Home Page

Today's Paper

Video

Most Popular

Times Topics

Search All NYTimes.com

Business

World

U.S.

N.Y. / Region

Business

Technology

Science

Health

Sports

Opinion

Arts

Style

Travel

Jobs

Real Estate

Autos

Global

DealBook

Markets

Economy

Energy

Media

Personal Tech

Small Business

Your Money

May 6, 2010, 6:11 am

It’s Not About Greece Anymore

By PETER BOONE AND SIMON JOHNSON
Louisa Gouliamaki/Agence France-Presse — Getty Images Protesters at the Acropolis in Athens waved flags and hung
banners in front of the Parthenon.

Peter Boone is chairman of the charity Effective Intervention and a research associate at the Center for Economic
Performance at the London School of Economics. He is also a principal in Salute Capital Management Ltd. Simon
Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The Greek “rescue” package announced last weekend is dramatic, unprecedented and far from enough to stabilize the euro
zone.

The Greek government and the European Union leadership, prodded by the International Monetary Fund, are finally
becoming realistic about the dire economic situation in Greece. They have abandoned previous rounds of optimistic
forecasts and have now admitted to a profoundly worse situation. This new program calls for “fiscal adjustments” — cuts
to the fiscal deficit, mostly through spending cuts — totaling 11 percent of gross domestic product in 2010, 4.3 percent in
2011, and 2 percent in 2012 and 2013. The total debt-to-G.D.P. ratio peaks at 149 percent in 2012-13 before starting a
gentle glide path back down to sanity.

This new program is honest enough to show why it is unlikely to succeed.

Daniel Gros, an eminent economist on euro zone issues who is based in Brussels, has argued that for each 1 percent of
G.D.P. decline in Greek government spending, total demand in the country falls by 2.5 percent of G.D.P. If the
government reduces spending by 15 percent of G.D.P. — the initial shock to demand could be well over 30 percent of
G.D.P.

Obviously this simple rule does not work with such large numbers, but it illustrates that Greece is likely to experience a
very sharp recession — and there is substantial uncertainty around how bad the economy will get. The program announced
last weekend assumes the Greek G.D.P. falls by 4 percent this year, then by another 2.6 percent in 2011, before recovering
to positive growth in 2012 and beyond.

Such figures seem extremely optimistic, particularly in the face of the civil unrest now sweeping Greece and the deep
hostility expressed toward the country in some northern European policy circles.

The pattern of growth is critical because, under this program, Greece needs to grow out of its debt problem soon. Greece’s
debt-to-G.D.P. ratio will be a debilitating 145 percent at the end of 2011.

Now consider putting more realistic growth figures into the I.M.F. forecast for Greece’s economy — e.g., with G.D.P.
declining 12 percent in 2011, then the debt-to-G.D.P. ratio may reach 155 percent. At these levels, with a 5 percent real
interest rate and no growth, the country needs a primary surplus at 8 percent of G.D.P. to keep the debt-to-G.D.P. ratio
stable. It will be nowhere near that level. The I.M.F. program has Greece running a primary budget deficit of around 1
percent of G.D.P. in that year, and that assumes a path for Greek growth that can be regarded only as an “upside scenario.”

The politics of these implied budget surpluses remains brutal. Since most Greek debt is held abroad, roughly 80 percent of
the budget savings the Greek government makes go straight to Germans, the French and other foreign debt holders (mostly
banks). If growth turns out poorly, will the Greeks be prepared for ever-tougher austerity to pay the Germans? Even if
everything goes well, Greek citizens seem unlikely to welcome this version of their “new normal.”

Last week the European leadership panicked — very late in the day — when it realized that the euro zone itself was at risk
of a meltdown. If the euro zone proves unwilling to protect a member like Greece from default, then bond investors will
run from Portugal and Spain also — if you doubt this, study carefully the interlocking debt picture published recently in
The New York Times. Higher yields on government debt would have caused concerns about potential bank runs in these
nations, and then spread to more nations in Europe.

When there is such a “run,” it is not clear where it stops. In the hazy distance, Belgium, France, Austria and many others
were potentially at risk. Even the Germans cannot afford to bail out those nations.

Slapped in the face by this ugly scenario, the Europeans decided to throw everything they and the I.M.F. had at bailing out
Greece. The program as announced has only a small chance of preventing eventual Greek bankruptcy, but it may still slow
or avert a dangerous spiral downward — and enormous collateral damage — in the rest of Europe.

The I.M.F. floated in some fashion an alternative scenario with a debt restructuring, but this was rejected by both the
European Union and the Greek authorities. This is not a surprise; leading European policy makers are completely
unprepared for broader problems that would follow a Greek “restructuring,” because markets would immediately mark
down the debt (i.e., increase the yields) for Portugal, Spain, Ireland and even Italy.

The fear and panic in the face of this would be unparalleled in modern times: When the Greeks pay only 50 percent on the
face value of their debt, what should investors expect from the Portuguese and Spanish? It all becomes arbitrary, including
which countries are dragged down.

Someone has to decide who should be defended and at what cost, and the European structures are completely unsuited to
this kind of tough decision-making under pressure.

In the extreme downside scenario, Germany is the only obvious safe haven within the euro zone, so its government bond
yields would collapse while other governments face sharply rising yields. The euro zone would likely not hold together.

There is still a narrow escape path, without immediate debt default and the chaos that that would produce:

1. Talk down the euro — moving toward parity with the American dollar would help lift growth across the euro zone.
2. As the euro falls, bond yields will rise on the euro zone periphery. This will create episodes of panic. Enough short-
term financing must be in place to support the rollover of government debt.
3. Once the euro has fallen a great deal, announce the European Central Bank will support the euro at those levels (i.e.,
prevent appreciation, with G-20 tacit agreement), and also support the peripheral euro zone nations viewed as solvent
by buying their bonds whenever markets are chaotic.
4. At that stage, but not before, the euro zone leadership needs to push weaker governments to restructure. That will
include Greece and perhaps also Portugal. Hopefully, in this scenario Spain can muddle through.
5. European banks should be recapitalized as necessary and have most of their management replaced. This is a massive
failure of euro groupthink — including most notably at the political level — but there is no question that bank
executives have not behaved responsibly in a long while and should be replaced en masse.

To the extent possible, some of the ensuing losses should be shared with bank creditors. But be careful what you wish for.
The bankers are powerful for a reason; they have built vital yet fragile structures at the heart of our economies. Dismantle
with care.

E-mail This

Print

Share Close
 Linkedin
 Digg
 Facebook
 Mixx
 My Space

 Permalink


Daily Economist, Daniel Gros, European Central Bank, European Union, eurozone, Greece, Gross Domestic Product,
international economics, International Monetary Fund, national debt, Portugal, Simon Johnson

Related Posts

From Economix

Irish Miracle — or Mirage?

Can Europe Save Itself?

The Next Global Problem: Portugal

Meanwhile, in the Rest of the World

Greece, the Latest and Greatest Bubble

Previous post Was It Really a Bubble?

Next post How Cheap Are Stocks?

Search This Blog

Previous post Was It Really a Bubble?

Next post How Cheap Are Stocks?

Featured Economix Posts

Finding Profit From Investing in Workers

A six-year study finds that offering pay incentives and health benefits to low-level workers, and listening to their
suggestions, can benefit the bottom line.

Who Creates the Wealth in Society?

Mothers and schoolteachers do not receive enough credit for their roles in nurturing human capital, an economist
says.

Irish Miracle — or Mirage?

Ireland’s tax policies for foreign companies helped mask underlying weakness in its economy, two economists write.

Wealth, Race and the Great Recession

The gap in assets between white and black families has “more than quadrupled over the course of a generation,” a
study finds.

The Value of College

Some economists and higher education experts say many teenagers should never enroll in college. Yet the pay gap
between college graduates and others continues to rise. What’s going on?

Jobs That Aren’t Coming Back

 Some people are out of work not only because demand is relatively weak, but because their skill sets don’t match
what employers want anymore.

Jobs Vs. Wages

Wages have held up far better than employment during this recession. Today’s somewhat weak report on jobless
claims continues the trend.

South Koreans Put In Most Hours

…or at least, the longest hours, according to the Organization for Economic Cooperation and Development.

Bring Your Questions on the European Debt Crisis

A panel of experts is answering reader questions about the Greek debt crisis, contagion worries in Europe and the
United States, and what the heck is going in the markets.

Comparing This Recession to Previous Ones: Job Changes

Since the downturn began in December 2007, the economy has shed, on net, about 5.6 percent of its nonfarm payroll
jobs.

Subscribe

Economix RSS

Economic Indicators

In order to view this feature, you must download the latest version of flash player here.

Staff Contributors

Catherine Rampell is the economics editor at nytimes.com.

Posts

David Leonhardt writes the Economic Scene column, which appears in The Times on Wednesdays.

Posts

Sewell Chan writes about economic issues from Washington D.C.

Posts

Jack Ewing about European economics and business from Frankfurt.

Posts
 Marc Lacey is The Times's bureau chief for Mexico, Central America and the Caribbean.

Posts

Daily Economists

Economists offer readers insights about the dismal science.

Nancy Folbre

University of Massachusetts-Amherst

Bio | Posts

Edward L. Glaeser

Harvard University

Bio | Posts

Simon Johnson

M.I.T./Peterson Institute

Bio | Posts

Casey B. Mulligan

University of Chicago

Bio | Posts

Uwe E. Reinhardt

Princeton University

Bio | Posts

About This Blog

Economics doesn’t have to be complicated. It is the study of our lives — our jobs, our homes, our families and the little
decisions we face every day. Here at Economix, David Leonhardt, Catherine Rampell and other contributors will analyze
the news and use economics as a framework for thinking about the world. We welcome feedback, at
economix@nytimes.com.

Welcome to Economix

Comments Policy

Credit Crisis Indicators

In order to view this feature, you must download the latest version of flash player here.

Introducing
 Apture allows readers to dig deeper into a subject without ever leaving the blog post. When you
click on any link marked by the icons , , or , you will be able to view video, reference materials, images and other
related media. Please e-mail your feedback and thoughts on this feature to apture@nyt.com.

Multimedia
Breaking Down the Bailout

An accounting of the government’s rescue package.

How the Government Dealt With Past Recessions

Three economists explain what worked and what didn’t.

Geography of a Recession

A map of unemployment rates across the United States, now through January.

Related Article

In order to view this feature, you must download the latest version of flash player here.

Faces, numbers and stories from behind the downturn.

Special Features

The Debt Trap

 A series about the surge in consumer debt and the lenders who made it possible.

The Reckoning

A series exploring the origins of the financial crisis, from Washington to Wall Street.

Blogroll
Blogroll

Barking Up the Wrong Tree

Brad DeLong

Cafe Hayek

Calculated Risk

Capital Gains and Games

Dani Rodrik's Weblog

DataPoints: The Dismal Scientist Blog

Econbrowser

EconLog

Economist's View

Greg Mankiw

Marginal Revolution

Nouriel Roubini's Global EconoMonitor

Nudge

Robert Reich

Tax.com

TaxProf

TaxVox

The Baseline Scenario

The Becker-Posner Blog

The Big Picture

Will Wilkinson: The Fly Bottle
Blogs From Newspapers and Magazines

Andrew Sullivan

Ezra Klein

Felix Salmon

Floyd Norris

Freakonomics

Free exchange (The Economist)

James Surowiecki

Megan McArdle

Money-Supply (Financial Times)

Paul Krugman

Real Time Economics (WSJ)

Wolf Forum (Financial Times)
Economic Resources

Employment Statistics

GeoFRED: Geographic Federal Reserve Data

Historical Data on Job Growth and Wages

Historical Unemployment Data

Inflation Calculator

Interactive Housing Calculator

International G.D.P. Rankings

Latest Job Market Data

Local Gas Prices

Statistics on Income, Poverty and Health Insurance Coverage in the U.S.

U.S. G.D.P. Statistics

Tag List

DAILY ECONOMIST 376

HEALTH CARE 195

TAXES 183

UNEMPLOYMENT 168

HEALTH INSURANCE 98

UWE E. REINHARDT 96

EMPLOYMENT 95

EDWARD L. GLAESER 93

HOUSING 93

STIMULUS 84

CASEY B. MULLIGAN 79

JOBS REPORT 75

RECESSION 69

SIMON JOHNSON 69

JOBS 67

U.S. HEALTH CARE COSTS 66

BAILOUT 63

NANCY FOLBRE 62

WOMEN IN THE WORKFORCE 62

CREDIT CRISIS 59

FEDERAL RESERVE 58

INTERNATIONAL ECONOMICS 55

BANKS 55

BUDGET DEFICIT 54

FINANCIAL CRISIS 54

HIGHER EDUCATION 53

OPEN MARKET 51

STOCKS 50

EDUCATION 49

GROSS DOMESTIC PRODUCT 48

Archive

Select Month

Home

World

U.S.

N.Y. / Region

Business

Technology

Science

Health

Sports

Opinion

Arts

Style

Travel

Jobs

Real Estate

Autos

Back to Top

Copyright 2010 The New York Times Company

Privacy

Terms of Service

Search

Corrections

RSS

First Look

Help

Contact Us

Work for Us

Advertise

Site Map