Greece’s bailout by the EU and the IMF is the largest in history – €245 billion.
The seriousness of the Greek debt problem is clear to see – see graphic below. Next month the Greek government must make it clear to those euro-zone governments and the IMF that they have made €11.5billion worth of cuts to its own spending. If it doesn’t make these cuts access to further loans will be suspended and Greece will eventually have to print its own currency. For Greece there are two major challenges as well as paying back the debt:
Debt is still rising at 1.5 times the size of the economy and
Wages and prices need to be forced downward to make the country more competitive.
In the past 3 year the Greek economy has contracted by 14% and the expectation is that it will be 6.4% by the end of this year.
IMF v Germany
In order to protect the economy the IMF suggested that there should be:
– structural reforms to the economy and
– spending cuts but over a longer period of time.
However, Germany demanded that both the structural reforms and the austerity measures should take place at the same time. This involves bringing down the budget deficit from 15.8% of GDP in 2009 to under 3% by 2014. But the spending cuts and tax increases pushed the economy into such a deep recession that the deficit got stuck at around 10% of GDP.
The exchange rate problem with the euro.
It is usual that when the IMF imposes austerity measures, it makes a country devalue its exchange rate in order to make its exports more competitive and therefore offset weak domestic demand. However, Greece doesn’t have its own currency so this is policy option is not on the table.
So where does Greece go from here? With having to impose structural reforms as well as austerity measures the country is caught between a ‘rock and a hard place’. One wonders how they are going to generate any government income with virtually no growth and increasing unemployment.
The major concern for the world economy is that if major economies are going to follow austerity programmes at the same time it will be left to the private sector to generate aggregate demand. But if they don’t borrow and increase consumer spending there is a real risk of an economic depression.