For years, the country of Greece had a good economy. It had a very high-income economy and was one of the world leaders in terms of standard of living for its citizens. The tourism industry was growing faster and faster and helped to fuel the fire beneath the economy. In fact, Greece’s economy expanded at one of the highest rates in the Euro zone in the early 2000’s due to the high volume of tourists that it accommodated. Unfortunately for them, this growth was about to come to an abrupt halt. When the world economy took a turn for the worse, all of the money that Greece had been borrowing in order to fund large projects was examined more closely. It was revealed that Greece had been over-borrowing at such staggering levels that even the EU was shocked. With a down world economy, they were no longer able to borrow at such cheap rates and could not pay off their debts (Hoffman, CBS News). Throughout the rest of this paper, I will examine exactly what led Greece into this mess and what policies that the Greek government should put in place in order to try and resolve this issue with the least amount of damage possible.
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First things first, let’s look at how Greece got into so much trouble. During the good times, the Greek government decided to borrow billions upon billions of dollars to help the country grow. This would have been fine if they were receiving enough tax revenue in order to cover these debts but, of course, they were not. Now they’re stuck with this huge debt burden that equals around 133% of their total GDP (an estimated â‚¬300 billion or $413.6 billion) and that number only continues to grow as the economy shrinks even further (Hoffman, CBS News). These numbers have led Greece to have the lowest credit ratings in the entire Euro zone and made borrowing for them extremely expensive. Now the fear is that the Greek government will declare bankruptcy and default on all their debt unless drastic steps are taken. And as usual in situations like this, these steps are not going to be very popular with the citizens of the country.
So what has Greece already done to try and stem off a catastrophic event? They have essentially turned to large institutions for help. The International Monetary Fund, the European Central Union, and the EU have all decided that they will help Greece out by providing them with enough funds to keep up with their current debt. However, these funds are not just being handed over without a catch. By taking these funds, Greece is agreeing that they will institute large scale budget cuts in the upcoming months. These “austerity measures” are key to getting the country back to a level where their spending is under control once again and they can start paying back some of the debt that is already owed. These institutions are only helping out because they know that if Greece were to default on their debt, the world could see an even greater financial crisis than when Lehman Brothers collapsed (Hoffman, CBS News). Greece is already is huge trouble. Now it just turns into damage control.
I mentioned the so-called “austerity measures” above but I feel that it is necessary to go a little more in depth to the specifics as to what these actually are. Keep in mind, these are the measures that Greece must abide by just in order to get the funds that they so desperately need right now. The primary stipulation, as you may have been able to guess, is cutbacks in spending. These cuts are specifically found in the fields of pharmaceuticals ($1.32 billion cut), defense budget ($398 million cut), government and election spending ($358 million cut), and pension funding ($398 million cut). Going a bit further, the IMF has also stipulated that they must cut back $530 million in public spending and find an additional $431 million so that they can keep on track with their debt repayments. Finally, Greece has agreed that they will sell off $66.3 billion worth of assets and cut approximately 15,000 jobs by the end of this year (Greece Austerity Measures, Fox News). As you can see, this isn’t just a simple restructuring. We’re talking about lots of money changing hands here and it’s a tough crisis to try and solve.
There are other ways that Greece is dealing with their problems other than by receiving funds by obliging to certain austerity measures. The other major part of this whole deal they have to deal with is their private creditors like bondholders. They are cutting costs in this area by what is called a “haircut.” Bondholders may have to accept cuts of up to 70% on the money that they lent to Greece. This has a lot of private creditors in a very bad mood because they are essentially getting ripped off. For every dollar that they lent to Greece, they would only be getting $0.30 back (Hoffman, CBS News). This sounds like a terrible deal for them but there really is no other option if the IMF does not want to deal with a messy default.
After quickly detailing a little bit of how the European Union and the International Monetary Fund are dealing with this crisis, I can finally put in some of my own thoughts as to how I think they’re handling the situation. I definitely think that the institutions involved in this whole deal are going about it in the correct way with the austerity measures. Instead of just handing over money in the form of a bailout, they are actually demanding that certain requirements be met first. If they would have just handed over the money, it probably would have created moral hazard from other countries like Portugal and Ireland who are also on the verge of a debt/currency crisis. They would’ve just continued to borrow and spend knowing that if they were about to default, the IMF and EU would just bail them out. It’s a great thing that they did not just do this.
As far as the “haircuts” go that I previously mentioned, I think it’s a good idea. But I also have no stake in that game. If I would have bond holdings in Greece, I’m sure my opinion would change dramatically. However, during tough times, tough decisions must be made. Maybe the one area that I disagree with is the fact that they are cutting $398 million from pension funding. This is literally people’s lives that we are talking about here. In an article that I read titled, “Greek Suicide a Potent Symbol Before Election”, it tells the story of a Greek pensioner’s suicide and the note that he left behind. The man said that he would rather die than have to scavenge for food due to the loss of his pension fund (Maltezou, Yahoo News). He is definitely not the only one. As I searched for articles on the currency crisis in Greece, the search engines were littered with articles on Greek suicides due to financial problems. The government got the country into this mess. Its citizens do not deserve the kind of treatment that they are getting.
Stepping back a little bit from just primarily focusing on Greece, I’d also like to detail in more of a macro level what is happening to the Euro and what needs to be done in order to save it. In a very broad sense, the euro is in some serious trouble. A currency crisis basically occurs when there is a large deficit in the balance of payments. When speculation starts running wild in the foreign exchange market, the value of the currency is put to question and people start to doubt that it still holds value as a medium of exchange. This is exactly what is happening to the euro due to many countries in Europe running large deficits. Unless they can change their policies quickly, the market may just bet against the euro so much that it fails (Save the Euro, The Economist).
In a general sense, the European Union must take quick, drastic measures in order to save the euro. Four main objectives must be met: determine with governments are in trouble (illiquid), make sure Europe’s banks could withstand a default, quit only budget cutting and try to promote growth instead, and start making a new model that will not get us in this mess again. The first part, determining which governments are in trouble, sounds like an easy feat. Apparently it isn’t since there are so many already and we never even noticed before. Obviously there is Greece, Ireland, Spain, Portugal, etc. But they need to really get down to the nuts and bolts of the whole deal and really take a look at each and every country. There’s no point in going through all this if you miss a country that is in financial trouble (Save the Euro, The Economist).
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Shoring up banks is obviously just a precautionary measure in case a messy default would occur. If this was to happen and the European Central Bank was unable to help out, we’d be looking at a global financial crisis. It is also imperative that European countries don’t solely focus on budget cuts but also promote growth. By increasing taxes on citizens and cutting back on all your budgets, you are essentially just setting yourself up to go further into recession. This is why promoting growth is such an important part of this plan. By promoting growth, you are also trying to instill confidence. This will increase your credibility has a nation and help the euro to appreciate (Save the Euro, The Economist).
The last part of this plan is to start to implement a new model that will ensure this mess will never happen again. This will definitely take the longest of the four steps since it would involve many votes and treaties between all the countries. Anytime those types of things are involved, you are looking at a solution that could end up taking a long time. By ensuring others that you are indeed already looking to the future so that this will never happen again, it will also instill more confidence in the euro. This will also instill confidence and help the euro right now, along with helping in the future (Save the Euro, The Economist).
To achieve some of the things that I have stated above, we need to look at which way the Mundell-Fleming model needs to shift. Since the government needs to decrease spending, the IS curve would shift to the left. The problem with that, though, is that it will cause the local interest rate to lower and also GDP to decline. This will actually make the currency weaker which goes against what Europe wants to do. By doing this, the weaker exchange rate will make foreign goods even more expensive. This is why I stated earlier than instead of primarily focusing on budget cuts they also need to focus on economic growth.
As you can see, the Euro-zone has a lot of work to do. There really is no simple solution to a problem of this magnitude. When you have something like this that could potentially cause one of the biggest financial crises in world history, you must put a lot of heads together and come up with a solid solution. We’re at the point where not everyone in Europe is going to get what they want. In fact, some countries are going to really fall into a deep recession. Years of over-spending and being risky with their assets has led to this. I’ll leave you with a quote from EU President Herman Van Rompuy that states, “We’re in a survival crisis. We all have to work together in order to survive with the euro zone, because if we don’t survive with the euro zone we will not survive with the European Union.”
According to (Alogoskoufis), “Greece’s crisis is not simply a debt crisis. It is a dual confidence crisis, due to the mismanagement of the expectations of international creditors and domestic consumers and investors.” Thus, to resolve the crisis, confidence needs to be restored on both fronts. The main difficulty of the Greek program is that is has so far failed to address the confidence crisis that has led to its adoption. The Greek program ought to be modified to break this vicious circle. This must be the top priority of the new government.
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