Needed: Large Greek Devaluation or Large-Scale Transfers to Greece

Consider Olivier Blanchard and Daniel Leigh: Growth Forecast Errors and Fiscal Multipliers:

This strongly suggests to me that of the 7%-points by which Greek growth fell below IMF estimates in 2010-2011, 5%-points of that were due to the fiscal consolidation that the IMF had forecast would be imposed on Greece. Consider that the IMF had already expected the Greek economy under baseline to shrink by 4%-points, and for fiscal consolidation to shrink the Greek economy by 3%-points, and we have 8/14 of the damage to the Greek economy relative to a counterfactual forecast under some zero-spending-austerity baseline was due to austerity.

I find this hard to square with the very-sharp Olivier Blanchard’s contribution of today:

Olivier Blanchard: Greece: Past Critiques and the Path Forward: “The decrease in output was indeed much larger than had been forecast…

…Multipliers were larger than initially assumed.  But fiscal consolidation explains only a fraction of the output decline.  Output above potential to start, political crises, inconsistent policies, insufficient reforms, Grexit fears, low business confidence, weak banks, all contributed to the outcome…

That is, this statement seems to me to be true if and only if “only a fraction” is replaced by “more than half”.

Let us back up: In 1829 economist John Stuart Mill pointed out that “Say’s Law”–Jean-Baptiste Say’s claim that potential supply in the form of workers eager to work at the prevailing wage necessarily called forth the demand in the form of the desire to spend backed up by income to employ them, that there could be an excess supply of some currently-produced goods and services only if there was an offsetting excess demand for others–was wrong. In a monetary economy there can–and often is–be a large excess demand for safe liquid cash money that can only be produced by a credit-worthy government, and a counterbalancing excess supply of all currently-produced goods and services: a “general glut” of commodities.

It is the job of a government conducting stabilization policy–and of an international agency located, cough, cough, near Pennsylvania Avenue in Washington DC–to make Say’s Law true in practice even though it is false in theory. How are governments and international agencies supposed to do this? By creating the safe liquid cash money that the private sector wants to hold in order to induce it to spend its full-employment income on currently-produced goods and services, and to fill in remaining gaps by itself serving as a liquidity-provider, a credit-guarantor, a lender, a buyer, and an employer of last resort when necessary.

In the case of Greece in 2009-2010 the New York financial crisis meant that spending in Greece by the private sector was going to go way down. The three components of aggregate demand for work done in Greece were: (i) private spending in Greece; (ii) public spending in Greece; (iii) exports. It was the job of the ECB and of the Greek government–and of the EU and the IMF that stood behind them–to do some combination of:

1. making Greeks feel rich and safe so that they would be willing to spend their full-employment incomes on useful consumption and productive capital goods;
2. filling in holes in private domestic demand by boosting public spending; plus
3. boosting Greek exports–boosting outside demand for work done in Greece.

Now comes Olivier Blanchard to say that since 2009 the ECB, the EU, and the IMF:

• couldn’t do (3) because the Greek drachma is pegged irrevocably to the German deutschmark, and
• couldn’t help the Greek government do (2) because Greek government finances were already unsustainable.

That would seem to leave (1). To some extent, you can achieve (1) by lowering interest rates and promising to keep them low enough for long enough to make more investment projects in Greece profitable, and to make the Greeks feel richer and thus be more eager to spend. And some, like Ben Bernanke, think that this is–or ought–to be enough:

Ben Bernanke: Why are interest rates so low, part 2: “As Larry [Summers]’s uncle Paul Samuelson taught me…

…in graduate school at MIT… at a negative (or even zero) interest rate, it would pay to level the Rocky Mountains to save even the small amount of fuel expended by trains and cars that currently must climb steep grades…

But the ECB appears to be unwilling or unable to pursue (1) a la Bernanke to the limit…

And that then leaves the Texas 1991 solution:

Paul Krugman: What A Real External Bank Bailout Looks Like: “Texas after the savings and loan crisis of the 1980s…

…The cleanup from that crisis cost [U.S.] taxpayers about $125 billion… around 60 percent… in Texas (pdf)… $75 billion in… outright transfer. Texas [annual] GDP was about $300 billion in 1987… giving… [it] 25 percent of its [annual] GDP… And in the US it wasn’t even treated as an interstate political issue…. If Texas had been an independent country in 1986-87 it would have experienced a huge financial and fiscal crisis…

Why was the United States government willing to do this? Because Texas is part of the United States, and also part of our civilization. Indeed, the “part of the United States” is not crucial to the expenditure of the resources of U.S. taxpayers, as everybody who remembers the Marshall Plan–or, indeed, remembers the much larger amount of resources spent on destroying a Nazi Germany that was not in any sense an imminent threat to the U.S. in the 1940s–knows.

There is no fundamental real flaw in the real economy that is our societal division of labor and our system of production, distribution, and consumption that requires that a quarter of Greeks eager to work at the prevailing wage be unemployed for a decade. It is only a flaw in the monetary system we have collectively constructed to help manage this real economy that is trying to enforce that result. And if one rules out other ways–cough, cough, devaluation–and finds that the only way to avoid that result is by truly massive fiscal transfers to Greece, than it is the obligation and duty of the ECB, the EU, and the IMF to make such transfers. As the U.S. government did to Texas in 1991.

“But that will leave the Greeks too rich and the Germans too poor!” the masters of the Eurozone say:

Jared Bernstein: Greece’s Electorate Punches Back Hard at Austerity: “As one German economist put it to me…

How do you think the people of Manhattan would like bailing out Texas?…

And the German government has the power to block fiscal transfers–even if they are the only remaining way to make Say’s Law true in practice–if it thinks they make Germans and Germany too poor.

And it is at this point that I note that at the left edge of my desk I have the brand-new biography A Complex Fate of mid-century American journalist William Shirer, and beneath it is William Shirer’s masterwork: The Rise and Fall of the Third Reich. And in that bottom-most book, there is a quote from one Hans Frank:

A thousand years shall pass and the guilt of Germany will not be erased…

Until 2934, every politician speaking for anything calling itself “Germany” needs to believe that they are in an open-hearted and open-handed gift-exchange relationship with all the other peoples of Europe in which they do not count the cost and do not stint their share if they can be of assistance. And if the politicians of anything calling itself “Germany” do not believe that, they need to at least have the decency to pretend to believe that. Until 2934.