Some Greece stuff

Greece blinks first...

And here are some arguments for and against cancellation of Greek debt, from tutor2u:

 Discuss the view that the Euro Area would benefit from Greece having some or all of their debt cancelled.

 Greece currently has one of the largest public debt to GDP ratios, standing at around 175% (although a recent Forbes article did try to claim that it was actually just 18%1) with a bond yield of 10% - far above the 6% critical point where debt is seen as manageable in terms of repayment. It is also currently entering its sixth year of recession that has led to a 27% fall in real GDP and to 26% unemployment, primarily demand- deficient. As a protest to the Troika at the government's inability to have some of this massive debt cancelled, the left-wing Syriza party was recently elected to power who strongly oppose the austerity that has been imposed on them and have threatened to leave the Eurozone.

But the question remains of how far Greece is being constrained by the inability to spend and whether a debt cancellation is a viable option - a question that shall be considered today. The first and most significant argument for a partial or total debt cancellation is that it would give a hamstrung Greece greater flexibility in fiscal decisions. Given the current depression that might translate into an increase in government spending which may in turn help reverse the current, damaging economic trend.

 An increase in Greek growth would almost universally benefit other countries in the Euro Area - as it grows it would increase the trade between Greece and other countries, which via traditional theories such as Ricardian comparative advantage would be beneficial overall. Furthermore, as many New Keynesian economists (such as Olivier Blanchard) have stressed, the fiscal multiplier in times of recession is particularly high. Thus the ability to increase government spending at this time could lead to substantial growth and thus trade in the euro area. Furthermore, given the extent of the recession, it is important to stem it as soon as possible. Once a recession drags on for too long (and there is a case that it already has), human capital in particular deteriorates as hysteresis occurs. 

Therefore, the debt cancellation should be made as it is unlikely that the Hellenic economy will grow its way out of this recession naturally before permanent long term damage is indicted on the labour force.

However, as with all debates surrounding the government, there is the question of the competence of the government. Unfortunately, one only has to look at the 2004 Greek Olympics to see that increased government spending does not necessarily lead to sustained long run growth (the infrastructure put in place for the event now contributes next to nothing in the long run productive potential of the economy.)

Indeed, the argument could be made that enforcing painful debt repayments would help encourage better governance. It could be the case that this short term pain is necessary for long term gain, and this is something worth bearing in mind. On a similar note, Greece is in a special situation in its relationship with the Euro Area, as highlighted by the popularity of the term "Grexit".

There is no doubt that Greece leaving the Euro Area, at least in the short term, would be disastrous for the Euro Area. It would immediately create huge instability, which naturally translates into the debt markets asking for a higher risk premium. This could cripple countries such as Italy and Portugal who already have nearly unmanageable levels of debt and lead to another debacle as seen in 2012 and usher in another few years of stagnation.

 Debt relief would be particularly effective in quelling, at least to an extent public unhappiness at the Eurozone. As Kevin Featherstone correctly remarks, "despondency is everywhere" in Greece, and although it is true that the vast proportion of Greeks want to keep the Euro, a few more years in the same situation will no doubt lead to a general rethinking - a rethinking that could have disastrous impacts on the Eurozone.

On the other hand however, would it be so bad if Greece did leave the Eurozone after all? One channel of benefits is that the drachma would not doubt depreciate massively against the euro which could lead to an export led recovery for Greece - the Hellenic tiger as dubbed by King. Furthermore, Greece is currently mired in deflation of -2.61%. This is bad for other Euro Area countries not simply because Greece will not grow and thus not trade as much but moreover because there is the heightened risk in a monetary union of exported deflation whereby other countries' exporters have to drop their prices to match this of Greece, thus bringing deflation into their own countries.

This obviously leads to all the detrimental effects of deflation, such as debt deflation and a decrease in consumer and business spending. On the other hand there are arguments against Greece being given a debt relief. Despite all the attention attracted by the election of Syriza, there are numerous other countries that have exceedingly high debt to GDP ratios, such as Spain (92%), Italy (114%) and Portugal (134%).

Should Greece be granted partial or total debt relief, then the natural response of these countries is to ask for the same. Should debt relief be granted, this could create a dangerous atmosphere driven by moral hazard within the Euro Area. Arguably this could be beneficial in the short term - numerous commentators including Martin Wolf have cited the lack of expansionary fiscal policy in the demand deficient Eurozone as a key cause of the stagnation there.

However in the long term, there are distinct drawbacks to this. Governments would no longer feel such restraint in their public finances which would become inflationary once the output gap in the Eurozone (which admittedly is embarrassingly high at the moment) closes. Whilst it is up for debate whether such an inflationary focus of the ECB is beneficial, the ECB currently does have the mandate of price stability, a mandate it would be unlikely to be able to keep to were government's allowed to spend safe in the knowledge that debts were likely to be cancelled. Whilst to the right wing this may be a compelling argument, it seems broadly unfair to argue that the lives of the Greeks should be mired in suffering simply due to the risk of future profligate governments.

 Indeed, it would appear that with some chronically high unemployment, especially among the youth, the likelihood is that the "lesson" has been learnt by the Greek people and indeed by other countries. So even if all the debt of the PIGS countries was brought down to say the Eurozone average that would not, in my opinion, suddenly lead to a huge amount of profligacy by governments. Finally, there is one weak point that should be mentioned.

This is that whilst debt relief is useful to governments in the short term, it cannot sustain long term growth. Theoretically and artificially this does indeed make sense - it is akin to huge privatisations that lead to a nice spike in public revenues but is not a model for long term sustainable healthy government finance.

However when the context of Greece is looked at it is clear that the long term is very much the not-important term. With all the damning statistics about their macro-fundamentals as well as reports on widespread unhappiness, it becomes clear that the policies Greece needs are those that address its problems that it is facing here and now.

Therefore I find this argument distinctly contrived and worthless. In conclusion, I would like to talk about something which is often not discussed when talking about the Greek and indeed European debt crisis, and that is the comparably huge levels of private-debt to GDP ratios. As the economist Tim Jones puts it "European and Greek banks have been bailed out, whilst a debt has been left with the Greek people." Indeed with Greek consumption having fallen by 40% over the last six years, it may be more effective if the debt cancellation in question was targeted at private debt and not public debt. As Giovanni Dell'Ariccia argues, the time lags involved in governmental decisions make policies aimed at relieving private debt more effective at stimulating an economy. Furthermore, it would remove the main drawback - the creation of moral hazard, and thus be less risky as a policy choice.