James Mansell - Personal Site

So one set of Economists have come out and said that Government spending should be cut in 2010 and another group have come out and seid no leave it 'til 2011.

Surely the key thing as Greece is finding out is that you will have to cut when your creditors turn off the tap. The debate that assumes that cutting is in the hands of the government is to some degree artificial. If we are to convince our creditors that we are going to go on a diet, like going on a diet we can't say it will start tomorrow. I fear we have no choice but to start now.

Recently found this briefing paper about the UK Tax System produced by the Institute of Fiscal Studies, well worth reading.

http://www.ifs.org.uk/bns/bn09.pdf

I'm currently in Austria, so haven't been following the day to day crisis that is affecting Greece. There has been a lot of talking about whether this could cause the break-up of the Euro. It seems that there are two ways in which this is being proposed might happen:

Germany Leaves the Euro

At one level this seems the most attractive option because the German Mark of equivalent could be allowed to appreciate, and there would unlikely to be a run on the dollar. Because Germany runs a current account surplus, in simple trade terms there is an excess demand of Marks (due to the surplus) would cause Mark to rise, reducing the current account surplus etc.

However, I think there are two reasons this won't happen, firstly, the Germans who have seen their real incomes fall (to account for increasing currency) are unlikely to allow the other European countries to devalue their currencies in order to allow them to re-balance output the easy way.

Secondly, the Euro is a reserve currency block, many central banks have been holding Euros as  response in the decline of the purchasing power of the US Dollar as the US Government has been running a large current account deficit. The act of Germany leaving the Euro would lead the a mass run from the Euro into the Mark, Sterling and the Dollar, something that would not benefit Germany.

Greece Leaves the Euro

Ireland has been toying with this for about a year. However, for Greece to leave the Euro would be equally difficult to achieve in the short term. If they simply decided to start paying debt, workers, benefits etc. in Drachma, however, Greek's including their creditors would be unlikely to be pleased by this, probably causing them to off-load Greek Debt, leading to spiraling inflation (as the purchasing power of Drachma declined). Thus the Greek government would achieve the cuts in real expenditure through a painful devaluation and inflation.

So either way Greeks see a fall in their real incomes.

Conclusion

Therefore, on the basis of the above, the only option is for the Euro zone to carry on, Germany will have to accept that it will have to help Greece out in return for having purchased German goods for some years. These fiscal transfers will be unpopular in Germany and the costs unpopular in Greece. However, both countries benefit from being part of a reserve currency group, that will allow them if they can get through this crisis to continue to borrow cheaply. It's the only option, and probably Europe has the political will to do it.