Torrens doesn’t know what to write about first – Greece or Europe. Let’s start with Europe. It’s not looking good. Here is a chart from Bloomberg showing the European purchasing manager index – it’s a survey that tells you about planned purchases of goods and services – hence an excellent leading indicator of economic activity, and according to the PMI “tea leaves” Europe is headed into another proper recession, not that it ever really recovered from the last one.
OK. That is the bad news. The good news is that analysts are finally catching up and accepting that there must be plans for Greece or any other member to find an orderly way (or perhaps the most orderly way possible) to exit the Euro. In Greece’s case there is no alternative – the status quo is unsustainable and a disorderly exit will be a nightmare.
As noted in earlier posts, there are 3 reasons why Greece needs a real devaluation: 1) to deal with the sudden stop in capital inflows that were financing unsustainable expenditures; 2) to deal with the switch in expenditures away from services that austerity is generating; and 3) to deal with the Keynesian fall in aggregate demand. As has been argued elsewhere (Ricardo, do you have a link?), much of what we are seeing is to do with a coordination failure that prevents relative prices from adjusting as they should. In such circumstances, monetary policy and exchange rate adjustment is and can be an effective tool. So how does the Specie Flow recipe for orderly exit work.
Recall the main elements of the Specie-Flow approach:
1) Greece remains euroised. That is, banks in Greece still accept euro deposits and make euro loans. This prevents the sudden run on the banking system that would trigger disorderly exit.
2) The Greek government introduces a parallel depreciating currency (or scrip, a la what happened in the little hamlet of Worgl). This does a few things: first, it increases the money supply which stimulates demand and, since it is expected to depreciate over time, people will tend to spend it quickly before it loses its value (this idea goes back to Gessel).
3) To ensure that Greece doesn’t end up with stagflation (rising inflation and unemployment). The government would require that wages must be paid in the new currency and in addition the government would need to impose a freeze on nominal wages in terms of the new currency. Frankly, TH doesn’t think that the 22 percent of the labour force that is currently unemployed would care too much.
Now TH knows that he will get flack for this, but he reckons that the unions could be enticed to accept the deal if some of the new cash was simply transferred directly to the poor. Cash transfers to “hand-to-mouth consumers” are known to be one of the most effective means of inducing demand stimulus.
Oh and TH reckons that you need a 4th element too – a tough central banker to anchor expectations (perhaps John Crow, who laid the ground work for inflation targeting in Canada twenty odd years ago).
So how does this work? Check out the diagrams (borrowed from an earlier post).
The Greek economy is currently producing at A3 well within the production possibilities and consuming at C3 – in this illustration, it is running a trade surplus — Greece isn’t.
In the labour market, the demand for labour in traded sector is shown at point R the demand for labour in services (flipped around measuring from right to left) is shown at U and unemployment is measured by the distance RU.
So what happens when the new Greek Scrip is introduced. First, the monetary injection (the step 2 above) increases demand. It moves the consumption bundle in the economy from C3 to A2 in Chart 1. Since some of this is spent on domestic services, it will increase the price of services relative to traded goods and cause an increase in production of services from and production from A3 to A2. This will help to reduce the Keynesian unemployment (increasing labour demand in the services sector from LD4 to LD3). Second, the increase in demand would gradually raise prices of both tradeable and non-tradable goods in new currency terms (a little bit of inflation can be a good thing). So long as wages are fixed in new currency terms this should reduce unemployment. (Imagine the demand for labour shown in terms of new greek currency shifting up in both the traded goods and non-traded services sectors shifting vertically up to intersect at point S). As demand rises and unemployment falls, the economy tracks along the ray OA2 to OC1 and full employment is restored – compared with the pre-crisis equilibrium, where Greece was producing at A (see earlier post) the Greek economy is producing more traded goods and its traded deficit (which was CA before the crisis) has disappeared.
OK this is highly abstract and a very simple economic model, but it captures a lot of what is happening in Greece. Note that this doesn’t get rid of Greece’s debt problem. But the Greek economy is unlikely to start growing again until the unemployment rate changes direction and starts to fall. And growth is the key to getting a bankrupt Greek economy on its feet again.
Just think what could be done with the new scrip. Perhaps some of the scrip could be specially earmarked for use in participating restaurants and hotels. You could hand it out to tourists as they arrive in Athens!
OK. There are a few technical things. Like wouldn’t people just convert their depreciating currency straight into Euro? That is the subject of the next post (if Torrens can figure the solution to that problem out by then).