Working Paper: CEPR ID: DP13762
Authors: Gabriel Chodorow-Reich; Loukas Karabarbounis; Rohan Kekre
Abstract: The Greek economy experienced a boom until 2007, followed by a decade-long collapse with magnitude and persistence that have no precedent among modern developed economies. We assess quantitatively the sources of the boom and bust and the role of policies in an estimated dynamic general equilibrium model with heterogeneous households and multiple production, banking, government, and external sectors. Demand from the rest of the world and the government fueled the boom in production, whereas realized and anticipated transfers fueled the boom in consumption. Contractionary tax policies, amplified by a decline in factor utilization and financial frictions, account for the largest fraction of the bust in production, whereas the rise of uninsurable idiosyncratic risk accounts for the largest fraction of the bust in consumption, decline in prices, and the sudden stop of capital flows. Fiscal policy amplified the depression by concentrating the burden of adjustment on taxes instead of spending and by raising the fraction of taxes that firms prepay before revenues are realized. By contrast, equity injections to banks mitigated the depression by lowering the cost of borrowing.
Keywords: Greek Depression; Productivity; Fiscal Policy; Financial Markets
JEL Codes: E20; E32; E44; E62; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| external demand shifts (J23) | production levels (E23) |
| government spending (H59) | production levels (E23) |
| contractionary tax policies, decline in factor utilization, financial frictions (H32) | bust in production (D20) |
| uninsurable idiosyncratic risk (G22) | consumption decline (E21) |
| increased risk (D81) | higher precautionary savings (D14) |
| higher precautionary savings (D14) | reduced consumption (E21) |
| fiscal policy adjustments (E62) | consumption and investment (E20) |
| equity injections to banks (G21) | borrowing costs (H74) |
| lowering borrowing costs (G21) | economic outcomes (F61) |