Krugman’s blog, 7/7/15

There were two posts yesterday.  The first was “Debt Deflation in Greece:”

However things play out from here — I find it hard to see a path other than Grexit — the troika’s program for Greece represents one of history’s epic policy failures. Even if you ignore the economic and human toll, it was an utter failure in terms of restoring solvency. In 2009, before the program, Greek debt was 126 percent of GDP. After five years, debt was … 177 percent of GDP.

How did that happen? Did the Greeks continue massive borrowing? As the chart shows, the answer is a definite no. Greek debt at the end of 2014 was only 6 percent higher than it was at the end of 2009. Admittedly, that number reflects a significant haircut on private debt along the way, but it was still nothing like the continued borrowing binge some imagine.

What happened instead was, of course, the collapse of GDP — itself largely the result of the austerity program.

What this suggests is that the troika program was simply infeasible, and would have been infeasible no matter how willing the Greeks had been to make sacrifices. The more they cut, the worse things got, because of Fisherian debt deflation.

I suppose you can argue that structural reforms might have delivered a boost in competitiveness, but the truth is that there’s very little evidence supporting the conventional faith in such reforms.

Some of my more conventional contacts like to insist that Greek austerity was unavoidable, and it’s true that one way or another Greece was going to have to achieve a primary surplus. If currency devaluation had been an option, this would have required much less austerity, because of the boost from easier monetary policy; but within the euro a lot of austerity was indeed something that had to happen. But the key point is that the austerity ended up being not just incredibly painful but completely futile, because it wasn’t accompanied by massive debt relief.

Is this kind of futility always the case? Not necessarily; if you try to do the arithmetic here, it becomes clear that a lot depends on the initial level of debt. If Greece had received major debt forgiveness, it would still have gone through hell, but with at least some hint of an eventual exit. Instead it was pushed into a cycle of ever-worse pain without hope.

Yesterday’s second post was “Milton Friedman, Irving Fisher, and Greece:”

I continue to be amazed by how many people regard debt relief and devaluation as wild-eyed radical ideas; of course, it matters most that so many influential people in Europe share this ignorance. Anyway, for the record (and for my own future reference) I thought it would be helpful to post what Milton Friedman and Irving Fisherhad to say about the Greek disaster. OK, they weren’t writing specifically about Greece — Friedman was writing in 1950, Fisher in 1933. But their analyses ring truer than ever.

First, Friedman (why oh why isn’t there a full electronic copy of this essay online?):

That tells you everything you need to know about why “internal devaluation” has been such a costly strategy — and why the ECB’s failure to move aggressively early on to achieve and if possible surpass its 2 percent inflation target was a major contributing factor to this disaster.

Then Fisher on why austerity hasn’t even helped on the debt:

The basic story of the European periphery — not just Greece — is one of a poisonous interaction between Friedman and Fisher, which has produced incredible suffering while failing to reduce the debt/GDP ratio, which even in star pupils like Ireland and Spain is far higher than when austerity began; the only success has been in suffering long enough so that some growth has finally resumed, and they can call it vindication.

The bizarreness of the whole thing is how flaky, speculative ideas like expansionary austerity became orthodoxy, while applying the economics of Fisher and Friedman became heterodoxy bordering on Chavismo.



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