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Published by Sampath Kumara, 2022-07-11 15:06:18

B20 IS 1020 - Preseen Case Study

B20 IS 1020 - Preseen Case Study

IS 1020



Greek Economic Crisis

In 2015, Greece defaulted on its debt. Some concluded it as Greece fell into "arrears”. However,
its missed payment of €1.6 billion to the International Monetary Fund (IMF) was the first time
in history a developed nation had missed such a payment. Greece joined the Eurozone in 2001,
adopting a single currency and many other policies.

Though some blamed joining Eurozone as one main reason for the downfall, Greek economy
was plagued by several problems. During the 1980s, the Greek government had pursued
expansionary fiscal and monetary policies. In contrary to the expected result of strengthening
the economy, the country suffered from mounting inflation rates, high fiscal and trade deficits,
low growth rates, and exchange rate crises. In this dismal economic environment, joining the
European Monetary Union (EMU) appeared to offer a glimmer of hope. The belief was that
the monetary union backed by the European Central Bank (ECB) would control the inflation,
help to lower nominal interest rates, encourage private investments, and stimulate economic
growth. Further, the single currency would eliminate many transaction costs, leaving more
money to deal with the deficit and the debt of the country.

However, acceptance into the Eurozone was conditional. Of all the European Union (EU)
member countries, Greece needed the most structural adjustment to comply with the guidelines;
for instance, limit government deficits to 3% of GDP and public debt to 60% of GDP. For the
rest of the time, Greece attempted to meet these criteria. While Greece was accepted to the
EMU in 2001, some argue that it was not qualified to be there yet. Greece was hoping that
despite its premature entrance, membership to the EMU would boost the economy, allowing
the country to deal with its fiscal problems. In 2004, the Greek government openly admitted
that its budget figures had been adjusted to meet the entry requirements for the Eurozone's
single currency.

Greece’s acceptance into the Eurozone had a symbolic significance, as many banks and
investors believed that a single currency eradicates the differences among European countries.
Suddenly, Greece was perceived as a safe place to invest, which significantly lowered the
interest rates the Greek government was required to pay. These lower interest rates allowed
Greece to borrow at a much cheaper rate than before 2001, resulting government spendings to
increase. While indeed encouraging economic growth for several years, the country still had
not dealt with its deep-seated fiscal problems which, contrary to what some might think, were
not primarily the result of excessive spending. Instead, the lower government income was a
culprit, which was a consequence of systematic tax evasion. Meantime, self-employed,
wealthier workers under-reported income while over-reporting the debt payments. The
prevalence of this behavior revealed that the root cause is more related to a social norm which
was not corrected in time.


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IS 1020
Eurozone membership helped the Greek government to borrow cheaply and to finance its
operations in the absence of sufficient tax revenues. However, the use of a single currency
highlighted a structural difference between Greece and other member countries, notably
Germany, and it worsened the government’s fiscal problems. Compared to Germany, Greece
had a much lower rate of productivity, making Greek goods and services far less competitive.
The adoption of the currency “Euro” only highlighted the competitiveness gap as it made
German goods and services relatively cheaper than those in Greece. Having given up an
independent monetary policy, Greece could no longer devalue its currency relative to that of
Germany. This served to worsen Greece’s trade balance, increasing its current account deficit.
The global financial crisis that began in 2007 exposed the true nature of Greece’s financial
condition. The recession weakened Greece’s already insignificant tax revenues, which caused
the deficit to worsen. In 2010, U.S. financial rating agencies stamped Greek bonds with a "junk"
grade. As capital began to dry up, Greece faced a liquidity crisis, forcing the government to
seek “bailout funding”, which they eventually received with rigorous conditions. Bailouts from
the IMF and other European creditors were conditional on Greek budget reforms, specifically,
spending cuts and higher tax revenues. These tight measures created a vicious cycle of
recession with unemployment reaching 25.4% in August 2012.
Far from helping the Greek economy to get back on its feet, bailouts only served to ensure that
Greece’s creditors were paid while the government was forced to scrape together insignificant
tax collections. The weakened tax revenues made Greece’s fiscal position worse. Strict
measures also created a humanitarian crisis: homelessness increased, suicides hit record highs,
and public health significantly deteriorated. While Greece had structural issues in the form of
corrupt tax evasion practices, Eurozone membership allowed the country to hide from these
problems for a time but ultimately created economic restrictions and a huge debt crisis
evidenced by the country's massive default. The Greece’s crisis was written among the nearest
list of crises after the Great Depression.


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