Greece’s government borrowing has become the most contentious sovereign debt crisis in memory and also the longest running. How this crisis gets resolved may determine whether the still fledgling eurozone survives in something like its present state. The whole episode reminds us that what made the eurozone attractive also left it vulnerable to shocks. Formerly soft currency member countries enjoyed lower borrowing costs because of the greatly lowered exchange rate risk. This helped countries like Greece to borrow, invest and prosper in the years after the euro was launched. In hindsight, this was probably an unsustainable boom under any conditions. But when the Great Recession hit, the downward impact on Greece was amplified, by both the great increase in debt and the absence of devaluation as a buffer. Greece could not meet its sovereign debt obligations, and the crisis was on.
Since the credit crisis first emerged in 2009, the other nations of Europe, the European Central Bank and the International Monetary Fund have all supported debt relief in many forms. And not surprisingly, the relief has always come with conditions on matters such as budget deficits, privatization, and government employment. Many of the conditions were politically unpopular in those countries and imposed fiscal austerity on the economy. The recession deepened into depression, the capacity to service debt worsened rather than improved, and the tensions between Greece and its creditors only intensified.
Perverse fiscal policy is hardly the only cause of this depression, but contractionary policy has been a downward force when the opposite was needed. Much has been made of the fact that the primary budget—the balance apart from interest payments—is now in balance. But the depressing effect of the contractionary budget is much worse than this would suggest. An estimate of the high employment balance, which measures where the budget would be with the economy at high employment rather than depression levels, would show a very large surplus indicating a severe fiscal drag on present economic activity.
Starting in 2009, the Greek voters have thrown out 5 prime ministers. Now, Alexi Tsipras, heading Syriza, a seemingly weak left wing coalition government, has been elected with a mandate to stop the economy from sinking further. Its finance minister, Yanis Varoufakis, is an outspoken crusader for debt relief without counterproductive strings attached. The conditionality of previous debt relief programs is hardly the only cause of the economic depression. Greece itself has plenty of past excesses and mistakes to answer for and Varoufakis’ aggressiveness has rankled many. But on the most important issue going forward—the need for economic stimulus rather than more austerity—Greece is certainly right.
Is there much chance a useful compromise encompassing debt relief and stimulus to the economy can now be found? Although many observers see the relations between Greece and its creditors as strained beyond repair, there is good reason to think the strain is only temporary and that both sides would like to compromise and make a new deal. If the lenders were not, at bottom, sympathetic to the Greek plight, they would not have repeatedly found ways and reasons to avoid a Greek default. Rather than come up with such bailouts, a more ruthless coalition of bondholders might have closed the lending windows much earlier.
Strengthening the bond among Europeans was the main motivation for forming the eurozone in the first place, and the present crisis offers the stiffest test yet of that bond. Greece will almost surely be forced out of the Eurozone if agreement on a new deal cannot be found, and this would push the country into a far more desperate economic state. How many Europeans really want this? And if empathy with Greece is not enough, creditors will recognize that the eurozone itself, which works because its members are secure within it, could be mortally wounded if Greece were forced to leave. For all these reasons, it is likely a new, more constructive deal on debt relief will be struck.
It would be useful if new negotiations were to start without precedents from the past. Debt relief could sensibly be conditional on reforms that were designed jointly by the creditors and the Greeks who will live with them. And by replacing old debt with new debt at today’s rock bottom long-term interest rates, the default risk for lenders would be sharply lowered and the interest burden on Greece would become manageable. Economic recovery is in the best interest of both Greece and its creditors, and helping it should be the decisive test of any deal.
The Greeks would have to commit to all the important terms of the deal, and then they would have to deliver. Given the lack of experience of the new government, the absence of any track record, and the left lean of the government, this will require a leap of faith on the part of creditors. But so would a deal that simply repeated past mistakes. Why trust the Greeks? It’s the best choice.