Greece and Detroit
By Scott Sumner
In a recent post I claimed that it made no sense to talk about NGDP at the global level. In the comment section Nick Rowe argued that one might be able to come up with a meaningful estimate of global NGDP growth. Even so, I find the national figures to be much more useful. And I shouldn’t even say “national”, as what really matters is the NGDP for a given currency area. That’s because NGDP is an excellent indicator of the stance of monetary policy.
Here it might be useful to compare Greece and Detroit:
1. Both areas are part of a larger currency zone.
2. Both have seen NGDP decline significantly during the Great Recession.
3. Both areas defaulted on a portion of their public debt.
4. Both areas have structural weaknesses that go beyond monetary policy.
You don’t see people talking about monetary policy in Detroit, as it’s assumed it faces the same monetary policy as the rest of the US. After all, both Detroit and Silicon Valley use the US dollar, and face the same foreign exchange rates. Banks in both areas pay the same interest rate in interbank loans. Even their inflation rates are similar, although not identical. But NGDP is doing much better in Silicon Valley than Detroit, for various structural reasons (high tech vs. UAW-dominated auto manufacturing, education level of workforce, etc.)
Lars Christensen has a new post pointing out that Greece’s debt problem has been made worse by the sharp decline in NGDP. I think that’s right, as is his conclusion that it might make sense to combine debt relief with vigorous structural reforms.
Both Detroit and Greece face problems that are specific to their regions, and (especially in the case of Greece) are partly self-inflicted. (Here’s where the analogy breaks down a bit, as Detroit is now essentially a poor neighborhood in a large country, whereas Greece is an entire country, with a more diverse set of skills, and thus greater short term possibilities for economic growth.)
While Greece and Detroit have structural problems, both have also faced a tight monetary policy. A medical analogy might be helpful. Imagine a family exposed to a flu virus. One older member with heart disease catches the flu and goes into critical condition. Another family member catches the flu and is somewhat sick for a week. Another family member with a very strong immune system fights off the virus with no symptoms showing up.
In the analogy, Germany is like the person with the strong immune system (partly due to labor market reforms), France and Netherlands are like the person who got sick for a week, and Greece is the individual in critical condition. Just as a person can suffer from two medical conditions at the same time, a country can suffer from both structural and demand-side problems.
So in that case, how can we evaluate the role of monetary policy in Greece’s troubles? In my view the proper metric is eurozone-wide NGDP data. That data shows that money has been too tight, but nowhere near as tight as you’d infer from merely looking at Greek NGDP data. Lars Christensen is right that Greek NGDP data is the right metric for judging their difficulty in servicing the public debt. On the other hand eurozone NGDP data is the right metric in judging the extent to which Greece has been “victimized” by bad ECB policies. To conclude:
1. The ECB policies were bad enough to produce a French or Dutch level recession, in a eurozone country with average structural problems.
2. Eurozone countries that have done more aggressive labor market reforms (i.e. Germany) were able to get by with a much milder than average recession.
3. Eurozone countries with much worse than average structural problems (i.e. Greece) had a worse than average recession.
It’s not an either/or situation; both NGDP and structural factors matter, and they both matter a lot. Just as it makes sense to eat right and exercise to avoid getting heart disease, it makes sense to wash hands to avoid catching the flu. The same is true in economic policymaking. Keep the structure of your economy in sound shape through free market policies, and avoid unnecessary demand shocks by having a monetary policy that produces slow but steady NGDP growth.