Friday, August 19, 2011

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

by Rebecca M. Nelson, Paul Belkin and Derek E. Mix

U.S. Congress

Congressional Research Service
August 18, 2011

The Eurozone is facing a serious sovereign debt crisis. Several Eurozone member countries have high, potentially unsustainable levels of public debt. Three—Greece, Ireland, and Portugal—have borrowed money from other European countries and the International Monetary Fund (IMF) in order to avoid default. With the largest public debt and one of the largest budget deficits in the Eurozone, Greece is at the center of the crisis. The crisis is a continuing interest to Congress due to the strong economic and political ties between the United States and Europe.

Build-Up of Greece’s Debt Crisis

In the 2000s, Greece had abundant access to cheap capital, fueled by flush capital markets and increased investor confidence after adopting the euro in 2001. Capital inflows were not used to increase the competitiveness of the economy, however, and European Union (EU) rules designed to limit the accumulation of public debt failed to do so. The global financial crisis of 2008-2009 strained public finances, and subsequent revelations about falsified statistical data drove up Greece’s borrowing costs. By early 2010, Greece risked defaulting on its public debt.

Policy Responses with Limited Success

EU, European Central Bank, and IMF officials agreed that an uncontrolled Greek default could trigger a major crisis. In May 2010, they announced a major financial assistance package for Greece, and the Greek government committed to far-reaching economic reforms. These measures prevented a default, but a year later, the economy was contracting sharply and again veered towards default. European leaders announced a second set of crisis response measures in July 2011. The new package calls for holders of Greek bonds to accept losses, as well as for more austerity and financial assistance.

These responses have prevented a disorderly Greek default, but the prospects for Greek recovery remain unclear. The economy is contracting more severely than expected, and, as a member of the Eurozone, Greece cannot depreciate its currency to spur export-led growth. Unemployment is close to 16%.

Additionally, the policy responses have not contained the crisis. Ireland and Portugal turned to the EU and IMF for financial assistance. In the summer of 2011, interest rates on Spanish and Italian bonds rose sharply.

Broader Implications

Greece’s economy is small, but its crisis exposes the problems of a common currency combined with national fiscal policies. Additionally, its crisis set precedents for responding to crises in other Eurozone countries; highlighted concerns about the health of the European financial sector; created new financial liabilities for other Eurozone countries struggling debt; and sparked reforms to EU economic governance. It has also revealed tensions among EU member states about the desirability of closer integration.


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