Scott Sumner  

Greece and Detroit

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In a recent post I claimed that it made no sense to talk about NGDP at the global level. In the comment section Nick Rowe argued that one might be able to come up with a meaningful estimate of global NGDP growth. Even so, I find the national figures to be much more useful. And I shouldn't even say "national", as what really matters is the NGDP for a given currency area. That's because NGDP is an excellent indicator of the stance of monetary policy.

Here it might be useful to compare Greece and Detroit:

1. Both areas are part of a larger currency zone.

2. Both have seen NGDP decline significantly during the Great Recession.

3. Both areas defaulted on a portion of their public debt.

4. Both areas have structural weaknesses that go beyond monetary policy.

You don't see people talking about monetary policy in Detroit, as it's assumed it faces the same monetary policy as the rest of the US. After all, both Detroit and Silicon Valley use the US dollar, and face the same foreign exchange rates. Banks in both areas pay the same interest rate in interbank loans. Even their inflation rates are similar, although not identical. But NGDP is doing much better in Silicon Valley than Detroit, for various structural reasons (high tech vs. UAW-dominated auto manufacturing, education level of workforce, etc.)

Lars Christensen has a new post pointing out that Greece's debt problem has been made worse by the sharp decline in NGDP. I think that's right, as is his conclusion that it might make sense to combine debt relief with vigorous structural reforms.

Both Detroit and Greece face problems that are specific to their regions, and (especially in the case of Greece) are partly self-inflicted. (Here's where the analogy breaks down a bit, as Detroit is now essentially a poor neighborhood in a large country, whereas Greece is an entire country, with a more diverse set of skills, and thus greater short term possibilities for economic growth.)

While Greece and Detroit have structural problems, both have also faced a tight monetary policy. A medical analogy might be helpful. Imagine a family exposed to a flu virus. One older member with heart disease catches the flu and goes into critical condition. Another family member catches the flu and is somewhat sick for a week. Another family member with a very strong immune system fights off the virus with no symptoms showing up.

In the analogy, Germany is like the person with the strong immune system (partly due to labor market reforms), France and Netherlands are like the person who got sick for a week, and Greece is the individual in critical condition. Just as a person can suffer from two medical conditions at the same time, a country can suffer from both structural and demand-side problems.

So in that case, how can we evaluate the role of monetary policy in Greece's troubles? In my view the proper metric is eurozone-wide NGDP data. That data shows that money has been too tight, but nowhere near as tight as you'd infer from merely looking at Greek NGDP data. Lars Christensen is right that Greek NGDP data is the right metric for judging their difficulty in servicing the public debt. On the other hand eurozone NGDP data is the right metric in judging the extent to which Greece has been "victimized" by bad ECB policies. To conclude:

1. The ECB policies were bad enough to produce a French or Dutch level recession, in a eurozone country with average structural problems.

2. Eurozone countries that have done more aggressive labor market reforms (i.e. Germany) were able to get by with a much milder than average recession.

3. Eurozone countries with much worse than average structural problems (i.e. Greece) had a worse than average recession.

It's not an either/or situation; both NGDP and structural factors matter, and they both matter a lot. Just as it makes sense to eat right and exercise to avoid getting heart disease, it makes sense to wash hands to avoid catching the flu. The same is true in economic policymaking. Keep the structure of your economy in sound shape through free market policies, and avoid unnecessary demand shocks by having a monetary policy that produces slow but steady NGDP growth.


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COMMENTS (12 to date)
Brian Donohue writes:

Very good post.

Kenneth Duda writes:

Great post, Scott.

I have an off-topic question, something that I think might make a very interesting post.

Some people argue the Federal Reserve needs discretion to serve as lender of last resort to save systemically important financial institutions that become victims of market forces that really no one saw coming. An old, familiar narrative.

The question is: what if we said, "wrong!" ?

In other words, what if we said, look, the Federal Reserve will do *whatever it takes* to stabilize the level-path of nominal GDP. In that context, suppose there was a 30% plunge in real estate values, leaving major commercial banks, investment banks and insurance companies seriously exposed. What would the NGDP futures market be telling us? Probably some version of, "holy crap." Imagine the Fed responds not by bailing out preferred financial companies, but instead by buying mountains of assets, until the NGDP futures market is saying we're pretty much okay. As yields drop to zero and P/E's soar, wouldn't the private market take a look at the situation and say, "this is starting to look like a pretty good opportunity. Let's figure out which stressed financial institutions are the best, and buy their equity to fund their short-term liquidity, or let's figure out which distressed assets are the best, and just buy them outright with the cash we just got from the Fed by selling our more marketable securities?" This way, both the job of figuring out whom to bail out and on what terms falls to the private market, which is probably much better at it than the Fed, and at the same time, whatever damage is done is contained to the financial sector, rather than spilling all over the real economy like it did in the NGDP plunge we saw in 2009.

In other words, the best "macro-prudential" policy is, in fact, NGDPLT.

What do you think?

-Ken

Yaakov writes:

Very good post. Thanks.

I wonder what you expect would have happened to Greece if they would have had the same fiscal and regulatory policies, but instead of joining the Euro they would have remained on the Dracma and used your system for fixed NGDP growth of the Dracma. What would have been their situation now?

dlr writes:

I like your virus metaphor but then you surprised me.

You don't see people talking about monetary policy in Detroit, as it's assumed it faces the same monetary policy as the rest of the US...On the other hand eurozone NGDP data is the right metric in judging the extent to which Greece has been "victimized" by bad ECB policies. To conclude:

Not sure this is the most useful definition of victimized. It seems quite possible for Detroit to be "victimized" by Fed policy that maintains US NGDP expectations to trend. Detroit may be structurally challenged, which would produce lower RGDP amid even optimal monetary policy, but that does not mean it should also be subject to a virus that only it can catch. If 5% expected NGDP growth for the US means a drop in Detroit's trend from 5% to 2%, rather than a hypothetical optimal Detroit policy of continued 5% nominal growth but with more inflation, Detroit sure seems to be a victim in an important sense. The same can be said about Greece.

Even "perfect" monetary policy in a putatively optimal currency area can leaves dozens of regional victims in its wake. The reason Detroit is seen as less of a victim than Greece seems to be that it enjoys more labor mobility and fiscal stabilizers relative to its monetary union than Greece, which mitigates the decline in NGDP and perhaps more flexible (labor) markets which mitigates the idle resource impact of price stickiness.

If lower than optimal NGDP in Detroit means that people in Detroit are unemployed who would not be under optimal monetary policy even given their structural challenges, victim is a pretty appropriate word. Greece surely has that problem, and would even if Euro-wide policy was not too tight.

Thomas writes:

ECB has a choice about which assets it purchases in order to return NGDP to it's pre 2008 trend. Should it not purchase assets that support increases in Greece's N G D P?

Njnnja writes:

[Comment removed for crude language.--Econlib Ed.]

Pemakin writes:

A few questions.

Surely, you meant NGDP growth is a good measure of monetary policy? For debt sustainability, the level of NGDP to debt is more important, although future growth matters as well.

On a related point, why isn't the right measure of sustainable debt relative to NGDP minus the direct government portion? The difference between G being 20% and 40% is huge when it comes to a recession. Countries with large G to begin with will have a hard time getting creditors to agree to anything but something austere. Countries with low G could potentially increase G (if they did not control their monetary policy like Euro zone) and get reasonable multiplier effects.

Gordon writes:

"It's not an either/or situation; both NGDP and structural factors matter, and they both matter a lot."

Scott, last week Lars referenced a paper by Robert Hetzel in which he attributed Greece's depressed economy to the price-specie flow mechanism described by David Hume.

https://www.richmondfed.org/publications/research/working_papers/2015/pdf/wp15-04.pdf

Greece ran a current account deficit in the tens of billions of euros for a good number of years until its creditors forced reforms. I've seen some writers attribute this deficit to the inflated wages and pensions that the Greece government supported.

What are your thoughts on this explanation? Certainly, tight monetary policy has not helped Greece. But do the structural problems account for the vast majority of Greece's economic woes?

Floccina writes:

Does Detroit need a lower minimum wage?

Scott Sumner writes:

Thanks Brian.

Ken, Exactly. I couldn't have put it better myself.

Yaakov, Much better, but they'd still face their structural problems. I would add that the pre-2007 Greek boom would have been considerably smaller without the low interest rates provided by the euro. But yes, they'd have had a much less volatile cycle, and in retrospect they should have stayed out of the euro (as even the Greek finance minister indicated.)

dlr, In my view the troubled regions can only claim "victimization" for the portion of the NGDP drop that occurs across the entire currency zone. That's the part of the regional drop that is unjustified. That's true of both Detroit and Greece.

Perhaps the term "victim" is the problem. I see the term as implying "hurt by unjustified actions of others." Perhaps you define it differently.

Thomas, That might depend on whether Greece agrees to structural reforms. Normally the ECB should just buy a cross section of eurozone debt.

Pemakin, Both growth and level of NGDP matters. If NGDP plunges 50%, and then rises 10%, it's still depressed in absolute terms.

The sustainability question is complicated, but your comments on G seem sensible to me.

Gordon, I'll have to look at Hetzel's paper, but my initial reaction is that Greece's problems are only partly monetary. Perhaps more than 50% monetary in the post 2008 period, but longer term the problems are mostly structural. Even in the boom year of 2007, Greece was much poorer than Switzerland or Sweden or Japan. Poorer than Greeks living in America as well, which suggest there is nothing wrong with the Greeks as individuals.

It's hard to give exact percentages, because the post-2008 problems may be interrelated.

Floccina, Yes, but that won't help very much.

Anand writes:

This gives me the opportunity to ask my earlier question again. If the "debt crisis" is really a "collapse in NGDP" crisis, why does Greece have to undertake "structural reforms" in the middle of a depression? Why can't it wait till NGDP recovers?

In Germany (I as assuming you are referring to Hartz reforms) they didn't do it in the middle of a depression. Also German reunification (which was partly responsible for reduced wages) was accompanied by a lot of spending in East Germany to ease the adjustment.

Perhaps Greece needs pension cuts, perhaps it doesn't. But the insistence on them, (which are not the main thrust of the problem), right in the middle of a depression, simply smacks of creditors trying to get as much as they can out Greece before it goes bankrupt. (Or more cynical views like "disaster capitalism" stuff)

Lorenzo from Oz writes:

"Here's where the analogy breaks down a bit, as Detroit is now essentially a poor neighborhood in a large country, whereas Greece is an entire country, with a more diverse set of skills, and thus greater short term possibilities for economic growth."

Perhaps now, but Detroit public policy had something to do with its present trials. Makes it an Awful Warning of a slightly different sort.

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