The Greek Stand-By Arrangement
For tomorrow’s column I went back to the original, May 2010 stand-by arrangement for Greece, to see what the troika was demanding and predicting at the beginning of the austerity push, and how it compares with what actually happened.
First of all, I quite often encounter people who claim that Greece never really did austerity. I guess this is based on national stereotypes, or something, because the numbers are actually awesome. Here’s non-interest spending as projected in the original agreement versus actual spending since 2010. Because the troika kept increasing its demands, Greek spending has ended up far lower – austerity has been far more intense – than anything envisaged at the beginning.
So how can Greece still be in debt trouble? The original agreement assumed a brief, fairly shallow recession followed by recovery – nothing like the reality of depression and deflation. Here’s nominal GDP as predicted versus actual outcome. Naturally, the collapse of GDP reduced revenue and raised the debt/GDP ratio.
Oh, and unemployment was supposed to peak a bit under 15 percent, not hit 28.
How did they get it so wrong? In the spring of 2010 both the ECB and the European Commission bought fully into expansionary austerity; slashing spending wasn’t going to hurt the Greek economy, because the confidence fairy would come to the rescue. The IMF never went all the way there, but it used an unrealistically low multiplier, which it arrived at by looking at historical examples of austerity while ignoring the difference in monetary conditions.
The thing is, we now have essentially the same people who so totally misjudged the impacts of austerity lecturing the Greeks on the need to be realistic.
Much too responsible
The United States and Europe have a lot in common. Both are multicultural and democratic; both are immensely wealthy; both possess currencies with global reach. Both, unfortunately, experienced giant housing and credit bubbles between 2000 and 2007, and suffered painful slumps when the bubbles burst.
Since then, however, policy on the two sides of the Atlantic has diverged. In one great economy, officials have shown a stern commitment to fiscal and monetary virtue, making strenuous efforts to balance budgets while remaining vigilant against inflation. In the other, not so much.
And the difference in attitudes is the main reason the two economies are now on such different paths. Spendthrift, loose-money America is experiencing a solid recovery — a reality reflected in President Obama’s feisty State of the Union address. Meanwhile, virtuous Europe is sinking ever deeper into deflationary quicksand; everyone hopes that the new monetary measures announced Thursday will break the downward spiral, but nobody I know really expects them to be enough.
On the U.S. economy: No, it’s not morning in America, let alone the kind of prosperity we managed during the Clinton years. Recovery could and should have come much faster, and family incomes remain well below their pre-crisis level. Although you’d never know it from the public discussion, there’s overwhelming agreement among economists that the Obama stimulus of 2009-10 helped limit the damage from the financial crisis, but it was too small and faded away far too fast. Still, when you compare the performance of the American economy over the past two years with all those Republican predictions of doom, you can see why Mr. Obama is strutting a bit.
Europe, on the other hand — or more precisely the eurozone, the 18 countries sharing a common currency — did almost everything wrong. On the fiscal side, Europe never did much stimulus, and quickly turned to austerity — spending cuts and, to a lesser extent, tax increases — despite high unemployment. On the monetary side, officials fought the imaginary menace of inflation, and took years to acknowledge that the real threat is deflation.
Why did they get it so wrong?
To some extent, the turn toward austerity reflected institutional weakness: In the United States, federal programs like Social Security, Medicare and food stamps helped support states like Florida with especially severe housing busts, whereas European nations in similar straits, like Spain, were on their own. But European austerity also reflected willful misdiagnosis of the situation. In Europe as in America, the excesses that led to crisis overwhelmingly involved private rather than public debt, with Greece very much an outlier. But officials in Berlin and Brussels chose to ignore the evidence in favor of a narrative that placed all the blame on budget deficits, and simultaneously rejected the evidence suggesting — correctly — that trying to slash deficits in a depressed economy would deepen the depression.
Continue reading the main storyContinue reading the main storyContinue reading the main story
Meanwhile, Europe’s central bankers decided to worry about inflation in 2011 and raise interest rates. Even at the time it was obvious that this was foolish — yes, there had been an uptick in headline inflation, but measures of underlying inflation were too low, not too high.
Monetary policy got much better after Mario Draghi became president of the European Central Bank in late 2011. Indeed, Mr. Draghi’s heroic efforts to provide liquidity to nations facing speculative attack almost surely saved the euro from collapse. But it’s not at all clear that he has the tools to fight off the broader deflationary forces set in motion by years of wrongheaded policy. Furthermore, he has to function with one hand tied behind his back, because Germany remains adamantly opposed to anything that might make life easier for debtor nations.
The terrible thing is that Europe’s economy was wrecked in the name of responsibility. True, there have been times when being tough meant reducing deficits and resisting the temptation to print money. In a depressed economy, however, a balanced-budget fetish and a hard-money obsession are deeply irresponsible. Not only do they hurt the economy in the short run, they can — and in Europe, have — inflict long-run harm, damaging the economy’s potential and driving it into a deflationary trap that’s very hard to escape.
Nor was this an innocent mistake. The thing that strikes me about Europe’s archons of austerity, its doyens of deflation, is their self-indulgence. They felt comfortable, emotionally and politically, demanding sacrifice (from other people) at a time when the world needed more spending. They were all too eager to ignore the evidence that they were wrong.
And Europe will be paying the price for their self-indulgence for years, perhaps decades, to come.
Kaj pa Švicarji?
Ah, Switzerland, famed for cuckoo clocks and sound money. Other nations may experiment with radical economic policies, but with the Swiss you don’t get surprises.
Until you do. On Thursday the Swiss National Bank, the equivalent of the Federal Reserve, shocked the financial world with a double whammy, simultaneously abandoning its policy of pegging the Swiss franc to the euro and cutting the interest rate it pays on bank reserves to minus, that’s right, minus 0.75 percent. Market turmoil ensued.
And you should feel a shiver of fear, even if you don’t have any direct financial stake in the value of the franc. For Switzerland’s monetary travails illustrate in miniature just how hard it is to fight the deflationary vortex now dragging down much of the world economy.
Continue reading the main story
RELATED IN OPINION
Regime Change in SwitzerlandJAN. 16, 2015
What you need to understand is that all the usual rules of economic policy changed when financial crisis struck in 2008; we entered a looking-glass world, and we still haven’t emerged. In many cases, economic virtues became vices: Willingness to save became a drag on investment, fiscal probity a route to stagnation. And in the case of the Swiss, having a reputation for safe banks and sound money became a major liability.
Here’s how it worked: When Greece entered its debt crisis at the end of 2009, and other European nations found themselves under severe stress, money seeking a safe haven began pouring into Switzerland. This in turn sent the Swiss franc soaring, with devastating effects on the competitiveness of Swiss manufacturing, and threatened to push Switzerland — which already had very low inflation and very low interest rates — into Japanese-style deflation.
So Swiss monetary officials went all out in an effort to weaken their currency. You might think that making your currency worth less is easy — can’t you just print more bills? — but in the post-crisis world it’s not easy at all. Just printing money and stuffing it into the banks does nothing; it just sits there. The Swiss tried a more direct approach, selling francs and buying euros on the foreign exchange market, in the process acquiring a huge hoard of euros. But even that wasn’t doing the trick.
Then, in 2011, the Swiss National Bank tried a psychological tactic. “The current massive overvaluation of the Swiss franc,” it declared, “poses an acute threat to the Swiss economy and carries the risk of a deflationary development.” And it therefore announced that it would set a minimum value for the euro — 1.2 Swiss francs — and that to enforce this minimum it was “prepared to buy foreign currency in unlimited quantities.” What the bank clearly hoped was that by drawing this line in the sand it would limit the number of euros it actually had to buy.
And for three years it worked. But on Thursday the Swiss suddenly gave up. We don’t know exactly why; nobody I know believes the official explanation, that it’s a response to a weakening euro. But it seems likely that a fresh wave of safe-haven money was making the effort to keep the franc down too expensive.
If you ask me, the Swiss just made a big mistake. But frankly — francly? — the fate of Switzerland isn’t the important issue. What’s important, instead, is the demonstration of just how hard it is to fight the deflationary forces that are now afflicting much of the world — not just Europe and Japan, but quite possibly China too. And while America has had a pretty good run the past few quarters, it would be foolish to assume that we’re immune.
What this says is that you really, really shouldn’t let yourself get too close to deflation — you might fall in, and then it’s extremely hard to get out. This is one reason that slashing government spending in a depressed economy is such a bad idea: It’s not just the immediate cost in lost jobs, but the increased risk of getting caught in a deflationary trap.
It’s also a reason to be very cautious about raising interest rates when you have low inflation, even if you don’t think deflation is imminent. Right now serious people — the same serious people who decided, wrongly, that 2010 was the year we should pivot from jobs to deficits — seem to be arriving at a consensus that the Fed should start hiking very soon. But why? There’s no sign of accelerating inflation in the actual data, and market indicators of expected inflation are plunging, suggesting that investors see deflationary risk even if the Fed doesn’t.
And I share that market concern. If the U.S. recovery weakens, either through contagion from troubles abroad or because our own fundamentals aren’t as strong as we think, tightening monetary policy could all too easily prove to be an act of utter folly.
So let’s learn from the Swiss. They’ve been careful; they’ve maintained sound money for generations. And now they’re paying the price.