Why the Greek bailout won’t work

By Felix Salmon
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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Step 1: Denounce speculators;
Step 2: Bail out speculators.
Step 3: Declare victory.

Posted by johnhhaskell | Report as abusive

Felix, you are right. Public wage cuts are appropriate but this is massively deflationary. Something serious would need to compensate, such as money-financed tax cuts. Otherwise most debt in Greece must necessarily go bad, having been stranded by deflation. Will that be enough for Greece to tell the EU to shove it?

Posted by DanHess | Report as abusive

I think the two Krugmans are reconcilable. In a country that wishes to grow out of deficits via exports (i.e., foreign consumption), deflation is fine (if the alternative of devaluing the currency is off the table). In a country like the US that wishes to grow out of deficits by stimulating domestic consumption, deflation is not fine. The Greek bailout package demands that Greece take the medicine of deflation in exchange for the time it needs for deflation to work. I don’t share your pessimism; I’m more worried that the required austerity will permanently damage the good that is the Greek welfare state than that the bailout will fail to get Greece through its fiscal troubles.

Posted by Wismar | Report as abusive

I should add that I don’t quite understand the worry that deflation increases the debt burden for the country seeking export driven recovery. Cheaper exports increases the flow of revenues from abroad making it easier to pay down debt. The debt burden problem happens when deflation hits a country seeking to recover through domestic consumption.

Posted by Wismar | Report as abusive

Felix, it just seems that it is keeping the ball up in the air but not solving the problem. Similar to what we are doing here in the good USA with the banking system. And it seems that many writers agree. Most are not impressed with the bailout. Titles such as “Greece bailout will do nothing” are commonplace (http://www.socialnews.biz/tag/Greece)

Posted by dantes1807 | Report as abusive


Put most simply deflation is a decrease in the money supply. With deflation there is less money sloshing around the system with which to repay debts.

Suppose the whole nation takes a 15% pay cut. That would mean a government revenue drop because taxes would drop as income and consumption drop. Nominal GDP would also drop. Then the debt-to-GDP ratio is actually higher because GDP is smaller. So the debt burden has increased.

Unfortunately it does not stop there, because in deflationary depression with incomes declining, default rates in the private sector increase sharply. Defaults reduce the money supply further (remember that in a fractional reserve system when a bank lends money, money is created; when there is a default or loan repayment without new lending, money is destroyed).

As money supply declines further, debts become ever more difficult to service and defaults increase. This is the deflationary spiral that central bankers fear, and it was at the heart of the Great Depression.

How long could deflation go on? Consider that for the last thirty or forty years prices and nominal debt values have risen steadily on waves of credit expansion rather than on creation of new base money.

If all that leverage came back out of the system and nominal prices and wages reverted back to 1980 levels or whatever, most debt, based on 2000s nominal prices, would be completely stranded, and totally unservicable. Many people who took out apparently conservative mortgages and loans would be stuck, as would the government.

How to escape this? When credit-money collapses, there must be new money created. Ben Bernanke understands this, God bless his bubble-unaware heart! Consider the massive amount of quantitative easing (money out of thin air) and government borrowing and how little inflation there has been. That should tell a person how strong the countervailing deflationary winds have been.

Greece has no Ben Bernanke, only hard money. They are straddled the bomb, waving a cowboy hat vigorously in hand as they ride that baby down to Earth. I wish them the best of luck and my condolences.

Posted by DanHess | Report as abusive

From Munchau:

http://www.ft.com/cms/s/0/461663a0-5613- 11df-b835-00144feab49a.html

“Angela Merkel and her inexperienced economic advisers have no idea about the dynamics of sovereign crises. They never bothered to look at the experience of other countries, notably Argentina. Waiting until the moment a country is about to fail – which is how the German chancellor interpreted the political agreement she accepted in February – constitutes an abrogation of leadership that is bound to end in financial ruin. It means that everybody, Germany especially, has to pay billions of euros more than would have been the case if the EU had sealed this in February.”

I agree with this, and have been generally agreeing with him throughout this crisis. As he says:

“So what is the endgame of the eurozone’s multiple crises? For Greece it will be debt restructuring, a polite term for negotiated default. The broader outcome is more difficult to predict: it will either be deep reform of the system or a breakup.”

I’m betting on deep reform because I can’t see Germany walking away from this even though it’s a hard road ahead and they’ll constantly temporize.

Posted by DonthelibertDem | Report as abusive


I very much appreciate your taking the time to discuss this issue with me. My thought is that your account mostly applies to the case in which a country hopes that domestic consumption will deliver it from fiscal crisis. In the case of Greece, exports, not domestic demand, are the tool of deliverance. Deflation cheapens Greek products, increasing foreign demand for them. Money flows in from abroad, arresting the deflationary spiral and setting the country back on track. As Felix alludes, Latvia and Ireland are following this path. It isn’t economically unsound; only politically difficult, wrenching, and potentially damaging to the welfare state.

Posted by Wismar | Report as abusive

Interesting! As far as know, Greece’s biggest export is tourism. If Greece plans to export its way out, they will therefore need to cut back on the rioting.

Seriously, what amount of deflation would make Greece competitive again? Thirty percent deflation?

By way of reference, during the Great Depression, there was a 27% decline in the price level, accompanied by a 46% decline in nominal GDP (or a 25% decline in real GDP).

Posted by DanHess | Report as abusive


It is assumed that deflation means a decline in nominal GDP. Unless you are proposing a scenario in which deflation is not accompanied by recession, the doomsday debt trap will not be defused by export growth.

Posted by wiretap | Report as abusive

The problem for Greece is the euro currency. They don’t have their own currency to degrade with financial gimmicks as the U.S. does. They will have to abandoned the euro, but the Greeks may not have much faith in their government’s paper either; certainly nobody else well. There is simply no fix for every big screw-up. They should have been mindful of the mess they were making. They shouldn’t be surprised others don’t care about cleaning it up for them.

Posted by dyllman | Report as abusive

The problem with Greece is Greece, well maybe not the only problem, but a major part of the problem. I’ve lived there, I have family there, I own property there, I pay taxes there, I am part of that society and I am comfortable pointing out some obvious truths. The society is inefficient, corrupt, and bereft of personal responsibility. In Felix’s post, he highlights the political problems with getting Greeks to accept the austerity (unlike the Irish and Latvians). Greeks are rejecting the policies not because they are unfair, but because they refuse to accept any responsibility in their present situation and wat other to pay for the solution.

We can debate whether this new course of action will work, or if it is optimal for Greece. But what is undeniable is that the Irish accepted responsibility for their situation, as did the Latvians. It is galling that the Greeks continue to insist that the problem is not theirs and that other in the EU should solve it.

It is especially galling because the Greeks are happy that the Irish have accepted austerity instead of coming to the Greeks for assistance. The Greeks are demanding exceptional treatment, and on this point, they’re wrong.

Posted by Kosta0101 | Report as abusive

Greece: Politics or Science?

“To relieve the present exigency is always the object which principally interests those immediately concerned in the administration of public affairs. The future liberation of public revenue they leave to the care of posterity.”
- Adam Smith, The Wealth of Nations (1776)

So, it’s 2010 and another financial crisis. This time, Greece. Greek politicians blame everyone but the perpetrators … they themselves. European politicians claim the way to relieve the crisis of debt is debt itself.

How about an alternative to this political “solution”? One based upon Science.

[(-4) + (4)] = 0

Firstly, describe the 4 negatives comprising the issue.
Context: A currency without a country nor a system of enforcement.

Antecedent: Rising interest-rates for Greek bonds.

Behavior: Greece promises to behave.

Consequence: EU and IMF agree to loan Greece more money.

Now, state the 4 positive steps toward resolving the issue.
Specify the Problem: An excess of spending by Greece.

Target a Goal: To have Greece abide by its initial agreements.

Plan: Agree to a reduction of the Greek deficit beginning now with completion within 3 years with specific benchmarks every 6 months (not in the latest agreement). Via a private agency, Greece tries to post a series of performance-bonds representing each benchmark. No governmental or IMF money.

Consequence of failure? Default. Game over. If successful, each new bond is posted after Greece has retired the previous bond.

Consequence of failure to retire a bond? Default. Game over.

Consequence of failure to secure the next bond in the series? Default. Game over.

Measurement: Responsibility falls upon the bonding agency. Greece gives full access to all financial records. The bonding agency pays the auditor. Consequence of not giving full access at any time or not passing the audit? Default. Game over.

The point is to resolve the crisis permanently scientifically not relieve it till the next election politically.

Gene Richard Moss
Author, Inescapable Consequences (2009)

Posted by Moss_GR | Report as abusive

Felix, you and the Monday Krugman are wrong.

How long is the recession proposed to last? 2 years? So ramp in the cuts so most of the effects fall outside of the “recession” period. You still need the cuts so you can sell longer term debt.

Then you go on to quote Erlanger who says that Latvia and Ireland have already made spending cuts, without facing a great depression. It wasn’t Hoover who made the depressions great, whatever Krugman demagogues, it was all of the other plans that prevented a proper reset in values.

The Euro, in some ways, is a great thing for economics, because it shows the weakness of people of like Krugman, whose irresponsible solutions of inflating away debt don’t work in a currency union.

Posted by mattmc | Report as abusive


You’re correct excepting the part about Herbert Hoover. HH not only prolonged the economic downturn of 1929, he created the context for FDR to turn the downturn into a truly great depression without end, were it not for WWII. I refer you to programs such as the RFC. In fact, during the campaign of 1932, FDR ran on a “balanced budget” and accused HH of leading America down the road to socialism. I submit that had Calvin Coolidge run in 1928, he certainly would have been elected, and America would have avoided not only The Depression but the profligate spending of HH, FDR, and their successors.

As I stated above, the point is to resolve these crises permanently not relieve them till the next election. The PIIGS, the Brits, and we Americans can do so only by applying the approach that succeeds so well everywhere else to our own behaviors; namely, that of Science.

Gene Richard Moss

Posted by Moss_GR | Report as abusive

Why can’t Greece face reality and emulate what Dubai World is doing? Restructure your debt into more manageable and realistic chunks which will not stunt growth (needed to service debt) and less straining to the general Greek public.

This will also provide the Greek government time and opportunity to restructure the economy for a more sustainable future.

Obviously, bringing in the EU and IMF will surely shackle the Greek economy into a recession for at least a decade.

Posted by EW75 | Report as abusive

Posted by johnhhaskell
Step 1: Denounce speculators;
Step 2: Bail out speculators.
Step 3: Declare victory.

When you refer to Speculators,
Do you intend it to mean Politicians who “Speculate” that they can borrow and dispense money to buy the votes of their subjects, while Speculating that they will be dead before the lenders or voters wise up to the impossible scheme?

Or could you be implicating the gullible believers of the gimlet eyed Politicians who handed over their hard earned and saved cash based upon the soverign promise to repay. That promise based upon their supposedly unlimited power to tax and extract cash from their happily retired and unproductive citizens of age 60 and above.

Posted by Augustus | Report as abusive

“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?”

The monday Krugman is an idiot. Continuing to overpay government workers and unions cannot possibly help Greece service its debt. The only other option to belt tightening is default.

Posted by inboulder | Report as abusive

as far as I know Mr. Roubini is in no position to have any idea whatsoever about Greek politics. So how can he pass judgement on whether cuts in public spending are acceptable or not ?
He may turn out to be right and he may turn out to be wrong, but this would be a random event, nothing more.

Posted by ggeorgan | Report as abusive