The Geek Crises - Essay Example

? The Geek Crises of the Macro & Micro Economics of the Concerned 28 June 0 Executive Summary The New York Times article, Greek Crises Poses Unwanted Choices for Western Leaders published on 20 May 2012 talks about the eventual consequences of a Greece exist on the eventual future of the European Union. The recession that has overtaken the European zone post the housing bubble burst in the US is poised to shake things up in the European region as well. The small states like Greece, Spain and Italy which hitherto have been irresponsible and caviler with their fiscal policies have been putting the overall aggregate demand within their territories under too much of a stress. The augmenting debt has not only placed the aggregate demand in these countries under too much of a stress, but has also lead to drastic changes in the wage and labor markets, which has made the aggregate supply and consequently the national outputs to shrink as well. This call for drastic austerity measures so that the free market forces could come into play and rescue the shrinking aggregate demand thereby resuscitating the aggregate supply to the full employment levels in Greece and other suffering European states. Table of Contents 1.1 Executive Summary ……………………………………………………… 2 2.0 Introduction ……………………………………………………….... 4 2.1 Things to be Discussed ………………………………………………………. 5 3.0 Discussion ………………………………………………………………….. 5 3.1 Explaining the Greek Dilemma in the Light of the AS-AD Model …… 5 3.2 Steps being taken by the Greek Government to Solve the Problem …… 6 3.3 Shortcomings in Government Policies ………………………………… 7 4.0 Recommendations ……………………………………………………… 7 Reference List …………………………………………………………………. 9 2.0 Introduction The article under consideration enunciates the jitters being felt by the salient European nations in the situation of a Greek exist from the European Union. The adverse states like Germany tend to favor a staunch approach towards the Greek situation by suggesting situation bound and conditional rescue packages tagged to tough austerity measures and an enhanced centralization of fiscal power in the European Union (Erlanger 2012). In contrast the liberal states like France intend to propose a more lax attitude towards the Greek situation and want to allow Greece a measure of fiscal and financial freedom thereby allowing the possibly new elected government in Greece a somewhat enhanced flexibility and maneuverability (Erlanger 2012). At present the possible Greek exit has emerged to be a bone of contention between the liberals and conservatives in the European Union. Not to mention that the current political situation in Greece at the time when this article was published happened to be volatile with no stable government that could accrue the people’s confidence and thereby push the proposed European backed reforms and austerity measures. The situation demands a withdrawal of the state fiscal measures from the Greek economy in a time bound and systematic manner so that the free market forces could operate and bring back the economy to a normal level (Erlanger 2012). However, no party in Greece seems to be willing to face the wrath of the masses by raising the public anger. In the mean time the capital from Greece is flowing out and the rating agencies have not only downgraded the credit worthiness of Greece as a region, but have also downgraded the credit worthiness of many salient Greek financial institutions and banks (Erlanger 2012). This has given way to a catch 22 situation in which the European Union expects Greece to act responsible and accept a conditional bailout package and opt for tough austerity measures while the people of Greece seem to be totally averse to any such compromises. The stress on the Greek financial framework and consequently the Euro financial viability is increasing with each passing day. Though the hawks in the European Union are not averse to a possible Greek exit from the Union as they hold that the European fiscal system is strong enough to absorb the eventual impact of a Greek exit, there is no dearth of the supporters who believe that it is vital to retain Greece in the European Union (Erlanger 2012). These experts take Greece to be a test case and believe that if Greece is allowed to fall out of the European Union, it will automatically give way to a domino effect leading to the exit of many other troubled states like Ireland, Spain and Italy (Erlanger 2012). There is a group of Euro Zone supporters who are not willing to see the demise of the European experiment. However, the pressure from the outside forces like the UK is increasing which expect the European Union to pull up its act so that the European recession may not spill out to the other regions (Erlanger 2012). 2.1 Things to be discussed The given report intends to discuss the Greek debacle in the light of the overall impact of the Greek government policies on the aggregate demand and aggregate supply in the nation and the commensurate impact on the wages and labor market in Greece. The purpose of this report is to analyze as to how the expansionist fiscal policy and the augmenting national debt contributed to the economic instability in Greece and to explain this phenomenon in the light of the AS-AD Model. The same model will be used to explain as to how the adoption of the austerity measures on the part of Greece could somewhat restore the nation’s fiscal health in the long run. 3.0 Discussion 3.1 Explaining the Greek Dilemma in the Light of the AS-AD Model The seeds of the Greek problem are embedded in the fiscal policies pursued by Greece in the post recession environment (Castle 2011). At that time, Greece like the other European states resorted to being welfare states and engaged in deficit financing. This was normal to do so as enhancing the state spending was an accepted way of managing and influencing the aggregate demand (Castle 2011). However the problem was that instead of focusing its fiscal deficit on the supply side of the Greek economy that would have buoyed the aggregate supply and thereby had a salubrious impact on the national aggregate demand, Greece resorted to focusing its deficit financing on artificially raising the standards of living of the masses that led to an enhanced national dependence on the state for a large number of goods and services that the people would have purchased for themselves (Benczes 2008, p. 107). Now the problem was that the deficit financing engaged in by the previous Greek governments needed to be financed on a day to day basis and so as to finance this deficit, the Greek government resorted to traditional measures like overseas and domestic debt (Howard 2008, p. 129). In a pre recession scenario the European Union had the wherewithal to support the deficit financing being resorted to be the relatively weak states like Greece. However, in the long run, the government borrowings from the local and overseas sources led to an augmenting national debt (Shalishali 2008). This meant that not only the government was less able to engage in deficit financing to artificially boost the aggregate demand and thereby leaven the wages and employment scenario, but, also it had to pay more interest on the debt accrued from local and overseas sources (Shalishali 2008). This also led to a negative distribution of wealth in the Greek economy in the sense that with the soaring national debt the government was less able to transfer the national wealth to the people that would have shifted the aggregate demand curve towards the right and thereby would have also stimulated the aggregate supply, had to direct the national wealth as an interest secured on the loans (Converse 2012, p. 191). Besides, the wastage of the national wealth in the form of focusing deficit financing on the public sector discouraged the private enterprise that would have positively impacted the wages and labor markets in the long run. Now aggregate demands stands for the goods and services demanded by people and the capital investments made in the machinery and raw materials. As the perpetual deficit financing by Greece led to a soaring national debt this not only discouraged the public and private sector sentiment but also gave way to a flight of capital from the national economy. This reduced the aggregate demand and the aggregate demand curve shifted to the left, thereby attaining a new equilibrium with the aggregate supply curve at a point lower than its previous position. Hence, going by a fall in the aggregate demand the private sector resorted to a shrinking of the aggregate supply that led to a reduction in the rate of employment. This further gave way to a vicious cycle where the falling aggregate demand worsened the employment situation in Greece that reduced the dispensable income in the hands of the people which further shrunk the aggregate demand. The private sector continued to respond to this continual fall in the aggregate demand by shrinking the aggregate supply, thereby leading to further layoffs. The worsening employment situation made the people more dependent on the government support, thereby necessitating the incurring of debt on the part of the state. However, in a post recession scenario, with the European Union tightening the purse strings, Greece is no more able to solicit loans and this has brought the nation to a standstill. 3.2 Steps being taken by the Greek Government to Solve the Problem The present Greek government has agreed to the European proposal of availing a bailout package in exchange for unleashing tough austerity measures on the home turf (Birnbaum 2012). This means reducing the wasteful state spending on employment benefits, pensions, state media, public sector, etc (Birnbaum 2012). This is indeed economically pragmatic in the sense that this will help the state deal with the short term rigidities in the employment market. If the state continues to support a high unemployment level in the form of employment benefits, the labor force will be averse to getting employed at low wages that the private sector affords to pay right now in the light of the shrinking aggregate demand. However, if the state withdraws from deficit financing and let the market forces operate, eventually the labor will be willing to get employed at the current reduced wages. This will facilitate a new AS-AD Equilibrium that will nudge the aggregate supply faster towards the full employment levels, thereby stimulating the aggregate demand. 3.3 Shortcomings in the Government Policies Though the Greek government has agreed to adopting tough austerity measures like reducing the state spending and curtailing the fiscal deficit in the belief that it will let the free market forces operate at their own pace leading to a new AS-AD Equilibrium thereby raising the aggregate demand to the full employment levels, the thing that needs to be understood is that this equilibrium will only be achieved in the long run as the wages tend to be flexible only in the long run. However, in the short run the Greek economy is suffering from the natural labor market rigidities that are giving way to high unemployment. This is not only reducing the disposable income in the hands of the people but is also dampening the people’s and investors’ confidence, which will further delay the Greek economic revival. Hence, some measure of deficit financing is necessary on the part of the Greek government to stimulate the national economy and thereby leaven the aggregate demand. Secondly, the withdrawal of state spending on things like health, pensions and education is not only creating hardships for the Greek people, but this will also harm the economic revival in the long run as it will negatively impact the quality of available labor in the long run. Besides, the shrinking government spending is giving way to public unrest that is further destabilizing the national government (Mcdonald-Gibson 2013). This political instability is giving way to a flight of capital that is delaying the achievement of a propitious AS-AD Equilibrium. Therefore, in the interest of the political stability, the state needs to support the people to some extent. 4.0 Recommendations In consonance with the AS-AD Model, this report makes the following recommendations: The Greek government should accept the European bailout package in exchange for the tough austerity measures. However, the Greek government should resort to some measure of deficit financing on the supply side. The European Union should extend enough fiscal leverage to Greece to enable it to invest in imperatives like health, education and pensions. The Greek government should take measures to restore the public confidence so as to give way to an augmenting investor confidence in the Greek economy. Reference List Benczes, I 2008, Trimming the Sails, Central European University Press, Budapest. Birnbaum, M 2012, ‘Greece’s Parliament Approves Austerity Measures’, The Washington Post, 12 February, viewed 28 June 2013, Castle, S 2011, ‘Greek Deficit Exceeds Target set by Bailout’, The New York Times, 26 April, viewed 28 June 2013, Converse, R.W 2012, Fiscal Crisis and World Order, Algora, New York. Erlanger, S 2012, ‘Greek Crisis Poses Unwanted Choices for Western Leaders’, The New York Times, 20 May, viewed 28 June 2013, Howard, M 2008, Public Sector Economics for Developing Countries, University Press of the West Indies, Barbados. Mcdonald-Gibson, C 2013, ‘Unrest May Spread Across Europe, Warns Red Cross Chief’, The Independent, 24 May, viewed 28 June 2013, Shalishali, M.K, 2008, ‘Dynamics of National Debt Accumulation and Economic Performance’, Journal of Economics and Economic Education Research, vol. 9, no. 1, pp. 55-59. The New York Times May 20, 2012 Greek Crisis Poses Unwanted Choices for Western Leaders By STEVEN ERLANGER PARIS — The leaders of the Group of 8, emphasizing growth as well as fiscal discipline at their meeting on Saturday, made a strong plea for Greece to stay in the euro zone and the European Union. And no wonder. Despite efforts at official reassurance, no one really knows the consequences of a Greek exit from the euro zone, or how rapidly big countries like Spain and Italy, and their banks, will feel the effects. However cavalierly some European officials talk of “managing” a Greek exit, the political and financial costs would represent a fundamental challenge to the European Union and its credibility, and the point of no return may be approaching faster than anyone anticipated. “Anyone who thinks a Greek departure would be cleansing and not cause systemic contagion is deluding themselves,” said Simon Tilford, chief economist at the Center for European Reform in London. “Already we’ve seen a sharp increase in spreads and the beginnings of capital flight in other struggling euro zone economies,” with the risk of a full-blown banking crisis in Spain, where 16 banks and four regions have just been downgraded by Moody’s Investor Service. The stresses on the system are now so great that to contain panic and contagion, while protecting countries too big to bail out, would require political choices and financial commitments that many countries, including Germany, Finland and the Netherlands, seem unlikely to make — the prime reason they would prefer that Greece remain. The problems of Greece and Spain are complicated enough, but the pressure on euro zone leaders to resolve the evident contradictions in the common currency and to move faster toward more political and fiscal integration is rising by the day. The election of Francois Hollande, a committed European, as president of France may help push Berlin toward more collective responsibility for the euro zone, but Chancellor Angela Merkel of Germany, with her own domestic political concerns, has rarely been willing to move quickly or boldly, which many believe has prolonged and deepened the euro crisis. Even the British prime minister, David Cameron, warned Europe of the urgent need to fix its economic imbalances and structure. Britain is outside the euro zone and has no intention of joining, so Mr. Cameron’s words were resented. But they rang loudly. Europe, he said, “either has to make up, or it is looking at a potential breakup.” While Greece is only a small part of the euro zone — and European officials concede it should not have been allowed to join in the first place — its exit is likely to be more expensive and complicated than figuring out a way for it to remain. That would be subject, of course, to Greek voters producing a functioning government in new parliamentary elections on June 17. Ms. Merkel is now talking of special stimulus programs for Greece to help ease the pain of austerity, but any new deal with Athens will have to be negotiated with a real government, and there is no guarantee that the next elections will produce a working majority. They might even lead to a governing coalition that is hostile to the loan agreement that Germany has insisted is not open to significant renegotiation. In the interim, as European officials try to send strong messages to Greek voters about the consequences of an exit, a continuing run on Greek banks — a panic that threatened to spread to Spain last week — could force the European Central Bank to jettison Greece anyway by refusing to replace the euros fleeing the country for lack of proper collateral. European finance officials are trying to be reassuring about a Greek exit, saying that most Greek debt is now held by nations, which can afford the loss if necessary, and that better firewalls exist to protect the rest of the euro zone, and so that the impact on the world economy will be manageable. But while Europe is better prepared for a Greek restructuring of its debt — writing down what is currently held by states and the European bailout funds — a Greek departure is likely to be seen as the beginning of the end for the whole euro zone project, a major accomplishment, whatever its faults, in the postwar construction of a Europe “whole and at peace.” “A Greek exit should be avoided; it will be very disruptive and disorderly, and not just for the Greeks,” said Nicolas Veron, an economist at Bruegel, a research and policy institute, in Brussels and the Peterson Institute for International Economics in Washington. “It’s a classic clash between moral and economic attitudes. A neighbor may keep starting fires, which is exasperating, but if you know his fire is going to run to your roof you have to act to put it out. Leaders need to make hard calculations about what is best for everyone.” Daniela Schwarzer, a European Union expert at the German Institute for International and Security Affairs, said that a Greek default, within the European Union or without, would be costly, requiring a write-down of much of the debt held by European states and the European Central Bank, which member states would then have to recapitalize. But that is just the financial expense, which is the least of it. More important is “to avoid the first example of European Union membership not being forever,” Ms. Schwarzer said. “If that taboo is broken, I think there will be considerable contagion,” including unsustainable spikes in the bond market; further runs on the banks in Spain, Portugal and Italy; and social and political unrest beyond Greece. “There’s a very real risk that Spain could go the way of Greece, Portugal and Ireland,” which have had to seek bailouts, Mr. Tilford, the economist, said. “That’s a systemic risk to the euro as a whole.” Experts believe that damage could be limited, but only by bold political steps toward more centralization of power in the euro zone that may prove too hard for politicians to take. A Greek departure would have to be accompanied by “a package of substantive reforms of how the European Union is run, not just a bigger firewall, but a move to some measure of debt mutualization, of pan-euro-zone bank protection and regulation and a commitment to broaden the mandate of the European Central Bank,” Mr. Tilford said. The bank must be able to act as a lender of last resort, as the Federal Reserve does in the United States, to stop “this poisonous interplay between government debt and the banking sector,” he said. In the United States, for example, if a major bank fails it does not take Delaware with it, and if the state of California has debt problems, it does not undermine confidence in California’s banks. Mr. Veron suggested that leaders should simply announce that the European bailout funds would guarantee all national bank deposit insurance plans — that Europe would stand behind all euro zone deposits. “That would be a massive enhancer of trust for depositors and investors,” he said, especially in Greece. But such changes would mean a major political leap for Ms. Merkel and other Northern European leaders and a redrawing of the European Central Bank charter, a step Berlin has so far refused to support. And it would imply that as in the United States, funds from countries with healthy surpluses would flow in some measure to help the weaker ones with deficits. “If Greece goes, there would have to be a clear signal from Germany that it would do everything necessary to keep Spain, and that the E.C.B. will do all it must to help Spanish banks,” said Charles Grant, director of the Center for European Reform. Keeping Greece or letting it leave will be costly either way. Even if the Greeks elect a pro-European majority in Parliament, at this point nearly all the Greek parties are calling for a renegotiation of the latest bailout deal. Ms. Merkel is now talking of some stimulus and job-creation programs for Greece in parallel, but even a mini-Marshall Plan will not pull Athens out of its debt trap without a restructuring of the rest of its obligations. Mr. Veron said that there was more Athens could do — or if it could not, it must allow others to do it — like firing of additional state employees, breaking up cartels and creating a fair and effective system of tax collection. “There is scope for compromise on austerity, because the strategy has not worked very well,” he said. “But to do that you need to give creditors a modicum of trust that remaining obligations will be met. The Greek public doesn’t want austerity, wants to stay in the euro and likes being sovereign. But some of that will have to give, no matter what.” The Social Democratic Party in Germany, which has been emboldened by Mr. Hollande’s victory, may encourage Ms. Merkel to make more daring political moves to reinforce the European Central Bank. Ms. Merkel needs the Social Democrats if she is to get her own fiscal treaty and the new permanent bailout fund, the European Stability Mechanism, ratified by the required two-thirds vote in Parliament. “It really comes down to the Germans,” Mr. Grant said. “If they don’t do the right thing, the euro zone comes closer to unraveling.” Read More