Greece – one month on

It is now one month since Syriza came to power in the Greek general election. Much has been said across Europe, many meetings held but little has changed.

Syriza said, both ahead of and immediately after the election, that they would immediately and unilaterally throw out the Troika (the term for the EC, ECB and IMF group that oversaw Greece’s adherence to the bailout conditions imposed) to regain sovereignty over economic policy and end austerity. They said that they would demand a haircut on the amount of debt owed and that the rest of Europe would agree to this because it was (a) fair and just and (b) Europe would be scared that Greece might pull out of the euro and set off a chain reaction amongst other members that would call into question the very existence of the single currency.

Over the last few days Syriza has backed down from all of these demands, with apparently very little gained in return. Europe has stated very clearly that any write-down in the value of the outstanding debt is unacceptable to them, and Europe has continued to demand that the same trio of institutions (though now called the institutions rather than the Troika) determine whether Greece is complying with its obligations under the original bailout agreement. Also rather than anything happening immediately as Syriza demanded further discussions will take place over the next four months and conclude just before Greece is required to repay the next tranche of its debt.

It seems difficult to argue anything but that Syriza has failed miserably to deliver what it had promised the Greek voters – and indeed the risk now is that Syriza is unable to get its own MPs to give parliamentary approval to what it has agreed with Europe – which would lead to a new crisis.

With a finance minister who was formerly a professor of game theory, everyone was interested to see the negotiating techniques that Syriza adopted. At the time, and even more so with hindsight, they do not seem to have been very smart. The first acts of Tsipras and Varoufakis (the prime minister and finance minister) seemed designed to upset and offend the Germans, which may have good for domestic politics, but not ideal for bringing on board the key decision-maker in reaching agreement with Europe. They also made significant concessions very early – within a few days of coming to power, Tsipras was saying that Greece intended to repay every euro of its debts. Syriza’s maximum leverage was always likely to be immediately after the election, when “democracy” was on their side – by allowing discussion to go on for another four months they will lose that benefit. Finally it became clear as time went on that the “disaster” scenario of Greece pulling out of the euro, was something that Germany was quite prepared to live with (indeed many Germans are actively campaigning for it) whereas Syriza did not have a mandate to allow that , given that 70% of Greeks want to remain in the euro.

By contrast, Europe, led by Germany but strongly encouraged by both other Northern countries such as Finland who share the German approach to economic discipline, and by Southern countries such as Spain and Portugal, who have been through similar austerity programmes to Greece without (much) complaint and did not see why Greece should get any special treatment, played their hand in a very robust style. Schauble, the German finance minister seemed to revel in the role of “euro-enforcer”, and has insisted on Greece backing down on almost every substantive element of their demands.

The lessons from the last month seem to be (i) when going into a negotiation you need a credible fall-back position if you can’t get what you want – Syriza rather put a gun to their own head and threatened to shoot, (ii) Syriza, by conceding externally in Europe, may well have lost credibility internally, disappointing both many of their own party members and many Greeks who voted for them and (iii) Europe does not recognise democracy as an appropriate reason to go against past agreements and the rule of law (Juncker has made this point explicitly) – it should now be abundantly clear that being a part of the euro means a substantial loss of sovereignty for a nation, especially if they have a weak financial system.

Not much has changed in the last month. Greece is still stuck with debt it will never be able to repay, the Greek government has almost no say in how its economy is to be run, and the European political class have asserted their right to ignore the results of democracy in their quest to maintain the structurally-flawed single currency. This is not a long-term equilibrium – there are more crises to come.

Why most economic forecasts have been so wrong in recent years

In its recent six-monthly World Economic Outlook report, the IMF included a section examining why it, and just about all other economic forecasters, had been consistently too optimistic in its forecasts of economic growth over the last three years. This has been particularly painful for those governments undergoing austerity programmes, where the shortfall in growth relative to forecasts has meant larger deficits and the need for further austerity programmes.

The very clear conclusion is that their estimates of the fiscal policy multipliers have been far too low. The fiscal policy multiplier measures the degree to which the economy is impacted by a change in fiscal policy (either a tightening of policy created by raising taxes or cutting spending, or an easing of policy created by cutting taxes or boosting spending). For the 30 years up to 2007, economists had identified this multiplier to have a value of about 0.5, so that a fiscal tightening equivalent to 1% of GDP, could be expected to reduce the growth rate of the economy as a whole by about 0.5%. However since 2008 this previously stable relationship has changed and the multipliers now appear to range between 0.9 and 1.7. Further, it was  those economies which underwent greater austerity which saw the higher multipliers on final economic demand.

For the UK, this is unfortunate news for Mr Osborne, since this is exactly what his Labour opponent, Mr Balls, has been saying for some time. It means that the steady approach to austerity at about a 1% rate of tightening per annum, that he adopted is having a greater effect on the overall economic growth than he envisaged.

The higher multipliers identified where there is greater austerity is probably due to an economic confidence effect, as the deep cuts in government spending and large increases in taxes will lead everyone to believe that recession is imminent and thus curtail their spending immediately. For Greece, Spain and Portugal this goes some way to understanding why their previous austerity plans have not worked – those who are bailing them out have demanded that they get their fiscal houses in order in a short space of time and this has resulted in even weaker economies and larger than expected budget deficits.

At the same time as the fiscal policy multipliers have risen, so the monetary policy multipliers appear to have fallen. Cutting interest rates from 6% to 5% has a far more dramatic effect on the economy than cutting the from 1% to 0% and Quantitative Easing policies are generally agreed to work best the first time they are used and have less effect with each repeated use. Keynes is often attributed with describing such policies as “pushing on a string”. Central Banks are now having to make significant monetary policy changes to have any effect on the economy.

So the world finds itself in a real policy bind. The area of policy being tightened (fiscal) is working too effectively on growth, and the area of policy being eased (monetary) is not working at all effectively on growth. This approach does help to provide an understanding of why economic growth is consistently disappointing the economic forecasters. The policy implications are at odds with conventional wisdom – governments should adopt a slow but sure approach to austerity, and a more effective form of Quantitative Easing needs to be adopted with the concept of the Modern Debt Jubilee (espoused here), appearing to be an increasingly interesting idea.