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Leaked Greek bailout document: Expansionary fiscal consolidation has failed

By Rob Parenteau, CFA, sole proprietor of MacroStrategy Edge, and a research associate of The Levy Economics Institute.

Below is the leaked Greek bailout document that everyone has been talking about. Yesterday, the Financial Times wrote:

Greece’s economy has deteriorated so severely in the last three months that international lenders would have to find €252bn in bail-out loans through the end of the decade unless Greek bondholders are forced to accept severe cuts in their debt repayments.

The dire analysis, contained in a “strictly confidential” report by international lenders and obtained by the Financial Times, is more than double the €109bn in European Union and International Monetary Fund aid agreed just three months ago.

-EU looks at 60% haircuts for Greek debt –

Here is my understanding of what the Troika analysis demonstrates about the European Sovereign Debt Crisis. We have embedded the document at the bottom of this post.

This leaked Troika “debt sustainability analysis” submitted to the EU Summit yesterday will no doubt be a part of the deliberations in the Greek debt restructuring proposals to be hammered out by Oct. 26th.

Point 1. A. on the first page is a pretty open and blatant admission that expansionary fiscal consolidation (EFC) has proven to be a contradiction in terms, at least in Greece. Moreover, there is a serious policy incompatibility problem, at least over the intermediate term horizon, with efforts at internal devaluation (ID) – that is, attempting nominal domestic private income deflation in order to improve trade prospects when one has a fixed exchange rate constraint.

This latter point is further amplified in the "stress test" scenario discussed on the bottom of page 5, which I think we all know is soon to become the Troika’s base case scenario. They stop short of recognizing that their demands and the actions they have imposed on Greek policymakers are setting off a Fisher debt deflation implosion of the Greek economy. But clearly, the EFC policy is rupturing any semblance of a social contract, and ripping the social fabric to shreds as well.

This is a very large step for the Troika to have taken; admitting that EFC is not working, and that pursuing internal devaluation will aggravate matters further, including the ability of Greece to hit fiscal targets, is a fairly large step in the recognition of the reality of the situation. This is not something that Troika economists are often prone to do. It is not what their incentive structures, formal and informal, tend to encourage them to do.

More importantly, this admission by the Troika shows the rest of the periphery, the UK, the US, and even Japan that the road to debt deflation hell is paved with good intentions – intentions the Troika appears even now prepared to question – but of course, only in the very special conditions of Greece.

We must argue Greece is not a special case, but rather a case in point of what happens when you impose fiscal consolidation on countries with high private debt to GDP ratios, high desired private net saving rates, and large, stubborn current account deficits. Many of my colleagues have laid the groundwork for this type of case to be made, including speeches at the Minsky conference in 2010 and numerous blog posts over the past two years. With this document, now it is evident that analysts at the EU, the IMF and the ECB understand these points as well.

My recommendation: That this become a launching pad for proposing alternative policy approaches and plausible exit/default strategies for oppositional governments that may emerge as Greece and other nations go ungovernable as popular reactions against the Troika’s policies are rejected.


This page is a post from outside of Credit Writedowns' regular contributors.


  1. Gloeschi says:

    Everything that contains the words “Euro” and/or “stress test” seems to be a complete farce. It is hard to believe the Troika members believe in their own analysis. What if this is all done with the only aim to stretch the crisis out over time so that write-downs at lenders can be spread over many quarters, possibly years, and hence mitigated by other earnings? Munich Re recently hinted to be writing down more on their Greek assets in Q3, after having done so already in Q2. This way, bankruptcy of the most exposed lenders might be averted. Of course this has two consequences: 1. The final default will be more costly (as interest and more official loans will have been added to the total debt). 2. This “dragging out” seems unfair to the indebted country and its population as continued austerity unnecessarily prolongs their suffering when an immediate debt restructuring (combined with Euro exit) could have sent the country already onto the path of recovery.

  2. chiller says:

    The time has come for people of the world to retake their countries from their manipulated and corrupt leaders. While doing so please remember this: “There’s nothing to lose by doing a lot, but there’s a lot to lose by doing nothing.”

  3. joebhed says:

    Your logical recommendation is accepted.
    Please, Rob, launch away while you have the podium.
    Opposition politics in Greece is in dire need of setting out the specifics of a new way forward.
    And, thanks.

  4. David Lazarus says:

    The fact that they have recognised that the current policy is counter productive is a huge step. Though I suspect that the 50% haircuts are also too small to end the problem. I think that write-offs closer to 90% will be the end result. Force the banks to accept that level of losses, and declare it a default. Trigger the CDS tsunami which will hopefully wipe out that market and allow sanity to prevail. So far everything has been done to avoid triggering a CDS event.

  5. economist_addict says:

    This commentary says that forcing a more balanced government budget in Greece has failed because the debt level is still unmanageable? This logic is completely false. I don’t think anyone besides the author expected that government budget cuts were every going to get Greece to the point that it could manage its existing debt load. The budget cuts are being forced for a different reason: so that when the writedown does come, Greece doesn’t borrow its way right back into bankruptcy. The point is that Greece needs severe cuts in government spending AND a huge debt writedown.
    The process we have seen, where the debt writedowns are being held hostage to the budget cuts, has been ugly and has multiplied the pain, but it has happened because there is no other way to force any financial discipline on the Greek government and Greek society at large.
    This commentary implies that there is or was a better path, that if the drastic spending cuts hadn’t been forced, the result would have been much better. In the short term that might have been true. However, if the debt writedown had been made without these cuts, we would see every other country decide to stop paying its debts as well, and investors would demand extreme returns for buying any government’s debt in the future. The financial crisis would have multiplied immensely. Instead, leaders of the other PIGS countries look at Greeks rioting in the street and are finally getting their houses in order. Also, this process is forcing dramatic changes in the Greek economy which will probably cause it to be in a much better place ten years from now, with significantly better job opportunities for young people.

    • Procopius says:

      I have an idea. How about we accept that Greece MUST default, and force the Troika to own up to their desire to support the banks by giving money directly to the banks. After that let anybody who wants to lend money to Greece and if Greece is bankrupt again they lose it all. As they should have the first time. Unless the ECB actually becomes a central bank and lender of last resort.

      • David Lazarus says:

        I support that. Today the IMF have vetoed the €8 billion to tide Greece over, so I would invite the entire Troika leadership to Athens with the Army providing security, telling all the soldiers that the people who are visiting are the ones personally responsible for their pay being stopped. Lets see what happens then?

  6. Frances Coppola says:

    Despite the sheer illogicality of the concept of “expansionary fiscal contraction”, and the overwhelming evidence that it simply doesn’t work, it is still widely accepted – even by the last commentor on this blog, it seems. Basic balance sheet accounting shows that if both private and public sector net save concurrently and current account is in deficit, a country’s economy must be forced into recession. It does not “set up a country better for the future”. It wrecks people’s lives and causes immense pain to them and their families for absolutely no reason.

    • David Lazarus says:

      I have never thought that it would work. In order to get out of a debt crisis you need stable or increasing income not decreasing income. There is a limit to how much you can cut the spending without seriously damaging the economy. Without enough courts or police how can you have contracts or not have to spend on expensive security. Without education how can you have a qualified workforce. The US and the UK are going to have significant long term problems because they have such high student debts which distort the economic decisions of people. It might discourage education because of the accumulation of private debts by students but does not create enough graduates with the right qualifications that businesses need. Ireland, Iceland and the Baltic countries are going to have significant long term problems as their youth emigrate, creating a demographic time bomb at the same time. So austerity will leave the nation with scars for decades after the crisis is over.

      So yes austerity only ever works if your nation is the only one trying it and not one of many. Things will continue to deteriorate while we follow neoclassical economics.

    • economist_addict says:

      All I said was that the budget cuts and the debt reduction BOTH needed to happen, and the first was never expected to prevent the need for the latter.
      I didn’t suggest that the term “expansionary fiscal contraction” made any sense- it’s rubbish, of course. If a government cuts spending dramatically at the same time as the private sector is broke, then yes there’s going to be a recession. And there’s probably a multiplier effect to that cut in government spending.
      Maintaining Greek government spending at its prior level would of course reduce the immediate economic pain. But unless you personally have a few hundred billion you’d like to give them, nobody else is still stupid enough to fund their ongoing deficits. Living within their means is a painful concept for the Greeks to face, just as it is for other Europeans and Americans. That’s why we’ve all avoided it until we have no other choice. But at some point we do have to learn to live within our means. We can do it before or after writing down our debts , before or after the ECB prints enough Euros to generate inflation, but sooner or later we need to live on what we produce.
      You seem to be suggesting that never having a recession in Greece would be better than having a recession now. That’s a lovely fantasy, but it’s unfortunately impossible given where Greece is today. Waiting for some hypothetical period of healthy economic growth in which to make the necessary adjustments is more fantasy. Unfortunately, the can has already been kicked down the road so long that it is now a 55 gallon drum which can be kicked no further, so that isn’t really an option anyway.
      I’m not saying recessions are good, or that I want any country to have one. I’m just saying that cutting now and enduring their present hellish recession is less horrible than somehow sustaining the deficits for several more years and then having an even more tragic economic meltdown.
      One way to validate that hypothesis is to look backwards. If Greece had made the adjustments five years ago, it would have endured much less pain. Ten years ago, even less pain. But you think that waiting five more years will make this somehow easier?

      • David Lazarus says:

        The biggest problem that the Greeks face is tax evasion. They need to have more tax collectors with nasty teeth to get the rich to pay up. The whole attitude to avoidance trickles through the economy. Hence the latest property tax is attached to electricity bills. If they managed to get the taxes owed they might actually be in a much better state. As for exiting the euro that could harm business. So they need to solve problems with tax evasion and then the banks. With those done properly they could get through without having to exit the euro. If that happens it would immediately end much of the flight capital out of the periphery to the core.

  7. The_Invisible_Hand says:

    The whole idea of sovereigns sharing a common currency was probably a bad idea to begin with. Greece has become a battleground for how the Eurozone will deal with sovereign debt issues in the future (Ireland, Spain, Portugal, Italy, etc.) should other countries have to be “dealt with”. And Greece “LOOKS” like a battleground because of it.

    A removal from the Eurozone 2 years ago and a phased restructuring of their debt would have gone a long way to engineering a “soft landing” for Greece. But it became more about “who’s going to take the haircut and how much? Or, how will the credit markets react?” over, “how can we prevent a disaster in Greece?”. At some point, everyone (even those in charge in Greece) decided that they didn’t give a (blank) about what was going on internally in Greece.

    We are having the same problems here in the United States. Instead of forcing write downs, debt restructures, and principle reductions in our housing markets, we are dragging it out forever. And it’s dragging our economy back into the proverbial ditch. But it’s because everybody is standing around waiting for the government to bail them out so nobody will have to take a haircut. It’s ridiculous.

    Greece needs to stop worrying so much about what the other Eurozone countries think or want and start looking after themselves first. That is certainly what the banks and the other Eurozone countries are doing.