With talks ongoing about resolving the Greek debt crisis, it is clear that there is no agreement that will satisfy both sides – the Greek government and the troika of lenders (the IMF, the ECB and the European Commission). Their current negotiating positions are irreconcilable. What is needed is something more fundamental to provide a long-term solution. What is needed is a ‘deus ex machina‘.
A deus ex machina, which is Latin for ‘god from a machine’, was a device used in Greek tragedy to solve an impossible situation. A god would appear from above, lowered by a crane, or from below through a trap door, and would put everything right. The tragedy would then be given a happy ending.
So what possible happy ending could be brought to the current Greek tragedy and who could be the deus ex machina?
The negotiations between Greece and the troika currently centre on extending credit by €7.2bn when existing debts come up for repayment. There are repayments currently due to the IMF, or by the end of June, of €1.5bn and more in July, September and December (another €3.2bn). There are also €6.7bn of Greek bonds held by the ECB, as part of the 2010 bailout programme, that are due for repayment in July and August. Without the €7.2 billion bailout, Greece will be unable to meet these debt repayments, which also include Treasury bills.
But the troika will only release the funds in return for harsh austerity measures, which involve further cuts to pensions and public expenditure. Greece would be required to run a substantial budget surplus for many years.
Greece could refuse, but then it would end up defaulting on debt and be forced out of the euro. The result would probably be a substantial depreciation of a newly restored drachma, rising inflation and many Greeks suffering even greater hardship – at least for a period of time.
So what is the possible deus ex machina? If you’re looking for a ‘god’ then it is best, perhaps, to look beyond the current actors. Perhaps the Americans could play the role in finding a solution to the impasse. Perhaps a small group of independent experts or politicians, or both, could find one. In either case, the politics of the situation would have to be addressed as well as the economics and finance.
And what would be the ‘fix’ to satisfy both sides? Ultimately, this has to allow Greek debt to be sustainable without further depressing demand and undermining the fabric of Greek society. 
This would almost certainly have to involve a large measure of debt forgiveness (i.e. debts being written off). It also has to avoid creating a moral hazard, whereby if the Greeks are seen as being ‘let off lightly’, this might encourage other indebted eurozone countries to be less willing to reduce their debts and make demands for forgiveness too.
Ultimately, the issue is a political one, not an economic one. This will require clever negotiation and, if there is a deus ex machina, clever mediation too.
Videos
Greek PM Tsipras warns lenders bailout plans ‘not realistic’ BBC News, Jim Reynolds (5/6/25)
Greece defers IMF payment until end of June BBC News, Chris Morris (5/6/15)
Greek debt talks: Empty shops and divided societies BBC News, Chris Morris (10/6/15)
Potential Grexit effects Deutsche Welle (13/6/15)
Articles
It’s time to end the pretence: Greece will never fully repay its bailout loan The Guardian, Andrew Farlow (9/6/15)
Greek exit would trigger eurozone collapse, says Alexis Tsipras The Guardian, Phillip Inman, Helena Smith and Graeme Wearden (9/6/15)
The eurozone was a dream of unity. Now Europe has turned upon itself The Guardian, Business leader (14/6/15)
Greece bailout talks: an intractable crisis with three possible outcomes The Guardian, Larry Elliott (2/6/15)
Greece needs an economic defibrillator and a debt write-off Financial Times letters, Ray Kinsella (25/3/15)
Greece’s new debt restructuring plan Times of Change, Peter Spiegel (5/6/15)
Eurozone still in denial about Greece BBC News, Robert Peston (3/6/15)
Greece bailout talks – the main actors in a modern-day epic The Guardian, Phillip Inman, Ian Traynor and Helena Smith (9/6/15)
Greece isn’t any old troubled debtor BBC News, Robert Peston (15/6/15)
Greece in default if debt deadline missed, says Lagarde BBC News (18/6/15)
Burden of debt to IMF and European neighbours proves too much for Greece The Guardian, Heather Stewart (17/6/15)
Paper
Ending the Greek Crisis: Debt Management and Investment led Growth Greek government
Questions
- To which organisations is Greece indebted? What form to the debts take?
- To what extent is Greece’s current debt burden the result of design faults of the euro?
- Would it be possible to restructure debts in ways that make it easier for Greece to service them?
- Should Greece be treated by the IMF the same way it treated the highly indebted poor countries (HIPCs) and granted substantial debt relief?
- What would be the effects of Greek exit from the euro (a) for Greece; (b) for other eurozone countries?
- What bargaining chips can Greece deploy in the negotiations?
- Explain what is meant by ‘moral hazard’. Where in possible outcomes to the negotiations may there be moral hazard?
- What has been the impact of Greek austerity measures on the distribution of income and wealth in Greece?
- What are the practicalities of pursuing supply-side policies in Greece without further dampening aggregate demand?
Let’s say that the world slides back into recession, or at least, the eurozone, the USA and other major economies. This is not unthinkable, given the determination of many countries to reduce public-sector deficits and debt, concerns about slowing growth in China and other major developing countries, and worries about various geo-political developments, such as conflict in the Middle East and the possible exit of Greece from the euro and the shock waves this might send. If it happened, what could governments and central banks do to stimulate aggregate demand? The problem is, according to the linked articles below, the world has largely run out of policy instruments.
In normal times, the main policy instruments for stimulating aggregate demand are cuts in interest rates (monetary policy) and increases in government expenditure and/or tax cuts (fiscal policy). But with interest rates currently at virtually zero, there is little scope for further cuts. And with governments attempting to ‘repair’ their balance sheets by cutting deficits, there is little appetite for increasing deficits again.
It is possible that central banks could engage in further quantitative easing. Indeed, the ECB is only just starting its large QE programme, involving monthly bond purchases of €60bn until at least September 2016 (totalling €1.14tr at that point). But QE leads to market distortions, such as increased asset prices (e.g. share and house prices), made higher and more unstable by speculation. By providing ‘cheap money’, it also encourages potentially risky investments.
The articles below considers the dilemma and looks at six possible options for policy makers suggested by Stephen King, chief economist at HSBC. But are they realistic? Read the articles and then consider the questions.
Financial crisis fixes leave policymakers short of ammo for next recession The Guardian, Larry Elliott (31/5/15)
How to get the economy working for us Guardian Letters, Mary Mellor; Colin Hines; Martin London; William Dixon and David Wilson (2/6/15)
HSBC’s Stephen King Outlines “Economic Nightmare” ValueWalk (14/5/15)
HSBC: Central Banks Are Running Low on Ammunition Bloomberg, Julie Verhage (13/5/15)
If the US economy is signalling an iceberg, bad news: we’re out of lifeboats The Guardian, Nils Pratley (13/5/15)
Policy makers lack the firepower to fight another US recession Financial Times, Stephen King (18/5/15)
The new surrealism Global Economics Quarterly, Stephen King (Q2, 2015)
Questions
- What are the risks to global recovery?
- Why has recovery from the 2008/9 recession been slower than that from previous recessions?
- What are the traditional instruments for combatting a recession?
- Why might central banks be wary of engaging in further rounds of quantitative easing?
- What is meant by ‘helicopter money’? Would this be a better solution to a recession than quantitative easing?
- Go through the other five policy options identified by Stephen King and discuss the suitability of each one.
The eurozone has been suffering from deflation: that is, negative inflation. But, the latest data show an increase in the rate of inflation in April from 0% to 0.3%. This is still a very low rate, with a return to deflation remaining a possibility (though perhaps unlikely); but certainly an improvement.
The eurozone economy has been stagnant for some time but the actions of the European Central Bank (ECB) finally appear to be working. Prices across the eurozone have risen, including services up by 1.3%, food and drink up by 1.2% and energy prices, albeit still falling, but at a slower rate. All of this has helped to push the annual inflation rate above 0%. For many, this increase was bigger than expected. Howard Archer, Chief European Economist at HIS Global Insight said:
“Renewed dips into deflation for the eurozone are looking increasingly unlikely with the risks diluted by a firming in oil prices from their January lows, the weakness of the euro and improved eurozone economic activity.”
Economic policy in the eurozone has focused on stimulating the economy, with interest rates remaining low and a €1.1 trillion bond-buying programme by the ECB. But, why is deflation such a concern? We know that one of the main macroeconomic objectives of a nation is low and stable inflation. If prices are low (or even falling) is it really as bad as economists and policy-makers suggest?
The problem of deflation occurs when people expect prices to continue falling and thus delay spending on durables, hoping to get the products cheaper later on. As such, consumption falls and this puts downward pressure on aggregate demand. This decision by consumers to put off spending will cause aggregate demand to shift to the left, thus pushing national income down, creating higher unemployment and adding to problems of economic stagnation. If this expectation continues, then so will the inward shifts in AD. In the eurozone, this has been a key problem, but it now appears that aggregate demand has stopped falling and is now slowly recovering, together with the economy.
It is important to note how interdependent all aspects of an economy are. The euro responded as news of better inflation data emerged, together with expectations of a Greek deal being reached. Enrique Diaz-Alvarez, chief risk officer at Ebury said:
“The move [rise in euro] got going with the big upside surprise in eurozone inflation data — especially core inflation, which bounced up from 0.6 per cent to 0.9 per cent. This is exactly what the ECB wants to see, as it is proof that QE is having the desired effect and removes the threat of deflation in the eurozone from the foreseeable future.”
One of the key factors that has kept inflation down in the eurozone (and also the UK) is falling oil prices. It is for this reason that many have been suggesting that this type of deflation is not bad deflation. With oil prices recovering, the general price level will also recover and so economies will follow suit. The following articles consider the fortunes of the eurozone.
Eurozone inflation shouldn’t shift ECB’s QE focus Wall Street Journal, Richard Barley (2/6/15)
Eurozone deflation threat recedes Financial Times, Claire Jones (2/6/15)
Eurozone inflation rate rises to 0.3% in May BBC News (2/6/15)
Eurozone back to inflation as May prices beat forecast Reuters, Jan Strupczewski (2/6/15)
Boost for ECB as Eurozone prices turn positive in May Guardian, Phillip Inman (2/6/15)
Eurozone inflation higher than expected due to quantitative easing International Business Times, Bauke Schram (2/6/15)
Euro lifted by Greek deal hopes and firmer inflation data Financial Times, Roger Blitz and Michael Hunter (2/6/15)
Questions
- What is the difference between the 0.3% and 0.9% figures quoted for inflation in the eurozone?
- What is deflation and why is it such a concern?
- Illustrate the impact of falling consumer demand in an AD/AS diagram.
- How has the ECB’s QE policy helped to tackle the problem of deflation? Do you think that this programme needs to continue or now the economy has begun to improve, should the programme end?
- To what extent is the economic stagnation in the eurozone a cause for concern to countries such as the UK and USA? Explain your answer.
- Why has the euro risen, following news of this positive inflation data?
As we saw in the blog post The UK’s poor productivity record, the UK’s productivity, as measured by output per hour worked, has grown much slower than in other major developed countries since the financial crisis. In fact, output per hour is lower now than in 2008. In France and Germany it is around 3 per higher than in 2008; in Japan it is nearly 6% higher; in the USA it is over 8% higher; and in Ireland it is 12% higher.
The chart below shows international comparisons of labour productivity from 2000 to 2014. (Click here for a PowerPoint of the chart.)
And it is not just labour productivity that has fallen in the UK. Total factor productivity of labour and capital combined has also fallen. This reflects the fall in business investment after the financial crisis and, more recently, meeting the demand for extra output by employing more labour rather than by investing in extra capital.
In his first major speech since the election, the Chancellor of the Exchequer, George Osborne, told the CBI that the government was intent on tackling the problem of low and stagnant productivity. This would require investment in infrastructure, such as high-speed rail, better roads, superfast broadband and a new runway in the south east. It would require investment in education, training and research; it would involve cutting red tape for business; it would require making it easier for both parents in a family to work by cutting the cost of childcare. The details of the government’s policies would be made clear in the soon-to-be published Productivity Plan.
But how much difference can the government make? Are there intractable problems that will prove virtually impossible to overcome? How much, indeed, can a government do, however much it would like to? The articles explore the issues.
Articles
Will George Osborne’s productivity plan help make Britain a world-beater? The Guardian, Larry Elliott (24/5/15)
UK productivity has stayed stubbornly low for years. Dare we hope for better? The Guardian (24/5/15)
Joseph Stiglitz: ‘GDP per capita in the UK is lower than it was before the crisis. That is not a success’ The Observer, Anthony Andrew (24/5/15)
Osborne says low productivity key economic challenge BBC News (20/5/15)
Solving the productivity puzzle BBC News, Duncan Weldon (20/4/15)
Osborne faces up to productivity challenge BBC News, Robert Peston (20/5/15)
Osborne makes priority of boosting UK productivity Financial Times, George Parker (20/5/15)
The Bank of England is living in cloud-cuckoo land on wages Independent, David Blanchflower (18/5/14)
Cameron’s Plan Hasn’t Cracked Productivity Slump Flagged by BOE Bloomberg, Jill Ward (14/5/15)
To solve Britain’s productivity puzzle, try asking the workers The Conversation, Stephen Wood (29/6/15)
Report
Inflation Report: Chapter 3, Output and Supply Bank of England (May 2015)
Questions
- Define (a) labour productivity; (b) capital productivity; (c) total factor productivity.
- Why has the UK experienced lower productivity than other developed countries?
- Why may the UK’s lower unemployment than other countries in the post-recession period be the direct consequence of lower productivity growth?
- For what reasons might it be difficult for the government to achieve a significant increase in UK productivity?
- How might demand-side policy negatively impact on the supply-side policies that the government might adopt to increase productivity?
- How might the period up to and beyond the referendum in the UK on continuing EU membership impact on productivity?
- How might poor productivity be tackled?
The US economy has been performing relatively well, but as with the UK economy, growth in the first quarter of 2015 has slowed. In the US, it has slowed to 0.2%, which is below expectations and said to be due to ‘transitory factors’. In response, the Federal Reserve has kept interest rates at a record low, within the band 0.0% to 0.25%.
The USA appears relatively unconcerned about the slower growth it is experiencing and expects growth to recover in the next quarter. The Fed said:
“Growth in household spending declined; households’ real incomes rose strongly, partly reflecting earlier declines in energy prices, and consumer sentiment remains high. Business fixed investment softened, the recovery in the housing sector remained slow, and exports declined.”
Nothing has been said as to when interest rates may rise and with this unexpected slowing of the economy, further delays are likely. An investment Manager from Aberdeen Asset Management said:
“The removal of the Fed’s time dependent forward guidance could be significant. It means that any meeting from now on could be the one when they announce that magic first rate rise.”
Low rates will provide optimal conditions for stimulating growth. A key instrument of monetary policy, interest rates affect many of the components of aggregate demand. 
Lower interest rates reduce the cost of borrowing, reduce the return on savings and hence encourage consumption. They can also reduce mortgage repayments and have a role in reducing the exchange rate. All of these factors are crucial for any economic stimulus.
Analysts are not expecting rates to rise in the June meeting and so attention has now turned to September as the likely time when interest rates will increase and finally reward savers. Any earlier increase in rates could spell trouble for economic growth and similar arguments can be made in the UK and across the eurozone. The following articles consider the US economy.
Federal Reserve keeps interest rates at record low BBC News, Kim Gittleson (29/4/15)
Shock stalling of US economy hits chances of early Fed rate rise The Guardian, Larry Elliott (29/4/15)
US Fed leave interest rates unchanged after poor GDP figures Independent, Andrew Dewson (30/4/15)
Fed could give clues on first interest rate hike USA Today, Paul Davidson (28/4/15)
Fed’s downgrade of economic outlook signals longer rate hike wait Reuters, Michael Flaherty and Howard Schneider (29/4/15)
Five things that stopped the Fed raising rates The Telegraph, Peter Spence (29/4/15)
Questions
- By outlining the key components of aggregate demand, explain the mechanisms by which interest rates will affect each component.
- How can inflation rates be affected by interest rates?
- Why could it be helpful for the Fed not to provide any forward guidance?
- What are the key factors behind the slowdown of growth in the USA? Do you agree that they are transitory factors?
- Who would be helped and harmed by a rate rise?
- Consider the main macroeconomic objectives and in each case, with respect to the current situation in the USA, explain whether economic theory would suggest that interest rates should (a) fall , (b) remain as they are, or (c) rise.
With talks ongoing about resolving the Greek debt crisis, it is clear that there is no agreement that will satisfy both sides – the Greek government and the troika of lenders (the IMF, the ECB and the European Commission). Their current negotiating positions are irreconcilable. What is needed is something more fundamental to provide a long-term solution. What is needed is a ‘deus ex machina‘.
The negotiations between Greece and the troika currently centre on extending credit by €7.2bn when existing debts come up for repayment. There are repayments currently due to the IMF, or by the end of June, of €1.5bn and more in July, September and December (another €3.2bn). There are also €6.7bn of Greek bonds held by the ECB, as part of the 2010 bailout programme, that are due for repayment in July and August. Without the €7.2 billion bailout, Greece will be unable to meet these debt repayments, which also include Treasury bills.
So what is the possible deus ex machina? If you’re looking for a ‘god’ then it is best, perhaps, to look beyond the current actors. Perhaps the Americans could play the role in finding a solution to the impasse. Perhaps a small group of independent experts or politicians, or both, could find one. In either case, the politics of the situation would have to be addressed as well as the economics and finance.
This would almost certainly have to involve a large measure of debt forgiveness (i.e. debts being written off). It also has to avoid creating a moral hazard, whereby if the Greeks are seen as being ‘let off lightly’, this might encourage other indebted eurozone countries to be less willing to reduce their debts and make demands for forgiveness too.
