The IMF, Greece and the ECB

There have been leaks of alleged minutes of an IMF high rank conference call about Greece. Allegedly, Poul Thomsen, Director of the IMF’s European Department and his colleagues agreed that Greece only decides on the brink of default (p. 6). While Thomsen is right that Greek decisions are taken in the most effective way only close to default, there is little the fund could do about it. Greece is technically insolvent and is only able to keep on going with the extensive support of the ECB (and the ESM), in fact it is only political will that keeps Greece afloat, so the whole arrangement is near-default anyway. So, the only institution able to exert influence on Greece is the ECB. But the fund is not at all in a position to have a sizeable influence on the developments in Greece anyway, neither economically, since the Greek debt is guaranteed by the ECB’s various unconventional monetary policy programmes, nor politically, since they are currently not taking part in the “rescue” programme. The IMF wants a debt cut (which German chancellor Angela Merkel refuses) and will until then stand on the sideline.

That being said, Greece’s debt – sustainable or not – is not the problem. We have seen that the ECB is able to keep the Greece and the rest of the Euro Area periphery afloat against all market forces. As long as the ECB acts as a backstop, there is neither need for a debt cut nor (unfortunately) for Greek reforms in order to grow again. Actually, the fund is not needed at all, neither for keeping Greece afloat nor for exerting pressure on the Greek government. The ECB alone is enough to keep Greece in its current fiscal limbo and is hence the only institution that can somewhat influence the Greek government. The only reason the IMF is still on board is because the German government insists on it.

Still, Thomsen’s assessment that the Greek government must be forced to reforms is valid, but this should not be political but economic force. Only the markets are able to find the correct price of the government’s reform laziness. Granted, this price is probably prohibitive and Greece will default once the ECB withdraws its support, but recent experience from the Fed’s tapering shows how a gradual, clearly indicated and communicated withdrawal from extraordinary policy measures work. A similar approach would be worthwhile to usher in the return to normal times in Europe and to convince Greece that outside aid is no permanent solution – it never was a solution, actually, but rather a crude fix. The tricky part is to taper fast enough to form expectations towards normal interest and inflation rates and to taper slow enough to give the notoriously slow government in Athens the time to push through and implement reforms and to let them have an effect.

The ECB could start by hinting at the slow progress of reforms by the Greek government and extend an offer of institutional support by officials from all over Europe to help increasing the Greek bureaucracy’s efficiency. Such offer should be accompanied by an announcement to evaluate the effectiveness of the ECB’s emergency policies in the near future and the possible fade-out of the less effective ones. Theses threats should then increased in order to have the Greek government get the point without actually having market forces exert pressure on Greece, but only threatening with theme. Still, such a setting of expectations makes it feasible to withdraw support for Greece in order to force it into compliance without wrecking the whole thing at the first instant. The advantage is twofold: first, the ECB gradually leaves its cumbersome role as a fiscal player and government backstop and second, the Greek government has both incentive and protection to sort out its mess. The beginning of such tapering will surely have a depressing effect on Greek bonds, but with the right expectations, the ECB might be able to pull off this trick. Could the fund do something like this? Not likely.

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I write about economics and politics. I take Ordnungspolitik seriously. While not blogging, I study monetary unions for my doctorate.