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PRAVEEN
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European Union
An economic and political union of 27 countries
Generates 21% of world gross product 200916 members form Eurozone - economic and monetary union
(EMU)
European Central Bank determines the monetary policy for
these 16 countries union
Common policies in trade, agriculture, fisheries, customs and
migration
Diverse national fiscal policies
Incomplete political union
Economic differences between Northern and Southern
countries(Pareshs slide)
Close relation between European banking system andsovereign credit systems
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Criteria Member states
Allowed limit of 3% of budget deficit
Debt should be below 60 % of GDP
Inflation rate should be no more than 1.5% points higher
than the average of the three best performing countries Long term interest rate be no more than 2% points higher
than the average of the three best performing countries
Of the 27 countries, 20 already crossed these limits
Greece becomes 12
th
country to adopt Euro currency in2001 (through manipulating figures)
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Why EU?
Member states are small to compete in world trade
Meet the challenges of globalisation
To provide a Europe-wide free market to build
competency Single currency and monetary policies to simplify trade
economic, social, technological, commercial andpolitical clout than if its member states had to actindividually
Security Stability and disaster control
Sustainable development- Earth Summit
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EU problems
Milton Friedman was critical of the eurozone when it wascreated skeptical of an economic crisis putting groups
against one another Krugman: didnt think the continent was ready for the
euro experiment, not unified politically Countries were entering the eurozone without having met
the requirements (i.e. Greeces manipulated numbers) Because political unity was never mandated, countries such
as Greece arent held as accountable for high levels of debt,and the Union isnt obligated to prevent fiscal failure
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Background of Greek economy
Greek economic miracle (1950-1975)- average
growth of 7%
25th
largest economy in the world Member of OECD,WTO, Black sea economic
cooperation and EU
High HDI- ranking 22nd
in the world Was facing inefficient bureaucracy, tax evasion
and corruption
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GDP
Maritime industry(4.5 % of GDP)
Tourism (15% of GDP)
High GDP growth in last decade
Public sector- 50% of GDP
Mediocre growth in the 1980s (oil crisis)
Recession (1981-1983)
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Politics
PASOK- socialist party (ruled from 1981 till now, except for abrief spell from 2004-2009)
PASOK was characterized by highly populist policies(excessive capital expenditure and benefits to public sector
employees)
This caused high deficits and inflation
Change of national debt during PASOK reign
1981 1991 1993-2010
25 71%
>100%
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Statistics (2008-2009)
GDP $343 billion (nominal, 2008
est.) 339.2 billion (PPP, 2008
est.)
GDP growth 2.0% (2009)
GDP per capita $29,060 (nominal 2010
estimate); $29,420(PPP 2010
estimate)
GDP by sector agriculture: 3.4%; industry:
20.8%; services: 75.8% (2009
est.)
Inflation (CPI) 5% (2009 est.)
Population
below poverty line
< 2.0% (2009)
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Exports $18.64 billion (2009 est.)
Export goods food and beverages,
manufactured goods,
petroleum products,
chemicals, textiles
Main export partners Italy 11.5%, Germany 10.5%,
Bulgaria 7.1%, Cyprus 6.2%,US 5%, UK 4.7%, Romania
4.4% (2008)
Imports $61.47 billion (2009 est.)
Import goods machinery, transport
equipment, fuels, chemicals
Main import partners Germany 12.1%, Italy 11.7%,
Russia 7.4%, China 5.6%,
France 5.1%, Netherlands
4.7% (2008)
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Major players
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SHRUTI
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A Classic Sovereign Debt Crisis Greece had shifted to the Euro in 2001. October 2009, the newly elected Greek
government revised the estimate of thegovernment budget deficit for 2009 from6.7% of gross domestic product (GDP) to12.7% of GDP
Reliance on financing from internationalcapital markets left Greece highlyvulnerable to shifts in investor confidence
Maturing debt obligations estimated at54 billion for 2010
National debt exceeded 300 billion Euros
Maturing debt obligations, estimated at54 billion ($72.1 billion) for 2010
On April 23, 2010, the Greek governmentrequested financial assistance from otherEuropean countries and the IMF
Fitch ratings called Greece as Euro zone'sweakest member
Greeces debt was 113% of its GDP.
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W
hat caused the Crisis?
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Domestic Factors Budget Deficit stood at 12.7% of GDP in 2009 well above the EUs
agreed-upon 3% of GDP threshold
In the last 6 years, government expenditures increased by 87%,revenues grew by only 31%
High Government Spending
In 2009, Greek government expenditures accounted for 50% of GDP An overstaffed and inefficient public administration in Greece
Costly pension and healthcare systems an aging population,entitlement to a full pension requires only 35 years of contributionand not 40 years
Weak Government Revenues
Informal economy in Greece estimated to represent between 25%-30% of GDP
Tax evasion owing to high levels of taxation and a complex tax code,excessive regulation and inefficiency in the public sector
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Domestic Factors cont.
Declining international competitiveness
High relative wages - have increased at a 5%annual rate since the country adopted the euro,
about double the average rate in the Euro zone asa whole
low productivity - Greek exports to its majortrading partners grew at 3.8% per year, only half
the rate of those countries imports from othertrading partners
Low savings rate
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International Causes
Increased access to capital at low interest rates owing toGreeces adoption of the euro as its national currency in2001 Currency bloc anchored by economic heavyweights Germany
and France
a common monetary policy conservatively managed by theEuropean Central Bank (ECB)
The perceptions of stability conferred by euro membershipallowed Greece to borrow at a more favorable interest rate than
would likely have been the case outside the EU access to artificially cheap credit allowed Greece to accumulate
high levels of debt
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International Causes Cont.
Issues with EU Rules Enforcement The lack of enforcement of the Stability and Growth Pact
(adopted in 1997 by EU members), an agreement to enhancethe surveillance and enforcement of the public finance rules setout in the 1992 Maastricht Treatys convergence criteria forEMU
calls for budget deficits not to exceed 3% of GDP and debt notto exceed 60% of GDP
excessive deficit procedure to be applied to member states thatsurpassed the deficit limit
more than 30 excessive deficit procedures have beenundertaken but EU has never imposed a financial sanctionagainst any member state for violating the deficit limit
Less incentive for EU countries to cut down on debt
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International Causes Cont.
Unsatisfactory quality of public data EUs statistical office, Eurostat, had not certified or had unilaterally
amended data provided by the National Statistical Service of Greecesince 2000
Through creative accounting Goldman Sachs helped Greece meet
the required 3% deficit ratio by using collateralized debt obligationsrendering SGP criteria meaningless
Between 2004 and 2007 revealed that Greece had violated the 3%limit in every year since 2000, with its deficit topping out at 7.9% ofGDP in 2004
Greeces debt had been above 100% of GDP since before Greece
joined the euro Lack of investor confidence and not the level of absolute debt
Slashing prices of Government-backed bonds and credit defaultswaps
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A viewpoint
George Soros new Instituteof New Economic Thinking
Markets are irrational
Global monetary system notfully explained throughmathematical models butpsychology of people
Questions a system where aprivate credit rating agencyhas so much control on anentire nations economy
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SUSHANTH
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Actions Taken
1 Sold Government Bonds
2
Reduced Government expenditure-austerity measures
3 Received financial assistance
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If measures taken are insufficient, either
Default
Restructure Debt
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Restructuring Debt
Companies use debt restructuring to avoid default onexisting debt or to take advantage of a lower interestrate.
A company will often issue callable bonds to allowthem to readily restructure debt in the future. Theexisting debt is called and then replaced with new debtat a lower interest rate.
Companies can also restructure their debt by alteringthe terms and provisions of the existing debt issue.
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SUSHANTH
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Why is EU scared?
Financial contagion refers to
the transmission of a financial
shock in one entity to other
interdependent entities.
Reasons:
inancial links wherebytwo entities are connected
through the international
financial system
real links such as
competitive trade
political links in whichexchange rates are closely
tied
the propensity of a herd
mentality to develop
among investors
EU has a common monetary
but diverse fiscal policies
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Sovereign Debt Crisis
Sovereign default: is a failure by thegovernment of a sovereign state to pay back itsdebt in full.
If potential lenders or bond purchasers begin tosuspect that a government may fail to pay backits debt, they may demand a high interest rate
in compensation for the risk of default. Adramatic rise in the interest rate faced by agovernment due to fear that it will fail to honorits debt is sometimes called a sovereign debtcrisis.
Governments may be especially vulnerable toa sovereign debt crisis when they rely onfinancing through short-term bonds, since thiscreates a situation ofmaturity mismatchbetween their short-term bond financing andthe long-term asset value of their tax base.
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Sovereign Debt Crisis cont.
Since a sovereign government, by definition, controlsits own affairs, it cannot be obliged to pay back itsdebt. Nonetheless, a government which defaults maybe excluded from further credit; some of its overseas
assets may be seized; and it may face political pressurefrom its own domestic bondholders to pay back itsdebt. Therefore governments rarely default on theentire value of their debt.
Instead, they often enter into negotiations with their
bondholders to agree on a delay or partial reduction oftheir debt payments, which is often called a debtrestructuring. The International Monetary Fund oftenassists in sovereign debt restructurings.
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Greek situation vis--vis other European
countries
Yield Spread of Bonds Concept
Market assessment for Default Risk.
Spreads for PIIGS reached record levels since Inception(Euro zone 1999, Greece 2001)
Switch to German bonds Most liquid n safe
Sovereign Credit Rating
Competition from government-backed bank bonds
E.g. UK government-backed bank bonds have higher
ratings than Greece
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Greek situation vis--vis other European
countries
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Greek situation vis--vis other European
countries
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Greek situation vis--vis other European
countries
Contagion : Ring of Fire Concept : Transmission of shocks across countries
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PARESH
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Greek situation vis--vis other European
countries
Credit Default Swap(CDS) Concept
Launched a decade ago
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Greek situation vis--vis other European
countries
CDS Market Insurance-like contracts that promise to cover losses on certain
securities in the event of a default
Were seen as easy money for banks
The economy was booming and corporate defaults were few
back then, making the swaps a low-risk way to collect premiums
and earn extra cash
CDS market exploded to $45 trillion in mid-2007, twice the size
of the U.S. stock market (which is valued at about $22 trillion andfalling) and far exceeds the $7.1 trillion mortgage market and
$4.4 trillion U.S. treasuries market
Banks and insurance companies are regulated; the credit swaps
market is not
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Greek situation vis--vis other European
countries
Credit Default Swap(CDS)
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Greek situation vis--vis other European
countries
Credit Default Swap(CDS)
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Greek situation vis--vis other European
countries
Less Exposure for US Banks Direct Losses from Lending / Derivatives: limited, especially
compared to European banks The U.S. banking system relies very little on overseas earnings (< 20%)
Tier 1 capital is well in excess of direct exposures
However, indirect impact of an escalating crisis could be
significant: Bank spreads are particularly vulnerable to exogenous shocks in the global
financial system
Negative impact on lending and bank facilities
Contagion through increased systemic risk
Heightens focus on financial regulation (with upward pressure on capital, and
downward pressure on earnings)
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Greek situation vis--vis other European
countries
Less Exposure for US Banks
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Greek situation vis--vis other European
countries
Current Situation Bailout packages for Greece and Ireland (85-billion ($115-
billion)
Permanent mechanism for Debt Swamped Economies
Each bill, note and bond issued by a euro zone member willinclude legal language laying out what happens in the event
of default.
The 2009 trade deficits for Spain, Greece, and Portugal were
estimated to be $69.5 billion, $34.4B and $18.6B, respectively($122.5B total), while Germany's trade surplus was $109.7B
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Greek situation vis--vis other European
countries
European Central Bank Institution of the European Union(EU) and administers the
monetary policy.
Prolong measures to provide ready cash to banks
Bond Buying Program of financially troubled euro zonecountries
Bonds of both Ireland and Portugal rose (Relief)
The bank, the European Union and the 16 governments that
share the euro are struggling to contain a crisis caused by toomuch state debt in some countries. They are trying to reassure
bond investors that countries will not default and keep the
interest rates on their debt loads from rising
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Greek situation vis--vis other European
countries
European Imbalance Single Monetary Policy but 16 different Fiscal Policies and single
currency.
Northern European
1) Rely on exports for
economic growth
2)Wage moderation to keep
production costs low
3) Conservative fiscal policiesresulting into high credit
surpluses
4) Pursue policies to
promote export led growth.
Southern European
1) High levels of wage
growth
2) Expansionary fiscal
policies leading to less
competitive exports.
3) Lower savings due to
spending on luxuries.
4) Led to large current
account deficits and hence
borrowing.
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Smitesh
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Bail Out by IMF and EU
On April 23, 2010, Papandreou announced
that Greece would draw on 45 billion as Bail
Out
Total Size: EUR 110 billion
EUR 80 billion from Euro nations
EUR 30 billion from IMF
Cost: Approximately 5%
Duration: 3 years
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Other Options considered
Raise debt in capital markets: too little demandfor Greek debt; pricing too high
EU Debt guarantees : violation of EU treaties
EU Bond issuance : reconciliation with EUtreaties challenging
Bilateral arrangements: moral hazard
issues; little German domestic support
Infrastructure advances: not sufficient
size
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Austerity Measures: Aim
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MEASURES TAKEN
1: Revenue Raising Initiatives
Increase value added tax from 19% to 21%
Excise tax on petrol, alcohol, cigarettesand luxury goods
Sale of selected state assets
Taxing illegal construction 2: Expenditure Reductions
Reduce public sector wages and pensions
Reduce size of public investmentprograms
Reduce education expenditures
Banning increases in public sector salaries
and pensions for at least three years Capping annual holiday bonuses and axing
them for higher earners
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The role of IMF and EU
EU has embarked on a path of not justintensely monitoring Greek policy, but actuallysteering it
Greek interest rate policy: to be determinedby the European Central Bank
Greek currency policy: to be determined by
the EMU Greek fiscal policy: monitored by the EU &
IMF
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Sivaharsh
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Greek situation vis--vis other European
countries
Long term Solutions
1)
Creation of European Financial Stability Facility
European Treasury
2)
Cross Border capital flows remain unregulated
Balance of Payments to be satisfied
3)
If large current account or trade deficit then country must borrow to pay forthe imports
Conversely, if large trade surplus, i.e., net exporter should lend money to bycapital to buy their goods
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Greek situation vis--vis other European
countries
Long term Solutions
4)
The 2009 trade deficits for Spain, Greece, and Portugal wereestimated to be $69.5 billion, $34.4B and $18.6B, respectively($122.5B total
Germany's trade surplus was $109.7B.
5)
A country with a large trade surplus would generally see thevalue of its currency appreciate relative to other currencies
However, many of the countries involved in the crisis are on theEuro, so this is not an available solution at present
6)
Alternatively, trade imbalances might be addressed bychanging consumption and savings habits.
For example, if a country's citizens saved more instead ofconsuming imports, this would reduce its trade deficit.
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Greek situation vis--vis other European
countries
Long term Solutions
7)
Likewise, reducing budget deficits is another method of raising a country's levelof saving.
Capital controls that restrict or penalize the flow of capital across borders isanother method that can reduce trade imbalances
8)
High Interest rates to encourage domestic saving, although this benefit is offsetby slowing down an economy
The suggestion has been made that long term stability in the euro zone requiresa common fiscal policy
9)
Unjust crisis management & call for additional regulation of banking sector.
Over 23 million EU workers have become unemployed as a consequence of theglobal economic crisis of 2007-2010, whilst thousands of bankers across the EUhave become millionaires despite collapse or nationalisation .
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How Greek Concealed the Debt
Simple!!! Accounting Techniques.
Paid Goldman Sachs and
Swaps- Over the Counter (OTC) Derivatives based onexchange of cash flows
swap agreement defines the dates when the cash flowsare to be paid and the way they are calculated
Usually at the time when the contract is initiated atleast one of these series of cash flows is determined by
a random or uncertain variable such as an interest rate,foreign exchange rate, equity price or commodity price.
swaps can be in cash or collateral
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Currency Swaps
Government debt issued in dollars and yen wasswapped for euro debt for a certain period -- to beexchanged back into the original currencies at a laterdate.
For example, suppose a U.S.-based company needs toacquire Swiss francs and a Swiss-based company needsto acquire U.S. dollars. These two companies couldarrange to swap currencies by establishing an interestrate, an agreed upon amount and a common maturity
date for the exchange. Currency swap maturities arenegotiable for at least 10 years, making them a veryflexible method of foreign exchange.
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Fictional Exchange Rates
US bankers devised a special kind of swap withfictional exchange rates.
Helped Greece receive a far higher sum than
the actual euro market value. In that way Goldman Sachs secretly arranged
additional credit worth billions for the Greeks
The Maastricht rules can be circumventedquite legally through swaps
Standards modified in 2007 to prevent this
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European Integration
Single Monetary Policy
16 Separate fiscal Policies
Combined with conservative fiscal policies that promotehigh levels of savings, a northern countries have run large
current account surpluses. Southern European countries, like Greece, have had higher
levels of wage growth and more expansionary fiscalpolicies, leading to less competitive exports and lowerlevels of savings.
These countries have run large current account deficits andborrowed to finance these deficits.
To Bridge the imbalance a fiscal policy integration to someextent is required
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Thank you
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Questions
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Impact of Crisis
Greece is already in major breach of Euro-zone rules ondeficit management and with the financial marketsbetting the country will default on its debts, thisreflects badly on the credibility of the euro.
Impact on private individuals:
The most obvious way would be through tax bills, asEurope agrees to ride to the rescue and help Greecedeal with its mounting public and foreign debts.
Any assistance to Greece will come at a cost that willultimately have to be borne by taxpayers in the nationsthat contribute.
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Contagion Effect
Greek crisis has made investors nervous about
lending money to governments through buyinggovernment bonds. Everybody's interest rates areheading higher as governments are having to paya greater risk premium to borrow money.
Reduced wealth:Take-home pay is likely to fall as it is eroded by
rising taxes and everyone will have to work longerbefore they retire - by which time they are likelyto find that their pensions have shrunk
Slower recovery
The crisis is also set to slow down the embryoniceconomic recovery.
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Strikes and demonstrations have long been a way
of life in Greece
Greece's adjustments to its new economic reality
won't be fair. For instance, if you turned 60 in2009, you're comfortably retired. If you turned 60
in 2010, you'll need to work seven more years
Greek VAT (Value Added Tax, a national sales tax)will incrementally rise from 19 percent to 25
percent
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Result of the measures taken
central government revenues coming in
closely as expected
firm expenditure control in the state budget
Progress in the structural reforms in areas
such as local administration, privatization,
labour market, and tax administration
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Conclusion
Greeces Debt Crisis has put the EU under thescope, & it has shifted the attention to theefficiency & the success of the Euro-zone. Itsconsidered as probably the biggest test the EU (&
the EMU-in particular) has gone through. Howthe EU & Greece are handling the crisis with thewhole bail-out plan will reflect to what extent theEU is able to function on its own as a powerful
economic entity. Its too early yet to measure the effectiveness of
the bail out plan.
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Thank you
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Background to Greek economy
Greece had shifted to the Euro in 2001.
European integration helped an otherwiseweaker economy to raise billions of dollars in
capital. It further lowered its interest rates onthe German model.
This money was principally used to finance
larger government spendings.
High government spending and crowding out
effects
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Background to Greek economy
Greece had shifted to the Euro in 2001.
European integration helped an otherwiseweaker economy to raise billions of dollars in
capital. It further lowered its interest rates onthe German model.
This money was principally used to finance
larger government spendings.
High government spending and crowding out
effects
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Greek situation vis vis other European
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Greek situation vis--vis other European
countries
Long term Solutions Unjust crisis management
Over 23 million EU workers have become unemployed as a
consequence of the global economic crisis of 2007-2010, whilst
thousands of bankers across the EU have become millionairesdespite collapse or nationalisation (ultimately paid for by
taxpayers) of institutions they worked for during the crisis, a fact
that has lead many to call for additional regulation of the banking
sector across not only Europe, but the entire world
Greek situation vis vis other European
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Greek situation vis--vis other European
countries
Long term Solutions Creation of European Financial Stability Facility & European
Treasury
Cross Border capital flows remain unregulated.
Country that runs a large current account or trade deficit (i.e., itimports more than it exports) must also be a net importer of
capital; this is a mathematical identity called the balance of
payments. In other words, a country that imports more than it
exports must also borrow to pay for those imports. Conversely,
Germany's large trade surplus (net export position) means that it
must also be a net exporter of capital, lending money to other
countries to allow them to buy German goods.
Greek situation vis vis other European
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Greek situation vis--vis other European
countries
Long term SolutionsThe 2009 trade deficits for Spain, Greece, and Portugal were
estimated to be $69.5 billion, $34.4B and $18.6B, respectively
($122.5B total), while Germany's trade surplus was $109.7B.
A country with a large trade surplus would generally see thevalue of its currency appreciate relative to other currencies,
which would reduce the imbalance as the relative price of its
exports increases. This currency appreciation occurs as the
importing country sells its currency to buy the exporting
country's currency used to purchase the goods. However, many
of the countries involved in the crisis are on the Euro, so this is
not an available solution at present.
Greek situation vis vis other European
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Greek situation vis--vis other European
countries
Long term SolutionsAlternatively, trade imbalances might be addressed by changing
consumption and savings habits. For example, if a country's
citizens saved more instead of consuming imports, this would
reduce its trade deficit. Likewise, reducing budget deficits isanother method of raising a country's level of saving. Capital
controls that restrict or penalize the flow of capital across
borders is another method that can reduce trade imbalances.
Interest rates can also be raised to encourage domestic saving,
although this benefit is offset by slowing down an economy andincreasing government interest payments
The suggestion has been made that long term stability in the
euro zone requires a common fiscal policy
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