by Avinash Persaud
Peterson Institute for International Economics
February 24th, 2015
Now that over 75 percent of Greece’s debt has been transferred from private banks to the official sector backed by European taxpayers—there is a novel solution to the Greek tragedy that would satisfy the interests of borrowers as well as creditors. This solution could also temper unhelpful nationalism on both sides and doesn’t promote future fiscal irresponsibility.
Under this proposal, official creditors and borrowers would enshrine debt stability by setting interest rates equal to nominal growth. Greeks would rejoice. But it would also be necessary and possible to embed strong incentives to discourage Greece from abandoning fiscal responsibility and reform as soon as growth returns. Interest rates would be further adjusted above nominal growth by the amount of a primary deficit and fall below it by the size of the surplus. Creditors would approve.
Any solution to the current impasse must satisfy at least three tests. First, the primary budget surplus required of Greece must not be so large as to inhibit sustainable economic growth. By primary budget surplus we mean revenues less expenditures, excluding interest or debt repayments. This is a better measure of a budget’s impact on economic activity than the overall deficit. When the animal spirits are low like now, the multiplier of fiscal conditions on to GDP growth is high. And without GDP growth, there can be no stabilization of the debt-to-GDP ratio.