The agreement to reschedule Greek debt has been in the news recently. Frequently it is pointed out that Greek debt has not been forgiven, but “merely” rescheduled. While economists and some journalists argue that this distinction is not really important in an economic sense, I am not sure that this is widely understood. It may therefore be helpful to present a few back-of-the-envelope calculations that show the power of rescheduling debt servicing, which essentially means pushing payments into the future. It brings into play what can be called the “power of exponential growth”, which is like the inverse of the “power of compound interest” that can make debt burdens snowball.
I am going to take two time periods, based on an assessment that the recent Greek debt deal extends “the average loan maturity to over 40 years from 32.5 years currently”. To keep things simple we’ll use 32 and 40 years.
The ECB has an inflation target of just under 2% a year. While it is true that it still struggles to hit its target in the wake of the crisis, looking forward over longer timescales it seems sensible to use that figure as a benchmark. After 32 years, an inflation rate of 2% a year has pushed the price level up by almost 90%, and after forty years it has significantly more than doubled (220%). The inflation effect alone means that the real value of the debt to be repaid is only a little over half (53%) after 32 years. The recent agreement to extend average maturities reduces that further, to around 45%.
Of course, the effective burden of debt repayment depends on the size of the economy. Let us assume that, having emerged from crisis, Greece can manage 2% real growth per year. This is not a prediction, but purely for the sake of argument and illustration. The assumed nominal rate of growth is then 4%. Even without overt debt forgiveness the debt “burden”, in terms of the effective capacity to repay, falls to 28% of the original after 32 years, and to just one fifth after 40 years.
Greece’s current debt-to-GDP ratio is currently of the order of 180%, which is widely perceived as crushing. However, Martin Sandbu is correct to call this “now a virtually useless number”. Applying the same nominal growth rate as above, when the debt has to be repaid (on average) the ratio of the existing debt to annual GDP will be only just over half (32 years) and slightly more than a third (37%) after 40 years.
All this does not mean that the agreement reached can be considered optimal, much less that the support provided to Greece since 2011 could not have been organised in a much less costly way. Maintaining primary surpluses over extended periods of time, as the deal requires, is not easy, implying a need for equally persistent current account surpluses. Still, critics need to recognise the simple fact that lending money now while pushing back interest and principal repayments far in the future, when the value of the currency is deflated, and the real capacity to pay substantially higher, is a genuine form of solidarity. The recent maturity extension – and that is only one of a series of measures – uses the “power of exponential growth” to good and economically very substantial effect.
 Of course the stand-off of 2015 – irrespective of how one apportions the blame for it – was hugely costly. It substantially worsened debt dynamics. An analysis of the situation at the end of 2014, when Greece appeared to be emerging from crisis, showed that debt could be made sustainable even without huge primary surpluses provided interest payments were kept down, the economy was given space to grow and inflation returned to normal rates.
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