The Monetary Origins of the Greek Tragedy

Greece stands on the brink of default and possible exit from the Eurozone. It looks unlikely they will be able to find the €1.5bn they owe despite asking all public bodies to give up their cash reserves. The most plausible escape route is for Greece to come to some sort of arrangement with their creditors to release the final €7.2bn of the bailout package. However the EU and IMF are demanding further economic reforms before they will contemplate this.

Alexis Tsipras and his left-wing Syriza party were swept to power in January’s General Election based on their opposition to further cuts. The cost of austerity is clear, 25% of the population are unemployed, most for over a year. The Greek people sent a clear message when electing Syriza, the cost of reform is too painful and it is high time this was recognised by Eurozone leaders. Fiscally Greece has been a mess for years, hence its vulnerability to a debt crisis and yes it was necessary to reform its public sector. Nevertheless the Eurozone must share much of the blame for the current situation, in particular the European Central Bank as this is just as much a failure of monetary policy as it is a fiscal crisis.

In the UK fiscal austerity was to a certain extent offset by a massive monetary expansion. The Bank of England cut rates to record lows and introduced a quantitative easing (QE) programme worth £375bn. While this might not be much compensation for those who lost their job or saw their essential benefits cut it has lessened the strain on the British economy. The ECB only introduced QE earlier this year, coming much too little and much too late to make a difference in Greece. However there are lessons to be learned with growth still low across the rest of the Eurozone.

The ECB was much slower than their counterparts in the UK and US to drop their hawkish approach to inflation. Since the Volcker disinflation of the 1980s the conventional wisdom in economics was that stable prices (i.e. low inflation) is the aim of prudent central bank policy. Yet without inflation there will be no growth. The ECB’s hesitation to aggressively combat low growth is at the heart of this crisis.

When setting interest rates to meet the needs of 19 very different countries there must be a one size fits all approach. Unfortunately the shoe chosen by the ECB was the incorrect size and largely based on the economic conditions of an outlier. German resistance to inflationary monetary policy is understandable given their historical experiences with hyperinflation in the 1920s. Nonetheless this must be balanced with the needs of the other 18 economies. These needs were overlooked while the German economy continued to carry the rest on its back. Of course this had many benefits in propping up the credibility of the Euro but it also damaged the growth in the most vulnerable periphery economies.

Hysteresis is the process through which the unemployed lose skills the longer they are out of work thus trapping them into long-term unemployment. This is taking hold not just in Greece but also other periphery economies such as Spain and Italy where youth unemployment has also reached worrying levels. Not only must an arrangement be made to salvage the situation in Greece, but the ECB must also hold firm with low interest rates and ambitious QE even if prices begin to rise in Germany as a result.

The political cost of a lost generation of European youth would be massive. In the German historical case of hyperinflation extremists such as the Nazis did benefit from the resulting instability. Once price changes had been brought under control their influence died away only to undergo a political resurrection after the Wall Street Crash left many Germans without work or more importantly without any prospect of work in the foreseeable future. This draws alarming comparisons with the rise of Golden Dawn in Greece as well as other anti-Europe and anti-immigration parties across the rest of the continent.

My point is twofold; Firstly the present crisis is not just the result of mismanagement of Greek public finances and as a result its creditors must make allowances for their own mistakes in the ongoing negotiations. Secondly Germany more than most should know the consequences of a failure to rejuvenate faltering Eurozone economies, in particular Greece. Given the debt crisis, growth must be achieved through monetary expansion. The ECB have started down this road but must not be tempted to deviate at the first sign of inflation.

About the Author

Callum Trimble-Jenkins is a recent graduate of Trinity College Dublin having studied Philosophy, Politics, Economics and Sociology, majoring in Economics. He is currently working in communications for an international NGO having previously edited Ireland’s only student run financial newspapers The Bull. Callum is particularly focused on issues of economic policy making, European affairs and British politics. Hailing from Northern Ireland he also watches developments in his homeland with keen interest.

You can find him on Twitter

*Cover image ‘Grexit Scrabble‘ by Jeff Djevdet