Associated Press
When the Greek economy collapsed in 2007, it sent the country into the worst depression in modern history, lasting a decade. Understanding what happened, and what the country’s leaders could have done differently, may offer useful insights for countries around the globe, suggests research by Harvard’s Gabriel Chodorow-Reich, University of Minnesota’s Loukas Karabarbounis, and Chicago Booth’s Rohan Kekre. Among other lessons, they find that bank bailouts can be a useful tool, and that it’s important in a budgetary crisis to strike the right balance between cutting spending and raising taxes.
Depressions of this magnitude and duration happen so infrequently that many of their causes and consequences remain a mystery to economists. To make sense of Greece’s economic cycle, the researchers developed a macroeconomic model featuring diverse households, the government, banks, production sectors, and the rest of the eurozone.
They find that Greece’s economic boom resulted from increased demand for the country’s goods and increased consumption spurred by government transfers such as pension and unemployment payouts. The ensuing bust, they argue, was caused by a combination of demand and supply factors, including an uptick in long-term unemployment and higher taxes imposed by the government, which led to more precautionary savings and lower overall economic activity.
Using their model, which closely mirrors the country’s actual experience from 1998 to 2017, the researchers also evaluated what might have happened had Greece implemented several alternative policies or actions. Granted, the model doesn’t account for possible political events such as a revolution or massive social unrest—but within its scope, it provides a way to evaluate several other scenarios.
If the Greek government had focused more on cutting spending and less on raising taxes to address its budgetary crisis, the economy would have been better off, the researchers find.
Their model suggests that the decline in output would have been 6 percentage points narrower by 2017.
The research doesn’t explore who might have benefited most from that improvement, focusing on the overall picture for Greece. But if the goal is maximizing output, “Did they choose the right mix of fiscal adjustments?” Kekre asks. “If you need to plug a hole in the budget, should you do it by cutting spending or raising taxes? We argue they went too far in the latter direction.”
The expanding political and fiscal union in Europe, motivated by a desire not to repeat the mistakes leading to the two world wars, rests on centuries of interrelated but distinct national beliefs, values, desires, and morals—factors that lie at the foundation of economic practices.
To Understand the Eurozone Crisis, Consider Culture
Though it’s worthwhile to examine the origins of the Greek crisis, we shouldn’t get so busy dissecting it that we forget to ask the underlying question: Does the European Union make sense?
Without Some Fiscal Redistribution, the Eurozone Is Headed for DivorceIn another alternative, if Greece had not received bailouts from the International Monetary Fund and European institutions, the country’s depression would have been even severer, the researchers find. Without that external assistance, Greece would have experienced an additional 20 percent decline in output at the beginning of the crisis and an additional 5 percent contraction by the end of the crisis, Kekre says.
Greece’s use of some of those funds to bail out its banks was also important for mitigating an even worse depression, according to the model. Without this action, output would have been 4 percentage points lower in 2017.
“When the banks receive bailouts, it’s reducing the cost of borrowing for households and firms in the Greek economy,” Kekre says. “As banks are recapitalized, they are better positioned to make loans and don’t need to charge such high interest rates, and that passes through to the real economy.”
Though Kekre cautions that each country’s economic situation is different, that’s an important point for government leaders and economists to ponder. The findings suggest that bank bailouts can be an important means of stimulating an economy overall, and that the decision to use them as a tool is not nearly as stark an either-or choice between banks and consumers as it’s made out to be.
Greece’s boom-and-bust cycle further highlights the importance of nuance, and of evaluating specific situational factors when considering austerity or stimulus measures, Kekre says. There are multiple tax and spending levers governments can pull, and they may all have different impacts over various time horizons.
Gabriel Chodorow-Reich, Loukas Karabarbounis, and Rohan Kekre, “The Macroeconomics of the Greek Depression,” Working paper, June 2021.
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