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The Coming Greek Default: How Minister Varoufakis Thinks



On May 19 I spoke at the Emergency Economic Summit for Greece in Athens and got a firsthand understanding of how Greek Finance Minister Yanis Varoufakis views a possible deal with the International Monetary Fund (IMF) and the European Commission (EC). In brief, the minister considers their position fundamentally flawed, and says he will not budge in signing anything until they realize their error. Given that another large payment to the Greek creditors is looming on June 5, I now think there is considerable chance that Greece will default. Here is why.

The gist of Minister Varoufakis's argument is that the international institutions use backward induction to come to the conditionalities of their rescue package. They start by positing that from 182 percent of GDP now, Greece's public debt should be reduced to 139 percent by 2020. For this to happen, they induce that the cumulative primary deficit during this period has to reach 27 percent, and cumulative economic growth has to reach 21 percent. (I report the numbers as Minister Varoufakis used them in his speech at the summit.) Herein lies the problem: Minister Varoufakis considers these numbers to be inconsistent with each other and believes that there is a trade-off between the primary surplus and economic growth. While on paper the international institutions' plan may seem coherent, he sees it as wildly off the mark.

To support his thesis, the Greek finance minister points to the last five years of forecasts on the Greek economy, and argues the IMF and the EC have consistently overvalued growth. In the absence of a functioning banking intermediation in Greece, and with constant pressure to cut public spending, current forecasts are inaccurate. Unless the Institutions (as the Troika is called now in Greece) understand that, there is no negotiation and no likely deal. Minister Varoufakis seems confident the Institutions will back off.

Nobel Prize laureate Thomas Sargent, who was also among the presenters, asked Varoufakis what his plan B is. Sargent gave as a counterexample the expectations of the original 13 US states in the 1820s and 1830s that the federal government would bail them out from high accumulated debt payments. It did not, and as a consequence the states struggled mightily for two decades before passing in the state legislatures constitutional amendments to balance the budget each year.

Former finance minister of Hungary Lajos Bokros commented that he has seen such unrealistic expectations more recently. In 1998 Russia was confident that the IMF would bail it out. They didn't, and default became the only option. Bokros argues that the uncertainty and loss of income that ensued in Russia gave rise to the demand for a political strongman—President Putin. Greece seems to be heading in the same direction.

In my book Inside the Euro Crisis, published last year by the Peterson Institute, I recount my own thoughts on a possible Greek default—namely, that Greek politicians do not have the stomach for the type of structural reforms that Eastern Europe implemented to avert disaster. The Emergency Economic Summit for Greece corroborated this view.

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