Depression’s Advocates

Unfortunately, that prediction turned out to be wrong. Not only have policymakers in the eurozone insisted on repeating the blunders of the 1930s; they are poised to repeat them in a more brutal, more exaggerated, and more extended fashion. I did not see that coming.

When the Greek debt crisis erupted in 2010, it seemed to me that the lessons of history were so obvious that the path to a resolution would be straightforward. The logic was clear. Had Greece not been a member of the eurozone, its best option would have been to default, restructure its debt, and depreciate its currency. But, because the European Union did not want Greece to exit the eurozone (which would have been a major setback for Europe as a political project), Greece would be offered enough aid, support, debt forgiveness, and assistance with payments to offset any advantages it might gain by exiting the monetary union.

Instead, Greece’s creditors chose to tighten the screws. As a result, Greece is likely much worse off today than it would have been had it abandoned the euro in 2010. Iceland, which was hit by a financial crisis in 2008, provides the counterfactual. Whereas Greece remains mired in depression, Iceland – which is not in the eurozone – has essentially recovered.

To be sure, as the American economist Barry Eichengreen argued in 2007, technical considerations make exiting the eurozone difficult, expensive, and dangerous. But that is just one side of the ledger.

Using Iceland as our measuring stick, the cost to Greece of not exiting the eurozone is equivalent to 75% of a year’s GDP – and counting. It is hard for me to believe that if Greece had abandoned the euro in 2010, the economic fallout would have amounted to even a quarter of that. Furthermore, it seems equally improbable that the immediate impact of exiting the eurozone today would be larger than the long-run costs of remaining, given the insistence of Greece’s creditors on austerity.

That insistence reflects the attachment of policymakers in the EU – especially in Germany – to a conceptual framework that has led them consistently to underestimate the gravity of the situation and recommend policies that make matters worse.

In May 2010, Greece’s GDP had fallen by 4% year on year. The EU and the European Central Bank predicted that the first bailout program would drive Greek GDP down by another 3% below 2010 levels, before the economy began to recover in 2012.

By March 2012, however, reality had set in. With GDP headed to 12% below 2010 levels, a second program was put in place. By the end of the year, GDP had fallen to 17% below 2010 levels. Greece’s GDP is now 25% below its 2009 level. And while some predict a recovery in 2016, I fail to see how any analysis of demand flows can justify that forecast.

The main reason the forecasts were so wrong is that those making them chronically underestimated the impact of government spending on the economy – especially when interest rates are near zero. And yet the clear failure of austerity to restart the economy in Greece or the rest of the eurozone has not caused policymakers to rethink their approach.

Instead, they seem to be doubling down, on the theory that the deeper the crisis, the more successful the push for structural reforms will be. Such reforms are needed to boost long-term growth, the thinking goes, and if that growth does not rapidly emerge, it is because the need for them was even greater than originally thought.

This, sadly, is the story of the 1930s as well. As the American commentator Matthew Yglesias points out, Europe’s major center-left parties at that time recognized that what was being done was not working, but nonetheless failed to offer an alternative. “It was left to other parties with less worthy overall agendas – Hitler, for example – to step in and say that if the rules of the game led to prolonged spells of mass unemployment, then the rules of the game had to be changed.”

Today, Yglesias adds, Europe’s center-left politicians similarly “don’t have a strategy for changing the rules, and they don’t have the guts to tear up the rulebook.” As a result, austerity reigns, and dissent is left to populists like France’s Marine Le Pen or Italy’s Beppe Grillo – whose economic proposals seem even less likely to be effective.

One would have thought we were capable of learning from the past, and that the Great Depression was important enough in European history that policymakers there would not be repeating its mistakes. And yet, at the moment, that is precisely what seems to be happening.