Stabilization Policies in Greece in the Context of Modern Macroeconomic Theory [1 ed.] 9783428466078, 9783428066070

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Schriften zu internationalen Wirtschaftsfragen

Band 10

Stabilization Policies in Greece in the Context of Modern Macroeconomic Theory By

Volbert Alexander and

George D. Demopoulos

Duncker & Humblot · Berlin

VOLBERT ALEXANDER / GEORGE D. DEMOPOULOS

Stabilization Policies in Greece in the Context of Modern Macroeconomic Theory

Schriften zu internationalen Wirtschaftsfragen Band 10

Stabilization Policies in Greece in the Context of Modern Macroeconomic Theory

By Volbert Alexander University of Gießen (West Germany)

and George D. Demopoulos The Athens School of Economics and Business Science (Greece)

Duncker & Humblot - Berlin

CIP-Titelaufnahme der Deutschen Bibliothek Alexander, Volbert: Stabilization policies in Greece in the context of modem macroeconomic theory / by Volbert Alexander and George D. Demopoulos. — Berlin: Duncker u. Humblot, 1989 (Schriften zu Internationalen Wirtschaftsfragen; Bd. 10) ISBN 3-428-06607-3 NE: Dëmopulos, Geörgios D.:; GT

Alle Rechte vorbehalten © 1989 Duncker & Humblot GmbH, Berlin 41 Druck: Werner Hildebrand, Berlin 65 Printed in Germany ISSN 0720-6984 ISBN 3-428-06607-3

PREFACE This study is the outcome of a research project financed by the German Volkswagen-Foundation for the period 1983-85. The project has been undertaken as a "joint product" of a "German-" and a "Greek"-Group. In this context we want to express our sincere appreciation for all the unbureaucratic help we received from the foundation. Of course this book would have never been finished without the help of many colleagues and the remaining participants of the two groups. At first we would like to thank P. DeGrauwe, D. Henderson, H.E. Loef, P. Minford, H.G. Monissen and G. Wood for helpful comments. Special thanks should be expressed to our research assistants H.-W. Hohl and G. Samaras for their help at all stages of the preparation of this study. In particular we want to express our sincere appreciation to H.-W. Hohl who among other things conducted the whole computer work. Further, we are indebted to Mrs. G. Repmann and Mrs. A. Schwarz for their efficient typing of the manuscript. We also thank the University of Siegen which provided all the computer facilities and carried out the necessary administrative work of the research project. Needless to say we are responsible for all remaining errors and shortcomings.

Volbert Alexander

George D. Demopoulos

CONTENTS CHAPTER ONE INTRODUCTION

13

CHAPTER TWO INSTITUTIONAL ARRANGEMENTS AND THE PROCESS OF ECONOMIC POLICY-MAKING IN GREECE: 1953 -1983 I. Introduction

21

Π. The Financial Sector

25

1. The Main Institutional Arrangements

25

a. The Greek Financial Institutions

26

b. The Currency Committee

26

c. The Bank of Greece

27

d. The Capital Market Committee

30

e. Private and State-owned Financial Institutions

31

2. The Period 1953 -1963

35

a. Policy Objectives

35

b. Instruments Employed

36

3. The Period 1963 - 1973

37

a. Policy Objectives

37

b. Instruments Employed

38

Contents

8

4. The Period 1973 -1983 a. Policy Objectives b. Instruments Employed III. The Public Sector 1. The Main Institutional Arrangements 2. The Period 1953 -1963

40 40 43 49 49 56

a. Policy Objectives

56

b. Instruments Employed

57

3. The Period 1963 -1973

59

a. Policy Objectives b. Instruments Employed 4. The Period 1973 -1983

59 59 61

a. Policy Objectives

61

b. Instruments Employed

62

IV. Balance of Payments Arrangements 1. The Main Institutional Arrangements

70 70

2. The Period 1953 -1963

73

a. Policy Objectives

73

b. Instruments Employed

74

3. The Period 1963 -1973

75

a. Policy Objectives

75

b. Instruments Employed

76

4. The Period 1973 -1983

79

a. Policy Objectives

79

b. Instruments Employed

79

V. The Real Sector

81

Contents

CHAPTER THREE A SURVEY OF RECENT MACROECONOMIC STUDIES OF THE GREEK ECONOMY I. Introduction

102

II. Models of the Real Sector of the Economy

102

1. The Model of Garganas

104

2. The Model of Sallas

114

3. The Model of Vernardakis

119

4. The Model of Tsoris

124

III. Integrated Models of the Real and Monetary Sectors 1. The Model of Kouzionis 2. The Model of Voloudakis, Brissimis, and Leventakis IV. Studies Dealing with Special Macroeconomic Problems 1. Analysis of the Special Studies 2. Evaluation of the Special Studies V. An Overall Evaluation of the Models Reviewed

132 133 139 144 145 161 163

10

Contents

CHAPTER FOUR A THEORETICAL STAGFLATION-MODEL FOR GREECE I. Basic Characteristics

170

II. The System of Equations

171

1. The Demand Side Specification

171

2. The Analysis of the Supply Side

175

a. The Production Function

175

b. Labor Demand and Supply

177

c. The Energy Market

183

d. The Equilibrium Condition of the Output Market

184

3. Endogenous, Exogenous Variables and Expectations Hypotheses

185

4. Long-Run Implications and Compatibility with Standard Rational Expectations Models ΠΙ. Solution of the Model with Adaptive Expectations

188 194

1. The Output Equation

197

2. The Employment Equation

204

3. The Inflation Rate Equation

208

IV. Solution of the Model with Rational Expectations

208

1. The Output Equation

209

2. The Employment Equation

216

3. The Inflation Rate Equation

217

V. Concluding Remarks

222

Contents

CHAPTER FIVE THE EMPIRICAL ANALYSIS I. Introductory Remarks 1. Restrictions 2. The Data Problem 3. Statistical Procedures 4. The Testing Strategy II. Computation of Expected Values 1. Exponential Smoothing Procedures 2. Expected Values under Rational Expectations ΙΠ. Empirical Results of the Adaptive Expectations Model 1. Output Results 2. Employment Results 3. Inflation Rate Results IV. Empirical Results of the Rational Expectations Model

224 224 228 229 231 231 232 234 238 238 241 243 248

1. Output Results 2. Employment Results

248 252

3. Inflation Rate Results

255

12

Contents CHAPTER SIX CONCLUDING REMARKS AND POLICY IMPLICATIONS

I. Discussion of Important Empirical Results II. Policy Implications

APPENDIX I CONSTRUCTION OF SPECIAL VARIABLES

APPENDIX I I DATA SERIES

BIBLIOGRAPHY

CHAPTER ONE INTRODUCTION The main purpose of this study is an analysis of influences running from Greek monetary and fiscal policy impulses to important macroeconomic variables, like real output, employment and inflation. The character of the Greek economy as a small open economy with intensive real and financial international relations implies, in addition, that aggregative effects must be considered affecting the Greek economy via different balance of payments mechanisms (external impulses). Naturally the problem of aggregative effects of fiscal and monetary policy is as old as macroeconomic theory. After World War II it represents the central issue of the Keynesian stabilization policy approach. Up to the late sixties it was treated as a demand management problem according to the standard assumptions and conclusions of post-Keynesian-analyses. The stagflation experiences in most Western economies at the beginning of the seventies shed some new light on the traditional Keynesian stabilization policy concept. New analytical concepts were developed to overcome the impotence of post-Keynesian-tools in explaining and dealing with the simultaneous problem of high inflation and unemployment: in addition to the demand oriented Keynesian analysis, the supply side of the aggregate goods market is considered more extensively. It is shown that the supply curve tends to be inelastic far before a full employment level. As a consequence, an increase in demand via expansionary fiscal or monetary policy measures has mainly inflationary effects. The discussion therefore shifts to economic relations of the supply side, namely to the labor and energy markets. "Supply-constraints" are incorporated explicitly into

14

Chapter One

macroeconomic models to reveal supply-determined consequences for an effective stabilization policy. A second important development concerns expectations about future economic events. In particular, the incorporation of the rational expectations hypothesis into macroeconomic models shows some new insights into transmission processes from economic policy impulses to important economic aggregates. If transactors take into account all available information - a central characteristic of the rational expectations hypothesis - they also exploit information about strategies of economic policy authorities. In this situation no systematic economic policy can influence the economy without a systematic reaction of private transactors. Both developments improve the explanatory power of economic theory according to a separation of output and inflationary effects of monetary and fiscal policy actions. As a result, a dramatic change in stabilization policy concepts occurred in many Western countries. Many central banks and governments have become very sceptical about the effectiveness of short run demand oriented policy actions. In contrast, they have followed more and more a long run supply side oriented policy concept with great emphasis on price stability [Alexander (1985)]. The theoretical foundation for the so-called stagflation models, which include supply constraints and rational expectations, was given by the work of Lucas, Sargent, Wallace, and Barro [Lucas (1973), Sargent (1976), Sargent/Wallaçe (1976), Barro (1977)] . In nearly all papers following this Lucas-Barro-Sargent/Wallace-approach

(LBSW-approach),

a

strong

concentration on monetary policy can be observed. In a second round, the analysis is extended to open economies with the consequence that in addition to monetary policy, external impulses affect real output, employment

and inflation

[Alexander/Loef

(1979), Parkin

(1981),

Parkin/Bentley/Fader (1981), Loef (1984), Cozier (1986)]. Only little attention is paid to fiscal policy. The normal way fiscal policy enters these models can be described as follows: One or several alternative summary

15

Introduction

measures of fiscal policy are constructed and treated as explanatory variables in the goods demand functions [Barro (1977), Neumann (1978), Wogin (1980), Wasserfallen (1981)]. In constructing the summary fiscal policy measures, well known concepts are used, like thefiscal stimulus, full employment budget surplus, etc., which implies that, by construction, these measures are dominantly demand oriented. If we look to the basic characteristics of the LBSW-models the following aspects should be stressed: (1) The demand side is specified in a very rudimentary form. The demand for output

is explained by policy impulses and past values of Y^. The

compatibility with the Andersen-Jordan-equation representing the goods demand function is obvious [Andersen/Jordan (1968)]. (2) The supply side is given by a Lucas-supply function. The supply of real output Y s is determined by a potential (YP) and a cyclical (Y°) component, where Y° depends on the difference between the actual and Λ Λρ

expected inflation rate (P-P ). Λ

(3) Rational expectations about the inflation rate Ρ are modelled by treating Λ»

the expected value of the inflation rate Ρ as an endogenous variable. (4) Real output and employment are only influenced by potential aggregates and unexpected policy impulses. (5) The rate of inflation is determined by potential, expected and unexpected variables, where the expected impulses dominate the unexpected ones. (6) The main focus of analyses of the LBSW-type lies on the explanation of the cyclical output component Y \ Potential output Y

P and the

corresponding natural rate of unemployment are treated as exogenous variables.

Chapter One

16

The rudimentary role fiscal policy plays in models of the LBSW-type has its origin in the "crowding-out-debate" [Christ (1978), (1979)]. One main result of this debate says that especially budget deficits financed by issuing bonds lead to a crowding out of private demand via different price-, interest rateand wealth-mechanisms. Deficit spending therefore tends to be ineffective in stabilizing the economy. Additional arguments concerning the negative pressure on private demand by high and lasting budget deficits lower the impact of fiscal policy in the long run [Barro (1974), Demopoulos/Katsimbris/Miller (1987)]. As an example, the anticipation of higher future tax burdens leads to a pressure of current private spending which undermines the expansionary effects deficit spending exerts on real output and employment. If we analyse the rolefiscal policy impulses play in modern macroeconomic models in greater detail the following methods of incorporating fiscal policy can be separated: (1) Demand side modelling with only one summaryfiscal impulse variable The well known procedure here is the use of Andersen-Jordanequations for open economies [Andersen/Jordan (1968), Läufer (1975), Hafer (1982)]. The characteristics of Andersen-Jordan-equations as reduced forms of goods-, money- and bond-market models clearly show their concentration on the demand side of the goods market. The main objective of these analyses is a test of the relative importance of monetary, fiscal and external policy impulses, where fiscal policy is defined as a single summary impulse. Another type of models is derived from the assignment-analysis in the sense of Mundell/Flemming. The central issue of these studies is the capability of fiscal policy to stabilize domestic and foreign equilibria [Flemming (1962), Mundell (1962), Takayama (1969), McKinnon (1976)]. Fiscal policy is treated as a summary impulse, especially as a budget surplus or deficit.

Introduction

17

(2) Demand side modelling with alternative summary fiscal impulse variables The basis of this kind of studies are Andersen-Jordan-equations, too. Alternative summary fiscal policy measures are used as fiscal policy impulses. The main objective here is to find "superior" fiscal policy measures according to different criteria [Wasserfallen (1981)]. (3) Demand side modelling with severalfiscal policy impulses The impact of individualfiscal policy impulses like tax rates, transfer payments etc. on macroeconomic aggregates is analysed in crowding-out studies [Christ (1978), (1979), Dieckheuer (1981), Demopoulos/ Katsimbris/Miller (1983)]. Here a strong concentration on the demand side can be observed, too. Supply side effects of fiscal policy impulses are treated only scarcely. No hypothesis is formulated treating inflationary expectations explicitly. The main objective of these studies is an analysis of implications for real output and inflation which arise from different types of budget constraints. (4) Fiscal policy in rational expectations models In the context of rational expectations models the supply side is specified explicitly by a Lucas-supply-function [Lucas (1973), Barro (1976), Sargent/Wallace (1976)]. Fiscal policy is defined as a single summary impulse where real output and employment are only influenced by the unanticipated impulse component [Dutton (1978), Fourçans (1978), Fratianni (1978), Faulwasser/Woll (1980), Alexander (1981), Neumann (1981)]. In all cases where supply side effects of individual fiscal impulses are considered explicitly, these effects influence potential output only. Potential output, however, is then treated as a variable exogenous to the model with the consequence that no systematic integration of supply side effects of individualfiscal policy impulses is given [Korteweg (1979)].

Chapter One

18

(5) Supply side analysis of individual fiscal policy impulses Supply side effects of fiscal impulses are the dominant element in a series of theoretical and empirical studies concerning labor market reactions. In particular effects are analysed running to the supply of labor from changes in income tax rates, side payments to employees and transfer payments [Brown (1980), Canto/Joines/Laffer (1981), Hamermesh (1981), Hausman (1981)]. Great emphasis is laid on a microeconomic foundation of labor supply. The underlying framework are decisions of individuals concerning income and leisure within an intertemporal context. The most famous formulation is the "Laffercurve". This relation is dominantly influenced by a labor supply which reacts systematically to a tax burden. As a main result of these studies, in which expectations are not modelled explicitly, tax changes, in particular variations in the marginal income tax rates, have stronger aggregative effects than government spending. (6) Supply-demand models with individual policy impulses In a study by Newman and Spindler individual fiscal policy impulses are treated very extensively [Newman/Spindler (1979), Spindler (1980)]. Beside the well known demand side effects of fiscal policy transmission mechanisms are modelled running from individual fiscal policy impulses to the supply of goods. Part of the government output is also treated as an input factor for private production. Only the formation of expectations is not considered. This brief survey shows clearly that fiscal policy is not considered sufficiently in the context of modern macroeconomic studies. All available models include only parts of the aspects mentioned above. First attempts to include

all

aspects

of

the

previous

description

are

made

by

DeGrauwe/Fratianni/Nabli (1985) for many Western countries and by Alexander (1986) for West Germany. A full integration of fiscal policy in modern macroeconomic analysis requires:

Introduction

19

- an explicit formulation of expectations (rational and/or adaptive) - a specification of supply and demand-side transmission mechanisms of fiscal policy impulses - a detailed analysis of the effects individual fiscal policy impulses exert on macroeconomic aggregates, where the choice of the individual impulses depends on the institutional structures of the analysed economy - an explicit formulation of international economic relation the economy is involved in. Three developments in economic theory and empirical research can be used as arguments for a more detailed and careful analysis of fiscal policy in the context described above: (1) In the discussion about appropriate definitions of potential output γΡ a shift can be observed from mechanistic, capacity-oriented [Okun (1962), Perry (1977)] to behavior-oriented equilibrium concepts [Korteweg (1979), Perloff/W achter (1979)]. Long-run equilibrium in the labor market is to a considerable extent influenced by government regulations (for example minimum wages) and legal structures, not only by existing physical resources. (2) One implication of empirical studies about the contribution of YP in explaining the actual real output

is that the developments in Y ( are to

a great extent determined by changes in the potential component. According to Rasche/Tatom (1977) variations in Y t are dominantly (8090%) influenced by γΡ-changes. Only the rest stems from fluctuations in the cyclical component. Therefore it should be argued that all models which treat

Y

P as an exogenous variable can explain real output and

employment only to a very limited extent because they do not systematically integrate important explanatory variables. As far as fiscal policy impulses affect γΡ there could be a systematic underestimation of

Chapter One

20

these supply side effects which are "hidden" in the exogenous variable. (3) For many countries like Greece, energy is to a considerable extent an imported good. The dramatic rise and fall in energy prices in 1974,197980 and 1986 drew more and more attention to energy as a scarce factor of production [Rasche/Tatom (1977), (1981)]. Like in labor markets fiscal policy measures especially taxes on gas or subsidy payments on coal products play an important role in the energy market. If energy as a factor of production limits potential output, we can have another influence of fiscal policy on real output and employment. The main objective of this book is to analyse the development of the Greek economy on the basis of all aspects briefly described above. In Chapter Two we first give a detailed descriptive analysis of institutional structures and important empirical developments of the Greek economy Crom 1953-83. Chapter Three contains a survey of existing macroeconomic studies of the Greek economy. The theoretical model following the lines described above is developed in Chapter Four. On the basis of reduced forms derived from the theoretical model Chapter Five shows the empirical procedures and results. A summary of all importantfindings and policy conclusions is given in Chapter Six. The book is completed by the Appendices I and Π, containing technical details for the construction of special variables and the underlying data series.

CHAPTER TWO INSTITUTIONAL ARRANGEMENTS AND THE PROCESS OF ECONOMIC POLICY-MAKING I N GREECE: 1953 -1983 I. Introduction The Greek economy, having developed under the pressure of meeting the reconstruction needs of the country immediately after the end of World War Π, has not undergone fundamental institutional changes which would have promoted further its efficiency in mobilizing and efficiently allocating its recources for the desired objectives of economic development and stabilization. Its institutional structure introduces uncertainty in the implementation of economic policy and gives rise to losses of economic welfare. The necessity for a rigorous reconstruction of the country's prevailing institutional arrangements for purposes of economic development and stabilization continues to be pressing. This study purports to provide a descriptive presentation of the existing institutional arrangements of the Greek economy over the past thirty years. It helps to understand how monetary and government authorities affect the process of structural change and industrialization when they manipulate policy variables. It allows the comprehension of the structure of the Greek economy. It has definitely a policy orientation and purports to provide information

and

guidance

in

the

development

of

a

structural

macroeconomic model; the structure of such a model cannot be invariant to

Chapter

22

the actual process of economic policy-making and the institutional arrangements of the reality under investigation.^ Section Π presents and analyses the existing institutional arrangements related to the structure and functioning of the financial sector of the economy. Second, it describes the policy objectives for economic development and stabilization adopted by the authorities for the same sector and for the periods 1953-63, 1963-73, and 1973-83. Third, it describes and analyses the policy instruments employed by the authorities in their effort to efficiently promote the policy objectives for the same sector and for each corresponding period. Section ΠΙ presents the public sector of the economy following the same type of analysis described above, while Section IV presents the foreign sector. Section V provides significant data for the real sector designed to demonstrate the process of structural change and industrialization which has 2 taken place in Greece over the past thirty years. The study covers the period 1953-1983 which is further distinguished into three periods, namely 1953-1963, 1963-1973, and 1973-1983. The main consideration that dictated the separation of the period into three decades is the nature of the stage of economic development which has taken place in Greece over the past thirty years.

In this respect, the present study forms the foundation for the construction of a Macroeconomic Model of the Greek Economy which is presented in Chapter Four. 2 A quantitative analysis of the structure and efficiency of the actual process of economic policy-making in Greece in the post-war period is given in G.D. Demopoulos (1984 b), Trends and Economic Developments of the Greek Economy, Working Paper No. 3, Prepared for the German Volkswagen-Foundation, October.

Introduction

23

The factor that dictated the use of the year 1953 as the starting date of the period is that it marks a new era in the country's economic development. A large devaluation of the drachma (50 percent) against the U.S. dollar and a subsequent political stability in association with a number of measures taken by the authorities created a conducive environment for the process of the economic development in Greece. The year 1983 is suggested as the end date of the period for simply technical reasons, namely to complete a thirty year horizon since the starting date of the period. During the decade 1953-1963, the economy has undergone a moderate transformation. Greece was developed from still a largely agricultural country to the beginnings of industrialization.

The Greek economy

experienced a remarkable progress. This development was mainly due to: - a steadily growing public investment in construction and infrastructure, - the active support of the government through direct or indirect subsidization schemes which led to a sufficient capital formation in the private sector; this in turn, induced important private investment in the industrial sector. As a result: the share of public investment in GDP rose from 3.9 percent in 1953 to 6.5 percent in 1963, while the corresponding share of private investment rose from 9.6 percent to 15.4 percent respectively (Table 2.10 on page 92). Productivity in the industrial sector increased at an average annual rate of 6.9 percent between 1951-1961 as opposed to the productivity of thé agricultural sector which rose by 4.9 percent. The result was a massive reallocation of labor away from rural to urban areas, and the share of agricultural sector in GDP decreased from 29.1 percent in 1951 to 263 percent in 1961 and the corresponding share of 3 See L.T. Katseli et al. (1983), Structural Change and Macroeconomic Policy: Suggested Evidence from Greece, Paper Prepared for Presentation at the Annual Conference on Medium Term Economic Assessment, Lisbon, Sept. 12-14 (Manuscript, Sept. 9). This part draws heavily on Katseli's adopted characteristics in describing the three decades of economic development in Greece.

24

Chapter

the industrial sector moved from 18.4 percent to 24.0 percent respectively (Table 23 on page 85). By the end of the decade, the economy is still characterized by a protective environment of tariffs and uninterrupted process of economic development The decade 1963-1973 is characterized by an uninterrupted growth of output and productivity, an increasing openness of the economy due to the association of Greece with the European Communities which became effective as from November 1, 1962, a massive reallocation of employment from the agricultural sector to industrial service and public sectors, a fast growth of the wage sector, moderate inflation growth rates, non-existent unemployment rates, and a growing trade deficit. Thus, Greece was slowly transforming from a still major agricultural economy into a newly industrialized country. The decade 1973-1983 is a period of adjustment to external supply-side shocks. The first oil price shock of 1973-74 had aggravated the recession both directly - the country is ill-endowed with indigenous energy resources and indirectly, through the ensuing recession in the OECD area. Lower GDP growth rates, a remarkable slowdown in private consumption and a sharp decline in gross fixed investment, a sharp increase in the consumer price index, a restoration of labor's income share due to its deterioration through the years of the dictatorship, a sharp deterioration of the country's terms of trade, a reduction in foreign demand, have been the general characteristics of the recession. During the second oil price shock of 1979-80, prices accelerated again to 24.8 percent in 1980. In contrast to other members of the EEC, fiscal and monetary policies were not used to correct this situation, but rather seem to have fuelled the inflation process. These developments along with the decline in productivity, the deterioration in terms of trade, and the stagnant investment growth resulted in a severe recession in 1980 which continued through 1983.

The Financial Sector

25

The main obstacles for a recovery today are the two-digit inflation as well as wage and money (M^) growth rates leading to positive real wage gaps and negative real interest rates. These disappointing developments induced substantial policy reactions. Therebyfighting inflation plays the crucial role. A detailed elaboration of the transformation of the Greek economyfrom a rural, relatively closed and flexible economy to an urban, industrializing and rigid one over the last thirty years along with the actual process of economic policy-making and the institutional arrangements prevailed, is an objective of the present study.

II. The Financial Sector 1. The Main Institutional Arrangements4 Greece has not yet a fully developed and adequatefinancial system. At the centre of the Greekfinancial system is the Bank of Greece, the country's central bank. Around it there is a "thin" complex of private and governmental financial institutions which include commercial banks, 3 This section is taken from G.D. Demopoulos (1983 b), Financial Markets and Institutions in Greece, European Economy, No. 15, March, pp. 149-155. For the structure and development of the Greek monetary policy see also X. Zolotas (1965), Monetary Equilibrium and Economic Development, Princeton, NJ.: Princeton University Press; G.D. Demopoulos (1981), Monetary Policy in the Open Economy of Greece, Athens, Centre for Planning and Economic Research; G. Kasmas (1972), Money and Monetary Policy in a Developing Economy: The Case of Greece 1956-1966, Ph. D. Dissertation, University of Manchester, January; DJ. Halikias (1978), Money and Credit in a Developing Economy: The Greek Case, New York: N.Y. University Press; Bank of Greece (1981), A Study of the Banking System, Report Prepared by a Committee Chaired by N. Harissopouloe (in Greek); A.S. Courakis (1981), Financial Structure and Policy in Greece: Retrospect and Proepects, Greek Economic Review, 3, December; G. Kalamotousakis (1979), Report of the Subcommittee on Credit Controls, Interest Rate Policy, and the Currency Committee, Bank of Greece (Mimeo); P. Koriiras (1984), Experiences, Problems, and Proepects of Greek Monetary and Credit Policy, Bank of Greece, Arch, of Studies and Speeches, Nò. 49 (in Greek).

Chapter

26

investment banks, government-owned specialized credit institutions and the Athens Stock Exchange. There are also private and foreign insurance companies, and pension funds as well as investment companies. There are, however, no building societies, hire purchase andfinance houses nor any other kind of organization, apart from the above, which could be characterized as afinancial intermediary. Non-banking institutions do not play an important role in financing investment mainly due to the underdeveloped nature of the capital market. Thus, the banking system is the most important institutionalized means of mobilizing and allocating private and publicfinancial resources.

a. The Greek Financial Institutions The Greek banking system consists of: (1) the Bank of Greece, (2) commercial banks, (3) investment banks, and (4) government-owned specialized credit institutions. Before 1946 the Bank of Greece was the exclusive body of conducting monetary and credit policy in the country.

b. The Currency Committee Since 1946, a collective body, the Currency Committee, holds full responsibility for the country's monetary and credit policy while the role of the Bank of Greece has been limited to that of suggestions and advice through the participation of the Governor of the Bank in the meetings of the Currency Committee. The Currency Committee was set up in 1946 and reformulated as a collective body in 1951 under the chairmanship of the Minister for

The Financial Sector

27

Coordination and including the Ministers for Finance, Industry, Commerce, and Agriculture, as well as the Governor of the Bank of Greece. The Currency Committee shaped the conduct of the country's monetary and credit policies and had the overall supervision of the responsibility for the exercise of these policies. It assigned the day-to-day execution for monetary and credit policies to the Bank of Greece. It is, in other words, the principal and the only authority of framing monetary policy. Since June 1982, the functions of the Currency Committee have been distributed between the government and the Bank of Greece. The government, through its Council of Government and Economic Policy, continues broadly to shape the country's monetary and credit policies, but the Bank of Greece has the responsibility for the development and implementation of these policies. The new legislation gives the Bank of Greece the power to administer interest rates, change the reserve requirements, apply credit ceiling etc., and generally to take any action required for the implementation of monetary policy. Essentially, more powers are given to the Bank than previously.

c. The Bank of Greece The Bank of Greece, established in 1928, has the exclusive right of issuing bank notes; it provides credit to the banking system and, to a much lesser extent, to private enterprises; it provides finance to the government and manages its payments and receipts; it also manages the country's foreign exchange reserves and administers exchange controls. Thus it seeks to protect the internal and external value of the Greek drachma and plays a direct role in financial intermediation. (i) The Bank of Greece as the government's bank is not permitted to make direct loans or advances to the government or to public entities except of temporary advances to the former for covering its annual budget

Chapter

28

expenditures. There is an upper limit to these advances which the government has to pay back by the end of the first quarter of the next financial year.^ The Bank of Greece also handles the business of issuing and servicing the government debt (Treasury bills and bonds). The issue of Treasury bills started in 1957. There is no market for Treasury bills; operations in Treasury bills are taking place between the Bank of Greece (the Central Bank), the commercial banks, the government-owned specialized credit institutions, and the two privately-owned investment banks.6 The issue of government bonds started in 1960. They are placed every

η

time within the monetary system.

The Greek monetary authorities through the Bank of Greece have never used open market operations as an instrument of monetary policy, a fact which greatly affects the way the policy is conducted and the degree of its effectiveness. The Greek monetary authorities have deprived themselves of such a direct instrument in regulating the supply of money and the structure of interest rates (short-term and long-term) and thus the general liquidity of the economy. (ii) The Bank of Greece as the Bank of the Banking System (a) Although the Greek monetary authorities do not use open market operations as an instrument of monetary policy, they have, in their efforts to achieve the stabilization and economic development 5

See also G. Kasmas (1972).

6

Since August 1985 Treasuiy bills are sold to the public as well.

7 For a detailed analysis on these issues and the official intervention in the primary and secondary securities markets, see G.D. Demopoulos (1983 b); see also G. Kasmas (1972) and AS. Courakis (1981).

The Rilanciai Sector

29

objectives, heavily relied on monetary policy as a means of demand management as well as of influencing the allocation of credit to various sectors of the economy. To these ends, on October 1956, the authorities have introduced a complex system of quantitative controls, such as compulsory differential reserve requirements on banks' liabilities and assets, selective credit controls, thefixing of interest rates ο paid on bank credit and deposits, and credit ceilings. The various controls were aiming at: - the efficient distribution of available credit between the private and the public sector; - the efficient reallocation of credit to sectors of "national priority"; - the

prohibition

or

discouragement

of allocating

credit to

nonproductive activities. (b) Commercial banks are permitted to resort to the Central Bank (the lender of last resort) for cash by rediscounting their portfolio of eligible commercial papers. The rediscounting is operating within limits fixed by the authorities. Rediscounting started only after 1956. Hence

8

;

A thorough analysis of this complex system of controls and their disadvantages thereof for the desired objectives of economic development and stabilization is given in a recent paper by G.D. Demopoukx (1964 a), An Analytic Formulation and Evaluation of the Existing Structure of Legal Reserve Requirements of the Greek Economy: An Uncommon Case, Economic Papers, No. 33, Commission of the European Communities, Brussels, June. See also G.D. Demopoukx (1961) and A.S. Courakis (1981). On the question of selective controls see also G.C Bitros (1961), The Fungibility Factor in Credit and the Efficacy Question of Selective Controls, Oxford Economic Papers, Nò. 3, November, pp. 459-477. On the administratively determined interest rates see also J.M. Papadakis (1978), The Policy of Administratively Determined Interest Rates, Athens: Institute of Economic and Industrial Research (in Greek). This and items (c) and (d), which follow, draw on G. Kasmas (1972), pp. 32-34.

30

Chapter

the rediscount rate, i.e. the bank rate, became operative as a means of monetary control only after 1956. (c) Commercial banks are also permitted to make overdrafts in their "current account" with the Central Bank to meet their temporary shortages of funds (banks' cash holdings in the form of balances at the Central Bank make the "current account"). Overdrafts are operating within limits and are considered as satisfying urgent financial needs (particularly seasonal). (d) Apart from the above activities, the Bank of Greece is allowed by its statue law to carry out "ordinary banking activities" with the private sector. These include mainly the acceptance of deposits (without interest), transactions in commercial bills and making loans and advances. In the immediate post-war years and through 1956, these activities had a particular monetary significance since the financing of the economy was made mainly through the Bank of Greece. After 1957 when banking activities were remarkably increased, the above activities of the Bank of Greece gradually diminished.

d. The Capital Market Committee The Capital Market Committee -a public body- is entrusted with specific power to stimulate, improve and strengthen the capital market. The Committee operates under the auspices of the Ministry of Commerce with the participation of the Ministries of Economy and Finance, the Bank of Greece, the commercial and investment banks, the Athens Stock Exchange and the Athens and Thessaloniki Chambers of Commerce. At present, the Deputy Governor of the Hellenic Industrial Development Bank acts as a Chairman of the Committee.

The Financial Sector

31

The Capital Market Committee formulates the country's capital market policy and has the overall supervision of and responsibility for the execution of this policy. It acts as adviser to the government and the Bank of Greece.

e. Private and State-owned Financial Institutions10 (i) Commercial Banks Commercial banks constitute the main body of the country's credit system. They are highly concentrated in the sense that the greater part of commercial banking activity is accommodated by the two major banks, namely the National Bank of Greece and the Commercial Bank of Greece. The former covers 60% of total commercial banking activities, while the latter (along with the Ionian and Popular Bank) covers approximately 20%. They both have an extensive network of branches all over the country. This illustrates the oligopolistic structure of commercial banking which, however, is technically well developed. Despite the extent of the branch network, the use of checking accounts is very limited in Greece, the greater part of the liability side of the balance sheet of the commercial banks being in the form of private savings and time deposits. Commercial banks extend short-term credit to industry, domestic services, import and export trades, the tobacco trades and shipbuilding. Medium- and long-term credit is extended to industry and other enterprises for investment in plant and equipment and also to public enterprises. A relative peculiarity of the Greek system is the practice whereby commercial banks participate in the equity capital of a number of private enterprises. Finally, the banks are

10

It is taken from G.D. Demopoulos (1983 b).

Chapter

32

required to invest a large part of their total private deposits in interestbearing Treasury bills. (ii) Investment Banks There are three Greek investment banks: the Hellenic Industrial Development Bank, which is a state-owned institution; the Investment Bank, and the National Investment Bank for Industrial Development, which are private banks. These banks were founded with the purpose of boosting the development of the capital market in Greece. The main functions of the investment banks are to extend medium- and long-term credit to industry and other enterprises such as mining, tourism and shipping, to participate in the equity capital of private enterprises, to issue and underwrite new issues of shares and bonds and to provide technical and managerial assistance to their clients. (iii) Specialized Credit Institutions Under this heading we classify the (mainly state-owned) institutions engaged in extending credit to specific sectors within the country's economy. They extend credit to sectors where there is lack of interest on the part of the private financial institutions, mobilizing and allocating public and private financial resources in the process. (iv) The Specialized Credit Institutions are: (1) the Agricultural Bank of Greece, with an exclusive network of branches spread all over the country. It functions as a bank in the sense that it accepts deposits (mostly in the form of savings). It is, however, mainly financed by the Bank of Greece. It extends short- and long-term credit to agriculture; it distributes fertilizers and other supplies to farmers; it supervises farm cooperatives and provides technical and management assistance;

The Financial Sector

33

(2) the Postal Savings Bank which functions as a bank in the sense that it accepts deposits (mostly in the form of savings) and extends long-term credit to local authorities; public enterprises and to public sector employees and pensioners for housing; (3) the National Mortgage Bank of Greece functions as a bank in the sense that it accepts all types of deposits including deposits in foreign exchange. It is, however, mainly financed by the Bank of Greece. It extends credit to the housing sector, tourist enterprises, public enterprises and to non-profit-making organizations. It is the major mortgage institution of the country; (4) the Mortgage Bank which also extends credit for housing; (5) the Consignations and Loans Fund which accepts consignment deposits as well as private savings deposits; it manages the funds of public entities; it extends credit to public entities, non-profit-making organizations and to public sector employees and pensioners for housing. (v) Insurance Companies There are numerous insurance companies, both Greek and foreign, operating within the country. The Greek insurance companies can be divided into two categories: Those which are directly controlled by commercial banks, i.e. the "banking insurance companies", and others all of which are small family companies. The insurance companies in Greece, in contrast to those in economies with a developed capital market, do not occupy an important position in the financial markets. They invest much of their assets in real property, with only minor purchase of fixed-interest securities. However, they do engage in some purchases of business stocks and shares, though their total credit to the private sector is still rather than low. By contrast, the insurance

34

Chapter

companies hold a substantial percentage of their total assets in bank deposits. It is noteworthy that insurance business claims (mainly unpaid premiums) represent a significant percentage of their total assets, too. The main reason for the peculiar investment pattern of the insurance companies is, as suggested above, the underdeveloped nature of the capital market in Greece, where the number of securities transacted on the stock exchange is limited and investment in securities with satisfactory productivity and a high marketability is very difficult. This situation suggests, of course, that savings are not being efficiently channelled towards capital formation. (vi) Pension Funds Pension funds can affect the liquidity structure of an economy by switching operations in the vast amounts of reserves they hold as well as through their investments of newly accruing funds. They can also play a special role in the longer term capital market due to the special nature of their liabilities, since they are in a position to hold long-term investments. In Greece, pension funds do not exercise an independent investment policy, particularly as regards their holdings of financial assets. They are required by law to invest all their funds in the form of deposits with the Bank of Greece, where in turn they are mainly utilized for the financing of agriculture, trade and industry; the remainder is invested in government securities, shares and units of the Greek investment funds and in other shares quoted on the Athens Stock Exchange.

The Financial Sector

35

2. The Period 1953-1963 a. Policy Objectives The basic objectives of monetary policy were 11 - price stability, - high rate of economic growth; - stability in the external value of the currency; - high level of employment. Price stability was considered as the primary economic objective since Greece experienced three socially and economically disruptive hyperinflations during and immediately after World War Π. These have created a highly inflation-conscious public which reacted immediately to inflationary expectations (attempting to acquire assets such as gold, real estate, etc.). Thus, price stability was chosen as the main objective for the country's economic development. Economic growth was considered to be rather a long-run economic objective. Raising the ratio of savings to income, growth could have led to structural transformation of the economy necessary for a sustained development process. The stability in the external value of the currency could have affected positively the confidence of the public who had experienced a long period of instability during and immediately after World War II. Moreover, since Greece was heavily dependent on resources from abroad, equilibrium in the balance of payments was essential for the purpose of economic development.

See also G. Kasmas (1972) and Bank of Greece, Annual Reports, 1953-1963.

36

Chapter

Finally, the objective of a high level of employment was also considered along with the other objectives.

b. Instruments Employed By 1956 institutional arrangements for the extension of credit were beginning to operate normally.

12

The discounting mechanism was established in 1956 and banks were allowed to rediscount their portfolio of eligible commercial paper with the Bank of Greece. The rediscounting was operating within limitsfixed by the monetary authorities. In the immediate post-war years, thefinancing of the economy was made mainly through Central Bank funds. Commercial banks were permitted to make overdrafts in their current accounts with the Central Bank to meet their temporary shortages of funds. They were operating within limits and were considered as satisfying urgent financial needs (particularly seasonal). However, the Treasury bills market is still in its infancy. The needs of the private sector for short-term credit are covered almost exclusively from commercial bank funds. The capital market, the corporate stock market, and the corporate bond market are very thin. The market for government bonds has not improved considerably. There is no great variety of financial intermediaries in the Greek financial system. Thus, a large amount of savings is channelled directly to investment without the intervention of financial intermediaries. The remaining part, due to underdeveloped capital market, takes the form of bank deposits and especially the form of savings deposits. As a result, commercial banks grow fast and dominate both the capital and money markets. 12

See also G.D. Demopoulos (1983 b); G. Kasmas (1972); DJ. Halikias (1978); Bank of

Greece, Annual Reports, 1953-1963.

The Financial Sector

37

The implications of the above for the workings of the monetary system are: (i) The transmission mechanism of the monetary system does not operate as in economies with advanced capital and money markets. (ii) The monetary authorities enhance their power over the control of the country's money supply. (iii) The monetary authorities have deprived themselves of using the conventional measures of control, i.e. open market operations. Instead, they have introduced a complex system of quantitive controls, such as compulsory differential reserve requirements on banks' liabilities and assets, selective credit controls, the fixing of interest rates paid on bank credit and deposits, and credit ceilings.

3. The Period 1963-1973 a. Policy Objectives From 1963 to 1966 the authorities looked at the same basic objectives as in the previous period 1953-1963, namely: price stability, high rate of economic growth, balance of payments equilibrium, and high level of employment. In 1967 when the economy turned into a recession period due to the loss of the public's confidence, the military government set the objective of reactivating the economy by stimulating aggregate demand through expansive monetary and credit policies and an active fiscal policy. Particularly the basic objectives for the period 1968 to 1972 were outlined in the Five-Year Economic Plan of the military government, they were: an annual rate of economic growth of approximately 8 %, stability of the external value of the currency, high levels of employment, investment, and export trade.

38

Chapter

The active economic activity continued through 1972. As a result of the overexpansion of domestic demand and the substantial increase in foreign prices, the inflationary pressures were seriously built into the economy and the military government adopted by the end of 1972 restrictive monetary and credit policies and price controls. At the same time, the authorities resorted more and more to the safety value of foreign borrowing.

b. Instruments Employed In September 1963, the Currency Committee modified most of the quantitative credit controls imposed in the post-war period and introduced a substantial reform with the objective to liberalize and simplify bank credit policies (Decision 1294/13.9.1963). The principle modification was the introduction of a few general principles and criteria on banks' lending activities. Nonetheless, the pre-existed complex system of qualitative credit controls and regulations was basically maintained though in certain types of 13 credit a number of quantitative controls was eased. In September 1966, the Currency Committee modified further the system of bank credit. The new liberalization was directed towards the bank credit to industry and export trade; the qualitative credit controls were mostly abolished and some freedom was given to banks in their credit allocation to these sectors. Also, banks were allowed, for the first time in the post-war period, to extend credit to private enterprises at their own evaluation. All other credit controls and reserve requirements were maintained. In the year 1967 the economy was disturbed and turned into a recession as a result of the April military coup. The public's confidence in the banking institutions was adversely affected and withdrawals of their deposits had reduced commercial banks' liquidity.

On these developments see DJ. Halikias (1978), pp. 48-65.

The Financial Sector

39

The government of the Colonels decided to reactivate the economy by stimidating aggregate demand. So, from 1967 to 1971, they introduced an expansionary monetary and credit policy and allowed a rapid growth of public expenditures. The Bank of Greece returned to the post-war period as a source of finance for all credit institutions: rediscounting and overdrawing facilities at lower borrowing costs were enhanced; the specialized credit institutions were allowed through the facilities of the Bank of Greece to extend short- and long-term credit to different sectors of the economy; ceilings on credit for the housing industry, the trade and other sectors were raised; investment of the manufacturing sector was made available through the governmentowned specialized credit institutions and private investment banks; credit for agricultural products was also eased through the Agricultural Bank of Greece. To this end, a removal of a number of qualitative and quantitative credit controls was introduced in September 1968, such as: elimination of the previously held large number of interest rates on credit to the private enterprises; preferential interest rates on bank credit were adopted for different sectors, such as export trade, long-term credit of investment in manufacturing, mining and tourism (the subsidized interest rates were born mostly by the monetary system); ceilings on credit to different sectors of the economy were raised. Through this change, the authorities aimed at using the interest rate policy as an instrument of monetary management; such an instrument, however, never worked since the basic structure of the complex system of credit controls remained unchanged and continued to be used as a main policy instrument. From mid-1971, there was a recourse to the previously held system of credit restrictions and controls due to irregularities which the liberalization introduced in September 1968.

Chapter

40

By the end of 1972, when the inflationary pressures were seriously built into the economy, the authorities introduced additional credit restrictions and controls and the existing price controls were further enhanced. In general the instruments employed were: - a complex system of qualitative and quantitative credit controls and regulations; - differential reserve requirements on banks' liabilities and assets; - a multiple system of administered interest rates paid on bank credit and deposits; - a multiple system of rediscounting policy (a central discount rate was maintained); - ceilings on bank credit; - price controls.

4. The Period 1973-1983 a. Policy Objectives14 The restrictive policies which were adopted by the end of 1972 to fight the excessive inflationary pressures continued through mid-1974. However, the success of these policies in defeating the inflationary burst of 1973 and 1974 was only partial. Between 1973 and 1974 the consumer price index rose by 26.9 percent. The combined effect of restrictive policies and disruptive inflation had resulted in a deepening recession. Lower GDP growth rates, a remarkable slowdown in private consumption, and (despite the increased level of government consumption to stimulate domestic demand) a sharp decline in gross fixed investment have been the general characteristics of the recession. This section draws on G.D. Demopouloe (1984 b); see also Bank of Greece, Annual Reports, 1973-1983.

The Financial Sector

41

The first oil price shock of 1973-74 had aggravated the recession both directly - the country is ill-endowed with indigenous energy sources - and indirectly, through the ensuing recession in the OECD area. The Turkish invasion of Cyprus in mid-1974 resulted in adversely affecting the public's confidence in the ability of the banking system to maintain convertibility of its deposits into cash. The restrictions on the withdrawal of private deposits imposed by the military government aggravated the problem. The democratic government, which assumed power in late July 1974, had to deal with a severe recession and an accelerated inflation. The policy objectives were directed mainly towards stimulating demand and economic activity, the objective of reducing inflation had to be reconciled, too. Between mid-1974 and mid-1975, the combination of measures taken to improve the private sector's liquidity, and the expansionary effects of the government sector's operations, balanced by the contractionary money supply effects of the external deficit, suggest that monetary policy seems likely to provide a relatively small impetus to demand. Monetary authorities were confronted with the difficult task of reconciling the government's objective of reducing the inflation with the need to finance the substantial government deficit, while continuing to provide sufficient credit to support private sector activity. In response to expansionary monetary, credit and fiscal policies, the country's GDP recovered strongly in 1975. However, there was an acceleration of money growth (both M^ and M^) which continued into 1975. The main expansionary factor behind this growth was the public sector's borrowing, particularly that of the central government. As a result, by the middle of the year, the authorities switched to restrictive monetary and credit policies. The Greek GDP continued to grow again through the year 1978 and even more rapidly than that of the rest of the EEC countries. However, in the recovery years 1975-78, Greece did not return to the low inflation rates of

42

Chapter

the 1960's or even to single figures, the low point being 12.5 percent for 1978; and this, in contrast to the objectives of the authorities to limit the inflationary consequences stemming from the rapid rise in the monetary aggregates in 1979 and the reduction in the banks' liquidity since 1977. During the second oil price shock of 1979-80, prices accelerated again to 24.8 percent in 1980. In contrast to other members of the EEC, fiscal and monetary policies were not used to correct this situation, but rather seem to have fuelled the inflation process. Thus, though the annual growth of domestic bank credit to the private sector was more favorable than to the public sector during 1970-78 (except in 1973 and 1974), in each year since 1979 the acceleration of credit expansion to the public sector far beyond the expansion of credit to the private sector remained sustained. In spite of this restraining factor, the growth of the money supply (Mj) accelerated. A substantial acceleration of the money supply was due also to the explosion of the Public Sector Borrowing Requirement (PSBR) in 1980 and 1981. The substantial acceleration of the money growth runs in contrast to the authorities' objective of limiting the inflationary pressures in 1979-80. These developments along with the decline in productivity, the deterioration along with the decline in productivity, the deterioration in terms of trade, and the stagnant investment growth resulted in a severe recession by 1980 which continued through 1983. In October 1981, the new government adopted a wide range of policies based on the objectives of social justice and the modernization of the economy. Among the first measures taken were: a system of automatic indexation; a substantial improvement of the social security of the agricultural sector; raising the average minimum wages by 40 %; raising new taxes on large holdings of real estate; the working week has been reduced from 42 to 40 hours and a right to four weeks paid holiday has been implemented; the socialization of certain enterprises also reflects the government's objectives.

The Financial Sector

43

The government's programme to modernize the Greek economy is fully incorporated in the Economic and Social Plan for the years 1983-1987. From about the middle of 1982, the stance of monetary and credit policies began to change due to the rapid growth of M^ which accelerated from 20.9 percent in 1979 to 31.3 percent in 1981 and to 323 percent in 1982 (on the basis of annual averages). The objectives now were directed towards: restrictive credit controls; simplifying the interest rate structure and narrowing the large differentials which have existed between the various interest rate categories, and raising gradually the whole range of interest rates in real terms; the anti-inflation policy has been based on measures affecting prices and incomes: the authorities have relied on strict income policies (partial indexation) to restrain inflation; at the same time, the authorities have strengthened the operation of long-standing laws controlling prices (whole-sale prices are also subject to control). The instruments employed are detailed in the next section.

b. Instruments Employed The restrictive measures which were taken from the end of 1972 through the mid-1974 to fight the accelerating inflation included: - A major increase in banks' reserve requirements; tightened consumer bank credit conditions; severe limitations on bank credit for new housing investment; and a ceiling on short-term bank credit. The banks were instructed to apply the credit restrictions selectively so as to favor high priority activities. - An increase in Central Bank's discount rate; maximum deposit rates were also increased as were rates of interest charged on bank credit. The pace of monetary expansion decelerated sharply in early 1974, reflecting the sluggish growth of credit, a recovery of savings and time

44

Chapter

deposits and the contractionary effects of the external trade. However, these restrictive measures together with the disruptive effects of an accelerated inflation have resulted in a severe recession. From the mid-1974 through the mid-1975, special steps were taken by the new democratic government to ease the liquidity problems, while a series of measures were introduced in an effort to stimulate demand and economic activity (the objective of reducing inflation also had to be considered): - Ceilings on short-term bank credit to industry, export trade, and tourism were raised; long-term bank credit for industrial investment and advance financing of export orders for manufactures were also exempted from the ceiling on bank credit to the private sector; also a more flexible system on bank credit to the manufacturing sector, shipping, and tourism was adopted; in addition, banks were given much greater freedom than before in selecting their credit policy; furthermore, restrictions on consumer credit were eased, provisions for housing loans were raised, and the ceiling on mortgage loans by the state-owned specialized credit institutions was raised. - Reserve requirements on banks' deposits were lowered, and the Central Banks' discount rate was reduced along with the rate charged on banks' overdrafts with the Central Bank. The provision of ample credit to finance different sectors of the economy and especially those of housing and domestic trade activities has reinforced speculative pressures and exacerbated inflationary strains in these sectors. At the same time, the expansionary monetary and credit policies led to an acceleration of the money growth, which continued into 1975. Thus, by the middle of 1975, the authorities switched to restrictive monetary and credit policies:^

15

Sec G.D. Demopoulos (1984 b); DJ. Halikias (1978), pp. 68-71.

The Financial Sector

45

- Reserve requirements on banks' deposits were increased, and the discount rate was raised along with the rate charged on banks' overdrafts with the Central Bank. - The Central Bank had transferred to commercial banks lending activities that had been actually financed directly or indirectly out of Bank of Greece funds; banks were also encouraged to increase their lending activities for the purpose of financing the investment programmes of public enterprises, an activity which in the previous years depended largely on Bank of Greece funds. These measures have proved inadequate for decelerating the money growth which exceeded the target fixed by the authorities and hence facilitated the maintenance of a high inflation rate, due mainly to the rapid expansion of bank credit to support private sector's activity at the same time (an expansionary effect of the government sector's operations was taking place). To this end, the authorities imposed seasonal reserve requirements on banks' deposits in September 1976, and at the beginning of 1977, reserve requirements were extended to all types of deposits, including, for the first time, deposits in foreign exchange. At the same time, the state-owned specialized credit institutions were requested to raise funds from the market on their own account in order to reduce their dependence on the Bank of Greece for funds. Monetary policy was tightened in 1978.16 For the first time since the adoption of a more flexible system for monetary management (mainly based on reserve requirements) in the mid-1970s, the 1978 measures relied heavily on officially-controlled interest rates for the implementation of the monetary objectives; most interest rates paid on bank credit and deposits increased sharply. In the past, when the key instrument for monetary management was credit controls, interest rate changes were fairly small and infrequent. Of On these developments see references cited in footnote 14; also see OECD, Economic Survey for Greece (various issues), Paris.

Chapter

46

particular importance was the rise in two successive steps in 1978 in the penalty rate applied on banks' debit position on their current account with the Bank of Greece. As a result of this sharp increase in interest rates, the extension of bank credit to trade sector decelerated markedly. During the second oil price shock of 1979-80, prices accelerated again to 17 24.8 percent in 1980. To limit the inflationary consequences, the authorities fixed in 1979 fairly restrictive targets for the growth of currency in circulation and for total credit to the private sector. Whereas the expansion of bank credit to the private sector had been much more favorable than to the public sector during 1970-78 (except in 1973 and 1974), in each year since 1979 the larger share of bank credit expansion has gone to the public sector. Allocating a larger share of bank credit expansion to the public sector at the expense of the private sector in recent years might be thought to establish some control over the monetary expansion though yet no significant improvements are visible. In spite of this restraining factor, the growth of M^ accelerated from 20.9 percent in 1979 to 313 percent in 1981 (on the basis of annual averages). A substantial acceleration of the money growth was also due to the explosion of the PSBR in 1980 and 1981. Therefore, it can be argued that monetary and fiscal policies in Greece were not used to correct the accelerating inflation during the second oil price shock, but rather seem to have fuelled the inflation process. In October 1981, the new government adopted a wide range of policies based on the objectives of social justice and the modernization of the economy. In the area of thefinancial sector the government has taken the following measures: (1) An important institutional arrangement, which has been mentioned in Section Π.1, was the abolition of the Currency Committee through which Ministers had previously controlled the Bank of Greece τη

It draws on G.D. Demopoulos (1984 b).

The Financial Sector

47

operations and the assignment of the responsibility for the development and implementation of the country's monetary and credit policies to the Bank of Greece; the new legislation (L.1266/82) defined also the terms of the government's access to Bank of Greece credit. This institutional change sets monetary policy undoubtedly on a sounder basis while improving its effectiveness.*® (2) In 1981, reflecting the official policy objective of raising the real earnings of low income groups, a formal partial indexation system was established providing for automatic adjustment every four months:*^ For 1982, average earnings in the non-agricultural sector increased in real terms with a significant reduction in wage differentials. However, rapid wage increases, longer holidays, shorter working hours and weak productivity trends have led to a steady acceleration in the growth of 20

unit labor costs. (3) From about the middle of 1982, the stance of monetary and credit policies began to change: credit expansion had been restricted considerably; credit controls were intensified and the Bank of Greece's penalty rates on banks and enterprises were strictly enforced, thus the supervision of the operations of commercial banks became stricter; the targets for private sector monetary and credit expansion were broadly observed in 1982, which after taking into account the effects of recession and higher than expected inflation, imply a fairly restrictive stance towards the private sector as it has been analysed earlier in this section; on the contrary, in line with official policy, credit to small- and medium15 The abolition of the Currency Committee and the return of its functions to the Bank of Greece had been established first in a theoretical framework on the workings of the monetary policy in Greece by G.D. Demopoulos (1981). 19 2 0

A detailed analysis of the working of the system is given in Chapter Three, Section IV.2. See OECD, Economic Survey for Greece, 1983, Paris, pp. 16-28; G.D. Demopoulos

(1984 b).

Chapter

48

size firms continued to increase since 1982 while providing sufficient resources for the easiestfinancing of investment initiatives (agriculture, housing, etc.); the temporary financing of problematic firms was also encouraged through funds collected by the Bank of Greece from the deposits of commercial banks. The credit to the public sector far beyond the expansion of credit to the private sector remained sustained during the world recession years of the early 1980s. For the years 1981, 1982 and 1983 credit to the private sector decelerated from 25.6 % to 22.8 % and to 17.5 % respectively, while credit to the public sector reached 54.2 %, 39.2 % and 21.1 %. The growth of M 3 accelerated first from 313 % in 1981 to 323 % in 1982 and then fell to 21.9 % in 1983. 21 (4) On interest rate policy: it has been the intention of the authorities to simplify the interest rate structure and at the same time narrow the large differentials which have existed between the various interest rates in real terms. In this context, the authorities gradually raised nominal interest rates of all kinds, including the interest rate charged to industry for loans for working capital while restricting thefirms' recourse to the Bank of Greece for refinancing relevant credits. Also, the recent increase in the interest rate on Treasury bills has facilitated not only government borrowing through the banking system by improving banks' income so that they could be in a position to offer higher rates on their deposits, but has also made the government aware of the true costs of its decision.

2 1

See G.D.Dcmopouloe (1984 b).

The

ic Sector

49

III. The Public Sector 1. The Main Institutional Arrangements We have seen in Section Π that the Bank of Greece (the Central Bank) acts as the government's bank; that is, the former meets the financial needs of the latter. This means that monetary policy is subordinated to the financial needs of the public sector. Under these circumstances one cannot expect to encounter an independent monetary policy. This is unlike the situation in other industrialized countries where there is no direct link between federal government deficits and open market operations. In Greece, the bulk of public debt, in the form of Treasury bills and government bonds, is held by the banking system and insurance companies; the holdings of public debt by the private non-banking sector are 22

negligible. The central government makes its operations clear by presenting each year its major budgets. There are three types of budgets: The ordinary budget, the investment budget, and the budget for agricultural support. They are presented below along with the items which enter the revenue and expenditure side respectively. (i) The Central Government Budget The central government presents its annual budget just before the end of the calendar year. Its structure is presented in Table 1.

22 The Public Sector Borrowing Requirement (PSBR) is analysed below.

Chapter

50

TABLE 1: CENTRAL GOVERNMENT BUDGET Revenue - Ordinary budget - Investment budget - Management for agricultural markets Expenditure - Ordinary budget - Investment budget - Management for agricultural markets Deficit - Ordinary budget - Investment budget Table 2 presents the Central Government Revenue. TABLE 2: CENTRAL GOVERNMENT REVENUE A. Ordinary budget LDirect taxes 1. Income taxes 2. Other ILIndirect taxes 1. Customs duties and levies 2. Taxes on the consumption of imported goods 3. Excise duties 4. Taxes on transactions 5. Other ΠΙ. Non-tax receipts (revenuesfrom entrepreneurial activities, etc.)

The Public Sector

B. Investment budget 1. European Regional Development Fund 2. Other C. Agricultural management (EAGGF Guarantee Section) Table 3 presents the Central Government Expenditure TABLE 3: CENTRAL GOVERNMENT EXPENDITURE A. Ordinary budget 1. Wages and pensions 2. Debt servicing 3. Refunds and reimbursements 4. Agricultural subsidies 5. Other transfers 6. Other consumption expenditures B. Investment budget 1. Agricultural expenditures 2. Industry, craft industries, energy 3. Transport 4. Education 5. Works of regional interest 6. Debt servicing 7. Miscellaneous C. Agricultural management (EAGGF Guarantee Section) 1. Withdrawals, storage, etc. 2. Production aid 3. Exports refunds 4. Miscellaneous

Chapter

52

The budget has taken this form since Greece's accession to EEC on 1 23 January 1981. To this end, some explanations are called fon ΛJ

- Agricultural management (Receiptsfrom EAGGF Guarantee Section)

Finance for this budget is provided by the European Communities. It refers to subsidies to those agricultural products which are financed by the EEC. The EAGGF Guarantee Section is gradually taking over the support of the agricultural market, which had been managed within theframework of offbudget trade accounts and had produced enormous deficits. Under community rules, subsidies are gradually being replaced by higher agricultural prices, and price support costs are covered by EAGGF Guarantee Section transfers. However, subsidies to cover the operating deficits of national trading operations other than those covered by EAGGF are now to be included in the ordinary budget, and the Bank of Greece is prohibited by law from financing agricultural subsidies. These measures have helped to put the budget on a sounder and more transparent basis. - Investment budget Finance for this budget is provided through its own revenues, subsidies, foreign aid and credit. The items on the expenditure side are given in Table 3. - Ordinary budget Ordinary budget revenue and expenditure are presented in Tables 2 and 3 respectively. 23 Central government made its operations clearer by presenting its major budgets together in 1982. 24 On this see G.D. Demopouloe (1984 b); Commission of the European Communities, European Economy (various issues).

The

ic Sector

53

(ii) Current Revenue and Expenditure of General Government The structure of current general government revenue and expenditure in Greece is presented in Table 4. TABLE

4:

CURRENT

REVENUE

AND

EXPENDITURE

OF

GENERAL GOVERNMENT A. REVENUE 1. Indirect taxes 2. Direct taxes 3. Social security contributions 4. Other current resources B. EXPENDITURE 1. Final consumption expenditure 2. Subsidies 3. Social security benefits 4. Other current transfers 5. Other expenditures (property income payable) (iii) The Public Sector Borrowing Requirement (PSBR) The PSBR derives both from the general government and from the public enterprises. The overall structure of the PSBR on cash basis is given in Table 5 . ^

25 For an extensive analysis of PSBR see G.D. Demopouloe (1984 b). See also G.D. Demopoulos and A Gagales (1982), An Aggregate Model of the Greek Economy, Athens, July (Mimeo).

54

Chapter

TABLE 5: THE PUBLIC SECTOR BORROWING REQUIREMENT ON CASH BASIS A. NET PSBR 1. Government budget (ordinary and investment) 2. Accounts for the purchase of agricultural products and supplies 3. Public enterprises 4. Local governments and other public entities B. SUPPLEMENTARY DATA 1. Change in sight deposits of public enterprises and other public entities 2. Debt amortisation payments As can be seen the PSBR is to a large extent under the control of the authorities and the same is true for credit extended by specialized credit institutions. The PSBR is essentially a financial concept and is revealed since: - the bulk of the public debt in the form of Treasury bills and government bonds is held by the banking system and insurance companies; - the market of government bonds has been inactive. New issues of government bonds have not appeared since 1973 (apart from a recent modest revival of bond sales by the banks); - the portion of public debt held by the private non-banking sector and by non-residents is negligible; - the private non-banking sector is not allowed to invest in Treasury bills;

The

ic Sector

55

- the general government component of the PSBR will in general not correspond exactly with the general government balance as shown in the national accounts. The authorities have the option to finance deficits alternatively through: - taxation; - money creation; - increase in reserve requirements (essentially costless borrowing from commercial banks); - selling Treasury bills to commercial banks and insurance companies; - attracting deposits at specialized credit institutions; - borrowing from abroad. The reluctance of the government to raise funds through the capital market stems from the fact that the public succeeds in satisfying new capital requirements by borrowing from the banks (which, as mentioned in Section Π, accumulate the bulk of short-term savings) at lower interest rates than would be required on the new issues market. Given the inflationary experience of Greece, the latter would demand relatively attractive rates which could contribute further to increasing the national debt. (iv) Public Enterprises There are over 40 public enterprises, some very large and important in terms of services and budgets and others very small. The business activities undertaken by the Greek public enterprises extend far beyond the area of public utilities to include trading enterprises, direct productive concerns especially in the manufacturing sector, and state-owned

From G.D. Demopoulos (1983 b), pp. 152-153.

56

Chapter

specialized credit institutions. In addition, there is a number of "autonomous public enterprises" which are also state-controlled. It is generally agreed that their efficiency stands at a very low level; it can be, however, improved; but this would involve a large reduction in the manpower they employ with unavoidable consequences for unemployment and the social security budget. Their operations result in a considerable deficit which is covered either by the central government budget or else by the operating surplus of other public enterprises.

2. The Period 1953-1963 a. Policy Objectives It was not until 1950 that the Greek government was able to embark on the task of the country's economic reconstruction which was financed partly out of public revenue and partly by the U.S. aid under the Marshall Plan. To this end, an Economic Development Plan for the period 1952-56 was adopted. The plan was aiming at increasing the potential for economic development, solving the demographic problem, and restoring an organic equilibrium in the economy. The plan outlined an array of specific productive investment projects for the purpose of utilizing the natural resources of the country (domestic energy sector, establishment of state-owned manufacturing units, such as aluminium, magnesium, nickel, oil refineries, etc.). Financing of the plan could have been possible through the restoration of domestic monetary stability and increasing the inflow of foreign capital for purposes of productive investment through the establishment of a legal framework. To this end, a large devaluation (50 percent) of the drachma in April 1953 and "a subsequent favourable political climate along with a number of measures taken by the authorities, created an environment which

The

li Sector

57

was characterized by a satisfactory internal stability and a high increase in 27 the level of economic activity". The period through 1956 exhibited a substantial increase in prices due mainly to the devaluation in 1953; by 1956 the devaluation effects had worked themselves out and a new period of remarkable monetary stability started thereafter. 2Q The objectives set out for fiscal policy started in 1956 were: - to improve economic development and to achieve a more equitable distribution of income; - to increase the surplus in the current account of the budget, thus promoting the objective of monetary stability and increasing the savings of the government; - to build up the infra-structure of the economy by enlarging the government investment programme. These objectives were well observed through the year 1966.

b. Instruments Employed The instruments employed in order to meet the objectives of fiscal policy were: - tax measures - expenditure policy.

27 28

See G. Kasmas (1972), p.6. This section and the following draws heavily and quotes from G. Kasmas (1972).

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As to the tax policy: revenue considerations were placed on a secondary basis in the context of tax policy when the current account of the budget was balanced after the year 1957. This orientation of the policy led to a reduction in direct income tax rates and an increase in indirect tax rates (on consumer goods, particularly luxuries imports from abroad). Also, a readjustment of taxes on property as well as extending different tax incentives were adopted for purposes of economic development. Thus, adjustments in tax policy with the exclusive purpose of affecting aggregate demand were rarely adopted. As to the expenditure policy: first, the monetary authorities made an effort to expand investment activities through the budget. To this end, Treasury bills were first issued in 1957 and were placed within the monetary system; commercial banks and specialized credit institutions were required to invest a certain percentage of their private demand and savings deposits in Treasury bills. Second, to the extent that the investment programme of the government was not covered by domestic borrowing or through foreign sources, the government resorted to the Bank of Greece. The needs of the developing economy were also met through the process of continuously increasing the money supply. This increase, however, did not take place through the banking system (i.e. decrease in reserve requirements and extension of rediscounting facilities) but rather directly through the Central Bank (i.e. direct advances to the economy and direct advances to the government). This process of growth of the money supply provided a convenient way of stabilizing the economy.

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ic Sector

59

3. The Period 1963-1973 a. Policy Objectives The period 1963-1973 was a period of fast output and productivity growth in all sectors of the economy. It was the period where a wage sector was formed while the economy became integrated into the world economic system; the association agreement of Greece with the European Economic Communities which became effective as from November 1, 1962, marked 29 the beginning of a new era for the Greek economy. The policy objectives for the period 1963 to 1966 were the promotion of economic development, a more equitable distribution of income, the increase in the surplus of the current account of the budget, and the expansion in the government's investment programmes; fiscal policy was also used as an instrument to preserve monetary stability. In 1967 when the military government assumed power, the policy objectives which were outlined in the Five Year Economic Plan 1968-1972, were directed towards promoting economic development, high levels of employment and stability of the external value of the currency.

b. Instruments Employed30 In the period 1963-66 there was a reduction in the tax rates and other related tax reforms. As a result there was a rapid rate of increase in ordinary budget revenue caused by the rapid increase in national income, the high income elasticity of the tax system, and the yield from new taxes. Due to this 2 9

Sec L.T. Katseli et al. (1983) and G.D. Demopoulos (1984 b).

30 This section draws and quotes from Bank of Greece, Annual Report (various issues); OECD, Economic Survey for Greece (various issues), Paris.

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Chapter

orientation of the fiscal policy, there were noteworthy changes in the composition of tax receipts. That is, revenue from direct taxation increased faster without raising direct tax rates. It resulted mainly from the rapid increase in money income. At the same time, it appears that there was an improvement in the tax assessment and collecting system. In the period 1967-73 the surplus in the current account of the budget had increased rapidly but the total deficit increased as well due to widening increase in the public investment expenditures. Thus, the portion of direct taxes in total tax revenues was raised although essential weaknesses in the tax system continue to exist. On the other hand, there was a considerable increase in expenditures for public investment, public debt interest payments, and subsidies, while expenditures for public salaries and pensions were reduced. The high rate of growth of the revenue from direct taxes resulted mainly from the rise in revenue from personal income, from the increase of revenue from taxation on income earned in previousfiscal years, increased revenue from inheritance and gift taxes, and from curtailing of tax evasion. The slight decline in the growth rate of revenue from indirect taxes did not come about from an orientation of the policy to reduce them, but was basically due to the reduction of customs revenue and the decline of the rate of increase in revenue from taxes on tobacco and transportation. Under this type of fiscal policy important public investment projects were promoted through the period which contributed highly to economic development. At the same period, there was a continuous expansion of investment undertaken by public enterprises such as the Public Power Corporation, the Hellenic Telecommunications Organization, the Workers' Housing Organization, etc., plus private-sector investment financed with medium- and long-term credit from the state-owned specialized credit institutions. This type of fiscal policy was used through the Year 1972.

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61

By the spring of 1973, when the inflationary pressures were seriously built into the economy, the authorities announced restrictive policies, including the curtailment of public investment and regular budget expenditures to the levels of the first quarter of 1972. At the same time, they increased the incentives for regional development investment. The restrictive budget measures were applied through the middle of the year 1974 when the military dictatorship fell.

4. The Period 1973-1983 a. Policy Objectives The restrictive monetary measures which were taken at the end of 1972 and those of fiscal nature which were adopted in the spring of 1973 to fight the excessive inflationary pressures were not successful. Instead, the combined effect of restrictive measures and disruptive inflation had resulted in a deepening recession. The first oil price shock of 1973-74 had aggravated the recession. The public's confidence in the ability of banks to maintain convertibility of their deposits into cash had declined, and the Turkish invasion of Cyprus had worsened the situation. This had been the situation when the democratic government assumed power in late July 1974. The objectives of the new government were to stimulate aggregate demand so as to curb the recession, to secure monetary and price stability, and to restore labor's income share which had fallen sharply throughout the dictatorship period.

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b. Instruments Employed31 It was anticipated, as early as 1972, that economic policy would have to tackle serious problems in successfully increasing the level of economic activity and curbing the inflationary pressures at the same time. So, restrictive policy measures were taken as early as 1973 under which there was a curtailment of the public investment programme and of consumption expenditure of lesser significance for economic and social development. This reflected the objective of the authorities in enhancing the effectiveness of the general policy of curtailing the inflationary pressures and of checking their effect on the country's balance of payments. In addition, presentation of the 1974 budget plan in November 1973 had projected large cuts in government investment expenditures from the 1973 level, minor increases in ordinary expenditure and revenue and a reduction of the overall deficit to one-fifth of 1973's deficit. Gross borrowing needs would largely be covered through foreign borrowing. The measures taken in August 1974 and widespread feeling of confidence generated by the country's return to democracy helped to curb the recession. These measures were in the context of fiscal, credit and incomes policy. The government budget was revised in order to achieve sound fiscal management and cope with the various emergencies arising from the Cyprus crisis and strengthening the country's defense capability: - significant changes had been introduced in both direct and indirect taxation: a tax on real estate was introduced and certain indirect tax rates were increased; taxes on new buildings permits were abolished; a special non-recurring surcharge on large personal and corporate incomes was It draws and quotes from Bank of Greece, Annual Report (various issues); OECD, Economic Surveys for Greece (various issues), Paris; G.D. Demopouloe (1984 b).

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63

introduced; general government budget expenditure had reduced by 2^00 million drachmas from the level earlier envisaged for 1974; the public investment programme was modified with a view to strengthening its role in promoting economic development and improvingflexibility for shortterm adjustments. These measures were aimed at boosting production and consumer spending, gaining control of inflation and securing monetary stability. The changes in taxation aimed at redistributing the tax burden from personal and corporate income tax for the benefit of lower income groups. In February 1975, a new tax action was approved by the Parliament, including: income tax cuts for lower income groups; income tax increases for higher income groups; increased taxation of shipping; increased taxation of company profits; introduction of taxation on real estate; increases of the general turnover tax, the purchase tax on new cars, the tax on private cars in use, fiscal stamp duties and taxes on matches, cards, salt and cigarettes. Wages and pensions in the government and public enterprises sector were raised by 10 percent. Pensions provided under the social security scheme increased by 15 percent. The new democratic government not only had to end the over-heating of the economy but also to restore labor's share in GDP; labor's share has fallen throughout the dictatorship period. So, the 32 civilian government started to increase the share of labor income. The government continued to introduce some minor changes in the structure of tax policy and government expenditures along with its annual budget through 1978. These measures were initiated to improve the productivity of the public sector, to close certain loopholes in the tax system, G.D. Demopoulos (1984 b). On tax structure changes see T A . Georgacopoulos (1981), Tax Structure Changes and the Balance of Payments, Greek Economic Review 3, No. 1, April; on government expenditures see G A . Provopouloe (1981), Government Expenditures and Economic Activity, Athens: Institute of Economic and Industrial Research (in Greek).

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to simplify the process of assessment and payment of taxes, to expand tax incentives for regional development and company mergers. In 1977, new tax reforms were submitted to the parliament by the government which were aimed at reducing personal income tax on medium and lower income groups, lessening the burden from other taxes and limiting tax evasion. Again in 1978, radical changes were introduced infiscal policy which were reflected in the government's budget for 1979. The principal objectives were: to curb tax evasion; gradually abolish government subsidies and readjust the prices of goods and services supplied by the state or by public entities; secure surpluses for the self-financing of a considerable part of the investment programmes of several public enterprises; resort to borrowing directly from the capital market to cover a steadily increasing proportion of the public sector deficit so as to reduce its expansionary effects on the money growth; also, some important budgetary reforms were introduced, aiming at a more equitable distribution of the tax burden (they lessened the burden on lower income groups and especially farmers, wage and salary earners from income tax, capital tax and some indirect taxes), the curtailment of inflationary pressures and the promotion of regional and overall economic development. The result of all the abovefiscal measures taken between 1975-78 was a continuous growth of the Greek GDP through the year 1978 which was even more rapid than that of the EEC countries. Nonetheless, during the recovery years 1975-78 Greece did not return to the low inflation rates of the 1960's or even to singlefigures (the low point being 12.5 percent for 1978). During the second oil price shock of 1979-80, prices accelerated again to 24.8 percent in 1980 from 12.5 percent in 1978. Thefiscal measures adopted during this period were as follows: first, taxation scales were modified in November 1979 with the objective to reduce the tax burden which had increased owing to the high inflation and to curtail the excessive increase in imports of cars and luxury consumer goods, thus reducing the large expansion of the deficit of the balance of payments. Second, a set of fiscal measures to ease property taxes announced in July 1980 with the view

The Public Sector

65

(again) to reducing the burden from personal income tax owing to inflation, and eliminating certain expenditure evidence used in assessing taxpayers' presumptive income which seemed to have restraining effects on economic, particularly, construction activity. Tax concessions were in effect made in the form of tax credit, the novelty being that the accounts of credit equal the tax corresponding to specific tax brackets. Other fiscal measures during this period were: a 12 percent cut in government investment expenditures in 1979; a cut in the investment programmes of public enterprises, such as the Public Power Corporation, the Hellenic

Post

Office,

and the

Hellenic

Telecommunications

Organization, further a suspension of new recruitment in the public sector was extended in December 1979 for six months. The government was making efforts to reduce the growth of public expenditure, but fiscal and monetary policies, in contrast to other members of EEC, were probably not used effectively to correct the accelerating inflation but rather seem to have fuelled the inflation process; since the second oil price shock Greece has diverged substantially in inflation from other EEC members. Its causes were not only related to the impact of the second oil price shock, the strength of the U.S. dollar and the recovery of agricultural and other non-labor incomes, but also to the monetary and credit expansion which created an atmosphere of uncertainty. In April 1981, taxation scales were modified again aiming at cushioning the impact of sustained inflation on income tax, introducing a progressive revenue from indirect taxes and abolishing certain tax restrictions. The brackets of the tax scale expanded by about 20 percent (remained unchanged since 1974) in an effort to adjust it to developments in the consumer price index. In July, the suspension of new recruitment in the public sector with the exception of armed forces, hospitals and educational institutions was extended. By the end of the year the revenue shortfall on the ordinary budget was concentrated on indirect taxes, both on imported and domestically-produced goods reflecting the decline in real domestic demand and in the volume of merchandise imports. Receipts from taxes on petrol and luxury goods in

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particular grew substantially less than expected. Direct tax receipts also fell below the estimates. The deficit in the investment budget increased considerably, representing mostly interest and debt repayments (transferred from the ordinary budget). Expenditures were generally higher than planned partly because of higher inflation. In October 1981, the new government adopted a wide range of policies based on the objectives of social justice and the modernization of the economy. The first package of economic policy measures includes: (i) The Granting of "Corrective Sums" The policy adopted from January 1, 1982 provided the granting of "corrective sums" of 2,000-5,000 drachmas inversely proportionate to the level of gross earnings of each employee. (ii) A System of Automatic Indexation A formal system of automatic indexation of the public (and indirectly private) sector wages exists from January 1982. The wage adjustments are taking place in January, May, and September of each year. Under the formal system incomes up to 35,000 drachmas per month (approximately equal to average earnings) were totally indexed, and higher incomes received a degressive proportion. Analytically: for incomes between 35,000 and 55,000 drachmas indexation was set equal to 100 percent for the portion up to 35,000 drachmas and 50 percent for the portion between 35,000 and 55,000 drachmas. For incomes between 55,000 and 80,000 drachmas indexation was set equal to 25 percent for the portion between 55,000 and 80,000 drachmas and as previously for the portions 0 to 55,000 drachmas. There is no 33

See also Commission of the European Communities, European Economy, Annual Economic Report and Annual Economic Review, and Supplements (various issues).

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67

indexation increase for the portion of incomes exceeding 80,000 drachmas per month. In December 1983 the policy became considerably more severe since the wage increase due for the price rise recorded between September and December 1982, which should have normally be paid on January 1,1983 was delayed for months and was paid in two equal installments on January 1 and May 1, 1983: the wage rise due for the period from January to August was paid on September 1,1983. In December 1984, the government raised the upper limits on income brackets used as a basis for indexation: the upper limit on the first bracket to which full indexation is applied is now 50,000 drachmas (formerly 35,000 drachmas); that on the second bracket to which 50% of the indexation is applied is 75,000 drachmas (formerly 55,000 drachmas); and that on the third bracket to which 25% of the indexation is applied is 100,000 drachmas (formerly 80,000 drachmas). (iii) Other Social Measures Among those are: - An improvement of the social security of the agricultural sector. Pensions paid to farmers increased by 76%. - The working week has been reduced from 42 to 40 hours and a right to four weeks' paid holiday has been enacted. - The minimum daily nominal wage increased by 37% and the minimum salary by 42.5%, so that on average minimum wages increased by 40%.

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(iv) Socialization of Certain Enterprises The government decided to bring under public control certain enterprises which were not yet state-controlled. "Supervisory Boards"-Committees were established representing various interests, such as those of employees and local authorities. These boards are responsible for harmonizing enterprises' programmes with the government's development plans. This type of socialization was thought to increase the degree of participation in decision making and to make economic activity more responsive to the broad needs of national developments; at the same time it is claimed that they will not reduce competition since they have been applied to areas where competition has been considered to be low since many years back. This was especially required for those enterprises which have been in financial difficulties. It was decided that those which are not productive and viable should not be allowed to continue and that only those with long-term prospects of success should be allowed to survive through a process in which bank debt is converted into public equity capital and then come under social control. Socialization, however, has not required sweeping general legislation so far partly because key areas, such as commercial banks, insurance companies, etc., have been already under state-control. (v) Economic and Social Plan for the Years 1983-1987 The government's programme to modernize the Greek economy is fully incorporated in the Economic and Social Plan for the Years 1983-1987. It provides: government incentives for investment, including grants up to 50 percent of the cost of the investment, depending on the region and the branch of activity; interest subsidies and high depreciation allowances. Other tax measures were introduced in 1982:"^ income tax on undistributed profits was increased as well as the tax on dividends was Bank of Greece, Annual Report (various issues); OECD, Economic Survey for Greece (various issues).

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69

raised; business turnover tax and property tax were also increased; with the purpose of mitigating fiscal drag, income tax allowances of wage and salary earners were raised; most tax brackets were also increased by the same rate. Their objective was to cushion the impact of sustained inflation on income tax, to lower taxation of net profits of small partnerships and limited liability companies, to raise revenuefrom indirect taxes, to abolish or reduce certain tax exemptions, and to increase the efficiency in tax collection. The expansionary government policy in 1981,

intended to stimulate

domestic demand by improving income distribution in favor of lower income groups, resulted in a substantial rise both in public consumption and current transfers: the ratio of total general government expenditure (on a national account basis) to GDP was a 19 percent annual increase in 1981 in relation to the previous year. General government revenue on the other hand, which remained at higher levels than current expenditure as a proportion of GDP before 1980, did not increase expenditure in 1981, moving general government budget into deficit during recent years. The emerging gap of savings, which was about 5.7 percent of GDP in 1981, dropped to 2.8 percent in 1982 and to 22 percent in 1983 owing to sharply increased tax revenues in these years (considerable tax increases were adopted in 1982). In response to the sharply rising budget deficit and expenditure both on public enterprises and for the purchase of agricultural products and supplies, the public sector borrowing requirement (PSBR) on cash basis as a proportion of GDP increased by almost 100 percent in 1981 and tended to decelerate gradually thereafter; it was reduced from 15.14 percent in 1981 to 13.42 percent in 1982 and around to 12.0 percent in 1983, but still in double digit figures. Since the end of 1982, the government has changed its policy mix, relying on a strict incomes policy to restrain inflation and using fiscal policy both to

The analysis draws and quotes from G.D. Demopouloe (1984 b).

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promote employment and assist in correcting the structure of the Greek economy.

IV· Balance of Payments Arrangements 1. The Main Institutional Arrangements 36 Despite a rapid growth and the development of foreign trade, Greece has not managed to liberalize the convertibility of its currency over the post-war period. Greek exchange arrangements are still characterized by special institutional arrangements and strict administrative rules introduced in the post-war period and retained mainly because of structural problems experienced with the balance of payments. The structural weaknesses of the balance of payments are revealed from the following developments: the first is related with the highly increasing level of imports, a characteristic consequence in the process of economic development. The second is related with the fact that the Greek balance of payments depends to a great extent on unilateral transfers from abroad. That is, invisible items cover traditionally part of the trade deficit; however, the trade deficit has kept increasing at a higher rate and has more then outweighted the increase in invisibles. Between April 1953 and March 1975, the Greek exchange arrangements were guided by the system of fixed par value of the drachma against the U.S. dollar. In April 1953, the drachma was devalued by 50 percent against the U.S. dollar to a par value of drachma 30 to a dollar and points to a new era This section draws on G.D. Demopoulos (1984 b); Commission of the European Communities, European Economy, Annual Economic Report, Annual Economic Review (various issues). For an analytical treatment on the subject see G.D. Demopoulos (1983 a), Exchange Rate Policy in Greece, Working Paper, Brussels, June.

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71

in the country's economic history. This enormous depreciation was part of an overall economic programme intended to promote exports, attract foreign capital and encourage investment. Until 1970, the effective and real exchange rates of the drachma did not fluctuate very widely since the currencies of Greece's principal trading partners were fairly stable against the dollar and the inflation rate in Greece both in consumer prices and in unit labor costs remained lower than those of Greece's main trading partners. This enabled Greek products to remain 37 at competitive prices with a fixed exchange rate against the U.S. dollar. In October 1973, in view of the international monetary disturbance, it was decided to unpeg the drachma and upvalue it by 11.1 percent against the dollar, mainly in order to curb domestic inflationary pressures and improve the psychological climate. The policy pursued since then was a "controlled float". 38 In March 1975, the Greek authorities relaxed the strict pegging of the drachma to the U.S. dollar and the drachma embarked on a "controlled float" of its effective exchange rate under official Greek exchange arrangements. Since 1975 and until August 1983, exchange rate policy continued to concentrate on the par value of the drachma against the U.S. dollar while ensuring more or less steady depreciation of the effective exchange rate in order to preserve export competitiveness. From 1977 to 1979, the drachma remained practically constant against a depreciating dollar and fell only by about 24 percent against the ECU.

37 Sec G.D. Demopoulos (1984 b), pp. 52-56. 38

See Bank of Greece, Annual Report for the Year 1973, pp. 22-23.

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In October 1980, the Greek authorities introduced a new legislation which set up an interbank foreign currency market and this in conformity to the country's responsibility to the EEC to organize an exchange market in Athens and to quote the national currency on another community market. Under the interbank foreign currency market banks were authorized to maintain open positions against the drachma (within limits) and to carry out spot transactions: - This removal of restrictions on exchange transactions led to a certain degree of competition between banks to the advantage of users. - Since interest rates are regulated, the interbank foreign currency market has been confined to spot transactions. Forward cover for three and six months against the dollar has been provided by the Bank of Greece only for commercial banks. In December 1980, the drachma was brought into the Parisfixing. The market which is managed by the Banque de France is narrow and practically confined to purchasing, but it does ensure that other markets recognize the drachma rate. The official rate of the drachma is determined at the daily fixing by the Bank of Greece and official rates for other currencies are established accordingly as cross-rates. From 1980 to 1982, when the ECU fell by about 30 percent against the dollar, the drachma depreciated only by about 36 percent; this produced a distortion in the country's external competitive position. Thus, in January 1983, the drachma was devalued by 16 percent against the dollar, and by 15 percent against the ECU (in relation to the value at the end of Dec. 1982). From January 1983 to August 1983, the Greek authorities kept a fairly stable drachma-dollar rate; while the dollar was rising, the drachma appreciated by about 7.5 percent against the ECU despite the high inflation

Balance of Payments Arrangements

73

in Greece relative to the rest of the community. This policy produced adverse effects on Greece's competitiveness in relation to the community. Consequently, in August 1983, the Greek authorities were pushed to change their exchange rate policy once again. Since then, successive downward adjustments have restored a drachma-ECU rate more in line with the country's price and costs levels relative to those of the community partners. The exchange rate policy since 1975 has been directed rather towards the objective of preserving the competitiveness of the economy while attenuating the perverse effects of the self-perpetuating spiral of inflation and devaluation. The evidence shows that price competitiveness has been maintained since 1975, while cost competitiveness has deteriorated, particularly in relation to the community partners. This indicates that the "controlled float" has not been a conclusive experiment. Even after the 1983 devaluation, Greek relative costs for the economy as a whole did not return to the 1975 level in relation to the world main trading partners and were 39 much above the 1975 level in relation to the community partners.

2. The Period 1953-196340 a. Policy Objectives During the period 1953-1963 the stability of the external value of the currency had been a basic objective of economic policy, i.e. balance of payments equilibrium. Other special interests and objectives concerning the development of the balance of payments were considered. They were: 3 9

See G.D. Demopoulos (1984 b), pp. 47-52.

40 This section and the sections IV.3 and IV.4 draw heavily and quote extensively from Bank of Greece , Annual Report (various issues).

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74

- the increase in exports; - the improvement in foreign exchange reserves; - the attraction of foreign capital and also of the interest of foreign enterprises. Exports have always been considered a dynamic factor with a decisive role in the country's economic development. Hence, the concentration of efforts in the direction of enhancing production of exportable agricultural, handicraft and industrial products was of special interest. On the other hand, improvement in foreign exchange reserves was a prerequisite for creating confidence abroad about the country's foreign exchange position and thus for attracting foreign capital.

b. Instruments Employed In order to try to influence the external transactions favorably, the government took two measures in 1953. First, according to the law 2415/53 the drachma was devaluated by 50 percent against the U.S. dollar to a par value of drachma 30 to a dollar. The second measure was the Legislative Decree 2687/53. It was designed to attract long-term loans and entrepreneurial capital. Also, as an important step in the direction of eliminating the deterring effects of administrative interventions in the private entrepreneurial activity and in order to simplify the procedures for the establishment of new enterprises as well as for the expansion and merging of existing enterprises, the Legislative Decree No. 4256 was enacted in summer of 1962. It was referred to as "the establishment and expansion of industrial and handicraft enterprises". This decree could have encouraged domestic competition and could have led to the modernization of the manufacturing sector. The final result could have been the promotion of exports.

Balance of Payments Arrangements

75

Accordingly, the developments were the following: first, the devaluation of the drachma had favorable effects on the external transactions of the country. The only adverse influence refers to the rise in the drachma cost of imports. Imports continued to increase throughout the period as a result of both increase of money incomes and the rapid expansion of credit which probably led to a considerable leakage of funds to the financing of consumption. There have been, however, appreciable differences in the distribution of imports with a strong preference for the imports of capital goods. The volume of exports presented a considerable change in their distribution among bilateral and multilateral trading countries which reflected the changed conditions of exportable products upon the foreign markets. Thus, there continued to exist a deficit in the trade balance underlying the dependence of the Greek economy on foreign income. Though invisable foreign exchange receipts had grown rapidly, the deficit of the balance of payments continued mainly due to the deterioration of the trade balance. Second, the L.D. 2687/53 did not lead to a substantial increase in the flow of long-term credit and entrepreneurial capital. Hence, foreign borrowing continued to increase, though at a lower rate than before, through the year 1963.

3. The Period 1963-1973 a. Policy Objectives The Greek economy after a prolonged period of high rates of growth of economic activity entered this period facing serious economic problems. They stemmed mainly from a growing deficit in the trade balance on the current account. Higher imports coupled with stagnant or falling exports resulted in the deterioration in the balance of payments. The consequence of this had imposed severe constraints on economic growth and on other objectives, such as employment, income distribution and resource

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76

allocation.4* So, the authorities' objectives were concentrated on: (i) The promotion of exportable goods and in this respect there had been an encouragement of export-oriented industries by granting them special incentives; (ii) the need for external borrowing; and (iii) the need for restructuring of the economy. The objectives were also recognized due to the fact that the country had to take advantage of the new opportunities created by the association of Greece to EEC which became effective as of November 1, 1962. Also, the restructuring of the Greek economy needed additional foreign borrowing though foreign reserves were sufficient; the country had already improved its international confidence. In the period 1967-1971 under the dictatorship administration, the government had attached great importance to the attractiveness of foreign industrial ventures. However, since 1971 and due to the international monetary crisis, the objective switched to the protection of the competitive situation of the Greek economy and the minimizing of the balance of payments constraints on economic growth.

b. Instruments Employed In 1964 and 1965 an enormous leakage of resources towards gold hoarding took place. In December 1965 the monetary authorities decided to abolish the free market for gold sovereigns. They also maintained the control upon i/%

the market and adopted free convertion of gold hoarding into drachmas. The measure proved to be very successful. Speculative activities centered on it

Bank of Grcccc, Annual Report for the Year 1964, p. 18; OECD, Economic Survey for

Greece 1972, Paris, p. 24. 42 Bank of Greece, Annual Report for the Year 1965, pp. 24-25.

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77

the gold sovereign were restricted seriously. The new regulations restored confidence in the currency. Official borrowing from abroad during this period and especially in the years 1965 and 1966 made it possible to recover part of the losses of official reserves of gold and foreign exchange experienced during the two previous 43 years. During the period 1967-1971 various measures were taken with the objective of facilitating the inflow of foreign capital. Also striving for attracting savings from Greeks, seamen and workers abroad, further facilities were given for keeping deposits in foreign exchange and the relevant interest rates were increased beyond those applicable to deposits in drachmas. The new policy on tourism led to a substantial expansion of the country's hotel capacity and to an increase in receipts from this section. Also, corresponding the incentives offered a lot of shipping companies transferred their headquarters to Piraeus, with subsequent foreign exchange earnings for the country. Between 1971-1973, the main task was to cope with the severe monetary crisis and protect the competitiveness of the Greek economy. Since the U.S. suspended the dollar-gold convertibility and the Group of Ten agreed on the currency realignment, the Greek government decided to keep the drachma at its original dollar parity (30 drachmas per one U.S. dollar), which had been set in 1953. The same situation prevailed in February 1973, when the international monetary crisis led to a new international currency realignment. However, the drachma's parity with other currencies was affected by the depreciation of the dollar by 10 percent against gold and by various rates against other currencies, mainly those of the EEC countries 44 and Japan. 23 4 4

OECD, Economic Survey for Greece 1967, Paris, p. 38. Bank of Greece, Annual Report for the Year 1972, pp. 20-21.

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In the same period, a new system of refunding interest to exporters was brought in effect. Also, the insuring of export credit through the Credit Insurance Fund which was operated by the Bank of Greece facilitated seriously the country's export efforts. The policies adopted and the instruments employed during the period 1963-1973 resulted in the following developments: Exports increased from 295.9 millions of U.S. dollars in 1963 to 1,230.5 in 1973 or they increased at an average annual rate of growth for the ten-year period of 16.1 percent against 8.9 percent in the decade 1953-1963. Imports increased even faster at an average annual rate of growth for the ten-year period of 19.7 percent as compared with 123 percent in the preceding decade. This fact resulted in a marked growth of the trade deficit, which from 4343 millions of U.S. dollars in 1963 increased to 2,816.7 millions of U.S. dollars or increased with an average annual rate of 22.0 percent. Despite the fact that the balance of invisibles increased quite rapidly at an average annual rate of growth for the ten-year period of 16.0 percent against 10.7 in the previous decade, and despite the various measures taken with the objective of improving the structure of the balance of payments and the process achieved in this field, the current account deficit had risen significantly over the past 10 years. It amounted to 1,191.5 millions of U.S. dollars as compared to 36.1 millions in 1963, that is, an average annual rate of growth for the ten-year period of 67.9 percent.

Balance of Payments Arrangements

79

4. The Period 1973-1983 a· Policy Objectives The decade 1973-1983 is a period of adjustment to external supply-side shocks. As was mentioned in the introduction of this Chapter, the first oil price shock of 1973-74 had aggravated the recession which had already started by the end of 1972. In addition, the international monetary disorder which led to successive currency readjustments along with the Cyprus Crisis and the ensuring recession in the OECD area had all brought a serious deterioration in the balance of payments at the beginning of this decade. Thus, the main objectives were: (i) the gradual reduction of the current account deficit, and (ii) a better composition of the capital inflow. By the end of 1975 there was an improvement in the deficit of the current account. By this time, the main task of economic policy switched to the maintenance of the external balance. This was accomplished through a reduction in the growth of imports and the reinforcement of the competitive situation of the economy especially via fighting the sluggishness of investment in manufacturing. Following the outbreak of the new energy crisis in 1979, the Greek economy entered a critical phase characterized by an accelerating inflation, a decline in the productivity, a deterioration in terms of trade, and a stagnant investment growth. These developments resulted in a severe recession in 1980 which continued through 1983. The policy objective was centered on the maintenance of the competitiveness of the economy through improving productivity and fighting the accelerating inflation.

b. Instruments Employed As was mentioned before, in February 1973 the authorities decided to leave the dollar-drachma parity unchanged, when the U.S. devalued its currency by 10% against gold and certain currencies. However, in October

80

Chapter Two

1973, in view of the international monetary disturbance, it was decided to unpeg the drachma and upvalue it by 11.1 percent against the dollar, mainly in order to curb domestic inflationary pressures and improve the psychological climate. The policy pursued since then was "controlled float". 45 In order to protect the competitiveness of the Greek economy, the authorities decided to disengage the drachma from the dollar and adopt a new system of setting currency parities on 8th March, 1975. That was on the basis of the average rates of a basket of currencies where the U.S. dollar was also included. This policy led to an improvement of the balance of payments. In July 1975, the drachma was linked to the movements of the European currencies. In order to increase the autonomous inflow of private capital, interest rates on deposits in foreign exchange were kept at a high level, although they declined seriously in foreign markets. In the period 1976-79 there was an increase in the invisible earnings mainly due to the pay increases received by Greek seamen, because of the collective agreement which raised minimum salaries by 20 percent, starting from March 1977 and also due to the 25 percent rise of hotel rates, as stipulated in the contracts for 1977 between Greek hotel owners and foreign tour operators. Since 1979, the flexible foreign exchange policy was used to pursue the protection of the competitiveness of the Greek economy. This policy also had an expansionary effect on the inflow of emigrants' remittances. With the objective of curbing the influence of inflationary pressures from abroad and of maintaining the price competitiveness of Greek products, a 35 Bank of Greece, Annual Report for the Year 1973, pp. 22-23.

The

l Sector

81

more flexible foreign exchange policy was implemented in 1982, compared with the practice of simply following developments in the EMS currencies, as was generally done in 1981. Thus the drachma was devalued by 17.1 percent with respect to the US. dollar, by 10.9 percent with respect to the Deutsch-mark and by 5.6 percent with respect to the ECU. A little more than half of this depreciation was due to the depreciation of the drachma vis-à-vis the dollar, while one-third resulted from the drachma's devaluation against the EMS currencies. As regards the two realignments (in February and June) of the EMS currencies, the drachma remained virtually unchanged vis-à-vis those currencies.^

V. The Real Sector The Real Sector is presented in a series of tables. There are 19 tables concerning 5 areas. A. Total Economy: B. Public Sector: C. Manufacturing Sector: D. Agricultural Sector: E. Foreign Sector:

Tables 2.1-2.7; Tables 2.8 - 2.11; Tables 2.12-2.14; Tables 2.15-2.16; Tables 2.17-2.19.

The time span which is covered by the tables, is usually the period 19531983, devided in 3 decades. Using the average annual rate of growth, we refer to the previous ten-year period. But sometimes data problems occur. For example, there are serious data problems concerning employment. Before 1974, the only source about employment was the decennial census of population conducted by the National Statistical Service of Greece on 1951, 1961, 1971. Therefore, in tables, where we refer to employment or to variables where employment enters, e.g. productivity, we use the years 1951, iz Bank of Grcccc, Annual Report for the Year 1982, pp. 141-142.

82

Chapter Two

1961,1971,1981,1983. Here, the average annual rate of growth refers to the two-year period between 1981-1983. Also, wherever there were difficulties in collecting information, the period was used for which data were available, like in tables 2.7, 2.11, and 2.14. In those tables the corresponding period is the time span between the years mentioned on the top of the tables. We do not give extensive comments and explanations on the real developments in Greece during the period in question, because nearly all relevant and important real factors and developments are mentioned in the previous sections.

1951

517.699

426.104

Secondary Sector Average annual rate of growth for the corresponding period.

Manufacturing Average annual rate of growth for the corresponding period.

3,225.081

Total Employment Average annual rate of growth for the corresponding period.

16.1

100.0

24.3

13.2

1,927.960

56.3

1971 1% of Absolute Total

1961

|

0.6%|

3,423.431

0.8 %

853.305

0.6 %

452.426

2.2 %

642.166

-0.9 %

100.0

2.6 %

24.9

1.8 %

13.2

2.6 %

18.8

0.03 % - 4 . 5 % - 1 . 2 %

59.6

ΓΓ07 Total

1,022.900

1.2 %

3,143.040

2.7 %

1,095.392

1,083.500

IMS % of Absolute

17.2

-0.3 %

100.0

3,529.300

1,424.600

1.0 %

34.8

680.800

-0.9 %

26.3

2.3 % -0.55 %

540.184

2.2 %

825.892

38.9

Total

-1.4%

1,221.756

L2ÛJ % of Absolute

Employment by Sector, 1951 - 1983

1) Included the employed, who did not answer about the kind of their job. Source: National Statistical Service of Greece, a. For 1951, 1961, 1971: Census of Population, b. For 1981, 1982, 1983: Labour Force Surveys.

784.796

Tertiary Sector * Average annual rate of growth for the corresponding period.

1

1,922.586

Primary Sector Average annual rate of growth for the corresponding period.

Absolute

In"000 of employed persons

Table 2.1:

Total

3,508.500 100.0

1,454.000 41.4

673.300 19.2

1,003.600 28.6

1,050.900 30.0

% of Absolute

100.0

40.3

19.3

29.0

30.7

Total

The l Sector 83

'°4° ^

5 14?

Silurate of growth for the corresponding period.

%

%

|

104 921

'

% 49

10.6

| 11.5 X

°·°

10

'

52 ,?9

n.0

^

13#1

'

,6 365

13.5 I

'

20.7 %

143

20.6 X

'

287 422

20.8 X

·0

,00

49.8

51.6

360.769

1

MS6.74S

957,892

»·>

] 2 ]%

'

22.9 *

'

55 57

t

30.6

100.0

2,709^300

100.0

53.3

,8.2

29.2

494^250

1,444^850

, 9.4

1983Π

473,400 17.4

791[θ»

17.7

fthlfl1||t r

At Current Prices ~ 1981

329,285

569,568

«·'

31.9

20.2 %

,7.9

,390

iq,6 %

°·°

21.0 X 10

'7

208 %

·6

,5

20.2 X

24 7

7.2 %

'

52 334

Togli

Source: Ministry of National Econony, National Accounts of Greece. Various Issues.

1) For 1982, Provisional Data. For 1983, Estimates.

'°38

36

Srannual rate of growth for the corresponding period.

·

1β 6Μ

'

Absolute

25 5

ToUl

1971

Chapter Two

Average^annua?rra te of growth for the corresponding period.

%

^

14.2 t

'

25 939

%

°3

2M

Absolute

________ 1961

12.3

^

Total

12.6

7

Avera ge Τηηua f ° r a t e of growth for the corresponding period.

'

1M95

MSI

Average SSfl rate of growth for the corresponding period.

Absolute

In Million of Drachmas

Table 2.2: Gross Domestic Product by Sector, 1951 - 1983

84

14,782

11.5

42,254

Secondary Sector Average annual rate of growth for the corresponding period.

Manufacturing 9,281 Average annual rate of growth for the corresponding period.

Tertiary Sector Average annual rate of growth for the corresponding period.

6.0 X

100.0

5.2 X

24.0

6.8 X

278,551

7.1 X

48.8

10.7 X

54,586

9.7 X

70,078

8.0 X

13.8

9.3 X

35,858

2.6 X

26.3

4.2 X

100.0

132,141

59,516

0.13 X

100.0

53.9

84,000

31.7

14.3

417,500

224,821

21.1

1.5 X

49.9

-2.3 X

88,064

-1.5 %

32.6

-1.4 %

17.5

416,515

4.9 X

139,087

5.0 X

19.6

3.8 X

90,802

2.0 X

48,662

Ministry of National Economy, National Accounts of Greece, Various Issues.

For 1982, Provisional Data. For 1983, Estimates.

143,772

52.5

37,836 4.9 X

19,886

18.4

29.1

100.0

231,600

20.1

128,150

57,750

X of Total Absolute

55.4

30.7

13.8

Total

At Constant 1970 Prices

l Sector

Source:

1)

Total GDP 80,511 100.0 Average annual rate of growth for the corresponding period.

23,475

138] iQfn ) X of % of Absolute Total Absolute

1

Gross Domestic Product by Sector, 1951 - 1983

1951 1961 197 ΠΓ0Τ ΙΊΓ07 I Absolute Total Absolute Total

Primary Sector Average annual rate of growth for the corresponding period.

In Million of Drachmas

Table 2.3:

The 85

61.142

111.029

11.4 %

11.1 %

91.447

734.071

19.0 %

556.817

526.094

17.6 %

772.210

788.212

22.7 %

21.2 %

993.707

17.7 %

21.1 %

672.394

16.5 %

16.5 %

130.903

10.6 %

529.919

450.471

At Current Prices

19.7 %

303.909

19831*

10.2 % 16.2 % 102.874

40.393

9.6 % 7.7 %

10.1 %

30.648

23.704

10.1 %

36.171

10.1 %

13.599

9.5 %

42.835

1961 1971 1981

13.902

1951

Productivity by Sector, 1951 - 1983

For 1982, Provisional Data. For 1983, Estimates. Source: 1. For Employment: National Statistical Service of Greece, a. For 1951, 1961, 1971: Census of Population. b. For 1981, 1982, 1983: Labour Force Surveys, 2. For GDP by Sector: Ministry or national Economy, National Accounts of Greece. Various Issues.

1)

Total Economy 11.174 Average annual rate of growth for the corresponding period.

Tertiary Sector Average annual rate of growth for the corresponding period.

Manufacturing 12.079 Average annual rate of growth for the corresponding period.

Secondary Sector Average annual rate of growth for the corresponding period.

Primary Sector 5.407 Average annual rate of growth for the corresponding period.

In '000 of Drachmas

Table 2.4:

86 Chapter Two

41.996

Total Economy 24.964 Average annual rate of growth for the corresponding period. 5.3 X |

88.625

-1.8 X

2.9 X

118.997

159.285

124.759

127.690

19831) 54.952

129.183

0.4 X

0.5 X

118.016

2.2 X

157.813

2.5 X

129.354

1.7 % -0.5 %

109.944

7.8 X

4.3 X 4.5 X

126.975

7.1 % 8.4 X

101.051

6.9 X 7.0 %

55.839

0.6 X

54.929

1981

For 1982, Provisional Data. For 1983, Estimates. Source: 1. For Employment: National Statistical Service of Greece, a. For 1951, 1361, 1971: Census of Population. b. For 1981, 1982, 1983: Labour Force Surveys. 2. For GDP by Sector: Ministry of National Economy, National Accounts of Greece. Various Issues

82.125

Tertiary Sector 53.841 Average annual rate of growth for the corresponding period.

1)

43.954

28.553

39.830

1971

At Constant 1970 Prices

Productivity by Sector, 1951 - 1983

4.9 X 7.3 % 3.3 X

1961

19.625

1951

Manufacturing 21.781 Average annual rate of growth for the corresponding period.

Secondary Sector Average annual rate of growth for the corresponding period.

Primary Sector 12.210 Average annual rate of growth for the corresponding period.

In *000 of Drachmas

Table 2.5:

The l Sector 87

Chapter Two

88

Table 2.6:

IS: Ratio Representing the Structure Of the Economy, 1953 -

19832)

1953

1963

6,943

19,244

86,151

10.9 %

16.4 X

GDP: Agricultural Sector 3^ 15,609 Average annual rate of growth for the ten-year period.

30,663

87,311

8.6 %

11.6 %

18.8 %

0.444

0.627

0.986

1.044

3.9 %

4.9 %

2.0 %

GOP: Manufacturing Sector Average annual rate of growth for the ten-year period.

IS :Ratio Average annual rate of growth for the ten-year period.

» « - s; 2)

For 1982, Provisional Data. For 1983, Estimates.

3)

Included Forestry and Fishing.

1973

494,250 19.2 % 473,400

- Tj^iiTcti:drachmas·

Source": Ministry of National Economy, National Accounts of Greece, Various Issues.

The

Table 2.7:

l Sector

REAL VALUE ADDED PER PERSON EMPLOYED, 1960 - 1982 Average annual rate of growth for the corresponding period

1960-1968 Agriculture Industry Manufacturing Services

1968-1973

8.2 6.8 7.1 5.5

Source: OECD, Economic Outlook,

8.6 7.4 7.8 5.2

1973-1979 3.2 1.2 2.7 2.3

1979-1982 5.0 -3.7 -3.3 -2.8

Historical Statistics, 1960 - 1982.

8,503

9,407

Absolute

14.4 X

25,249

14.0 X

31,646

Absolute

20.4

25.6

GDP

1983

27.3 X

95,806

22.8 X

116,588

Absolute

[ X of ΠΓ5?

1973

22.4

27.2

GDP

1,052,970

895,200

Absolute

X of

Ministry of National Economy, National Accounts of Greece. Various Issues.

11.7 X

17.3

13.0 X

19.2

GDP

1963

1)

At Current Prices

38.9

33.0

GDP

Current Revenue and Expenditure of Generai Government, 1953 - 1983

ΓΓ0Τ

1953

For 1982, Provisional data. For 1983, Estimates.

Source:

1)

Current Expenditure of General Government Average annual rate of growth for the ten-year period.

ten-year period.

Current Revenue of General Government Average annual rate of growth for the

In Million of Drachmas

Table 2.8:

90 Chapter Two

100.0

8,841

For 1982, Provisional Data. For 1983, Estimates.

58.1

41.9

5,141

3,700

14.4 %

13.0 %

13e8

60.1

15.3 %

39.9

100.0

17,972

11,943

Total

% 24.2

14.6

9.7

GDP

1973

13.4 % 18.0 29,915

10.5

12.6 %

7.5

Absolute

I X of I X of

1963

24.5 %

114,216

64,826

25.4 %

49,390

Absolute

Total

22 J

100.0

56.8

43.2

I i of % of

26.7

%

15.1

11.5

971,630

463,480

508,150

100.0

47.7

52.3

Total

At Current Prices

Absolute

% of

GDP

19831)

%Jf

Direct and Indirect Taxes of General Government, 1953 - 1983

Source: Ministry of National Economy, National Accounts of Greece. Various Issues.

1)

Indirect Taxes of General GoverniîËnt Average annual rate of growth for the ten-year period. Total Tax Revenue Average annual rate of growth for the ten-year period.

ten-year period.

Direct Taxes of General Government Average annual rate of growth for the

GDP

pTöf

Total

1953

ΠΠϊΤ

Absolute

—

In Million of Drachmas

Table 2.9:

35.9

17.1

18.8

GDP

The l Sector 91

For 1982, Provisional Data. For 1983, Estimates.

1

1

100.0

70.3

29.7

Absolute

1 15.4 %

27,072

15.4 %

19,033

15.9 %

8,039

GDP

GDP

135,677

98,010

37,667

I I 17.8 %

21.9

18.5 %

15.4

16.9 %

6.5

Total

1973

% of % of ITöf

31.7

22.9

8.8

Total

1983°

ITöf

17.0 %

100.0

16.2 %

72.2

19.6 %

27.8

Absolute

Source: Ministry of National Economy, National Accounts of Greece, Various Issues.

1)

P^10*·

13.5

Total 6.632 Average annual rate of growth for the ten-year

100.0

9.6

Private 4,721 71.2 Average annual rate of growth for the ten-year period.

Total

3.9

Absolute

1963

Gross Fixed Capital Formation, 1953 - 1983

* or I s or

1953

28.8

Public 1,911 Average annual rate of growth for the ten-year Period.

In Million of Drachmas

Table 2.10:

623,100

410,100

213,000

GDP

% of 7.9

Total

100.0 23.0

65.8 15.1

34.2

Absolute

At Current Prices

nnp

92 Chapter Two

1960 ΓΊΓ07 Absolute GPP -2,473 2.7

1963 ΓΤ57 Absolute GPP -2,339 1.9

1 9 7 3 ΠΓ07 Absolute GPP -4,736 1.1

______ i of Absolute GPP -285,139 10.5

1983

l Sector

* The overall budgetary results of the public sector differ from the effect of this sector on money supply as evidenced In the analysis of factors affecting money supply. This difference Is basically due to the following: First, In the analysis of factors affecting money supply, the cash deficit 1n the management account of fertilisers from the Agricultural Bank of Greece 1s Included In the private sector, not In Central Government. Second, the factors affecting money supply and the analysis of the Central Government's contribution Include certain accounts, such as State documentary credit, whose outstanding balance 1s affected by the time lags between orders of and payments for commodities (chiefly petroleum products) on behalf of the State. It also Includes certain liabilities and claims of the Government towards the banking system, stemming from purely financial dealings not connected with public revenue and expenditure. Third, the deficit of public enterprises 1s evidenced by the data of the enterprises and Includes the part financed by foreign loans and credits as well as by private sector credits. Conversely, the factors affecting money supply show loans contracted by public enterprises from the domestic banking system only. 1) Results from the movement of respective accounts with the Bank of Greece and the Agricultural Bank. 2) Estimates on the basts of their investment on securities and bank deposits and of the change 1n their liabilities towards the banking system. Source : Bank of Greece.

1. Government budget (ordinary and investment) Average annual rate of growth for the corresponding period. 7.7X 7.8X 62.6* 2. Accounts for the purchase of agricultural -731 0.8 -147 0.1 -11,193 2.6 9,254 0.3 products and supplies 1). Average annual rate of growth for the corresponding period. 3,224.41 382.9X 26.IX 3. Public enterprises -1,236 1.3 -972 0.8 -9,899 2.3 -88,234 3.3 Average annual rate of growth for the corresponding period. -0.6X 33.4X 33.4% 4. Local government and other +586 0.6 +934 0.8 +3,869 0.9 +33,345 1 2 public entitles 2). Average annual rate of growth for the corresponding period. 29.4X 23.3X 97.IX Net public Sector -3,854 4.1 -2,524 2.0 -21,959 5.1 -349,282 12.9 borrowing requirement (1+2+3+4) Average annual rate of growth for the corresponding period. -10.4X 73.4X 35.9X

In Million of Drachmas

Table 2.11 Overall Budgetary Results of the Public Sector on Cash Basis, 1960-1983*

The 93

I

12.079

9,281 11.5

A. Productivity: At Current Prices Average annual rate of growth for the corresponding period.

GPP: Manufacturing At Constant Prices Average annual rate of growth for the corresponding period.

0.6t

12.6t

14.3

It of 1% of

19 6 1

1.8t

13.2

20.8t

15.6

673.300

·

2

Î^ÏSSÎ

Labour^Force^Surveys?^ ^^

'

'

1951 l961 19715

Ä·"·

Source: 1. For GPP: Manufacturing: Ministry of National Economy, National Accounts of Greece. Various Issues

20 1

494,250

19.3

84,000

-1.8%

-2.3t

21.1

734.071

124 759

88,064

2.5t

5.0t

10.7t 101.051 129.354

54,586 19.6

13.8

8.4t

19 5 3

19.4

-0.55t

680.800

12.lt

360,769

17.2

55,571 19.3

2.3t

540.184

102.874 529.919

13.lt

16,365

452.426

19 5 1

18.2

19.2

It of It of It of It of h of It of Absolute Total GPO Absolute Total GPP Absolute Total GPP

I 19 7 1

Absolute Total GPP

B. Productivity: 21.781 43.954 At Constant Prices Average annual rate of growth for the corresponding period. I 7.It 1) Employment : In Ό00 of employed persons Productivity: In '000 of Drachmas GPP: Manufacturing: In million of Prachmas 2) For 1982, Provisional Pata concerning GPD. For 1983, Estimates concerning GPP.

8.0t

19,886

36.171

5,147

GPP: Manufacturing At Current Prices Average annual rate of growth for the corresponding period.

13.2

^26.104

A^ra^Tannual rate of growth for the corresponding period.

Absolute Total GPP

It of \ % of

M 5 1

^

A. At Current Prices B.At Constant 1970 Prices

Table 2 . 1 2 Employment and Productivity of the Manufacturing Sector, 1951-1983^

94 Chapter Two

For 1982, Provisional Data. For 1983, Estimates.

°°·°

1

27

15.4 %

'

13 5

'°72

3,509

16.7 %

1.6

17.8 %

°°·°

1

20.3 %

13.0

21β9

2.8

17.0 %

'

15.4

135 677

16.3 %

20,919

Source: Ministry of National Economy, National Accounts of Greece. Various Issues.

1)

Average °annua1 rateM32 of growth for the ten-year period.

Total Econony: Gross Fixed Capital

11.9

·°

100

·100

623

14 6

Total GDP

90,776

·7

31

4.9 '

19831) % of Absolute

At Current Prices

Manufacturing Sector: Gross Fixed Capital Formation, 1953 - 1983

1953 1963 1973 * of % of % of % of \% of % of 1% of Absolute Total GDP Absolute Total GDP Absolute Total GDP

Manufacturing Sector: Gross Fixed CaprtiT" Formation -1 786 Average annual rate of growth for the ten-year period.

In Million of Drachmas

Table 2.13:

·

100 0

3 4

The l Sector

23.0

Chapter Two

96

Table 2.14:

Competitiveness and Trade Balance of Manufacturing Sector in Greece, 1970 - 1983 1975 = 100

Competitiveness ^ Average annual rate of growth for the corresponding period. Trade balance in manufacturing sector (Million U.S. dollars) Average annual rate of growth for the corresponding period. Trade balance in manufactured goods (as percentage of GDP)

1970

1973

121.8

103.4 5.3 %

-244.4

-571.0

-2.4 %

1983 133.0 2.9 %

-414.6

11.0 %

947.7 %

-2.9 %

-1.2 %

1)

Definition of Competitiveness: C = yjjjj, where:

A.

Relative Unit Labour Costs (Inflation), in Manufacturing Industry (calculated in national currency) employees only, against 19 countries.

B.

Effective Exchange Rates.

Source : Eurostat and Commission Services.

4.9 X

2.6 X

7.3 X

"

'

11.4 X

7.2 X M5

37 836

«

1

1 9 B 1

19 7 χ

3.3 χ

'

«·«»

·5

450.'47,

06 %

· "

'

329 285

17

"3

1.050.900 151

Absolute Total GPP

59 5

"·'»«

1 4χ

17

22 7 I 48 662

2 0 X

263

20 2 X

182

1.083.500 151

lftf

1 9 8 3

x 4 % 52 334

'

389

»3:909

20 7 X

255

-1 2 χ

lJXUm

26,003

-4.5 X

4.9 X 19ί

^

9.5 X

12.3 X

28,8

0.03 X

^^

5M

,7

X of X of X of X of ϊ ηι Absolute Total GPP Absolute Total GPP

1 9

X of 1 of Absolute Total 6PP

.

B. At Constant 1970 Prices

Employment : In '000 of employed persons. Productivity: In '000 of Orachmas. GPP: Agriculture:IIn million of Prachmas. 2) For 1982, Provisional Pata concerning GPP. For 1983, Estimates concerning GPP. 3) Included Forestry and Fishing. Source! 1. For GP0: Agriculture: Ministry of Natlnal Economy, National Accounts of Greece, Various Issues. 2. For Employment: National Statistical Service of Greece, a. For 1951, 1961, 1971: Census of Population. b. For 1981, 1982. 1983: Labour Force Surveys!

1)

Average annual rate of growth for the corresponding period.

feMfflL ·«

l2n0

'

fffaiffiffffi Average annual rate of growth for the corresponding period.

L,

M 475

Average annual rate of growth for the corresponding period.

·

,3 9Μ

10,395

^ ^

ji Current'pHcM ^

Knurren t"PH ces Average annual rate of growth for the corresponding period.

Averag^annual rate of growth for the corresponding period.

of

* * Absolute Total GPP

of

1 9 5 11 9 6 1

A. At Current Prices

Table 2.15: Employment and Productivity of the Agricultural Sector. 1951-1983 2 >

"·

57^50 13.8

'7

The l Sector

97

7.8

of

15.4 χ

27,072

23.4 X

1.1

1963

13.8

135,677

3.0

GDP

1973

17 8 %

21.9

13.5 *

100.0

3,739

of [Tof Absolute Total

I*

623,100

3.0

8.0

Total

100.0 23.0

49,776

1% of 1 of GDP Absolute

1983

31.7

9.5

\7.Q %

100.0

15.1 %

12,857

% of \ t of Absolute Total

Λ n . At Current Prices

Agricultural Sector: Gross Fixed Capital Formation. 1953 - 1983 Π

Source: Ministry of National Economy, National Accounts of Greece, Various Issues.

Included Forestry and Fishing.

2)

13.5

For 1982, Provisional Data. For 1983, Estimates.

100.0

515

1)

Total Economy: Gross Fixed Capital Formation. 6,632 Average annual rate of growth for the ten-year period.

Agrlculturai Sector:2 Gross Fixed Capital F0nnatl0n · Average annual rate of growth for the ten-year period.

of

I* I* Absolute Total GDP

In Million of Drachmas

Table 2.16:

1.8

GPp

98 Chapter Two

The

Table 2.17:

99

l Sector

Exports, Imports, Trade Balance, Balance On invisibles, Balance on Current Account, 1953-1983

In Million of U.S. Dollars 1953 Exports Average annual rate of growth for the ten-year period.

134.1

Imports Average annual rate of growth for the ten-year period.

243.3

Trade Balance Average annual rate of growth for the ten-year period.

-109.2

Balance on Invisibles Average annual rate of growth for the ten-year period. Balance on Current Account Average annual rate of growth for the ten-year period.

1963 295.9 8.9 % 730.2 12.3 % -434.3 12.2 %

150.6

398.2 10.7 %

+41.4

-36.1 2.9 %

1973

1983

1,230.5

4,105.4

16.1 %

14.0 %

4,047.2

9,491.3

19.7 % -2,816.7

9.6 % -5,385.9

22.0 %

7.6 %

1,625.6

3,510.0

16.0 % -1,191.5

8.8 % -1,875.9

67.9 %

Source: Bank of Greece, Annual Report; Monthly Statistical Bulletin (various issues).

8.2 %

'

7 7

,

,6

23.0

-,5·426

'

18.6

'°

7

»

~

,2 5

'

'

,9 S

·978

%

-60·'"

^

102

«4.1

-452'.643

31.3

Chapter Two

,6.7

848.295

14.5

«.6

392.652

*ngf

At Current Prices | ι983

Absolute

1973

«··

GOP*

25>5 %

' "

42 8

Absolute

3 %

,

GDpf

24 129

15.9« [

-3'759

11>3

'

,4 6

%

' °3

Absolute 8 7

10.6

^

G0pf

1963

Exports, Imports. Trade Balance. 1953 - 1983

Source: National Statistical Service of Greece, a. 1953-1982. Statistical Yearbook of "· 1983. Monthly statistical Bui letin^^'

Average'Innual rate of growth for the ten-year period. [

'7JS6

Sg annual rate of growth for the ten-year period.

'

3 39?

Absolute

1953

Sg annual rate of growth for the ten-year period.

In Million of Drachmas

Table 2.18:

100

The

Table 2.19:

101

l Sector

Foreign Trade Indices and Terms of Trade, 1953 - 83

1970 « 100

1953 Exports: Index of average value. Average annual rate of growth for the ten-year period. Imports: Index of average value. Average annual rate of growth for the ten-year period.

70.8

1963

101 »5 4.0 %

81.4

90.5 1.4 %

1973

1983

136.0

644.8

3.3 % 134.6

17.2 % 856.7

4.9 %

20.8 %

Terms of Trade: """«s

· '00

Average annual rate of growth for the ten-year period.

Source:

87.1

112.1

2.7 %

101.0

-0.9 %

Bank of Greece, Annual Report; Monthly Statistical Bulletin (various issues).

75.3

-2.8 %

CHAPTER THREE A SURVEY OF RECENT MACROECONOMIC STUDIES OF THE GREEK ECONOMY I. Introduction In this Chapter a survey of recent macroeconomic studies of the Greek economy is presented. Analytically, the Chapter reviews and evaluates models of the real sector of the economy, integrated models of the real and monetary sectors, and studies dealing with special macroeconomic problems of the Greek economy. The purpose of this survey should not be seen as a thorough and detailed analysis of the models presented. Instead, their structural characteristics as well as their empirical results are analysed and evaluated in a way that could be regarded in the context of the existing institutional arrangements of the Greek economy as a guide to the theoretical foundations of our model which is presented in the Chapter that follows. A table presenting the main components of the models which are reviewed is added at the end of this Chapter.

II. Models of the Real Sector of the Economy In the 1960s and early in the 1970s the macroeconomic models of the real sector which were developed for the Greek economy emphasize the demand side in the Keynesian tradition; the supply side is not modeled explicitly at all. A very brief analysis of these models is presented here for expository purposes. An extensive analysis of the recent macroeconomic models of the real sector of the Greek economy will follow.

Models of the Real Sector of the Economy

103

Daniel Suits (1963) developed a complete econometric model of the Greek economy. The structure of the model consists of a linear equation system with seven identities and 28 behavioral equations. The structural parameters of the model are estimated with annnal data for the period 1951 to 1961 using the ordinary least squares procedure (OLS). The demand side specification considers the structural and institutional characteristics of the Greek economy in a very abstract way. The monetary sector is neglected. In the mid-sixties, a model was developed by P. Pavlopoulos (1966). This model presents the first serious effort to deal with the Greek economy. It contains 12 behavioral equations and five identities. The coefficients are estimated on a unit volume base with annual data for the period 1949 to 1959 with both the OLS and the two stage least squares methods (2-SLS). This model is totally an effective demand model. The author tries to incorporate

structural

characteristics

intensively.

He

specifies

two

investment functions - one for private investment in plant and equipment and one for private investment in residential construction - but both are not linked to the stock of capital since there is no production sector. The model ignores labor, the capital market and money. The foreign sector consists only of one aggregate import function. The main effort of Pavlopoulos' model is the special treatment of the agricultural sector which was so crucial to the Greek economy during the period studied. He analyses this sector through a submodel, using both a function explaining output and another explaining demand for domestically produced agricultural products. A third model of this kind is formulated by Adelman and Chenery (1966). Their model consists of 20 behavioral equations and nine identities. The authors use annual data and estimate their model for the period 1950 to 1961. Their model is formulated in the Keynesian tradition. It analyses particularly the external sector of the economy with special emphasis on the role of foreign assistance in economic development for Greece.

104

Chapter Three

A model developed by K. Prodromidis (1971) is quite similar to the Suits' model He estimated the model with annual data for the period 1954 to 1965 applying both OLS and 2-SLS procedures. Since the middle of the 1970s the macroeconomic models which were developed for the Greek economy examine the demand side extensively; the supply side is considered in a rather rudimentary way. That is, the models are in the Keynesian tradition. Nevertheless, they represent the recent standards of an adequate modeling with respect to specific characteristics of the real sector of the Greek economy at the end of the seventies. They are reviewed in the section that follows.

1. The Model of Garganas A first version of a model developed in an unpublished paper by Garganas (1978) was used by the Bank of Greece for forecasting purposes as well as for policy-oriented analysis. Since then, the model has been variously amended and extended [Garganas (1983)] primarily in order to improve both its performance and its testing and validation.

a« Discussion of the 1978-Model We first present the 1978 model. The model consists of 153 equations, of which 56 are structural equations and 97 are identities and definitions, which are summarized into the following principal equation blocks:* 1

To illustrate the specific diffîculties incorporating the monetary sector within a

macroeconomic model, Garganas describes the state of research in that field as follows: "As it stands, the model contains no formal monetary sector as such. One reason for this is that there is at present hardly any research in this country to throw some light on the basic issue of how, and how strongly, monetary policies influence the real economy. A preliminary attempt was made to incorporate the effects of monetary variables as far as possible into some of the equations that explain the behavior of the individual components of private expenditure, but in practice great difficulty has been experienced in obtaining statistically significant estimates."

Models of the Real Sector of the Economy

105

(1) consumer expenditure (2) grossfixed investment (3) capital stock (4) stocks (5) exports of goods and services (6) imports of goods and services (7) factor cost adjustment (8) net incomefrom abroad (9) personal income (10) personal taxes (11) corporate income, payments and savings (12) corporate taxes (13) current balance of payments (14) prices It is neither intended to present here in any great detail the structural characteristics of the model nor it is possible to consider the exact form of its estimated equations. Instead, we present a selected description and discussion of the main elements of the model, its empirical results and finally we give a short evaluation of its main features.^ A discussion of the essential structural equations, particularly against the background of the Greek specific characteristics is presented. Personal consumption expenditure disaggregated into consumption functions for both durable and nondurable goods are typically related to the level of real personal disposable income in the current period and its own value lagged one period. In addition, it is also related to the ratio of wages The analysis of all the models and studies reviewed in this Chapter is heavily based on the papers of the author. ^ The same procedure is followed for the models which are surveyed in this section and in section ΠΙ.

106

Chapter Three

and current government transfers and grants to other income, which should capture the effect of income distribution on consumption, as well as dummy variables of the zero-one type to allow for the effects of changes in hire purchase controls in recent years.* Total grossfixed investment is divided into public and private investment. Private fixed investment is disaggregated into sectors. There are separate equations for investment in private dwellings and in agriculture; all other private fixed investment, including manufacturing investment, as well as public fixed investment, is treated as exogenous. The equation for investment in private dwellings is derived from a stock adjustment model. Residential investment depends on real personal disposable income, real flow of credit for home purchases and the stock of housing at the end of the preceding year. A dummy variable is also included to account for the effects of the introduction and abolition of taxes arising from private buildings and the development of value of the land. The equation for agricultural investment is based on the familiar flexible accelerator model in which the desired capital stock is related to the availability of credit. The credit arguments in these two equations present the implicit rudimentary integration of the monetary sector in this model and link monetary impulses via effects on investment to real variables. The level of the current total net stock of capital is derived from accounting identities as the sum of current gross investment and the capital stock at the end of the previous year less replacement investment.

Models of the Real Sector of the Economy

107

The equations explaining exports and imports to determine the real foreign trade balance are treated on a national accounts basisi The exports of goods are disaggregated in separate equations for manufactured and non-manufactured goods. The value of manufactured exports depends on an index of world imports and relative export prices, and the level of lagged exports; these determinants are all treated as exogenous variables. The volume of exports of non-manufactured goods is related to world trade and various dummy variables used to eliminate the effect of special factors. Exports of services are sub-divided into gross receipts from tourism and other services. The tourism receipts are explained by earnings of world tourism expenditure, both expressed in current U.S. dollars, and a time trend that reflects changes in competitive factors. Garganas complains that it was not possible to express tourism expenditure in constant prices, and to allow explicitly for the effects of changes in relative prices. Till 1978 the author failed to construct a reliable price index for tourism expenditure and attempts to identify an appropriate price effect were unsuccessful. Therefore, an identity is used to convert the current dollar value of tourism receipts into constant drachma figures compatible with the national income accounts. Other exports of services covering heterogeneous items are treated exogenously. On the import side Garganas distinguishes between imports of goods and invisibles. Imports of goods are disaggregated into three categories: crude oil, machinery and transport equipment and all other imports, which are related to gross domestic product, relative prices, and the lagged volume of imports; a dummy variable is also included to capture the effects of the sharp rise of imports in 1973 due to an unprecedented increase in stocks for speculative purposes. Imports of machinery and transport equipment are As the statistical statements of international trade activities differed between the national accounts and the customs statistics (mainly due to differences in commodity coverage, timing and valuation basis), the customs figures both of relevant export and import are converted into a national accounts basis.

108

Chapter Three

determined by components of investment and consumer spending on durables, and relative prices, while imports of crude oil are treated at present as an exogenous component Imports of services cover a number of heterogenous items. Garganas explains as endogenous components, in this sector, travel expenditures abroad by Greek residents, payments for freight and insurance, and transport and miscellaneous service debits. Whereas travel debits are explained by real personal disposable income and the ratio of wages and government grants to personal income, the freight and insurance payments are mainly determined by volume of real imports. Real transport and miscellaneous service debits are related to real gross domestic product (GDP). Factor cost adjustment is defined as the difference between total indirect taxes and subsidies. Indirect taxes in turn depend on total final demand and dummy variables, which were used to account for distortions of the GDP deflator for net indirect taxes resulting from the high rate of inflation since 1973 and for the shift in tax revenue due to an increase in tax rates in 1966. Net factor income from abroad is related to total gross receipts from shipping. The various income variables used in the model are either explained by the use of structural equations or treated as exogenous.** Usually, the wage and salary bill in the non-agricultural sector is calculated as the product of average earnings and the number of employees in employment outside the agricultural sector. While Garganas treats the average earnings as exogenous, he has to calculate the employment series indirectly due to the fact that reliable series are not available. He obtains an employment function simply by transforming and converting a given production function of the Cobb-Douglas type. Thus, the estimating equation of the wage and salary bill is derived by adding the logarithm of average earnings and the calculated series through the constructed employment equation. However, 6

In our review we only describe the "author's explanation concerning both the personal

income in the non-agricultural and the agricultural sector.

Models of the Real Sector of the Economy

109

the agricultural income depends on gross agricultural product at current prices. For the purpose of generating the net corporate income after taxes as a residual item, total profit income before taxes and several allowance components, particularly the dividends and corporate taxes are explained endogenously. The other variables are connected by identities and are exogenous. The determination of the principal items in the balance of payments on current account is treated in terms of the concepts and definitions used in the balance of payments presentation of foreign trade which means, that there is a divergence with the transactions based on customs statistics or on national accounts estimates. While the specifications of the several behavioral equations are similar to the import and export equations explained above, the principal difference is the different valuation of these international transactions. To make the figures comparable appropriate convertions are used. Finally, Garganas determines price deflators for various income and goods categories. The price equations are cost determinated. The most important explanatory variables are unit labour costs, import prices, and an index of prices expressed by a dummy variable, which is included in each equation to reflect the unprecedented rate of increase of prices during the second part of 1973 and in the early months of 1974 when speculative fever increased profit margins.

b. Empirical Results of the 1978-Model In his 1978 paper Garganas estimates annual data with the model by applying ordinary least squares (OLS) and two-stage least squares with principal components (2-SLS+PC.). Both methods yield very similar results.

110

Chapter Three

As an initial test of the performance of the complete system against post data, the reduced form for selected exogenous variables is determined for a dynamic simulation for the period 1962-1975 and by actual values of the exogenous variables. The results of the simulations show that by and large the values of the major endogenous variables are simulated with a reasonably high degree of accuracy taking the fourteen year period as a whole. As a check on the short and medium term performance of the model, one to five year period dynamic simulations are also computed for the period 1962-1975. It comes out that the model performs marginally better when the number of years decreases. The general conclusion from these results appears to be that the predictive performance of the model is robust against alternative sub-period simulations. Garganas also carried out two simulation experiments to illustrate the properties of the multipliers of the model. He investigates the effect of two fiscal impulses within the period 1971-76 using the actual values of the exogenous variables and the actual initial conditions existent in 1970. In the first simulation experiment, the real public consumption was increased by 1.0 billion drachmas relative to the selected endogenous variables and is compatible with the a priori supposition of the transmission of the fiscal impulse. In the second experiment, the personal income tax was reduced by 1 billion drachmas at 1970 prices again in each year relative to the base run. Again, the time pattern profile of the estimated coefficients shows the a priori assumption about the transmission on the selected endogeneous variables. It is remarkable that a comparison of the results of both simulations indicates that the profiles of the real GDP multiplier are the same; nevertheless, their values are lower in cases of tax cuts because of the greater leakage involved in this particular form of stimulus than in cases of an increase in public expenditure.

Models of the Real Sector of the Economy

111

c. Discussion of the 1983-ModeI A second version of the model was published by Garganas in 1983. It consists of 172 equations, of which 45 are behavioral relationships, 22 are technical equations, and 105 are identities. An overview of the model is presented in the following table, which lists

η

the principal equation blocks and endogenous variables: Main Equation Blocks and Endogenous Variables: Block

Main Endogenous Variables

1. Consumption

Consumers' expenditure on cars; other durable goods; nondurable goods and services.

2. Investment

Investment in private dwellings; private investment in agriculture; non-agricultural Stockbuilding.

3. Foreign trade

Exports of goods; exports of services; imports of goods; imports of services at constant and current prices (National Income Accounts definition and Bank of Greece settlements data).

4. Output

GDP; Gross National Income (GNI) at constant and current prices; Gross National Product (GNP) at constant prices; output originating in manufacturing.

5. Incomes

Corporate income; personal income from property and entrepreneurship; wages and salaries outside agriculture; personal disposable income; real personal disposable income; net income from abroad.

7

The table is taken from N. Garganas (1983), An Evaluation of the Predictive Accuracy of the Bank of Greece Model of the Geek Economy, Greek Economic Review, 5, No. 2, p. 104.

112

Chapter Three

6. Taxes

Personal income tax; contributions to social insurance; corporate income tax; indirect taxes at constant rates.

7. Employment

Employment in manufacturing.

8. Money wages

Hourly earnings in manufacturing; average earnings outside agriculture.

9. Prices

Implicit price deflators for: GDP, GNI; private consumption; exports of goods; imports of goods; consumer price index; wholesale price index.

In this section, we only present some revised and new elements which Garganas has incorporated into his new version of the model. In accordance with the first version, the basic determinants of the demand side structural equations are personal disposable income, prices, output, credit flows, world trade, relative domestic and foreign prices and the exchange rate. On the demand side, the main innovation has been the inclusion of the rate of inflation acting as a proxy variable for wealth effects as an argument in the consumption function for non-durables goods. On the supply side, Garganas revised his approach in generating the wage and salary bill in the non-agricultural sector. In this version, this income category is related to expected average earnings, and the main determinants of employment, namely output and trend productivity with a lag outside the agricultural sector. The expected average earnings are not treated exogenously. They are determined by a dynamic adjustment model (adaptive expectations), in which changes in money earnings are explained by lagged real earnings movements, a real earnings trend and a proxy for demand 8 Both certain components of fixed investment, stocks, exports, imports and the government expenditure are treated exogenous.

Models of the Real Sector of the Economy

113

pressure. This wage determination procedure represents a target earnings increase by workers.

0. With α > 0, that is c^e^ > a . 2

If we substitute equation (2) into (1), equate the resulting demand function Λ

with supply function (13) and solve for Ρ it turns out that

ÔP ß

=

SP e

This means, ß measures the influence of changes in the inflationary A

expectations on the actual inflation rate P. A ß = 1 describes a "neutral" AG

situation in the sense that a change in Ρ of χ % leads to a change in actual A

inflation Ρ of χ %. The above inequality

Solution of the Model with Adaptive Expectations

+ a

3

+ a

4

197

+ a b >a 2 2 2

is a sufficient condition for a 0 < ß < 1. It simply implies that on the demand side the cumulated positive output effects of an increase in the monetary impulse, government expenditure, deviations from purchasing power parity and from the inflationary induced decrease of the real tax burden overcompensate the negative output effect of a nominal tax increase - an absolutely plausible assumption. As a consequence of this short analysis we always assume in the following that α > 0 and 0 < ß < 1.

1. The Output Equation To get the reduced form of the model with adaptive expectations given by equations (1) to (8) we at first have to substitute (2) into (1). Using (8) we receive the following expression for the growth rate of real output demand:

(16) Y = 1 + a b 2 1

- h

+ a

3

+ a

4

+ ad - a Ρ 2 2 2

+ a HI + a G - a b t 1 3 2 3 1 - a b t 253

- a b t 264

+ aP 4

- a b t 242

+ aX + aY + u 4 5A d

Chapter Four

198

The reduced form for real output growth then is calculated by equating (13) and (16), solving for Ρ and substituting the resulting expression for Ρ into (13). This leads to the output equation (17) on pages 200 and 201. Λ

From (17) we can see that the growth of real output Y is explained by actual and expected fiscal impulses, a monetary impulse, external impulses, a price expectations effect and other influences. The fiscal impulses affect Y via the demand side (G, t-j), via the supply side (SBe, T r u e , U C e ) and via demand and supply channels (t^ t^, t^). Government expenditure growth G and the growth rate of the stamp duty tax t 1 are pure demand effects: a rise in G increases output demand and equilibrium output growth Y, which is captured by the positive coefficient 3a„ 1 + a b 2 ι If t^ is increased output demand decreases with a negative effect on Ϋ. The tax rates t^, tg and t^ appear as arguments in the output demand and supply equations. Changes in these taxes therefore influence Y via the demand and the supply side. For a detailed discussion of the different transmission channels we assume an increase in the growth rate of the transactions tax: ^ > 0. A first effect on real output growth comes from the demand side of the output market: higher transactions taxes lower disposable income, Λ

consumption, output demand and therefore Y. This demand effect is captured by the negative coefficient ßa b

2 4

1 + a b 2 ι

Solution of the Model with Adaptive Expectations

199

On the supply side ^ > 0 lowers after tax profits of firms with the consequence that labor and energy demand decrease. The reduced labor demand diminishes real output via the production function by the coefficient c d e 1 2 1 d

+ e

ι

ι

The negative influence on Ϋ coming from the reduced demand for energy is captured by the coefficient (^f^. In the following we refer to these transmission channels as to "direct" supply side effects. A third influence λ

a

from U to Y stemsfrom the fact that a reduction of labor demand leads to a new nominal equilibrium wage rate W in the labor market. W - given by equation (11) - is reduced. This lowers energy demand according to the energy demand function (7), because lower nominal wages reduce labor cost a

j

compared with the cost of energy inputs. This negative impact on E coming from the substitutability between energy and labor as factors of production λ

/ν

reduces E and therefore Y. It is captured by the coefficient c d f 2 2 4 d

ι

+ e

ι

and is called an "indirect" supply effect. Output equation (17) shows further that all direct and indirect supply effects are accompanied by a corresponding impulse that affects real output growth in the opposite direction. The reason for these mechanisms is the influence of changes in real output supply on the equilibrium inflation rate A

P. If, for example, real output supply is diminished by a reduced demand for labor the inflation rate increases because the unchanged output demand is met by a reduced supply. This upward movement of the price level reduces the real impact of the diminished output supply and therefore stimulates labor and energy demand again because firms base their input decisions

Y

'

cf

eJ

c

ti

/ι

dj + ex

3

d;

l 3el

c d

,

"

? + «î

Coe-jfy, - C j d i e ?

a) d

3

2d3f4

e;

+ c

[ c j d - e , + c 2 d 4c f 4f (1-3) ά χ + ex * 27

(1

2 bs

ga

:

Tr

u

* 1 • a2bj

ßa 2 b 4 - t44^

ga b 2 e 2df 4 +- ec l d l e 2l 2 6 l l " 1 + *2bl

( ΐ - β ) c2r 6 - 1

aJ

(1-β) - c2f 3 •

c

ί1-') -

ο,άρβ, + c?d«f 2^5 - 1 *dj + 2 4

2b3 1 + a2b1

gd

TTT^

Equation ( 1 7 ) : The Output Equation

A

;

e

4

*3

-P

Λ

expected

se6

t2

; M

G

actual

impulses

fiscal

200 Chapter Four

4

+

e

C

l

f

22

2d6f 4 .c

d

C

I+

6a

4

1 + a2b1

f

J'lVl * 2 5 4 . f c 1 d 12 l + ei

l

d

l 6el +

C d

Κ

(1-B)C3

• Uj

Pe

X

MI

- (1-3)α

J 1 + a2bx

(1

n cJ

1 + a2b1

ßa

I +

A

*

external impulses

other i n f l u e n c e s

price expectations effect

γ

EN

p

;

p

monetary impulse

Solution of the Model with Adaptive Expectations 201

Chapter Four

202

upon real price and cost magnitudes. The corresponding opposite effects are captured by the coefficients ^ i V l d

ι

+ e

ι

(= corresponding "direct" supply effect on the labor market), ß ^ f j (= corresponding "direct" supply effect on the energy market) and ßc d f

d

2 2 4 + e ι ι

(corresponding "indirect" supply effect). It should be stressed that every corresponding effect in the opposite direction is smaller than the original impulse because 0 < ß < 1 as analysed above. Similar considerations can be adopted to show the influence of the energy λ

tax rate growth t j on real output. Beside a negative demand effect

λ

a rise in t^ has a negative direct impact on energy demand (c^Cp because it increases the cost for energy as a factor of production. As a consequence of the substitutability between labor and energy labor demand is stimulated. _

Λ

This leads to an indirect positive impact on Y:

Solution of the Model with Adaptive Expectations

203

c d e 17 1 d + e ι ι Another indirect effect occurs in the energy market: the rise in labor demand increases the nominal equilibrium wage rate W, which is an argument in the energy demand function (7). Energy demand is stimulated with a positive effect on real output: c d f 1 7

4

d + e ι ι All supply side effects are accompanied by a corresponding opposite influence as analysed above. To understand the impact of changes in the income tax rate on real output it should be noted ihat on the supply side t^ only enters the labor supply function. The energy market, therefore, is only affected via the A

change of the nominal equilibrium wage rate W. The remaining fiscal impulses affecting real output growth are pure supply effects. The growth of expected real social security payments from employers to employees SB reduces labor demand, stimulates energy demand because of the substitutability between labor and energy and also influences the nominal equilibrium wage rate. The expected growth of real subsidy payments to firms T r u lowers the cost of both factors of production and therefore stimulates labor and energy demand. Expected unemployment /\

compensation growth UC

a,

reduces labor supply and stimulates energy

demand via an increase in the nominal equilibrium wage rate. To sum up the reduced form for output growth in the model with adaptive expectations shows all important effects of different fiscal policy measures via the output supply and demand side. This is one central objective of our

Chapter Four

204

study. It turns out that Y is influenced by actual and expected fiscal impulses. Λ

To understand the influence on Y which comes from the remaining impulses only a few remarks are necessary: A

- Monetary policy affects Y only via the demand side of the output market. Α

/Ν

^

- External impulses influence Y as pure demand effects (P*, Y A ) , as Λ /s 6 demand and supply effects (X) and as pure supply effects (Pj^j). Λ.

/N

/\

- Inflationary expectations Ρ have a negative, Κ a positive impact on Y.

2. The Employment Equation The reduced form for the growth rate of employment in the model with adaptive expectations [equations (1) to (8)] is obtained by equating (16) and Λ

>

(13), solving for Ρ and substituting the resulting expression into (10). This leads to equation (18) on pages 206 and 207 which represents employment Λ

growth L. As far as fiscal impulses are concerned, some similarities with output equation (17) are obvious: L is influenced by actual and expected fiscal Λ

Λ

Λ

-

Λ

impulses which occur as pure demand (G, t.), pure supply (SB , Tr Λ

Ρ

Λ

Λ

ρ

,

Λ

UC ) and combined demand and supply effects (t^ t^, t^). /s Pure demand impulses affect L via the following transmission process: an increased (reduced) demand for real output pushes up (diminishes) the equilibrium output growth Y. According to the production function (3) the

The identification of particular transmission channels can be done along the lines of the above analysis of the fiscal policy impulses.

Solution of the Model with Adaptive Expectations

205

equilibrium employment growth must be higher (lower). Equation (18) a

a

a

shows these influences of G and t^ on L. The remaining tax rates tp t j and t^ affect L from the demand and the supply side: ^ directly reduces labor demand and therefore L by the coefficient

V d

ι A t^ has a direct negative impact on labor supply leading to a reduction of L by

A

ν e

i The growth of the energy tax rate tg affects L indirectly via a substitution between energy and labor which is captured by the coefficient

V d

ι

All other transmission channelsfrom t^ tg and t^ to L are consequences of the induced changes of the equilibrium inflation and nominal wage rates. These indirect effects need not be discussed here in detail. Λ

Λ

«

Λ

Α

L is, in addition, directly affected by the pure impulses SB , Tr λ

-

Λ

a

an increase in SB reduces labor demand and as a consequence L by

ν d

ι Α

Ρ

Α

and UC :

Λ

An upward rise in T r u increases labor demand directly which affects L by

f

2b3

v

a

3

I

c

2

6

2d3f 4

α

q^q

βγ [ c l d l e 3 -

c

1

V

j " ^r

e

3*

2 d 4 f 4l x V cq-

"

c

2 e 3 f 4l

B y [ r f cld4el + IT " 2 7 d j + e j

By [ c l d 3 e l + ο dj + ej

'

Tr

u

58

c

G

!

a b Byf C l d 2 e l + C 2 d 2 f 4 , 2 4 1 V q-TT^ + 2 5 - 1 • aa 2bb 1 " ï d ïfH c d e βγ[ Γ , l 7 l + c2d7f4 2 +5 1 x 7 Y 4 α 2 3 dj + ej 1 + a 2 bj 3γ" 3 a b Byf C l d l e 2 ' c 2 e 2 f 4 2 6 1 ^ t α dj + ej ι + a2bj " ej 4

" o(l + a 2 b j )

Sya

• a( 1 + a 2 b 1 >

B

Equation ( 1 8 ) : The Employment Equation

e

- e

-e

;

tj

I

expected

actual

"—

I

impulses

fiscal

206 Chapter Four

l 6 e l * c 2 d 6 f 4] + 2 2 ύχ + ex

c d

+ u2

α ο

- —c^

γ(8-1)

α ( 1 + a2br)

c d e ByL f l 5 l + ^ 2 d+5 f 4 l , V ~ 2 1 ύ χ + ex cq~

βγ Κ +r f ΊΓ 1 + à 2 b x + +

d

6Y

Y

A

ι

;

*

external impulses

monetary impulse

Κ other i n f l u e n c e s

P e price e x p e c t a t i o n s effect

EN

X

'

ΒΥ3 4 «(1 + a2bx) p

ΜΙ

α( 1 + a 2 b x )

Solution of the Model with Adaptive Expectations 207

Chapter Four

208

An increase in the expected growth rate of the unemployment compensation UC^ directly diminishes labor supply and therefore L by

e

ι

If we analyse the monetary, external and other impulses the following points should be stressed: Λ

Λ

- In contrast to output equation (17) X and P ^ have no direct effect via the energy market. Beside the influences via induced changes of equilibrium Λ

Λ

Λ

inflation and nominal wage rates L is affected by X and Pgjsj by an indirect substitution process. This is captured by the coefficients

ι

ι λ

The growth rate of existing real capital influences L negatively. All the Λ

Λ

Λ

A

S\

Λ

other arguments MI, P*, Y ^ and Ρ affect L in the same direction as Y.

3· The Inflation Rate Equation The reduced form for the inflation rate under adaptive expectations is Λ

obtained by equating (13) and (16) and solving for Ρ using the equilibrium

η

condition (8). The resulting equation (19) defines the impact of all actual A

/\

and expected impulses on Ρ where Ρ conceptually is the rate of inflation bringing into equilibrium output demand and supply growth. As a consequence all effects reducing output supply (demand) increase (diminish) P. Influences which have a negative (positive) impact on output demand reduce (push up) the inflation rate. 7

Equation 19 is presented on pp. 210-211 below.

Solution of the Model with ati

Expectations

209

As can be easily seen from equation (19) the analysis of the particular transmission channels is simile to the corresponding mechanisms in the output and employment equations (17) and (18) and need no further comments.

IV. Solution of the Model with Rational Expectations As pointed out above the model of equations (1) to (8) treats the expected A -

inflation rate P

as an exogenous variable. This characteristic is not

compatible with the rational expectations hypothesis where economic agents use all available information in forming their expectations about future developments. This implies that they exploit the information about the movement of economic aggregates given in the structural equations (1) to A

(8). Particularly they exploit the model's explanation for Ρ according to equation (19). Rational expectations therefore imply a model-consistent Α -

Λ

Β

formulation for Ρ : Ρ has to be defined as the expected value of the rightAG

hand side of equation (19). Ρ then becomes a variable endogenous to the model - this is expressed by the new equation system (1) to (9).

1. The Output Equation To obtain the output equation in the model with rational expectations we A

at first define the expected value for Ρ according to equation (19). If we /S.

Α

Ρ

Λ

A

_

Λ

Α

ρ

A

A

ρ

keep in mind that t^ = t j , ^ = t^ , tg = tg and t^ = t^ because changes of tax rates can take place only after a long legislative procedure and therefore are known to everybody in advance, we obtain the difference p_pe.8

P-

a

2bl Ι

c

2 5 " 1 + a 2 bj

a2b4

c

e

J

f

S [ l l 3 - 2 3 4l α dj + e t

c d e

~ . c,d,e, + Cod^f£ 131 2 3 4 f α ύχ + *χ 2 6 β Cvd-e, + Cod-fi[- c 2 f 7· I 4 d ; + e ; 4 4

c d e ß[ r f l 7 l + c2d7f4 a2b5 à 2 3 dj + e x 1 • a 2 bj 5 [cldle2 " c 2 e 2 f 4 a2b6 a * ei 1 + a2bj

α dj +

B [a2b3 Ι a [1 + a 2 b l I 6 [c 1 d 2 e 1 + c 2 d 2 f 4

α 1 +

"

( 1 9 ) : The Inflation Rate Equation

eh J

Equation

4

]

ν

- eSB

4

uc

t

*3

actual

»•»«'·
2b1 d1 • e t J c 1 d s « 1 • c.2 d_s f 4

5 »(1 • t 2 bj)

s,

"i +

Solution of the Model with ati 221

222

Chapter Four

economy (real output, employment) and the dominance of expected impacts to determine the rate of inflation. - Because of the identity between actual and expected values all tax rates affect Ρ with their actual values. This is equivalent to the expected impulse effects in the cases of all other arguments with an unanticipated component different from zero.

V. Concluding Remarks This Chapter represents the central part of our theoretical analysis about stagflation problems in the Greek economy. The development and discussion of the structural equations and reduced forms of our models with adaptive and rational inflationary expectations show different transmission channels from monetary, fiscal, and external impulses on important macroeconomic aggregates like real output, employment and inflation. The model is based on modern macroeconomic theory which implies that demand and supply impulses are incorporated extensively, that particular institutional and legal characteristics of the Greek economy are considered and that processes of forming expectations are integrated explicidy. The reduced forms give space for answers in a variety of questions. All important fiscal and monetary policy effects on real output, employment, and inflation can be identified. Their supply side and demand side impacts can be separated. The solution of the models also shows clearly the indirect effects of particular fiscal policy measures which stem from substitution relations between labor and energy as factors of production and from their influences on equilibrium price and wage rate movements. In addition the main transmission channels are analysed running from external impulses to real output, employment, and inflation. External impulses like the exchange rate, inflation abroad, foreign income growth,

Concluding Remarks

223

and real energy prices valued in foreign currency (dollars) affect the Greek economy via output demand and supply. The main supply impulses enter the Greek economy via the energy market because energy in Greece is to a very large extent an imported good. The extensive elaborations of alternative hypotheses in forming inflationary expectations allow an analysis of the role inflationary expectations play in the process of transmitting policy and external impulses to important macroeconomic aggregates. It is shown how actual, expected, and unexpected impulses work in the context of the underlying structure under rational and adaptive expectations. Especially the reduced forms of the models [equations (17) to (19) and (21) to (23)] can be used for a variety of empirical tests concerning stagflation processes in Greece: (1) Regression tests of the reduced forms can figure out the most important monetary, fiscal policy and external impulses in determining output and employment growth as well as the inflation rate. The inclusion of time lags can identify underlying lag structures. (2) Discriminating evidence can be found by comparing the model with adaptive and with rational expectations. The empirical relevance of alternative hypotheses in forming expectations can be shown. (3) The model's ability to separate cyclical and potential output components in the context of an equilibrium approach in the markets of factors of production allows tests of the relative importance of potential and cyclical factors in determining the Greek economy.

CHAPTER FIVE THE EMPIRICAL ANALYSIS I. Introductory Remarks 1. Restrictions The objective of the present Chapter is an extensive empirical test of stagflation problems in Greece for the period 1961-1982. All the tests are carried out on the basis of the reduced form equations (17) - (19) and (21) (23) of Chapter Four. If we look at the reduced forms above we observe different transmission channels which run from our exogenous impulse variables to the A

A

A

endogenous variables Y, L and P. For the empirical analysis therefore the following problem arises: in many cases it is not possible to identify the expected direction of influences from impulses to endogenous variables. As A

s\

A

many fiscal, monetary and external impulse variables affect Y, L, and Ρ via different supply and demand side channels the signs of the reduced form coefficients are ambiguous. In order to reduce the ambiguity in the signs of coefficients the following restriction is imposed on the reduced form equations (17) - (19) and (21) (23): in all cases where we have transmission impulses from a particular explanatory variable which influences the dependent variable in alternative directions we assume that the direct impulses always dominate the indirect ones. To illustrate this assumption we refer to our example of Chapter Four, Λ

the impact of the tax rate Ιχ on real output according to equation (17). As can be seen the coefficient for ^ in (17) includes the following effects:

Introductory Remarks

225

- a direct demand effect 0a2b4 1 + a b 2 ι influencing Y in a negative direction; - a direct supply side effect via the labor demand function c

12 1 d

ι

+ e

ι

affecting Y negatively; • a direct supply side effect via the energy demand function c ^ with a negative impact on Y; an indirect supply effect stemmingfrom the reduction in the nominal wage rate c d f 2 2 4 d

ι

+ e

ι

also influencing Ϋ negatively; - corresponding indirect effects ßcde H 1 2 1 d + e i l

d

2 2 4 + e l i

andßc^fr, 1 D

all with a positive impact on Y. Λ

/Ν

With 0 < ß < 1 - as analysed above - the overall impact of ^ on Y is unambiguously negative.

t3

Impulses

Impulses

monetary

t2

flscal

Dependent Variables

(HI -HIe)

MIe

MI

uce

Tr®

SBe

t4

h

(G-G e )

2e

Ê

0

0

+

-

-

0

•

* Y

.

•

•/-

+/-

o

0

0

.

.

•

+

•/-

+/-

0

•

L

*

0

0

+/-

0

o

•

P

+

+

Model with Adaptive Expectations

0

-

0

o

•

-

0

+

0

+

0

t

0

0

Y

•

•

0

Λ

0

+

+/-

+/-

I

0

•

+

0

P

•/-

+

Model with Rational Expectations

•

-

0

+

Table 1: Expected Signs of Coefficients Under Dominance of "Direct" Effects

Impulses

other

impulses

external

X

0

(X-X e )

0

(K-K e )

+

i 0

0

(PEN-PgN )

Ke

0

+/-

?\H

PEN

0

0

Xe

+/-

•

îA 0

0

STCRW, = TCR ,

; J = 1, . . .

5

(t-i) The data for all interest rates and credit weights are taken from: Bank of Greece, Monthly Statistical Bulletin (various issues).

Construction of Special Variables

273

L T C R L T C R W

k, ( t - 1 )

T C R

(t-i)

(STCRWj = short-term credit weights; STCRj = short-term credit volumes; LTCRW^ = long-term credit weights; LTCR^ = long-term credit volumes; TCR = total long- and short-term credit volumes) The following symbols represent credit volumes for various sectors (all credits to the private sector are included): STCR^ : short-term credit volumes to manufacturing and mining sector; STCR2 : short-term credit volumes to agricultural sector; STCR3 : short-term credit volumes to handicraft sector; STCR4 : short-term credit volumes to trade sector; STCRj : short-term credit volumes to other sectors.

LTCR^ : long-term credit volumes to manufacturing sector; LTCR^ : long-term credit volumes to agricultural sector; LTCR3 : long-term credit volumes to housing sector; LTCR4 TCR

:

l o n g ~ t e r m credit volumes to other sectors.

: total bank credit volumes to private sector.

274

Appendix I

3. The monetary impulse M I is calculated by the formula

MI - Σ i „ J J,t

· STCRW

_1}

• Σ i k

k.t

· LTCRW

λ

4. All original data for constructing M I are given below in table form:

ST,

STo

'ST.

STc

1961 1962 1963 1964

10.00 10.00 10.00 10.00

6.58 7.00 7.00 5.50

7.50 7.50 7.75 8.50

11.00 11.00 11.00 11.00

10.00 10.00 10.00 10.00

1965 1966 1967 1968 1969

10.00 10.00 10.00 9.75 9.00

5.50 5.50 5.50 5.50 5.50

8.50 8.66 9.00 9.00 9.00

11.33 12.00 11.75

11.00

11.00

10.00 10.00 10.00 9.75 9.00

1970 1971 1972 1973 1974

9.00 9.00 9.00 10.00 12.83

5.50 5.50 5.50 5.50 7.33

9.00 9.00 9.00 10.00 12.83

12.00 12.00 12.00 13.00 14.42

9.00 9.00 9.00 10.00 12.83

1975 1976 1977 1978 1979

12.88 12.50 13.00 14.46 17.71

7.50 7.50 9.16 11.58

8.00

12.88 12.50 13.00 13.50 15.92

14.88 14.50 15.00 16.75 21.83

12.88 12.50 13.00 14.46 17.71

1980 1981 1982

22.25 22.33 21.50

14.75 14.50 13.50

19.75 20.50 20.50

23.25 22.33 21.50

22.25 22.33 21.50

Construction of Special Variables

279

SB

1961 1962 1963 1964

-2.223 4.443 9.212 3.771

5.161 8.189 2.908 6.012

5.023 8.073 0.422 4.745

19.460 14.130 15.520

181.960 4.460 68.070 89.590

1965 1966 1967 1968 1969

-0.496 23.739 2.139 4.120 -3.160

13.200 6.831 8.485 8.184 0.502

-3.991 8.784 5.536 6.207 0.418

17.770 11.200 15.710 13.010 5.900

40.180 56.260 18.030 -14.800 -29.620

1970 1971 1972 1973 1974

2.705 -1.432 3.423 5.960 -1.678

-8.364 0.211 3.553 -11.566 -32.757

0.227 3.619 0.205 -7.628 11.560

8.010 7.730 3.720 -0.530 -3.450

-0.530 54.210 15.670 61.080 30.140

1975 1976 1977 1978 1979

9.604 4.678 -0.006 -1.095 8.011

66.200 -5.345 2.423 4.546 -4.796

-5.154 20.400 -1.465 5.424 2.298

9.110 12.720 14.830 15.710 -0.990

1.900 19.970 10.170 4.560 -17.020

1980 1981 1982

-3.390 1.243 22.679

-12.139 0.368 -10.136

7.521 -6.622 13.813

0.730 5.250 15.700

-5.680 77.120 -19.060

î r

u

Appendix

280

UC

MÌ+>

1961 1962 1963 1964

11.570 0.460 9.380 24.680

-0.0511 -0.0234 0.0139 -0.0003

2.900 4.000 4.100 3.800

5.200 4.300 4.300 5.800

1965 1966 1967 1968 1969

-5.260 13.270 62.470 -9.870 -24.290

-0.0737 0.0000 0.0100 0.0190 -0.0393

4.000 3.500 2.500 3.300 4.700

4.100 3.700 3.400 5.200 5.600

1970 1971 1972 1973 1974

-13.410 -14.100 0.530 -13.270 110.960

-0.0338 0.0126 0.0000 0.0000 0.0957

5.100 6.600 6.400 8.700 14.200

4.800 3.400 4.100 5.900 1.700

1975 1976 1977 1978 1979

48.310 -29.450 31.340 16.150 3.310

0.2604 -0.0115 -0.0607 0.0347 0.1241

13.700 10.800 9.900 7.200 8.900

-1.200 5.000 2.400 3.200 3.300

1980 1981 1982

-3.400 18.400 8.500

0.3066 0.2558 0.0302

11.200 10.100 8.700

1.300 -0.400 0.400

+

) Own computation see Appendix I .

Data Series

A

Χ

Λ

Ρ

ΕΝ

1961 1962 1963 1964

0.000 0.000 0.000 0.000

-1.050 0.470 -3.120 10.260

1965 1966 1967 1968 1969

0.000 0.000 0.000 0.000 0.000

0.700 -4.920 -1.610 -0.400 -2.350

1970 1971 1972 1973 1974

0.000 0.000 0.000 1.020 -1.010

-3.050 -18.650 12.650 -2.620 41.500

1975 1976 1977 1978 1979

-15.840 -3.740 4.300 -1.380 -5.940

3.570 -3.890 -2.240 -0.690 6.680

1980 1981 1982

-17.880 -19.110 -18.330

-0.400 -5.960 -8.210

Appendix

282

2. Series of Expected Variables (Adaptive Expectations)

SB

Tr

UCc

1961 1962 1963 1964

19.460 19.460 14.397

181.870 181.870 84.295 75.344

11.570 11.570 11.015 10.933

1.870 1.870 -0.344 3.052

1965 1966 1967 1968 1969

15.464 17.655 11.522 15.501 13.135

83.196 59.543 57.732 35.896 8.013

11.620 10.776 10.901 13.480 12.312

0.998 2.567 5.040 1.810 0.471

1970 1971 1972 1973 1974

6.262 7.923 7.740 3.921 -0.307

-12.685 -5.994 27.118 20.816 42.961

10.482 9.287 8.118 7.739 6.687

2.313 3.099 3.043 4.361 14.991

1975 1976 1977 1978 1979

-3.293 8.490 12.509 14.714 15.660

35.910 17.204 18.725 14.020 8.817

11.904 13.724 11.566 12.555 12.735

26.314 14.131 13.209 12.250 12.525

1980 1981 1982

-0.157 0.686 5.022

-5.393 -5.551 39.918

12.263 11.480 11.826

18.695 24.533 24.502

—

283

Data Series

3. Series of Expected Variables (Rational Expectations)

κ

uc e

MIe

19 . 4 6 0 0 11 .6130 12 . 7 5 5 0

181.9600 4.4600 44.5150 81.6210

11.5700 5.2527 -0.3774 12.4810

-0.03785 -0.01070 0.00237 -0.00198

13 . 0 2 5 13 . 5 1 3 14 . 3 1 3 14 . 2 8 8 17 . 0 1 6

14 . 6 0 5 0 9 .2049 12 . 9 1 2 0 10 . 6 9 3 0 4 .8490

58.4770 50.3050 32.1870 -2.6427 -24.1320

-14.4280 20.2100 11.5050 -15.7660 3.0314

-0.05312 -0.03934 -0.02173 -0.03017 -0.05145

1970 1971 1972 1973 1974

12,.823 12,.968 14..789 15, . 5 7 1 17, ,323

6.. 5 8 3 2 6 .3531 3,.0574 - 0