Lost liquidity

Since Greece signed its first bailout deal with its creditors three-and-a-half years ago, the recipe for the country’s economic recovery has not been altered despite numerous admissions that it is flawed and, more importantly, despite the widely held belief that it has simply failed to revive the Greek economy, which is not just flailing but actually doing much worse than expected.

The fact is that the recipe cooked up by the International Monetary Fund, the European Commission and the European Central Bank does not include any ingredients that will drastically boost demand, or generate a demand shock, to use the economic term. The internal devaluation and the structural changes, especially those concerning market deregulation, were aimed at boosting exports and competitiveness, and therefore increasing demand. On a practical level, however, we have not seen much improvement in those areas and have instead experienced a protracted recession and a massive spike in unemployment.

Why? The simple answer that the creditors like to provide is that the reforms were not implemented by Athens as and when they should have been. This is true, but only partially. Greece has implemented some sweeping reforms, but the problem lies in the fact that none of them has been specifically targeted at boosting demand by jump-starting the economy’s growth, nor have they been designed to protect the weaker members of society who have borne the brunt of the crisis. In contrast, the prevalent philosophy has been one restricted to austerity measures in all areas and deregulation. Even the debt haircut came too late, which seriously undermined its efficacy. The IMF itself has admitted as much recently and now, based on the Greek experience, it is redesigning the way it helps countries dealing with similar crises.

Of course, the failure to increase demand to the needed levels cannot be attributed exclusively to errors in the design and prevailing philosophy of the Greek rescue program. It is also due to the reluctance of banks and funds to invest in the real economy. Instead, they have opted for the safer route of government bonds and seeking out long-term gains. This is a fact that the ECB has also pointed out as it sees that the liquidity it has provided has not trickled down to households and businesses in order to help them rally. It is now looking for way to compel banks to modify their stance and become more forthcoming with providing businesses with a lifeline. A similar effort is under way in the UK, where the Bank of England is looking for ways to divert liquidity from the real estate bubble into small and medium-sized enterprises.

In Greece, which is continuing to come apart at the seams, funding for small businesses and households, the cornerstone of policy to boost demand, is simply nonexistent. Instead, businesses and individuals are having to draw on what few savings they have left just to keep up with their tax commitments.