The Economics Behind Sovereign Debt Default   Greece has voted No More Austerity.  Ashoka Mody [1] critiques the IMF position by explaining the economics linking deflation, austerity, & debt.  The Greeks may have been wise to vote No; to finish the IMF treatment would likely have killed the patient.

He writes:
To see this [that the Greek debt burden is much greater than portrayed], we must go back to a lesson that American economist Irving Fisher taught in 1933.  He says on page 344 that “the more debtors pay, the more they owe.” That pathological condition arises in the midst of Great Depressions, such as the United States in the 1930s and Greece in the last 5 years.

Here is how this principle applies today to Greece. Recall that prices in Greece have been falling for about two years now. Since debt repayment obligations do not change when businesses sell at lower prices or when wages fall, businesses and households struggle to repay their debt in that deflationary environment. Investment and consumption are held back, the government receives less revenue, making its debt repayment harder. If fiscal austerity is imposed in such a deflationary setting, prices and wages are forced down faster, making debt repayment even harder. This is Fisher’s debt-deflation cycle. Greece is in a debt-deflation cycle.

After stepping through the IMF's role, it's recommendations, and the policy decisions taken by Greece since 2010, he concludes:

We may not like the conclusion, but it is quite simple. Greece has not grown and prices have fallen because that was to be expected when persistent austerity is laid on top of an unsustainable debt. The debt-deflation spiral always outpaces the returns from structural reforms.

As certainly as these things can be predicted, on the path set out by the creditors, the stakes will continue to be escalated: the debt-to-GDP ratio will continue to rise, the calls for more austerity will grow, and, as the pattern repeats, more debt relief will needed.

So we arrive to the present. The IMF looks back at its diagnosis in November 2012 and says, the Greeks did not follow our advice; it is no surprise that they are in a mess and they need more debt relief. The truth is that the Greeks are in a mess precisely because they followed the IMF’s austerity advice and because the promised elixir of structural reforms was illusory.

If this is true, then Greece, sadly, follows a string of countries whose economies were made worse by following IMF advice.  Take your pick from the Latin American debt crisis countries [2], beginning with Mexico in 1982 and ending with Argentina in 2001.


Further Reading:

[1] Ashoka Mody, In Bad Faith, 4 July 2015, Bruegel
http://www.bruegel.org/nc/blog/detail/article/1669-in-bad-faith/

[2] Wikipedia: Sovereign Default
https://en.wikipedia.org/wiki/Sovereign_default

[3] Paul Ebeling: The Federal Open Market Committee (FOMC) Dilemma: How tight and loose financial policies work, and the relation of these cycles to the US Dollar decoupling from the gold-backed instrument (Bretton-Woods)
http://www.livetradingnews.com/janet-yellen-and-the-fomcs-dilemma-110181.htm#.VZmn9EZdM2U

[4] List of Sovereign Debt Crises: 
https://en.wikipedia.org/wiki/List_of_sovereign_debt_crises