Open letter to European policymakers: The Greek crisis is a European crisis and

needs European solutions

For weeks the attention of the financial markets, media commentators and policymakers

has been on the Greek crisis. Yet it has rumbled on. The Greek population is being asked

to make painful cuts which will only depress incomes output and employment further,

even as interest rates are driven up to crippling levels. Most recently its bonds have been

declared ‘junk’ by rating agencies. This is a disaster for Greeks, but it is also profoundly

the wrong course for Europe as a whole, which needs to chart a European path out of the


We are appalled that European policymaking has systematically lagged behind events,

allowing itself to be driven by volatile market sentiments, populist politicians and a

media that all too often exhibits fundamental ignorance about the issues. This has

dramatically raised the costs and risks of resolving the crisis.

Greece’s fiscal catastrophe has four causes. First, there is the past fiscal weakness of the

Greek state, in particular the inability to generate tax revenues, as a share of GDP, in line

with its European neighbours, but also inexcusable statistical manipulation. Second,

Greece’s relative competitiveness has steadily worsened, especially within the euro area,

as reflected in a sustained current account deficit as a result of above-average increases in

unit labour costs and prices and a stronger economic growth dynamic. Third the

economic crisis – which, given the country’s conservative banking sector was a classic

external shock – has ravaged public finances, just as in other countries. And last but not

least, fourth, the interest cost burden has dramatically increased, as genuine concerns

about fiscal sustainability combined with speculation and misinformation to dramatically

raise the rate of interest on new Greek government bonds.

Only the first of these reasons calls unambiguously for Greeks to accept the pain of fiscal

austerity. All the others have a strong European dimension and call for European

solutions. In particular, the loss of competitiveness by Greece (and a number of other

countries, including Spain and Ireland) is the mirror image of an increase in relative

competitiveness by others, notably Germany, Austria and the Netherlands. The latter

countries could not have increased their net exports without the faster demand expansion

in the former group, which, it is often forgotten, were also responsible for much of

Europe’s economic and jobs growth in recent years, while demand and output growth in

the surplus countries has been sluggish. The problem is symmetrical and the solution

must be as well.

For Greece has not – as is often claimed or implied – lagged behind Germany in raising

productivity: on the contrary hourly labour productivity increased more than twice as fast

in Greece than Germany during the ten years of the euro since 1999. Nor do frequent

claims in the media of Greek ‘laziness’ stand up to scrutiny: average annual working

hours are the longest in Europe (and hundreds of hours per year longer than in

Germany!). The problem has been with nominal wage and price setting.


Due to strong differences in wage setting, Greek nominal unit labour costs increased by

more than 30% since the start of EMU – and the increases in Italy, Spain, Portugal and

Ireland were even higher – whereas in Germany they rose by just 8%. Monopolistic price

setting is also critical, enabling firms to pass on higher wage costs or imported prices

onto domestic prices. Such wage and price divergences are not sustainable within a

monetary union where exchange-rate adjustments are no longer possible. But this

requires an adjustment from both ends. Wages and prices in Greece and other countries

need to fall in relative terms, but they must increase faster in Germany, whose aggressive

wage moderation policies are deflationary, export unemployment and threaten to explode

the monetary union. This is the only way to rebalance the euro area while avoiding the

huge risk of a deflationary spiral.

Misunderstanding these causes, European policymakers have fiddled while Greece has

burned. Monetary policy has been left entirely out of the discussion. Fiscal support offers

have been too little, too late and subject to unreasonable conditions. As a result

speculators have driven the cost of resolving the crisis higher and higher. Lending public

money to Greece, at interest, is not charity. It is a recognition of the interconnections of a

monetary union and in the vital interest of all Europeans. No-one benefits from Greece

and other countries embarking on massive fiscal austerity, demand deflation and

competitive price deflation. This is all the more so when monetary policy is up against

the zero bound and the European economy as a whole still dependent on policy stimulus.

Greece must not be forced into massive demand deflation: having avoided the mistakes

of the Great Depression at European level it makes no sense to repeat them at national


On the contrary it is in Europe’s vital interests to resolve the Greek crisis on the basis of

rising incomes across the continent and to put in place the needed machinery to cope with

competitive and fiscal imbalances in the future. The future of the euro area as a whole is

at stake. There is a serious risk of a falling Greek domino knocking over a series of other

countries. Portugal and other countries now stand where Greece was a few months ago.

The economic, political and social costs would be enormous. Has Europe learnt nothing

from the 1920s when Germany was, in many ways, in a similar situation to Greece

today? Prevented from raising exports to service its foreign debt (reparations) by

mercantilist policies, Germany embarked on a disastrous course of deflation and

depression which paved the way for the horrors that followed. Today as then, deficit

countries cannot simply save their way out of crisis, they must have the opportunity to

grow their way out. And this is also the only way to limit the damage to surplus

countries, who are otherwise also destined to lose out in terms of growth, employment

and financial stability.

We call for a coordinated economic policy response around the following five elements:

The ECB must provide as much support as possible to the fiscal consolidation and

rebalancing effort. In the short run that means committing to maintaining its base

rates close to zero. Keeping interest rates low is vital to help minimise refinancing


costs while pushing up the rate of nominal GDP growth. It must continue to

accept Greek bonds as collateral.



Euro area governments should commit to meeting Greece’s needs to restructureits sovereign bonds for a three-year period. The sums involved do not require the

involvement of the IMF, whose participation is only justified, if at all, by political

considerations. This would immediately and drastically reduce the market

interest rates to be paid on new bond issues: the rate demanded by euro area

governments should be explicitly tied to the benchmark rate for German Bunds

plus a penalty rate, which should be set so as to ensure the best possible chances

for consolidation while avoiding future sovereign moral hazard.



Greece accepts enhanced supervision of its public finances and announces alonger-term fiscal consolidation package designed to have as limited negative

effects on demand as possible in the short run (notably drastically reducing tax

evasion), but primary fiscal surpluses in the medium run; it couples this with a

time-limited freeze on wages and administered prices and policies to increase

product market competition.



Germany, Austria and other surplus countries commit to maintain fiscal stimulusand a period of faster-than-productivity-growth wage increases; more generally,

fiscal exit strategies should be coordinated within the Council to underpin areawide

economic recovery while rebalancing demand within the currency area. This

requires asynchronous exit strategies. Greece and other deficit countries have to

employ them earlier while the surplus countries like Germany follow later on.

After the adjustment period wage policies should return to an orientation to the

medium-run growth of national productivity plus the ECB’s inflation target in all




Greece is not the only crisis country and policies are needed to prevent the crisisspreading to other vulnerable countries. The issuing of Eurobonds, possibly with a

role for central bank purchases on the secondary market, should be considered to

reduce financing costs. Moreover, the EU should embark on an immediate review

of its various policy coordination mechanisms with a view to strengthening them

and refocusing them in the direction revealed to be necessary by the crisis,

namely: a symmetrical focus on surplus and deficit countries; the monitoring of

private debt-savings dynamics, rather than just the public sector, and thus a focus

on current account positions; incorporating wage and price setting and

accordingly strengthening the role of social partners.

The Greek crisis is a chance to drive European integration forward to the benefit of all

Europe’s citizens. But current policies, based on misperceptions of economic

interlinkages and short-sighted and erroneous views on ‘national’ interests, threaten to

destroy the monetary union, set back European integration and imperil its economic and

political future. EMU simply cannot go on like this. We call on European policymakers

to find European solutions that serve the interest of all Europe’s citizens.