involve:
- Rescue programmes for sovereign borrowers
- Rescue programmes for private banks
- Redistribution of funds to private firms that cannot
secure external and/or banking financing
40
The road to recovery
• Macro policies and supply side reforms
leading to:
- Structural reforms
- Improved expectations
- Improved macro-indicators
- Increase in growth/employment
41
General government deficit measures
20
15
10
5
0
-5
2001
2002
2003
2004
2005
2006
Headline
2007
2008
Primary
2009
2010
2011
2012
2013
2014
Structural
42
Ease of doing business index (rank)
2010 (out of 183)
2012 (out of 183)
2014 (out of 189)
140
135
36
50
41
66
Employing workers
147
N/A
N/A
Getting electricity
N/A
77
61
Registering property
107
150
161
87
78
86
154
155
80
Paying taxes
76
83
53
Trading across borders
80
84
52
Enforcing contracts
89
90
98
Closing a business
43
N/A
N/A
Resolving insolvency
N/A
57
87
Ease of doing business index
109
100
72
59.28
58.15
61.23
Starting a business
Dealing with construction permits
Getting credit
Protecting investors
Distance to frontier
43
10-year government bond yield spread (bps)
30
25
20
15
10
5
0
44
2001Jan
2001May
2001Sep
2002Jan
2002May
2002Sep
2003Jan
2003May
2003Sep
2004Jan
2004May
2004Sep
2005Jan
2005May
2005Sep
2006Jan
2006May
2006Sep
2007Jan
2007May
2007Sep
2008Jan
2008May
2008Sep
2009Jan
2009May
2009Sep
2010Jan
2010May
2010Sep
2011Jan
2011May
2011Sep
2012Jan
2012May
2012Sep
2013Jan
2013May
2013Sep
2014Jan
2014May
Private bank deposits (millions of EUR)
260000
240000
220000
200000
180000
160000
140000
120000
100000
45
May-2014
Jan-2014
May-2013
Sep-2013
Jan-2013
May-2012
Sep-2012
Jan-2012
May-2011
Sep-2011
Jan-2011
Sep-2010
Jan-2010
May-2010
Sep-2009
Jan-2009
May-2009
Sep-2008
Jan-2008
May-2008
Sep-2007
May-2007
Sep-2006
Jan-2007
May-2006
Sep-2005
Jan-2006
May-2005
Sep-2004
Jan-2005
May-2004
Sep-2003
Jan-2004
May-2003
Jan-2003
May-2002
Sep-2002
Jan-2002
May-2001
Sep-2001
Jan-2001
Athens Stock Exchange
350
300
250
200
150
100
50
0
46
PMI
ESI
Aug-14
Jun-14
Apr-14
Feb-14
Dec-13
Oct-13
Aug-13
Jun-13
Apr-13
Feb-13
Dec-12
Oct-12
Aug-12
Jun-12
Apr-12
Feb-12
Dec-11
Oct-11
Aug-11
Jun-11
Apr-11
Feb-11
Dec-10
Oct-10
Aug-10
Jun-10
Apr-10
Feb-10
Dec-09
Oct-09
ESI and PMI indexes
105.0
55
100.0
50
95.0
90.0
45
85.0
40
80.0
75.0
35
47
Competitiveness:
Real effective exchange rates
105
100
95
90
85
80
CPI-based
ULC -based
48
Net exports of goods and services
(billion EUR)
0
-1
-2
-3
-4
-5
-6
-7
-8
-9
-10
49
Exports and imports of goods and
services (billion EUR)
25
22
19
16
13
10
7
Exports
Imports
50
GDP growth
8
6
4
2
0
-2
-4
-6
-8
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
51
Credit growth, output growth and unemployment
reduction (y-t-y % change)
30.0
20.0
10.0
20.0
0.0
-10.0
10.0
-20.0
-30.0
0.0
-40.0
-10.0
-50.0
GDP growth
Credit growth
Unemployment reduction (unemployment growth times minus one)
52
Strategy for short-run growth
• No room for fiscal expansion (by and large,
wrong anyway)
• Restoration of normal liquidity conditions
- Greek banks recapitalisation (completed)
- Eliminate legal uncertainty regarding default
resolution (DOI 2014: 87/189)
- Reduce delays in judicial resolution (DOI 2014:
97/189)
53
Risks to recovery
•
-
Internal
Resistance of vested interests
Limited social tolerance
Overall: Political risk
• External
- Many EMU economies fragile
- Rescue fatigue in creditor countries
54
Conclusions – I
1. Greek economic crisis mainly the result of
misguided internal economic policies
2. Current Greek economic consistent with
modern international macro mainstream
(NC/NK synthesis)
3. Current policy works but can work better
55
Conclusions – II
4. Eventual success not guaranteed due to
significant internal and external risks.
5. Resolution of Greek and EMU economic crisis
conditional upon:
- Consistent implementation of reforms
- Creation of new European architecture (banking
union and deeper fiscal integration)
56
Should Greece stay in the euro?
• Yes, definitely
• Currency itself does not determine long-term
economic prosperity
• However, expectations and institutional
performance do
• Given past experience and present fragility:
• Greece’s credibility and institutional stability, i.e.
economic prosperity, are better served within the
EMU rather than outside.
57