Early steps by households to prepare for recession may result in quicker recovery

Greece’s ability to meet its ambitious fiscal deficit targets and avoid a multiyear stagnation trap will depend on the way consumers behave and whether business spending picks up. Two schools of thought appear to be emerging at this point, an optimistic and a pessimistic one, and it remains to be seen which will turn out to be correct. If pundits are right, the Greek economy may shrink by 3 to 3.2 percent in 2010 compared to 4 percent projected in the program agreed with the EU, the ECB and the IMF. This will give some breathing space to the country to attain the reduction of this year’s budget deficit to 8.1 percent of GDP from 13.6 percent or more in 2009, despite a likely slippage in revenues as the recession bites more and more. Perhaps this news has encouraged a small bunch of bankers and economists to turn more optimistic on the growth outlook of the country. However, what seems to have played a role in turning more positive is the assumed behavior of the average Greek household in six to eight months from now. Although the consensus among market participants, many businessmen and others is that the Greek economy is still at the beginning of a difficult journey marred by economic recession, some take a different approach. They argue the local economy may be close or at the bottom of the recession and will start sending signals of stabilization in the second quarter of 2011 and positive growth in the second half of the same year. Their main source of optimism is an unlikely fellow: the average Greek consumer. According to them, the average household started restraining spending at some point in 2009 – that is, well before the recession became obvious to everybody. This happened despite the fact disposable incomes were rising and unemployment had not yet begun climbing. Some call it precautionary savings while others refer to the Ricardian equivalence theorem in economics to suggest it was a natural reaction to an expected increase in taxes and spending cuts to balance the state budget deficit. It is noted that the theorem, which owes its name to 19th-century economist David Ricardo, was advanced by Harvard professor Robert Barro in the 1970s to suggest the public will save any extra money to pay for anticipated future tax increases aimed at reducing the public debt. That’s why some call it today the «Barro-Ricardo equivalence proposition.» According to this notion, the average Greek household has adjusted its consumer spending downward before any negative events took place, such as cuts in wages and salaries, a rise in taxes and a pick-up in unemployment. If the economy does not break down and the unemployment rate does not skyrocket, then the argument goes that consumer spending is going to stabilize and make a full circle. This is expected to happen in the first half of 2011. The likely attainment of fiscal targets is likely to boost consumer confidence even further, optimists say, making the recovery of the Greek economy more likely in the second half of 2011. It is noted the importance of consumer spending in the local economy is paramount. Consumption spending accounted for more than 86 percent of GDP between 2000 and 2009, being the highest in EU-15. It stood around 90 percent of GDP between 1990 and 1999 and 83.7 percent between 1980 and 1989, being the highest in EU-15 again. But the majority of market participants do not ascribe to this point. Pessimists argue the savings ratio in all countries where the IMF intervened went up for a few years. To them, a key factor determining consumer behavior will be bank lending which partly fueled the Greek consumer binge in previous years. With banks in a deleveraging mood, it is hard to see how consumer spending will be supported. The pessimists brace for weak consumer demand for the years to come and leave a window of hope open if Greece is able to attract large direct investments from Greeks and foreigners to make up for the expected weakness in domestic and more specifically consumer spending. According to them, the Ricardian equivalence theorem does not hold if the state has a large public debt and has to remain fiscally restrained for years to bring it down to more sustainable levels. Undoubtedly, both sides have some strong arguments about the behavior of the Greek household in the next six to 12 months or more. It would have been nice if the optimists, favoring the Ricardian equivalence theorem, turned out to be right but we will have to wait and see, since some of the arguments on the other side are well-founded.