Austerity and the Greek Depression

1/7/2015

By Paul Krugman

Olivier Blanchard offers a defense of the IMF’s role in the Greek crisis. Basically, he argues that given the political realities, there was no alternative to requiring that Greece move into primary budget surplus, whatever the cost. This is surely true.

But how big was the cost? I’m with Brad DeLong in being highly puzzled by this assertion:

The decrease in output was indeed much larger than had been forecast. Multipliers were larger than initially assumed. But fiscal consolidation explains only a fraction of the output decline. Output above potential to start, political crises, inconsistent policies, insufficient reforms, Grexit fears, low business confidence, weak banks, all contributed to the outcome.

Where is this coming from? I look at the data prior to this year — when we have indeed seen a crisis of confidence — and Greece’s output decline looks like just about what you should have expected given the austerity imposed. The chart shows changes in the structural budget balance versus changes in output, for all eurozone countries for which the IMF provides estimates of both numbers.

The line is the relationship between austerity and growth fitted to all eurozone countries except Greece, implying a multiplier of 1.5; I extrapolate that line down to Greece, and it’s pretty close. Obviously you could do more complicated analyses, but on the face of it Greece appears to have suffered a slump overwhelmingly because of the austerity; surely there’s no grounds for dismissing this impact as a mere fraction of the problem.

So if the austerity was necessary, so was the depression-level slump — a slump that has left Greece’s debt ratio far higher after 5 years of hell than it was when the program began.

What this tells us is that the Greek program was infeasible from the start. A very big debt haircut early in the game might not have offered much relief from the slump, but it would have at least offered a chance to avoid debt deflation. Other than that, given the political constraints, there was no way this could have worked.

So now what? A few months ago I thought that stabilizing Greece at a small primary surplus might work, in the sense that it would allow a return to growth even if it didn’t do anything to make up lost ground. But the creditors are still demanding a rising primary surplus over time, and balking at top line debt relief that might at least offer a clear marker of progress. If those are the requirements for Greece to stay in the eurozone, Grexit is inevitable.

Πηγή