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Supply-oriented macroeconomics and the Greek economy : an empirical model

University of British Columbia

Post-war Greek economic history is interesting and challenging to understand and model. Despite a promising start in the race to catch up with industrial economies, it has been losing ground in recent years. Since 1974 Greece has experienced business cycles and serious stagflation, a productivity slowdown and balance of payments crises. Until then, rapid growth with high investment rates and virtually no cyclical behaviour had been the rule. World economic events, domestic political events and the oil price shocks are expected to have contributed to the change, but to what an extent is a subject of controversy. This thesis attempts to analyze the structure of the Greek macroeconomy and to investigate such issues of economic history and related policy issues, through the estimation and simulation of a supply-oriented macro model. At the core of the model lies a supply block. Production structure is described by a long-run production function in capital, labour and energy, that defines normal output. A behavioural capacity utilization equation explains deviations of actual output from normal output in terms of unexpected sales, costs and inventory changes. Factor demands represent partial adjustments to desired factor levels derived consistently from the production function. Alternative hypotheses on output determination are tested against the null hypothesis of variable factor utilization but fail to reject it. An expenditure block covers imports, exports and consumption. The estimated income elasticity of exports is higher than the one for imports, to an extent that could justify optimism about improvements in the trade account, as long as the exchange rate stays close to PPP and Greek growth rates are comparable to the rest of the world's. It appears that recent balance of payments crises are mostly due to the collapse in unrequited transfers. There is strong evidence of consumption smoothing through time. In the price and wage block one clear message that emerges is that Greece is a small open economy very prone to imported inflation. Estimated indices of real and nominal wage rigidity are about average for OECD countries. Estimates of the full-employment wage depend strongly on assumptions, and it is difficult to blame "excessive" real wages for continuing stagflation. Aggregate energy demand is split among different forms by interrelated quantity share equations, in order to endogenize energy price and energy imports. Government finance enters very simply. The monetary and international finance sectors are ignored for institutional reasons. Finally, simulations of issues of economic history and policy are carried out. Political instability in 1967 (the colonels' coup) and 1974-75 (the Cyprus crisis) is shown to have reduced the productive potential of the economy and caused an economic downturn, the latter being much more serious. The oil price shocks are shown to have caused lower output and capital formation, higher inflation and a deterioration in the trade balance. Fiscal and devaluation shocks have the usual effects, with devaluation fuelling inflation. The long-term out-of-sample stability of the model depends strongly on the specification of exogenous variable paths. Two other general conclusions are: 1. The Greek economy has slow speeds of adjustment to changes in equilibrium quantities, that have been exacerbating the problems from international and domestic supply and demand shocks. 2. The observed slowdown in productivity growth can be attributed to cyclical forces rather than a secular decline, although more observations may eventually refute this preliminary conclusion.

Text

2010-10-18

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http://hdl.handle.net/2429/29258

Economics

University of British Columbia

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