Posted by: Dirk | March 25, 2012

IMF chief economist Olivier Blanchard on Greece

Olivier Blanchard expresses his view on the IMF blog:

Equally, or perhaps more importantly, Greece has to reduce its current account deficit. For two separate reasons. First, no country can run a large current account deficit and borrow from the rest of the world forever. Second, as fiscal austerity cuts into domestic demand, the only way to return to growth is to rely more on foreign demand to reduce the current account deficit.


This leaves decreases in relative wages, at least until higher productivity can kick in. In countries with flexible exchange rates, this can be achieved through currency depreciation. In a country which is part of a common currency area, it has to be achieved by decreasing nominal wages and prices. In Greece, wages have increased faster than productivity growth for years, compounding the problem. Unit labor costs―which is a key measure of competitiveness―increased by over 35 percent during 2000-10, compared to just under 20 percent in the euro area. This has to be undone.

The interesting thing I want to get at here is that the inflation-targeting monetary policy of the euro zone has allowed above equilibrium – in the sense of a balanced current account – wage growth. The money to pay higher wages and support a higher price level must have come from somewhere. I remember a discussion with Marc Lavoie last summer in Berlin, which can be nicely summarized by this graph. While fixing the interest rate, the ECB did not care about where the money supply increased. Therefore, credit expansions in the periphery was ignored when alarm bells should have been ringing. And now, after the fact, we still have mostly the same people in the institutions, from governments and banks to European organizations. Nothing has been fixed in the financial markets, no change in monetary policy, and certainly no change in economic thinking on the side of the mainstream.

Of course, some parties benefited from the boom in the periphery, especially in connection to the real estate bubbles. Greece is already known to be quite corrupt, according to

Greece’s ranking on Transparency International’s closely watched Corruption Perception Index (CPI) worsened in 2011, with the country taking joint 80th position out of 183 countries on the list, which was published on Thursday. Its ranking puts it on a par with El Salvador, Morocco, Peru and Thailand.

Then, we had the recent inquiry in Ireland. The Irish Times reports the short version of the resulting report:

3,270 pages? No, thanks. Give it to me in a paragraph.

Bertie lied. Again and again. We don’t know where £165,000 in his accounts came from. And, therefore, we can’t determine whether he received corrupt payments from developer Owen O’Callaghan.

Ouch! But there’s more to this report than Bertie Ahern, surely?

Much more. The words “corrupt” or “corruption” are used 977 times in the report. Fourteen politicians are listed as having received corrupt payments. In most cases, developers and landowners knew about the payments, even when fixers like lobbyist Frank Dunlop were doing the dirty work for them.

There is more. In Spain, the caso Guertel shows how corruption connected the real estate companies to political parties. Here is Wikipedia:

The Gürtel case is an ongoing political corruption scandal in Spain. The investigative operation was given the name Gürtel in a cryptic reference to one of the principal suspects, Francisco Correa (Correa means belt in English, Gürtel in German). Correa is a businessman who cultivated links with officers of the People’s Party (PP), Spain major right-wing party, some of which have been forced to resign or have been suspended. An investigation began in 2007 after information was obtained from a whistle-blower.[1] The case came to public attention in early 2009.

Among the accusations are bribery, money laundering and tax evasion implicating a circle of businessmen lead by Francisco Correa and politicians belonging to the People’s Party. The alleged illicit activities related to party funding and the award of contracts by local/regional government in Valencia,[2] the Community of Madrid and elsewhere.

Probably this is just the tip of the iceberg. However, judge Baltasar Garzon, who initiated the case, has been neutralized by his opponents. The NY Times reported under the headline A chilling verdict in Spain:

The enemies of Judge Baltasar Garzón have finally gotten their way. Spain’s Supreme Court this week found the judge guilty of misapplying the country’s wiretap law and suspended him from the courts for 11 years.

Judge Garzón has played an important role in Spain’s transition to democracy, as a scourge of corrupt politicians left and right and a powerful champion of international human rights law. His efforts to prosecute the former Chilean dictator, Gen. Augusto Pinochet, and investigate the horrors of the Spanish Civil War era, though unsuccessful, advanced the principle that there can be neither amnesty nor impunity for crimes against humanity.

Last but not least their is the case of Iceland, which was first to fall in the on-going financial crisis. The Huffington Post reported on the upcoming trial of former prime minister Geir Haarde:

A former prime minister of Iceland on Monday rejected charges he failed to adequately protect his country’s economy from financial shocks, as he took the stand in the first criminal trial of a world leader to result from the 2008 financial crisis.Geir Haarde said neither he nor financial regulators knew the real state of Icelandic banks’ precarious finances until they collapsed in October 2008.

“I reject all accusations and believe there is no basis for them,” Haarde said. He said it was the first chance he had to answer questions in the case.

The point of all these cases is that there have been coalitions of politicians and business (real estate, exporters, financial industry) that conspired to make huge profits for themselves while increasing – financial and other – risks for the public. These coalitions were very happy with a monetary policy that did not look at domestic monetary aggregates, since that ensured that the macroeconomic imbalances could build up undisturbed. The euro is a currency that is very hard to administrate, since the euro zone effectively runs a gold standard where adjustment is deflationary. This is what Blanchard describes in his post above. Since there is no fiscal union, domestic demand can fall by a lot and there are no automatic stabilizers anymore if a balanced budget is enforced by the troika. This is a huge problem and will lead to catastrophe if allowed to run unchecked.

Mariano Rajoy has understood this and renegotiated his budget deficit by forcing Olli Rehn and the EU to the table (see The European project is doomed if national politicians are responsible for European decisions. Angela Merkel maximizes her chances of reelection in Germany while her policies negatively affect millions in the European periphery. The return to an economy without automatic stabilizers is what I consider a step backwards into the 19th century. The European periphery will over the next years converge to developing country status if nothing happens.

The European model desperately needs change.



  1. […] European austerity – approach to ruin? […]

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