Search Penny Hill Press

Wednesday, May 19, 2010

Greece’s Debt Crisis: Overview, Policy Responses, and Implications

Rebecca M. Nelson, Coordinator
Analyst in International Trade and Finance

Paul Belkin
Analyst in European Affairs

Derek E. Mix
Analyst in European Affairs

Buildup of Greece's Public Debt: Over the past decade, Greece borrowed heavily in international capital markets to fund government budget and current account deficits. The profligacy of the government, weak revenue collection, and structural rigidities in Greece's economy are typically cited as major factors behind Greece's accumulation of debt. Access to capital at low interest rates after adopting the euro and weak enforcement of EU rules concerning debt and deficit ceilings may also have played a role. 

Outbreak of Greece's Debt Crisis:
Reliance on financing from international capital markets left Greece highly vulnerable to shifts in investor confidence. Investors became jittery in October 2009, when the newly-elected Greek government revised the estimate of the government budget deficit to nearly double the original number. Over the next months, the government announced several austerity packages and had successful rounds of bond sales on international capital markets to raise needed funds. In late April, when Eurostat, the European Union (EU)'s statistical agency, further revised the estimate of Greece's 2009 deficit upwards, Greek bond spreads spiked and two major credit rating agencies downgraded Greek bonds. 

Eurozone/IMF Financial Assistance:
The Greek government formally requested financial assistance from the 16 member states of the Eurozone and the International Monetary Fund (IMF), and a €110 billion (about $145 billion) package was announced on May 2, 2010. The package aims to prevent Greece from defaulting on its debt obligations and to stem contagion of Greece's crisis to other European countries, including Portugal, Spain, Ireland, and Italy. Despite the substantial size of the package, some economists are concerned that the Eurozone/IMF package might not be enough to prevent Greece from defaulting on, or restructuring, its debt, or even from leaving the Eurozone. Greece's debt crisis threatened to widen across Europe, as bond spreads for several European countries spiked and depreciation of the euro began to accelerate. 

On Sunday, May 9, 2010, EU leaders announced that they would make an additional €500 billion ($636 billion) in financial assistance available to vulnerable European countries, with the IMF contributing up to an additional €220 billion (about $280 billion) to €250 billion (about $318 billion). The same day, the European Central Bank (ECB) announced it could start buying European bonds, and the U.S. Federal Reserved also announced it would reopen currency swap lines with other major central banks, including the ECB, to help ease economic pressure. When markets opened on Monday, May 10, 2010, bond spreads in Europe dropped and the euro began to strengthen, suggesting that the package was successful in stemming the spread of Greece's crisis. 

Implications for the United States:
Greece's debt crisis could have several implications for the United States. First, falling investor confidence in the Eurozone has weakened the euro, which, in turn, could widen the U.S. trade deficit. Second, given the strong economic ties between the United States and the EU, financial instability in the EU could impact the U.S. economy. Third, $16.6 billion of Greece's debt is held by U.S. banks, and a Greek default would likely have ramifications for these creditors. Fourth, some have suggested that Greece's current debt crisis foreshadows what the United States could face in the future. Others argue that the analogy is weak, because the United States, unlike Greece, has a floating exchange rate and a national currency that is an international reserve currency. Fifth, the debate about imbalances within the Eurozone is similar to the debates about U.S.-China imbalances, and reiterates how, in a globalized economy, the economic policies of one country impact other countries' economies.

Date of Report: May 14, 2010
Number of Pages: 29
Order Number: R41167
Price: $29.95

Document available via e-mail as a pdf file or in paper form.
To order, e-mail Penny Hill Press or call us at 301-253-0881. Provide a Visa, MasterCard, American Express, or Discover card number, expiration date, and name on the card. Indicate whether you want e-mail or postal delivery. Phone orders are preferred and receive priority processing.