For months, the Greek government (run by the neophyte left-wing Syriza party), its euro-area partners, and the International Monetary Fund (IMF) have been engaged in negotiations about payment of the last tranche of an existing bail-out program. In exchange for receiving 7.2 billion euros in bail-out money, the Greek government has to credibly commit to undertaking the necessary fiscal and economic reforms that are inscribed in the so-called Second Economic Adjustment Program for Greece.
The cooperative scenario is superior to the non-cooperative one, even if it does not mean the end of Greece’s difficulties.
Given that Syriza was elected on an anti-austerity platform with the stated objective of renegotiating the bail-out terms, the negotiations are at a standstill. The Greek government wants much more lenient terms for receiving financial assistance, while the IMF and eurozone governments want Greece to provide some guarantees that it will be able to stand on its own feet fiscally in the foreseeable future.
In the meantime, the Greek government is quickly running out of money, meaning it will have to default on its debts by the end of the month. Greek banks are surviving with the help of the European Central Bank (ECB), since Greeks are taking their money out of banks (and often the country) out of fear that Greece will end up leaving the Eurozone, imposing capital controls, and force-converting euro-denominated bank deposits into devalued drachmas.
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Such a scenario, which Jacob Kirkegaard of the Peterson Institute for International Economics in Washington calls the “noncooperative” one, would be even more disastrous for the Greek economy than bail-out induced reforms (i.e. the “cooperative scenario”). First, the banking system would fail because the ECB would have to stop providing Greek banks with emergency liquidity. Second, economic activity would decline as a result of bank failures and overall uncertainty and insecurity; investment would come to a halt and commerce would be impeded by the lack of a functioning banking system. Third, the government would have to issue IOUs to pay pensions, employees and suppliers. These IOUs would have to work as an inefficient medium of exchange (i.e. money) until a new currency (e.g. a new drachma) would be introduced; and given the government’s financial prospects, they would be traded at a heavy discount.
With the Greek government already experiencing a ‘primary’ fiscal deficit (i.e. spending is higher than revenues even after removing interest payments on public debts), it has two choices under such a scenario. One is that it could reduce spending dramatically to balance the budget (since revenues would also fall as economic activity declines), which would negatively impact the economy further. Alternatively, it could print IOUs and/or new drachmas in increasingly larger quantities as the real value of such currency declines because of people’s lack of confidence in it (i.e. high inflation).
It is therefore clear that the cooperative scenario is superior to the non-cooperative one, even if it does not mean the end of Greece’s difficulties. The problem is that the Greek government has painted itself into a corner, making unrealistic promises and now having to deliver on those promises. The IMF and euro-area governments have the strong hand here, both politically and economically, and they will not budge much.
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Politically, euro-area governments cannot be seen to help Greece without credible commitments that it will mend its ways, stop asking for money, and pay back at least some of what it owes. Economically, a so-called ‘Grexit’ from the euro would not be catastrophic for the euro area, as Greece represents about 1.8% of eurozone GDP, and is no longer seen by sovereign bond investors as contagious to Italy, Spain and Portugal (as it was a few years ago). The ECB and euro-area governments would suffer losses as a result of the Greek government defaulting on its debts, but those would be relatively easy to manage.
If Syriza leader Alexis Tsipras ends up making the necessary compromises to get the last tranche of money that Greece has been promised, paving the way for a third bail-out arrangement along with a new round of debt restructuring (i.e. the “cooperation scenario”), then he will lose a good chunk of his party, even if he wins the necessary parliamentary vote as a result of support from opposition parties. It would mean the end of Syriza and possibly his own political career.
If he instead chooses to default unilaterally and take Greece out of the euro, then Syriza might stay intact but it is unlikely to stay in power for long, given the social and economic calamity that would hit the Greek people. After all, he is driving a Fiat 500 on crash course with the eurozone’s 18-wheeler, a game of chicken he cannot win. Hopefully, he will swerve at the last minute, preventing Greeks from experiencing a long period of isolation and poverty.