COMMENT

The debate on the Greek program

By Olivier Blanchard

Is Greece’s memorandum with the troika responsible for the difficult situation that the country now finds itself in? There has been much debate over this point in Greece, and more recently the debate has drawn in the International Monetary Fund’s work on fiscal multipliers, with the claim made that a defect in the original program design has been responsible for the depth of the recession.

It is certainly correct that Greece has underperformed projections: Output has fallen steeply, unemployment has risen to an unacceptably high level, and inflation has not fallen as far as expected. But to associate this with program design represents a fundamental misreading of the historical record and of the IMF’s research on fiscal multipliers.

The problems Greece is facing come fundamentally from past excesses. By 2009, fiscal deficits and debt had reached critical levels and Greece had already fallen into recession. Huge trade deficits pointed to an economy that had lost competitiveness. There was no short cut to the need to adjust, a fact punctuated by Greece’s loss of market access.

Greece needed many things to go right for its adjustment to work as programmed. In a crisis program, there are always a lot of unknowns. Assumptions are based on past evidence and best estimates, be it the effects of fiscal policy, the effects of the real exchange rate on exports, the state of banks and credit conditions etc.

Regarding the fiscal multiplier, it is only one of many potential influences on economic outcomes, and in the case of Greece, its impact was dwarfed by other unanticipated factors. Contrary to expectations, Greece suffered a prolonged period of political instability and poor program implementation. Deposit flight caused very tight liquidity and credit conditions, investor confidence plummeted, and people – inside and outside Greece – began to question the country’s prospects within the eurozone. The steadily deepening confidence crisis was by far the main reason for the much deeper than anticipated recession.

The important thing is that the program was adapted as we all learned and adjusted our assumptions. For instance, at the urging of the IMF, the timeline for fiscal adjustment was extended by two years, the amount of total fiscal adjustment was reduced, and the size of the fiscal multiplier was increased. And when the economy drifted into an adverse circle of high debt, low confidence and deep recession, the IMF pressed Athens and Europe for a solution to Greece’s debt sustainability problem. Greece restructured its debts with its private creditors, and also received further support from its European partners in the form of substantial transfers.

Looking forward, what should be done? Given Greece’s debt position, and available sources of finance, there is no option but to continue with fiscal consolidation, where the country has already made significant progress. To ensure that this consolidation is socially fair and has broad political support, it is essential that the rich and self-employed pay their fair share of taxes.

Most importantly, priority must be given to overcoming entrenched resistance to structural reforms, in order to ensure that competitiveness is improved through higher productivity, rather than through painful wage cuts. Greece’s European partners have stressed that they will do “whatever it takes” to help as long as the program remains on track. The key to resolving the crisis thus continues to lie with Greece.

Olivier Blanchard is the chief economic counselor and director of research at the International Monetary Fund.

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