What should Greece do?

There’s been a lot of discussion of the problems of Greek sovereign debt, its implications for the euro and so on. But I haven’t seen much discussion of what the Greek government should do in dealing with the simultaneous problems of an economic downturn and unsustainable debt (feel free to point me to good discussions).

The course of action being demanded by the bondholders and their advocates, as well as by the EU governments that are likely to bear the costs of a bailout is that of drastic retrenchment on the lines the IMF would normally advocate in cases of this kind. But that is obviously not a desirable policy response when considered in macroeconomic terms. I’m not well informed on the details of Greece’s budget problems, so I’m mostly going to make generic suggestions that are applicable to a case like this.

What Greece needs, if it can be delivered is a policy that will maintain its access to credit markets, while avoiding a drastic contraction in the short run. That requires a credible commitment that holders of Greek government bonds will be paid in full, or fairly close to it, a commitment that is inconsistent with sustained budget deficits.

The strategy that seems to be indicated is one that has the following main characteristics

* A sustained increase in the ratio of tax revenue to national income over time. That suggests a commitment to raise the VAT rate gradually over several years, with the extra revenue being hypothecated to debt service. On the income tax side, the most credible commitment to raise revenue in the long run is probably one of vigorous action against tax avoidance and evasion, benefitting from the efforts of the bigger European economies in this respect

* On the expenditure side, it’s likely that Greece, like most countries has unsustainable commitments on retirement incomes. A staged increase in retirement and pension ages, as has been done in Australia, is a reasonably credible way of constraining future growth in expenditure without too much adverse impact in the short run.

* Finally, there are the various non-conventional ways previous governments found to take on debt obligations, for example by mortgaging future income flows. Unlike the case of standard government bonds, there is no need to preserve access to this kind of borrowing in the future. On the contrary, action to ensure that no future government can borrow in this surreptitious fashion is highly desirable. So, these deals should be renegotiated to reduce the burden they impose, with the threat of repudiation/default in the absence of a satisfactory agreement. The prominent role of major Wall Street banks in organising these deals is a potential political asset here. An outcome in which Goldman Sachs gets stiffed, while bondholders in general are paid, would be an ideal way of softening the political pain associated with expenditure cuts and tax increases.

95 thoughts on “What should Greece do?

  1. simon johnson has quite a bit on this at his site and business insider
    i liked Nathan Lewis’ thoughts as well,

    Let’s imagine what might happen if Greece were “kicked out of the eurozone,” presumably against their will by irate Germans. Would the government then issue their own currency? They might, or they might not. Maybe they would just let Greeks use the euro, as they have becomed accustomed to. The Germans might complain: “No, you can’t use the euro! That’s our currency!” So what. Greece is no longer part of the eurozone. That means that they don’t have to do what the Germans say anymore. Greece could be just like Montenegro, and use the euro “without permission.”

    they wont kick em out though, no way

  2. Not unlike the GFC, lack of adequtate and reliable data is one of the problems


    Deutschewelle reports more or less continuously – in English. Here are a few web-sites.




  3. The EU is not responsible for the debt of member nations so why would the EU want to chuck anybody out of the Eurozone? This idea only makes sense if you think that the debt ought to be defaulted on via currency devaluation (ie a policy of inflation). A much better solution is to simply default proper, as in ceasing to pay back the debt. This would piss off bond holders and it would mean nobody wants to lend the Greek government money for a generation or so but so what? The private sector could still borrow and the government could still operate so long as it spent within it’s means for a generation or so but it is hard to see a downside with this (except for bond holders).

    Perhaps I’m over rating the size of the problem but why raise taxes and punish taxpayers for the stupidity of government.

  4. I don’t think it is possible to discuss what the Greek government should do without referring to the political unit of the EU or the European Monetary Union.

    Proposal for the Eurozone

    Remarks Clarified

    Perhaps I’m over rating the size of the problem but why raise taxes and punish taxpayers for the stupidity of government.

    Politically: They elected the government, so shouldn’t they pay for their mistakes

    Economically: Wouldn’t your proposal dramatically raise unemployment in Greece?

  5. Politically: If I vote for Tooheys beer do I suddenly become responsible for any financial troubles the Lion Nathan company encounters? I think not. Besides not everybody votes.

    Economically: I can’t see how or why. Although it might mean a few public sector jobs get axed.

  6. @TerjeP (say tay-a)
    “Besides not everybody votes.” Well they should and if they don’t that doesn’t make them a sovereign entity within another state, i.e. they have to abide by the decisions of the body that has the constitutional power to govern. Your Toohey’s analogy doesn’t make sense, unless you are voting for the board of Lion Nathan, you don’t vote for beer. Or perhaps you do by either buying it or not, anyway the scenario is not analogous to paying tax.

  7. It’s a loose analogy but the idea that taxpayers are morally obligated for the sins of their government is obscene. What about all those taxpayers who voted for somebody else? And why are you so sympathetic to bond holders. They’re adults after all and they didn’t have to risk their money on the Greek government.

  8. JQ – can you ellaborate on the non-conventional debts. Are you sure these debts haven’t been onsold by the bankers.

  9. Here is an idea….

    How about Turkey who wants to get into EU, stop with their continuous threats on Greek airspace and oil reserves in Aegean, the occasional attempted land grab (1996 Imia incident), and their repression towards the remaining Greeks and the Orthodox Patriarch in Constantinople (Istanbul). No to mention their continued presence of their military on EU soil in Cyprus!!

    If they did, Greece would not have to waste so much money on their military. You know, it might just help Greece’s budget?

  10. ‘It’s a loose analogy but the idea that taxpayers are morally obligated for the sins of their government is obscene.’
    It’s not a moral issue, it’s an operational one. We have to acquiesce in government for a society to work; we can’t choose which debts we accept (pink batts?) and which we don’t (green loans?).
    I mention this because it’s well known that Greece’s middle class has been failing to pay its taxes for about as long as its members have been drawing their generous pensions. In other words, they’ve been happy to receive government (other taxpayers’ and borrowed) money. Now they are in trouble.
    Greece has both to collect taxes seriously and to reduce its pensions. It’s not going to be pleasant or easy. There are no easy solutions. (Painless AGW cure is a good analogy to what Greece can’t achieve.)

  11. Terje, I don’t know anything about modern greek political culture, so this is an ignorant statement, but reproting suggests that the Greek people fully aided and abetted living beyond their means, and it is political poison to promise to fully balance the budget.

    That’s democracy for you…

  12. Several imaginative solutions have been proposed in addition to TerjeP(say tay-a)’s more or less fixed idea regarding private versus public. Perhaps it would be useful to first look at what the locals (EU) say as to what the problem is. This is what I found very quickly:

    1. Size of the short term financing problem: 50 billion Euros to finance year 2010 budget deficit and interest on existing debt. (Finance terminology: financial distress – just like GM and the entire private US banking system and some EU banks since mid-1997.)
    2. The EU has rules (targets) on debt/GDP ratio, both at the time of entry to the EU and thereafter. Exceptions to the rule have to be agreed. (This is, I assume, common knowledge.)
    3. The national accounts data provided by Greece to the EU has been found to have been fudged (unreliable). This means that Keynesian or Friedman type macro-economics policy solution concepts cannot be considered until clarity is reached on the actual financial situation. It is a reminder that evidence based decision making presupposes reliable data. (IMHO, this data quality problem is simpler than that underlying the global financial crisis (GFC) because in the fudged Greek data case the categories of data are known and there are established data collection processes. By contrast, the GFC involved a more fundamental problem, namely the reporting of interbank derivative contracts. Since these contracts involve many jurisdictions, the problem is even more complex. I have no news on the progress to address this fundamental data problem. I would not be surprised if EU savers, who bought securities issued in the US before the GFC, would be very happy if JQ’s ideas regarding the 2 Wall Street banks were implementable. JQ, what about our friends the rating agencies?)
    4. The Greek government is said to have done a bit of off-balance sheet financing – just like the private US banks who sold and still do sell CDOs. (The ‘private is better than the ‘governemnt’ story doesn’t match and the reverse does neither without having many other conditions fulfilled.)
    5. Allegedly, the black economy (transactions not recorded in the national accounts) of Greece is 30% of GDP.
    6. The Greek taxpayers include an apparently non-trivial number of fudge their tax returns.
    7. The EU wants to have its auditor involved in the Greece national accounts processes (teaching and supervision).
    8. The EU is in discussions with the Greek government regarding the latter’s proposal to solve its debt problem. (In contrast to the GFC event, at least there is an institutional framework in place to rationally deal with a problem.)

    Source: http://www.dw-world.de/popups/popup_printcontent/0,,5168553,00.html
    Terms in brackets are my comments.
    None of the EU countries is in a position to simply make a donation of xbillion EU. The GFC is one of the reasons for this. I would be most surprised if the EU commission is asking for advice from anybody from the US.

    PS: This post replaces my earlier post, which is still in moderation.

  13. I agree with O6. Greece has simply been enjoying a standard of living beyond what it can pay for for quite a long time. That needs to change. The Greeks are unlikley to volunteer to make the change. Never mind the Euro valuation, they have received billions per year in subsidies from the EC, even more per capita than poorer countries like Portugal and Malta. They have 2% of Europe’s farmland but get 6% of the subsidies. This had to end even before the debt problem became serious.

    Without devaluation, they need to reduce pensions, increase working ages, pay more tax and reduce the size of the public service. They need ot reduce corruption too, but I won’t hold my breath. It is not insoluble, but I can’t see any populist government making the changes. Hence kicking them out is a reasonable option. How can the EU tell the Turks they can’t enter, if they allow the Greeks to stay in?

  14. Kenneth Rogoff, points out that “Greece has been in default roughly one out of every two years since it first gained independence in the nineteenth century.”
    Putin says not to worry, the US is in far worse shape

  15. ChrisB – I’d say the exact opposite. When we appoint an agent to act in our interest they are always likely to value our interests less than we do. Governments are almost universally less intelligent on issues of public interest than the voters which is why making governments accountable to the people is such a good idea.

    O6 – the argument against defaulting on government debt seemed to me to a moral argument. If a government is inclined to borrow too much and too often then defaulting on the debt is an operationally effective way to cure the deficiency.

  16. Terje,
    If they default then the changes will be forced on them anyway as the inability to borrow (combined with an inability to resort to the printing presses) will mean the budget would be very rapidly forced back into balance.
    The people are going to be forced to wear the sins of their government one way or another. This might just be the only way to get all of them to understand that.

  17. Andrew – yes that is my point (and JQs I suspect). Default is an under rated option. It means the taxpayer does not get slugged for past stupid government behaviour, nobody lends to the government in future and hence budgets have to be balanced. It is hard to see any downside at all except for creditors. However even burning them has a silver lining in that they might in future lend to a productive entity instead of to a government.

  18. Well the point is is that “sins of the government” is a bit of a nonsense – it seems to me that the greek people are just as deluded as their governments (across the spectrum) and are going to have to suffer a bit of a shock to the system to atone for their collective sins…

    all very protestant of me..

  19. I actually agree with Terje that default is the least worst option for Greece.

    But it’s a dreadful option for others in the EU because quite a few of them need to flog a lot of government paper in the next few years. If Greece defaults they will find that hard – even honest governments who are in fact good for the money will have a hard time convincing bondholders, let alone the likes of Italy. These governments will now take the easier course of trying to get German taxpayers pay up now.

    A silver lining to all this may be that the Greek veto on Turkish entry to the EU will get a lot less sympathy from other Europeans. The Germans, in particular, will want Turkey in and may now have the influence to make it happen.

  20. derrida derider,
    Bond purchasers are (generally) fairly bright people. They know that Greece is a different case to (say) Germany. What this will do is similar to a bank default – all risk will be repriced to take into account the knowledge that there are no bailouts.
    The result is fairly typical. Worse risks (like Greece, Portugal or Italy) will pay more and the better risks will pay less. This happens because the better risks will no longer be implicitly supporting the poor risks and there will be more money around for the better risks.
    Personally, I think defaults are a good thing from time to time. They tend to ensure that risk is priced more correctly. In the long term that actually reduces systemic risk. Bailouts (IMHO) do the reverse.

  21. “Governments are almost universally less intelligent on issues of public interest than the voters which is why making governments accountable to the people is such a good idea”

    I think California falsifies this statement.

  22. No,

    I just think there are certain aspects of democracy that don’t work as well as others in some places. In some places, for example, people are obviously responsible enough to vote for anything they feel like (e.g., Switzerland). In other places, perhaps some decisions to do with money especially shouldn’t be left to popular vote. I’m pretty happy, for example, that people don’t get to vote on what the interest rate should be, and I’m also happy that the RBA is independent. The second of those is quite undemocratic, because I have no real say at all in what the RBA does — I can’t even vote the board out (although I guess I could vote for a party that would change the constitution to get rid of them). Also — as Lars Von Trier used as a joke in Mandelay, we don’t vote on when to set the time (except WA!).

  23. I’d close the RBA and cease the central planning of interest rates.

    Switzerland doesn’t have smarter voters, just a better system of democracy that avoids centralised government growing powerful.

  24. Not that I’m an expert on it by any stretch of the imagination, but I believe the thing which causes California the problems is pretty much the same thing that doesn’t cause Switzerland problems, so I’m not sure that it really has anything to do with better-or-worse types of democracy — it’s a cultural thing that causes different outcomes from essentially the same starting point.

  25. You make out like California is a starving third world nation rather than one of the richest economies on earth and the home of silicon valley and Hollywood. I think California is doing okay.

  26. I’m not saying that at all — I personally think it’s a great place. Alternatively, when (if) it defaults on it’s bonds, that will be a serious problem and no doubt so will be the consequences for years and years to come, unless the rest of the US wants to bail them out.

  27. If they don’t get bailed out? I’m sure other people are better than me at speculating on that and many have (just search for “consequences of California Bond default” and similar). None of it seems very pretty — Apart from short pain (even higher unemployment and the inability of the government to borrow money easily), I imagine in the long term a lot boils down to whether people (quite possibly via direct voting) are willing to trade-off their future for serious immediate concerns (e.g., their education system vs. aged care).

  28. I think an inability for government to borrow easily would be a fabulous situation. I don’t really see why this would increase unemployment.

  29. TerjeP (say tay-a) :
    It’s a loose analogy but the idea that taxpayers are morally obligated for the sins of their government is obscene. What about all those taxpayers who voted for somebody else?

    But one could just as easily argue that it is not fair that those who make poor voting choices still benefit from the more sensible voting choices of others. So it is a somewhat selective cherry-picking argument to say that one should not have to carry the costs of the poor choices of others while still benefiting from the sound choices of fellow citizens. In a democracy everyone has to live with the collective decisions made.

    And it doesn’t really follow that because not everyone has contributed equally to the problem, the whole populace therefore deserves a get-out-of-jail-free card. The world doesn’t work that way, nor should it.

    With rights come responsibilities. And the price of democracy is that if voters make poor choices they must live with the consequences. Indeed, the chief virtue of democracy is that people largely get the government they deserve. That doesn’t seem to stop the whingeing and victimhood though.

  30. Monkeys Uncle – you are confused.

    In a democracy everyone has to live with the collective decisions made.

    Yes, but that was never the point in dispute.

    I was suggesting a collective decision, which was to default on government debt. The objection offered by Sennex was that this collective decision was not acceptable on what appears to be moral grounds; “They elected the government, so shouldn’t they pay for their mistakes”.

    What I’m objecting to is the idea that a moral imperative prevents a collective decision to default on government debt. That taxpayers must be forced to carry the burden of government debts because not doing so would be immoral. This line of argument is obscene.

    In any case the point of democracy should not be to make voters accountable for the action of governments. It should be to make governments accountable for their own actions.

  31. I understand the recently elected socialist government of Greece has discovered that the predecessor conservative government has done a bit of creative accounting and off balance sheet financing with the help of some famous Wall Street bankers. There are similar problems with tax(non)payers.

    So, what should the Greeks do? I propose the current government should hold the previous government official and their banking assistants personally responsible and do the same with tax (non)payers.

    With a bit of luck, history repeats itself (the Romans copy the Greeks) and Berlusconi & co pays up too. The ideas travel north, Guido Westerwelle (FDP, Germany) appreciates a bit more the reality of contemporary life and, by doing so, avoids further court cases (for insulting people on social security).

    PS: The source of the information for paragraph 1 has been supplied in my post of 17 February, which is stuck in moderation. JQ advised that it is not him who objected but it got stuck in some auto-moderation. I suspect it is because I linked to an audio link. Be it as it may, the information in paragraph 1 is now in the local press, too.

  32. What will be the consequence?

    are you suggesting there is no consequence if the eighth largest economy defaults?
    if so then we have found the basis for an economic perpetual machine, yes?
    borrow money, borrow more, borrow some more, default …
    borrow money, borrow more, borrow some more, default …
    if only keynes, smith or minsky could have come up with that terje

  33. default or no default i think its looking increasingly like a trojan horse, (ha, ha)
    voices of the european establishment are increasingly expressing the view that it is not the monetary system that is the problem,
    drum roll …
    it is the outdated sovereign states that need to merge into a european nation and cach up with the economic system,
    europe the nation is the solution, the kites have been sent up, lets see how it plays out

  34. For Greece default would lock the country out of the credit markets for a while and force the budget into balance overnight. A credible plan for fiscal retrenchment without default could give Greece more time to balance its budget.

  35. Ernestine,
    I would have thought a more credible option would be to default on the debt and off balance sheet financing that was not made public (if indeed you are right). That would penalise the financiers that provided the funds that were provided in a less than transparent manner and show that the new government was determined to clear things up.
    The financiers of the defaulted instruments could then pursue their claims through the courts, where the rights and wrongs could be correctly examined.
    In the meantime, Greece could put its fiscal house in order, perhaps with the assistance of any financiers that are prepared to help in this process in exchange for having the current government continue to make payments on the debt.
    Sure – it would increase the risk ratings (a sovereign default always will) but it would send a clear message about transparency, the correct risk of dealing in a less than clear manner with the Greek government and still provide a credit line to the current government if they are genuinely seeking to clean things up.
    To me an EU bailout, like virtually any bailout, merely encourages more bad behaviour later.

  36. @Andrew Reynolds

    Andrew R.,

    1. My source for paragraph 1: 1 EU source, 1 SMH source. (There are several European newspapers with national language and English web-sites).

    2. As you know, for a long time I’ve been talking about the lack of an adequate theoretical concept of ‘money’ in a monetary economy and the inadequacy of the financial accounting system as a record keeping system. I’ll offer yet more examples.

    You speek about ‘the financiers’ who would be penalised if the newly elected government would default on existing debt. But who are these ‘financiers? How could one be sure that it isn’t the proverbial moms and dads, who, via voluntary or compulsory pension funds or on the ‘in good faith’ advice of their local banks bought securities, aren’t the ultimate losers? One can’t be sure. You may agree, or not, when I say these small individual savers (wages and profits from small enterprises) can’t afford individual court cases and having class actions isn’t all that easy to organise in all juristictions, if at all. It seems to me, the current government is in a much more plausibly powerful position to take such actions. Furthermore, they have the power to levy special taxes on segments of the population. (Germany levied a ‘unification pfennig’ tax on taxpayers above a certain threshhold income level to partially finance the unification. There was no public outcry and the major parties, SPD and CDU, concurred.)

    3. As history shows, the belief that the threat of bankruptcy will automatically prevent it, is a naive belief and so is the weaker form of this belief that actual bankruptcy would improve future behaviour. It is useful also to distinguish between the old-fashioned risk classes, called business risk and financial risk. The latter refers to leverage. It is financial risk which causes the Minsky type episodes. It is these episodes which threaten the payment system and more or less ‘everybody’.

    4. I have no information which would indicate a straight EU bailout. I understand the EU Commission wants to have its auditor involved in Greece (I assume advice comes with it). In a sense the Greece financial fiasco is easier than the GFC because the former involves existing data collection categories while the latter pertains to systemic risk, for which there are no adequate data collection categories (my point in 2 once again). Furthermore, I understand the Greek government has already come forward with proposals to improve the financial affairs and there have been meetings with EU member states and there is another meeting with EU officials in the near future (I have forgotten the date). Again, there is an important distinction between the Greece case and the GFC. The latter involved the whole world but in a manner which was not mapped properly (my point in 2 once again). As I see it, the USA government had a choice of saving, at least partially, its reputation as a non-tinpot country by means of a version of a bailout, or go down a multi-pipe gurgler very fast.

    5. Remembering the words of a local representative of a German bank, the ratings of rating agencies are possibly the least of the EU members’ worries.

    6. It became evident very quickly that the EU has a negotiation framework in place which was not available for the GFC fiasco. Lets see what the next round of negotiations reveals.

  37. smiths :

    What will be the consequence?

    are you suggesting there is no consequence if the eighth largest economy defaults?if so then we have found the basis for an economic perpetual machine, yes?borrow money, borrow more, borrow some more, default …borrow money, borrow more, borrow some more, default …etcif only keynes, smith or minsky could have come up with that terje

    I never suggested there were no consequences and it is a bit sly of you to suggest otherwise. Conrad suggested that there would be serious consequences and my question was directed at eliciting his views on what they are.

    My own view is that a default would hurt bond holders. And it would constrain the ability of Greece to readily borrow more. My position is much the same as that expressed by John Quiggin in the article and Andrew Reynolds above. There is no perpetual economic machine involved.

  38. I don’t think other EU nations should be making noises that signal it might bailout Greece. If Greece can’t pay it’s debts it should default. No other nation should assume those debts or signal that they are entertaining the thought.

    I agree with the limited default suggested by John Quiggin in the article and Andrew Reynolds above. It seems like a very sane course of action.

  39. “An outcome in which Goldman Sachs gets stiffed, while bondholders in general are paid, would be an ideal way of softening the political pain associated with expenditure cuts and tax increases.” Source: JQ.

    Happy to hear that TerjeP agrees.

  40. “No other nation should assume those debts or signal that they are entertaining the thought”

    The term ‘nation’ is interesting. Suppose we interpret the term ‘nation’ as a geo-politically defined country. Suppose further that citizens of country A buy securities issued by citizens or institutions in country B and the issuers default then the question arises: how can ‘nation’ A avoid taking on the debts of ‘nation’ B?

  41. EG – I could quibble with details but broadly speaking I think JQ is on the right track. I’m glad this makes you happy.

  42. EG – Your pedantry nature has gained one more scalp. When I said nation I meant government. My apology for baffling you.

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