How Strong Is Business Investment, Really?

DeLong rises to defend Ben Bernanke, against claims that unconventional monetary policy in recent years has discouraged businesses from investing. Business investment is doing just fine, he says:

As I see it, the Fed’s open-market operations have produced more spending–hence higher capacity utilization–and lower interest rates–has more advantageous costs of finance–and we are supposed to believe that its policies “have hurt business investment”?!?! … As I have said before and say again, weakness in overall investment is 100% due to weakness in housing investment. Is there an argument here that QE has reduced housing investment? No. Is nonresidential fixed investment below where one would expect it to be given that the overall recovery has been disappointing and capacity utilization is not high?

As evidence, DeLong points to the fact that nonresidential investment as a share of GDP is back where it was at the last two business cycle peaks.

As it happens, I agree with DeLong that it’s hard to make a convincing case that unconventional monetary policy is holding back business investment. Arguments about the awfulness of low interest rates seem more political or ideological, based on the real or imagined interests of interest-receivers than any identifiable economic analysis. But there’s a danger of overselling the opposite case.

It is certainly true that, as a share of potential GDP, nonresidential investment is not low by historical standards. But is this the right measure to be looking at? I think not, for a couple of reasons, one relatively minor and one major. The minor reason is that the recent redefinition of investment by the BEA to include various IP spending makes historical comparisons problematic. If we define investment as the BEA did until 2013, and as businesses still do under GAAP accounting standards, the investment share of GDP remains quite low compared to previous expansions. The major reason is that it’s misleading to evaluate investment relative to (actual or potential GDP), since weak investment will itself lead to slower GDP growth. [1]

On the first point: In 2013, the BEA redefined investment to include a variety of IP-related spending, including the commercial development of movies, books, music, etc. as well as research and development. We can debate whether, conceptually, Sony making Steve Jobs is the same kind of thing as Steve Jobs and his crew making the iPhone. But it’s important to realize that the apparent strength of investment spending in recent expansions is more about the former kind of activity than the latter.  [2] More relevant for present purposes, since this kind of spending was not counted as investment — or even broken out separately, in many cases — prior to 2013, the older data are contemporary imputations. We should be skeptical of comparing today’s investment-cum-IP-and-R&D to the levels of 10 or 20 years ago, since 10 or 20 years ago it wasn’t even being measured. This means that historical comparisons are considerably more treacherous than usual. And if you count just traditional (GAAP) investment, or even traditional investment plus R&D, then investment has not, in fact, returned to its 2007 share of GDP, and remains well below long-run average levels. [3]


More importantly, using potential GDP as the yardstick is misleading because potential GDP is calculated simply as a trend of actual GDP, with a heavier weight on more recent observations. By construction, it is impossible for actual GDP to remain below potential for an extended period. So the fact that the current recovery is weak by historical standards automatically pulls down potential GDP, and makes the relative performance of investment look good.

We usually think that investment spending the single most important factor in business-cycle fluctuations. If weak investment growth results in a lower overall level of economic activity, investment as a share of GDP will look higher. Conversely, an investment boom that leads to rapid growth of the economy may not show up as an especially high investment share of GDP. So to get a clear sense of the performance of business investment, its better to look at the real growth of investment spending over a full business cycle, measured in inflation-adjusted dollars, not in percent of GDP. And when we do this, we see that the investment performance of the most recent cycle is the weakest on record — even using the BEA’s newer, more generous definition of investment.

Real investment growth, BEA definition

The figure above shows the cumulative change in real investment spending since the previous business-cycle peak, using the current (broad) BEA definition. The next figure shows the same thing, but for the older, narrower GAAP definition. Data for both figures is taken from the aggregates published by the BEA, so it includes closely held corporations as well as publicly-traded ones. As the figures show, the most recent cycle is a clear outlier, both for the depth and duration of the fall in investment during the downturn itself, and even more for the slowness of the subsequent recovery.

Real investment growth, plant and equipment only

Even using the BEA’s more generous definition, it took over 5 years for inflation-adjusted investment spending to recover its previous peak. (By the narrower GAAP definition, it took six years.) Five years after the average postwar business cycle peak, BEA investment spending had already risen 20 percent in real terms. As of the second quarter of 2015 — seven-and-a-half years after the most recent peak, and six years into the recovery — broad investment spending was up only 10 percent from its previous peak. (GAAP investment spending was up just 8.5 percent.) In the four previous postwar recoveries that lasted this long, real investment spending was up 63, 24, 56, and 21 percent respectively. So the current cycle has had less than half the investment growth of the weakest previous cycle. And it’s worth noting that the next two weakest investment performances of the ten postwar cycles came in the 1980s and the 2000s. In recent years, only the tech-boom period of the 1990s has matched the consistent investment growth of the 1950s, 1960s and 1970s.

So I don’t think it’s time to hang the “Mission Accomplished” banner up on Maiden Lane quite yet.

As DeLong says, it’s not surprising that business investment is weak given how far output is below trend. But the whole point of monetary policy is to stabilize output. For monetary policy to work, it needs to able to reliably offset lower than normal spending in other areas with stronger than normal investment spending. If after six years of extraordinarily stimulative monetary policy (and extraordinarily high corporate profits), business investment is just “where one would expect given that the overall recovery has been disappointing,” that’s a sign of failure, not success.


[1] Another minor issue, which I can’t discuss now, is DeLong’s choice to compare “real” (inflation-adjusted) spending to “real” GDP, rather than the more usual ratio of nominal values. Since the price index for investment goods consistent rises more slowly than the index for GDP as a whole, this makes current investment spending look higher relative to past investment spending.

[2] This IP spending is not generally counted as investment in the GAAP accounting rules followed by private businesses. As I’ve mentioned before, it’s problematic that national accounts diverge from private accounts this way. It seems to be part of a troubling trend of national accounts being colonized by economic theory.

[3] R&D spending is at least reported in financial statements, though I’m not sure how consistently. But with the other new types of IP investment — which account for the majority of it — the BEA has invented a category that doesn’t exist in business accounts at all. So the historical numbers must involve more than usual amount degree of guesswork.

Guest Post on Portugal

(In comments to one of the posts here on Greece, Tiago Lemos Peixoto posted some observations on the situation in Portugal. In response to some questions from me, he sent the message below. We don’t hear much in the US about the the political-economic situation in Portugal, and I thought Tiago’s discussion was interesting enough to post on the front page. I’ve posted his original comment first, and then then the followup. My questions to him are in italics. JWM.)

I am a 37 year old Portuguese, born merely 4 years after a semi fascist dictatorship that furthered our already geographical peripheral position to one of political isolation. We joined the EEC 10 years after that, while still trying to recover from the aftermath of the democratic transition on the promise of cooperation, solidarity, prosperity, and a helping hand in developing our economy to the european standards of living.

Now, let’s forget for a while the fact that such a thing never happend. Instead of modernizing and improving our competitiveness, the EEC brought in fact production quotas to our industries and agriculture, and effected a great many deals that turned out to be unilateral. One example out of many would be our milk and dairy production, which is capable of producing in vast quantities, but due to said quotas are, to this day, often destroyed and wasted so that we don’t outperform.

We didn’t readily see that, however. Along with our joining in 1986 came communitary funds which were generously abundant, almost trickle down. Why would we think about our lack of competitiveness when Europe paid our producers subsidies to cut down excess? Who could really complain when great and bloated artistic endeavours, ambitious new infrastructures were being developed via communitary funds? Or with the tearing down of the old borders, the freedom to move within anywhere in the Schengen space? After the years of dictatorship and extreme poverty, after all that crippling isolation, it seemed like the dawn of a new age. And there are striking paralels to Greece here as well, what with their being a peripheral country who survived a period of dictatorship.

Add to that the promise of the €. Now, that one was harder to sell, since it actually doubled a lot of the prices, but hey, all seemed to be going so well, surely it would all adjust soon, and this is just another step to an unified Europe of progress.

That’s what we’ve been pretty much conditioned to believe, and that is the mindset that made people equate the European project with prosperity. For the Greeks, it’s very likely that any Greek between 50 and 60 grew up in a dictatorship, and same goes to every Portuguese between 40 and 90. Adults like myself grew up with the European Union and its promise of a better world and barely know any world outside of it. And communitary funds, even if they’re all almost universally badly applied, worked like a Skinner’s box of sorts.

And now, they threaten us, the adults who barely know a world outside EEC/EU, the young adults who grew up on the possibilities given by Erasmus projects, the older people who grew up or lived through overt dictatorships, that all this can go away. And that with it comes fire and brimstone, that we HAD to join the € because our currency was too weak (and what better argument to NOT join the Euro?) and would be even more worthless if we were to readopt it. They throw the ghosts of market anathema at us, “leaving the Euro would be catastrophic, the markets react just from your mere mention of it, you really want to go back to those bad old days? Do you really want to be out of the cool kids’ club, and have no EU funding for your arts association anymore?”

That is why we fear the alternative, even as we begin to see the bars that hold our gilded cage.

Is there any kind of organized challenge to austerity there? Is there any kind of left opposition party?

Well, there is, and there isn’t. The most consistent and organized opposition is the local Communist Party (PCP), which commands a respectable position in parliament (about 11%). What’s more significant, the vote on PCP has been relatively unchanged since the 1974 revolution, so they’re a familiar presence in our democracy, and relatively well respected outside of its circles for the fact that they were the “vanguard” against Salazar’s regime. They’re incredibly well organized and have the support of the majority of the unions. They’re also relatively less “orthodox” than something like the KKE, for the most part. However, despite all this, their voting base is incredibly stable for better and for worse.

Then there’s Bloco de Esquerda (Left Bloc or BE) which could be seen as our own Syriza: a broad front of minor leftist parties of different traditions, disgruntled communists and modern socialists which formed 15 years ago and was on the rise in parliament. They took a huge hit in the last elections, though, through a combination of leadership bickerings, lack of cohesive message, and the center left Socialist Party (PS) being able to sideline them via pushing BE’s social issues agenda on issues like women and LGBT rights. Many saw BE a bit redundant after PS pushed those issues through parliament. They managed to have around 12% at their best, got 5-6% on the last election.

And that’s the extent of organized opposition. BE and PCP do work together a lot better both in parliament and on the streets than in other countries and are a lot closer than say, KKE and Syriza. But whereas PCP’s strength and weakness lies in the rigidity of its speech, BE has failed to have an open discussion on issues like debt restructuring and the like.

Social movements were strong for a while in 2010-2012, and were a ineffectual, uncohesive mess after that, I’m sad to say. There was a strong grass roots response to the austerity packages with absolutely gigantic demonstrations occuring in 2011-2012. But there was also failure to plainly articulate a political alternative, as well as the prevalent “sibling rivalries” that so often fracture these kinds of movements. The government and mainstream media narrative effectively pushed back via Thatcher’s “TINA”, and it’s not so much that people bought the narrative, but they’re failing to see anyone present anything else.

Dairy has been an issue in Greece too, it’s specifically mentioned in the new agreement. It seems as tho the crude mercantilist arguments, which I think mostly miss the larger picture, really may be the story in agriculture.

There is an apparent mercantilist side to the way that the EU is constructed. In many ways, it’s a paradox: its current ruling minds come from that neoliberal school of Thatcher and Reagan policies, but the actual construct is almost neo-colonial, with very apparenty peripheries and semi peripheries forming around the German epicenter. Any analysis of trade relations will show Germany as either the no. 1 or no. 2 exporter to other European countries: Spain, Italy, Greece, Portugal, all of those have Germany in their top 2 of imports. Which is, I believe, all the more significant when you cross that data with the prevalence of production quotas.

Though I’d argue that in Portugal’s specific case, these quotas end up helping Spain, especially in terms of food products. Germany’s our second larger import origin, but we import a staggering 27% from Spain alone. Now, though I’m no economist and my field lies in History, I do believe this is a rabbit hole worth chasing.

Has there been significant liberalization in Portugal over the past five years? Rolling back of labor laws, weakening of unions, cutting back pensions, etc.? In other words, has the crisis worked?

It has. Completely. Nearly anything that could be privatized, including energy, our airfields, our air company, our telecommunications grids our energetic infrastructure, our mail service, all have been sold off at the time we’re speaking. It’s worth mentioning that, while it could be argued that there were severe deficiencies in the management of these companies, nearly all of them actually turned a profit. So, selling off, say, our energy for €3 billion 5 years ago stops being an impressive feat when we see that the company’s profits were at about €1 billion/year, and we’d have €2 billion more at our disposal by not selling.

Collective bargaining took a major hit. Most new jobs are being created on a temporary basis. People have in fact been “temps” without social welfare benefits for more than ten years now in many cases (this did not start with the crisis, but did speed up considerably). Others work under weekly renewable temp contracts, which can prolong themselves for months. Our minimum wage is net €505/month, but many make less than that by working 6.5 hour long “part time” jobs for €300-400. Any company can hire you and sign temp contracts with you for a period of 3 years during which the rules are more or less “at will”; firing you sometime during those 3 years, waiting a couple of months and then calling you back to rehire you (obviously resetting that 3 year grace period) is a very common occurence. Unpaid internships are the norm, with some of them taking on surreal form. Unpaid internships for bartender or hairdresser are things we can see on job websites and ads papers.
Unemployment is predictably high, currently at 14% after a 18% peak. We should account for the fact that Portugal measures unemployment by the number of people who have enrolled in our unemployment centers. Which are ineffective to Kafkaesque levels, often summoning you by letter to interviews which have already happened by the time you received that letter, at which point you’re out of the center (and the stats) and have to justify your absence or wait for four months before you can enroll again. Add to those numbers the fact that half a million left the country in the last 5 years. In a country of 10 million, that means 5% of our population, most of them college educated youths between 20 and 35 is absent from the active population.

But despite all that, despite the 6% GDP contraction, or the fact that the austerity measures actually skyrocketed the debt from 95% to 130%, we’re told (in an election year, no less) that we can rest assured in the fact that we’re not Greece (which if one wants to argue that we’ve been put under a slow burn as opposed to Greece’s scorched earth can be a point I do concede), and that “though the Portuguese are worse off, the country is better” (actual quote from Luis Montenegro, Parliamentary leader to the majority party), and that the worst has passed, and austerity is a thing of the past… though they need to make an extra 500 millions in pension cuts this year alone.

Lessons from the Greek Crisis

The deal, obviously it looks bad. No sense in spinning: It’s unconditional surrender. It is bad.

There’s no shortage of writing about how we got here. I do think that we — in the US and elsewhere — should resist the urge to criticize the Syriza government, even for what may seem, to us, like obvious mistakes. The difficulty of taking a position in opposition to “Europe” should not be underestimated. It’s one of the ironies of history that the prestige of social democracy, earned through genuine victories by and for working people, is now one of the most powerful weapons in the hands of those who would destroy it. For a sense of the constraints the Syriza government has operated under, I particularly recommend this interview with an unnamed senior advisor to Syriza, and this interview with Varoufakis.

Personally I don’t think I can be a useful contributor to the debate about Syriza’s strategy. I think those of us in the US should show solidarity with Greece but refrain from second-guessing the choices made by the government there. But we can try to better understand the situation, in support of those working to change it. So, 13 theses on the Greek crisis and the crisis next time.

These points are meant as starting points for further discussion.  I will try to write about each of them in more detail, as I have time.

Continue reading Lessons from the Greek Crisis

Greece Thoughts and Links

Like everyone sympathetic to Greece in the current crisis, I was pleased by the size of the “No” vote in last weekend’s referendum. Even taking into account support from the far right, the 62% for No represents a significant increase in support from the 36% of the vote SYRIZA got in January.

But, I’m not sure how the vote changes the situation in any substantive way. Certainly it hasn’t led to any softening of the creditors’ position. The situation remains what it was before: Greece must comply with the full list of policy changes demanded by the creditors, and any further changes demanded in the future, or else the central bank will keep the Greek banking system shut down. The debt itself is just a pretext on both sides — repayment is not really what the creditors want, and default isn’t really what they are threatening.

I continue to think that the Bank of Greece is the key strategic terrain in this contest. If the elected government can regain control of the central bank — in defiance of eurosystem norms if need be — then it removes the source of the creditors’ power over the Greek economy. There is no need for a new currency in this scenario. If the Bank of Greece simply goes back to performing the usual functions of a central bank, instead of engaging in what is, in effect, a politically-motivated strike, then Greek banks can reopen and the Greek government can finance needed spending without the consent of the official creditors.

More broadly, I think we cannot understand the economics of the situation unless we clearly understand that “money,” in modern economies, refers to a network of promises between banks and not a set of tokens. In this sense, I don’t think it makes sense to think of being in or out of a currency as a simple binary. As Perry Mehrling emphasizes, there have always been overlapping networks of money-contracts, with various economic units participating in multiple networks to different degrees.

Here are a few relevant links, some spelling out my thoughts more, some useful background material.


1. Here is an interview with me on the podcast RadioDispatch. If you don’t mind listening rather than reading, this is my fullest attempt to explain the logic of the crisis.

RadioDispatch interview June 2015


2. I had a productive discussion with Dan Davies on this Crooked Timber thread. Since my last comment there got stuck in moderation for some reason, I’m reposting it here:

From my point of view, the key question is whether the ECB is constrained by, or at least acting in accordance with, the normal principles of central banking, or if it is deliberately withholding support from the Greek banking system in order to advance a political agenda.

Obviously, I think it’s the second. (And I think this is really the only leverage the creditors have — there is no reason that a default in itself should be particularly costly to Greece.) On whether it is plausible that the ECB would (ab)use its authority this way, I think that is unequivocally demonstrated by the letters sent to the governments of ItalySpain and Ireland during those countries’ sovereign debt crises in 2011. In return for support of those countries’ sovereign debt markets, the ECB demanded a long list of unrelated reforms, mainly focused on labor-market liberalization. There is no credible case that many of these reforms (for instance banning cost-of-living clauses in private employment contracts) were connected with the immediate crisis or even with public budgets at all. I think it can be taken as proven that the EC has, in the past, deliberately refused to perform its function of stabilizing the financial system, in order to put pressure on elected governments.

We can debate how exactly this precedent fits Greece. But I don’t think a central bank that allows its country’s banking system to collapse can ever be said to be doing its job. Every modern central bank — including the ECB with respect to every euro-area country except Greece — will go to heroic lengths, bending or ignoring rules as need be, to keep the payments system operating.


3. Over at The Week, I talk with Jeff Spross about the idea that changes in private financial flows between euro-area countries can be passively offset by balances between the national central banks in the TARGET2 system, avoiding the need to mangle the real economy to produce rapid adjustment of trade flows.

Like many critics of the euro system, I used to think that they had succeeded in creating something like a modern gold standard, and that the only way crises could be avoided was with a fiscal union, so that public flows could offset shifts in financial flows. But I no longer think this is correct, I think that the TARGET2 system can, and has, offset changes in private financial flows without the need for any fiscal payments.

(The Week also had a nice writeup of the Reagan-debt post.)


4. I reached this conclusion after reading several pieces by Philippine Cour-Thimann, who is the source for understanding TARGET2 and its role both in the normal operations of the euro system and in the crisis. I recommend this one to start with. (Incidentally it was my friend Enno Schröder who told me about Cour-Thimann.)


5. One topic I’ve wanted to get into more is the (in my view) limited capacity of relative-price adjustments to balance trade even when exchange rates are flexible. In the past, I’ve made this argument on the crude empirical grounds that Greece had large trade deficits continuously for decades before it joined the euro. I’ve also pointed out Enno’s work showing that the growth of European trade imbalances owes nothing to expenditure switching toward German products and away from Greek, Spanish, etc., but is entirely explained by the more rapid income growth in the latter countries. Now here is another interesting piece of evidence on this question from the ECB, a big new study finding that while there is a substantial fall in exports in response to large appreciations, there is no discernible growth in exports in response to depreciations. This fits with the idea, which I attribute to Robert Blecker, that in a world where prices are mainly set in destination markets rather than by producer costs, changes in exchange rates show up in exporter profit margins rather than directly in sales volumes. And while large losses will certainly cause some exporting firms to exit or fail, large (potential) profits are only one of a number of conditions required for exporters to grow, let alone for the creation of new exporting industries.


6. This is a great post by Steve Randy Waldman.


7. Here’s an interesting find from a friend: In the 1980s, Fidel Castro proposed “a cartel of debtor nations” that would require their creditors to negotiate with them as a group. See pages 278-285 of this anthology.


UPDATE: Re item 2, here’s Martin Wolf today (his links):

The European Central Bank could expand its emergency lending to the Greek banking system. If the ECB were a normal central bank that is exactly what it would do. Greece has a run on its banks. As the lender of last resort, the central bank ought to lend into such a run. If the ECB believes the banks are solvent, it must lend. If the ECB believes the banks are insolvent, it should arrange recapitalisation — by converting non-insured liabilities into equity, by selling banks to new owners or by securing funding from the European Stability Mechanism (ESM).

Unfortunately, the ECB is not a normal central bank…

What Greece Must Do

Greece doesn’t need a new currency, it needs control over its central bank.

The Greek crisis is not fundamentally about Greek government debt. Nor in its current acute current form, is it about the balance of payments between Greece and the rest of the world. Rather, it is about the Greek banking system, and the withdrawal of support for it by the central bank. The solution accordingly is for Greece to regain control of its central bank.

I can’t properly establish the premise here. Suffice to say:

(1) On the one hand, the direct economic consequences of default are probably nil. (Recall that Greece in some sense already defaulted, less than five years ago.) Even if default resulted in a complete loss of access to foreign credit, Greece today has neither a trade deficit nor a primary fiscal deficit to be financed. And with respect to the fiscal deficit, if the Greek central bank behaved like central banks in other developed countries, financing a deficit domestically would not be a problem. And with respect to the external balance, the evidence, both historical and contemporary, suggests that financial markets do not in fact punish defaulters. (And why should they? — the extinction of unserviceable debt almost by definition makes a government a better credit risk post-default, and capitalists are no more capable of putting principle ahead of profit in this case than in others). The costs of default, rather, are the punishment imposed by the creditors, in this case by the ECB. The actual cost of default is being paid already — in the form of shuttered Greek banks, the result of the refusal of the Bank of Greece to extend them the liquidity they need to honor depositors’ withdrawal requests. [1]

(2) On the other hand, Greece’s dependence on its official creditors is not, as most people imagine, simply the result of an unwillingness of the private sector to hold Greek government debt, but also of the ECB’s decision to forbid — on what authority, I don’t know — the Greek government from issuing more short-term debt. [2] This although Greek T-bills, held in large part by the private sector, currently carry interest rates between 2 and 3 percent — half what Greece is being charged by the ECB. And of course, it’s not so many years since other European countries were facing fiscal crises — in 2011-2012 rates on Portugal’s sovereign debt hit 14 percent, Ireland’s 12, and Spain and Italy were over 7 percent and headed upwards. At these rates these countries’ debt ratios — not much lower than Greece’s — would have ballooned out of control and they also would have faced default. Why didn’t that happen? Not because of fiscal surpluses, delivered through brutal austerity — fiscal adjustments in those countries were all much milder than in Greece. Rather, because the ECB intervened to support their sovereign debt markets, and announced an open-ended willingness to do “whatever it takes” to preserve their ability to borrow within the euro system. This public commitment was sufficient to convince private investors to hold these countries’ debt, at rates not much above Germany’s. Needless to say, no similar commitment has been made for Greek sovereign debt. Quite the opposite.

So to both questions — why is failure to reach agreement with its official creditors so devastating for Greece; and why is the Greek government in hock to those creditors in the first place? — the answer is, the policies of the central bank. And specifically its refusal to fulfill the normally overriding duties of a central bank, stabilization of the banking system and of the market for government debt, a refusal in the service of a political agenda. The problem so posed, the solution is clear: Greece must regain control of its central bank.

Now, most people assume this means it must leave the euro and (re)introduce its own currency. I don’t think this is necessarily the case. It’s not widely realized, but the old national central banks did not cease to exist when the euro was created. [1] In fact, not only do they continue to operate, they perform almost all the day to day operation of central banking in the euro area, with, on paper, a substantial degree of autonomy from the central authorities in Brussels. So what’s required is not “exit,” not a radical step by the Greek government. Rather simply a change in personnel at the Bank of Greece. The BoG only needs to halt what is in effect a politically motivated strike, and return to performing the usual functions of a central bank.

Now, I cannot exclude the possibility that if Greece takes steps to neutralize the creditors’ main weapon, they will retaliate in other ways, which will result in the eventual exit of Greece from the euro. (Though “exit” is not as black and white as people suppose. [2]) But this would be a political choice by the creditors, not in any way a result of economic logic. We should not speak of exit in that case, but embargo.

Here is my proposal:


1. The Greek government takes control of the Bank of Greece. It replaces the BoG’s current leadership — holdovers from the old conservative government, appointed at the 11th hour when Syriza was on the brink of power — with suitably qualified people who support the program of Greece’s elected government. The argument is made that the central bank has abused its mandate, and failed in its fundamental duty to maintain the integrity of the banking system, in order to advance a political agenda.

Either legislation could be passed explicitly subordinating the BoG to the elected government, or use could be made of existing provisions for removal of central bank officials for cause. The latter may not be feasible and we don’t want to get bogged down in formalities. Central bankers have critical public function and if they won’t do it, they must be replaced with others who will. Whatever the law may say.


2. The new Bank of Greece leadership commit publicly to maintain the integrity of the Greek payments system, to protect deposits in Greek banks and to prevent bank runs — the same commitment the ECB has repeatedly made for banks elsewhere in Europe. The Greek government asserts its rights to license banks and resolve bank failures. Capital controls are imposed. Greek banks reopen.


3. If necessary, the BoG resumes Emergency Liquidity Assistance (ELA) or equivalent loans to Greek banks. While the promise to do this is important, it probably won’t be necessary to actually resume ELA on any significant scale because:

– removing the previous threats to withdraw support from Greek banks will end the bank run and probably lead to the voluntary return of deposits to Greek banks.

– capital controls and, if necessary, continued limits on cash withdrawals, block any channels for deposits to leave the Greek banking system.

– resumption of Greek payments to public employees, pensioners, etc., to be soon followed by resumed economic growth, will automatically increase the deposit base of Greek banks.


4. The Greek government resumes spending at a level consistent with domestic needs, including full pay for civil servants, full payment of pensions, etc. Taxes similarly are set according to macroeconomic and distribution objectives. The resulting fiscal deficit is funded by issue of new debt to domestic purchasers. This new debt will be senior to existing debt to the public creditors.

It may be that this debt will end up being held by the banks, but that is no big deal. Greek government debt currently accounts for less than 6 percent of the assets of Greek banks, the lowest of many major European country and barely half the euro-area average. And in the absence of capital flight, bank assets and deposits will increase in line, so there is no need for any additional financing from the Bank of Greece. Even more: If resolution of the crisis leads to a repatriation of Greek savings abroad, then the increase in deposit liabilities of Greek banks will be balanced by increased reserves at (or rather reduced liabilities to) the Bank of Greece. The BoG in turn will acquire a more positive Target balance, or if it’s ejected from Target (see below), an equivalent increase in foreign exchange holdings.


5. The interest rate on the new debt needs to be comfortably less than the expected nominal growth rate of the Greek economy. I see no reason why this will not be true of market rates — there are already private holders of Greek T-bills with yields between 2 and 3 percent, and the combination of a Greek central bank committed to stabilizing the market for Greek public debt, and capital controls preventing Greek banks and wealth holders from acquiring foreign assets, should tend to push rates down from current levels. But if necessary, the Greek central bank will have sufficient hard and soft tools to get Greek banks to hold the new debt at acceptable rates.


6. The official creditors are offered a take-it-or-leave-it swap of existing loans for new debt. (I think this kind of forced restructuring is preferable to outright repudiation for various reasons.) The new debt will have a combination of writedown of face value of the current debt, maturity extensions and reduced interest rates so as to keep annual payments at some reasonable level. I think it might be better to avoid an explicit reduction of face value and simply offer, let’s say, 30 year bonds paying 2%, of equal face value to the current debt. It would be best if the new bonds were “Greek-denominated.” Perhaps it’s sufficient to say that the new bonds are issued under Greek law.


7. The Greek government must be prepared for declarations from the creditors that its actions are illegal, and for possible retaliation. Rhetorically, it may be helpful to emphasize that Greece remains sovereign and Greek law continues to control the Greek central bank and private banks; that the ECB (and its agents at the Bank of Greece) have abused their authority to advance a political agenda; and that the wellbeing of the Greek people must take priority over treaty obligations. But framing may not make much difference here and anyway these kinds of tactical-political questions are for the Syriza leadership and not for an American sympathizer.

What concrete form will creditor retaliation take? One possibility is they will stop deposits in Greek banks from being used to make payments elsewhere in Europe, by shutting off Bank of Greece access to Target2, the settlement system that currently clears balances between national central banks within the eurosystem. [3] Concretely, lack of access to Target2 needn’t be crippling. Payments within Greece won’t be affected, domestic interbank settlement can use accounts at the Bank of Greece just the same as now. Foreign payments will be made using deposits at banks in the exporting country, just as trade payments outside the euro area are already made. Since Greece currently has a small trade surplus, there is no need for anyone outside of Greece to accept a Greek bank deposit in payment. And even if foreign borrowing is desired, the resulting funds can take the form of deposits at a bank in the lending country — again, just as already happens for loan transactions outside the euro area. In effect, by cutting off Target2 the ECB will just be helping Greece enforce its capital controls.

Now one potential issue is the foreign obligations of private Greek units. Can they be paid with deposits in Greek banks? Let’s be clear that a negative answer requires a change in the law by the other euro countries — they are the ones that will redenominate, not Greece. But to be safe, Greece should pass a law clarifying that euro-denominated deposits at Greek banks are legal tender for all existing payment obligations by Greek households or businesses. And it would be good to have a sense of the scale of such obligations.

Assuming Greece loses access to Target2, its export earnings, going forward, will take the form of deposits in non-Greek banks or equivalent claims on non-Greek financial institutions. Which leads to…


8. It is critical to ensure that Greek export earnings are available to finance Greek imports. Many discussions of Greek default focus on what are, to my mind, non- or minor problems, while ignoring this major one. [4] If payment for Greek exports takes the form of deposits in foreign banks, as will presumably be the case of Target2 access is shut off, steps must be taken to ensure that those deposits are available for import payments rather being used to finance private acquisition of foreign assets.

Given Greece’s overall near-zero trade balance, access to foreign loans should not be necessary to finance continued imports. But this assumes that export earnings are available to finance imports. There is a danger that exporters will seek to evade capital controls by holding export earnings abroad, manipulating invoices if necessary to disguise noncompliance with the law. This is a serious problem in subsaharan Africa and elsewhere — individuals involved in foreign trade overstate the value of imports and understate the value of exports in order to retain foreign earnings abroad for their personal use. This kind of capital flight can leave a country that notionally has a positive trade balance nonetheless dependent on foreign borrowing to finance its imports. (Ireland is a recent example within the euro area.) The Greek government needs to have enforcement mechanisms to ensure that export earnings are used to finance imports and not to accumulate foreign assets. This should be straightforward where foreign sales are easily visible to regulators, as in tourism or refining, but may be challenging in the case of shipping.

Other European countries will presumably not be cooperative with Greece’s efforts to enforce capital controls. This is a reality that has to be planned for, but it also should be called what it is: Collusion with criminals to steal goods and services from Greece.


9. The government may need to ration foreign exchange. If capital controls are ineffective, or, in the first year or two, if seasonal variation in Greek exports swamps the overall balance, Greek export earnings may be insufficient to pay for current imports for some period, and foreign credit may not be available. This need not be a crisis. But it does mean that the government should be prepared to allocate scarce foreign exchange to particular sectors. The mechanisms to do this are already implicit in the imposition of capital controls. And the centralized allocation of foreign exchange is consistent with….


10. In the long run Greece should learn from the model of Korea and similar late industrializers. (This, also, is the argument for nationalizing the banks, rather than the fact that the “true” value of their assets, in some sense, leaves them insolvent.) Little if any boost to Greece’s net exports should be expected from devaluation. The goal rather must be to channel savings and foreign exchange to sectors that are not currently competitive, but that plausibly might become so.  Centralized allocation of credit and foreign exchange is needed to transform the industrial structure, rather than passively following current comparative advantage.


[1]  Those requests themselves are largely the result of the hysterical fear-mongering by the BoG and its masters in Greece, the exact opposite of the normal efforts of central bankers to prevent panics. In any case, the rules of the eurosystem give the ECB/BoG almost unlimited discretion with respect to liquidity assistance, so they can’t claim this decision is forced on them.

[2] You can think of a continuum from current membership, to the situation of Cyprus with capital controls, to Andorra which prints its own euro currency but does not have shares in the ECB, to Montenegro which uses the euros as domestic currency without any formal participation, to Denmark which has its own currency but clears balances with euro-area central banks through a Target2 account at the ECB.

[3] The best discussions of Target2 I know of are by Philippine Cour-Thimann.

[4] Here as so often, the political authorities step in to do what “market forces” supposedly ought to be doing but aren’t.

[5] Don’t believe the stories you will hear that this is somehow a necessary or automatic reaction to replacement of BoG leadership. It is not. Countries that are not in the euro at all are still permitted to participate in Target2.

[6] When I was debating this stuff with the very smart Nathan Tankus a few days ago, he brought up the possibility that foreign ATM cards wouldn’t work in Greece, and of an adverse ruling from the European Court of Justice. Oh no!