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Impact Of The Financial Crisis On Greece Economics Essay

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The report outlines the impact of the financial crisis on Greece which is the current issue in the world economy facing financial crisis and economic downfall. Hence the impact of the crisis on the following topics is outlined.

GDP growth

Inflation

Unemployment

International trade

Currency

Monetary Policy

Fiscal Policy

The period of information from year 2008 - 2010 and the impact on the years is explained. And through the deep knowledge and understanding of economics we have been successful in completion of the report.

Greece is the current interesting issue in the world and the downfall of its economy has been discussed. The financial crisis affected the entire economy, thus the topics are interrelated to each other. Hence the crisis affects all the sectors in the country. Thus the reasons for the crisis and its impact have been outlined in the report.

INTRODUCTION

Greece is a developed country with a high human development index situated in southern Europe. Athens is the capital of Greece. The current President of Greece is Karolos Papoulias and the Prime Minister is George Papandreou.

Greece became the tenth member of the European Union in 1981 which ushered the period of remarkable sustainable growth in the country.

The country aimed to raise their standard of living to unprecedented levels which would be achieved by widespread investments in industries, growing revenues from tourism and shipping.

The country then adopted the Euro in 2001. In 2004 Greece hosted the Olympics games.

The country is one of the most mountainous regions in Europe attracting many tourists which is their effective source of income adding to 73% of the total GDP.

In 2001 the government fully encouraged foreign investment which was particularly in its infrastructure projects of highways and Athens Metro subway system. Greece receives help from European Unions financial assistance for agricultural and industrial sectors.

In the late 19th century the Greek economy began with the adoption of social and industrial legislation in order to protect the tariffs, and the creation of industrial enterprises.

At the turn of the 20th century, industry was mainly concentrated on food processing, shipbuilding, and the manufacturing of textile and simple consumer products.

During the period of 1960s, Greece achieved its high rates of economic growth due to large foreign investments. However by 1970s, its GDP growth rate and the ratio of investment to GDP declined, which caused labor costs and oil prices to rise. The government pursued aggressive and strict economic policies which resulted in rise of inflation and heavy debt.

To stop the rising public sector deficits and heavy debt payments, the government had to borrow money heavily from external sources. Then In 1985, it was supported by a US$1.7 billion European Currency Unit (ECU) loan from the European Union.

The government began a 2-year stabilization program which was at moderate success. However Inefficiency and corruption in the public sector and excessive government spending caused the government to multiple borrowings.

By 1992 government debt exceeded to about 100 percent of Greece's GDP which was unhealthy for the nation and hence caused the crisis. Greece became very much dependent on foreign borrowing to pay for its deficits. at 1998, public sector external debt was at US$32 billion, with overall government debt at US$119 billion (105.5 percent of its GDP) which was very high for the economy to be stable. High interest rates remain the misery despite fall in treasury bills and bank rates for savings and loans institutions.

However today the major problems faced by the Greek economy is rising unemployment levels, inefficient Government reforms and widespread corruption. Cause of which the country suffers from high levels of the political corruption and low global competitiveness related to the European Union countries.

GROSS DOMESTIC PRODUCT (GDP)

Economic growth is measured by an increase in the size of a nation's economy. GDP is the market value of the goods and services in the country.

Greece economy stands as the 27th largest economy in the world. According to the International Monetary Fund for the year 2008 it is 33rd largest by purchasing power parity.

Its GDP per capita is the 26th highest in the world. GDP PPP per capita is the 25th. Standard of living of Greece stands 22nd highest in the world. The public sector accounting is 40% of GDP. The service sector contributes 75.7% of the total GDP, industry 20.6% and agriculture 3.7%.

Greece is the twenty-fourth globalized country in the world and is classified as a high income economy. GDP per inhabitant in purchasing power standards (PPS) stood at 95% of the EU average in 2008.

The Gross Domestic Product (GDP) of Greece was contracted as an annual rate of 0.80 % in the last quarter. Gross Domestic Product of Greece is 357 billion dollars worth or 0.58% of the world economy. Prior to the global financial crisis of 2008-2009,

Greece had managed to achieve a fast-growing economy after the implementation of stabilization policies in recent years. Greece has a majority service economy, which (including tourism) accounts for over 73% of GDP.

Graph showing the GDP growth rate adjusted by Inflation

Year

Mar

Jun

Sep

Dec

Average

2009

-1.00

-1.90

-2.50

-2.50

-1.98

2008

2.70

2.70

1.90

0.70

2.00

According to the report on the Greek Stability and Growth Program, the GDP will drop by 0.3-0.8 % in 2010.

Greek economy contracted by 2% in the same period of 2008.An encouraging sign is that the public revenues in the first two months of 2010 increased by 13.1%, higher than the 10.8% target set for the year by the government. Public expenses in the same period dropped by 9.6%, far exceeding the 2.8 % target set in the government budget.

Unemployment reached 10.2 % last December, slightly down from 10.6% in November, but even the Greek Labour Minister Andreas Loverdos has expressed fears that it could climb higher during 2010.

Graph showing the GDP annual growth rate

Year

Mar

Jun

Sep

Dec

Average

2009

-1.00

-1.90

-2.50

-2.50

-1.98

2008

2.70

2.70

1.90

0.70

2.00

Greek GDP declines 2.5 percent in 4th quarter of 2009. As shown in the graph the Greek gross domestic product (GDP) declined by 2.5 percent during the forth quarter of 2009.

The budget shortage in the first two months of 2010 declined by 77.4%, while the target was set at 27%.

Goods and services which were imported was declined by 18 % in the last quarter of 2009 year-on-year and the trend continues this year.

It expected the Greek economy to shrink by at least 2.25% in 2010. However, the country's sternness measures are sufficient to safeguard its budget targets. It added that the country has done enough to meet its promise of cutting budget deficit to 8.7% of GDP this year from 12.7% of GDP in 2009.

INFLATION

Greece adopted the euro as its new common currency in 2002. The adoption of the euro provided Greece which was formerly a high inflation risk country under the drachma with access to competitive loan rates and also to low rates of the Eurobond market.

This led to a dramatic increase in consumer spending and has given a significant boost to economic growth of the country. 

Key economic problems with which the government is currently dealing with include a burdening government deficit and increasing public debt.

The most important sector is tourism which indicates 73% of the total GDP and is a major source of foreign exchange earnings.

Greece current currency is Euro. Greece went through its worst inflation in they year 1944, the overall impact caused hyperinflation which means inflation which is out of control and very high.

Greece has a mixed capitalist economy with a large public sector accounting for the GDP. Greece is an agricultural country having 20% employed in it and 60% employed in service sector and 20% in the industry.

The economy of Greece went into recession in 2009, and the growth in the economy contracted to 2.5 % as a result of the financial crisis, the tightening government policies and increased Government expenditure.

Graph showing Annual change in consumer price index

Year

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

2010

2.40

2.80

3.90

 

 

 

 

 

 

 

 

 

2009

1.80

1.60

1.30

1.00

0.50

0.50

0.60

0.80

0.70

1.20

2.00

2.60

2008

3.90

4.40

4.40

4.40

4.90

4.90

4.90

4.70

4.60

3.90

2.90

2.00

According to the above data the inflation rate in Greece is currently 3.90%. In greece the inflation rate was normal in the year 2008. However it has decreased by the year 2009 where the lowest rate was recorded being 0.50%. Greece is a developed country having high human development index and a high standard of living.

According to the Philips curve, when inflation rises the unemployment decreases and Vice versa. Thus falling unemployment causes higher inflation. However in Greece, the rate of unemployment has increases massively as the rate of inflation has decreased down to 2.80

Hence the graph shows the decrease in inflation rate at the start of the year 2010. However this causes the rate of unemployment to increase rapidly. In Greece the cost of production is high due to low productivity.

Unemployment

As financial crisis around the world worsen, the situation is no better in the EU countries, especially Greece.

Unemployment rates have raised once again back from 9.3-10.6 which is believed to be the highest for Greece since March 2005, according to the National Statistics Service (NSS).

Most cases are of young people or fresh graduates looking for employment. Moreover a lot of them, as not many companies willing to employ them, are willing to choose to do something different which is incompatible with their studies and hence they are usually underpaid.

There is a 27.8 percent of 15-24 years old unemployed in the country.

Signs of an improvement in Greece's economy are diminishing as strikes are being seen almost every week by angry protestors.

Greece's runaway budget deficit is currently more than four times the European Union limit of 3%.

It currently has the highest debt of the 16-member bloc and its economy is considered to be the euro zone's weakest. Here is a graph comparing the unemployment rates of different countries and EU.

Unemployment rates - September 2008-February2010

From the graph we can see that Greece is currently facing the highest unemployment rate after Ireland and Spain.

There is surely a high raise in cyclical unemployment as demand has fallen which has resulted in less work and therefore fewer workers.

Frictional and structural unemployment also exist as many are looking to work in jobs they are not qualified for but have experience in as it pays better.

Moreover, in these financial downturns, people are willing to work in any position for any amount of pay to survive or to remain employed.

Alpha Bank's Maroulis said he expected unemployment to stabilize in 2010 and then start falling again when investments in the private and public sector pick up.

But Diego Iscaro of IHS Global Insight struck a grimmer tone. He says that the outlook for the labor market is extremely challenging and he believes that higher unemployment, combined with significantly tighter fiscal conditions, will hit private consumption, which represents around 70 percent of the GDP. "The outlook for the labor market is extremely challenging," he said. "We believe that higher unemployment, combined with significantly tighter fiscal conditions, will hit private consumption, which represents around 70 percent of GDP."

Graph showing percentage of the labor force unemployed

Country

Interest Rate

Growth Rate

Inflation Rate

Jobless Rate

Current Account

Exchange Rate

Greece

1.00%

-0.80%

3.90%

10.20%

-3701

1.3510

Year

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

2009

8.80

8.80

8.80

9.20

9.20

9.20

9.80

9.80

9.80

10.20

10.20

10.20

2008

7.80

7.80

7.80

7.50

7.50

7.50

7.50

7.50

7.50

7.90

7.90

7.90

2007

8.60

8.60

8.60

8.40

8.40

8.40

8.20

8.20

8.20

8.00

8.00

8.00

Having a look at another graph and a table showing the unemployment of Greece from the year January 2007 - January 2010, we can clearly see that unemployment was decreasing in 2007 and from 2008 it kept increasing until it reached 10.6 in 2010.

This is a relatively high increase and has created fears and worries in the Greek economy. It is believed by economists that unemployment will be on the rise throughout the year 2010 until its debt-crisis are solved.

With little hope of things getting better, people in Greece are still working harder every day to ensure they are employed and just pass through the current financial crisis.

International Trade Policy

As we know Greece is part of European Union (EU) since 1981, this has helped Greece improve imports and exports. European Union helps trading between the members of EU, Greece eliminated tariffs and quotas on imports from EU countries, by 1986 and aligned its own tariffs on imports from other countries with other EU members.

Imports from non EU countries are charged and Quotas are set to protect local business also domestic products and setting of tariffs is a good source of revenue to the government.

Most of the raw materials enter to Greece for free, manufactured have rates set from 5% to 7% such as electronics, textiles etc.

Other goods like motor vehicles have special duties Greece impose value added tax 8% to 18%.Main export of Greece is Food and Beverages, Manufactured Goods Petroleum Products & Textiles and main imports are Machinery, Boats, Fuels, Chemicals & Hydrocarbons. Greece main trades between countries are Italy, Germany, Cyprus, US, UK & Romania.

EU joined with World Trade Organization(WTO) in 1 January 1995. Greece's trade policy is the same as for other members of the European Union. The common EU average tariff rate was 1.3 percent in 2008.

On the other hand, the EU has high or rising tariffs for agricultural and manufacturing products, Non-tariff barriers reflected in EU and Greek policy include agricultural and manufacturing subsidies, quotas, import restrictions and bans for some goods and services, market access restrictions in some services sectors.

In 2009, Greece economy suffered due to drop in exports, as the figures dropped from $29.14 billion (2008) to $18.64 billion in 2009.The country in terms of export volume ranked 65th in the world.

The increase in amount of imports has always been a cause of problem for Greece economy. Greece imports decreased during recession, the volume remained higher than exports.

Greece economy had to rely on tourism and. In 2009 the imports volume was $61.47 billion, at the same time previous year the volume had been $93.91 billion. Greece are preparing for a long and deep recession ahead as it begins to dawn on them that the cost of fixing the country's public finances will need years.

During this time Greece will be facing falling employment growth, decline in wages and lower non-labour income growth should weigh on disposable income.

The economic downturn, joined with high budget deficits, is expected to push debt higher, from 112½% of GDP in 2009 to more than 135% of GDP by 2011, as a result weakening the already delicate sustainability of Greek public finances in the long term.

The external deficit reflects strongly due to their imbalance in the trade of goods. Their imports exceeded their export with a wide margin which means they have been less competitive in the international trade, to other countries in promoting and distributing their domestic products. Hence exports were decreasing and thereby fall of GDP due to deficiency in competitiveness. The imbalance in trade is explained in the graph below.

Graph showing Greece exports

Year

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Total

2010

1040.3

 

 

 

 

 

 

 

 

 

 

 

1040.3

2009

1157.5

1182.2

1320.1

1200.1

1253.0

1327.5

1337.0

1236.3

1327.3

1292.4

1215.4

1469.2

15318.0

2008

1659.4

1513.2

1391.0

1485.0

1697.1

1771.9

1876.9

1806.3

1788.8

1915.2

1451.4

1456.7

19812.9

The graph shows the reduction in exports gradually from 2009, in 2010 the exports were 1040.3 which was low compared to their imports.

Graph showing Greece Imports

Year

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Total

2010

4116.6

 

 

 

 

 

 

 

 

 

 

 

4116.6

2009

4060.7

3655.0

3654.3

3866.5

3691.8

3875.1

4292.2

3514.1

3925.1

3674.2

3627.4

4241.8

46078.2

2008

5534.2

5052.0

4818.6

5374.6

5657.5

5858.1

5956.9

5005.0

5926.9

5650.8

4512.9

4514.2

63861.7

The graph shows the increase in imports from 2009, however the imports in 2010 was 4116.6 which is greater than Greece exports causing the imbalance in trade.

CURRENCY

Euro (EUR; symbol €) = 100 cents. Notes are in denominations of €500, 200, 100, 50, 20, 10 and 5. Coins are in denominations of €2, 1 and 50, 20, 10, 5, 2 and 1 cents

The foreign exchange, or forex, market handles the trading of one currency with another.

The exchange rate of a currency in the forex market depends on various factors such as economic factors, political conditions of the corresponding countries, and market psychology. The monetary value of a currency is another major determinant of the exchange rate.

Foreign exchange market Greece is a flourishing market with good potentialities. The forex market of Greece is used for exchange of currencies. This market provides liquidity to the currency traders.

This is a global market and the market regulatory authorities are different in different countries. The foreign exchange market Greece is regulated by the Central Bank of Greece.

This bank is the prime authority of the country to maintain the value of the national currency and to take reformatory measures when the value of the currency goes down.

However, The Greek crisis has precipitated the existing crisis of the European Union. The EU crisis began with the abortive attempt to write a European constitution that could find ratification, and with the expansion of the EU to 27 members. A monetary union, however, was successfully created, with its common currency, the euro.

The euro, after a period of weakness shortly after the circulation of banknotes and coins in 2002, increased to a high of more than 50 percent over the dollar but is now falling back.

The Euro currency crisis has been less visible but has been rocking world markets for weeks.

The Greek debt crisis has become the biggest test not only of the European Union, but of its fledgling currency, the Euro, which until recently had been enjoying newfound status as a reserve currency second only to the U.S. dollar.

But the Euro has lost 10 percent of its value against the dollar since the Greek debt crisis erupted in December, and some influential investors are betting that it will tumble further.

The crisis has highlighted the serious debt problems of EU countries such as Greece, Portugal, Spain and Italy. It also has raised the prospect that the entire Euro area will fall back into a recession as sharply rising interest rates threaten the weak growth that started last year.

Greece's finances are in a critical state. Its total debt now exceeds the country's annual GDP. Its credit rating is slipping. And now the European Union is keeping it under a close watch.

As a member of the Euro, Greece is supposed to stay within strict deficit boundaries. At the last count, the country was more than four times over the limit.

MONETARY POLICY

Year

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

2010

1.00

1.00

1.00

1.00

 

 

 

 

 

 

 

 

2009

2.21

2.00

1.57

1.26

1.04

1.00

1.00

1.00

1.00

1.00

1.00

1.00

2008

4.00

4.00

4.00

4.00

4.00

4.00

4.23

4.25

4.25

3.86

3.33

2.61

The Bank of Greece was established and its Head Office is located in Athens. The banks main concern was to safeguard gold standard and foreign exchange reserves.

Hence a new committee was established at the Bank of Greece called the Monetary Policy Council who is responsible for monetary policy and exchange rate policy.

The Bank of Greece at present controls liquidity indirectly which is open market operations and by changing official interest rates and reserve requirements.

The commercial banks in Greece behaved in a very irrational manner where they granted loans over a extended period of time and amount. However the banks were mainly exposed to the Eastern Europe whose economy is very fragile.

Fiscal deficit in Greece caused the financial crisis partly in the country. The multiple debts faced by Greece arose even before the international crisis of 2008. hence the international crisis amplified the cumulative negative effects and accelerated the downturn of the economy.

In 2008 the Greek economy predicted their crucial structure as the global situation worsened. However the Monetary Policy Report which was issued by the Bank of Greece stressed on rise in the cost of borrowing. Hence interest rates for lending loans increased highest being 4.25% to withstand the current situation.

As the report stated 'a widening of the yield spread would increase the future burden on taxpayers.' In 2009 Greece was determined to implement a multi- year plan of fiscal consolidation and reforms being restructured.

Greece fell into increased borrowings and debt servicing costs which added to the financial turmoil. Where the expenditure incurred by the Government of Greece exceeded the revenues earned by the country, hence it is called budget deficit.

The Greek economy fell into a vicious circle where only one way is the solution. Greece has to reduce their fiscal deficit, reduce the expenditures and repay back the heavy debts.

Their main drawback was, they had heavy loans to repay back even before the financial crisis hit them, hence they flowed multiple borrowings which caused them to fall into the trap.

Greece had low level of private savings which hindered in their way to pay debts off from their domestic savings.

Thus the public debt cannot be financed by the low domestic savings as it was insufficient. Which resulted in rising external debt as the country then borrows loans to repay their debts, thereby falling into current account deficit. The current account deficit reflects the public debt and loss of competitiveness.

The crisis affected the entire economy of Greece hampering the Banking system and creating uncertainties, also challenging the social and economic attitudes. Where as the citizens also have high debts to pay and hence they also incur the financial stress.

The GDP contracted by 2% in 2009 because of the fall of investment by the consumers weakening the private consumption and exports in the country.

A change in the practice of the business occurred where public spending rapidly reduced as due to lack of liquidity money in their hand.

Greece banking system which was fundamentally sound has faced liquidity constraints and lead to credit constraints. Hence restricting bank access to finance and raise finding costs. The recession has thus slowed down the deposits in finance houses affecting the supply of credit.

However the interest rates for borrowing have fallen down to 1% where their aim is to increase borrowings in order to gain equilibrium for supply of money in the economy.

Hence to maintain balance of money they encourage lending loans at low interest rates. Thereby attaining price stabilization policies carried out by the central bank.

FISCAL POLICY

In 2000-2007, the development in Greece has been very fast amongst the countries in Europe leading to rapid reduction in unemployment increase in GDP at 4.2% annually versus 1.9% in the European zone.

When observing the economic expansion in Greece there was rapid increase in domestic demand by the expansionary fiscal policy of the Government reflected in their public deficit and Stability and Growth pacts.

Also the economy was to be developed by rapid credit expansions to household and private enterprises.

However this caused the large public sector deficits which were combined with heavy debts. The plan was disorganized and did not perform as planned, the rate of growth of GDP in comparison to the rate of debt did not match, and the debts of the country exceeded the rate of growth of GDP.

This started the phase of public sector indebtedness and hence the private sectors debt burden also increased heavily as a result of the rapid growth plan which included credit expansion to household and private businesses.

Hence the net savings in the Greek economy was negative on average and could be financed only by external borrowings. The economy had insufficient savings to finance the public and private sector debts.

With interest rates in 2000 being much higher compared to those of subsequent years, the rise in the interest deficit can only be attributed to a rise in the country's foreign debt.

Hence the Government had a change in their reforms and policies. Where for the economies private sector, high deposit rates and elevated cost of borrowing was to be encouraged in order the citizens will have more savings rather than credit expansion for consumption and investment. Which will exert a negative effect on the importing of goods and hence the consumers will be more reliable on domestic products.

For the public sector, high cost of service for the public debt was encouraged to regulate the public deficit.

Greek Prime Minister George Papandreou needs to raise 11.6 billion euros by the end of May to cover the maturing debt, with another 20 billion euros required by the year end to pay interest and finance this year's deficit. Greece's standing at the IMF would allow it to borrow about 2.8 billion euros from the Washington-based fund at an interest rate of 1.26 percent, as of today's rate.

The European Union will thus provide Greece with 30 billion euros of three- year loans at an interest rate of about 5 percent if the nation requests the cash.

The Government is planning multi year programs to basically fund financial assistance in order to achieve their state of economic prosperity. The fund program is consistent with the agreement among the leaders and thus the financial support of the European areas should go hand in hand with IMF and financial assistance.

CONCLUSION

The Greek government now faces the challenge in the economy of restructuring the reforms and to ensure that the economic policies continue to enhance economic growth and increase Greece standard of living and development in the economy.

Having a budget deficit of nearly 13 percent of annual output and a euro300 billion debt, the government has planned to commit to slash spending and boost the revenues in a bid to bring the deficit under 3 percent of the economic output-the EU ceiling-in 2012.

Pursuing a strong fiscal policy which is combined with public-sector borrowing and the lowering of interest rates has been the challenge for Greece. The Central bank of Greece is also making efforts to increase borrowings at low interest rest in order to stabilize the economy.

The Government should reduce its expenditure and hence domestic products need to be encouraged. As the excess of exports would enable finance the deficit in the economy. Also it will lead to rise in GDP thereby leading to decline in rate on unemployment.


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