Greece: No Lessons Learned

By Ashoka Mody, Professor of Economics at Princeton. Cross posted from Bruegel; originally published at Handelsblatt


In November 2003, former German Finance Minister Hans Eichel explained why the “deal” between Greece and its creditors is virtually certain to fail. Fending off the pressure then on Germany for more fiscal austerity in an economic recession, Eichel wrote in a Financial Times op-ed: “A policy geared solely to attaining quantitative consolidation targets in the short term runs the risk not only of curbing growth but also of increasing debt.”

Eichel’s theorem says that the latest Greek government, even if stable, will not overcome the illogic of the creditors’ program. Growth will be slower and deflation stronger than anticipated. The debt burden will continue to increase.In November 2003, former German Finance Minister Hans Eichel explained why the “deal” between Greece and its creditors is virtually certain to fail. Fending off the pressure then on Germany for more fiscal austerity in an economic recession, Eichel wrote in a Financial Times op-ed: “A policy geared solely to attaining quantitative consolidation targets in the short term runs the risk not only of curbing growth but also of increasing debt.”

Eichel’s theorem has proven stunningly durable through the Great Recession: persistent austerity is counterproductive, the more so the weaker the economy is. Everywhere, austerity has dragged down growth. Greece, which has undertaken the most severe austerity, has experienced the deepest economic contraction. Even the glimmer of Greek economic growth in 2014 came during a pause in austerity.

By most estimates, Greece is running a small primary fiscal deficit: government expenditures (not counting interest payments) exceed receipts. Achieving the creditors’ primary surplus target of 3.5% of GDP in three years will cause the economy to contract. But the projections claim that Greece will resume growth.

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It gets worse. When, in 2003, Germany was freed of the shackles of fiscal austerity, world trade also zoomed up. For the four years, 2004-7, world trade growth averaged 9% a year. The claim to a German “miracle” is based on two years of 3.5% annual growth in 2006-7 amidst that buoyant world economy. Today, Greece is embarking on another round of austerity with world trade growth under 3% a year. The U.S. Federal Reserve, in its decision to not raise interest rates last week, emphasized how fragile the global economy is. The IMF has lowered its forecasts of world GDP growth and trade three times since the start of the year. ................(more)

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