From Grexit to Growth,or Trapped in Recession?

Nicos ChristodoulakisAthens University of Economics & Business,

and Hellenic Observatory LSE

Brussels, November 2013

The Adjustment …

Fiscal deficits backat pre-crisis levels

Greece from -16% -4% in 2013Ireland from -32% -5% in 2013

External deficits all in surplus

Source: Ameco Database, 2013

The Result …

All economies in serious contraction for six consecutive years Greek economy collapsed by -23% of GDP

Source: Ameco Database, 2013

Output gap from potential GDP much higherand proportional to the intensity of austerity programs

The intensity of austerity the size of adjustment programs as % GDP, per country j=GR, IR, IT, PT, SP and GE

Source: Financial Times

http://www.ft.com/cms/s/0/feb598a8-f8e8-11e0-a5f7-00144feab49a.html#axzz2JSOwncys.

Recessionary impact is defined as

a simple time-trend projection in 2000-2007

For details: Christodoulakis (2013), Austerity and Recession in the Euro Area

As austerity gets more intense, its impact becomes stronger

This is in sharp contrast with the early optimism adopted by IMF and ECB, that a front-loaded adjustment would have only small and transient effects

Optimism #1: The growth impact of fiscal consolidation was estimated to be mild and in any case disappear soon

IMF WEO Report (2010, p. 94):• The deflationary impact would be limited and recession would bottom-out in late 2010 and gradually rebound afterwards.

• A fiscal correction by 1% of GDP, reduces output by 0.50% and raises unemployment by only 0.30%.

Optimism #2:The optimal-debt theoriesDebt to GDP above a range 80-90% is detrimental to growth

AER: Reinhart and Rogoff (2010) IMF: Kumar and Woo (2010) OECD: Cecchetti et al (2011) ECB: Checherita and Rother (2010), Baum et al (2012).

Thus, Governments should “… swiftly implement ambitious strategies for debt reduction

Unemployment from 8.5% to 27%

Debt from 125% in 2009 to 180% of GDP in 2013!

GREECE: Fiscal Punishment and Failure

The snow-ball effect on debt in Greece and the Euro area

After 2008, Greece adds 5-15% of GDP on debt

every year, solely due to the lack of Growth

Greece

Euro17

The case of Greece: Major shortcomings

1.Private sector salaries fiercely attacked 2.Public sector universally cut, hitting incentives

3.Too many taxes, most on the same households

4. Banks’ recapitalization by issuing new public debt

5.The Grexit scare: lack of strategy, referendum, etc

6.RECESSION: Debt burden increases in recession

2012

Non-Oil Exports improved in 2012 by only 3.90% vs. 2011despite a wage cut by -23% in the private sector

Source: Bank of Greece, Conjectural Indicators, Aug 2013

Domestic Devaluation and Competitiveness

2013

2012

Income Tax Revenues not improving, despite rates surgingIn 2013, nearly 1.5% GDP below 2012

Source: Bank of Greece, Conjectural Indicators, Aug 2013

VAT rates rise, VAT Revenues fall !

Recapitalization

Debt fully restored

Bailout Installment

Banks

Govt. Debt

PSI 2012 had only limited effect in cutting debtI.Banks recapitalization annulled most of the “haircut”II. Haircut in Social Funds, no effect on current debt of GG

haircut

CapitalInjection

Social Funds

Central Government

GG Debt cut = 0

PSI+

haircut

PSI+

PREREQUISITES for Exiting Recession in Greece

1.Recapitalize Banks via EFSF, not Greek Public Debt(Financial Times, editorial, 22/2/2013) 2.Change the Policy Mix: More reforms, less austerity More Public Investment

Fewer taxes to raise demand & liquidity Selective actions, no universal cuts

3.Create a Growth Front: More CSF, EIB initiative

4.For credibility, endorse fiscal rules in the Constitution

The official scenario (European Economy, 2012)

2012 2013 2014 2016 2017 2018 2019 2020

GDP growth real (%) -4.70 0.00 2.50 3.00 2.80 2.60 2.50 2.30

Gross debt (% of GDP) 160 164 161 145 137 130 123 116

Primary surplus (%of GDP) -1.00 1.80 4.50 4.50 4.50 4.30 4.30 4.30

Impossible figures !!!

An alternative scenario with more growth, less austerity

1. Primary surplus less by 2% of GDP. From 4.5% to 2.5% per year Finance Public investment, cut taxes, etc

2. Growth higher by 1.80 to 3.40% per year (according to the higher fiscal multipliers)

Result: Debt/GDP ratio falls more, because of the snow-ball effect

All failed!!!

More investment, fewer taxes can spur growth,cut unemployment & achieve debt sustainability

Debt Forecast 2020: Push Less to Get More

Some General Conclusions:

1. Before the crisis, fiscal multipliers were very low. Fiscal policy homogenized via SGP,

growth affected by other structural factors.

2. After the crisis, countries got differentiated Fiscal cuts seriously affected incomes.

3. Intense and front-loaded austerity programs fuelled uncertainty and caused deep recession

4. Adjustment programs should relax immediately, thus causing milder effects on recession