The Road to the Euro: The Greek Experience

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The Road to the Euro The Greek Experience

• Christos Papazoglou
• Bank of Greece, Economic Research Department,
  Athens, Greece

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I. A Look at the Period 1981-93

• Greece joined the European Communities in January
  1981.
• Slow speed to maturity by Greek economy and
  institutions.
• Economic Performance was rather disappointing
• Stabilization Efforts in 83, 85-7 and 91-3 had
  only temporary gains

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Poor growth performance and increasing
unemployment
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Double Digit Inflation
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Substantial Fiscal deficits

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Overall poor fiscal Performance
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Incomes Policies Resembled a Pendulum and
Productivity was low
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High Current Account Deficits
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II. The Period 1994-99

• The Signing of the Maastrcht Treaty in 1992
  called for a Policy Change
• Adoption of the New 1994-99 Convergence Program
  of the Greek Economy
• Shift in the economic Policy Mix More Effective
  Coordination of Monetary, Fiscal, Incomes and
  Structural policies
• The Objective of Joining the Euro Area provided
  powerful Incentives for Policy Adjustment.

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Policy measures undertaken were the Following

• 1. The Exchange Rate used as a Nominal Anchor,
  i.e., The Hard Drachma Policy.
• Hoping that a visible Exchange-Rate Target would
  Enhance Credibility of the Dissinflationary
  Effort Through
• The Stabilization of the Traded-Goods Component
  of the Price Level
• Restraining the Wage-Setting and Price- Setting
  Behavior.

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The Functioning of the Hard Drachma Policy
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2. Fiscal Policy was Progressively Tightened
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• 3. Financial Deregulation, which started in the
  late 1980s, was completed and in 1994 the Capital
  Account Was Opened. The Deregulated Financial
  System Facilitated the Use of Indirect
  Instruments of Monetary Policy and Allowed Rapid
  Policy Responses.
• 4. The Greek Parliament Approved Independence of
  the Bank of Greece.

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Impact on Economic PerformanceInflation
Convergence
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Interest Rate Convergence
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Output Growth, which was largely facilitated by
the Rise in Investment
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5. Other Policy Measures

• 5.1 Structural Reforms in the Labor and
• Product Markets.
• Labor Market
• The Compulsory arbitration of labor Disputes was
  Abolished. Free Collective Bargaining was
  introduced.
• The Automatic Wage Indexation System was
  Abandoned
• Important Labor Legislation Passed Contributing
  to Labor Market Flexibility.

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5.2 Reforms to Enhance Competition in Product
Markets and Reduce the Size of State-Sector

• Three Main Headings
• Privatization Program
• Market Liberalization
• The Establishment and Operation of the
  Competition Commission and of Regulatory
  Authorities in Various Sectors

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5.3 Foreign non-EU Immigrant Workers A Positive
Historical Coincidence

• Due to Changes in Eastern and Central European
  Countries, Greece Became a Host Country for
  Immigrants. Positive Impact on the Economy
• Contribute to Economic Growth
• Add Flexibility and avert Bottlenecks in Labor
  Market
• Help Moderate Labor Cost Growth and Inflationary
  Pressures.
• Augment the Revenues of Social Security Funds

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Back to Hard Drachma Policy

• It Produced Difficulties
• High Domestic Interest Rates led to a
  Capital-inflows Problem.
• Sterilization of these Flows by the Bank of
  Greece.
• Real Exchange Rate Appreciation contributing to a
  Widening Current-account Deficit.
• These Combined with rapid wage growth, Fed Market
  Expectations that the Drachma was Overvalued and
  Provided the Basis for Contagion from Asia.
• A Further Regime Shift was needed.

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Real Interest Rates at the Short end Kept in the
Vicinity of 5
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Real Exchange Rate Appreciation and the Widening
Current-Account Deficit
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III. Devaluation and Entry into ERM

• In March 1998 the Drachma Joined the ERM at a
  Central Rate that Implied a 12.3 Devaluation
  against the ECU.
• The new Central Rate was agreed by all members.
• The Devaluation of the Drachma was both Backward
  Looking and Forward Looking.
• A Package of Supportive Fiscal and Structural
  measures was Announced.

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Unlike Past Devaluations, Why was this
Devaluation Successful?

• The Drachma exited a Unilateral Peg and Entered a
  Systems Arrangement, Benefiting from the
  Credibility of ERM
• Fiscal Tightening Continued and Labor Market
  Policy Adjusted to the Needs of Fiscal
  Discipline.
• Prudential Regulation and Supervision of the
  banking System was Enforced and There Was no Net
  Foreign Exposure of the Banking System.

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The Usefulness of ERM

• An Announced Central Rate can Help to Anchor
  Inflationary Expectations and Impose Discipline
  on the various Economic Actors in the Economy.
• The System is Designed to Cope with Shocks.
• The ERM is a Credible Multilateral System.
  Central Rates within the System are Agreed by all
  Members and the ECB.

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IV. Some Concluding Remarks

• An Intermediate Exchange Rate can be viable in a
  World of High Capital Mobility
• The ERM Provides Credibility as well as
  Flexibility through the Wide Fluctuation Bands.
  Credibility could be Endangered in Case of
  Frequent Changes in Central Parity.
• Consistent Policy Mix is Crucial and has
  Important Implications.
• The Trust Evoked by Governments is of Critical
  Importance.
• A General Lesson from the Greek Experience
• Real and Nominal Convergence are Complements and
  not Substitutes