Greek ELSTAT released the unemployment figures for 2014Q3 today which marked the fall of the unemployment rate to 25.5%, down from 27.2% during the corresponding quarter of 2013. Given the positive outlook of the release I ‘d like to take a closer look at the details of Greek employment and if this drop of the unemployment rate really signifies a substantial improvement of the economy.

Based on various tables of the quarterly employment figures I have constructed the following table of certain numbers that I feel are important:

Greek employment 2013Q3 - 2014Q3

Personally I usually pass through the unemployment rate and go straight to the employment figure. As we can see, although unemployment dropped by 91 thousand people (compared to the same quarter of 2013), employment increased by 53 thousand which resulted in the labor force decreasing by 38,000. What is even more interesting is the fact that a large part of the drop in the labor force was due to a fall of the population over 15yr (-30,000). Obviously the fall in the unemployment rate becomes much less impressive if one looks only at employment while the (steady) fall in the 15+ population and the labor force are certainly not positive signs for the future.

Taking a closer look at the unemployed we see that the fall in that category was only due to people who were unemployed for less than a year while the long-term unemployed actually increased by another 10 thousand to reach close to 930,000 persons. These opposite movements are a worrying sign for the future since they might be indicators for the presence of hysteresis among the long-term unemployment. This will make reducing unemployment much more difficult (given that short-term unemployed are only 6% of the labor force with long-term unemployment reaching 19%).

Moving to employment we observe that the increase came almost entirely from part-time employment. If one also notices that under-employment was the major driver of employment (with under-employed now being close to 6.8% of employment) it is clear that employment growth is driven mainly by short-term, part-time unsecured jobs which probably pay very low salaries. The fall in the unemployment rate actually hides an increase in under-utilization of labor which finds it very hard to enter into full-time steady jobs while long-term unemployed seem to be left out of even these part-time employment opportunities.

Given the recent substantial increase in Greek political risk and the high probability of early elections I ‘d like to comment on a recurring theory that ECB can threaten to close down Greek banks access to liquidity (in the same manner it did in Cyprus) in case that a newly elected Syriza government does not adhere to the currently agreed upon measures, reforms and budget cuts.

In my view, 2015 is quite different than 2012 and the possible threats that the ECB could (then) make against Greece are no longer possible.

The main measure that the ECB can take against Greece in case that the current program is put on hold is to remove the waiver on accepting Greek government guaranteed securities and other assets as collateral in its regular refinancing operations. The important fact to keep in mind though is that Greek banks do not hold significant amounts of Greek government bonds on their balance sheets any more. They only have a little over €10bn of relevant securities of which almost €5bn are Treasury Bills. The collateral being used in ECB operations are mainly the EFSF notes that banks acquired from the Hellenic Financial Stability Fund (HFSF) when they were recapitalized after the PSI. The nominal value of these notes exceeds €37bn which coupled with other assets (such as credit claims) covers current ECB financing which stands close to €45bn.

Any additional financing requirements can be covered through ELA financing although this will necessarily result into much higher borrowing costs (since the ELA rate is more than 150bps higher than the ECB marginal lending rate). The threat of closing down ELA (as in Cyprus during 2013) is only possible if the Greek banks do not cover minimum capital requirements. Given that it’s only been a few weeks since the ECB stress test results were announced during which the central bank affirmed the strong capital position of Greek banking institutions it is not at all clear how the ECB would be able to justify not allowing or placing hard limits on ELA financing.

Moreover, even if negotiations between Greece and its creditors go south this cannot have any effect on the EFSF notes held by banks since any principal and interest payments on EFSF loans will be made after 2020 (interest payments have been deferred and capitalized until at least 2022). Coupon payments on PSI bonds (including bonds issued during 2014) stand around €1bn per year and do not create substantial problems. Unfortunately the EFSF loan does contain cross default clauses referring to the rest of Greek obligations so a future Greek government should proceed with caution although the Greek law covering ECB SMP bonds does provide some room to maneuver* .

Greek debt payments during 2015 mainly involve T-Bill rollovers and payments of €7bn towards the ECB (for SMP bonds) and €9bn towards the IMF:

Greek Bonds T-Bills 2015

ECB’s main leverage over Greece concerns whether liquidity will be provided through regular OMOs or ELA and if Greek bonds will be included in a possible future QE program. The latter will obviously allow a much more orderly access to capital markets for bond issuance, especially coupled with the presence of an EFSF ECCL program.

* When I first wrote the post I had in mind that ECB Greek bonds are covered by Greek law. It turns that the ‘default events’ on the EFSF financing agreement cover more or less all of Greek government liabilities.

Recently I was going through the German real Investment by type of good (based on Ameco data) and noticed something quite interesting:

Germany Real Gross Fixed Capital Formation

Breaking down investment in three major categories and using 1991 as base year we see that:

  1. Non-residential construction increased for a few years after the re-unification until 1995 and then went on a long-term secular decline path until mid-2000’s. Since then it has remained roughly stable between 80-90% of the 1991 value.
  2. Equipment investment went through large long-term swings and a large ‘bubble’ between 2004 and 2008. It regained a large part of the 2009 losses but appears to be on a stable path around 130%.
  3. Residential construction (dwellings) is the most interesting. It increased significantly after re-unification until the end of the 1990’s decade after which Germany went through a ‘balance sheet recession’ correction with construction slowly returning back to 1991 levels. But since 2009 construction has rebounded strongly and is now 20% higher than the trough.

Residential construction can account for a part of Germany’s positive growth since 2009. In contrast to earlier Euro years, (real) house prices are now in positive territory fueling new construction and a wealth effect for house owners (who can increase their consumption). This allows the German economy to decouple up to a point from the rest of the Eurozone and achieve growth based on internal demand (which is now the main contributor to overall growth and not external net demand).

Germany Real House Price Yearly %change

If this picture continues for the upcoming years we might see a structural change in the Savings – Investment surplus of Germany which will obviously affect its current account. This will also depend on the future fiscal stance of course.

Secular stagnation has become a very hot topic lately and quite rightly so. In this short post I ‘d like to point to a graph reflecting these stagnation dynamics for the periphery. It is a simple sum of the working age population (people 15-64 years old) and the capital stock for Greece, Portugal, Spain and Italy with 1961 as the base year:

Working age population and capital stock - Euro Periphery

It is quite clear that the Euro periphery working age population reached a peak during 2009 and is now on a secular decline trend (it is projected to lose almost 2% by 2015 according to Ameco). The capital stock has also stopped its increase since 2011, remaining roughly stable during 2011 – 2015. Regardless of the assumed production function these dynamics can only point to much lower potential product and growth for the medium-term future. Taking into account the large numbers of the long-term unemployed (who face large risks of becoming unemployable) the Euro periphery faces a difficult future of lower potential product which can only reduce the amount of (private and public) debt that can be serviced without further affecting output growth (through higher savings and lower credit ratings).

The graph also points to the underlying reason for adopting the current crisis resolution policy which mainly consists of reducing labor bargaining power and wages. Since after 2009 labor would have become the ‘scarce factor of production’, lowering labor compensation and ability to demand wage increases is a powerful way of maintaining the profit share in output. The question of course is whether such a policy is enough to accomplish a ‘profit-led’ growth model for the periphery countries.

The ‘outlier’ of this policy is Greece which is the only country where real compensation has seen a truly dramatic fall since the start of the crisis:

Real Compensation per employee - Euro periphery

Real compensation per employee is now on its way to return to 1995 levels! This dynamic can help explain why the fall in output was so dramatic in the Greek case while it also casts a doubt on strong recovery scenarios, especially taking into account the large unemployment spell and the stock of outstanding private debt in the country (and the NPLs that it creates in bank balance sheets).

ECB’s Targeted LTRO is now a reality. What I would like to examine in this short post is the fact that actual net liquidity injection will not be equal to the TLTRO’s allotment as most people would think but the net result of various liquidity providing operations and LTRO repayments. More specifically, net liquidity will be the sum of:

  1. TLTRO allotment (€82.6bn)
  2. Repayments of earlier 3Y-LTROs which increased substantially after the TLTRO auction (a total of €19.9bn)
  3. Changes in MROs
  4. Changes in maturing (3-month) LTRO rollovers.

Adding today’s 3m-LTRO rollover the data are as follows:

TLTRO net liquidity

Overall, ECB’s first TLTRO managed to inject a total of €48bn of net liquidity. Given the stated target of increasing the ECB balance sheet by close to €1tr it is clear that the operation was a drop in the ocean. European banks most probably used a large chunk of the TLTRO funds in order to replace 3Y-LTRO funding (the corresponding operations mature in a few months time) and MRO liquidity (replace short-term funding at a variable rate with stable long-term funding at a constant rate only 10bp higher than the current MRO rate) rather than to immediately expand their reserve position. Given that the remaining liquidity due to the 2 3Y-LTRO is still well over €300bn and will be maturing in a few months time it seems that a large part of the TLTROs will go in rolling over these reserves instead of creating additional excess liquidity.

FTAlphaville had a nice article on the evolution of real GDP per capita for various countries in the world during the last 10 years. Although real GDP per capita can provide some nice insights on potential product dynamics I feel it mixes demographics with current production too much. Although every metric has its problems (some are influenced by the business cycle too much) I ‘ve decided to do a simple breakdown of real GDP evolution into GDP per hour worked (productivity per hour) and employment for a number of Euro countries:

Real GDP Euro countries

Greece and Spain are one level above all other countries with an increase in GDP around 30% during 2000 – 2008. The rest of the periphery countries as well as Germany hover around 10%.

Real GDP can be decomposed in Real GDP per hour worked * hours worked per employee * employment. Hours worked showed a common downward trend for all countries so are left out.

Real GDP per hour Euro countries

Focusing on productivity per hour we can see that Greece had an increase close to 30%, much higher than any other country. Germany stands out as well while Italy stagnated during all the 2000s something that can explain its current problems with GDP growth.

Employment Euro countries

Employment increased substantially in Spain (close to 30%) which was the main driver of GDP growth with Greece also achieving a satisfactory growth of 15%. Italy was close to 10% while Germany and Portugal stagnated.

One can also take a look at a few of the above indexes and their change during the Euro crisis:

Real GDP and Employment

Germany stands out as the only country that managed to achieve significant gains in both its productivity and employment during the 2008 – 2013. All of the periphery countries observed substantial losses in employment. In a few cases this fall translated into positive changes in productivity (due to a larger fall in hours worked than output) although Greece managed to experience large losses in both indexes. Italy continues to stand out as the country where productivity did not experience and significant change during almost 15 years.

Given Italy’s demographic dynamics its ability to achieve future high GDP growth rates will be quite difficult and cast a shadow on its ability to service and lower its already very high debt.

The Greek Statistics Agency recently released detailed figures on the 2014Q2 GDP developments. It is rather evident that GDP in volume terms is close to returning to positive growth figures although deflation is still hovering around -2.5%. Looking into the expenditure breakdown leads to a couple of conclusions:

Greek GDP 2014Q2

Consumption expenditure has already stabilized around zero during the first half of 2014, a significant improvement from the almost double-digit drop of 2012. This stabilization is visible in both government and private consumption with fiscal consolidation being a much lesser drag on the economy during the last few quarters. The rather obvious question though is how sustainable can this improvement be given the current high unemployment rates and decreasing disposable incomes for most of the population. According to Ameco both aggregate disposable income and nominal compensation per employee is destined to fall by around 2.5% during 2014. Consequently, current improvements in private consumption might just be the result of postponed (durable goods) expenditures with a mostly one-off effect.

Fixed capital formation also shows significant signs of stabilization. Compared to -15% in 2013Q4, 2014Q2 figures came at only -0.8%. Exports and imports of goods and services were quite positive although the net result was almost negative during the second quarter with net exports contributing only €76mn in real terms.

Greek GFC Exports Imports 2014Q2

Looking in the detailed accounts for capital formation and trade in goods and services can help reach some important conclusions:

Dwellings construction continues to show extremely high losses. Capital formation was improved mainly by transport equipment (which increased 25% during the first half of the year), machinery as well as ‘Other Construction’. The large swing in machinery investment is very good news while ‘Other Construction’ is probably related to the restart of major road developments in parts of Greece. Nevertheless, in volume terms the largest contribution came from ‘Transport Equipment’ with an increase of over €250mn in every quarter of 2014. It is most probably due to the large increase in ship acquisitions during 2014H1 with a significant increase in imports (ship imports were almost €1.1bn higher according to BoG) with a rather low net contribution to GDP.

In the trade front, the improvement in exports is accounted for mainly by services with exports of goods actually registering negative performance during Q2. Considering the large increase in imports of both goods and services the overall impact on GDP is rather low and down to €100-200mn per quarter (compared to over €1bn/quarter during the previous years).

Overall, it looks like the Greek economy is on its way to achieving positive growth rates in the coming quarters. Still, dwellings will be a drag on capital formation while both investment and consumption seems to be targeted mainly on imported goods which negates the improvements in services exports. Moreover, goods exports still show large weakness and inability to translate the significant drops in ULCs to increased sales volumes abroad. Given that the banking sector is still quite fragile and not eager to provide credit and the state of most household balance sheets, the recovery will most probably be weak and not allow any noticeable improvement in employment and compensation.

Thus, a scenario of a low growth trap for the Greek economy is quite probable given the above dynamics. This has already been outlined by the IMF in a series of papers on the periphery current account positions ([1] and [2])

Following the tradition of decomposing accounting identities, an exercise that can still provide some very interesting results, this post will decompose the Unit Labor Costs (ULC) paths for Greece and Spain during the past couple of decades. According to Ameco ULC can be decomposed as:

ULC = Compensation per employee / Real GDP per person or ULC = (Compensation of employees / Employees) / (Real GDP / Employment)


Looking at the first relationship we can observe that since 2009 ULCs were driven mainly by compensation per employee which dropped significantly while real GDP per person exhibited much smaller contributions:

Greece ULC

A much closer look at each factor which drives ULCs can provide important conclusions:

Greece Compensation per employee

Compensation per employee shows a large drop since 2009 which was driven by the fall in total compensation. Although employment was much lower each year, total compensation fell even more lowering the wage costs for each remaining employee.

Greece Real GDP per person

Real GDP per person shows a rather ‘cyclical’ behavior. Between 2008 and 2012 it fell mainly due to the general Greek recession and the drop in real GDP which was not compensated by a corresponding fall in employment (there was some form of labor hoarding). Nevertheless, during 2012 and 2013 the fall in employment was much larger which resulted into a marginal increase in real GDP per person (which can be regarded as ‘productivity per person’) and contributed to the decrease of ULCs.

Overall the ULC decrease since 2009 was accounted mainly by the large fall in employment (which has a positive impact on productivity) and the even larger drop in compensation. These forces probably fed on each other with the fall in employment and compensation eating real GDP and not allowing real GDP per person to contribute significantly to an improvement (fall) in ULCs.


The Spanish case seems to display rather different dynamics compared to Greece:

Spain ULC

Instead of compensation per employee (which only had marginal contributions), labor productivity was the main driver of ULCs in Spain after 2009.

Spain Compensation per employeeAlthough since 2009 compensation and employment show large changes, these forces managed to counteract each other pointing to the fact that compensation of current employers did not change significantly and only drops in employment lead to corresponding falls in compensation.

Spain Real GDP per personReal GDP per person developments show that productivity was improved mainly through the large fall of employment which was not accompanied by a corresponding drop in real GDP. Although Spain displays unemployment figures similar to Greece the drop in real GDP was only 7% between 2008 and 2013 compared to 24% for Greece.

In general it seems that the ULC improvement in Spain was accomplished on the back of the unemployed while in Greece employed persons also contributed significantly through a large fall of their compensation. This difference can probably also explain (combined with the state of the Greek banking sector) why the fall in Greek GDP was much steeper than Spain’s.

* I am also uploading the relevant excel file which might prove useful for any similar decomposition for other periphery countries such as Italy and Portugal.

I recently came across a very interesting and thorough research paper from the IMF on the Zimbabwe hyper-inflation episode. What was quite clear from the document was that the high inflation of the period was the result of very high quasi-fiscal losses by the country’s central bank and not of runaway fiscal deficits. Probably the most important factor was interest costs of open market operations while also subsidies (mainly in the form of free forex to public enterprises) and foreign losses (due to a mismatch between foreign assets and liabilities) played a significant role. The annual flows were enormous, close to 60-80% of GDP which explains why annual inflation quickly reached levels of 600% and 1200%.

The rest of the post contains the relevant parts (and figures) of the paper that explain the hyper-inflation process more clearly:

While central bank losses in most countries have not exceeded 10 percent of GDP, Zimbabwe’s flow of realized central bank quasi-fiscal losses are estimated to have amounted to 75 percent of GDP in 2006. Losses have arisen from a range of activities including monetary operations to mop up liquidity; subsidized credit; foreign exchange losses through subsidized exchange rates for selected government purchases and multiple currency practices; and financial sector restructuring. Quasi-fiscal losses of this sort, rather than conventional monetary or fiscal laxity, have been the mainly responsible for the surge in money supply in Zimbabwe during 2005-7. The power to create money to finance losses quickly run into conflict with any recognized monetary policy objective with official inflation reaching 1,594 percent as of January 2007.

The following are noteworthy features of the balance sheet:

  • Nonearning assets are substantial; they amounted to 83 percent of total assets as of October 31, 2006.
  • RBZ securities, introduced as a sterilization tool at the beginning of 2004, became the largest liability by the end of that year, overtaking currency in circulation, previously the largest liability.
  • Starting in 2004 sharp increases in statutory reserves to finance the concessional credit to favored sectors, such as agriculture, led to a steep climb in required reserves, which are not remunerated.
  • Foreign liabilities, largely represented by credits from international financial institutions, have for some time been much larger than foreign assets. In this situation any currency depreciation produces losses.
  • The smallest liability is capital and reserves which has been kept constant at a very low level. A central bank increases its capital through seigniorage and reduces it by operating expenses and distribution of profits to the government. Figure 1 shows the evolution of seigniorage since 2001 in Zimbabwe. For the RBZ, seigniorage has fallen from over 5 percent of GDP in 2001 to about 0.1 percent of GDP in 2005 because, given very high rates of inflation, real base money has declined drastically in relation to nominal GDP and the RBZ has invested in assets, including QFAs, with large negative real interest rates. Only the failure to apply a recognized accounting framework keeps the RBZ capital and reserve from being negative.

Most of the RBZ’s quasi-fiscal losses were incurred in connection with activities that go far beyond conventional central banking functions. There were four main sources of the losses:

  • Subsidies in terms of free foreign exchange to public enterprises; price supports to exporters to partially compensate them for an overvalued exchange rate; and subsidized credit to troubled banks, farmers, and public enterprises.
  • Realized exchange losses stemming mainly from the purchase of foreign exchange from exporters and the public at higher prices than sales of foreign exchange to importers (mainly government and public enterprises); and recognition of previously unrealized exchange losses upon repayment of external debt, including to the Fund.
  • Interest payments associated with open market operations to mop up liquidity.
  • Unrealized exchange losses reflecting official devaluations because foreign liabilities exceeded foreign assets.

To contain money growth, the RBZ sterilized the impact of the direct injection of liquidity into the economy that the QFAs represented. In January 2004 the RBZ started to issue its own bills at effective interest rates of over 900 percent per annum. These RBZ Financial treasury bills were naturally attractive to the market but too costly to the RBZ, so they were soon abandoned and replaced by Open Market Operation (OMO) bills, introduced in May 2004, and Special RBZ bills, introduced in June 2004. The OMO bills had the same interest rates as the existing government treasury bills but the accounting for them was clearly separated from holdings of government treasury bills since the interest cost was charged to the RBZ. The issuance of these bills escalated beginning in September 2004 after the large-scale financial or “liquidity” support to troubled commercial banks. The Special RBZ bills were introduced to absorb excess bank liquidity at the end of the day. They had a maturity of two years and carried an interest rate that was sharply negative in real terms. The long maturities deferred the monetizing consequences of the high nominal interest rates.

The RBZ has accumulated substantial domestic interest-bearing liabilities through open market operations to absorb liquidity. The vicious circle of rising losses and rising remunerated liabilities has resulted in inflation and increases in the interest rates of the bills, further accelerating the interest cost for the central bank. By 2005 the net interest cost of sterilization equaled 40 percent of GDP. In 2006 the interest cost grew further but its liquidity impact was partly alleviated as the authorities lengthened the maturity of treasury bills, thus deferring interest payments.


table 1.central bank balance sheet

table 2.contributions to changes in reserve money

figure 4.adjusted government financing requirementfigure 3.Reserve money growth and inflation

Recently we had to write a large essay on the bank loan pricing procedure of the banking system under imperfect competition (for the banking course we ‘re currently attending). The end result was quite interesting and we have posted it as a Working Paper on ssrn. The paper is heavily based on the relevant work of Ruthenberg and Landskroner (2008) which has been extended with more realistic assumptions such as a non-zero Recovery Rate on loans and a securities portfolio to match capital and reserves.

The paper first describes a few stylized facts of modern banking with sections on modern monetary policy implementation and the actual interbank market (where monetary policy acts as an interest rate cap on ‘competitive spreads’). This is followed by a general (stochastic) model for the term and credit risk premium added on loan rates.

The model assumes that a bank finances a new loan by borrowing in the interbank market under Cournot oligopoly and Basel capital requirements. We only examine the case of a properly functioning interbank market with very low excess reserves and liquidity hoarding. The end result is the following equation:

bank loan pricing under imperfect competition

where RL is the loan rate, Ps the borrower’s probability of survival, Rf the risk-free rate, θ the spread in the interbank market over the risk-free rate, k cost of equity (RoE), H the Herfindhal-Hirschman index of concentration in the loan market, ε the elasticity of demand in terms of RL for new loans by bank customers and φ is the risk premium per borrower which is equal to:

φ = PD x LGD

(PD: Probability of default or 1-Ps and LGD: Loss-Given-Default).

Based on the above equation, it is clear that the main drivers of the loan rate are the  Probability of Default and the risk-free rate (these two factors account for over 90% of the loan rate). PD enters the equation both as a ‘compounding factor’ and in the risk premium φ. The end result is that for PD higher than 5% the compounding factor increases substantially and a loan becomes very expensive. The obvious conclusion is that the PD is used as a ‘first line of defence’ by banks in order to determine if a loan will be offered in the first place and the amount made available (especially as a percentage of available collateral, proxied by the Loan-to-Value ratio).

This explains why credit crises and large recessions lead to a ‘credit crunch’ since a large enough PD will result in loan rejections and not in a (very large) increase of the offered loan rate. Updates to a borrower’s PD /LGD (after a loan has been extended) are usually large enough that a bank cannot include them in the loan rate risk premium (without pushing a borrower to an early default) and are incorporated in Loan-Loss provisions.

Under perfect competition (H close to zero) banks are not able to earn a premium over the risk-free rate (apart from the borrower risk premium) and only get their required RoE. If market power exists banks are capable of gaining an above normal profit which is rather marginal for H lower than 0.1 (usually lower than 10% of the risk-free rate). For large enough HHI the premium becomes quite significant.

Both the RoE and Basel capital requirements play a role in the loan rate offered although that depends mainly on the loan’s risk weight.

The model specification was followed by a simple application in the Greek banking system during the Euro era (and before the 2007-2008 credit crisis). Although we did not use any econometric techniques in this essay, the model performed quite well with an R² of 0.93. Given the current HHI of 0.214 it seems that banks have gained (through M & As) significant market power and are able to impose a premium of close to 30% over the risk-free rate in their quoted loan rates (based on the model’s projections).

Our next step is to use the model in order to look into the Greek banking system with more detail and estimate an econometric specification. Still, the basic stylized facts that can be drawn are quite significant and can explain why credit crises lead to a credit crunch and how higher probabilities of default eat into bank profits through loan-loss provisions. Obviously we would appreciate any comments on the paper and the outlined model.


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