Travel and the demands of work have prevented me from posting for the past several weeks. But even if I had had the time I'm not sure what I would have said: like most observers, I suspect, I was both transfixed and confused by the bizarre turn of events. In the spring I was fairly confident that a deal would be struck simply because it was in the interest of both sides (see earlier blog post "Temptation Versus Justice"). However, as the negotiations of the past couple of weeks degenerated into name calling and brinkmanship, and the risk of an accident increased, I frankly began to doubt myself.
Opinions critical of Greece seems to be divided between those who saw the referendum and the subsequent machinations as an abuse of democracy, on the one hand, and the result of incompetence on the other hand. For some, the unstated premise seems to have been that Greece must try to get a deal and "stay in" — any other objective reflected intellectual or moral weakness (or, worse, a betrayal of the European project).
In this "there must be a deal" perspective, Greek actions were disruptive, counterproductive and self-destructive. However, it isn't clear that the Greek government (and evidently the Greek people) saw it that way. Their position could, I think, be summed up as: "we want to stay in the euro (as that will entail less uncertainty), but not at the cost of more austerity in a dysfunctional monetary union."
In this respect, while the travails of Greece could be "IMF" (read: "it's mostly fiscal"), it isn't exclusively fiscal. And, while monetary policy in a monetary union clearly can't be set solely in the interests of the weakest member, neither should it be set strictly for the strongest.
A dispassionate, disinterested analysis of the ECB post-Lehman would, I'd wager, be rather critical of Eurozone monetary policy. In prematurely pulling back liquidity, fearing an inflationary shock, the ECB effectively replicated the Fed's response to 1929 in the face of the biggest liquidity shock since, well, 1929. (This monumental error wasn't reversed until Mario Draghi's "do whatever it takes" comment in September 2012.) And the ECB was persistently blocked from doing QE until, a few months ago, the Eurozone was, as Paul Krugman would say, staring into the whites of deflation's eyes.
What accounts for this response?
Not to put too fine a point in it, because that is what Berlin has wanted. ECB policy doesn't look too bad from Berlin.
In fact, Germany has fared rather well compared to the rest of the Eurozone. As of last year, it was the only member with a GDP above pre-crisis level. At the same time, do the thought experiment of asking what if Germany had retained the DM over the past six years: the DM would have soared, German exports would have been more expensive and the trade position not as strong. It has, evidently, been a good crisis for Germany.
What is good for Germany, however, hasn't been good for the rest of the Eurozone, particularly heavily indebted members.
No sane person wants to kindle Weimar-like hyperinflation. But if you want to reduce debt-to-GDP ratios, you can cut the numerator or grow the (nominal) denominator. Modest inflation — certainly an absence of deflation — helps. Inflation reduces the real value of creditor's claims, however, so the core has consistently resisted more expansionary ECB policy. Ben Bernanke's Brookings Institution blog, here, asks the right question.
All of this underscores the fact that the prime directive of sovereign states is to protect the interests of their citizens. For the Greeks, this implies balancing the benefits of having the euro versus the costs of agreeing to more austerity. For the avoidance of doubt: policy in Greece could have been better before, during and after the crisis, but perhaps if the Greeks thought that, going forward, monetary policy would allow for somewhat faster nominal income growth in the Eurozone and/or a fiscal union is the offing, they might be more willing to do structural reforms. As is was, they could be forgiven for asking why do disruptive structural reforms when there is chronic insufficient aggregate demand? Similarly, it is not entirely unreasonable to ask if it really was wise to privatize state assets in the midst of a Great Depression collapse of economic activity and increase in risk premia.
Germans are justifiably proud of the sacrifices they have made to forge a successful union and address the structural problems they inherited. At the same time, the events of the past couple of weeks suggest that, perhaps, just perhaps, rather than negotiating on the basis of what is "right" for Greece (debt-service payments conditional on sustainable adjustment policies and a felicitous balance between financing and adjustment), what Keynes referred to as the 'Justice' option, the creditors sought to establish credible disincentives for others (Spain, Portugal, Ireland) to try to reopen their deals.
Of course, if they are fairly representing solely the interests of their own citizens, the creditors must adopt that position. But leadership requires balancing your own interests with those of your partners. While the post-war Bretton Woods system certainly advanced US interests, the global governance it provided created a positive-sum global economy that allowed the vanquished to recover and rejoin the concert of nations.
Such a worldview requires the right analytical foundations however. In this respect, part of the Eurozone's problem may be a resurgence in belief of the fallen shibboleths of Say's law and a rejection of the paradox of thrift.
In the New Age of Uncertainty it sometimes seems we are reliving the debates between Keynes and the Classics in the late 1920s and early 1930s. Ironically, Keynes was then arguing for a lessening of the debt burden on German reputation payments.
