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A Greek Default?

December 8, 2009

The Greek stock market fell 6% after the Fitch credit rating agency cut Greece’s rating to a 10-year low (i.e. the lowest since Greece joined the euro).  The head of the European Central Bank (which is responsible for interest rates in the euro-zone) also warned on Monday that the Greek Government needs to make drastic changes to control its spiraling level of debt.  The Greek Government’s budget deficit this year is forecasted to be almost 12% of GDP this year, compared to euro-zone average of 6.9%.  In addition, the Greece’s debt is forecasted to be 125% of GDP, which is the largest in the euro area.

This crisis began in October, when the newly elected Socialist government started radically revising government budget projections.  As a result, Greece has seen the spread on interest rates it must pay to sell government bonds increase rapidly and there are worries that it might default on its debt.  While never a happy option, default is made even messier by being in the euro-zone.  It is highly unlikely that Greece would drop out of the euro-zone and create a greatly depreciated new currency—thus the question is what will happen in the euro-zone if Greece defaults?

Technically, the treaty regulating the euro has a “no bail-out” clause preventing other member states from rescuing another euro member.  However, some member states may want to rescue Greece to prevent the euro from loosing value against other currencies, although with Greece is making some strong reforms.  A rescue would assure investors of the other members’ commitment to maintaining the stablity of the euro, calming investors and mitigating their flight from other euro member’s bonds.  On the other hand, how much would a Greek default influence the whole euro-zone, as Greece only accounts for about 2% of the area’s GDP?

One Comment leave one →
  1. December 10, 2009 4:47 pm

    Has a euro-zone member been in this positon before? If not, it will be interesting to see how the EU handles this as it will likely set a precedent for similar situations that may arise in the future. The no-bail-out position in the euro-zone is somewhat awkward. Because the EU lies somewhere between sovereign state and international organization, it is difficult for me to figure out how I feel about this. On the one hand, the euro-zone should not have to take a hit because of the misjudgment of a sovereign member state. On the other hand, I feel the EU cannot become more united if there are institutional regulations that keep it from assisting its members on a very intimate level. The status of EU members as both sovereign and sort of federal units certainly complicates this whole crisis. I want to say that in order for the EU to be successful, it has to have some strength in its central governance and an ability to deal with its members on an individual level, in this case EU to Greece. But the EU is a new kind of political body and it is important to allow it an opportunity to figure out how to function under its current structure.

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