February 25, 2021

…It is Elementary Mr Sherlock Holmes: The Growth Rate Should be Higher than Interest Rates

Part Α: Today’s Problem

The great classical economist D. Ricardo is regarded as the father of the Equivalence Principle: When the Government borrows in order to spend, the citizens will reduce private consumption since they can be certain that they will be taxed in the future. Therefore, we have an equivalent reduction in private spending, irrespective of whether government spending is financed by present taxation or issuance of bonds (future taxation). Consumers are either perfectly rational or care about the future generation. As contemporary Greeks we presented our own version of the Equivalence Principle: We will consume today together with the Government and the equivalent payment will come from our children, grandchildren and European partners. Was it lack of rationality, lack of concern about the future generations or …something worse ? Unfortunately for the present generation, the long term party, where of course some had greater appetite than others, was abruptly interrupted by the markets.

In Greece we love scenarios and conspiracy theories. We look for people spreading fake news, conspirators, and for exploitation scenarios where foreigners will cheaply acquire the state property. Responsibility rarely belongs to us We will not follow this line of thought .We will prefer instead to discuss a series of bitter truths:

Α) The famous by now ratio of Debt to GDP depends on the interest rates and the rate of growth . For this ratio to decrease, the numerator should increase at a slower rate than the denominator. It is therefore necessary that the nominal rate of interest is lower than the growth rate. This condition is extremely difficult to be fulfilled under current circumstances!

Β) Markets have been disappointed by the Greek approach to the solution of the debt problems. As a consequence they lead the two-year rates to over 25 % and the 10-year ones to over 15%. The intervention of the IMF (that we foresaw as necessary in January 2010) and of the EU decreased borrowing rates considerably with the €110b loan at 4.75%. Unfortunately, the growth rate of the economy is way too negative. The main reasons are the

heavy and complicated tax system and the existing contractionary fiscal policy that reduce aggregate demand. Recently signs appear that the public opinion has started to accept that a that the following fiscal policy mix as absolutely necessary : deep public spending cuts is as well as a simpler system of lower flat tax rates rates that will eventually increase tax revenues. Unfortunately, these policies are not implemented for political, social and other reasons!

C) The traditional methods of adjustment in cases where the Debt/GDP ratio is derailed are: ι) Creation of inflation through printing of new money
ιι) Devaluation of national currency
ιιι) Increase of real GDP

It should be stressed that the three solutions can lead to the satisfaction of the necessary condition between interest rates and the growth. The healthier way in order to address the debt problem is without doubt to achieve high real growth. The option of devaluation (if possible without inflation) can be beneficial to growth and employment. But even the option of creating inflation, that increases nominal GDP in a perverse way and hopes in controlleng interest rates increases can repay nominal debt!

D) If we consider the cases of the Anglo-Saxon countries that have a considerable deficit to GDP (however Debt is not in alarming levels) we will notice that : they can inflate (they have an independent monetary policy), devalue their currency and strengthen the growth process. Today they follow economic policies that are expansionary and pro-growth and avoid of austerity policies.

E) Greece has none of the above mentioned options. The accession to the EU has stripped the option of money printing

and of a national currency devaluation. GDP growth is negative since the Memorandum demands a strict, contractionary Fiscal Policy. The biggest problem however, is the tax bill that the Government presented before IMF arrival., Unfortunately, it removed every possibility of collecting satisfactory tax revenues and above all in promoting economic growth. High tax rates destroy the tax base by closing down businesses and creating unemployment. The complexity of the law bill creates side incentives to taxpayers and impedes the tax collection capacity. Internationally competitive, low, flat, and simple in collection tax rates would increase the growth rate, the tax base and tax revenues!

F) The solution to that the IMF , the EU and the Greek Government try to implement is internal devaluation with price and income decreases and promotion of competition. The hope is that eventually growth will come as a result of increased competitiveness. The political and social costs however are huge. Protests are raised from the Government employees that benefited from public overspending, and from the sections of the population that feel unfairly overburdened in the sharing of debt repayment. Unfortunately, valuable time has been lost due to the mistaken philosophy of the new measures and probably the errors cannot be corrected anymore..

G) It’s worth noting that the Greek debt is basically external. In case where the creditors or bond holders are domestic then the debt issue turns simply to be a redistribution problem: which part of the population is taxed and which part of the population benefits. In the Greek case however, there must be a net payment of Greece to the international creditors and bond holders. This net transfer payment has to be effected without disturbing the domestic and foreign

Banking System that are heavily invested in Greek Bonds.

As a conclusion, the following question arises: Could there be a growth rate considerably higher than the interest rates servicing the International Debt ? From a practical standpoint of view , Greece has failed to solve the problem of the reduction of the Debt/GDP ratio. She experienced a deviation between the two variables leading as expected, the ratio to about 150%. Therefore the following options could be implemented :

(ι) Achievement of a significant superiority of the growth rate over the level of interest rates. A high nominal growth rate(considerably higher than 5%) in order to be able to effectively reduce the Debt/GDP ratio.

(ii) A Primary surplus where Government spending will be considerably reduced and tax revenues will be increased.

(iii) A Decrease of the immediate repayment obligation to international creditors (restructuring).

(iv) A deferment of the sovereign Debt maturity

(iv) A Combination of the above mentioned solutions
The practical implementation of the solutions is necessary to satisfy the objectives of ensuring the European unity, the contagion to other South European countries, the health of the banking system, the political and social peace in Greece. We do not forget that the economist’s armchair from where he gives recommendations is more comfortable than the harsh reality of the politician who examines what can be achieved. But a major issue is whether we have in the political scene the “brave men”, according to John Kennedy, who will disregard their short-term personal interests and will choose instead to implement the long overdue necessary reforms?