Another Slideshow from Ed Dolan

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Another Slideshow fromEd Dolans Econ BlogWhy
hasnt the US become another Greece? A Comparison
of Two Budget Crises Posted April 4, 2013
Photo source Athens Indymedia via
http//commons.wikimedia.org/wiki/FileGreek_riot_
police_3.jpg

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  3.0 . You are free to use these slides as a
  resource for your economics classes together with
  whatever textbook you are using. If you like the
  slides, you may also want to take a look at my
  textbook, Introduction to Economics, from BVT
  Publishing.

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Not Long Ago the US Looked a Lot like Greece

• Not so long ago, the trajectory of the US
  government budget deficit looked a lot like
  Greece. Both countries seemed to be headed down
  the same rathole
• Since then, Greece has moved from crisis to
  disaster while the US has begun a slow but steady
  recovery
• What has made the difference?

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Reason 1 Greece was already Worse Off than we
Thought

• The first reason the US and Greek crisis have not
  continued in parallel is that already in 2009,
  the Greek economy was worse off than we then
  thought
• This diagram compares recent data for the Greek
  deficit in 2007-2009 with the vintage 2010 data
  available three years ago
• The Greek government has admitted that some data
  from that period were falsified to make the
  deficit look smaller than it really was

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Reason 2 The Advantages of a Sovereign Currency

• A second reason the US economy has done better
  than that of Greece is that the US has its own
  sovereign currency, the dollar
• Greece, by contrast, is a member of the Eurozone.
  It has no independent control over its currency.
• Having an independent currency has helped the
  United States in two ways . . .

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A Sovereign Currency Allows More Exchange Rate
Flexibility

• One advantage of a sovereign currency is greater
  exchange rate flexibility
• This chart shows real effective exchange rates
  for the US and Greecea broad measure of
  international competitiveness
• The US dollar has depreciated more during the
  crisis, helping US exports
• The Greek exchange rate, linked to those of
  strong economies like Germany, has depreciated
  less

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A Sovereign Currency Helps Keep Interest Rates Low

• Another advantage is that a country with its own
  currency can, if need be, always issue enough new
  currency to pay its debts, but one with a shared
  currency cannot do so
• The ability to issue additional currency to pay
  debts reduces the risk of default
• Reduced default risk, in turn, lowers interest
  rates
• Dramatically lower interest rates have made it
  far easier for the US to manage its debt during
  the crisis

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Using the Output Gap to Track the Business Cycle

• A countrys business cycle can be tracked using
  its output gap
• The output gap is the amount by which real GDP
  exceeds or falls short of potential real output
• Potential real output means the economys real
  GDP when it is operating along its normal trend,
  neither in a slump nor in a boom

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Procyclical vs Countercyclical Fiscal Policy

• Ideally, a countrys fiscal policy should be
  countercyclical. Such a policy would moderate the
  business cycle by stimulating the economy with
  tax cuts and new spending during a recession and
  using tighter policy to prevent overheating
  during a boom
• In contrast, a policy that makes the business
  cycle worse by adding stimulus during a boom and
  applying austerity during a recession is
  procyclical

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The Underlying Primary Fiscal Balance

• A countrys underlying primary fiscal balance
  (UPB) provides a good indicator of whether its
  policy is stimulating or restraining the economy
• The UPB is the governments budget surplus or
  deficit, adjusted to remove the effects of the
  business cycle on taxes and spending, as well as
  for one-off items like privatization revenue and
  tax amnesties

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Procyclical Fiscal Policy in Greece

• Fiscal policy in Greece has been strongly
  procyclical over the past decade, as indicated by
  the fact that the UPB and output gap have moved
  in opposite directions
• During the boom years of the early 2000s, the
  underlying primary balance moved toward deficit,
  causing the economy to overheat
• After 2009, at the insistence of its EU partners,
  Greece undertook stringent austerity measures.
  Its underlying primary balance rose into surplus
  as its output gap plunged into a deep recession

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Procyclical Fiscal Policy in the United States

• Fiscal policy in the United States has also been
  procyclical , but not as strongly so as in Greece
• As in Greece, during the boom years of the early
  2000s, the US underlying primary balance moved
  toward deficit, causing the economy to overheat
• In 2008 through 2010, the US at first used
  countercyclical stimulus to reduce the severity
  of the recession
• After 2011, the US began to tighten fiscal
  policy. The UPB rose toward balance, but not into
  surplus. The recovery was slow but it did not
  stop completely

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The Bottom Line

• The United States did not become another Greece
  for three reasons
• The Greek crisis was worse to begin with
• A sovereign currency gave the US government more
  room to maneuver, especially in terms of interest
  rates and exchange rates
• Both Greece and the United States have followed
  destabilizing, procyclical fiscal policies, but
  to a much greater degree in Greece than in the US.

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• For further discussion of the issues raised in
  this slideshow, see Why Hasnt the US become
  another Greece?, Ed Dolans Econ Blog, April 4,
  2013

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