Application: A very European crisis

It all started from Greece government-debt crisis in Feb, 2010. In 2009, Greeces budget deficit reached 12.7% of GDP. It has one of the worlds largest public debt burdens as % of GDP at 112.6%.
- Greece has a long history of fiscal trouble. When it became the 12th country to join the euro in 2001, its public debt was more than 100% of GDP, due to its chronic budgetary mismanagement. - For Greece, membership was a boon. Bond market investors no longer had to worry about devaluation (perceived lower risk) and are more willing to lend money to Greece. Lower interest rates allowed Greece to refinance debt on more favorable terms. Once it was safety inside the euro, Greece relaxed its fiscal grip, resulting in inflation. Greeces high inflation hurt its competitiveness. The economy relies increasingly on foreign borrowing.

ECON 1220 Principles of Macroeconomics

Application: A very European crisis

Forecasts for the 2009 budget deficit were at 5% of GDP, but after the Octobers election, the new government said the true deficit was likely to be 12.7% of GDP.
- Economic downturn in 2008 hurt tax revenues - Control of public spending had been relaxed in the run-up to the election.

ECON 1220 Principles of Macroeconomics

Investorss trust in Greek statistics was shattered, making them nervous about the country sovereign risk.
- Rating agencies slashed its rating of Greek government bonds. S&P said shareholders were likely to get back only 30 50% of their principal . - Stories that China had turned down an offer of Greek bonds denied in both Athens and Beijing also unsettled markets. - It results in rocketing of borrowing costs!

Application: A very European crisis

ECON 1220 Principles of Macroeconomics

There is growing anxiety about poor state of public finances in Portugal, Ireland, Italy and Spain. Each has some combination of big budget deficits and high public debt, though none is as financially stretched as Greece. But their deeper problem stems from a decade when wage growth ran far ahead of productivity gains.
- Stuck in euro, they can no longer cure that by devaluation. - Unlike U.S., there is no central fiscal authority at the Euro area region. - The only remedies are a period of wage restraint combined with structural reforms aimed at boosting productivity.
(Source: A very European crisis, The Economist, Feb 4, 2010.)