Thanks to Voxeu for reposting this note by Jacob Funk Kirkegaard on the Greek rescue. It was originally published by the Peterson Institute, whose website seems designed to make things easy to miss. I still think Kirkegaard is too generous to the EU leadership. I see more madness than method in their policies, a point I discussed elsewhere. But this is the clearest account I've read of the new deal, the background and the implications. One point on which Kirkegaard and I certainly agree is the need for structural reform, which he discusses here:
The deteriorating situation in Greece is frequently cited as an example of the adverse economic impact of Europe's insistence on austerity. Athens is alleged to be an example of a wrong-headed European crisis response, with its tough new Fiscal Pact and other rules to enhance surveillance and budgetary discipline within the common area membership. This critique, however, is only partly deserved. It ironically suffers from the same fetishist preoccupation with austerity that it criticises.
No doubt austerity hurts short-term growth prospects and the doctrine of 'expansionary consolidation' is a politically expedient myth without empirical foundation. But short-term austerity is not the only economic and political problem troubling Greece or the rest of the European periphery. Each crisis-stricken economy (as well as most of the rest of the Eurozone, noticeably France) faces its own idiosyncratic and complex structural barriers to growth. The Eurozone's short-term growth picture and outlook (-0.3% real GDP growth in Q4 2011) is not great, but the real growth disaster for Europe is the continent's low long-term potential growth rate, for which estimates since the beginning of the global financial crisis have fallen below 1%. That is less than half the estimated potential growth rate before the crisis began (Eurostat 2012). Substantial empirical uncertainty surrounds such estimates, yet without far-reaching structural reforms, the Eurozone crisis will pose a long-term threat to the potential growth rate of the Eurozone economy far greater than the short-term slump of the next several quarters.
In the ideal world, farsighted policymakers could simultaneously pursue short growth through fiscal stimulus and structurally overhaul their economy for the long-term and restore fiscal sustainability when growth returns. But such a political feat is impossible in a crisis with the unprecedented fiscal and banking turmoil in the Eurozone today. Elected leaders have a finite agenda at any one moment and must consequently sequence their responses.
Ultimately the right policy emphasis will vary from economy to economy. For the US, which continues to suffer from a cyclical downturn, more short-term economic stimulus is warranted. Again in an ideal world, Congress would pay for such stimulus (and other federal government spending programmes and defence) in a sustainable manner.
The Eurozone periphery is in a different situation, however. Current estimated trend GDP growth rates in the five countries are less than 1%. Spain will never see sustained job growth with its current labour market laws. Other Eurozone countries with average effective retirement ages of around 60, or the majority of workers protected from adjustments to their work rules and conditions, will never regain competitiveness without change. Indeed absent such structural reforms, new fiscal stimulus in the Eurozone periphery will be a waste.
Also hidden away on the Peterson website is this interesting short note by John Williamson on the role that a prices and incomes policy could play in Greece as an alternative to euro exit. I'm surprised this approach hasn't been more widely advocated. You might argue that cutting Greek wages and non-traded goods prices by 35% at a stroke, as Williamson contemplates, is unthinkable because of what that would do to real wages. It wouldn't be pretty--but the point is that devaluation will succeed only if it has the very same effect on real wages. If nothing else, Williamson reminds us how hard it will be for Greece to restore its competitiveness quickly, with or without a currency devaluation.
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