Sunday, May 09, 2010

it's not about greece anymore

NYTimes | The Greek “rescue” package announced last weekend is dramatic, unprecedented and far from enough to stabilize the euro zone.

The Greek government and the European Union leadership, prodded by the International Monetary Fund, are finally becoming realistic about the dire economic situation in Greece. They have abandoned previous rounds of optimistic forecasts and have now admitted to a profoundly worse situation. This new program calls for “fiscal adjustments” — cuts to the fiscal deficit, mostly through spending cuts — totaling 11 percent of gross domestic product in 2010, 4.3 percent in 2011, and 2 percent in 2012 and 2013. The total debt-to-G.D.P. ratio peaks at 149 percent in 2012-13 before starting a gentle glide path back down to sanity.

This new program is honest enough to show why it is unlikely to succeed.

Daniel Gros, an eminent economist on euro zone issues who is based in Brussels, has argued that for each 1 percent of G.D.P. decline in Greek government spending, total demand in the country falls by 2.5 percent of G.D.P. If the government reduces spending by 15 percent of G.D.P. — the initial shock to demand could be well over 30 percent of G.D.P.

Obviously this simple rule does not work with such large numbers, but it illustrates that Greece is likely to experience a very sharp recession — and there is substantial uncertainty around how bad the economy will get. The program announced last weekend assumes the Greek G.D.P. falls by 4 percent this year, then by another 2.6 percent in 2011, before recovering to positive growth in 2012 and beyond.

Such figures seem extremely optimistic, particularly in the face of the civil unrest now sweeping Greece and the deep hostility expressed toward the country in some northern European policy circles.

The pattern of growth is critical because, under this program, Greece needs to grow out of its debt problem soon. Greece’s debt-to-G.D.P. ratio will be a debilitating 145 percent at the end of 2011.

Now consider putting more realistic growth figures into the I.M.F. forecast for Greece’s economy — e.g., with G.D.P. declining 12 percent in 2011, then the debt-to-G.D.P. ratio may reach 155 percent. At these levels, with a 5 percent real interest rate and no growth, the country needs a primary surplus at 8 percent of G.D.P. to keep the debt-to-G.D.P. ratio stable. It will be nowhere near that level. The I.M.F. program has Greece running a primary budget deficit of around 1 percent of G.D.P. in that year, and that assumes a path for Greek growth that can be regarded only as an “upside scenario.”

The politics of these implied budget surpluses remains brutal. Since most Greek debt is held abroad, roughly 80 percent of the budget savings the Greek government makes go straight to Germans, the French and other foreign debt holders (mostly banks). If growth turns out poorly, will the Greeks be prepared for ever-tougher austerity to pay the Germans? Even if everything goes well, Greek citizens seem unlikely to welcome this version of their “new normal.”