A Macroeconomic Perspective on the Greek Debt Crisis

Abstract

This chapter’s departure point is that, according to the Greece’s credit ratings, the probability of default over the rest of the life of a 10-year Greek government bond in 2015 was at least 0.4; in other words, the country was practically bankrupt. The chapter investigates how this state of affairs arose and what are the policy options for the country to avoid default. Part of the problem has been a consequence of its political choices, part a failure of fiscal policy and part the result of being in the euro. The political choice over the last nearly forty years was to raise the size of the public sector in Greece’s quest to become more like those of its northern European neighbours. The unfortunate fiscal failure was that its tax revenues did not keep pace with its public expenditures which resulted in a huge increase in its level of debt. Another political choice, it is argued, was the decision to join the euro, which has exacerbated the country’s financial problems of Greece. Although the emphasis has been on the debt crisis, as it is of immediate concern, the longer term problem is Greece’s competitiveness and the effect this has on economic growth and hence tax revenues. In order to survive within the euro system, the country needs to modernise and become more productive and efficient. Additionally, though Greece has already done much to improve its fiscal stance, it still needs to go further and generate permanent primary surpluses. The current rescue package requires surpluses of the order of 3.5% of GDP for the medium term. Alleviation of the debt burden (either outright write-downs or extensions of maturity and reduction in interest rates) would, of course, make the task of debt management easier. The alternative is for Greece to leave the euro area and probably default on its debt. It would still need to carry out the same fiscal reforms, and it would bring other short-term costs, but there would be considerable long-term benefits. These are tough choices but they are the only way that Greece can retake control of its economy.