“A Program for Greece: Follow the IMF’s Research”

Today, we are fortunate to present a guest contribution written by Ashoka Mody, Charles and Marie Visiting Professor in International Economic Policy, Woodrow Wilson School, Princeton University. Previously, he was Deputy Director in the International Monetary Fund’s Research and European Departments.

Some had expected that the Greek government would have “blinked” by now. Others believe that by not conceding, the Greeks have bungled the discussions with creditors. And yet others think that the Greeks may turn out to be the better negotiators after all. But the drama of the never-ending exchange is obscuring the principles.

A medical analogy, often used to describe international financial rescues, is useful to frame the issues. When a patient comes into an emergency trauma room, the doctor on the floor typically does not refuse to treat him because the patient has lived an unhealthy life. Nor does the doctor ask him to first run around the block a few times—as proof of good faith—before stemming his blood flow. And certainly no doctor will first increase the hemorrhaging as a warning before treating the patient.

But by threatening to cut off Greek banks from funding and by keeping the Greek economy on a leash, the troika doctors have made the Greek patient worse with the passage of every day. The Greeks, it is argued, could have saved themselves this outcome by agreeing on the very first day to the troika’s conditions. In essence, the troika program stayed with the strategy that has been followed over the past five years:

Borrow more money (this time mainly from the European authorities) to repay one group of creditors (the IMF, to which substantial repayments are due); stay focused on more austerity, steadily increasing the primary surplus (the budget surplus not including interest payments); and undertake “structural reforms”—changes in labor and other markets to improve the Greek economy’s longer-term growth potential.

The Greeks could have agreed to this plan and, eventually, not delivered—just like they have not delivered for the past five years. In part, the Greeks have tried that even in this round. The Greek “agreement” on the primary surpluses is a façade of numbers with little reality behind them. For five years, this has not worked.

To see where things have gone wrong, it is helpful to follow three IMF studies:

Over-indebted countries struggle to grow. In its famous mea culpa for delaying the restructuring of Greek debt, the IMF acknowledged a well-respected academic tradition.

The “debt-overhang,” as economists term it, inhibits new investment and growth. For this reason, it is in the interests of creditors as well as debtors to forgive debt (for an early statement, see Krugman, 1988). The evidence for this proposition is clear, including in an important paper by the University of Chicago economist and former Governor of the United States Federal Reserve Board, Randall Kroszner. Professors Carmen Reinhart and Christoph Trebesch similarly find that growth picks up after debt relief.

Some might say that Greece does not have a debt overhang. With the ultra-low interest rates on its official debt, Greece, it is argued, can repay its debt without sacrificing growth and reasonable social objectives. But even under the troika’s calculations, the conclusion that Greece can comfortably pay back its debts is true only on the assumption that Greece will increase its primary surpluses. The troika’s demands earlier this year were for an extraordinary ramp up in primary surpluses—from a small negative number to over 4 percent of GDP. That demand has been steadily scaled down over the past few months. But even now, the troika requirement is that the surpluses increase by about 1 percentage point of GDP a year for the next three years. To achieve that goal would require a contraction of discretionary spending well above 1 percent of GDP a year. That, by any definition, is significant fiscal austerity, coming on top of an extraordinary austerity over the past five years.

That leads to the second set of IMF analyses.

Austerity in a weak economy is self-defeating. As the budget deficit is reduced, the economy slows down, and the ability to repay debt is undermined. Indeed, austerity can be self-defeating.

Here is how this principle applies today to Greece. Recall, that prices in Greece have been falling for about two years now. Since debt repayment obligations do not change when businesses sell at lower prices or when wages fall, businesses and households struggle to repay their debt in a deflationary environment. Investment and consumption are held back, the government receives less revenue, making its debt repayment harder. If austerity is imposed in this deflationary setting, the weaker demand forces prices and wages down faster, making debt repayment even harder. This is the so-called debt-deflation cycle. Greece is in a debt-deflation cycle.

For this reason, for example, increasing the VAT tax burden now is a terrible idea. Japan—which, despite its troubles, is an infinitely stronger economy than Greece—only recently got its wind knocked out by a premature increase in VAT rates. To be sure, the VAT rates will eventually need to be raised, and pensions and wages will need to be scaled back. But setting a demanding timeline now—before growth is firmly established—will keep Greece trapped in a debt-deflation cycle. The debt-to-GDP ratio, which was about 130 percent of GDP when the Greek crisis began in 2009 has risen to about 180 percent, and will keep rising.

Thus, the third element of the troika strategy: Greece should do structural reforms and spur growth even while it does “growth-friendly” austerity. These are soothing terms. So, consider the third piece of IMF evidence.

Structural reforms have, at best, an uncertain payoff. In Box 3.5 of this recent chapter from the IMF’s World Economic Outlook, the updated finding has a long pedigree: policy measures can possibly create an environment for growth in the long-run, but no immediate payoffs should be expected.

Indeed, where structural reforms are a code phrase for reducing wages and weakening employment contracts—as they are in the Greek context—we circle back to the immediate problem of curtailing demand in an already deflationary environment. But even the long-term growth benefits of these measures are unclear. With lower wages comes lower productivity. Both economic theory and evidence support this concern. And Germany’s much vaunted success came not from suppressing wages but from corporate-labor agreements to outsource labor-intensive tasks to lower-wage economies while German manufacturers upgraded their technology (Dustmann et al., 2014). The IMF’s analysis does find that investing in R&D to raise productivity in the information technology industries may have a long-term pay off. But that will be reaped over decades not in time to extricate Greece from its debt-deflation cycle.

Finally, those calling for throwing Greece out of the euro area must confront Barry Eichengreen’s essay on the costs of breaking up the euro. Professor Eichengreen has recently gone on to warn that a Greek exit could have consequences for the European and global economy that would dwarf the panic following the bankruptcy of Lehman Brothers.

So what should a Greek program look like? The objective should be to return Greece to the financial markets in a phased manner. Following the medical analogy, the objective should be to get Greece out of the Emergency room, work through rehab, and then resume as normal an existence as it can. To that end, the key elements of a Greek program must be:

  • Forgive Greek debt so that it comes down to 50 percent of GDP payable over 40 years [this is akin to stemming the blood loss].
  • Scale down the banking system, which has been badly damaged and will continue to create vulnerabilities [this is the surgery].
  • And agree to a flat 0.5 percent of GDP primary surplus over the next three years, which even Greece can deliver [light yoga in rehab].

With this preparation and its low debt obligations, Greece will be able to tap markets. To those concerned that Greece will return to its bad ways, the new debt should be in the form of sovereign cocos, which will contractually provide for standstills on repayments if debt exceeds 75 percent of GDP. The standstill provision will limit Greek access to markets and raise the costs of borrowing. Greece will learn to live within its means. This would be like Greece training for a 5K race.

If that goes well, then the Greeks can decide if they want to run in a marathon, in which case they will need to change their social contract. How they do that—through reduced pensions, lower wages, increased VAT, or through more effort to rein in Greek oligarchs—is a matter for the Greeks to decide. An international consortium, backed by a hysterical media, cannot micromanage Greece. The Greeks may well choose to let their standard of living gradually decline. That will be their choice.

Staying on the present course will mean that Greece will shuttle between the Emergency room and rehab. In particular, the idea of staggered relief is set to guarantee such an outcome. The debt forgiveness will come in driblets. It will be accompanied by indefinite pain for the Greeks and its creditors.


Dustmann, Christian, et al., 2014. “From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy,” Journal of Economic Perspectives 28(1): 167-188.

Krugman, Paul, 1988, “Financing vs. Forgiving a Debt Overhang,” Journal of Development Economics 29:253-268.

The post written by Ashoka Mody.

20 thoughts on ““A Program for Greece: Follow the IMF’s Research”

  1. Jeffrey J. Brown

    WSJ: Europe Asks if Greece Could Default Without Exiting Euro

    BRUSSELS—As the bailout standoff between Athens and its creditors escalates, some European officials are suggesting something that was once unthinkable: Let Greece keep the euro currency even if it defaults on its rescue loans.

    This idea breaks with the conventional wisdom of more than five years of debt crisis, where the shock of a default has been seen as sending Greece down an inexorable path of bank runs, capital controls and, finally, exit from the eurozone. Yet, with the risk of nonpayment higher than ever, finding a way to avoid the chaos of a Greek currency switch is looking more attractive. Proponents say it could spare Europe the embarrassment of one of its members crashing out of the eurozone, damp some of the market panic that would likely follow a default, and avoid setting a precedent that would undermine confidence in those still inside.

    The idea of keeping Greece in the euro despite a default was briefly discussed by senior officials from eurozone finance ministries last week, although many of them harbor serious doubts about if it would work, according to people familiar with the talks. “It is not so much a plan, but an evolution in the thinking,” says one person familiar with the discussions among Greece’s creditors.

    Proponents of a default-without-exit scenario largely fall into two camps: those who believe the shock of a temporary default would compel Prime Minister Alexis Tsipras to finally seal a financing deal with the creditors; and those who believe that an immediate ejection from the euro would trigger chaos in Greece and beyond.

  2. Jeffrey J. Brown

    I wonder if we are entering an age of massive and increasing migration, on a global scale, as people flee civil war & civil unrest, e.g., Libya & Syria, and poor economic conditions. Assuming that things continue to get worse in places like Greece and Venezuela, which seems likely, one would expect to see increasing emigration out of these countries. And of the course, the US has its own problems on its Southern border.

    An article, and images, I find rather disquieting:

    Migrants force their way into UK-bound lorries in broad daylight in shocking new footage as Calais struggles to deal with thousands trying to cross illegally to Britain 

    They used to try and sneak aboard lorries bound for the UK using the cover of darkness, but now migrants in Calais have been filmed clambering onto trucks about to cross the English Channel in broad daylight.

    Shocking footage shows migrants brazenly opening the doors of the lorries and climbing inside as police rush to the scene. The clip shows how the authorities at the French port have become overwhelmed by the sheer numbers trying to start a new life in the UK.

    The footage comes as the row escalates between Britain and the EU over how to deal with the increasing numbers of migrants who are making their way to Europe across the Mediterranean. 

    There are thought to be around 2,000 migrants in Calais, according to official figures, but last night one of the group of men put the number closer to around 4,000. And it is believed that between 50 and 150 arrive every day.

    An iconic picture, circa 1930’s in the US (Jobless men keep going):


  3. Lord

    Also, it is important they offer their plan, whether accepted or rejected, to allow the formation of future expectations, as to what they can and will do, and not end up completely reactive.

  4. Robert Lacoursiere

    I am sorry but this is just crazy how can you fault the troika to ask for reforms in exchange for FURTHER FUNDING? You gloss over the fact that a 0.5% primary surplus implies more deficits even at very generous loiw interest rates. They have not even complied with previous promises of reform. Yes it would be so much more easier if they just got the debt relief and more money without any conditions but that’s money from taxpayers of other countries and their elected representatives have every right to place any conditions they see fit. Greece has every right to decline and seek to borrow from the markets. Why should the taxpayers of poorer eu countries such as Bulgaria or Slovenia foot the bill for richer Greeks? Why are the poorer Greeks more special than the poor or the less wealthy eu countries?

    1. Ian Easson

      Your mental defect is in thinking that these IMF/ECB proposals are “reforms”, intended to make things better for both the Greeks and for other Europeans, instead od what they actually are.

      1. Ulenspiegel

        If you label others with “mental defect” then you should work harder to make an intelligent contribution. Instead, you obviously work with (implicit) nonsensical assumptions and come to an “interesting” conclusion.

    2. nottrampis

      err all the troika have done is imposed a depression on Greece which makes it impossible to pay back the money they owe. Moreover it is highly debatable whether the ‘reforms’ are likely to help in gaining economic growth as we have seen from both IMF and OECD research..
      Creditors are the most stupid people ever.
      I have to say another example of classical economics at its finest

  5. don

    Some nice analogies, but David Hume taught us the value of those….

    Greece’s biggest current problem, in my opinion, is being tied to the euro, which ensures that they will not be competitive without further very painful price and wage drops. Debt forgiveness will not solve this problem. Spain and Italy are in a similar bind.

    I am skeptical that a “Grexit” would bring European and global economic disaster. I think the greatest danger would be a Greek success story following such an exit, providing an example for others to follow. Apparently my skepticism is shared by others, or Greece would be having a much easier time with its the creditors.

  6. Levis Kochin

    The experience of Argentina suggests that after a period of confusion Grexit would be followed by a recovery from the Depression.

  7. westslope

    What about the danger to the euro zone if Greece stays in the EU?

    Greece needs to leave. Hit bottom, default on debt, suffer, start over.

    1. Ulenspiegel

      “What about the danger to the euro zone if Greece stays in the EU?”

      In principle there is no danger if Greece leaves the euro zone but stays in the EU. IIRC the issue, however, is that Greece very likely can’t leave the euro zone without leaving the EU.

      1. Bellanson

        why can’t Greece leave the Euro and stay in EU? Denmark, Sweden & Norway have their own currencies but don’t belong to the Euro-zone, and so does the UK. None of these countries are basket cases

  8. c thomson

    Underlying assumption here is that all humans are interchangeable spare parts and all human cultures are equivalent. This is ridiculous.

    Greece is a trashy, venal society – more Middle Eastern than European – and should never have been admitted to the EU. Greece has repeatedly broken financial commitments over a long period of time. Throwing more money at Greece without basic Greek reforms is just silly. Luckily it is also bad politics in northern Europe.

    Incidentally Greece was the only place I was ever asked for a large bribe by a government official in the course of routine business. The amount was so disproportionate to the value of the potential business that there was no temptation to pay – typically Greek.

    Great place for a holiday but a joke society.

  9. Steven Kopits

    Here again is my proposed plan for Greece. It will work, and will create good governance as well as debt repayment. (It implies a haircut of about 25% on official debt.)

    I am always happy to walk over to the WW School and give you a presentation on the topic. I will explain how corruption and venality work (based on my experience in Hungary) and how to use it as a policy tool.


  10. Rich man Johnny

    Very good post, well-balanced written, thanks.

    Greece has to leave the Euro, return to the Drachme, and restart the system after massive inflation. Germany would have to loose a lot according to Target2. But in my opinion the only solution. Greece does not belong to the common market for a lot of reasons, see http://www.cesifo-group.de/ifoHome/policy/Sinns-Corner.html#Eurokrise

    I think the political will to exclude Greece from the Euro is not given, I am afraid austerity and misery will continue. Until (even) more extremist parties will win elections, and then …

  11. aaa

    I bet you that neither the author of the article nor most of those who volunteered opinions have ever lived in Greece. I value and welcome their contributions but I see them for what they are: Either academic theories or projections that do not take into account the very special, perhaps unique, sociopolitical conditions of Greece. Because, make no mistake, the challenges facing Greece are much more sociopolitical than economic. Greece is not the country that most commenters imagine. The people of Greece are neither the profligate beach bums some people imaging nor the innocent victims of the IMF and the EU bureaucracy for whom others overflow with compassionate sympathy. The situation is much more complicated — at which point a lot of readers lose interest since they would rather think in terms of stereotypes.

    To begin with, Greece is a rich country in the sense that an awful lot of wealthy people live in Greece. The middle class (real middle class, the second third in the distribution of income and wealth) is doing better that their equivalents in other countries that are considered economically successful. Just look at the ECB study of wealth of households. Greece has a small but vibrant private sector, where people work hard and are paid little. The problems that brought Greece to bankruptcy have to do with a weak and corrupt state apparatus and a political system of “extreme clientelism”, for lack of a better term. Now, you may expect such a system in a poor country in Africa but not in a country at the core of EU. This may be what confuses a lot of people.

    And that is why the detested IMF was absolutely right to demand reforms. What followed is a different story. IMF demanded reforms but the extreme clientelism system resisted successfully, as it always does, and deflected reforms into other things that crushed the weakest echelons of society while little affecting the culprits or curing the ills of the system. Believe me, if you are a notary public, you still have a cushy and lucrative job. A restaurant owner in the island of, say, Spetses, can clear 100-300 thousand euros in five months (and be closed the rest of the year) while paying very little in VAT or income taxes. Thus, the problem is not IMF asking for austerity and that austerity has failed. For once, the doctor made the right diagnosis but the patient was of a different mind and with strong muscles. And all the noise from the perhaps well-meaning but definitely clueless bystanders, effectively encouraging the patient to do all the wrong things, was not helpful.

  12. Steven Kopits

    A belated thought here.

    It seems to me that if Greece defaults, the creditors will be forced to write off between 50-60% of their outstanding debt. Official debt (to the IMF, EU organizations and individual member countries) now totals about Euro 340 bn.

    If Greece defaults, it will in effect suffer all the consequences of doing so. However, one may question whether Greece–if it cannot service all the debt–has an incentive to service any of the debt.

    In other words, if Greece defaults, it is likely to walk to path of Argentina–excluded from credit markets but with creditors holding dead money. At this point, all the leverage will shift to Greece, because the EU will lack politically viable tools to recover its loan. Will it close Greece’s borders? Prohibit Greeks from traveling to the EU? Invade Greece and seize assets? Seize Greek assets in the EU? Close Greece to Schengen free transit? I don’t see any of these as politically viable.

    So Greece goes down the rabbit hole and emerges looking like Argentina, which for the record, is not a successful model for an integrated European country. So Greece becomes a kind of numb, blank spot on the map of Europe. It is still there, but somehow without nerve endings attached.

    Now, how does Europe induce Greece to begin to pay back any of its debt? It can argue that Greece will be excluded from credit markets for generations if it fails to do so, and this true. On the other hand, if Greece can’t afford to service the full debt, it has no incentive to try to service any part, it seems to me. So although the Greeks will readily concede the point on credit market exclusion, such a threat will lack any meaningful punch in motivating Greece to hop back on the wagon.

    And this is turn will lead to the Troika beginning to negotiate with itself. “Oh, we’ll waive 10% of the debt if Greece begins to service debt again.” And then, “Oh, we’ll waive 20% of the debt if Greece returns to servicing the balance.” And so on, until Greece decides to bite, maybe sometime around 2018, at 30-40% of current debt levels. This would lead to a write-off on the order of Euro 200 bn, much of it to be borne by Germany. (This would be the proportional equivalent of the US writing off a $1 trillion loan to Argentina. One can contemplate the political ramifications of that.)

    So, let me again return to my proposal for Greece. It will keep Greece in Europe, promote growth, create better governance and recover a solid $75 bn more for the creditors than their current de facto strategy.

  13. baffling

    agree with your comments, that at this point greek creditors need to realize it is their responsibility to make a deal work. and debt forgiveness is really a requirement for this to occur. greece cannot pay off its debt-nor will it. the banks and private enterprise have already been saved, because the debt is owned by the ecb, imf, etc. counterparty risk, so significant during the fiscal crisis a few years ago, has been addressed in a much better way from a systemic risk perspective. the biggest debt owned by the private sector, are pensions owed to the people. not an insignificant issue but with less systemic implications. it is in the best interest of germany, netherlands, etc to figure out a way to make greece grow at this point. the days of beatings are about to come to an end, at least for beatings limited strictly to greece. going forward, if greece takes a beating chances are others involved will as well. as you stated, what is germany going to do, invade and repossess? the beatings will continue until morale improves is not a long term policy solution.

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