Analistas 21/09/2015

Greece got caught in a Euro trap

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I have no reason to doubt that there are big things that should change, and that Greece would be much better off if the country could somehow break the political barriers that are stopping it from making these changes.

But I would argue that it’s very, very wrong to point to factors that are limiting productivity in Greece and then claim that those factors are the “cause” of the Greek crisis. Low productivity exacts a price from any economy; it does not normally, or need not, create a financial crisis and a huge deflationary depression.

Consider, for example, a comparison between Greece and Poland. The latter, like Greece, exists on Europe’s periphery, yet is closely linked to the rest of the Continent’s economy.

Poland is also a country with relatively low productivity by northwestern European standards.

But it has not had a Greek-style crisis, or indeed any crisis at all. Instead, Poland has powered through the turmoil of recent years.

What’s the difference? The main answer, surely, is the euro. By adopting the euro, Greece first brought on massive capital inflows, then found itself in a trap, unable to achieve needed real devaluation without incredibly costly deflation.

Every time someone asserts that Greece’s problems are really on the supply side, you should ask not whether the country has supply-side issues - it does - but why they should lead to collapse.

Greece seems to have about 60% of Germany’s productivity, which means that it should have real wages only about 60% as high as Germany’s. It should not have 25% unemployment.

Multipliers: What we should have known

The International Monetary Fund recently published a very nice interview with Olivier Blanchard, the chief economist who is leaving the organization.

And Mr. Blanchard says the right thing about changing one’s mind: “The issue I have been struck by is how to indicate a change of views without triggering headlines of ‘mistakes,’ ‘fund incompetence’ and so on. Here, I am thinking of fiscal multipliers. The underestimation of the drag on output from fiscal consolidation was not a ‘mistake’ in the way people think of mistakes, e.g., mixing up two cells on an Excel sheet. It was based on a substantial amount of prior evidence, but evidence which turned out to be misleading in an environment where interest rates are close to zero and monetary policy cannot offset the negative effects of budget cuts. We got a lot of flak for admitting the underestimation, and I suspect we shall continue to get more flak in the future. But, at the same time, I believe that we, the fund, substantially increased our credibility, and used better assumptions later on. It was painful, but it was useful.” (Read the interview here: shar.es/1708Ry.) Indeed.

There are a lot of people out there whose idea of a substantive argument is “you used to say X, but now you say Y” - never mind the reasons you changed your view, or whether it was right for you to do so. It’s important not to fall into the trap of being afraid to let new evidence or analysis speak.

However, on this particular issue, the I.M.F. should have known better. Mr. Blanchard says that the evidence “turned out to be misleading in an environment where interest rates are close to zero and monetary policy cannot offset the negative effects of budget cuts.”

But didn’t we know that? I certainly did.

And let me also beat one of my favorite drums: Experience has overwhelmingly confirmed the prediction that multipliers will be much larger in a liquidity trap.

So this was yet another victory for Keynesian analysis - the success story nobody will believe.