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Rogoff: EU’s Debt Move Just ‘One Stage in a Multi-act Drama’

European Union Central Bank Photo Credit: Hannelore Foerster | BloombergEU leaders meeting for a summit in Brussels Thursday pledged to act to help Greece avoid default on its massive public debt, but they offered few specifics about what aid might be offered and in what form.

With other countries in the eurozone, including Spain and Portugal, suffering from ballooning deficits, we spoke with Kenneth Rogoff, professor of economics at Harvard University and co-author of the recent This Time Is Different: Eight Centuries of Financial Folly, about what’s next for Greece, the issue of moral hazard, and what might be in store for the European economy.

Is what we saw today the EU coming to the support of Greece?

KENNETH ROGOFF: They have and they haven’t. This has to be looked at as one stage in a long drama. They have come to the tentative support of Greece –they haven’t exactly said what they are going to do. But most importantly, they have insisted that they will enforce the Greeks’ tightening their belts and I’d like to see it.

I think it’s a big mistake not to put the International Monetary Fund front and center as the lightning rod for all the complaints from the Greek people that we’re going to see more and more of. There is going to be a deep recession in Greece. Do they really want the Greek people protesting against the German government? We are very much in the thick of this. This is simply one stage in a multi-act drama.

And what are they saying? What are the details?

KENNETH ROGOFF:The Greeks have run a numbing public deficit since the early 1980s — over 7 percent per year — and that was in the good years. This year, it’s 13 percent — one of the couple highest in the world. We have reached a point where no one wants to lend them money.

So, they probably need to tighten their belts over the next couple of years to the tune of at least 10-12 percent of GDP. And no segment of society particularly wants to do it, no more than we Americans want to do it. And I think this tightening is coming no matter what they do – IMF, European Union, whether they do it on the own. The big question is who they are going to blame. And I think when push comes to shove, the Europeans will realize they want to put the IMF front and center and make them the bogey man for this inevitable tightening.

What can the Greeks do? We’ve seen large protests already at the prospect of salary cuts across the board.

KENNETH ROGOFF: There are just deep fissures in Greek society and the Greeks need to sort this out. I think it is helpful for the Europeans to provide some bridge lending support, some degree of lending through the IMF if necessary to give the government time to restructure.

But I don’t think it’s so obvious the creditors should get repaid. I really don’t see it. Here these people have been getting a couple of percent extra on Greek debt for oh so many years. And it’s just like with the banking system, where all the banks got paid off. It creates this huge moral hazard problem. What are they going to say to Portugal, Spain, Italy. I think it is a very, very tough and fluid situation. Today is just one step in a very complicated negotiation.

How vulnerable are Spain and Portugal and all these other countries that have huge deficits of their own?

KENNETH ROGOFF: In short, they are extremely vulnerable. They are not far behind Greece in some ways. A lot rides on whether Europe grows quickly. So if Europe has really vigorous growth, that covers a lot of sins. These countries will see their tax revenues grow, they will be able to start convincing their lenders things are OK.

Unfortunately, all evidence points to a very muted recovery in Europe. In fact, in these countries that have to tighten their belts, they are probably in for prolonged recessions. I don’t think this is nearly over even if Germany and France decide to become very generous. They are just pushing the problem off to the future. They are still going to have to confront it. There are massive debts in Europe and no clear plan for dealing with it.

The EU finance ministers are meeting Monday. More specifics then?

KENNETH ROGOFF: There will be some more specifics. But the bottom line is there will be some tentative backing of Greek debt with lots of caveats. The Greeks will asked to put in a very strict austerity program. But it’s not clear they can execute. And you can see that in the statement. The Europeans, even as they are trying to project confidence, note that this a very tough program that will be difficult to implement That’s the understatement of the year.

And you know, Greece has long had difficulties with default. They’ve been in default nearly half their years since independence. Carmen Reinhart and I note that in our book on financial crises. And when a country has a bad record of repayment, it’s all the more difficult to get lenders to believe you. It’s all the more difficult to get your own people to believe you. They have a massive credibility program to overcome. It’s helpful what the Europeans are doing. It buys time. But it’s just wrong to think of this as the end. It’s a step in what’s probably going to take years to play out.

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