Can Greece pull it off?

by Giancarlo Corsetti, Michael P. Devereux, John Hassler, Gilles Saint-Paul, Hans-Werner Sinn, Jan-Egbert Sturm and Xavier Vives

Vox
March 18, 2011

Will the Greek rescue package be enough or is restructuring inevitable? In this column, members of the European Economic Advisory Group argue that even if the sovereign debt crisis is resolved, Greece must deal with its unsustainable current-account deficit. This requires an unenviable choice between internal and external depreciation and a government strong enough to take on the country’s rife tax evasion.

By the third quarter of 2009 Greece had experienced the smallest drop in GDP relative to its peak level in 2008 among all Eurozone countries. It appeared that the country would be able to weather the global economic crisis with only a small dent on its stellar growth performance over the last decade. However, during the spring of 2010, it became clear that this performance was based on an unsustainable public and private spending spree that was reflected in the double-digit government budget and current account deficits. The Greek government was in serious financial trouble and needed massive support. In May 2010, a gigantic rescue package was put together by the European Commission, the ECB, and the IMF, in order to help Greece and reduce the risk of contagion to other EU member states.

Will this rescue package meet its intended goals and prove sufficient to help Greece onto a sustainable path without the need for further support after the current package expires in June 2013, or is restructuring inevitable as some observers claim (Eichengreen 2010b)?

The roots of Greece’s troubles

The roots of the fiscal crisis for Greece can be traced to the 1980s, when government spending experienced a huge expansion without a countervailing increase in government revenues. During the 1990s recorded deficits fell considerably. However, despite moderate deficits between the mid-1990s and the mid-2000s and fast growth in nominal GDP, government debt increased relative to GDP (Figure 1). The rise in the debt-to-GDP ratio was to an important degree due to off-budget activities. During the 1990s various outstanding liabilities were consolidated into the government debt. In 2009, the accumulated effect of these off-budget items had contributed to the outstanding debt relative to GDP by more than 60 percentage points (Moutos and Tsitsikas 2010). A successful return to sustainable public finances, assert the EEAG experts, requires full control of the development of these off-budget items.

Figure 1. Greek debt and deficits

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