This will be a very short post on the way the US used to not allow extreme income inequality during the Golden Age of Capitalism.

The idea was quite simple: Going into WWII, income tax rates on the highest bracket  reached levels around 90% which meant that wage earners had little incentives to increase their annual income above the highest bracket. At the same time, that bracket was set at 100 times the lowest bracket:

fredgraph(2)

The latter was at least 1.5 times personal income per capita although it reached even close to being 3 times larger. The very high level of the top income tax rate remained roughly constant for two decades (40’s and 50’s).

fredgraph

That meant that the highest income allowed was somewhere between 150 and 280 times that of average personal income depending on the specific year. As a result, extreme inequality was reduced through tax incentives. This is in contrast to today when CEO pay hovers around 300 times that of the typical worker:

CEO to typical worker pay

It is quite evident that fiscal (and more specifically tax) policy can be used as a tool for a society to place specific limits on the level of extreme inequality allowed within it.

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I ‘ve been reading Robert Gordon’s interesting book concerning economic growth and its drivers during the last 150 years. Gordon’s main thesis is that not all inventions and technological advances are created equal or have the same impact. The major technological breakthroughs which had a significant effect on productivity (and thus on economic growth) took place mostly more than a century ago and involved creating the networks we still use. Networks of water, sewer, electricity, roads, telecommunication, transport. Networks which were introduced only once, had a strong effect on growth for decades and are now present without having any more major impact on productivity.

One can agree or disagree with his (pessimistic) view of the future, yet what I think everyone will agree on is his powerful and extensive description of how life was just 150 years and the way in which these inventions changed everyday life and how everyone used their time.

In my view, there is a clear and strong interaction between social norms, property/voting rights and technological advancement. As long as most peasants (who accounted for the bulk of the population) lived at the subsistence level on mostly self-grown food and self-made clothing, property rights were limited and even forms of slavery were present for centuries (mostly in the form of serfdom in Europe). Once technological advancement changed and enlarged the consumption basket as well as created a demand for factory workers (and an «exit» option for peasants in the country fields), labor services were remunerated in monetary terms and property started to become widespread. The introduction of large massive armies (as opposed to forms of professional army service) also accelerated the abolition of serfdom since nations needed free men to fight their battles.

As a result, while only a few centuries ago most people in the countryside had no property, faced serious restrictions in their movement (even in their most basic personal freedoms in the case of serfs), did not have voting rights and lived in the subsistence level, the 19th (and especially the 20th) century found them enjoying an ever expanding consumption basket, holding property and claiming an expanded array of rights. The Industrial Revolution and technological advancement was the main driving force for these changes.

In particular, not too long ago, even the simplest things that today we take for granted were extremely cumbersome tasks. Most families lived in rural farm houses, with no electricity, no central water and sewer systems meaning that all water (and waste) had to be carried by hand. Light was provided by candles, half the family budget was spent on food while most of the clothing (especially women’s clothing) was made at home by mothers and daughters.

In 1925, wives reported working an average of 6 hours per day for seven days on household tasks, which translates to more than a full-time 5 day/week modern job. Moreover, infant mortality was close to 20% while roughly one in four infants died before reaching the age of 5.

The high children mortality rate, coupled with the needs for household and manual farm work meant that the birth rate was exceptionally high. White women laid birth to an average of 4.6 children while black women to 7.7. Obviously that meant that the wife was usually busy raising a new born child, apart from taking care of the household on a full-time basis.

This all changed in a couple of decades. Clean running water and a sewer system led to a dramatic reduction of deaths caused by infectious diseases (37% of all deaths in 1900) and a drop of infant mortality rates from 20% to 5% in half a century:

ScreenHunter_1180 Oct. 23 23.16

By 1950, the introduction and diffusion of modern conveniences and appliances had reached a critical point. At the same time, clothing was readily available in stores and did not need to be home-made. All this, led to a significant drop of the amount of work required to maintain a household and a large fall in fertility rates. In 1940, while the US was entering WWII only 65% of consumer spending was on categories that existed in 1869, with the share of services in the consumption basket doubling from 24% to 43% (while food decreased by a comparable amount from 44% to 22%).

ScreenHunter_1182 Oct. 23 23.22ScreenHunter_1181 Oct. 23 23.22

WWII full employment along with the millions of men occupied on the front line fighting the enemy, led to the women massively entering into the labor force for the first time. During the following decades, changing social norms meant that women would pursue academic education and a career in all occupations, increasing their participation rate from 35% in 1950 to 50% by 1980 (and 60% in 2000).

Yet what is quite interesting is the fact that, until roughly the end of the 19th century, necessity was the main driving factor for women non-participation in the labor force. Keeping the household was literally a full-time job, while high fertility rates meant that there was almost always an infant present in the family requiring constant attention. One had to choose between working manually in the agricultural fields or taking care of the household. There was no central heating, no running water, no refrigerator, no sewer at the house and every duty had to be done manually, taking hours to complete tasks that take only minutes today.

Obviously this division of labor was also the result of long-standing social norms as well as a function of the hardship associated with manual agricultural work. No work by women with a monetary remuneration meant limited property rights and subordination with regard to men.

Yet necessity and (the absence of) technology played a decisive role in this division. Once advancements in technology dropped the amount of time required for household maintenance coupled with lower infant mortality and a lower requirement of a large number of working hands for agricultural manual work, women’s time was freed on a extraordinary scale. Women started entering the labor force, first as manual factory workers (in WWII) and afterwards in all sorts professions once college education was made available to them (a task that required extensive fighting from their part).

Technology did not only change the consumption basket, create new professions and free human time for more leisure but it also had profound implications on long-established social norms, the division of labor within households and personal property rights, things that had remained quite stable for centuries. Today’s equality between men and women not only rests on decades-long women’s struggles but also on inventions and advances that completely changed the landscape of modern households.

In this post I will do a simple enough exercise: Look into the evolution of the Greek government primary current balance. This is just the balance of current income minus current expenditure excluding interest. Thus it excludes both the investment budget as well as interest payments on government debt.

Although public investment does impact national income (and is added in GDP in the first place), the current primary balance can act as a crude estimate of the «weight» of government on the economic process. Especially its change from one year to the other indicates the expansionary or contractionary stance of fiscal policy.

Greek Government Primary Current Balance 1995 - 2019 %GDP

The general pattern is quite clear. The primary current balance was in surplus in the late 1990s and reached a peak of 7.5% GDP during 2000. Afterwards, the fiscal stance relaxed substantially with a drop of 6.5% GDP in the 2001 – 2007 period to reach only 1% in the final year. The Great Recession took its toll with the balance dropping almost 6% of GDP during 2008-9 to a negative close to 5% GDP.

Then came austerity: The balance grew 8.6% of GDP in the 2010-13 period while it relaxed substantially during 2014 with a drop of 1.1% compared to an increase of 3% in 2013. This can most clearly explain the return to growth in 2014 since the economy experienced a change in the fiscal impulse of 4% GDP.

The effects of the 3rd economic adjustment program are also quite visible with the balance increasing 4.2% in the 2015-18 period which explains why these years had a sense of strong austerity despite a return to economic growth.

The 2019 current primary balance is expected to reach 7% of GDP, roughly similar to the 1999 balance. Yet 1999 registered 6% GDP private credit flow with a further increase to 10% during 2000 (which increased and persisted until 2008) while 2017 closed with a 1% fall in that flow. It is thus clear that the underlying dynamics are quite different and such a large surplus will definitely act as a serious drag on growth.

It is also interesting to take a closer look on the evolution of current revenue and primary expenditure during this time:

Greek Government Primary Revenue & Expenditure excluding interest 1995 - 2019 %GDP

Current revenue starts with a steady increase during 1996 – 2000 (close to 5% GDP total increase), remains stable for a couple of years and then makes a step drop of 1.5% GDP in 2003 to 37.5% around which it hovers until 2009. Since then it starts an uphill march to around 45% in 2013, a change of 7.5% GDP. Although it grew more than 3% GDP in 2014 to 48.4%, this level appears quite unstable since current revenue is projected to return to 45.5% during 2019. Assuming that 45% is the «new equilibrium», future current primary balance will depend heavily on the primary current expenditure trajectory.

The latter appears to grow steadily from 30% in 1998 to 39% a decade later. Even the large austerity package from 2010 onward was not able to break that limit, mostly because of the large fall in GDP which made the denominator fall substantially along with nominal expenditures. The 2013-17 average was 41.7% which dropped significantly during 2018 to 40% GDP and is projected to reach 38.5% in 2019, a cumulative fall of 3% GDP in two years. Whether such a fall can be sustained in the long-run is a question that will be difficult to answer.

If primary current expenditure returns to the 41.5% average, the primary current balance will drop to half its 2019 projection to 3.5% GDP. Since that is the current primary balance target until 2022 this implies that the investment budget will need to be balanced. Given that is close to impossible, the stability of the 3.5% primary surplus target will depend on the Greek government achieving a primary current expenditure level of close to 38.5% GDP.

Actually (Gross Fixed Capital Formation – Capital Transfers Received) has a mean value of -2.4% GDP and a standard deviation of 1.42% for the period 1995 – 2017. If the values were drawn from a normal distribution the probability of a non-negative balance would be around 4%.

Since my last post was mainly focused on the issue of inequality I would like to continue on this road and introduce a concept which I will call «Economic Reproduction Frontier» (ERF).

The main idea is rather simple: Take the threshold of the major brackets of income distribution as a share of average per capita income and examine their course across time. I will be using data from the World Inequality Database on a per adult (equal split) unit for this exercise.

One can think of average per capita income as a crude pointer for both the consumption basket (or frontier) in a given country at a given time as well as the cost of human capital development for an individual. An income say 20% of average per capita income will correspond to a significantly different (and highly constrained) consumption basket and place large obstacles on the opportunities and capabilities of an individual increasing and expanding his human capital. Since most economic output is mass consumed and production is highly connected to human capital, the income available to a large proportion of the population will ultimately act as a constraint on economic growth. Especially if individual income as a percentage of average per capita income falls on a permanent basis.

To do this I calculate the share of threshold income for various income brackets in the US during the period 1966 – 2014 (due to data availability). Below are two graphs, one for P20/P30 percentiles and one for P40/P50. Linear trendlines along with the exact equation and R² for each percentile are also presented.

P20 P30 Percentile threshold % GDP 1966 - 2014P40 P50 Percentile threshold % GDP 1966 - 2014

It is striking how all threshold shares are on a permanent downward trajectory, as well as the very strong R² for all lines (over 0.93 in all cases with stronger results in the P40 and P50 cases). The relative stability of the threshold shares up until the turning point of 1980 is also evident. The regression coefficient points to a fall of roughly 50bp annually for the P40 and P50 brackets which means that each bracket losses almost 5% share of per capita GDP every decade.

P20 and P30 brackets start below 50% and fall to 20% and 30% by 2014. What is striking is that the P40 brackets falls to roughly 40% by 2014 starting from 63% (the P50 bracket falls to 56% of average income starting from 77%). This suggests that at least 40% of the population  cannot maintain a middle-class consumption basket and human capital without going into debt since it is severely income constrained. Even P60 and P70 brackets show a clear drop in the given period (from 90% to 73% for P60 and from 106% to 94% for P70) suggesting an extremely strong middle class hollowing out in recent decades, at least for the p30p70 bracket. Only the top-10% threshold share shows an increase in the given period from 170% to 184% while even the P80 threshold share lost 2.5%:

Change in threshold share of average income 1966 - 2014

Although I am sure this simple exercise will have methodological issues it still suggests a strong loss of income resources for a major part of the general population with serious consequences on long-term growth. If 40% of the population are not able to finance their human capital development through their income nor afford a basic middle-class consumption basket without going into debt, this suggests that long-term growth will be affected in one way or another.

Modern capitalist economies are based on large scale production of mass consumption goods and on using a highly educated workforce in a large part of the production process and sectors.  Linear extrapolation suggests that the P50 bracket will fall to 50% of per capita income by 2026 (while P40 will be 35% and P30 24%) making the above process highly constrained. We might be nearing an inflection point for economic growth due to growing inequality.

Jordan Peterson is a clinical psychologist who’s earned his fair of publicity in recent years, especially through videos of his lectures and speeches on Youtube. Personally, I have found the views expressed on his videos quite helpful and inspiring while his lectures contain a ton of useful information and methodology on how to address life (I especially recommend the Biblical Series).

On the political front, it is clear the Dr. Peterson leans to the right and has been highly critical of far-left and Marxist views. Nevertheless, he makes a solid exposition for the necessity for both broad political parties with the right focusing on personal effort and values, order (which allows people to cooperate and plan for the future) and hierarchy of competence (implying equality of opportunity but not of outcomes). The left on the other hand tends to focus on classes instead of individuals, inequality (which is ultimately a destabilizing force) and change which attempts to balance out the fact that the economic games tends to work like «Monopoly» with most people stacking up at zero and a significant few acquiring almost all the wealth.

In a recent video he analyzes a film by «Future Majority», a team of Democrats trying to bring about change in the political landscape in favor of the working class. Dr. Peterson is especially critical of the main part of  the video which describes the surge in inequality during the last decades. In his own words, he considers this to be the weakest part of the film and that the inclusion was an error.

In my view, this is actually the stronger and most important part of the film and what distinguishes the creators politically. The part in question describes how incomes (for the lower and middle class) have stagnated for decades, how CEO compensation has skyrocketed when compared to worker wages and how almost all of the recovery since the Great Recession went to the top-0.1%.

What I especially like about this part is that it mainly analyzes the inequality problem in relative (rather than in absolute) terms and across time. CEO compensation is compared to their own workers wages and working class income to where it was decades ago. The important part is that the data are absolutely real.

The ratio of CEO to worker compensation has actually increased ten-fold in recent decades:

CEO to worker compensation ratio 1965 - 2014

while the bottom-90% has not seen any actual increase in real income since 1980!

US Bottom-90% real average income (base 1950)

Dr. Peterson basically states (and assumes) that income is mostly earned honestly through hard work with only a small minority being the result of exploitation or counter-productive endeavors. So it seems that CEOs earning 300 times average compensation (instead 30 times during 1980) is the result of exceptionally high productivity and work while the bottom-90% is just not being any more productive for almost 40 years now.

What is missing from the analysis is the fact that work/income outcomes are not only the result of personal choices and work but also of class negotiation power. Worker power will depend on the state of the business cycle (and the level of unemployment), union density and power, outsourcing threats, import penetration (which embody foreign labor acting competitively to domestic labor), the level of sectoral competition (which determines to what point a company will actually act as a monopsony) and a host of other factors.

Since 1980 unemployment has mostly been above the «natural level of unemployment» with only the second half of the 90s accounting for an actual high-pressure economy:

fredgraph

union density fell from 27% in 1973 to 19% in 1986 and 11% in 2011 while the real minimum wage (which mostly determines the floor for the bottom-20% income) has never increased above 85% of its 1980 level:

fredgraph(1)

Even increasing educational attainment has not really helped workers since only post-bachelor degree college education has posted steady increases in weekly earnings. Apart from an increase during the second half of the 90’s (when the economy was allowed to run hot) the rest of the college level education earnings have been flat all the while student loans outstanding have climbed to a total of 1.5tr $.

Real Weekly Earnings by Educational Attainment, 1963 = 100, 1963–2012

In my personal view, Dr. Peterson has allowed his own political views to cloud his analysis of income inequality. It seems that he clings to a stereotype where any actual exposition using hard data of the problem is a manifestation of resentment towards the hard-working wealthy instead of the first step of trying to determine and solve the problem. In so doing and especially by insisting that the film should not have included a section on inequality in the first place he appears to make the case that thinking and analyzing inequality has no value and wealth and income are only the result of personal choices, competence and hard work. Given that the Democrats voter base is within the bottom-90% working class it seems quite strange to insist on not really focusing on income inequality at a time when the working class has not been able to see its real income rise above 1980 levels.

I recently wrote a post on the ECB waiver (for Greek government collateral) and what its expiration on 20 August would entail. Since BoG released its August balance sheet it seems that this question has been answered.

BoG August 2018 balance sheet

As is evident there was no significant change in the relevant amounts of either regular refinancing operations or ELA financing during August apart from a very small fall of €350mn. What actually changed was the total amount of collateral posted by Greek banks which fell by €5.33bn. Since regular financing operations total amount remained constant it appears that collateral quality was enhanced given that the relevant haircut was reduced from 30% to 15%.

It is obviously interesting to know how Greek banks managed such a task. Unfortunately, bank balance sheets data from BoG is not available for August so we will probably need to wait a bit more to find out.

One last interesting fact was the large increase in government deposits of close to €14bn which coincided with an equal drop in Target2 liabilities. This was due to the disbursement of the last round of funds towards the Greek government (by the ESM) which was used to increase its cash buffer. As a result, BoG now only «owes» €26.50bn to the Eurosystem while simultaneously holding €64bn in securities (mostly as a result of the QE program).

According to recent Mario Draghi comments, the waiver allowing Greek government securities to be accepted as collateral in regular Eurosystem refinancing operations will expire along with the end of the Greek adjustment program on August 20 2018.

Based on the above I would like to take a look at what such a move will mean for Greek banks access to ECB (and ELA) lending. I will be using data available in monthly Bank of Greece balance sheet statements as well as Greek bank consolidated balance sheets (available from BoG).

Overall, Greek banks have significantly lowered their refinancing needs with a total balance of €9bn in MRO/LTRO and €7.3bn in Other Claims (ELA). Compared to the end of 2017 regular refinancing operations are down €3bn while Other Claims dropped a more impressive €14.3bn amount. If one compares the figures to a couple of years ago, the amounts are much more remarkable. MRO/LTROs are down almost €24bn while Other Claims decreased a staggering €47bn.

This drop was driven both by large decreases in liabilities towards the Eurosystem (Target2 and extra banknotes) as well as the ECB QE program. The first item is down €23bn compared to 2017 and €57bn during the last two years while ‘Securities held for monetary purposes’ increased by €31bn since June 2016.

Unfortunately it seems that Greek banks also lowered Debt Securities of Other Euro countries (EFSF notes?) by a similar amount of €33,8bn during the last two years. As a result, they now hold only €5.8bn in securities of that category while they also carry €10.6bn in Greek government securities on their balance sheet.

Compared to the total of €9bn in regular refinancing operations outstanding, Greek banks do not seem to hold enough non-Greek government securities to post as collateral. Moreover, they hold €186.7bn in credit claims (before provisions). According to BoG NPL statistics, almost 50% of credit claims are non-performing which means that much less than €100bn credit claims can be used as collateral in some form or another (with significant haircuts given current Greek bank loans quality). Actually, BoG states that Greek banks have already posted €54bn in assets as collateral on ELA operations (and another €12.7bn in regular operations) which suggests that not much is left unusable.

BoG Balance Sheet 2018H1

Consequently, it seems quite probable that at least some part of regular refinancing operations will have to be moved to ELA after the program expiration due to limited availability of high-quality collateral. The amount of financing allowed for ELA (as set by the Eurosystem and announced regularly from BoG) will be an early hint on that. Other developments such as the QE program or a return of deposits to the Greek banking system will act at the opposite direction. Unfortunately, the June 2018 BoG balance sheet statement states that less than €1bn in extra banknotes is outstanding which suggests that most of the ‘cash under the mattress’ has already returned and no major positive developments can be further expected on that front.

Recently, the IMF published its long-awaited Article IV consultation on Greece which includes an assessment of the latest developments of the Greek economy as well as its own DSA on Greek debt (which rests on significantly different assumptions than the ESM DSA).

The IMF starts with a stark chart showing how the Greek tragedy compares to the US Great Depression, the 1997 Asian crisis as well as the Eurozone crisis:

IMF Greece Crisis US Great Depression Asian Crisis

The depth of the Depression is quite similar to the US case while Greece has managed to «maintain» a 25% lower GDP for a period of 5 years.In contrast, even the US managed to return to its pre-crisis GDP level 7 years after the start of the Great Depression. This is a clear indication of the way the Greek case was tragically mismanaged by the European countries and the IMF whose priority was avoiding a principal haircut of official loans rather than a quick return of Greece to growth.

The IMF projects that Greece will grow moderately during the 2018-2022 5-year period which also coincides with the period during which the country will have to register primary surpluses of at least 3.5% GDP. Most of the growth is projected to come from fixed investment with private consumption contributing 0.5% annually and a neutral contribution from the foreign balance:

IMF - Greece 2018 - 2022 main macroeconomic projections

As I have outlined in the past, such a growth path rests on the assumption that Greek households will continue dis-saving at the order of €9bn annually even while they have already depleted their financial assets by €34bn in the 2011-2017 period. This is based on the fact that, given a neutral external balance and a 3.5% primary government surplus, sectoral balances indicate that the private sector will need to maintain a negative net asset position in order for the other sectors to achieve these balances.

Projecting nearly 1% annual increase in private consumption during the 2020 – 2023 period without any countervailing factor (such as a positive external balance or a significant relaxation in the fiscal stance) seems quite optimistic. An annual negative balance of just €8bn means that households will have to consume another €40bn of their financial assets in the 2018-2022 period. Only employment growth (which will increase disposable income of the household sector) will act as a countervailing force. It’s a pity that the IMF does not use sectoral balances to check whether assumptions for private consumption and government surpluses can be realistic in the long-run.

The other important part of the IMF document is obviously the Greek debt DSA as well as its assessment of the possibility of maintaining large primary surpluses for many decades.

In its baseline scenario the IMF staff agrees with the ESM that debt-to-GDP trends down and Gross Financing Needs (GFN) remain below 15% of GDP in the medium term.

Nevertheless, the IMF argues that Greece will be unable to maintain a primary surplus larger than 1.5% of GDP after 2022 while its long-run economic growth will hover around 1% in start difference with the ESM which is projecting a primary surplus of 2.2%. As a result, the IMF is much more pessimistic for the long-run, projecting that Greek debt will become unsustainable after 2040:

IMF - Article IV 2018 DSA

What is also quite interesting is how even medium-term sustainability rests on assumptions of large primary surpluses and growth during the 2018 – 2022. A small 2 year recession during 2019-22 (with a total of -3% GDP growth) coupled with a small primary deficit for just one year will immediately push debt-to-GDP close to 200% and GFN to 20%.

IMF - Adverse Scenario 2019 - 2022 Greek Debt

Lastly, the IMF staff try to justify analytically why Greece will be unable to maintain high primary surpluses and economic growth in the following years. While the specific arguments have been put forth many times in the past, it is interesting to repeat them here once more (in IMF exact wording):

  • Ceteris paribus, aging would imply an average yearly decline of 1.1 percentage points in Greece’s labor force during the next four decades.
  • Total factor productivity (TFP) growth over the last 47 years averaged just ¼ percent annually, by far the lowest in the Euro Area. Assuming this historical average TFP growth rate going forward, labor productivity (output per worker) would grow only at about 0.4 percent in the steady state (the rate of TFP growth adjusted for the labor share in output).
  • Combining the historical growth in output per worker of 0.4 percent with expected growth in the number of workers of -1.1 percent would imply long-term annual growth of -0.7 percent.
  • While studies have documented an impact on output levels of 3 to 13 percent over the initial decade, the impact of reforms on growth tends to fizzle out afterwards.
  • Lifting long-term growth from its baseline of –0.7 percent to 1 percent requires reforms to add 1.7 percentage points to growth per year for the next decades. The OECD (2016) estimates that full implementation of a broad menu of structural reforms could raise Greece’s output by about 7.8 percent over a 10-year horizon, which translates into an increase in annual growth of some 0.8 percentage points for about a decade. Bourles et al. (2013) estimate this gain to be slightly higher, at about 0.9 percentage points per year, while Daude (2016) finds that reforms focused on product markets and improving the business environment in Greece could boost growth by about 1.3 percentage points per year for a decade.
  • Implicitly, the 1 percent growth projection presumes that Greece would manage to increase labor force participation to levels that exceed the Euro Area average (to offset the significant projected decline in Greece’s working age population) and that would generate TFP growth rates permanently far above Greece’s historical average.
  • Historically, Greece has been unable to sustain primary surpluses for prolonged periods. During 1945–2015, the average primary balance in Greece is a deficit of about 3 percent of GDP, although a brief period of near-zero primary balance took place at the time of Greece’s EU accession. The high water-mark for Greece was a primary surplus exceeding 1 percent of GDP during eight consecutive years (1994–2001).
  • In a sample covering 90 countries during the period 1945–2015, there have been only 13 cases where a primary fiscal surplus above 1.5 percent of GDP could be reached and maintained for a period of ten or more consecutive years.
  • Economic conditions matter. Among EU countries, before entering a period of high average primary balances, countries tend to have strong real GDP growth (2.7 percent) and modestly high inflation (4 percent). They also have moderate unemployment (10 percent) and low net foreign debt (24 percent of GDP), conditions that do not conform to those now applying in Greece. Moreover, during the high primary balance periods, growth has been rapid (about 3.4 percent), inflation slightly elevated (3 percent), and unemployment contained (at about 7.2 percent). This suggests that sustained periods of high primary surpluses are driven by strong economic growth rather than by sizeable fiscal consolidation.
  • Unemployment weighs on the budget through higher social expenditures—such as for unemployment benefits and social safety nets—as well as lower income-related revenue. Greece’s unemployment rate is exceptionally high—only 10 countries have had unemployment higher than 20 percent in the postwar period.Within the above sample, the average primary balance corresponding to countries suffering double-digit unemployment rates is about zero percent of GDP (i.e. balance). For double digit unemployment lasting for 10 years or longer, the average primary balance is about -½ percent of GDP. With long-term unemployment likely to remain high for some time, pressures on social assistance spending in Greece—such as the guaranteed minimum income—are likely to mount.

Overall, the IMF tries its best to provide Europeans with political cover for the medium-term outlook on the Greek front while still presenting a scientific case for why the targets set in the Greek program are highly unrealistic and will not be achieved. In my view it should pay closer attention to sectoral balances which would make it even easier to argue why large primary surpluses cannot be maintained in a country with a structurally negative external balance.

It’s been a while since I last looked into Bank of Greece balance sheet figures and given that the Greek central bank has released its April 2018 numbers I decided to take another quick look into them:

BoG 2018Q1 balance sheet

A few things stand out:

  1. Other claims (which is code for ELA) is down more than €11bn to a total close to €10bn. It is clear that Greek banks are moving closer to eliminating their need for non-standard financing, something which could happen during 2018. Obviously this also means that ELA income for BoG (and by extension for the Greek Treasury) will also show a significant decline (BoG should earn a bit more than €10mn/month as ELA profits by now).
  2. The big drop in ELA was mainly driven by a reduction of almost €16bn in BoG liabilities towards the Eurosystem (Target2 and banknotes) which total €48.4bn.
  3. Since BoG participation in Eurosystem QE continued at a slower pace the ‘Securities held for monetary policy purposes’ registered a further increase to €62bn. This means that BoG has a surplus of €13.5bn in securities held as assets compared to its liabilities towards the Eurosystem which would make a possible Grexit a bit easier since settlement of BoG Euro liabilities would be made using its (Euro government) securities portfolio.
  4. The lower need for CB financing has led total collateral posted at BoG down to €80bn, a figure which is quite manageable and far lower than the peak of €200bn reached during the 2015 turmoil. Most of the collateral are used for ELA financing so a possible elimination of ELA in the near future will make life much easier for Greek banks.
  5. Government deposits at the BoG are now close to €15bn registering an increase of  €4bn during 2018. It seems that the Greek government is continuing its process of accumulating a large cash buffer for its «clean exit» scenario.

Overall BoG balance sheet figures suggest stabilization in external liabilities, ELA financing and a much lower toll on Greek bank profits from ELA loans (BoG should be around €40mn/month lower in April compared to a year ago).

So ELSTAT announced the Greek GDP figures for 2018Q1. The main taking point was that GDP increased 2.3% on an annual basis compared with 2017Q1. Yet if one takes a closer look I feel that there are a few worrying signs, specifically in the sectoral breakdown:

Greece 2018Q1 GDP

It is clear that consumption, especially private consumption continued registering negative growth for a third consecutive quarter. As I have outlined recently I find it quite difficult for Greek households to continue running down their financial assets at a pace of €9bn per year in order to maintain (or even increase) their consumption levels. This is destined to have its toll on investment activity which actually registered a 10% fall during 2018Q1.

As a result, Greek internal demand contributed negatively to GDP growth with only net exports being a driver of the positive 2.3% growth figure. Unless these internal demand dynamics take a positive turn during the next quarters I fear that GDP growth for 2018 will prove to be disappointing, at least compared to projections (the Commission projects that 2018 growth will be driven almost completely by internal demand and not by net exports). Obviously running a primary surplus close to 4% of GDP for the third year in a row will only make matters more difficult.

 

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Kostas Kalevras

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