Greece and the U.S.: The Importance of Monetary Policy Independence

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Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is Assistant Professor at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance

As a result of huge government deficits in 2009 Greece was faced with successive downgrading by all three major credit rating agencies that rendered its government securities to “junk bonds” status. This severely impacted Greece’s creditworthiness and it was forced to use a joint European Commission, European Central Bank and IMF rescue deal as Greek government bonds were plummeting and yields skyrocketed. This rescue package came with very strong “strings attached” as the package required a series of important austerity measures to curb government spending. These austerity measures led since then to a severe recession that Greece has yet to overcome.

Last week, Standard & Poor’s announced the downgrade of the U.S. economy for the first time in history from AAA to AA+ after the enactment of the Budget Control Act of 2011. Of course the severity of the fiscal problems of Greece and the U.S. are far from similar. Greece’s public debt amounts to 140% of its GDP while this number is only 70% for the U.S. But this is not the only difference between the two countries. What is most important is who is responsible for the conduct of economic policy: fiscal and monetary policy. Greece within this crisis is not in the position to conduct any of the two. Fiscal policy is virtually nonexistent as it is controlled by the bailout package and monetary policy is conducted by the European Central Bank since the country is a member of the Eurozone.

For the US economy, the Fed is the institution implementing the monetary policy and can alter the Federal Funds Rate in order to change interest rates within the country. The decision taken when the FOMC (Federal Open Market Committee) meets, usually every seven weeks, will affect all other interest rates in the US economy. These decisions are taken by the FOMC such that they will stimulate and benefit the US economy. Recently, the term “quantitative easing” has entered our vocabulary. Quantitative Easing is a tool employed by the Fed to stimulate the U.S. economy and keep interest rates at low levels to help investment and spending.  The Fed used to employ the Federal Funds Rate as a tool of monetary policy but recently it is very close to zero (0.07% in July 2011) and cannot be used as a stimulus (you need to decrease interest rates and since they are close to zero it is impossible to do so). That is why the Fed has shifted to “quantitative easing”: that means that the Fed expands its balance sheet by buying government bonds from financial institutions thus creating a notional increase in their demand which drives their prices up. As the price of the bonds increases, their yields -interest rates- decrease. This is the result we see these days. Of course this tool at the same time provides financial institutions with the increased liquidity to expand cheap credit to consumers and investors thus helping the U.S. economy.

For Greece the situation is quite different. The monetary policy of the E.U. is designed and implemented by the European Central bank.  As Greece is a small partner –in terms of GDP-

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About the Author:
Dr. Periklis Gogas is a faculty member at Democritus University of Thrace and an adjunct lecturer at the Greek Open University teaching Macroeconomics, Banking and Finance. He is also a Financial Consultant for Gerson Lehrman Group, Austin, Texas. He received his Ph.D.degree from the University of Calgary with supervisor Dr. Apostolos Serletis and worked for several years as the Financial Director of a multinational enterprise. His research interests include Macroeconomics, Financial Economics, International Economics and Complexity and Non-linear Dynamics.

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