Fair Debt Relief for Greece: New Calculations
— February 10, 2015
By Thomas Philippon
With Philippe Martin we have estimated the proximate causes of the crisis in each Eurozone country. We find that Ireland was brought down by reckless bank lending, Spain by the sudden stop, and Greece by reckless government spending during the boom years. So there should be no question that Greece is first and foremost responsible for its own demise.
But we – governments, households, investors – all make mistakes, and this is why debt restructuring exists. The problem is that Greece’s debt restructuring was hampered by the risk of contagion. The current firewalls (ESM, etc.) did not exist then. There was no banking union, no OMT. It was obvious to every observer in 2010 that Greece’s debt was not sustainable. Many advocated an early debt restructuring, coupled with strong fiscal consolidation, but the perceived risk of contagion made it impossible to implement. Eventually, in 2012, Greece’s debt was restructured. But this was clearly too late – much of the macroeconomic damage was done.
Here are my central points:
- Greece ran a reckless fiscal policy during the boom years, wasting much of the money that it received. There is no question that Greece needs a strong dose of fiscal consolidation.
- However, Greece’s debt should have been restructured much earlier. This restructuring was prevented by legitimate fears of contagion, and it is not fair to ask Greece to pay for that delay, which reflected a general lack of preparedness among Eurozone policymakers.
An alternative history for Greece
This section is based on structural model developed with Philippe Martin. The model takes into account:
- Private and public debt dynamics,
- Sudden stops of capital flows,
- Feedback from private and public debt onto the cost of funds for households and firms,
- Fiscal policy and spending multipliers,
- Unit labour costs and competitiveness.
Thomas Philippon is an Associate Professor of Finance.