The Greek financial crisis – from Grexit to Grecovery

A nice speech by Greece central bank head George A Provopoulos. He presents a complete and thorough picture on The Greece crisis.

He joined GCB just on the verge of the crisis:

let me mention that I became Governor of the Bank of Greece in mid-2008. During the following year – that is, in 2009 – the Greek sovereign- debt crisis erupted. Consequently, I have been at the battlefront of the euro crisis throughout the turmoil, and I would like to share with you my perspectives about what went wrong and what needs to be fixed to make the euro area a better-functioning economic and monetary union.

My presentation will be structured as follows. I will begin by discussing the origins of the euro-area crisis. Next, I will describe the adjustment that has taken place within the stressed countries. With Greece at the epicenter of the crisis, my focus will be on what has happened in my own country. I will then turn to some related issues, notably, the reasons for the deep economic contraction in Greece and the problem of debt-sustainability. Finally, I will discuss changes that are being made to the euro-area’s institutional set-up and their implications for the single currency’s future.

I am not going in to why the crisis happened. Though there is one distinction which has emerged with respect to how countries got affected. Greece was a case of sovereign crisis becoming a banking one and it was the other way round for Ireland, Spain and Portugal:

He discusses why Greece had such a sever contraction:

When Greece agreed to an adjustment programme with the troika – the IMF, the ECB, and the Commission – in May 2010, a recovery was projected for late-2012. Clearly, no one expected that the contraction, which began in late 2008, would last for 5 years and would cumulate to more than 25 per cent.

Why did the projections go so severely off track? There are several reasons.

The first reason concerns the magnitude of required fiscal adjustment. The magnitude of fiscal consolidation was bound to be substantial, because the size of the initial imbalances was very large. What increased the effects of the fiscal consolidation was the mix of policies adopted. Experience shows that fiscal consolidation programmes based on spending cuts lead to smaller economic contractions than those based on tax increases.

For this reason, I have been calling for fiscal adjustment comprised of two-thirds expenditure cuts and one-third revenue increases – mainly generated by expanding the tax base – since the inception of the programme. During the initial stages of the programme, however, the adjustment measures comprised a mixture of 60 per cent revenue – largely tax – increases and 40 per cent expenditure cuts. The tax increases reduced after-tax income, restraining private consumption, and decreased the after-tax return on investment, reducing the incentive to invest. They thereby had a negative effect on consumer and investor psychology, contributing to a cycle of pessimism that engulfed the economy.

The second reason for the deeper than expected economic contraction was that the Greek economy is relatively closed. In closed economies, any decline in demand hits domestically-produced goods more than imports. The decline in demand for domestic production, then, affects output more than if the economy were more open. I called attention to this matter in an article I wrote for the Financial Times in early 2012.

The third reason that economic contraction reached unprecedented levels concerns the implementation of structural reforms, privatization, and measures to improve tax collection. For an adjustment programme to be effective, all the inter-connected parts must be in place. In the early stages of the programme, that did not happen. Implementation in each of these areas was slow and inefficient, exacerbating the contraction. The slow pace of implementation of structural changes contributed to a rise of uncertainty, including widespread speculation of a Greek exit from the euro. In turn, the uncertainty – and the fact that it inflicted a paralysis on the economy – magnified the size of the fiscal multiplier.

 One obvious and ignored reason is blind faith in models. The mess Greece was in it was highly unlikely that it could recover so quickly.

Still the measures are working. There are improvements but there is a long way to go:

  • Spreads against 10-year German sovereigns have fallen by around 1,800 basis points, to around 700 basis points.
  • The Athens stock exchange has risen by about 85 per cent.
  • Bank deposits have increased by 9 per cent.
  • Reliance of banks on Eurosystem financing is down by about 50 per cent.
  • Economic sentiment has recently reached a 5-year high.
  • The twin deficits have been transformed into twin surpluses.
  • The recent release of the PMI for manufacturing for January 2014 points to expansion for the first time in 53 months.
  • It is now generally expected that 2014 will be the year in which growth – although very modest at first – returns to the Greek economy. Underlying this expectation of growth are the following factors.
  • The substantial progress achieved in terms of competitiveness, including the effects of structural reforms in labour and product markets, will lead to an improved export performance.
  • The return of confidence will help support a rise in consumption and investment.
  • Fiscal drag will be considerably less than in previous years.

Nevertheless, the euro’s financial storm clouds have not yet completely cleared. Here, again, the case of Greece illustrates the situation in the euro-area more broadly. The economic and financial environment in Greece remains fragile and sensitive to negative developments. The very high unemployment rate and the large sacrifices undergone by the Greek people led to social and political polarization. Political uncertainty, and the risks associated with that uncertainty, could escalate ahead of the European Parliamentary and local Greek elections that will take place in May, undermining the recovery.

It is my hope that such an unfortunate scenario will not occur. Greek citizens, like the citizens in the other crisis countries, have had to undergo tremendous sacrifices during the past few years. These sacrifices are now bearing fruit and it would be tragic to see them washed away. Despite these risks, I am confident that Grecovery is on the way.

The financial storm served an important purpose. It set in motion policy reforms at both the individual-country level and the euro-area level that will help foster a stronger and more secure Europe, improving the welfare of its citizens and enhancing its position as a major player on the world stage.


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