While financial markets around the world applauded the Greek government’s austerity measures, Greek citizens took to the streets in brutal riots protesting the measures, and some analysts are unsure the government in Greece will be able to follow through. What does the continuing turmoil in the euro zone mean for the U.S., amid growing signs that the domestic economy is strengthening? On February 15, Douglas Elliott took your questions in a live web chat moderated by Vivyan Tran of POLITICO.
12:30 Vivyan Tran: Welcome everyone, let’s get started.
12:30 Comment From Vi: Given the current crisis in Greece, was the euro experiment a mistake?
12:31 Douglas Elliott: It could go either way. If the response to the crisis is to integrate the economies sufficiently closely and to improve the governance procedures at both the euro zone and national levels, this could be the crisis that makes the euro rather than breaks it. There are considerable economic benefits from the adoption of the euro, if they get things right. On the other hand, the way they set up the euro originally is economically untenable, so bad answers could lead to a collapse of the zone either in the near or longer-term future. We also have to keep in mind that the euro zone serves the political purposes of European integration at least as much as it does economic purposes.
12:31 Comment From Jennifer S: What can U.S. or other global powers do to help stabilize the euro zone, and should they do it?
12:32 Douglas Elliott: This problem mostly has to be solved by Europe itself, but we should stand ready to support the IMF in providing technical advice and some loans, if a good, wider solution is put into place. The IMF is best positioned to provide some external discipline and our funds would be well-protected by the seniority the IMF has always had on its lending. However, this all depends on Europe providing a strong, workable solution, backed primarily by their own funds.
12:33 Comment From Tony: The U.S. economy seems to finally be getting back on its feet. What danger does the current situation in Greece pose to our recovery?
12:33 Douglas Elliott: It would be very bad for us if the Greek situation deteriorates to the point where it leads to a disaster in the euro zone as a whole, such as a series of national defaults that run from Greece to Portugal and all the way through to Italy. Europe would be hit by a deep recession and we would almost certainly fall into at least a modest recession over here. For its part, China would probably fall to 4 or 5% annual growth, which would create substantial political and financial difficulties for them.
12:33 Comment From Mark, Greenbelt: Is Greece the only problem in Europe? Or are there other shaky economies in the zone?
12:35 Douglas Elliott: Greece is the worst problem in Europe, but far from the only one. Portugal is in quite serious economic trouble and is probably the next riskiest, although there is a considerable gap between it and Greece. Ireland is making progress, but still very troubled. Spain is a big country with big economic problems. Italy is a big country with smaller economic problems, but still with quite tough political ones.
12:35 Comment From R. Garcia: Italy seems to have turned things around now that Berlusconi is out. Why can’t Greece follow the same path?
12:37 Douglas Elliott: Greece has much worse economic and political problems than Italy. Italy does have fairly high levels of debt for the size of its economy, although not as bad as Greece, but its budget deficit is getting down towards zero, while Greece’s is still very large. The Italian economy is holding up much better than Greece, which is in a terrible recession going on its fifth year. Italy, for all its political problems, is also better managed than Greece has been. Greece is in very bad shape, while Italy is a rich country with the means to solve its own problems.
12:37 Comment From Chandra P: The U.S. markets don’t seem to be too rattled by the unrest in Greece. Should they be?
12:39 Douglas Elliott: I think the markets are too calm about Europe right now, but I’m not sure they are that far off about Greece. We are reaching a point where a failure of Greece might not affect the rest of Europe that much, since it represents only 2% of the euro zone economy. We’re not there yet, but this is why markets have become a lot calmer about Greece. What I think they should be more worried about is the long list of other potential problems, from the Portuguese and Spanish economies to the political risks in Italy to the possibility of a larger backlash by the German public.
12:39 Comment From Vincent: Why should somebody on Main Street in Des Moines care about what’s happening in the euro zone? For that matter, what can the U.S. really do about it?
Former Brookings Expert
Partner - Oliver Wyman
12:41 Douglas Elliott: The U.S. has a major stake in what happens in Europe. I believe we will have a recession here, which we are ill-prepared for so soon after the last one, if Europe falls apart. We export a great deal to Europe and much of that would dry up. We also have massive investments in Europe which would go down in value, hurting our multinational companies, who might then have to let people go over here. We also trade a great deal with countries like China which export a great deal to Europe. The world is now globalized enough that we can’t have one of the world’s largest economies flounder without being affected ourselves.
12:41 Comment From Guest: Do you think Greece will fall out of the euro zone and/or will the euro fail?
12:44 Douglas Elliott: There is a fairly small chance of Greece falling out of the euro zone and an even smaller chance that other countries might follow. However, the transition costs would be immense. If Greece pulls out, it will be in order to massively devalue its new currency compared to the euro. This will bankrupt the Greek banks and many of their other companies, who have borrowed in euros from outside the country. There would also be massive capital flight as people realized this was going to happen. The uncertainties alone would dramatically harm business and employment. In addition, the benefits are often overstated. There seems to be the assumption that Greeks will riot if you cut their wages, but will be calm if you achieve the same thing by a major devaluation with its resulting huge surge of inflation.
12:44 Comment From John E: Some have floated the possibility that China might step in and bail out Greece/Italy? Is that really a viable solution?
12:46 Douglas Elliott: China will not save Greece/Italy or Europe. It will talk supportively and may provide some financial support alongside the IMF if we ever get to that point, but they have no interest in putting up a lot of money unless Germany and the other strong European countries do. And, if those countries do, we don’t really need the Chinese to do too much. Remember that the Chinese public is increasingly vocal about disliking the risk of having their government’s foreign exchange reserves in dollars or euros go down in value. This is a serious political problem for the Chinese.
12:47 Comment From Karen K: Are the austerity measures forced on countries like Greece and Italy actually hurting their recovery?
12:49 Douglas Elliott: That is a great question, which I wish I were smart enough to answer. There are two camps on this. The part that is indisputable is that the reduced demand for goods and services as governments, businesses and individuals cut back hurts the economy. The question is what would happen if these countries kept their deficits up in order to keep spending. Without some action on the debt, business confidence would collapse, since an eventual default would be clear. With too much austerity, the benefits are outweighed by the reduction in demand. It’s hard to know where the right balance is.
12:49 Comment From Abigail: What steps can Greece take to stabilize its situation, or are they entirely dependent on outside help?
12:51 Douglas Elliott: The Greeks are doing a great deal to reform their economy and they have been accepting quite large changes being forced on them by their European partners. The complaints are that they are agreeing to steps and then not taking them or doing so too slowly. I think the truth lies in between. They’ve actually done a lot, but certainly considerably less than they promised. In the end, they need to make some very painful changes to a rigid, badly working economy. But, they also need a lot of outside support, given how bad their situation is.
12:51 Comment From Vela: Is there any “moral hazard” here in a bailout? Look at the argument we’ve had domestically here about whether bailouts should happen, or whether poorly managed enterprises should be allowed to fail. Okay these are countries, but is the idea the same? Why should the German taxpayers bail out the Greeks?
12:53 Douglas Elliott: The moral hazard question is a very real and important one. The Germans and the European Central Bank could together solve the immediate market problems of the weak countries. But, they fear that providing too much help will cause those countries to hold back on politically painful steps. They have some reason to think so, both based on pure logic and because they believe that is what Italy did under Berlusconi once the ECB starting buying Italian bonds to help them out. That said, worrying too much about moral hazard in a crisis is also a mistake. You don’t let a neighbor’s house burn down just because you think they should have been more careful. There’s too much danger of the fire spreading.
12:53 Comment From Langdon: Is it possible to dissolve the euro zone in an orderly fashion, or would that inevitably lead to chaos and/or recession globally?
12:54 Douglas Elliott: I personally believe that dissolution of the euro would be a disaster. The transition costs would be immense. Among other things, the level of uncertainty it would produce in the world economy would stop businesses from investing and hiring and cause individuals to stop spending. That caution would itself induce a recession. The technical problems go way beyond this and way beyond what I can write here.
12:54 Comment From Chuck: Looking back at the U.S., do we need to go the way of Greece and Italy and start to impose serious austerity measures to get our financial house in order?
12:56 Douglas Elliott: I’m with the majority of economists who believe that it is critical that we cut back on our budget deficits sharply in the medium term, but that if we cut back this year we risk killing a nascent recovery. It would be great to put in place a real mechanism for ensuring medium and long-term change, though. This is a really important issue; we just have to get the timing right.
12:56 Comment From George: Wouldn’t a managed bankruptcy be better for Greece long term even if it meant an exit from the euro zone? Are there lessons to be learned from countries like Argentina?
12:58 Douglas Elliott: As I mentioned before, I think that withdrawing from the euro would be bad for Greece, as well as everyone else. The comparisons with Argentina are misleading. First, they had a horrible recession, even though the global economy was doing okay. Second, they had lots of commodities to export which benefited from the devaluation.
12:58 Vivyan Tran: Thanks everyone, see you next week.