Grexit Opacity: Why Are We Predicting Again?

Do we know how much we don't know?

(Photo credit from Reuters)

With the recent Greek elections, there's been a lot of talk about a possible Greek exit (or the cutely named "Grexit") from the Euro.  What has struck me about the situation is how much of it is still "up in the air".  You know, with  €436M dollar bonds lying around to be paid and high levels of uncertainty on what the EUR/USD exchange rate will end up as.  Much of it will be dependent on the political resolution in Greece, but also on political resolve in core countries such as Germany and France.

But time is running out.  If the breakup is going to work, it needs to be a surprise, but with European integration as is it's hard to imagine how Greece would be able to prevent capital flight.  Moreover, if they decide to break from the Euro, the other periphery countries would have a great incentive to leave the Euro as well, leaving only Germany to deal with the loss of so much Euro denominated debt.  Immediate losses could easily reach 400 billion in initial bank losses.

To me, this all illustrates how little we truly know about the way highly interconnected and leveraged economies work.  How do you build a model in which economic conditions in Greece endogenously create the political conditions over many rounds, endogenously weakening the political situation in Germany to create a contagious financial crisis over Europe?  There is no analytically tractable way to solve that system!  Moreover, we know about these factors now that there's been so much turmoil, but how was one supposed to be able to forecast all these issues beforehand?  I also see this as a worrying issue about NGDP targeting.  While, in the long run, NGDPLT makes sense, the real question is how the credibility is established in the short run.  If unanchored expectations can have so much impact on the interpretation of debt, it seems terrifying that so much of the global economy would become pinned on the monetary decisions of a few.  It just creates a whole new host of unknown possibilities.  We can barely work with the unknowns that we know about; I dread to think of the unknown unknowns that still remain.

The presence of those unknowns is also asymmetric.  There is likely nothing left that will manage to make Greece substantially better.  Had there been a quick fix, it would have already been tried.  Even if Germany decides to massively shift to increase Eurozone NGDP (which would also make Germany overheat by a large amount), it wouldn't be a cure-all; serious debt and supply-side issues would still remain.  We're reasonably certain of how good it can get; we have no idea how bad the left tail can go.

We can't continue down the path of development like this.  Antifragile solutions need to be found.