Home > Euro, Exchange Rates, Fiscal Policy > Greek Dilemma

Greek Dilemma

Greece’s bailout by the EU and the IMF is the largest in history – €245 billion.

The seriousness of the Greek debt problem is clear to see – see graphic below. Next month the Greek government must make it clear to those euro-zone governments and the IMF that they have made €11.5billion worth of cuts to its own spending. If it doesn’t make these cuts access to further loans will be suspended and Greece will eventually have to print its own currency. For Greece there are two major challenges as well as paying back the debt:

Debt is still rising at 1.5 times the size of the economy and
Wages and prices need to be forced downward to make the country more competitive.

In the past 3 year the Greek economy has contracted by 14% and the expectation is that it will be 6.4% by the end of this year.

IMF v Germany

In order to protect the economy the IMF suggested that there should be:

– structural reforms to the economy and
– spending cuts but over a longer period of time.

However, Germany demanded that both the structural reforms and the austerity measures should take place at the same time. This involves bringing down the budget deficit from 15.8% of GDP in 2009 to under 3% by 2014. But the spending cuts and tax increases pushed the economy into such a deep recession that the deficit got stuck at around 10% of GDP.

The exchange rate problem with the euro.

It is usual that when the IMF imposes austerity measures, it makes a country devalue its exchange rate in order to make its exports more competitive and therefore offset weak domestic demand. However, Greece doesn’t have its own currency so this is policy option is not on the table.

So where does Greece go from here? With having to impose structural reforms as well as austerity measures the country is caught between a ‘rock and a hard place’. One wonders how they are going to generate any government income with virtually no growth and increasing unemployment.

The major concern for the world economy is that if major economies are going to follow austerity programmes at the same time it will be left to the private sector to generate aggregate demand. But if they don’t borrow and increase consumer spending there is a real risk of an economic depression.

Advertisements
  1. Simon
    May 15, 2012 at 8:53 pm

    Greece was likely doomed to default the minuet Merkel said out load that Greece would never default. That was some time in the middle of last year…Anyway who would want to leave their money in Greece right now? By being a creditor to a Greek bank you take the very real risk that you may over night lose a substantial proportion of your money. The smart money left the country long ago and the rest is probably hard on its heels. You cannot invest in a country with such uncertainty. Even the very small business owners are probably holding off on investment and stashing money in Switzerland. No wonder GDP and tax revenues are crashing. What on earth do you expect. There is no way out unless the EU explicitly and unconditionally guarantees all Greek depositors and creditors in Euros.

  2. Simon
    May 15, 2012 at 8:56 pm

    Trouble is then they would have to do the same for Portugal, Spain, Itlay, France?? You do not have to be Nostradamous to see that this all will not end well

  3. Simon
    • May 16, 2012 at 4:13 pm

      I reckon the French will look at fiscal union with Germany and maintain the euro.

  4. Simon
    May 16, 2012 at 8:23 pm

    Based on recent precedents, IMOP, the most likely way out in the end will be for the ECB to print lots and lots of money. The case for it in Europe is possibly orders of magnitude better than it was in USA in 2008. It seems that announcements in Germany may be smoothing the way by calling for more relaxed inflation criteria. It would be interesting to do a google check on “weimar republic”

    http://www.google.com/insights/search/#q=weimar%20republic&geo=DE&date=today%2012-m&cmpt=geo

    Ok I did it but I could not isolate Europe just Germany. Maybe inflation or Quantitative Easing would be more informative.

  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: