Another Slideshow from Ed Dolan’s Econ Blog Why hasn’t the US become another Greece? A Comparison of Two Budget Crises Posted April 4, 2013 Photo source: Athens Indymedia via http://commons.wikimedia.org/wiki/File:Greek_riot_police_3.jpg Terms of Use: These slides are provided under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishing.

Not Long Ago the US Looked a Lot like Greece Not so long ago, the trajectory of the US government budget deficit looked a lot like Greece. Both countries seemed to be headed down the same rathole Since then, Greece has moved from crisis to disaster while the US has begun a slow but steady recovery What has made the difference? April 4, 2013 Ed Dolan’s Econ Blog

Reason 1: Greece was already Worse Off than we Thought The first reason the US and Greek crisis have not continued in parallel is that already in 2009, the Greek economy was worse off than we then thought This diagram compares recent data for the Greek deficit in 2007-2009 with the vintage 2010 data available three years ago The Greek government has admitted that some data from that period were falsified to make the deficit look smaller than it really was April 4, 2013 Ed Dolan’s Econ Blog

Reason 2: The Advantages of a Sovereign Currency A second reason the US economy has done better than that of Greece is that the US has its own sovereign currency, the dollar Greece, by contrast, is a member of the Eurozone. It has no independent control over its currency. Having an independent currency has helped the United States in two ways . . . April 4, 2013 Ed Dolan’s Econ Blog

A Sovereign Currency Allows More Exchange Rate Flexibility One advantage of a sovereign currency is greater exchange rate flexibility This chart shows real effective exchange rates for the US and Greece—a broad measure of international competitiveness The US dollar has depreciated more during the crisis, helping US exports The Greek exchange rate, linked to those of strong economies like Germany, has depreciated less April 4, 2013 Ed Dolan’s Econ Blog

A Sovereign Currency Helps Keep Interest Rates Low Another advantage is that a country with its own currency can, if need be, always issue enough new currency to pay its debts, but one with a shared currency cannot do so The ability to issue additional currency to pay debts reduces the risk of default Reduced default risk, in turn, lowers interest rates Dramatically lower interest rates have made it far easier for the US to manage its debt during the crisis April 4, 2013 Ed Dolan’s Econ Blog

Using the Output Gap to Track the Business Cycle A country’s business cycle can be tracked using its output gap The output gap is the amount by which real GDP exceeds or falls short of potential real output Potential real output means the economy’s real GDP when it is operating along its normal trend, neither in a slump nor in a boom April 4, 2013 Ed Dolan’s Econ Blog

Procyclical vs Countercyclical Fiscal Policy Ideally, a country’s fiscal policy should be countercyclical. Such a policy would moderate the business cycle by stimulating the economy with tax cuts and new spending during a recession and using tighter policy to prevent overheating during a boom In contrast, a policy that makes the business cycle worse by adding stimulus during a boom and applying austerity during a recession is procyclical April 4, 2013 Ed Dolan’s Econ Blog

The Underlying Primary Fiscal Balance A country’s underlying primary fiscal balance (UPB) provides a good indicator of whether its policy is stimulating or restraining the economy The UPB is the government’s budget surplus or deficit, adjusted to remove the effects of the business cycle on taxes and spending, as well as for one-off items like privatization revenue and tax amnesties April 4, 2013 Ed Dolan’s Econ Blog

Procyclical Fiscal Policy in Greece Fiscal policy in Greece has been strongly procyclical over the past decade, as indicated by the fact that the UPB and output gap have moved in opposite directions During the boom years of the early 2000s, the underlying primary balance moved toward deficit, causing the economy to overheat After 2009, at the insistence of its EU partners, Greece undertook stringent austerity measures. Its underlying primary balance rose into surplus as its output gap plunged into a deep recession April 4, 2013 Ed Dolan’s Econ Blog

Procyclical Fiscal Policy in the United States Fiscal policy in the United States has also been procyclical , but not as strongly so as in Greece As in Greece, during the boom years of the early 2000s, the US underlying primary balance moved toward deficit, causing the economy to overheat In 2008 through 2010, the US at first used countercyclical stimulus to reduce the severity of the recession After 2011, the US began to tighten fiscal policy. The UPB rose toward balance, but not into surplus. The recovery was slow but it did not stop completely April 4, 2013 Ed Dolan’s Econ Blog

April 4, 2013 Ed Dolan’s Econ Blog The Bottom Line The United States did not become “another Greece” for three reasons: The Greek crisis was worse to begin with A sovereign currency gave the US government more room to maneuver, especially in terms of interest rates and exchange rates Both Greece and the United States have followed destabilizing, procyclical fiscal policies, but to a much greater degree in Greece than in the US. April 4, 2013 Ed Dolan’s Econ Blog

March 29, 2013 Ed Dolan’s Econ Blog For further discussion of the issues raised in this slideshow, see “Why Hasn’t the US become another Greece?”, Ed Dolan’s Econ Blog, April 4, 2013 Click here to learn more about Ed Dolan’s Econ texts March 29, 2013 Ed Dolan’s Econ Blog