Monetary Policy

The Federal Reserve today delivered exactly what was expected: a liftoff in interest rates from the zero lower bound, coupled with strong assurances that the future rise in interest rates will be moderate. Markets reacted hardly at all to the statement and Janet Yellen’s press conference, beyond a bit of short covering, by and large seeing the decision as a comforting first step towards normalization at a time of significant global tensions. In sum: The Fed raised the target for the fed funds rate to 0.25 to 0.5 percent, increased the discount rate (the primary credit rate) to 1 percent, slightly revised downward its economic outlook, and released a statement that was comfortably dovish. The participants’ projection for interest rates (“the dots”) suggests perhaps 100 basis points in rate hikes in 2016 and that rates will remain below 3.25 percent through 2018. There also was an implementation note that built on previous releases and explained how the new target will be reached through payment of interest on excess reserves and repo facilities that reflects the detailed preparation that went into the decision and should provide confidence that market liquidity will be smoothly managed. The overall message was that monetary policy will remain extremely accommodative and supportive of a continued economic expansion in the United States. Four broad challenges await though if the Fed is to sustain this optimism. You can’t communicate what you don’t know. The Fed has done a poor job communicating this year, contributing to market volatility and at least temporarily weakening its credibility. In September, for example, within a few days the Fed’s statement, Janet Yellen’s press conference and her speech at the University of Massachusetts arguably provided three different messages about the risks (including importantly international risks) and conditions for liftoff. Adding to the confusion at that time was the perception that the Board was divided on the timing of liftoff, divisions that may well persist with the change in voting members in 2016. But the more fundamental point in the Fed’s defense is that at a time of economic uncertainty, it is hard to credibly precommit to a certain policy path when you are explicitly data dependent. And yet an accommodative policy depends importantly on credible forward guidance on policy. Traditional macroeconomic relationships (e.g., labor market measures and the Phillips curve) have over-predicted inflation in recent years, and there is a substantial debate over whether this represents a temporary or more persistent failure of the models. The current positive pricing in markets reflects a belief that the inflation will remain muted. It doesn’t require an inflation spike, only some evidence that such relationships again have predictive power, to create significant market volatility. A high risk of market turbulence.  It is easy to argue that markets in 2016 will face higher policy and geopolitical risks than they have for some time: China, emerging markets, and populism and anti-union pressures in Europe to name a few. As many have noted, the beginning of Fed normalization at a time when the European Central Bank (ECB) and Bank of Japan are still easing introduces a period of policy asynchronization that traditionally is associated with greater market volatility, especially for exchange rates. Emerging markets remain a central concern. There is growing concern about growth and financial fragility risks in emerging markets, against which continuing capital outflows creates an additional global uncertainty.  The Fed has made clear in recent months that international uncertainties have weighed on their decision making (though expressing confidence that those shocks would have a lessening effect on U.S. activity over time), and Janet Yellen’s press conference comments emphasized her commitment to communicate carefully their plans to avoid spillovers to other markets. I do not believe that there is a credible argument that the Fed has under-accounted for these external risks. Still, this may be the major uncertainty for the outlook. End of an era?  Since the start of the Great Recession, monetary policy has carried most of the burden of support for economic activity. Now that is coming to an end, reflecting not only the Fed’s decision but also a growing skepticism about the power that successive rounds of quantitative easing programs have on industrial economies. An increase in interest rates does provide some scope for rates to be lowered in the face of future adverse shocks, but the benefit of returning to zero is limited. One does not have to fully subscribe to secular stagnation theories to believe that fiscal and structural policies will need to take more responsibility for growth in the period ahead.

Markets were clearly underwhelmed by the European Central Bank’s (ECB) easing announcement yesterday, marginally cutting its (already negative) deposit rate and extending the duration of its asset purchase program (QE). I think the Financial Times had it about right. It would have been better to do more, but what they did was helpful and it retains the capacity for further action. Still, as Ted Liu and I argued yesterday, the main channel through which QE is going to boost activity in Europe (as the Federal Reserve normalizes) is through the exchange rate, which in the context of weak global demand and emerging market capital outflows may be a modest source of stimulus. The market reaction also underscores the challenge for a central bank to communicate its intentions when the governing council is divided and it is trying to be data dependent--i.e., it is hard to communicate what you don’t know. We also agree with the FT’s bottom line: at this time, monetary policy alone cannot be expected to carry forward a robust European recovery.  Fiscal and structural policies must do their part.

At the governing council’s meeting today, the European Central Bank (ECB) announced that it will cut benchmark deposit rate to -0.3 percent, extend its quantitative easing (QE) program to at least March 2017, and broaden the scope of assets purchased. On several occasions since October, ECB President Mario Draghi has hinted an easing was coming, stating that the central bank will do what they must to “raise inflation and inflation expectations as fast as possible.” There is a strong economic case for action: inflation has stalled at levels well below the ECB’s target inflation rate of below but close to 2 percent (headline inflation in October was 0.1 percent), growth remains weak, and unemployment rates are still sky high. But, as in the United States, there are growing doubts about how much a boost of QE will provide to the European economy. A few thoughts on why the ECB’s move still matters. First, as much discussed, the ECB’s further monetary easing will clearly begin a period of policy divergence with the Federal Reserve’s normalization of interest rates widely expected to begin this month. Given the different cyclical positions of the two economies, such divergence was inevitable, and I have previously argued that China-induced market volatility should not be a reason of indefinite inaction. Even after the Fed hikes, U.S. monetary policy will remain easy by any of a number of policy rules. Still, a divergence of this magnitude is likely to continue to exert appreciation pressure on the U.S. dollar against the euro. Euro depreciation now appears to be the primary channel through which QE will boost demand in the euro area through improved trade competitiveness. The other central transmission channel, through additional bank credit, appears more muted in Europe than in the United States (my sense is that much of the improvement in credit numbers in recent months reflects the natural healing of the European economy, though QE no doubt has played a role). More broadly, euro depreciation will add to the external pressures on emerging markets by reducing demand for their exports at a time of continuing financial outflows. Meanwhile, in the United States, the political implications of a stronger dollar could also be profound during the election cycle if the euro continues to depreciate. There is also a sense in which today’s decision represents a turning point, the end of a period when the ECB (like the Fed and the Bank of Japan) has been the dominant source of discretionary macroeconomic policy. This is not to say that the ECB is out of options—interest rates could be made more negative (though perhaps at a cost in terms of increased financial stability risks). Further, the proposal that some have made for the ECB to purchase equities and non-securitized debt is a bridge too far for now, but remains a “break glass” option. Still, it now appears that we are at a stage where further ECB options will have uncertain and potentially modest effect on activity, and where its decisions could become a source of greater unity or disunity in the euro area. For example, with the expansion of the program, ECB may soon run out of German or French bonds to buy, and have to resort to the bonds of bailed-out countries such as Ireland, Spain, and Portugal. This expansion could prove politically challenging, as fiscal disciplinarians (e.g., Germany) and populist governments (e.g., Finland) may argue against providing these former crisis countries with cheap financing. A lot has been asked of ECB, and today’s move will be closely watched within and beyond Europe. The decision will be an important step in determining whether the region will soon return to a more sustainable growth trajectory in the next year. Still, at a time of rising global risks, lackluster growth and bailout fatigue in the region, and economic populism is rising across creditor and debtor countries, fiscal policy and the continuing efforts to advance economic union in Europe now will need to become a more central focus.

In September 2014 the European Central Bank lowered its deposit rate to an all-time low of -0.2 percent, after which ECB President Mario Draghi declared that rates were “now at the lower bound.” What he meant by this was that, by the ECB’s calculations, banks would find holding cash more attractive than an ECB deposit at rates below -0.2 percent, so there was no scope for encouraging banks to lend by pushing this rate lower. The ECB therefore turned to asset purchases, whose efficacy is much in debate, in an effort to ease policy further. But was Draghi right? Had the ECB actually hit “the lower bound,” or could it have usefully cut the rate lower? The answer is important, because negative deposit rates above the lower bound encourage banks to “use it or lose it” – that is, to lend. One way to determine whether Draghi was right is to look at what’s happened to the number of €500 notes in circulation. If the ECB had hit the lower bound on deposit rates, then this number should have risen as banks accumulated cash in vaults. But as the top figure above shows, it’s barely budged: banks do not seem to have moved into cash to avoid negative rates. Another piece of data to check is the spread between the ECB’s deposit rate and the rate at which banks are willing to lend to each other overnight (“EONIA”). Normally, the deposit rate and the interbank rate move in tandem, as banks are generally willing to lend money at a set rate above what they can get from the ECB. But when the deposit rate falls below the lower bound, banks no longer pay it any heed: they just hold cash, and the spread rises. But as we see in the middle figure above, it has not – the spread has in fact fallen back to its historic low. A final piece of data that might suggest we were at the lower bound is bank net interest margins. If banks are already paying 0 percent on customer deposits, then any cut in their lending rates would have to come out of lending margins – that is, profits on lending. At the lower bound on the ECB’s deposit rate, then, further cuts may not stimulate banks to cut their lending rates. On average, however, eurozone banks are still paying 0.7 percent on new household term deposits with a maturity of less than a year, and 0.25 percent on commercial deposits. There is, therefore, scope for such deposit rates to fall further. Additionally, whereas the spread between new lending and deposit rates for both households and businesses has generally fallen over the past several years, as we see in the bottom figure above, it remains at or above the historical average in most countries. Finally, reported Q1-2 2015 net interest margins for Europe’s largest banks are generally not low by historical standards. This suggests that banks may well be willing and able to withstand further compression of lending and deposit rates. In short, the evidence suggests that Draghi was wrong. The ECB, we believe, could stimulate lower lending rates and more lending through further cuts in its deposit rate.

All eyes and ears are on the Fed as it ponders its first rate increase in nine years.  IMF Managing Director Christine Lagarde fears a rerun of the 2013 “taper tantrum,” or what we have been calling a rate ruckus. Emerging markets are clearly vulnerable to renewed outflows, as capital chases higher yields in the U.S. and drives up the cost of dollar funding abroad. Yet missing from the discussion is what other major central banks are doing.  Specifically, the European Central Bank (ECB) and the Bank of Japan (BoJ) have ramped up their asset purchase programs in the past year, and are committed to creating large amounts of new liquidity until at least mid-2016. As shown in the graphic above, the liquidity they intend to inject, combined, both this year and next is in line with that from Fed asset purchases at the height of QE3 in 2013. The new net global liquidity created by the ECB and BoJ in each of these years will be greater – even after subtracting the liquidity to be removed by the Fed through balance sheet contraction – than that created by the Big Three at any point since 2011. Why is this good news for emerging markets? First, asset purchases by the ECB and BoJ have a greater tendency to displace existing investment in government debt than do Fed purchases.  As new issuance of government debt is smaller in the euro area and Japan than in the U.S., the ECB and BoJ will have to purchase a larger amount of secondary market assets from private investors in order to meet their target quantity of purchases. Second, investors displaced by ECB or BoJ asset purchases are no less likely to invest in emerging markets than those displaced by Fed purchases.  To see this, let’s walk through their investment options. One is domestic non-government bond or equity markets. In fact, these are smaller in the euro area and Japan than in the U.S., which suggests less scope to reallocate in such markets. For one (large) class of investors – banks – there is also the option to increase lending to households and businesses. But the economic outlook remains weak in Europe and Japan, and weaker than in the U.S. at the time of the Fed’s QE3. This suggests fewer attractive opportunities to expand lending. If domestic markets and bank lending are likely to absorb less of the liquidity than in the U.S., then a greater proportion of money displaced by ECB and BoJ purchases will flow to foreign assets. Whether this is to emerging markets – and which ones – will depend on investors’ risk tolerance. And there is no obvious reason why investors displaced by the ECB or BoJ would be any less risk-loving than those displaced by the Fed. In short, a tightening of U.S. monetary policy does not mean a tightening of global liquidity.  In fact, the ECB and BoJ look set to expand it more than we’ve seen in any two-year period since the start of the crisis in 2007-8.

The Federal Reserve’s decision to not raise rates today was the market’s consensus expectation. Nonetheless, U.S. and foreign bond markets have rallied on revised expectations for Fed policy. With four members of the Federal Open Market Committee (FOMC) now forecasting that interest rates will lift off only in 2016 or later, markets are now putting significant weight on a rate hike only next year. More importantly, the forecast of FOMC participants—the “dot plot”—shows that the policy rate is only expected to reach around 2.5 percent in 2017 and 3.5 percent in the longer run. So whenever liftoff occurs, the Fed wants you to know that rates will increase very slowly in the coming years. Easy monetary policy is here to stay. The Fed’s statement highlights the role of international developments in their decision. “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.” Perhaps they would have held fire even if there were not for developments abroad, but it’s notable that Janet Yellen’s press conference highlighted global uncertainties (and their knock-on effects on inflation and inflation expectations) as important risks to the the U.S. outlook. It looks possible that the crisis in China, along with the decline in commodity prices and tightening in global financial conditions associated with this shock, was a decisive factor. By itself, the China news is a thin argument for not raising rates. The roughly 2.7 percent depreciation of the RMB against the dollar over the past month, and a roughly 0.5 to 1 percent mark-down in Chinese growth (the size of the reduction in growth forecasts over the past month in many market outlooks), would reduce U.S. growth by only about 0.1-0.2 percent. Hardly a reason to put off a move justified by an improving labor market and a forecast of continuing solid U.S. growth. Further, resolving the uncertainty of U.S. rate liftoff, combined with a strong signal that interest rates would move up only slowly, might well have been neutral for markets in the current environment. But clearly, on net, international developments continue to be a drag on the U.S. outlook, and conversely a moderately-growing U.S. economy can’t sustain growth abroad on its own. Any story whereby a China crisis has a material impact on the United States likely assumes either that there is much worse to come from China, or, more materially in my view, that the crisis in China spreads through emerging markets, affecting in particular both commodity exporters such as Brazil and countries (especially in Asia) with close ties to China and high levels of private debt and leverage. Already, the Chinese news has caused emerging markets to fall and capital outflows from these countries to accelerate, and if these trends continue we could see a move in the trade-weighted dollar and a decline in global demand that could be material. Stated more directly, China will remain a global risk and contagion a global concern. The challenge is that these scenarios will take some time to play out, and in any case it could be many months before they are ruled in or out. At some point, the Fed will need to accept that global risks and the volatility they generate are an enduring feature of markets and not a reason for indefinite inaction.  

While markets are debating whether the Fed will raise interest rates in September, a more challenging question is how will they implement that policy change.  There is a new blog by Stephen Cecchetti and Kim Schoenholtz that cuts through the clutter and clearly lays out how the Federal Reserve will operate monetary policy once it lifts off from the zero lower bound. As they note, their paper draws on a valuable primer by Federal Reserve economists Ihrig, Meade, and Weinbach that was recently released on the topic. (For disclosure purposes, I am married to one of the authors of the Fed paper.) Both are well worth reading. Cecchetti and Schoenholtz note that the old system for policy tightening “is no longer functional, and will not be for some years to come, if ever.” They describe the new system as a corridor system, and trace out how that works with the interest rate on excess reserves (IOER) as the principal new tool for policy tightening, supplemented by additional instruments designed to absorb funds from banks and nonbanks. Their bottom line: “How well this new mechanism works will only become clear when the Fed actually tightens, so fasten your seatbelts and get ready for the ride.”  

In March 2010, two months before the announcement of the first Greek bailout, European banks had €134 billion worth of claims on Greece.  French banks, as shown in the right-hand figure above, had by far the largest exposure: €52 billion – this was 1.6 times that of Germany, eleven times that of Italy, and sixty-two times that of Spain. The €110 billion of loans provided to Greece by the IMF and Eurozone in May 2010 enabled Greece to avoid default on its obligations to these banks.  In the absence of such loans, France would have been forced into a massive bailout of its banking system.  Instead, French banks were able virtually to eliminate their exposure to Greece by selling bonds, allowing bonds to mature, and taking partial write-offs in 2012.  The bailout effectively mutualized much of their exposure within the Eurozone. The impact of this backdoor bailout of French banks is being felt now, with Greece on the precipice of an historic default.  Whereas in March 2010 about 40% of total European lending to Greece was via French banks, today only 0.6% is.  Governments have filled the breach, but not in proportion to their banks’ exposure in 2010.  Rather, it is in proportion to their paid-up capital at the ECB – which in France’s case is only 20%. In consequence, France has actually managed to reduce its total Greek exposure – sovereign and bank – by €8 billion, as seen in the main figure above.  In contrast, Italy, which had virtually no exposure to Greece in 2010 now has a massive one: €39 billion.  Total German exposure is up by a similar amount – €35 billion.  Spain has also seen its exposure rocket from nearly nothing in 2009 to €25 billion today. In short, France has managed to use the Greek bailout to offload €8 billion in junk debt onto its neighbors and burden them with tens of billions more in debt they could have avoided had Greece simply been allowed to default in 2010.  The upshot is that Italy and Spain are much closer to financial crisis today than they should be.   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

U.S. and European efforts to resolve the Ukraine crisis seem to be finding their stride in recent days. U.S. Secretary of Defense Ash Carter ended months of “will they won’t they?” by announcing earlier this week that the U.S. would be sending heavy weaponry into Eastern Europe, and late last week EU leaders declared that EU sanctions against Russia would remain in place through the end of 2016, quelling months of anxiety around whether EU resolve on sanctions would hold. But surely if, as Carter put it, the real test is whether the U.S. and its NATO partners deliver on commitments to “stand up to Russia’s actions and their attempts to reestablish a Soviet-era sphere of influence,” then among the strongest measures of success regarding Ukraine will be whether the country remains capable of steering its own fate economically. As we have written elsewhere, transatlantic diplomacy suffers from a muscle imbalance when it comes to Ukraine. Far too much of the focus of U.S.-European attention has been on punishing Russia and deterring future aggression; the U.S., Europe, and allies need to do much more to support Ukraine’s economy, and they need to do so soon. Further, of what little international attention has remained focused on the economic dimensions of this crisis, the overwhelming share has fixated narrowly on the negotiations now underway between the Ukrainian government and its private creditors, which remain deadlocked. This is understandable—it’s a high-profile negotiation, significant amounts are involved, and the outcome is central to the country’s fate. But without a larger U.S.-EU economic vision for Ukraine to anchor it, even the most successful outcome to the current debt negotiations will likely be forgotten to history, swallowed by an ending in which no one—neither Washington, Brussels, Kiev, nor Moscow— comes off well. What, then, to do? Clearing the fastest possible path for Ukraine to return to market access requires five basic ingredients: a credible reform plan; secure medium-term financing; a reduction of government debt to viable levels; leaders capable of delivering those reforms; and a public which is willing to go along. In the view of some analysts, the pricetag for all of this is in the range of $40–50 billion over the next three to four years—not a small sum, but hardly imposing when compared to the hundreds of billions expended on lesser strategic priorities (e.g. keeping Greece in the eurozone). If Greece and other eurozone crises teach us anything, though, it is this: finding the right ratios of these five ingredients proves to be as or more important as securing a certain topline amount of short-term external financing. To their credit, Western leaders recognized almost immediately that, as willing partners in Kiev go, it won’t get better than the team currently in place. But what they fail to appreciate is that this is not a static point: it is true that Ukraine has its most serious reform-minded economic team since it gained independence twenty-four years ago. The current government has made meaningful downpayments on its reform commitments, passing anti-corruption legislation last October, standing up a new anti-corruption agency this past spring, and curbing jaw-dropping energy subsidies—one of the greatest sources of the country’s corruption— over recent months. Yet, it’s not enough. Support at home is eroding. Local opinion polls point to sharp declines in support for the Kiev government over the past year. Whereas nearly half of Ukrainian respondents viewed the Kiev government as having a positive influence a year ago, that figure is now down to one-third. More striking, this shift is particularly strong in western Ukraine, where those who view the government as a bad influence has jumped from 28 to 54 percent. This suggests that, in calibrating the right ratios—in determining how and how aggressively to push on the debt negotiations and on the broader reform agenda—Western policymakers would do well to see their task as defined, above all, by doing what is necessary to help the current Ukrainian government shore up support. So far, the IMF appears to understand this. The Fund is hosting a rare trilateral meeting of Ukraine and private creditors’ representatives in Washington this week in a hands-on bid to bridge the gaps between the two sides. The Fund also helpfully bolstered Kiev’s negotiating position by signaling last week that it was prepared to release the next tranche of its bailout even if Kiev suspended debt servicing. And it reacted warmly to Ukraine’s offer to issue securities linked to future growth in return for private creditors accepting a writedown in debt, what IMF head Christine Lagarde softly applauded as Ukraine’s “continued efforts to reach a collaborative agreement with all creditors.” The next step is for the government itself to meet with creditors, without conditions, to move the negotiations forward. Just as the Fund is doing its part to see that Ukraine emerges from the current creditor negotiations with a sustainable debt load, so too must the United States, EU, and other Western leaders do theirs: coming together around a common, detailed roadmap that does everything possible to support and hold the Ukrainian government to its own stated priorities. These include shrinking the bureaucracy, eliminating dozens of inspection agencies, improving the caliber of civil servants, and unifying all energy prices at the market level, which would eliminate the greatest cause of top-level corruption. There is no single correct answer as to what such a roadmap must entail. We’ve compiled a few suggestions and ideas all sides might do well to consider (many of which build on recommendations contained in an excellent report by the Vienna Institute for International Economic Studies): Prioritize energy efficiency reforms. The United States, the EU, and international financial institutions should triage energy efficiency and electricity sector reforms atop their various potential conditions for further assistance. Model legislation, drafted with the assistance of the European Energy Community, already exists for both reform areas (the European Energy Community had a similarly leading role in the drafting of Ukraine’s recently passed gas reforms); all these electricity and energy efficiency reforms need is the inducement of Western financing. Provide secure, multi-year financing. There is clear evidence of an emerging financing gap in the current IMF program, which should be addressed quickly. The IMF is unlikely to want to significantly expand its financial commitment, but shifting money from one year to the other or covering up the gap with optimistic economic assumptions is not the answer. Substantial multi-year financing commitments from major governments, in support of a strong reform effort, is the best way to restore confidence and stabilize the exchange rate. Do more to expose the beneficiaries of corruption and wasteful subsidies and leverage the government’s footprint in the economy for good. All sides seem to agree that financial and material assistance should be conditioned on progress in reforming the legal system, including requiring clear strategies for monitoring reform implementation. Western efforts should put more concerted focus on taxation of oligarchic assets and confiscation of illegally amassed wealth, though, as the rightful entry points for encouraging broader public tax compliance. Finally, given the Ukrainian government’s large presence in the economy, Kiev might harness its outsized procurement power to lead by example, setting new transparency and anti-corruption standards for all entities doing business with the Ukrainian government. Use government land to establish special economic zones, which might be backed by Western trade and investment preferences. To be attractive to investment, any such government-sponsored economic zone or park must provide clear ownership rights, good transport connections, abundant and reliable energy and water supply. They must also enjoy the full support of local and regional government bodies. Ukraine’s many state owned enterprises possess underutilized industrial land, which could be quickly repurposed in this way. Western governments could sweeten the inducement by lending these zones special trade and investment preferences. Revitalize the FDI agency InvestUkraine, preferably as an independent agency reporting to the prime minister. Several newer EU member states boast successful investment agencies (especially PAIiIZ in Poland and Czech Invest in the Czech Republic), which may serve as good sources of technical support to a similarly-revamped Ukrainian investment agency. Regional investment agencies in territorial-administrative units are necessary to direct investors to concrete leads and may also offer a vehicle for increasing the competence of oblasts and municipalities across the country. Catalyze public sector reforms through a salary top-up fund. Ukrainian officials are quick to note that they are not lacking in Western advice. Rather, what they need is a cohort of reliable, capable civil servants who are up to the task of translating this advice into long-term change. Western assistance dollars should strongly consider a ‘top-up fund’ where, in exchange for acting on public sector restructuring plans, the Ukrainian government would receive outside funding to help it pay the competitive salaries necessary to recruit top domestic talent. Jennifer M. Harris is a senior fellow at the Council on Foreign Relations.  

Since the IMF’s launch in 1946, 27 countries have had overdue financial obligations of 6 months or more.*  But the amounts involved have always been small, never exceeding SDR 1bn ($1.4bn). This could all change dramatically with Greece, which will default on the SDR 1.2bn ($1.7bn) it owes the Fund next week unless its troika creditors agree to extend further financial assistance before then.  Greece owes the IMF SDR 4.4bn ($6.2bn) through the end of this year and SDR 18.5bn ($26bn) over the coming ten years.  As shown in the graphic above, this is nearly four times the cumulative total of overdue funds in the IMF’s history. Although Greek prime minister Alexis Tsipras has blasted the Fund for “pillaging” Greece, the conditions it has imposed on the country have been mild by historical standards – particularly considering the size of the loans involved.  Non-payment by a European state will surely undermine the IMF’s credibility in the eyes of developing countries, and likely accelerate efforts to build alternative institutions. Next up: Ukraine . . . * “Defaults” in the post title are defined as financial obligations overdue by six months of more, or what the IMF refers to as “protracted arrears.”   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

IMF Chief Economist Olivier Blanchard has said that Greece needs to slash pension spending by 1% of GDP in order to reach its new budget targets.  The Greek government continues to resist, arguing that Greeks dependent on pensions have already suffered enough.  But it has yet to put a compelling alternative to its creditors. What depresses us is how little attention has been paid to one major area of Greek government spending that seems ripe for the ax: defense spending.  Greece spends a whopping 2.2% of GDP on defense, more than any NATO member-state save the United States and France.  Bringing Greece into line with the NATO average would alone achieve ¾ of what the IMF is demanding through pension cuts. Greece has long argued that its defense posture is grounded in a supposed threat from Turkey – also a big spender on things military.  But surely the United States and the major western European powers can keep a cold peace between NATO allies at much lower cost. So why don’t they?  German and French arms-export interests surely explain the silence on the creditor side: Greece is one of their biggest customers. With Greece sliding towards default and economic chaos, such silence is indefensible.   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”