Why the Greek bailout won’t work

May 3, 2010

Paul Krugman has an intriguing pair of back-to-back blog entries. On Sunday afternoon, he wrote this:

The plan still requires savage austerity on Greece’s part, and ensures a terrible few years for the Greek economy. But it does rise to the scale of the problem, and it might work.

Then, on Monday morning, he followed up with this:

Anyone demanding that countries not run such big deficits is, in effect, calling for higher taxes and slashed spending in the face of a deep recession — Hoovernomics. Is that really what they want? Is that their final answer?

I’m more on board with Monday Krugman than with Sunday Krugman. Steven Erlanger has a good analysis in today’s NYT:

There are serious questions about whether the deep cuts in salaries and benefits the agreement calls for are politically sustainable over time, even as deflation will make it impossible for Greece to grow its way out of debt…

“How can Greece grow out of its debt if there is deflation?” asked Jean-Paul Fitoussi, a professor of economics at the Institut d’Études Politiques in Paris. “Deflation increases the debt burden, so we are following this virtuous circle that is bringing us toward hell. Economics has nothing to do with virtue, which can kill an economy.”…

“Unfortunately for economists, there is democracy,” Mr. Fitoussi said. “If you impose too strict a program, the population will refuse.” Some countries, he acknowledged, have responded quietly so far to deep cuts, like Ireland and Latvia. “But Greeks are not Latvians,” he said, citing serious worker demonstrations already this weekend.

The fact is that the bailout package really doesn’t address the problem, which is one of solvency rather than liquidity. The European loans are being extended at about 5%, which while much lower than market rates is still not low enough to make anything approaching a dent in Greece’s debt dynamics. And by the time the bailout package is exhausted, if Greece even gets that far, its debt-to-GDP ratio will be significantly higher than it is right now, thanks to both a rising numerator and a declining denominator.

So the prospects of an imminent default seem to have eased: Greece will almost certainly have the money to roll over the debts coming due in a couple of weeks. But this is not a solution to the Greek problem, even if Greece successfully implements all the austerity that it’s promising. Which it won’t.


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