Interesting times we live in. That said, when an economist says ‘interesting’, it, of course, means that something somewhere is going wrong. Well, it is. While Greek freshly elected government is desperately trying to negotiate an extension of the bailout program with Germans, the rest of the 18 countries of the Eurozone confront the consequences in a form of deflation, and hopeless attempts to abate it via monetary-expansion measures.
The outlook does not seem to be too optimistic, and some experts even forecast a possible Grexit (if Greece leaves the Eurozone), or the country’s default. With the debt-to-GDP ratio of over 175 per cent, it is not hard to see the reason for such disquiet. Even though that scary scenario is still highly unlikely, the question is: what should other European countries do in order to save the day for Greece and the Eurozone?
First of all, a common mistake would be to think that if Greeks owe money, the rest of the countries should simply make them pay, oblivious of the fate of Greece. Let us go back in history for a moment. After World War II the Allied Countries made Germany pay enormous reparations, which set an already war-exhausted economy into an even deeper economic plunge. Although the situation here is different, because Greeks have to pay their debt, not reparations, the outcomes might be very similar: a more profound recession, or even economic collapse of Greece. The choice is then very simple: force Greeks to pay back the debt today, and they will not pay it back at all, because their recessed economy will be crashed completely.
That said, the EUR 300 billion worth of debt is only part of the problem. And while EUR 300 billion is a lot, it is not the biggest aftermath of the possible Greek collapse. If things go badly and Greece quits the Eurozone, it might engender a whole chain of events. Greece might be the first sailor to leave the boat, but more may follow. This would inevitably lead to further devaluation of the euro, due to high risks associated with a potential collapse of the Eurozone as a whole. However, this worst-case scenario still seems to be very improbable, so let us take a look at some of the more plausible consequences.
Mercifully, the largest economic shake-up of the modern times has passed, and the people in charge of the world’s economies are trying to restart the entire mechanism. This, however, is a tall order, and the authorities will have to use every trick in their magic box to cope with it. As we all know thanks to Morten, there are two mainstream ways of dealing with crises: using monetary and fiscal instruments. The latter one means acting on advice of Lord J. M. Keynes and executing the so-called fiscal expansion, reducing taxes and increasing government spending. This would mean running budget deficits in the short run that would be offset by budget surplus in the long term. Also, and it is critical,the effectiveness of such a measure would be less dependent on the people’s expectations (an increase in disposable income will always trigger consumption to grow, the same applies to an increase in government spending). The importance of the statement in italics will become obvious when we analyze the other measure of crises-battling.
The monetary measures imply trying to achieve monetary expansion, hence stimulating investments due to lower interest rates (‘cheaper’ money). Apparently, this is what the ECB is now trying to pull off with their profound, EUR 1 trillion quantitative easing program. This, however, does not seem to be working, because investment is probably the hardest component to stimulate. The hallmark of private investments as a component of GDP is the fact that they are very much dependent on economic agents’ expectations about the future. And in the current geopolitical and economic situations, those expectations are far from needed. This explains why, despite zero interest rates in most countries, investment spendings are still stuck. Worse still, this means that the QE may most probably be of no value, if the future outlook does not change.
The last and the most important question is simple: what to do? The obvious answer could be to abandon the QE and use fiscal tools instead. However, such changes would be too extreme and too audacious for the world that still very well remembers the pain of the last crisis. Various political reasons, personal beliefs and uncertainty about the future, even among global leaders, put constraints on fiscal policy as a measure of boosting the economy.
The only way out then is trying to act like John Roosevelt in the 1930’s, when his duty was to reignite the American economy after the largest crisis of all times. Being rather skeptical about fiscal expansion, he also did not give it too many chances. Instead, he did something that the world’s authorities should be trying to do now: persuade people that tomorrow will be better than today. As simple as it sounds, that one thing could set the Europe’s economy on the right track.
And you know what? For that, we might want to keep Greeks on board.