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I apologize for the simple wonky post on the weekend and that you will not get to enjoy a pithy observation on this otherwise fine weekend.

The “government budget identity” is simply a way to think about how a government can finance its expenditures. Suppose a government is required to help us build bridges and defend our borders – it requires funds to do this. A typical sovereign government can secure funds from three “legitimate” places.*What are these sources?

  1. Taxes today.
  2. Taxes tomorrow. In other words we can borrow money today in order to build our bridge and then use future tax revenues to pay for the debt tomorrow. By the way, if the government is in the business of actually producing valuable “public goods” then you can easily think of this as value enhancing.
  3. Printing money. It’s not generally done this way, but in effect the monetary authorities can monetize the borrowing of a sovereign entity (how they do it is beyond the scope of this post). For simplicity, imagine instead that a central bank prints new bank notes from scratch, hands them to the Treasury, and then the Treasury spends them on goods and services. This is just another form of a tax, again beyond the scope of this post.

So, this is what the government budget identity looks like for “normal” countries:

G = T + the change in debt + the change in base money

But what’s the deal with Greece? Ignore what it has been spending money on, and just suppose that it “needs” to continue to spend G. Greece (and the other PIIGS) faces two problems that the US does not. First, Greece is part of the European Monetary Union. This means that it “outsources” its central banking to the Euro zone. In other words, there is no independent Greek central bank that can print its own currency and spend it into circulation. Greece is to the Euro as Mississippi is to the dollar. There is no Mississippi central bank, so if the state of Mississippi wishes to spend resources, it can either tax the people of Mississippi or it can borrow (states have limited borrowing power). Mississippi also receives transfers from the federal government, and this is what some folks hope happens in Greece. So, Greece cannot print money to pay for its spending (which includes interest payments on previously issued debt).

So Greece’s government budget identity really is:

G = T + the change in debt

However, although Greece has an independent fiscal authority (it IS a sovereign nation) the last item is a problem for Greece. How does Greece borrow money? It must attract investors to lend it money and part of that requires a promise to pay back lenders in full. These lenders have typically come from outside of Greece. Now, given Greece’s historical fiscal record and current budget problems, folks are very skeptical that they would be paid back if they loaned the government of Greece money. In order to persuade folks to lend to them, the Greeks would have to offer a very attractive rate of interest. In fact, some recent Greek bond auctions have seen interest rates in the 20% range.

To put that in perspective, if the US had to fund its entire $15 trillion of debt at 20% interest, it would face an annual interest payment on the debt of $3 trillion. The total amount of federal tax revenues last year was … $2.3 trillion. Ding-dong, the witch is dead!

So, in effect the Greeks cannot afford to pay 20% interest even on newly rolled over debt. In other words, in addition to not being able to print money, the Greeks cannot borrow money. So their government budget identity looks pretty much like what a little kid’s does:

G = T.

The Greeks can only spend what it raises in taxes. I think you can see why this is a problem, particularly in an economy that is shrinking by something like 5% per year and in a country that is not exactly famous for having well-behaved taxpayers. This is why the game is up, Either the Greeks have to raise taxes, reduce spending or somehow persuade someone else to intervene in the place of borrowing and printing money.

I have no intention of posting on the political economy of all of this, but several students asked me for a “back of the envelope” illustration of the problem in Greece. I hope this helps. And note that I said nothing about how we got to the point where their spending was unsustainable. Perhaps for another day. Enjoy your weekend, I’ll keep grading.

* There is a 4th way to secure funds that the Charles Taylors of the world like to indulge in. That is to expropriate the assets and property of private citizens for public purposes. Of course that process is not “sustainable” for very long periods of time unless we think that private citizens obtain massive amounts of utility from contributing to a kleptocrat.

4 Responses to “Weekend Thought – Greece and the Government Budget Identity”

  1. Harry says:

    As Tim Geithner might write, “Here’s a chain letter that really works!”

  2. chuck martel says:

    The best plot to this bad novel would be that the Greek government checks to employees, suppliers and retirees would bounce and that nobody would show up for work or supply paperclips to the Greek Department of Consumer Irritation. Then they could perform the great experiment that would surprise the world, trade with private money.

  3. Inflation is taxing the future. Borrowing is paid for with future taxes. Really, unless the government has drop-buckets like a toll road, we all only pay our taxes in the future. Sales taxes, income taxes etc., certainly are not paid in advance. So, in truth, there is now only one mode of financing a government. As you note, G=T, identically. But it need not be so.

    In What Might Have Been: the Story of a Social War by Ernest Bramah (1907), the ruling class rises up angry against the Labour government and after the strike – suggested as a precursor to Atlas Shrugged – only bond holders can vote: one vote per share with bonds starting at 500 UKP (like $50,000 today).

    The governments could charge for access to the museums, including all of the fancy historical buildings and other sites. You could rent the Declaration of Independence – or certainly many other important documents if not The Big One – for display in your home or office. The government has tons of famous stuff to rent or sell at auction – and it gains more all the time. People highly prize flags that have been flown. Numismatists, and philatelists are a ready market for dies, proofs, trials, and discards without end.

    (Greece, in particular, could lease out its civil service pensioners to work as gardeners.)

    Once you start thinking in those terms, a myriad of alternatives come to mind.

  4. D. F. Linton says:

    Unless Wikipedia is completely crazy, the Greek Central Bank does in fact print Euro notes. Maybe they are supposed to say mother may I to the ECB, but that doesn’t mean they couldn’t print, print, print if they really wanted to.

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