Essay on "Greece's Debt Crisis Causes and Solutions"

Essay 9 pages (2671 words) Sources: 13

[EXCERPT] . . . .

GREECE'S DEBT CRISIS: CAUSES and SOLUTIONS

The current crisis that surrounds the Greek economy has been the first ordeal that has been felt in the market of Eurozone area. Such conception is certain to draw attention on academic research on the causes, impacts and solutions that Greek government has undertaken to mitigate the adversity of the situation. However, as the events, both economic and political are still recounting, though it may be imperfect, they are vital in determining the solutions to the predicaments. The paper outlines the recent upheavals of the prices' behavior and the Greek debt yield. It also provides valuable information that will enable the Greek government and European Union to articulate in an attempt to realize informed decision (Calomiris, 2010). For instance, the precipitous ascending path characterizing the debt yield on the Greek government bond will provide a podium for the government to undertake strategies that will minimize the adversity of the situation.

The current situation of Greece

Economic crisis of Greek occurred in August 2008 when the basis points (b.p.) of government bond yield increased from 25 b.p. To 65 b.p. This was an increase of 160%. It denoted that the government was bound to face severe economic crisis. This was followed by another phase of increment, between September 2008 and March 2009 which denoted the peak of the government's credit crunch crisis. Towards the end of March 2009, the spread of the Greek government bond yield had reached a high of 285 b.p. Indeed, the same situation was felt across other EMU periphery countries (Arghyrou and Tsoukalas, 2010). Towards April, the Greek government experienced de-escalation, which coincided with ease in the global economic crisis. Despite this economic breakthrough experienced across the economy, most of the global markets continued to have the Greek bonds on their bad books. Nevertheless, the Greek government bond yield, later on, declined to 121 b.p., and the perception of the Greek bonds remained the same.

Towards mid-2010, there was a marginal increase of the spread of government bond yields, it ranged between 120 and 130 b.p. However, the government faced various events in this period. Initially, there was snap election, which produced a change in the government. Secondly, the new government announced an increment in the government budget's from 6% to 12.7% (Spigelonline, 2010). This ensured that the government was able to allocate finances to the stock market; thereby, increasing the value of the government bond. Finally, there was submission to the European Commission of the newly proposed budgetary expenditure and revenues for the 2010; by the new Greece government. However, following these decisive events, the economy experienced rapid acceleration of the spread of government bond yield. This trend was not only experienced in Greece but also on across Portugal and Spain (Arghyrou, 2009).

Negotiations that were undertaken between the EMU member-states and the Greek government regarding the debt crisis showed that there was a split in the economic endeavors. Most of countries, including the prominent Germany, were opposing to the bail-out forwarded by the Greek government, while others, appeared to support Greece' prospect. Later on, EU agreed to apprehend the government's plan towards rescuing the Greek government debt crisis. This involved the strategy of issuing bilateral loans from the EU countries to Greece. In addition, the EU countries also complied with lowering of the loans rate in order to make the mortgage affordable to the Greeks. The plan that was announced included a sum of close to 45 billion Euros. Finally, in an attempt to mitigate the adversity of the situation; thereby, there was activation of IMF/EU approach to rescue the crisis (Institute of International Finance, 2011).

Causes of the Debt Crisis

Therefore, what are the causes of the Greek debt crisis across the economy? Ideally, the first cause of the debt crisis involves the deterioration of Greek currency. Ideally, in the first-generation crisis proposed by Paul Krugman (1979) the speculative development that has been trailed by the government and excessively funded in an attempt to deplete foreign currency reserves. Indeed, when the reserves declined below the threshold, especially when it anticipated for future collapse, the government bought the remaining foreign currency reserves in an attempt to force devaluation of the currency. This ensures that the exchange rate is restored to a consistent value through the Purchasing Power Parity (PPP).

Ideally, unsustainable fiscal policy defines the Greek economic and debt situation. Since EMU succession in 2001, Greece has experienced consistent-high inflation than the EMU average, which resulted in significant divergence from PPP, prominent competitiveness adversity and deficits recorded in the current account. Indeed, little doubt has been bestowed on the Greek fundamentals effect in an attempt to ascertain a first-generation attack that was felt on the Greece foreign currency reserves. Although the deterioration of Greek fundamentals plays a vital role in current events, the crisis' escalation in 2009 is unlikely to have been caused by fear of market changes that can be attributed to debt default by the Greece government.

Second cause is the shift in market expectations about Greek EMU membership. Maurice Obstfeld (1996) provides an insight on the effect of abandoning or honoring an exchange rate peg commitment where the outcome of a loss minimization problem solved by a fully rational government is expected. The optimal course of action that the Greek government undertook was to balance the cost incurred by defaulters against the cost incurred when using macroeconomic tools; this would have arisen due to the deviation imminent from these two distinct factors. Indeed, the ultimate form of a fixed exchange rate regime defines the commitment of EMU participation in the whole scenario. Following the credit crunch experienced globally in 2008, Greek fundamental was ultimately subjected to scrutiny by market, and it found out that the whole situation had deteriorated and was inconsistent (Spigelonline, 2010).

In conveying this issue to the Greece government, the economic market was able to transact in substantial volume of the government's bonds; thereby, enhancing the government to undertake corrective measures. As such, the government's willingness to undertake corrective measures was not questioned by EMU and Greek authorities operated under the flat loss function. The Greek government, however, perhaps with an eye to the forthcoming elections, failed to recognize the issue. As such, no corrective measures should be undertaken. The consequent lessening credit crunch across the globe reduced the pressure subjected to the Greek bonds (Maute, 2006). However, Greece, in conjunction with Ireland, was always scrutinized by the market as the government bond yield remained considerably high than those of Spain, Portugal, and Italy.

Consequently, the election that was undertaken in 2009 enabled the new government to implement its new policies in the market. However, like its predecessor government, it was not able to, cordially; interpret the market signals that the economy was demonstrating. As such, on the few vial weeks in its governance, the government was faced with severe and mixed feelings on the various policy priorities regarding the intention of the policy implementation. The government wanted to implement strategies that would have put the Greek bonds under unjustified speculative pressure. As such, lack of urgency to deal with the steep escalation of the debt crisis revealed that the Greek government, both the new and the outgoing were unwilling and not able to address the debt crisis with the urgency it requires. At this time, the government's commitment to end the crisis was questioned by the European Union.

Tax evasion is rampant in Greece, which costs the country an estimated €15 billion per year. There are several reasons for this. First, there are frequent changes in the tax code, which translates into an inherent weakness in the check-and-balance procedures and tax collection of the Greek taxation system. Often tax evasion cases are litigated in courts under different tax regulations and loopholes, which lead to waste of resources, reduced taxes, and delays in tax collection. Second, about one-third of the labor force consists of self-employed individuals with small businesses, which operate on a cash basis that is almost impossible to monitor and collect taxes from the economy. More generally, the Greek shadow economy is about 25% of GDP, the highest among the euro-zone countries. Third, there is a general mistrust for elected government officials by the public, and thus has less of sense of duty for the state. As a result, tax evasion is a common phenomenon in many professions. In a well publicized government survey of 2011, 150 rich doctors from the upscale district of Kolonaki in Athens reported that they made less than €30,000 per year, and 30 of them reported income of less than €10,000 per year (Zuckoff, 2005).

In addition, there is rampant corruption by tax officials. Media reports are rife with stories of corruption of tax officials accepting bribes to reduce tax penalties. Recently, 14 high ranking tax inspectors were charged for reducing or eliminating tax obligations by several private firms. The significant cause of the debt crisis is a fundamental flaw in the tax system, which allows… READ MORE

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