Abstract
A major issue that has arisen in the Euro area has been the appropriate policy response to a fiscal/sovereign debt crisis in a Euro zone member country. The debate has been particularly heated with respect to the responses of the troika—the International Monetary Fund, the European Union, and the European Central Bank—to the difficulties encountered by Greece in 2010 and subsequently. In this paper, I explore the relationship between “austerity” and other policies required by the troika, and the extension of financial support for a heavily indebted country. The essential argument is that, unless measures are taken to make sovereign debt sustainable over the medium or longer term, financial support for a country within a currency union cannot enable a resumption of growth. The necessary measures normally include fiscal adjustments which are politically unpopular. But the necessary “austerity” is less painful for a country than the abrupt adjustment that would be forced upon the country in the absence of external financial support. For those providing financial support, fiscal and other adjustments are a prerequisite for enabling the debtor to resume growth.
An earlier version of this paper was presented at a Conference in Honor of Ronald McKinnon in January 2015 at Stanford University
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Notes
- 1.
The Euro was first introduced as a currency in 1999, but the phase-out of national currencies was not completed until 2002.
- 2.
See Reinhart and Rogoff (2009) for a history of sovereign debt crises.
- 3.
John Maynard Keynes was foremost among those advocating an altered international monetary regime. He was a British delegate to the Bretton Woods conference which negotiated the Articles of Agreement of the International Monetary Fund. See Robbins et al. (1990) for an account.
- 4.
It is important to remember that the short-term lending was supposed to be to tide countries over temporary shortfalls in their ability to finance their outstanding balances.
- 5.
In some developing countries, good fortune in the form of high commodity prices offset inflationary pressure and there was no need for adjustment, at least until commodity prices fell again. A few countries experienced balance of payments difficulties without prior excessively expansionary policies because of sharp and unexpected drops in their terms of trade. But in the majority of cases, prior expansionary policies were the major contributor to difficulties, and even in cases where a drop in the prices of major exports was the proximate factor leading to difficulties, macroeconomic adjustment was called for.
- 6.
Few countries eschewed all intervention in the foreign exchange market, but many restricted their interventions to “smoothing” abrupt changes, or otherwise buying or selling foreign exchange in limited amounts (see Reinhart and Rogoff 2004).
- 7.
To be sure, there were some who were skeptics at the time the Euro was introduced, both in Europe and North America. Danish voters rejected the Euro in part because of doubts about its durability.
- 8.
This is not to say that there were no other important issues. These included questions such as the damage done by quantitative restrictions, the role of multinational corporations in trade, the determinants of trading patterns, and so on. However, none of these was/is central to analysis of the Greek difficulties.
- 9.
The classic paper was and is Friedman (1953).
- 10.
See Kenen (1983).
- 11.
Mundell (1961).
- 12.
See Obstfeld et al. (2005).
- 13.
See Issing (2008).
- 14.
There was supposed to be a financial penalty for exceeding the limits, but the first two Euro zone countries to violate them were France and Germany, and fines were not imposed.
- 15.
A few argued that entering into a currency union would prevent such disparities from arising and provide discipline for currency union members.
- 16.
Some had argued that countries specialized in the production and export of only a few commodities would not be fit candidates for a common currency and should tie to a currency such as the dollar. McKinnon rejected this argument, pointing out that citizens in a specialized country would have even greater need for financial integration so that they could reduce the risks associated with swings in the price of their exports by diversifying their financial portfolios.
- 17.
A few argued that entering into a currency union would prevent such disparities from arising and provide discipline for currency union members.
- 18.
As stated by Otmar Issing (see Issing 2008, pp. 192–96), who was a member of the preparatory committee for the Euro, members of the committee believed that a 3 % fiscal deficit would be sufficient to offset any downward shift in demand in any of the member countries. With hindsight, this had to be based on the view that there would be fiscal surpluses in good years.
- 19.
At the time of the launch of the Euro, there were concerns voiced in several countries, including Greece, that the rate of conversion from local currencies to Euros had been inappropriate and resulted in increases in domestic prices. Even if that was the case, the magnitude of the “mistake” was relatively very small compared to the later buildup of imbalances.
- 20.
See the World Bank Group (2014) for data. In the 2008 Report, before the onset of the crisis, Greece was ranked 100th in the overall Ease of Doing Business index. In 2010, Greece was ranked 109th, just below Yemen. In 2014, the ranking was 65th, but some crucial aspects had deteriorated. For example, Greece was ranked 158th in enforcing contracts (it had been ranked 87th in 2008). Even in the ease of obtaining electricity for a new business, Greece was ranked 80th in 2014.
- 21.
Most of the haircut on debt was borne by the private sector, so that about 85 % of remaining debt is to the official sector, including bilateral and multilateral (the EU, the ECB, and the IMF) creditors.
- 22.
It will be recalled that the rate at which the debt/GDP ratio changes is equal to the initial debt/GDP ratio times the interest rate minus the growth rate. The higher the growth rate, the more rapidly the debt/GDP ratio will decline for any given interest rate.
- 23.
Insofar as contagion was/is an issue, it centers primarily on the fact that the private banks in some Euro area countries (most notably France and Germany) held large quantities of Greek and other south European sovereign debt. Had Greece defaulted, it was and is clear that a considerable part of the equity of some of the banks in the creditor countries would have been significantly reduced. Their holdings were greatly reduced after 2010.
- 24.
Some assert that, even without fiscal imbalances, a crisis would have arisen because of the (largely policy-induced) structural rigidities in the Greek economy. That is not inconsistent with the view that the crisis itself was fiscal: It was fiscal excesses that prevented earlier falls in GDP.
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Krueger, A.O. (2017). Sovereign Debt and Austerity in the Euro Area: A View from North America. In: Christensen, B., Kowalczyk, C. (eds) Globalization. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-662-49502-5_13
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