Scott Sumner  

Paul Krugman on Greece and Germany

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The Syriza Party took power in January of this year, and immediately began to issue one inflammatory statement after another, demanding an end to the troika's austerity program. American bloggers were divided on the effectiveness of the Syriza strategy, with Krugman quite sympathetic to the leftist government. Here's Paul Krugman on February 27th:

Last week, after much drama, the new Greek government reached a deal with its creditors. . . . Greece came out of the negotiations pretty well, although the big fights are still to come. And by doing O.K., Greece has done the rest of Europe a favor.

In contrast, here was Tyler Cowen (who's been remarkably prescient about Syriza), from 10 days earlier:

I do not assume Syriza -- whom I have called The Not Very Serious People -- have a coherent bargaining strategy at all. I take this point from a broader reading of history, where I see that quite often leaders in critical positions simply do not know what they are doing. By no means is that always the case, but it is more often the case than narrative-imposing journalism encourages us to perceive.
And here's Krugman on July 5th, in a post entitled "Europe Wins":
Tsipras and Syriza have won big in the referendum, strengthening their hand for whatever comes next. But they're not the only winners: I would argue that Europe, and the European idea, just won big -- at least in the sense of dodging a bullet.

I know that's not how most people see it. But think of it this way: we have just witnessed Greece stand up to a truly vile campaign of bullying and intimidation, an attempt to scare the Greek public, not just into accepting creditor demands, but into getting rid of their government. It was a shameful moment in modern European history, and would have set a truly ugly precedent if it had succeeded.

And then yesterday morning:

The thing is, all the wise heads saying that Grexit is impossible, that it would lead to a complete implosion, don't know what they are talking about. When I say that, I don't mean that they're necessarily wrong -- I believe they are, but anyone who is confident about anything here is deluding himself. What I mean instead is that nobody has any experience with what we're looking at. It's striking that the conventional wisdom here completely misreads the closest parallel, Argentina 2002. The usual narrative is completely wrong: de-dollarization did *not* cause economic collapse, but rather followed it, and recovery began quite soon.

There are only terrible alternatives at this point, thanks to the fecklessness of the Greek government and, far more important, the utterly irresponsible campaign of financial intimidation waged by Germany and its allies. And I guess I have to say it: unless Merkel miraculously finds a way to offer a much less destructive plan than anything we're hearing, Grexit, terrifying as it is, would be better.

And then yesterday afternoon:

Suppose you consider Tsipras an incompetent twerp. Suppose you dearly want to see Syriza out of power. Suppose, even, that you welcome the prospect of pushing those annoying Greeks out of the euro.

Even if all of that is true, this Eurogroup list of demands is madness. The trending hashtag ThisIsACoup is exactly right. This goes beyond harsh into pure vindictiveness, complete destruction of national sovereignty, and no hope of relief. It is, presumably, meant to be an offer Greece can't accept; but even so, it's a grotesque betrayal of everything the European project was supposed to stand for.

Can anything pull Europe back from the brink? Word is that Mario Draghi is trying to reintroduce some sanity, that Hollande is finally showing a bit of the pushback against German morality-play economics that he so signally failed to supply in the past. But much of the damage has already been done. Who will ever trust Germany's good intentions after this?

A few hours later Greece accepted that unacceptable offer. What can we learn from all this?

1. Monetary "exit" is really frightening to most people, even most people on the left. In 1929 and 1930 the Labour Party in the UK opposed exiting the gold standard, despite high and rising unemployment. The Democratic Party platform in 1932 favored the gold standard. In 1933, important parts of America's labor movement opposed FDR's devaluation policy. A number of top FDR officials resigned in protest, including the Secretary of the Treasury.

From the beginning I was much more skeptical of Syriza than [was] Krugman. I opposed their referendum, and (unlike Krugman) would have voted yes. After the referendum I argued that the no vote might not sway the creditors. But I have to admit that in some respects I misread the Greek views almost as badly as Krugman did. Even 10 days ago I could not imagine Syriza accepting a deal like this---especially considering the well known fondness for FDR among top Syriza officials like Varoufakis. It turns out that although lots of leftist economists (and even some right wing ones) think Greece would be better off exiting and devaluing its currency---the politicians on the left find that option just as unthinkable as those in the center or on the right. That surprised me.

2. The hard constraint imposed by a single currency makes European countries behave more like (American) states than countries. Think about it. State debts tend to be much smaller than the Federal debt. States are desperately struggling to bring pension costs under control, while 70 Congressional Democrats call for "expanding" Social Security benefits. The top Federal income tax rate is 43.4%, while the highest top bracket at the state level is 13.3%. Taxes are much more regressive at the state level. Individual states don't try to boost AD in recessions. Because states are forced to live within their means, economic policy is in some sense more "conservative." By conservative, I don't mean precisely "free market"---local officials give big tax breaks to individual firms to get them to move into their state, a conservative policy that is not free market. In contrast, the US Federal government doesn't give tax breaks to individual firms to get them to move from France to America.

3. This means that in some sense the EU might be seen as a vast right wing conspiracy to bring conservative economics to Europe. Nationalism prevents complete political union in the EU. And without complete political union you can't have fiscal union. But they already have monetary union and free trade in goods, capital and labor. And it seems there is no going back and no going forward. This policy mix forces individual countries to become more conservative. That's not to say Europe will suddenly move to laissez-faire, the changes will occur at the margin. It just so happened that Greece faces a much more severe constraint than some of the others, and hence will have to change quite dramatically.

Krugman's actually right that Greece leaving the euro should not be viewed as unthinkable. But it turns out that it is, and as a result his political analysis was way off base. American macroeconomists tend to view things from the perspective of a national government that can control its own aggregate demand. That model no longer applies to Europe, and the one European institution that does have the technical ability to act---the ECB---is also constrained by a strict monetary constitution, and a conservative mindset. In that sort of world the only way for countries to succeed is to make their economy as competitive as possible, and stop running large deficits. Britain (which is outside the euro) just announced a huge rise in their minimum wage rate, while the Spanish government is desperately trying to hold down costs with labor market reforms. The German virtues are now hard-wired into the eurosystem.

PS. I hope it goes without saying that NGDP targeting would be especially useful in the eurozone, given the lack of room for fiscal stimulus.

Comments and Sharing

COMMENTS (18 to date)
TMC writes:

1. "From the beginning I was much more skeptical of Syriza than Krugman."

I've always been more skeptical of Krugman.

2. I still don't know why most people see Greece leaving the EU is a loss for anyone. The EU is better off for sure, even though they may be 'losing face'.

3. The EU should use this as an opportunity to allow members to ditch the euro and stay in the union. The euro is controlled by Germany and what is good for them is seldom good for the rest of the union. Greece would do well by printing drachmas. Ireland would have done well throughout the early 2000's having it's own currency. It's economy would not have overheated as it did, and would have tolerated the recession much better than it did.

E. Harding writes:

Ever since reading a blogpost by Varoufakis, I have always maintained Greece would never go off the Euro. All Greece's debts are denominated in Euro. Greece is afraid going off the Euro would make the situation worse than it already is.

Oh, and Syriza is nuts. Greek unemployment was already falling when it came into power, and Syriza has made things undeniably worse by leading to spikes in Greek risk premia.

BTW, have Panama, Zimbabwe, El Salvador, Timor, and Ecuador ever had problems with being in the dollarzone?

Lorenzo from Oz writes:

Currently reading Bernard Connolly's "The Rotten Heart of Europe" after the recommendation by Lars C.

American/wider Anglo commentary tends to be too "economist". That is, give too much weight to economic factors and not enough to political ones in their expectations of what people in the EU would/will do.

They (including Syriza) don't want to be independent (the reason why folks usually adopt a new currency), they want to be at the Big Table and all that implies. Unless you grasp the mixture of the EU as icon-of-Faith and elite networking/self-interest, you don't understand the political dynamics.

Syriza is being punished, Greece is being punished and Faith is being maintained against the "casino economics" of the Anglo-Saxons. It is hunting down Heresy, except Syriza doesn't really want to be Heretics. (They certainly do not want to embrace the vile economics of those Anglo-Saxon neoliberals.) So they come back to the bosom of the Faith, sackcloth and ashes and all.

SaveyourSelf writes:

Scott, I feel you are overthinking the motivations of the Greek people. Your explanations all have a "macro" flavor, and I don't think the Greek people--or any other people really--think that way or in those terms when making decisions. Separately--and unrelated to your position--I think Krugman is in the wrong universe.

The Greek people have indicated time and again that they are willing to default on their loans. The fact that they have not yet defaulted is easily explained by the fact that by continuing to play a game of promises with the rest of Europe they continue to get huge sums of money injected into their parasitic economy. Who wouldn't continue to make sacrifices in the future which they never intend to honor in exchange for huge benefits in the present. They will play this game for as long as the rest of Europe is willing to act paternal. It is a win-win for Greece. They win in the present by acquiring unearned treasure, and they win in the future when they default on their commitments and keep whatever treasure they legitimately create for themselves.

To Krugman: I do not think Germany is taking a moral position. The odds are they will lose everything they have given to Greece. That's not a moral position, it is a foolish position.

A second explanation to the continued Greek acceptance of their Creditors' demands is fear of the pain that must accompany changing from a debtor economy to budget neutral economy. Their brief experiences with all their banks closing, credit cards not working, and having to live off cash gave them just a taste of what is to come. They didn't like the taste. And I think that is where Germany's true intentions lay. Germany is slowly and methodically trying to ease the Greek people through the pain of change, in exactly the same way concerned parents sometimes try to help their alcoholic son wean off booze--slowly. Unfortunately, for both the enabling-parents and for Germany, this method rarely works. The incidence of any behavior tends to increase when rewarded and decrease when punished. A smaller and smaller reward given in response to a self destructive behavior is still a reward. Rewards do not ever lead to a decrease in the expression of a behavior.

Greece did win the last round of negotiation: the German proposals that they transfer assets to Luxembourg (to be held in escrow) or that they leave the euro temporarily (5 years) were the ones considered ridiculous by most partners. So was the idea that there be more direct oversight of Greece policy by observers in Athens (Troika reborn, twice as strong). In a sense, Greece's position on Saturday held by Monday morning and Germany signed on the dotted line. Complete victory for Greece on that last round.

Germany never really had enough support to push this through. My guess is that either (1) they miscalculated, or (2) they knew they were going to lose but figured that it not only sends a message [including to other countries and their own voters], but also moves the Overton Window, i.e., they are already negotiating the next bailout offer (maybe in 4 years, it won't be seen as ridiculous to propose that Greek assets be moved to Luxembourg, it'll be seen as a quite sensible idea).

foosion writes:
States are desperately struggling to bring pension costs under control, while 70 Congressional Democrats call for "expanding" Social Security benefits.
Many states have pension funding problems because they drastically underfunded pension plans, often to finance tax cuts. One might just as well write, states are desperate for more revenue.

The statement about Social Security is a non-sequitur.

Fun fact: the last round of Social Security change (Greenspan commission, et al.) set the upper limit on Social Security income subject to Social Security taxes at a level designed to capture 90% of national income. If that had worked, Social Security would be fully funded. It's failing because rising inequality puts a larger percentage of national income above the cap.

Michael Byrnes writes:

Would NGDP targeting work in the Eurozone, given its political structure? Or would it incentivize individual national governments to spend money (since monetary offset would affect the whole Eurozone)?

Jose Romeu Robazzi writes:

It looks from the news that Syriza has not completely accepted anything, but the Syriza supported (for now) government has. We see the same kind of thing in Brazil. The Worker's party won the election, but the policies they are implementing now are not the ones the "sold" in the campaign, rather, they went with the opposition "austerity" and fiscal adjustment.
It seems that modern democracy is in check: people say almost anything to win, but after, they do what must be done...

Scott Sumner writes:

TMC, That first quote is poorly worded, I'll fix it.

You said:

"I still don't know why most people see Greece leaving the EU is a loss for anyone."

You may not know, but the stock market certainly does. Presumably there is fear of a contagion effect.

E. Harding, Not everyone living in high crime neighborhoods gets murdered.

Lorenzo, Excellent. I wish I could come up with such wonderful metaphors.

Saveyourself, I wasn't suggesting the Greek people had a macro view, and I agree with most of your observations.

Luis, They "won"? The deal they got was far worse than they could have done 3 weeks ago.

Foosion, I don't follow---are you saying that expanding Social Security benefits is a good idea?

Michael, Yes, it would work much better than inflation targeting, especially if it was NGDPLT. It would not encourage spending.

Floccina writes:
I don't mean precisely "free market"---local officials give big tax breaks to individual firms to get them to move into their state,

Which is not considered interference with interstate commerce even though so much is. A non-corrupt person can no more get elected that a camel pass through the eye of a needle.

Hazel Meade writes:

Turns out that Greece leaving the Euro was unthinkable - to Greece. Or maybe, more accurately, Greece not getting another bailout was unthinkable to Greece.
Again, if Greece was running a primary budget surplus it could tell it's creditors to go hang and walk away.
But they weren't willing to do without another infusion of cash.

So the real issue is that Greece making the reforms necessary to run a primary surplus are unthinkable to Greece.

Dustin writes:

Perhaps it is expediency. Leaving the EU and devaluing may well be better in the mid / long run , but the immediate shock could make reelection success a less certain outcome.

Tsipras has but to claim
- Leaving the EU and Euro are unthinkable (for ambiguous reasons)
- This hardship was imposed on us, not my fault, reelect me

Mike Linksvayer writes:
I don't mean precisely "free market"---local officials give big tax breaks to individual firms to get them to move into their state,

Like Floccina above this looks like interference in interstate commerce to me. Is anyone trying to make it illegal? Good Jobs First is the nearest I've found, but they just want governments to get better deals, which seems unrealistic given how poorly governments negotiate (to make this comment a little less tangential).

ThomasH writes:

It the German "virtues" that preclude NGDP targeting by the ECB. Given that kind of monetary authority, I think Greece would have been (perhaps still will be) better off leaving the Euro.

Greece did win the Sunday meeting. They had caved 110%, but Germany was threatening to refuse even that offer saying that trust had been broken and upping the ante. 17 hours later, Germany signed the deal (it was past nine am the next day). So, yes, Greece was first defeated, retreated, but afterwards held on.
The question is why Germany led this final charge, which was clear they would lose as too many were ready to negotiate with Greece.

Mike Sax writes:

"This means that in some sense the EU might be seen as a vast right wing conspiracy to bring conservative economics to Europe."

Yes, that's how I tend to see it. What's interesting though is that Britain was the one country smart enough to avoid the euro-along with Denmark.

In Britain even now it's the Conservatives who are much more eurosceptical than Labor. If it were up to Labor maybe Britain would be on the euro.

While I'm hardly a fan of everything Thatcher did, her one inspired moment was keeping Britain off the euro.

Mike Sax writes:

Ambrose Pritchard also has a post where as a British conservative he's hoping that the left is finally going to get over it's loyalty to the EU idea.

Again, it's interesting that British conservatives have always been the euro skeptics.

Anand writes:

I have no idea why you think Krugman was wrong and Tyler Cowen was prophetic. Cowen actually predicts in the post you link that Greece will leave the Euro (it may still happen), while Krugman was "merely" urging it.

Regarding the rest of Krugman's points, from what I read, there is no contradiction there. The troika's terms are indeed madness, since there is no way Greece can repay, even if it was run by angels. The IMF just confirmed the obvious, but it was known beforehand. Also, VAT hikes on hotels and cuts to pensions are pure power play by creditors, with no economic sense behind them.

However, the politics has not caught up to the reality: most Greeks want to stay in the Euro, and no political party in Greece supports a Grexit, barring the Golden Dawn or the Communist Party -- I hope things do not deteriorate to such an extent that they gain credibility. There is no way Tsipras could have taken a path to Grexit based on the current mandate, so he had to fold under creditor demands.

About your "moral of the story", I tend to agree with your 3 points. My only quibble is that they, (especially point 3) were a staple of leftist preaching since before the Euro was launched.

Here is just one article, fairly typical of leftist thought, just before the Eurozone was launched.

Sample quote: "Europe is now run by econocrats and central bankers, and it has become the most austere and most orthodox region of the world, with balanced budgets and hard money taking the front seat, and everything else either in the back seat or left behind entirely."

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