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Ricardo Caballero: "Greece Is in Rehab"

The euphoria, following the Eurogroup's statement that Greece would receive the long-awaited tranche from the troika of lenders, soon vaporized. With the crisis worsening a viable solution regarding the sustainability of the Greek debt had been set as the main target of this official meeting. The statement, a product of compromise between the EU and IMF, was what critics suspected it would be: too little, too late, once again. There was a small difference. All the players involved cynically acknowledged the inadequacy of the decided actions. There were even hints that further measures to reduce the Greek debt, even an official sector write-down, -- which was at some point on the table -- could be only some time away.

Professor Ricardo Caballero is an expert in systemic crises. He currently holds the Ford International chair of economics at MIT and has written extensively on the 2008 crisis. Early in 2012 he has suggested dollar parity for the euro as desirable means of restoring growth to the crisis stricken countries. This was a radical analysis, even heretical for the dominant European economic thinking, but after three years of half-measures and delays perhaps a radical approach is what Europe needs. In this conversation Professor Caballero answers the Greek crisis' fundamental questions.

Vaios Papanagnou: Is austerity the solution out of the crisis for Greece?

Ricardo Caballero: Austerity is not the solution but a side effect of an enormous crisis. To draw an analogy, most rehab centers for alcoholism are very "spartan." This is not a goal in itself, but it is a characteristic of these centers since many people that fall into alcoholism also experience financial perils. But the final remedy is the treatment, not the bad conditions in which it happens. If Greece could improve its competitiveness and address its widespread corruption and tax evasion, then there would be less need of spending time in a spartan rehab center. Quite the opposite, if these fundamentals problems are not addressed quickly, then the financial conditions of the patient worsens, and it needs to be transferred to ever more spartan centers. It is as terrible downward spiral.

VP: According to your analysis which is the direction towards restoring growth in the Eurozone?

RC: Unfortunately I am not too optimistic on a fast growth recovery. Part of the "problem" of Europe is that it is rich, so it can afford spending a long time debating how to move on. Japan is a perfect example of this "problem." There is no question that the world has changed with the growth of China and others. This offers many new opportunities but also it requires flexibility to reallocate resources quickly across potentially prosperous industries. The European institutional system, especially the Southern European system, is not well adapted to this new world.

VP: Which initiatives could the ECB take to avoid recession in Europe? What can it do to stabilize Greece?

RC: The ECB has done a superb job in providing liquidity as needed. The Greek financial system, for example, would have completely collapsed a long time ago absent ECB's facilities.The new OMT is also a great insurance arrangement. But the ECB cannot substitute for much needed real adjustments, it can only buy time and reduce the financial panic associated to these transitions.

VP: Is parity with the dollar feasible (in the current climate of Franco-German relations)?

RC: If it happens not as the result of a widespread bank run and panic, the euro at parity would be fantastic news for Europe. But it is unlikely to happen since the U.S. is also struggling on these days.

VP: Progressive thinking in Europe suggests debt mutualization (and Eurobonds) and fiscal integration as the way out of the crisis and strengthening of the eurozone. Do you agree?

RC: I don't think this will happen. It may happen one day as a more solid foundation for the future, but I don't see it being applied retroactively to solve the crisis. It would imply massive transfers from the North to the South of Europe, which would hit political constraints in the North well before reaching the levels of transferred required to solve the current situation.

VP: Economists from the U.S. such as Krugman and Stiglitz call for different approaches than the predominant (German-led) dealing with the crisis. What is your position on Neo-Keynesian methods to deal with the euro crisis?

RC: Let me go back to my analogy with alcoholism rehab centers. There is the risk that as the center becomes too spartan, at some point the patient may quit the treatment, with obvious consequences. Surely the patient will feel euphoric early on, and it may even stay sober for a few weeks, but the odds are against him, and a relapse is the most likely outcome. Of course, societies are far more complex than an individual patient, as not everyone is in the same rehab center, and internal transfers become the center of the political discussion. But at the end of the day, with all its complexities, the issue is always a tension between the benefits of a cold turkey intensive treatment, and the patient's resilience to stay engaged.

VP: Do you think that the Obama administration will put pressure on the European leaders to adopt state intervention measures such as the stimulus package?

RC: The Obama administration has its hands full with its own fiscal cliff. Don't expect help from here.

VP: Do you consider these actions such as lower interest rates are steps towards a solution or stalling before an inevitable default?

RC: I don't see any chance, beyond a true growth miracle or a prolonged episode of European inflation, which also seems highly unlikely, that Greece will ever pay its debt. This was clear from the beginning, and it remains clear. It is up to Greece and its Europeans partners to decide how to structure and spread over time this default.

VP: Would it be best for Greece to return to the drachma?

RC: To solve what? Surely you could regain competitiveness quickly, but you would destroy your financial system, and would probably go through a much deeper crisis in the short run. Having said this, going back to the drachma may well happen, but it would be chaotic, not the result of a well thought through decision.

VP: The euro crisis started out as a financial problem, with markets attacking Greece to bring down the euro. Now that this danger is over I feel that it is now a problem of political will or lack thereof. Would you agree?

RC: I think part of the problem was that Europe and the IMF insisted early on in treating this crisis as a result of some irrational speculative attack rather than as an authentic solvency and competitiveness problems. It took an enormous time for policymakers to make the right diagnosis. Now that they finally have it, they realize that there are no easy solutions since it requires painful real adjustments and transfers. It is not just a matter of loud bazooka type speeches, in the hope that financial markets will reengage. It is a real problem that will require enormous sacrifice and resources to solve. The politics of this process are far more complex than the politics of speeches.

A Greek version of this interview can be found at To Vima.

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