On July 5, 2015, the Greek voters decided "NO" in a referendum on lenders' demands for further austerity in exchange for bailout accommodations. "No" is the appropriate answer to lenders who want higher taxes and lower spending that have crippled the Greek economy--unemployment is about 25 percent, economic growth is moribund, and the debt is higher than when the sad, sordid affair started. What Greece needs is a "Marshall Plan for Greece" that would further restructure the debt: debt forgiveness, revision of the repayment schedule, and cuts in interest rates on the debt. Absent this, exit from the European Union (EU) would remove Greece from the "troika" clutches, namely, the International Monetary Fund (IMF), the European Central Bank (ECB) and the European Commission (EC), which are making demands on Greece that cannot be met. The most intransigent player is German Chancellor Angela Merkel. Further, if Greece leaves the euro, the EU could put itself on a path to an uncertain destination.
International creditors have made some concessions: they believe Greece can show a primary surplus, which is the surplus less the interest payments. Creditors have also already lowered interest rates and extended loan maturities. (See WSJ) The issue now is: Is that enough, and should Greece suffer through further austerity?
Going forward, there'll be no need for complete debt forgiveness--although forgiveness has merit. Such a deal might set a bad precedence for Ireland and Portugal, facing their own debt "crises."
The Maastricht debt-to-GDP ratio requirement for euro zone members is 60 percent. Greece's debt-to-GDP ratio is 177.1 percent, about 2.95 times what Maastricht stipulates. (See Trading Economics) If lenders focus mainly on this, then the debt ratio will grow indefinitely without balance of trade surpluses. It can be shown that the growth of the debt-to-GDP ratio is equal to the trade-deficit-to-GDP ratio. In that case, the preceding sentence holds. But this is myopic. Another obvious way to reduce this ratio absent surpluses would be to forgive part or all of the debt. It can also be shown, that a change in the debt-to-GDP ratio is proportional to the growth in GDP. So policies that grow the Greece economy would affect the debt burden of the country. But the economy hasn't been growing: It's in a recession. Hence, there are two factors that can iinfluence the change in the debt-to-GDP ratio: (1) economic growth, and (2) the actual debt-to-GDP of the Greek economy. Together they say something about how much of the debt burden as a percentage of GDP is sustainable. For instance:
dD/GDP = c*(g)
where dD is the change in the total debt, c* is the fixed debt-to-GDP ratio, and g is GDP growth. Then the change in the dD/GDP is (as of 1/1/2015): (See Trading Economics)
-0.24= .6(-0.4)
-0.7084=1.771(-0.4)
Thus, negative GDP growth implies that the "sustainable" rate of the debt burden to GDP is -0.24 (using the Maastricht requirement), and -0.7084 (using Greece's current debt-to-GDP ratio). Perhaps, forgiving Greece 23 percent of its total debt would bring Greece into compliance with Maastricht. With economic growth, there's a "sustainable" growth in the debt burden provided, the debt-to-GDP ratio is constant.
If international creditors refuse to forgive a portion of the debt, they could reschedule debt repayment for a period of years, giving the country some breathing space. There's no reason why creditors couldn't both forgive a portion of the debt (or all of it) and give Greece an extended repayment schedule. Such a deal has implications for the debt bequeathed to future generations of Greeks. If the revamped repayment schedule leads to greater present investment (and growth), future generations will inherit more capital assets.
We know that the change in the debt is equal to the current account deficit plus the interest on the existing debt. Suppose the Greek current account were zeroed out, the interest on the existing debt could added to the country's external obligations. Given this scenario, if the rate of growth of GDP exceeds the interest rate on the debt, the growth rate of the debt-to-GDP ratio would decline. In the present scenario, whatever the rate of interest, it is certainly higher than the rate of GDP growth, which started the year declining 4 percent. Therefore, negative GDP growth in Greece, and a positive rate of interest assessed on loans advanced to Greece, means that there's no hope the country's debt burden will improve going forward. It is difficult to understand the motivation for that expectation, unless it is a sleight of hand attempt to get rid Prime Minister Alexi Tsipras and his leftist party, Syriza.
Effect of leaving the euro might not be an entirely bad thing. International creditors orchestrated the Greek crisis by demanding payment or more austerity. Austerity measures undertaken by the Greek government did not improve the Greek economy--in fact, they made it worse. The idea of raising taxes in a recession is wrong-minded. Taxes should have been cut! Likewise, cutting government spending in a recession is a tack to the side of imbecility. Government spending should have been increased!
Should Greece return to the drachma, it'll have control of monetary policy once again. This tool is useful. It would restore the Greek government's ability to manage the money supply: print money to lower interest rates, encourage domestic investment, and economic growth. Alternatively, the government could devalue the drachma to make Greek goods more competitive in the global market: Greece would sell more abroad than it buys. The Greek GDP will grow and her current account balance would improve: Greece's debt-to-GDP ratio would fall. As a member of the EU, monetary policy isn't available to the Greek government. And the country's welfare remains at the whim of creditors who put repayment above policies with a good track record for growth.
In all the scenarios discussed, GDP growth plays a central role. Yet, inexplicably the "troika" turns a blind eye to this. They seem prepared instead to sacrifice Greece's economic well-being on the altar of austerity.
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