Greek woes bring IMF to its senses

Heterodox policy would help solve Europe’s crisis, writes Kenneth Rogoff

THE acknowledgement by the International Monetary Fund (IMF) that Greece’s debt is unsustainable could be a watershed moment for the global financial system. Clearly, heterodox policies to deal with high debt burdens need to be taken more seriously.

Since the onset of the Greek crisis, there have been three schools of thought. First, there is the view of the troika (the European Commission, the European Central Bank and the IMF), which holds that the debt-distressed periphery (Greece, Ireland, Portugal and Spain) requires strong policy discipline to prevent a short-term liquidity crisis from morphing into a long-term insolvency problem.

The orthodox prescription was to extend bridge loans to the countries, giving them time to fix their budgets and undertake structural reforms to enhance growth potential. This has “worked” in Spain, Ireland and Portugal, but at the cost of epic recessions. Moreover, there is a high risk of relapse in the event of a significant global downturn. The troika policy has, however, failed to stabilise, much less revive, Greece’s economy.

A second school of thought also portrays the crisis as a pure liquidity problem but views long-term insolvency as an outside risk. The problem is not that the debt of these countries is too high but that it has not risen high enough.

This anti-austerity camp believes that when private markets lost confidence in Europe’s periphery, northern Europe could have solved the problem by co-signing periphery debt, backed by all eurozone taxpayers.

The periphery countries should then have been permitted to roll over their debt and engage in countercyclical fiscal policy for as long as necessary.

For the “anti-austerians”, the eurozone suffered a crisis of competence, not confidence. Never mind that the eurozone has no central fiscal authority. Never mind moral hazards or insolvency. And never mind growth-enhancing structural reforms.

All the debtors will pay up in future, even if they have not always been reliable in the past.

In any case, faster economic growth will pay for everything, thanks to high fiscal multipliers. Europe passed up a free lunch.

This is a coherent viewpoint, but naive. This view masks strong assumptions and risks. In fact, piling loans atop high debt burdens entailed a significant gamble, particularly as the crisis erupted.

Political corruption was endemic. Dual labour markets and product monopolies still hobble growth, and oligarchs have the power to protect their interests. Germany could not have underwritten all the periphery’s debt without risking its own solvency and creditworthiness. Expansive guarantees may have worked, but the economic rot could have spread to the centre.

A third view is that the debt crisis should have been diagnosed as an insolvency problem and treated with debt restructuring and forgiveness, aided by moderately elevated inflation and structural reform. This has been my viewpoint since the crisis began.

In Ireland and Spain, private bondholders, not taxpayers, should have taken the hit from bank failures. In Greece, there should have been faster and larger debt write-downs.

Governments would have had to use taxpayer funds to recapitalise banks. But the public would have understood the situation, while restructured banks would have been able to lend again.

Debt restructuring would have given Europe the reset it needed. Yes, there would have been risks, but it would have been worth it.

So what is the way forward? Deeper European integration, stricter equity requirements for banks and deeper structural reforms are key elements of any solution. Aid to the European periphery is still badly needed.

But Europe’s experience ought to spur a full rethink of the global system for administering sovereign bankruptcies.

That could mean bringing back older IMF proposals for a bankruptcy mechanism or finding ways to institutionalise the fund’s recent stance on Greek debt. There is no free lunch in Europe, but there are much better ways to deal with unsustainable debt. © Project Syndicate 1995–2015

Debt restructuring would have given Europe a reset. The risks would have been worth it

Rogoff, a former IMF chief economist, is professor of economics and public policy at Harvard.

Picture: REUTERS RIGHT TO WORK: Protesters shout slogans during an anti-austerity demonstration outside Greece’s labour ministry in Athens yesterday. The placard reads: “No to layoffs. Steady and permanent jobs for everybody.”