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'When you take the [German] diet too far, it becomes dangerous to the health of the underlying economy. You may just end up killing yourself,' says SocGen economist Michala Marcussen. (Michelle Siu for The Globe and Mail/Michelle Siu for The Globe and Mail)
'When you take the [German] diet too far, it becomes dangerous to the health of the underlying economy. You may just end up killing yourself,' says SocGen economist Michala Marcussen. (Michelle Siu for The Globe and Mail/Michelle Siu for The Globe and Mail)

taking stock

Greece's German diet 'all a question of dosage' Add to ...

When euro zone finance ministers gather in Brussels on Monday afternoon, they are expected at long last to sign off on the €130-billion ($170-billion) bailout needed to keep insolvent Greece from defaulting on its mountain of debt. Of course, nothing is certain when it comes to this fractious lot, and the deal could still come unglued. Which is why the oft-repeated headline “Greek debt deal closer” prompts outbreaks of laughter on bond desks.

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But the Germans, who will have to foot a big chunk of the bill, appear satisfied that they have squeezed the Greeks as much as they can. Greek political leaders of all stripes have bowed to the inevitable and made the necessary promises, in writing, of better fiscal behaviour. And other members of the club who would rather cut their losses and let Greece fend for itself appear to have packed away their vials of vitriol for now.

So, after seven months of often bitter wrangling, Athens will get its payday loan, private bondholders will reluctantly sit still for their “voluntary” 70-per-cent shearing and the European Central Bank will engage in a €50-billion bond-swapping scheme designed to keep it free of any such debt restructurings.

Needless to say, none of this will fix Greece’s deepening economic and structural woes. And the enforced austerity is sure to make a bad situation worse.

“It’s going to be a very hard struggle,” Michala Marcussen, London-based head of global economics with Société Générale, said the other day between meetings with bank clients in Toronto and Montreal.

Back in 2010, Ms. Marcussen first spoke in this space about the “German diet” of tough budget cuts in the euro area. At the time, she warned that exceedingly slow, or no, economic growth would make it tough for a Greece or Portugal to rein in soaring deficits. “You could find yourself in the nasty situation that you do the German diet and you’re still putting on weight on your public finances.”

But she added that there simply was no alternative.

Today, Ms. Marcussen is much less comfortable with continued deep public-sector cutbacks. Although not in the austerity-is-idiotic-in-hard-times camp of a Paul Krugman, she suggests it’s high time for European policy-makers to shift their focus to structural reforms.

“I think we’re getting to the point where more [slashing]is not a good idea,” she says, pointing to the fiscal multiplier effect, which is designed to measure the impact of tighter or looser fiscal policy on an economy.

Typically, fiscal tightening amounting to 1 per cent of GDP reduces real economic growth by about 0.5 per cent a year, according to some research studies. In normal times, deep fiscal cuts can be offset by easier monetary policy, which lowers interest rates and helps boost trade. “Obviously, that monetary policy transmission mechanism is not in full working order today,” Ms. Marcussen says.

“We think the fiscal multiplier today for advanced economies as a group is closer to 1:1. So every time we have fiscal tightening of 1 per cent, we lose 1 per cent of GDP. That’s obviously a sub-optimal situation. And in Greece, it’s probably well in excess of that today.”

Making matters worse, the austerity drive has done nothing to restore shaken confidence in the markets, which continue to bet heavily on a Greek default. And the notion of expansionary fiscal contraction – in which more-credible fiscal policy prompts higher private-sector spending – becomes laughable.

“It’s all a question of dosage,” Ms. Marcussen says between sips of her morning coffee. “There is such a thing as healthy and unhealthy dieting. That Greece needed to have something of a German diet is something that I fully believe.”

But she adds pointedly that “When you take the diet too far, it becomes dangerous to the health of the underlying economy. You may just end up killing yourself.”

There is little doubt Greece has fallen into the dreaded austerity trap, where additional cuts slam the economy and fiscal targets become ever more elusive.

To be sure, Athens has not exactly delivered on its promises, notably dragging its feet on shedding assets and pension reform. But all is not lost yet.

Indeed, unlike a growing number of her more pessimistic counterparts, Ms. Marcussen still sees a future for Greece within the euro area – if Athens adds what amounts to a lifestyle makeover to its austerity diet.

“There is a path where Greece can move ahead. That path requires a lot of emphasis on structural reform, which may be just as difficult from a social perspective,” she says. “We’re talking about a country that finds it difficult to collect taxes. Independently of what happens, it’s not acceptable for a country within the European Union not to be able to efficiently collect taxation.”

Such reforms will take years and considerable political will, which has been noticeably absent. But the alternative – a messy default within or outside the euro zone – will resolve nothing, Ms. Marcussen argues.

“Greece will still need to be funded. Greece will still need to reform its economy. And that means there can be no wiping the slate clean.”

Her advice: Forgive the country’s official-sector debt, now that the bulk of private creditors have accepted a restructuring, or ensure that Athens gains access to cheap funding for a very long time.

Good luck getting that past the finance ministers.

Follow on Twitter: @bmilnerglobe

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