Friday, July 10, 2015

Greece, competitiveness, adjustment and excess unemployment

Austerity is an integral part of the Greek tragedy by Simon Wren-Lewis
Under flexible exchange rates this competitiveness adjustment could happen immediately. Things are not quite so simple in a monetary union: competitiveness cannot immediately adjust because of wage and price rigidities. A period of ‘excess unemployment’ will be required to push wages and prices down if the country is uncompetitive in relation to required primary surpluses. However the excess unemployment can be relatively modest. In fact, because of the structure of the standard Phillips curve, it is much more efficient to achieve gains in competitiveness gradually through a measured increase in unemployment than quickly through a rapid rise in unemployment, for reasons I outlined here when talking about Latvia. 
To achieve this efficient outcome may well require the government to reduce its primary deficits gradually, because without this fiscal support while competitiveness adjusts output could fall rapidly. This in turn will require more government borrowing, and if the government cannot do this from the markets, the IMF or other governments should step in to ensure this efficient adjustment can take place and avoid the waste and suffering of unnecessary unemployment. 
This is what failed to happen in the case of Greece.

Needed: Large Greek Devaluation or Large-Scale Transfers to Greece. With Bonus Godwin's Law Violation! by Brad DeLong

Austerity and the Greek Depression by Paul Krugman


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