Greek Referendum

Papandreou says

“We have faith in our citizens, we believe in their judgment and therefore in their decision,” Mr Papandreou said after rejecting a call for early elections by some socialist politicians. “All the country’s political forces should support the [bail-out] agreement. The citizens will do the same once they are fully informed.”

Does he believe this? What are the implications for the euro?

How Would a Greek-Style Haircut Affect Ireland?

Someone asked me today how a Greek-style haircut for private bondholders would impact on the Irish debt situation if applied here. Without any claim that this is a prediction for what could happen to Ireland, or a policy recommendation, here are the calculations.

While the figure grabbing the headlines is the 50%-60% haircut for private holders of Greek sovereign bonds, it appears that the bonds bought by the ECB will not be written down, nor will the IMF loans. FT Alphaville discuss a UBS report that calculates that a 50% haircut for private bondholders actually implies a 22% reduction in total debt.

In Ireland’s case, the latest EU Commission report estimates (page eight) that our year-end general government debt will be €172.5 billion or about 110 percent of GDP. The report also estimates that by the end of this year, we will owe €38.2 billion to the EU and IMF.  (Table 4 on page 23).

We don’t know how much Irish sovereign debt the ECB own but it’s believed to be a large amount. I do remember a report from Barclay’s claiming they owned €18 billion by June 2010. Let’s say ECB owns €22 billion of Irish debt (that’s just a guess, I really don’t know). Combine that with €38 billion from EU-IMF and you have €60 billion in debt that wouldn’t be getting a haircut. Better guesses of ECB holdings of Irish sovereign debt are welcome.

Now apply a 50% haircut to the remaining €92.5 billion of our debt and you reduce the debt by €46.25 billion, or 29 percent of GDP, getting the debt ratio down to 81 percent. (Of course, we’d still be running large deficits, so it would start increasing again.)

So that’s the answer. Perhaps worth noting, however, is that an alternative method of writing down Ireland’s debt by close to 30 percent of GDP without haircutting private bondholders at all would be to have Anglo’s ELA debt to the Central Bank of Ireland written off.

According to its interim report Anglo owed €28.1 billion in ELA at the end of 2010 but this had risen to €38.1 billion by the end of June. This is because Anglo transferred €12.2 billion in NAMA senior bonds to AIB in February to back the deposits that were being moved out of the bank.

On July 1, Anglo was merged with Irish Nationwide Building Society (INBS) to form what is now called the Irish Bank Resolution Corporation (IBRC). As of the end of 2010, INBS had €7.3 billion in loans from the ECB. However, €3.7 billion of this was backed by NAMA bonds and other assets that were transferred to Irish Life and Permanent. INBS has been in receipt of ELA since February to replace this lost funding. While this has been admitted by a Department of Finance official (see this story) the exact figure has not been released. I assume it is about €4 billion.

So my estimate is that the IBRC now owes about €42 billion in Emergency Liquidity Assistance to the Central Bank of Ireland. If the European authorities ever decide they like the idea of haircuts for Irish debt, it would be fair to ask which of a fifty percent haircut or a write-off of ELA would be more likely to damage Ireland’s reputation or cause financial market contagion.

Bank Taxes and Buybacks

European politicians are engaged in frantic negotiations to deal with both the Greek debt problem and the wider question of the EU’s approach to the problems of peripheral countries.

On the approach to the Greece, I’m not encouraged by the reporting from the financial press which has focused on a bank tax and debt buybacks.

First, we’re being told that the idea of a tax on European banks to raise about €30 billion is emerging as a “popular consensus” approach to getting private creditors to “help pay for the estimated €115bn bail-out”.  As reported, it’s pretty unclear what happens with the €30 billion. Is it loaned to Greece and then later paid back to the banks that paid the tax? If so, it’s not really a tax in the usual sense of the word.  Anyone who understands this is welcome to explain it in comments.

However it’s structured, this seems to be the wrong approach to the wrong problem.  The goal seems to be to keep Greece’s debt burden exactly where it is (thus not solving the key problem) but to reduce the headline number for the size of a second EU-IMF loan (which solves a political problem in some countries).  In relation to private sector “burden sharing”, the approach still seems to view a Greek default as unthinkable (despite almost everyone viewing it as inevitable) while adopting a very strange approach to the demand for “private sector involvement”: Why should banks that don’t own any Greek debt have to pay a tax to contribute to a second bailout?

Maybe there’s a good idea hiding under this reporting: If so, I’m happy to have it explained to me.

Then there’s the increased focus on debt buybacks. The idea of debt buybacks is popular with both politicians and holders of debt. The politicians get to claim that there was no coercive default on the outstanding debt, thus saving face. The creditors usually manage to get the debt bought back at a nice premium to the current market value, so many of them make a tidy profit.

Academics that have looked at this issue generally don’t like debt buybacks. Here‘s a short article from VoxEU by some IMF staff. And here and here are two classic older articles written in the context of the 1980s Latin American debt crisis.

To briefly explain why buybacks are not as great an idea as they appear, consider the case of a country with debt and GDP of €100 billion, so the debt ratio is 100%. The market doubts this debt burden is sustainable and so prices the debt at 60 percent of its face value.

Now a programme is announced whereby funds are provided to allow the country to buy back all its debt. Those behind the plan imagine they can go into the market and start purchasing debt at 60c and get the debt ratio down to 60%.  However, because the debt ratio would be sustainable at 60% and at that point the government would be able to pay back all of its debts, there would be no need in such a situation for there to be a market discount on the price of the debt.

So, as the programme is announced and the government intervenes to start repurchasing its debt, the price of the debt would jump above 60c.  The final price of the debt would depend upon a number of factors including the terms on the money being provided externally to fund the programme. But the end result would probably be significantly less debt relief than obtained, for example, by a straight swap of new for old bonds involving a forty percent reduction in net present value.

In relation to the wider Euro area problems, I’m somewhat optimistic that Thursday will see a harmonisation and reduction of EU programme interest rates, extension of maturities, as well approval of EFSF loans for debt buybacks. Personally, I would like to see the remit of EFSF extended to allow it to lend directly to banks, replacing excessive ECB funding as well as Emergency Liquidity Assistance. Of course, I doubt if this is even being considered.

We’ll see what happens but my prediction is that political face saving will take precedence over economically efficient solutions.

Update: The FT has an answer to my question about the bank tax which mixes it together with the buyback plan: “According to officials, it would amount to a 0.0025 per cent levy on all assets held by eurozone banks and would raise €10bn per year for five years. The cash would go to the bail-out fund, which would then use the money to conduct a Greek bond buy-back.”

Schauble Proposes Greek Maturity Extension

It’s being discussed in the comments already but it’s worth giving German Finance Minister Wolfgang Schauble’s letter to the ECB, IMF and Ecofin ministers its own thread. The key proposal:

This means that any agreement on 20 June has to include a clear mandate — given to Greece possibly together with the IMF — to initiate the process of involving holders of Greek bonds. this process has to lead to a quantified and substantial contribution of bondholders to the support effort, beyond a pure Vienna initiative approach. Such a result can best be reached through a bond swap leading to a prolongation of the outstanding Greek sovereign bonds by seven years, at the same time giving Greece the necessary time to fully implement the necessary reforms and regain market confidence.

Just to be parochial about this for a minute, this raises an interesting question. If this approach was implemented successfully and did not trigger a financial crisis (I know some disagree — this is a hypothetical question) what are the chances that a similar restructuring would not be part of any potential second EU-IMF deal for Ireland?

LBS on Private Sector Involvement

With things heating up in Greece, Lorenzo Bini Smaghi today outlines his case against debt restructuring in Greece. He argues four points:

First, as I already mentioned, it would not be a way to prevent taxpayers from suffering the consequences of bad investment decisions. In our Monetary Union, given the integration of financial markets and the single monetary policy, the taxpayers of the creditor countries would suffer in any case. According to the Financial Times, for instance, a default on Greece’s debt would cost the German taxpayers alone “at least €40 billion”.

Second, this would be a way to punish patient investors, who are sticking to their investment and have not sold their bonds yet, and are confident that with the adjustment programme the country will get back on its feet. Restructuring would instead reward the investors who exited the market earlier or short-sold the sovereign bond, speculating that they would gain out of a restructuring.

Third, it would destabilise the euro area financial markets by creating incentives for short-term speculative behaviour. Given that markets are forward-looking, they would try to anticipate any difficulty faced by a sovereign by short-selling their positions, thus triggering the crisis. This would discourage investment in the euro area because of its potential volatility and perverse market dynamics.

Finally, such a measure would delay any return to the market by a sovereign, because no market participant would be willing to start reinvesting in the country for a long period if they know that this kind of investment might at some stage be penalised. This would thus discourage private sector involvement and oblige the official sector to increase its financial contribution.

These don’t strike me as very strong points.

On the first point, well yes “taxpayers” in Germany who own Greek bonds will lose out but the bonds are already trading at a huge discount to face value so, for many, the losses have already been taken and the price of the bonds factors in a restructuring.

The second point amounts to saying we should reward people who make wildly inaccurate judgments about the Greek macroeconomic situation, i.e. those who “are confident that with the adjustment programme the country will get back on its feet” should be rewarded. Should those investors who believe in Santa Claus get cheques from the EU and the IMF at Christmas?

The third point that investors would look to sell sovereign bonds of peripheral countries in anticipation of a restructuring appears to ignore that this has already happened. For example, Irish sovereign bond pricing is based on the assumption of a restructuring.

The final point, that a restructuring would delay Greece’s return to the market is debatable. Even if debt ratios stabilised over the next few years, private creditors will still see huge risks. A restructuring that restores sustainability, however, would be more likely to restore access to private bond markets.

If these are the best points the ECB have, you can see why they’re losing the argument.

Squeeze Is On for Greece’s Private Sector Creditors

Here’s a thread for people to discuss the latest stories (here and here) on Greece’s private sector creditors being asked to roll over their funds or else. A quick summary:

The governments will give Greece new lending, to be provided by the European Financial Stability Facility, the euro zone’s sovereign rescue fund, officials said. But that financing will likely come with the condition that the banks, pensions funds and other investors holding Greek bonds agree to exchange them for new bonds with a longer maturity to help fill Greece’s financing gap over the next three years, they said.

“Private investors would have a strong incentive to participate, because if they don’t, there will be a default,” said one official.

It’s the Don Corleone approach to default negotiation, involving making people offers they can’t resist.

Still, providers of CDS insurance will be thrilled to hear that

the debt-exchange process envisioned by the governments won’t rewrite existing bond contracts or trigger a credit event, the officials said, partly easing the ECB’s concerns that private creditors are being forced to contribute financing.

Can someone explain to me why it’s so important to the ECB or any government whether a restructuring scheme constitutes a credit event for CDS purposes? Are the firms that offer this insurance somehow more important sources of systemic risk than those who own Greek sovereign bonds? Or is it more for the appearance of purity — “it was not a default, now way, sure the CDS guys say it wasn’t a credit event”, that kind of thing?

Anyway, what odds are there now that holders of Irish sovereign bonds will walk away unscathed?

Greece Not a Threat to Irish Banks

As stories about a Greek sovereign debt restructuring gather pace, expect to read lots more stories like this one in which some guy claims that a Greek restructuring would “severely damage the banking systems of Ireland and Portugal.”

Let’s be clear. It won’t. We’ve been here before with people quoting figures from the BIS on Irish exposure to Greek debt that stemmed from holdings of foreign-owned banks in the IFSC. However, even the BIS figures now show “Irish” bank exposure to Greek debt has collapsed to below $1 billion (you can find a time series in here if you look hard enough.)  God knows there’s enough to worry about in relation to the Irish economy and its banks, so let’s at least try to put this one to rest.

Buchheit and Gulati on Greek Debt

Today’s article by Wolfgang Munchau is a summary of the dinner talk that he gave at last week’s EUI workshop on sovereign default. A very interesting counterpart to Munchau’s article is this paper by veteran sovereign debt lawyer Lee Buchheit (lead negotiator for Iceland! with its creditors) and Mitu Gulati (Duke law professor) which discusses other scenarios for Greek debt. Buchheit and Gulati gave very interesting presentations on this and other relevant topics at the EUI conference (a podcast is due to go up this week and I will pass on the link when it does). It perhaps goes without saying that this paper has a lot of relevance for Ireland.

Merkel Proposing Orderly Default Framework

Mrs Merkel has been speaking in the German parliament about her latest financial proposals. In addition to defending the CDS and short-selling proposals, the Germans are apparently preparing proposals for an “orderly insolvency of euro-region states”.  In a separate story this morning, I see that former Fed Governor Rick Mishkin has been reported as follows: 

“What they should have done was to let Greece go and say we are going to ringfence the rest of the system,” Mishkin said. “Ringfence the banks, protect the other countries that have problems such as Portugal, Italy and Spain, which have not been fiscally irresponsible the way the Greeks have been.”

It’s interesting to see how far the consensus has moved. We’ve gone from the idea that no Eurozone country can be let default and the IMF can’t possibly be allowed to help to getting ready for orderly defaults.

European Stabilisation Mechanism Announced

The European Union has announced an agreement among heads of state to address the mounting sovereign debt crisis. Here’s Commission President Barroso’s statement. The meat of the announcement is the following:

First the Commission will present a concrete proposal for a European Stabilisation Mechanism to preserve financial stability in Europe. This proposal the Commission will make will be presented to the ECOFIN meeting next Sunday, the day after tomorrow (9 May).

Much of the speculation about the content of this proposal revolves around the ECB. Some media stories (such as this one) are discussing an extension of the ECB’s liquidity operations, which is fine but doesn’t go to the heart of the soverign debt problems.

Other stories (such as this Reuters story carried by the Irish Times) point to the ECB purchasing sovereign bonds.

“You have this ‘no monetary financing’, but you are allowed to buy in the secondary market, so what’s the difference?” an official involved in European banking supervision told Reuters. “Buying in the secondary market, you take the pressure, and so you push people in the primary market.”

Analysts have estimated the ECB might buy some €200 to €300 billion of bonds, about 20 to 30 per cent of estimated annual new issuance in the euro zone.

This point that the ECB can actually do this is correct. The wording of the no monetary financing clause (article 123 clause 1 of the current version of the consolidated Treaty on the functioning of the EU) is as follows:

Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.

I suspect the direct purchase phrase was put in to make it clear that public debt instruments were fine for use in ECB repurchase agreements with banks. But the wording does not rule out secondary market purchases.

Exactly what effect this type of intervention would have would depend on how it was implemented. If it was simply a once off purchase of a load of Spanish, Portuguese or Irish debt, I can’t see how this would have much effect since the underlying stock of debt would remain the same.

If, however, the operation took the form of secondary market interventions right after primary market issues, then it would have an effect. For example, the Irish government could issue debt to some banks who could then immediately sell these bonds on to the ECB, perhaps for a small profit. the only risk for the banks being the small probability of being left with the hot potato at the moment of a default.

This would pretty much be breaking the spirit, if not the letter, of the Treaty. But, we’re in this territory already. The existing Greek bailout is being legally justified on the basis of this clause in Article 122:

Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, acting by a qualified majority on a proposal from the Commission, may grant, under certain conditions, Community financial assistance to the Member State concerned.

Greece, apparently, is suffering from a natural disaster or an exceptional occurence beyond its control.

Note the rumoured scale of this operation. If the rule of thumb relating to ECB capital subscription is applied again, Ireland would have to supply over €4 billion to this fund.

McCarthy on Greece and Ireland

I guess Colm has better things to be doing then putting links up on blogs but for those of you who haven’t seen it, Mr. McCarthy’s column in today’s Irish Times makes for interesting reading. Colm points out that “It would be unfortunate to celebrate the centenary of 1916 with macro-policy dictated from Brussels and Washington.” I wonder whether Martyn Turner had seen this column before producing today’s cartoon.

Jacques Melitz on Greece and the Euro

I have never really understood the idea that the Greek fiscal crisis is “a threat to the euro” but have generally sensed the tide running against me on this one as serious people warn darkly about the wider repercussions of a Greek default. Still, I find the arguments in this new CEPR Policy Insight paper from Jacques Melitz (“Eurozone Reform: A Proposal”) to be pretty convincing.

Melitz argues that much of the damage to the Euro caused by the Greek crisis has been due to the inaccurate focus by EU officials on the centrality of fiscal discipline. Some quotes:

The European problem is largely self-inflicted. There have been repeated affirmations by the ECB and government officials in Eurozone member countries that fiscal discipline and the Stability and Growth Pact are the very foundation stone of the Eurozone. This can only mean that Greek default is a big problem for the euro. On this view, the Eurozone is partly a victim of its own self representation …

So far as I can see, there is little reason why Eurozone should view government defaults with any greater alarm than any other central bank management in the world would view government defaults within its territory. To the contrary, the Eurozone is particularly well armed to deal with such defaults, since its own central bank has no large central government to contend with, the Maastricht Treaty guarantees the central bank’s independence and member governments are explicitly forbidden to bailout one another …

Accordingly, must not the official doctrine change? Should it not be that nothing so manageable as a Greek government default can upset Eurozone? In the event of a Greek government default, the system would assure the stability of the Greek financial sector, and concern itself with any bank runs or bank failures in the country, but not with the Greek government’s difficulties. In step with this doctrine, government bail-outs will never be contemplated. The Stability and Growth Pact will continue to serve as a code of good fiscal conduct for all members of the EU. But if any individual member government engages in irresponsible fiscal conduct, contrary to the Pact, its taxpayers and the creditors will bear the consequences.

Melitz argues that rather than institutionalising bailouts, there should be EU-level financial supervision of banks under the auspices of the ECB to allow for more efficient containment of the effects of fiscal default on financial stability.

IMF-EU Deal with Greece

Greece has agreed a deal with the IMF and the EU involving the provision of funds of €110 billion over the next three years. This IMF website has links to the various statements. It summarises the deal as follows:

Negotiators over the weekend wrapped up details of the package, involving budget cuts, a freeze in wages and pensions for three years, and tax increases to address Greece’s fiscal and debt problems, along with deep reforms designed to strengthen Greece’s competitiveness and revive stalled economic growth.

Whether this deal really avoids a Greek default will ultimately depend on whether the fiscal adjustments that are undertaken can, in fact, alter the underlying arithmetic to the point where the Greek debt burden becomes sustainable. Whether the existence of this deal eases further pressure on other European countries with debt problems is, as of yet, unclear.

Ireland’s Exposure to Greek Debt

On today’s RTE radio News at One, Sean Whelan reported that Irish banks have exposure of about €7 billion to Greek debt, that restructuring of Greek sovereign debt could lead to a fifty percent write-down of Greek debt and that because the Irish government are supporting the banks, the contribution of €450 million by the Irish government to the Greek bailout needed to be placed against the possibility of a potential loss of €3.5 billion for the banks.

Much of this is correct but it is perhaps worth clarifying what we know about Irish bank holdings of Greek debt. First, I’m guessing that Sean Whelan is quoting from figures released from the BIS which show that Irish banks hold $8.6 billion in Greek debt.  At an exchange rate of €1 = $1.31, this translates into €6.6 billion, so Sean Whelan’s figure is about right.

However, a few caveats about this are required. First, it appears that these figures relate to all Greek debt not just government debt.

Second, I believe the definition of Irish banks here include Irish outlets of non-Irish banks (such as various IFSC institutions) which are not receiving assistance from the Irish government.

Third, the figures available for the major Irish bank holdings of government bonds show that it is essentially impossible that these banks are holding such large quantities of Greek government debt. Greece’s rating was downgraded to BBB+ on December 16, this rules out AIB holding much Greek debt. The banks report their holdings of government bonds by ratings and they hold almost no government bonds with low rating (e.g. AIB only €109 million of these holdings were below A rating, Anglo have only €132 million).

So, to conclude, financial institutions in Ireland hold about €7 billion in Greek debt but we don’t know how much of this is Greek sovereign debt. We do know that the banks that are receiving assistance from the Irish government do not hold much Greek sovereign debt. For these reasons, the direct cost to the banks receiving assistance of a Greek restructuring would be a lot less than the €450 million figure cited for our direct contribution.

Keeping in mind that the caveats above are not accounted for, this post from the Peterson Institute is still worth reading.

Update: The Minister for Finance has now confirmed that Irish bank exposure to Greek sovereign debt is negligible relative to the size of their balance sheets–less than €40 million apparently.

Greek Bailout Unveiled

So finally we see the terms of Greece’s impending bailout. €30 billion to be made available from EU countries (€500 million potentially from Ireland) at an interest rate of about 5%. Apparently, a further €15 billion is available from the IMF. To my mind, the interest rate is a bit lower than might be expected for an emergency bailout that should be acting as a serious incentive to get the Greek fiscal house in order. The operation certainly seems to be slanted towards carrot rather than stick.

What next? Peter Boone and Simon Johnson discuss this issue and are not confident that Greece can emerge from the crisis with access to private debt markets. They worry about Portugal being next. We worry about something else.

The Impending EU\Greece Deal

It appears that a deal involving the EU and Greece is imminent. Greek bond yields hit their peak level in the current crisis, the ECB has altered its rules for collateral and the media are reporting that a deal is in place (here and here.)

The FT reports on the negotiations over the terms of the deal:

Officials added that Germany was sticking to its demand that the eurozone portion of the loans would have to be made at or near Greek market rates of 6 per cent or more, though this could lead to different rates being charged by other countries.

One said the agreement “reflects high rates … it is not a ‘subsidy’ and thus not a climbdown. Not even the Germans regard most recent rates as market rates”.

The FT also editorialises on this, blaming the Germans for failing to calm the bond markets sufficiently:

Berlin is also adamant liquidity support be given at market rates. This makes no sense: a rescue is needed precisely when debt markets cease to function and refuse to refinance Greece at sustainable rates. Insisting that a rescue takes place at “market rates” is to insist no rescue takes place at all. Market yields reflect this contradiction, and show that Europe has not yet put its money where its mouth is.

I have a tendency to question agreed wisdom so let me play the role of academic devil’s advocate here for a second. Ultimately, Greek fiscal stability will require a combination of lower spending and higher taxes. Yes, bond yields at current levels—if sustained—would be unlikely to be consistent with long-run fiscal stability.

However, a program that

(a) Made it clear that Greece would be able to roll over private sector debt because the EU will intervene to provide the funds

(b) Credibly lead to the adjustments in Greece’s structural deficit.

should stabilise the fiscal situation in Greece and lead to a return to lower borrowing rates for Greece. That the EU should charge a high interest rate for providing the funds for (a) and overseeing the program for (b) is, it could be argued, not unreasonable. Indeed, if the rates associated with (a) are not high enough to be painful then it may be difficult to get much traction going on (b).

Of course, the Greek government is going to look to get the interest rates on its assistant loans set as low as possible. But that doesn’t mean that a percent here or there on these loans is the key issue right now.

The other major unknown here is how any deal will affect the sovereign bond market’s attitude to Ireland.

Greek Bond Yields

The yield on Greek government bonds has now crept up to more or less where it was prior to all the EU meetings of the past few months (see here.) I’m not sure why the various annoucements haven’t helped and newspaper reports like this one and this one don’t explain as much as I’d like.

If the high bond yields are a sign of doubts about whether a rescue is actually going to happen, and thus the debt may be defaulted on, then the eventual arrival of the cavalry (in the form of the EU) to keep the debt rolling over would end up bring the yields down to more sustainable levels and hopefully stabilise the situation. A less sanguine interpretation of current events offered to me by a colleague is that the terms of the deal being offered by the EU—in which any lending would be at current market rates—doesn’t really offer Greece a route out of insolvency because bond yields at this level are not consistent with stabilisation of the public finances.

I’m more inclined to believe the former intepretation and that the EU will prevent Greece defaulting. Whether it should is a different matter.

Greece and the Threat to the Euro

I read time and again, for instance here, that Greece’s debt crisis “threatens the euro”. Indeed, there are lots of right-minded people around Europe who worry deeply about this threat and have determined that a Greek default has to be avoided to save the euro. I’m having trouble, however, figuring out what that this is supposed to mean.

There seem to be different interpretations of what the “threat to the euro” is. The more dramatic interpretations invoke the idea of an existential threat. Others view it as involving reputational harm. I’ll take each of these ideas in turn.

Continue reading “Greece and the Threat to the Euro”

Today’s Instant Solution to Greece’s Problems

Not wanting to be outdone by Martin Feldstein, Laurence Kotlikoff (recently based known for his Limited Purpose Banking proposals) is the latest US-based economist to bring his analytical skills to bear on the Greece’s problems to diagnose an instant solution:

Is there some way that Greece can devalue without devaluing?

There is, indeed. The government can implement wage and price controls for, say, the next three months, with these controls covering not just the growth in wages and prices over the next three months, but also their initial levels. Specifically, the Greek government would decree that all firms must lower their nominal wages and prices by 30 per cent, effective immediately, and not change them for three months. After three months, everyone would be free to put prices and wages back up.

This is an interesting proposal. Indeed, if this decree-based approach proves to be successful, it could then be applied to other areas. For instance, in the sphere of justice, the Greek government could decree that people should obey the ten commandments. And, if it works in Greece, we should try the decree approach here. After all, we’re all in favour of evidence-based policy formulation.

Rationale for the Greek Deal

I’ve been following the news stories on the proposed potential Greek bailout. However, reading articles like this, I’m struggling to find a good rationale for the agreement that’s been reached. The following questions come to mind:

  1. Greece needs to address its huge fiscal problems. To do this will require putting through highly unpopular measures. How does the EU’s offer of a potential bailout help get this achieved? How does the Greek government convince its people that harsh measures are required to reduce its deficit and keep open its access to sovereign debt markets when they now know that the EU tooth fairy is waiting by to help?
  2. Even if the senior figures in the leading EU countries have ultimately decided to intervene to prevent the disruptions associated with a Greek failure to roll over its debt, why not wait until that failure has happened?
  3. Why would the EU wish to be associated in the Greek public’s minds with the harsh expenditure cuts and tax increases that would still have to follow even after a bailout deal?
  4. Do those who advocate this policy really believe that the current Greek crisis is sui generis or are they planning to put in place a safety net for the whole Euro zone? If the latter, can such a policy really be credible?
  5. Is the long-run macroeconomic stability of the Euro area better served by avoiding the dislocations associated with one its constituent members going through a sovereign debt default or should we be more concerned about the problems created by the new bailout mechanism that lets governments know that the EU will intervene if they choose not to tackle their fiscal crises?

I feel that in asking these questions, I’ve clearly been missing something. Hopefully those who thrashed out this deal have thought these issues through. My concern is that in the somewhat fevered quasi-crisis atmosphere of this week, precedents may be getting set that we will live to regret.

Update: To be honest, I probably should have linked to this hand-wringing Times editorial as a better illustration of what I’m confused about. The editorial worries about “depressing the value of the euro” (which would in fact be a good thing for the Euro area economy) and discusses how this “raises major doubts about the future of the single currency” without explaining why this is the case.  The piece ends with the dramatic note of “The European Union remains on alert and on financial standby.”  It does make one wonder a little whether this issue is being hijacked somewhat by those who see “Europe” as the solution to most ills.