Brussels responds to the debate over fiscal multipliers

BRUSSELS – “Recent academic papers on fiscal multipliers offer little guidance on the specific case of Greece,” Simon O’Connor, spokesman of European Economic and Monetary Affairs Commissioner Olli Rehn, told Sunday’s Kathimerini.

“In 2009, the fiscal deficit had reached 15 percent of GDP and markets were no longer willing to finance Greece’s high debt levels. It was this situation that led to the launch of the financial assistance programme in the spring of 2010. However, persistent uncertainty and problems with implementation in the first years of the program meant that the Greek economy did not benefit from the confidence effects that should have mitigated the short-term impact of fiscal consolidation,” O’Connor added.

“Since last summer, the Greek program has been brought decisively back on track. A great deal has now been achieved in Greece in terms of fiscal consolidation and the implementation of growth-enhancing reforms. The agreement in the Eurogroup last December has removed the damaging uncertainty that had been hanging over Greece for too long, and paved the way for a return of confidence. It will now be up to Greek authorities to ensure through determined implementation of the reform programme that this confidence continues to grow,» concludes the EU official.

Many economic analysts share different views to the Commission with regard to the design of the Greek program and the issue of fiscal multipliers.

Benedicta Marzinotto, a research fellow at the Bruegel think-tank in Brussels, says: «In measuring the growth effects of fiscal austerity, international institutions have been using the same parameters they used in the past, possibly underestimating the fact that the euro zone has been going through exceptional times and circumstances. There are a number of reasons why this time is different.

“First and most importantly, monetary policy and exchange rates cannot be used to soften the recessionary impact of fiscal consolidation, and this is quite obvious and should have been accounted for.

“Second, the credit channel itself was impaired but the EU and the IMF have no «jurisdiction» over the amount of credit that flows into the Greek financial system, it is something they would have not been able to fix, plus when the Greek crisis imploded and the first adjustment program was put together the EU was not yet ready to think of European solutions to address the fragmentation of credit markets (ie. banking union).

“Third, fiscal austerity was being implemented simultaneously in other European countries, which would reduce crisis countries’ possibility to grow through exports and here the problem is institutional more than anything else: adjustment programmes are country-specific by definition, the mistake here is to treat assisted countries like «special cases» whilst everybody else is subject to the standard economic policy coordination exercise (i.e. European Semester), by contrast it would be more useful if they were considered an integral part of the, now enhanced, policy coordination cycle in the euro area».

There has been concern and disquiet in Brussels with regard to the IMF’s report on fiscal multipliers, which has gained much attention in Greece. Officials that were involved in negotiations regarding the design of the Greek program say that when looking at a “unique case” like Greece, it is futile to discuss multipliers because the country was cut off from the markers. However, the indirectly admit that the magnitude of the Greek problem may have been underestimated when the program was drawn up. However, they add that they had to work with the funds that were made available at the time.

With regards to the memorandum’s forecasts being wrong, Brussels sources stress that the predictions for 2010 were more or less correct. However, they add that from the fall of that year, a number of obstacles started appearing. For example, while Greek bond spreads were dropping, the meeting between Angela Merkel and Nicolas Sarkozy in Deauville, when the issue of restructuring the debt of eurozone countries first entered the agenda, was enough to send spreads skyrocketing. Then unpredictable events such as political instability and the call for a referendum heightened uncertainty.

According to experienced technocrats, these events damaged the funding of the private sector, led to major deposit outflows and worsened the recession and unemployment. The Greek state was being financed by the eurozone but the cost of borrowing in the private sector was outside of the limits of the program and could not be controlled.

The same sources said that if the uncertainty disappears and reforms in crucial sectors of the economy progress then there could be a complete turnaround in the multipliers, as happened in the case of Latvia.

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