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Depression’s advocates

Brad DeLong, professor of economics | July 31, 2015

Over at Project Syndicate: Depression’s Advocates: Back in the darker days of late 2008 and 2009, I had one line in my talks that sometimes got applause, usually got a laugh, and always made people more optimistic. Because the North Atlantic had lived through the 1930s, I would say “This time we will not make the same mistakes policymakers made in the 1930s. This time we will make our own, different — and hopefully lesser — mistakes.”

I was wrong. The eurozone is making the mistakes of the 1930s once again. And it is on the point of making them in a more brutal, more exaggerated, and more persistent form than they were made back in the 1930s.

But I did not see that coming. And so, when the Greek debt crisis emerged in 2010, it seemed to me that because the lessons of history were so obvious, the path to the Greek crisis’s resolution would be straightforward. The syllogistic logic seemed to me clear:

  1. If Greece were not not part of the eurozone, the obvious and effective path out of the crisis would be for it to default and restructure its debt, and to depreciate its currency.
  2. Brussels and Frankfurt really did not want to see Greece exit the eurozone — that would have been a major setback for “Europe” as a political project.
  3. Therefore Brussels and Frankfurt would offer Greece enough aid, support, additional money, debt write downs, and debt reschedulings to make Greece better off by staying in the eurozone than it would have been if it had exited, depreciated, defaulted, and restructured back in 2010.

But that did not happen. Greece right now appears to me to be vastly worse off than if it had abandoned the euro and its euro parity in 2010. Just look, in the chart below, at the relative degree of recovery — essentially complete, and none — in Iceland and Greece, respectively.

chart of recovery in Iceland vs. Greece

Full recovery in Iceland; no recovery and deeper depression in Greece.

You can argue — as Barry Eichengreen did argue, back in 2007 — that the technical issues massively raise the costs of exiting the eurozone. Thus any sane system of international economic governance would avoid such an exit. And all that is true. But the costs of non-exit up until now have been, by the Icelandic yardstick, 75% of a year’s GDP. They are rapidly growing.

I do not find claims that the economic chaos provoked by rapid exit back in 2010 would have been even a quarter as large to be credible. And, looking forward, I can not see short-run costs of exit now even approaching the long-run costs of remaining in the eurozone given the required austerity now on offer from Brussels and Frankfurt.

One major reason for the enormous failure of Brussels and Frankfurt to handle the Greek crisis has been their attachment to the wrong model of how the economy works. Thus they have constantly and severely underestimated the gravity of the situation. And they have constantly recommended policies that have made matters much worse.

Back in May 2010 Brussels and Frankfurt anticipated that their proposed first program would be associated with a further 3% fall in Greek GDP below 2010 levels that were then 4% less than 2009. The first program was duly implemented — mostly. But by March 2012 it was clear that 2012 would not see the forecast beginnings of recovery, but instead a Greek GDP that was expected to be 12% below the 2010 level. The second program was duly implemented — mostly. Yet 2012 Greek GDP was not 12% but 17% below the 2010 level.

Now Greek GDP is 25% below its 2009 level. And even though the program documents Brussels and Frankfurt will produce may well show Greek recovery in 2016, I cannot see how any analysis of demand flows can justify that forecast.

The key reason for the failure of forecasts is, of course, Brussels’s and Frankfurt’s — and Washington’s, both at the IMF and in the Obama administration — underestimate of the simple Keynesian multiplier at the zero lower bound on interest rates. Yet the failure of ever-greater austerity to summon the Confidence Fairy either for Greece or the eurozone as a whole has not provoked any rethinking of what proper technocratic policy would be in Brussels or Frankfurt.

Instead, the piece of flotsam currently being clung to is a version of Lenin’s “the worse, the better”: the deeper is the crisis, the more successful will be the push for structural reform; structural reform will boost long-term growth; and if long-term growth does not rapidly emerge it is only a sign that the need for structural reform was even greater than had been thought.

And now we have the most informed commenters at their wits’ end.

The very sharp Charles Wyplosz calls for Greek to prepare to exit, default, restructure, and depreciate — but then undermines that by saying that as long as “Grexit [is] a plausible solution” then its existence as “a credible threat point may deliver a better outcome”, and so “the purpose of the exercise… [is] not to do it”. But that trick never works: one cannot credibly commit to continuing a policy adopted only because its abandonment was expected.

The very sharp Barry Eichengreen cries how “Greece deserves better… Europe deserves better… Franco-German solidarity is worth nothing if [this is] the best it can produce… the German public deserve better… a leader who stands firm in the face of extremism, rather than encouraging it” in the form of “[a] new program is perverse… [and] provides no basis for recovery or growth…”

The very sharp Bill Emmett calls for Europe to accede to Schauble’s demands for Greek exit but only if Germany abandons its demands for continent-wide austerity and accepts large-scale fiscal reflation.

And this story is too, too familiar. This is the story of the 1930s. And so Matthew Yglesias tells us to reread Sheri Berman’s The Primacy of Politics about the unraveling of European social democracy in the 1930s, as Germany’s “SPD took the view… that capitalism was an inherently flawed system… but short of a revolution… there was just nothing to be done…” and Britain’s “Labour Party… enact[ed] spending cuts necessary to keep the country on the gold standard… [eventually] forming a[n austerity] coalition with Conservatives”.

Today, like the 1930s, Europe’s social democrats “don’t have a strategy for changing the rules and they don’t have the guts to tear up the rulebook.” That leaves policies trapped in ordoliberal austerity. And I see nothing to think that such policies will succeed. And if social democrats do not propose and argue for economic and other policies that work, the space for alternatives to austerity will fall to others — and their economic and other policies seem to me even less likely to work for social democracy.

So why have we not learned from our history? I still rub my eyes in amazement: I would have thought that the Great Depression was a salient enough event in European history that we would not be making the same mistakes, exactly, again — and right now it looks like in what will turn out to be a more extreme way.