The Greek Finance Minister Yanis Varoufakis has a new article for Project Syndicate. He is making a point that Market Monetarists have been making since the outbreak of the euro crisis – it is not really a ‘debt crisis’, but rather a monetary crisis.

This is Varoufakis:

The view that Greece has not achieved sufficient fiscal consolidation is not just false; it is patently absurd. The accompanying figure not only illustrates this; it also succinctly addresses the question of why Greece has not done as well as, say, Spain, Portugal, Ireland, or Cyprus in the years since the 2008 financial crisis. Relative to the rest of the countries on the eurozone periphery, Greece was subjected to at least twice the austerity. There is nothing more to it than that.

Here is his graph:

Now compare that with a graph I had in one of my blog posts back in 2012:

And this is what I wrote then:

The conclusion is very clear. The change in public debt ratios across the euro zone is nearly entirely a result of the development in nominal GDP. The “bad boys” the so-called PIIGS – Portugal, Ireland, Italy, Greece and Spain (and Slovenia) are those five (six) countries that have seen the most lackluster growth (in fact decline) in NGDP in the euro zone. These countries are obviously also the countries where debt has increased the most and government bond yields have skyrocketed. This should really not be a surprise to anybody who have taken Macro 101 – public expenditures tend to increase and tax revenues drop in cyclical downturns. So higher budget deficits normally go hand in hand with weaker growth. The graph interestingly enough also shows that the debt development in Greece really is no different from the debt development in Germany if we take the difference in NGDP growth into account. Greek nominal GDP has dropped by around 10% since 2007 and that pretty much explains the 50%-point increase in public debt since 2007. Greece is smack on the regression line in the graph – and so is Germany. The better debt performance in Germany does not reflect that the German government is more fiscally conservative than the Greek government. Rather it reflects a much better NGDP growth performance. So maybe we should ask the Bundesbank what would have happened to German public debt had NGDP dropped by 10% as in Greece. My guess is that the markets would not be too impressed with German fiscal policy in that scenario. It should of course also be noted that you can argue that the Greek government really has not anything to reduce the level of public debt – if it had than the Greece would be below to the regression line in the graph and it is not.

So yes I agree with Varoufakis that a lot of Greece’s fiscal troubles are a direct consequence of the collapse of Greek GDP. That, however, does not change the fact that Greece needs serious structural reforms – including pension reform, tax reform and privatisation – preferably also in my view serious constitutional reforms and I am not sure that the hard-leftist Syriza government is able or willing to deliver such reforms.

And I am not arguing that the EU and the IMF should let Greece off the hook, but on the other hand I do think that there are ways forward.

In my view the best solution – and there are no easy solutions at this point – is deep structural reforms in Greece combined with a refinancing of Greek government debt so the present debt to the European Stability Mechanism is replaced by newly issued bonds linked to Greek NGDP.

Interestingly enough Varoufakis has also suggested that Greek public debt should be linked to NGDP. This is how I explained the idea recently:

The general idea with NGDP linked bonds is that the servicing of the public debt is linked to the performance of Greek NGDP. This would mean that if growth picked up in Greece then the Greek government would pay of more debt, while is NGDP growth slows then Greece will pay of less debt. This of course would make Greek public finances much less sensitive to shocks to NGDP and therefore reduce the likelihood that the Greek government would be forced to defaults if growth fails to pick-up. On the other hand German taxpayers should welcome that if there I a pick-up in NGDP growth in Greece then the Greek government would actually pay back its debt faster than under the present debt agreement. Furthermore, more if public debt servicing is linked to the development in NGDP growth then Greek public finances would become significantly more counter-cyclical rather than pro-cyclical.

NGDP linked bonds is not a solution for all of Greece’s problems – far from it – but it could help reduce the pain of necessary structural reforms.

So once again I have to say that I to a large extent agree with Varoufakis analysis and some of his policy proposals. That, however, does not mean that I think he has the backing in the Syriza government to implement the serious structural reforms in the Greece that I also think is badly needed.

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