PAUL KRUGMAN-Greek Deal et al.

PAUL KRUGMAN --------http://krugman.blogs.nytimes.com/


May 2, 2010, 4:44 PM

Greek Deal

More serious than I expected.

The Greek fiscal problem has been turning into a death spiral, in which fear of default is driving up borrowing costs, making default even more likely. The EU has now, in effect, given up on trying to restore market confidence; instead, it’s going to break the death spiral by main force, providing Greece with all or almost all the financing it needs directly, at an interest rate much lower than the market was demanding.

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.

May 1, 2010, 8:47 AM

Why Devalue?

As the debate over possible departures from the euro heats up, there seems to a lot of confusion over the possible uses of devaluation. The main argument I’m hearing goes like this: since Greece’s debt is in euros, devaluing won’t relieve the debt burden — so it won’t help.

But that’s missing the point. True, devaluation wouldn’t reduce the debt burden. But it would reduce the macroeconomic costs of fiscal austerity.

Think for a moment about Greece’s predicament now, even if it were to default on its debt. It’s running a huge primary deficit, so even if it were to stop paying any debt service it would be forced to slash spending and/or raise taxes, to the tune of 8 or 9 percent of GDP.

This would have a massively contractionary effect on the Greek economy, leading to a surge in unemployment (and a further fall in revenues, making even more belt-tightening necessary).

Now, if Greece had its own currency, it could try to offset this contraction with an expansionary monetary policy — including a devaluation to gain export competitiveness. As long as it’s in the euro, however, Greece can do nothing to limit the macroeconomic costs of fiscal contraction.

And that’s why a devaluation would help — it wouldn’t reduce the need for fiscal adjustment, but it would reduce the costs associated with fiscal adjustment. As I argued yesterday, this difference is an important reason why Britain, with a primary deficit as large as Greece’s, isn’t in anything like the same amount of trouble.

Or to put it another way, exchange rate flexibility doesn’t solve fiscal problems by itself — but it makes solving such problems much easier.

April 30, 2010, 9:52 AM

Why Isn’t Britain In More Trouble?

There have been various versions of the “Britain is the next Greece!” story out there; a good rundown at FT Alphaville. As they note there, however, the CDS and bond markets don’t seem to agree:

So is Britain different, and why?

Some of the raw budget numbers are daunting: according to Eurostat, Britain ran a primary deficit — that is, a deficit not counting interest payments — of 9.5 percent of GDP last year. That’s larger than Greece’s 8.5 percent.

Against that, Britain had debt of “only” 68 percent of GDP, compared with Greece’s 115 percent.

But the really big difference is in economic prospects. Britain’s recovery hasn’t been as strong as one would like — but the economy is growing, and since deflation looks unlikely thanks to the floating exchange rate, Britain can expect to see growth of several percent a year in nominal GDP. Greece, on the other hand, is in the euro straitjacket, and is probably condemned to years of depressed activity and deflation; S&P says it won’t regain 2008 nominal GDP until 2017, and that sounds optimistic to me.

To see the implications, imagine for a moment that both Greece and Britain were paying 5 percent on their debt, but that Britain was expecting 3 percent nominal GDP growth, Greece zero. Then Britain would need to run a primary surplus of 1.5 percent of GDP to stabilize the debt/GDP ratio; Greece would have to run a surplus of 5.75.

Wait: there’s more. Britain can expect some “automatic” decline in its primary deficit as the economy recovers; Greece can’t.

And one more thing: Britain can offset the depressing effects of fiscal austerity with loose monetary policy; Greece can’t.

What all this suggests is that while Britain faces a nasty adjustment, it’s within the realm of possibility; Greece, even if it had retained market confidence, would face an adjustment at least two or three times as severe. Naturally, then, Greece has lost market confidence, turning the situation into a death spiral.

So Britain isn’t Greece – largely because it still has its own currency.

Really, that should be Gordon Brown’s slogan: “He kept us out of the euro.” And that’s the saving grace of the situation.