Friday, 22 January 2010


According to the updated Stability and Growth Programme, our current government is committed, despite everything, to a 15.3% reduction in public consumption over 3 years. I'm not sure they can do it, but I'm 100% sure it's the right thing to do, if they can pull it off.

Now not everybody takes my view on this. Our general union for the private sector has, as I've blogged here, made a strong if misguided Keynesian case for fiscal stimulus. Our farmers are clearly asking for a follow-up of the mad EUR500m package of last year. And some of our ministers, most notably our influential francophone Competitiveness minister, simply don't like what they see as neoconservative chemotherapy.

Apparently, a look at Greek government data from 1960 to 2000 shows that:

  • shrinking government increases growth
  • increasing government spending can have non-negative effects only if spending is shifted from public consumption to public investment
  • but even then it tends not to contribute to growth.

But of course it can be argued, as many do, that these are exceptional times. We need, it is argued, a massive fiscal stimulus (pre-election the opposition mooted a EUR3bn package) to keep the economy from spiralling downwards into the Dark Ages.

Now this is a valid if factually false argument based on the same old spin on Keynesianism that has reigned supreme over Greek fiscal policy for decades. The Keynesian philosopher's stone is the multiplier effect: you pour one penny into the economy, and the froth generated by the merry-go-round of increased spending inevitably turns it into 1.4. It's like a macro-economic get-rich-quick scheme. And it works even better when interest rates are, as they are now, at rock bottom.

The problem is that any extra spending has to be financed by debt issued in the teeth of a fiscal crisis. A EUR 3bn stimulus package does not, therefore, cost only the going interest rate (let's call it 5% or EUR150m). It costs interest plus, eventually, the marginal increase in interest on THE WHOLE OF OUR PUBLIC SECTOR DEBT. That, if any reminder were needed, currently stands at EUR 300bn and rising. So if raising the extra EUR 3bn increases the interest rate by 10 basis points (5% to 5.1%), the cost of funding the deficit in year will be the 150m + 0.1% * 300bn = 300m. This means a EUR3bn stimulus package will cost, in the long run, three times what our Keynesians think it will. Now if we could depend on a multiplier of 4 (which not even the most rabid Keynesians would not dare put on paper) and on bond market conditions to drastically improve, it might be worth spending more at this point, but of course we can't.

Now this is a very crude analysis, but happily someone's gone and run a rather more sophisticated one based on Greek data, and they have found the same.


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