Thursday, February 18, 2010

Myths and facts about Greece and the current crisis

Prof. Charles Wyplosz, co-author of the most popular text "Macroeconomics: A European Text' which many of you (my students) may use in college (mostly those bound for UK schools), wrote these 'Myths and Facts" that will definitely enlighten you:

Myth 1: Greece is bankrupt. Countries cannot be bankrupt; their governments can only default on their debts. In the absence of internationally recognised resolution mechanisms, government defaults open up a messy situation as governments negotiate with their creditors.

Fact 1: There is no reason for the Greek government to default. It is not in its interest and it can service its debt, whose size is half that of the Japanese government and the same order of magnitude as that of many other governments, including soon the UK and the US (OECD 2010). Yet, markets can force the government to default if they refuse to refinance the parts of the debt that reach maturity. This is a pure case of self-fulfilling crisis.

Fact 2: This crisis started as a panic reaction to fears of default but, as usual, some market players now also bet on a default. The market reaction is both defensive and offensive.

Myth 2: Greece is being singled out because it cheated repeatedly. Reports of Greek data manipulation have occurred long before this crisis. The latest report was issued by the government elected in October 2009 while the risk premia have been large since October 2008.

Myth 3: The Greek government is particularly vulnerable because its debt is widely held internationally, in contrast with the Japanese debt. Crisis after crisis, post-mortem examinations reveal that residents act exactly like non-residents. They panic and speculate like all financiers do, independently of where they live and work.

Fact 3: The monetary union is an agreement to take monetary policy out of national sovereignty. Very explicitly the Treaties leave budgetary matters in national hands. There is no sense in which the current crisis is a “proof” that Europe has failed. The Greek (and Portugese, and Spanish…) debt situation is a Greek (and Portugese and Spanish…) problem.

Myth 4: This is a euro crisis, which could result in a breakup of the monetary union. There is no mechanism for transforming the debt crisis into a Eurozone breakup. No country can be forced out and it is in no country’s interest to leave (Eichengreen 2007). Had Greece not been part of the eurozone, it would have long undergone a major currency depreciation, like in Hungary in November 2008. The euro protects Greece.

Fact 4: A debt default by the Greek government, on its own, would be a non-event. Greece is a relatively small country (with 11 million people, its GDP amounts to less than 3% of Eurozone’s GDP). Contagion to Portugal, which is even smaller, would also be a non-event. Moving on to Spain and Italy is another matter.

Myth 5: Contagion, already under way, would be destructive. This statement is too vague. It cannot destroy the monetary union, as argued above. But contagion can bring the value of the euro down – but this would be mostly good news for the Eurozone as it is suffering from an overvalued exchange rate at a time of anaemic domestic demand.

Fact 5: The real worry is the banking system. Some European banks hold part of the Greek debt and, if still saddled with unrecognised losses from the subprime crisis, some might become bankrupt. Many governments have simply not pushed their banks to straighten up their accounts, and they are now discovering some of the unforeseen consequences of supervisory forbearance.

Myth 6: Other Eurozone governments should support the Greek government to avoid destructive contagion. I argued that contagion need not be destructive if banks can bear it, so the need for a collective bailout is not established. There is a huge moral hazard cost, on the other hand.

Fact 6: The Treaty strictly prohibits bailouts. Art. 100(2) states: “Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by exceptional occurrences beyond its control, the Council may, acting unanimously on a proposal from the Commission, grant, under certain conditions, Community financial assistance to the Member State concerned. Where the severe difficulties are caused by natural disasters, the Council shall act by qualified majority.” This article has been written precisely to ban bailouts. Interpreting continuing fiscal indiscipline as “exceptional occurrences beyond its control” runs against the spirit of the Treaty. Violating the Treaty to rescue countries whose successive governments have made no effort to achieve fiscal discipline over the last decade (or longer) is indefensible.

Fact 7: If Greece, and other countries, needs support to refinance their public debts, they can and should call the IMF. In contrast to EU countries that have no instrument to impose debt discipline (the Stability Pact has failed over and again and is completely discredited by now), the IMF operates an effective conditionality machinery.

Myth 7: The IMF cannot intervene in this case because the euro is a shared currency; an IMF intervention would reduce the sovereignty of all Eurozone countries. This is a serious misunderstanding of what IMF routinely does. It deals with any financing problem, independently of currency difficulties. The IMF would impose conditions on fiscal policy, not on monetary policy. Besides, the Eurozone is not a member of IMF – it only has observer status – but individual countries are.

Fact 8: Greece, along with Spain, Portugal and Ireland suffer from a loss of competitiveness due to continuing higher inflation. This partly explains their widening current account deficits until the crisis. Yet, the budget deficits are unrelated to this evolution.

Myth 8: The loss of competitiveness is a threat to the monetary union that warrants collective support. It is true that the competitiveness situation represents a huge policy challenge but a bailout will not help and could well make matters worse if it means that unwarranted wage and price increases are supported by the rest of the Eurozone.

The remaining three can be found here.
(found at voxeu)

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