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The Greek Crisis: Uttering the Other "D Word"

Matías Vernengo

Default is not the dirty word that nobody wants to say.  Almost everybody now accepts that Greece will default.  Several people will prefer to use the euphemism of "re-profiling debts," but we all know what it means.  The interesting thing is that at least some authors, like Martin Wolf in a recent Financial Times column, also acknowledge that default is not sufficient.  The surprising thing that almost nobody asks is whether a default would actually solve the Greek problem.
Of course that would require understanding the problem in the first place.  And herein lies the problem, since most people still argue that the Greek problem is fundamentally fiscal.  In other words, in the conventional view the Greek government spent too much (and lied about it), and the solution must rely on the generation of sufficient fiscal surpluses to pay for the outstanding debt.  Further, to obtain the funds it is assumed that austerity is the way to go, privatizing public firms, cutting public sector wages, and reducing pensions.
Note that the cuts in spending hit public investment and social transfers, two items with relatively large multiplier effects, which is sure to have a significantly large negative impact on output and, as a result, on government revenue.  This is why fiscal austerity is self-defeating.  In Argentina, back in 2001, Domingo Cavallo tried to adjust the fiscal accounts with the "zero-deficit" law that prohibited the government from spending more than it raised in taxes.  The de facto economic laws that say that declining income reduces revenue took precedence over the de jure law, and Argentina had a budget deficit of around 6.5%.
Beyond that the only contribution of austerity to resolving the real issue, which is related to the large current account deficits (as I noted in a previous post), is that austerity restricts imports.  But austerity can only resolve the current account at the price of permanent stagnation and worsening fiscal balances, without creating capacity to repay outstanding debt.  So it is clearly not a solution, and, as correctly pointed out by Krugman, the Argentine example actually shows that default is necessary.
However, it is important to emphasize that default, although necessary, is not sufficient for economic recovery in Greece.  It is true that Argentina (and Iceland, for that matter) did very well after their defaults.  But Argentina also devalued its currency after more than a decade of a fixed nominal exchange rate pegged to the dollar.  The current account switched swiftly from deficits to surpluses, and combined with boosting exports and the recovery of domestic activity, fiscal revenues increased, leading to an improvement of the fiscal accounts.  Further, a strong renegotiation of the debt allowed for lower levels of indebtedness, so that fiscal consolidation resulted not from fiscal austerity (which actually failed) but from economic growth.
Most analysts fall short of mentioning the other dirty d-word, devaluation, because this would imply a break of the eurozone.  Yet, if default is inevitable, but insufficient to resolve the Greek dilemmas, no other alternative remains.  There are those who suggest that a move towards a more comprehensive European Union, boosting transfers from a larger European fiscal authority, would be part of the solution.  Or even that Germany should increase its real wages and boost spending to reduce its current account surpluses, to make the adjustment in the peripheral countries less painful.  But those seem clearly out the question.  Neither Germany nor the European Central Bank (or the IMF) seems to be willing to break from the austerity plan.
Holding to the euro, and accepting the austerity measures, is fundamentally a mechanism to punish the Greek population and transfer resources to German banks.  The euro, like dollarization in some Latin American countries, generates more problems than solutions.  I said it before: the euro is dead.  Greece should decide how long it will tie its future and the welfare of its own people to a failed model of monetary integration.  Tragedy may be a Greek invention, but there is no reason for the government to force its own people to live through it as a sort of morality play.


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