Greek crisis for newbies

In 1999, a new, logical continuation for the European project was born: Eurozone. This was seen as a removal of one of the main barriers and restrictions to the free trade, as now, with the same currency across countries it was much easier for countries to exchange goods. It also created new opportunities for countries with the smaller economies, such as Greece, to borrow funds at very small interest rates and in large quantities, as in case of default more powerful economies would bail them out. However, the main reason of low lend rates was expectation of financial markets that there is no risk of default of countries like Greece. It was never certain that Greece would be bailed out. However, 9 years later, the global financial crisis happened and its consequences can still be seen in Europe.

As we all know, around years 2004-2007 there was a rapid economic growth of the World economy which was largely fueled by the rising housing prices. People started taking mortgages with high-interest rates because the economy was booming and everyone thought that they would be able to repay their loans in the future. However, many of such mortgage loans were subprime. Subprime mortgages are mortgages that are given to people with bad credit ratings, who have a high chance of struggling to repay such mortgages.

During these years, bankers and salespeople were offered a high commission for the number of deals which they were able to make and this is why they often concluded such high-risk deals.

At September 15, 2008, one of the main US investment banks Lehman Brothers went bankrupt due to the fact that the value of their assets deteriorated as subprime borrowers could not pay back their loans (mainly bad mortgages). In case if all people simultaneously are willing to take out their money from the bank it means that bank has no money to pay them because most of the money received in deposits to the bank is given out to people in subprime mortgage loans.

This crisis had an immense effect on the world economy, in particular at that of some countries of the European Union.  That is because of several reasons:

  • Some of the countries had large budget deficits: a large number of public sector employees, which were not actually needed at the time. Large public sector means that the output is lower because fewer people are producing an actual product and more people are performing bureaucratic work or services which does not increase welfare of a country . According to Bloomberg (2018), Greece faked some of the data about its economy and was able to delude international bodies like EU or IMF. Official EU limit for the budget deficit in 2008-2009 was 3 percent, while Greece had overspent the budget by 15 percent, so 5 times higher than expected. Soon after the crisis, Greece had to cut its public sector employees by almost a third.

Source: Bloomberg


  • Low-interest rates. The Economist (Nov 12, 2011) concludes that many eurozone economies have had a long period of low rate borrowing, after what they were hit by the crisis. People lost their jobs, becoming more reliant on welfare payments, and at the same time people started paying less tax: partly because businesses collapsed, and partly because people just avoided paying taxes.

Domestic credit to private sector as a percentage of GDP. Source: World Bank.

At this graph you can see, how the number of loans to the private sector had increased from 50 to around 88% before 2008, skyrocketing afterward, because otherwise, countries would default.

According to Morten Hansen, Head of Economics Department at SSE Riga, Greece should have never joined the eurozone in the first place. There are several conditions to join the eurozone, and Greece has violated some of them. For instance,  government deficit cannot be higher than 3% of GDP, and Gross government debt should not exceed 60% of GDP. As we can see from the next graph, Greece has since the beginning of the nineties exceeded that limit of 60 %. And in 2001 that ratio for Greece was already around 100%.



We asked Professor Hansen if anything has changed in the regulations, in order to combat such falsifications of data in the future and he concluded that yes, indeed regulation of lending is much tighter right now, then it was before. Moreover, people who obtain credits are much more cautious and the attitudes to taking credits have changed. As long as banks won’t be involved in crazy projects, everything will be fine. Currently, such a crisis is much more likely to happen with countries that borrow not in their currency, which is not the case for the Eurozone. For instance, let’s say Turkey borrows a certain amount of US dollars and pays in Turkish lira. Then the value of Turkish lira plummets and Turkey has now to pay much more the amount of Turkish lira multiplied by the difference of the value of Turkish currency.


Greece has been facing severe liquidity problems, is celebrating the 10th year anniversary of its debt crisis and struggling with poverty and unemployment.  Why has Greece improved so slowly while receiving so much help from the EU with multiple bailout packages? Well, one of the reasons lay in the austerity policy the Greek government implemented. In order to pay off their debts, The Greek government introduces multiple austerity measures such as higher taxes with the plan of raising 14.1bn euros in five years. Needless to say, taxation is not the only villain in this equation. Public sector cuts, spending cuts, cutting benefits and privatization also play a part. These all resulted in high unemployment and a fast decrease in economic growth. With a slowing economy the deficits will not decrease but only increase.


Another problem that caused the huge debt crisis and why some say it would’ve been better for Greece if they had never joined the EU is the number of accumulated deficits before joining and the differences between the EU regulated monetary policy and each countries’ own Fiscal policy.

“Monetary policy consists of the actions of a central bank, currency board or another regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates.”

A monetary policy regulating the amount of money and what interest rates can a country use and fiscal being how each independent country uses it. Eurozone is a currency sharing union, not a country union, so in the case of the Eurozone, there is 1 monetary policy to 19 fiscal policies. For example, to solve the liquidity problem Greeks should issue more money for printing. In the case of the EU, no such act can take place as it would lower the interest rate on the Euro and in turn influence all of Europe and business partners with Europe. This is one of the aspects countries don’t fully realize when joining the European Union: the euro is much safer for doing business but it’s not a life ring- once a country joins, it needs to follow strict regulations and cooperate with each other to flourish.

Creditor governments, most of all Germany, face a dilemma. They need to save troubled governments to prevent contagion. On the other hand, they also want to keep up market pressure for reforms and to establish the principle that governments are on their own—so that German taxpayers will not be landed with the bill every time some EU country goes on a spending spree. So far Germany is trying to have it both ways and succeeding only in getting everyone deeper into the mire.

 “General government deficit is defined as the fiscal position of government after accounting for capital expenditures.” (OECD definition)


One of the innovative approaches to solving the European Debt crisis is called “The Blue Bond Proposal” and it was developed by a group of French economists recently. Currently, there are 19 different governments at the Eurozone, who are borrowing money, however, they are still borrowing at different, national markets. That means that the rate of borrowing for all of the countries if different, often based on the opportunity of the country to repay the money borrowed.

The Blue Bond Proposal is for the EU countries to take 60% of their gross government debts from these individual national markets and to create a united market for this debt. This would take the burden from smaller and weaker Eurozone economies. This united market will have a good liquidity as well as joint liability. There will still be red or national debt, which will include any amount of money which is over 60% of GDP, the probability of defaulting there will be higher and hence investors will need an additional return on their risk.  Governments of weaker economies will need to introduce much better fiscal policies, because starting from now, all the money they will borrow will be subject to the higher interest rate in the national market.


According to Morten Hansen, this idea is hard to implement, because bigger economies, like Germany, are against it. Furthermore,  this is likely to create a type of situation, called “Moral hazard”- a situation in which you do something, that seemingly will benefit them, but in the long run it actually only hurts. Germany understands, that if Greek politicians will be able now to place 60% of their debt to GDP in the United debt market, then they might start taking even more risky decisions and get involved into excessive amounts of spending in order to gain political capital.

Nowadays the situation in Greece has substantially improved. The deficit of Greece has decreased and reached normal standards for the EU. The Greek deficit of GDP in 2009 was 15.1%, however, the fiscal balance has significantly improved to 0.7% of GDP surplus in 2016. Which means that the EU can stop the support program for Greece which they did in August of 2018. Although the results are positive and the support program has been ended, Greece will still be tightly monitored so it does not spiral out of control again and is asked to review their fiscal policy. This means that Greece is on a slow path to recovery which is visible in the unemployment numbers as well. Although they are still high they are decreasing. This crisis has shown the world the importance of double-checking results given and opened a discussion about preparing for extreme situations and deciding how to prevent them.

Authors: Ispirs Haradzanjans, Alise Lidaka

Reviewed by: Pr. Morten Hansen