The Euro after Greece

The Euro 750 billion bail-out plan for the Eurozone countries that followed the Euro 110 billion rescue package for Greece has temporarily steadied global financial and equity markets. Yet, neither is this crisis of the European Union (EU) behind us nor is the future of the euro assured. The package of loan guarantees and sovereign bond buyback arrangements drawn up by EU governments, the European Commercial Bank (ECB) and the International Monetary Fund (IMF) may well be a case of too little, too late. Greece is at the centre of the crisis, but a number of other countries, including the United Kingdom, are facing severe erosion in market confidence in their public finances.

In hindsight, the crisis in Greece seems to have been predictable. Consider the events that preceded the crisis and now constrain its resolution. First, integration provided the Greek government with an opportunity to pump-prime the system and sustain growth by borrowing to finance the deficit. Taking a loan was easy because the currency of borrowing is the euro, which has lower exchange rate risk associated with it, and European banks in a world awash with liquidity were in search of opportunities to lend. This not only meant that the public debt to GDP ratio was originally high in Greece, but that it rose sharply over a short period starting around 2006. Greece had a fiscal deficit that was close to 13% of gdp in 2009 and a level of public debt that exceeded 100%.