Greece’s threat to the Euro

Desmond Lachman
American Enterprise Institute

March 22, 2010

 Stylized Greek Facts
• Budget deficit of 13 percent of GDP versus
Maastricht 3 percent limit

• Public debt at 120 percent of GDP versus

Maastricht 60 percent limit

• 30 percent loss in international competitiveness

• Current account deficit of 10 percent of GDP

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 Unpleasant Greek Arithmetic
• Regaining competitiveness implies at least 20
percent price deflation

• Greece’s taxes are 35 percent of GDP

• Correcting budget deficit by 10 percent of GDP

implies 15-20 percent GDP decline

• Deflation and depression will boost debt to GDP

ratio to above 180 percent
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 Greece’s Silver Lining
• Greece is not alone in having problems

• Club Med countries and Ireland all have lost

competitiveness

• Spain, Italy, Ireland and Portugal all have major

public finance issues

• A Greek default would have a domino effect

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 Spanish Stylized Facts
• Budget deficit over 11 percent of GDP

• 20 percent loss in price competitiveness

• Massive external CA deficits and an external debt ratio

above 130 percent of GDP

• A deep recession and unemployment at 20 percent

• A housing bubble that is still bursting

 Spain: Unemployment Rate Spain: Housing Prices
per cent Euros per square meter*
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 Probable Greek End-Game
• European Commission bails Greece out

• Greece agrees to adjust

• Greece fails to deliver

• Another crisis is followed by another bailout

• Greece loses political willingness or Europe loses

patience

• Greece defaults on its sovereign debt

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Does a bail-out serve Greece well?

• A bailout only kicks the can forward

• Greece goes through wrenching recession

and then has trauma of default

• Greece gets saddled with a mountain of

official debt
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 Greek default and the Euro
• Greek default would spell domestic economic
collapse and banking crisis

• No longer borrowing, Greece would not fear

wide interest rate spreads.

• Greece would be tempted to cheapen currency

to boost exports

• In depression, Greece would not fear inflation

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