An anatomy of Greek debt crisis: Origins, possible actions and implications

Abstract

Since late 2009, Greece has been in the talks due to its sovereign debt crisis. Public debt of Greece is close to 150% of its GDP. There is a possibility that Greece might default on its debt. The problem of excessive debt was aggravated primarily due to aggressive government spending, with the sub-prime crisis emerging as a precipitating factor. Greece joined the Economic and Monetary Union (EMU) in 2001, when it had satisfied the prerequisites for becoming a member of EMU as per the Maastricht Treaty. However, it was later revealed that Greece had manipulated its economic data and had never actually satisfied the prerequisites for joining the EMU. This study covers the background of the Greek debt crisis, analyses the situation based on various macroeconomic models and performs a simulation based on macroeconomic variables to evaluate the options available to Greece to emerge out of the crisis. The study also analyses the Maastricht Treaty which lays down the criteria for becoming a member of EMU. For the purpose of simulations, the study uses Domar-Tobin model, which links the debt-to-GDP ratio of an economy to nominal GDP growth rate, effective interest rate on debt and primary deficit. Based on the simulations, it is observed that opting out of the European Union and forcing a haircut on public debt is probably the only way for Greece to emerge out of sovereign debt crisis.