What We Owe by Carlo Cottarelli

Author:Carlo Cottarelli
Language: eng
Format: epub
Publisher: Brookings Institution Press

The Failure of the First Financing Program Extended to Greece

The adjustment and financing program agreed to by Greece on one side, and the IMF and the European countries on the other, in May 2010 envisaged, in addition to important structural reforms, a massive dose of fiscal austerity, with the goal of lowering the fiscal deficit below 3 percent of GDP by 2014: the deficit was targeted to decline by 5.5 percentage points of GDP between 2009 and 2010 (a 40 percent drop) and to decline further thereafter. It was also decided not to restructure public debt, with the implication that the debt was supposed to be paid back gradually. This prompted many to argue that blame for the fiscal austerity program, and the consequent loss of a quarter of Greek GDP, should be assigned primarily to the decision to protect German and French banks, the holders of large amounts of Greek bonds. But let’s look at things more closely.

There is no doubt that one key reason for the fall of the Greek GDP was fiscal austerity. But it should be recalled that GDP, as a result of the global crisis of 2008–09, was falling all over the world, including in countries that could afford an increase in public spending and a cut in tax rates to support the economy. Greece could not afford those adjustments because of the terrible condition of its fiscal accounts. That said, fiscal tightening by such a massive amount caused a further recessionary push, in addition to what was coming from abroad. Its extent was initially underestimated by the troika.

Could fiscal austerity policies have been avoided? Avoiding a fiscal tightening would have meant keeping the deficit at its 2009 level. Who would have financed that deficit? As European banks were no longer willing to do it, the financing would have had to come from the IMF and the European partners. But why should the European taxpayers have taken upon themselves the task of keeping unchanged Greece’s standard of living, which had increased in the run-up to the crisis well beyond Greece’s capacity to produce income? A fiscal tightening was therefore inevitable.

Would a more gradual fiscal adjustment have been possible had the decision been made to restructure public debt from the beginning? For example, Greece could have decided to repay only 50 percent of its debt. In that case the fiscal tightening could have been less strong, but not by much. The reason is that most of Greece’s fiscal deficit originated not in interest payments but in the underlying primary deficit. In 2009 the Greek fiscal deficit exceeded 15.5 percent of GDP. The primary deficit, however, was about 10.5 percent of GDP, while interest payments on government debt were 5 percent of GDP. This means that even if public debt and interest payments had been halved, it would still have been necessary for Greece to cut spending or increase taxes by an amount equal to 12.5 percent of GDP to maintain a balanced budget after the debt restructuring, owing to the difficulty of borrowing in markets after a default.

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