The Greek government met with the European Union, the European Central Bank, and the International Monetary Fund over the weekend. The meeting between Greece and the troika was intended to clarify requirements to qualify for the next round of bailout funds. Greece has already committed to more than 11.5bn euros in spending cuts and another 2bn euros in tax revenue. But Prime Minister Antonis Samaras concedes Greece is unlikely to meet expectations imposed by international lenders.
The challenge for Greece is that the plan is highly unpopular, and the country has been rocked by several rounds of widespread protest. The Greek economy has collapsed, contracting by 20 percent over the last year alone. Yet absent external relief from the IMF and EU, Greece faces the prospect of bankruptcy and potential expulsion from the eurozone. And outside of Greece, observers in Spain, Portugal, and other troubled eurozone economies are watching developments closely.
The current conundrum in Greece illustrates some of the economic challenges of the common European currency. In normal times, a common currency presents clear benefits. It facilitates closer and more efficient management of the economy, reduces transaction barriers and cost of trade between countries sharing the currency, and can help to reduce economic uncertainty. Indeed, when the euro was adopted as the exclusive currency in the eurozone in 2002, it was highly popular, and many eurozone members enthusiastically embraced the new currency.
At the same time, though, the common currency presents a key challenge, particularly during economic downturns. Traditionally, governments have two economic toolkits available to them. Fiscal policy, advocated most famously by John Maynard Keynes, focuses on the use of government revenue (taxation) and expenditures (spending) to influence economic activity in the country. Keynes argued that in good times, governments should run a budget surplus so that during poor economic times, it would have ample revenue to spend, including running a deficit, and prevent a deep recession or depression.
Monetary policy, on the other hand, focuses on manipulation of the money supply, often through interest rates, to promote economic growth and stability. Monetary policy, which was most famously promoted by Milton Friedman, provides that governments should lower interest rates to promote economic growth, but should engage in contractionary policies (including raising interest rates) to prevent the economy from overheating. Above all, monetary policy focuses on maintaining a stable money supply and money value, and keeping inflation as close to zero as possible.
In practice, governments regularly use a combination of both monetary and fiscal policy to manage economic growth and stability. However, the eurozone encompasses a wide range of countries and economies, ranging from the economic powerhouse of Germany to the crisis-ridden economies of Greece, Spain, and Portugal, to a large number of smaller economies somewhere in the middle. The question of how to balance competing demands across all eurozone economies presents a challenge. The monetary policies that would maintain economic stability and growth in Germany are different from the monetary policies that might be used to prevent economic collapse in Greece. Consequently, the European Central Bank faces the challenge of finding a fine line to walk between the two.
The other challenge, of course, is that because Greece is a member of the eurozone, it effectively has cut off one of the two primary economic policies governments might use to address the economic crisis. While the Greek government can continue to use fiscal policy, its ability to use monetary policy to address the crisis is sharply limited by the fact that the Greek government does not control the Greek currency.
Not that leaving the eurozone would make things better for Greece. For now, it appears the Greek government is committed to remaining in the seventeen nation eurozone, and the German government is committed to helping Greece remain there. But if Greece is unable to reach agreement with the troika, exiting the eurozone, either on its own terms or aftering being forced out by the other members, may be Greece’s only option.
What do you think? Do the benefits of eurozone membership outweigh the costs for the Greek government? Should Greece make the sharp spending cuts demanded by the international community to remain part of the eurozone? How would Greece leaving the eurozone affect future economic developments in other troubled European economies, like Spain and Portugal? Let us know what you think by leaving a comment or answering the poll question below.