Assignment 3

Mismanagement of Fiscal Policy Greece’s Achilles’ Heel

Name: Yash Aggarwal
Roll No: BD20073
Case Introduction

The case talks about how the Greece’s economy struggled because of decisions
taken at particular time to hide country’s economic health by creating
illusionary development, public investment and altered fiscal reports.
Country habit of borrowing money is not new, they took loan for their
independence from Ottoman empire from private investors. Later, every
government started spending money just to get vote base and created culture of
populism by macroeconomic.
Greece was getting bailout from other countries and IMF, but they were not
using that money to create another stream on revenue but to paying off debt,
waving off taxes and lowering interest rates.
Greece created their dependence on outside economy, they were functioning on
the borrowed money but the faced the most crucial impact in 2008 financial
crises.
Another fiasco was the Greek bonds, which was very risky because Greece was
dependent on other countries and if the flow of money gets affected then there
was a very high chance that Greece would be in situation of defaults which can
lead to lose the credibility to take money from the international markets and the
inflation rate will be skyrocketed.

Three Critical Issues and Challenges

1. Governments following populism

 Greece was lagging the structural reforms to maintain the

economic health
 The main revenue driver for Greece is consumption of goods and
services and people were not interested in savings and investment.

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 The government was also giving money on negative interest rates
which was encouraging to the population to spend the money
 To gain vote bank government was lowering taxes and giving high
wages and pension money than usual. The populism method was
used over many years to be in power
 The bailout money and the help getting from other countries and
international monetary fund(IMF) was spending in paying debts
and giving money in hands of people rather than development and
creating income source to support the debt payments

2. Premature entry in EuroZone

 To enter the European union there are certain norms, the deficit
should be 3% of the total GDP and capped the public debt on 60%
of the country’s GDP
 Greece was far behind the treaty’s standards and later agreed that
they fudged the fiscal deficit and public debt to enter into the
European union
 After entering EU suddenly Greece was considered as safe place
to invest, So Greece got money on low interest rates which
eventually fired up the spending nature of Greek government
 Greece spending expenditure was increasing rapidly still it was
lacking on revenue, the basic problem was tax waiver to the
private companies and their debt payment because of guarantee

3. Dependence on outside markets

 As the government of Greek was focusing on borrowing to

function the country’s activity, they started created dependence on
money from other countries’ governments
 When Greece entered into the European union the Greek bonds
were yielding very well and was considered as credible as safer
and mature German bonds, but due to dependence on other
countries jeopardize Greece to be in default situation
 The dependence of Greece came forward very evident in 2008 US
financial crises, which affected the country very badly and
lowered the Greek bond prices and eventually got discarded in
international market

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 Analysis

The Gloomy European Union

Greece was considering the European union as the golden gate to prosperity but
it did not turn out to be same, they got what they wanted. Money at lower
interest rates, as low as Germany gets the loan at same interest rates.
Money was used in paying debts, increasing customer spending and luring vote
banks but not in investments, increasing revenue and development in the
country.
During the EU times prices of Greek bonds surged and was considered as safe
as German bonds. The Greek bond was the safest option for the Greek
government as they would not get default in this scenario and they have got a
stream of money. If they get default they will print more cash and would pay
the money and the buyer of bond is also happy as they are getting their money
back.
The bonds lost their credibility and prices plummeted, suddenly people were
not interested to buy the bonds.

Why Greece didn’t come out from EU?

As coming out from European union is the best response, reinstate of drachma
in the country will reduce the unemployment rate by 25% and will boost the
economy, Greece can convert the debts of euro into drachma and pay out the
debts by printing more money, which will lead to reduce the exchange rate of
euro.
This can also lead to reduce the price of goods for exports and can lead attract
tourism for cheap rates
This seems to be the ideal solution for Greece but the foreign investors and the
debt owners will be apprehensive to do that. Some banks will go bankrupt in
this situation.

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Falling drachma can create hyperinflation situation as the import of Greece is
very high and this will skyrocketed the prices of goods in the country. In this
unstable situation the country will not get FDI and Greece have to rely on lease.

Austerity Measures and effects

Greece got the first bailout in 2010 from the European union countries, in
exchange Greece agreed to reduces the government deficit of the country,
which constitutes 12.5% of the GDP in the next three years. But the agreement
did not work out because the fiscal deficit indicated in 2010 was far greater the
deficit shown. So it was clear that Greece wouldn’t be able to clear the agreed
the fiscal deficit of worth 30 billion euro.

The second bailout was provided in 2012 and agreed to have 74% haircut for
the private Greek bondholders. The bailout was worth 130 billion euro in
exchange Greece has to reduce debt to GDP ratio from 160% to 120% by 2020.
This started working out which was shown by the vote bank started shifting
towards the left-wing party. Greece economy also grew up by 0.7%. The Greek
bonds values started growing and the demand for that also increased which
helped government to balance the budget. But the bond status still remain in
junk status and the debt to GDP ratio increased to 175% which was still an
issue for the Greek government.

The third bailout was the most crucial for the Greece as they were found default
of US for 1.7 billion dollar. This time the bailout came from IMF but the
government did not agree on the terms of bailout which IMF stated. Greek
government send their own terms and condition to avail the bailout and IMF
agreed on that. They got bailout worth of 86 billion euro which will dispatched
as instalments and would be completed in August 2018. In exchange the
lenders’ nation wanted to lay down the labour law reforms, tax reforms and
increase the budget surplus to 3.5%.
They also demanded to reduce the public spending and to start privatize the
public assets so that Greece can earn revenue with diverse revenue stream.

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 Macroeconomic theory/tools to analyse the case

1. Gross Domestic Product

The total market value of the goods and services produced within the
country boundaries in a particular amount of time. It acts like a report
card of economic health of the country.

As Greece majorly works on consumption revenue, the production of

goods and services within the boundaries of the country can gauge the
development in the country. It can also give comparison towards the
other nations and where Greece stands right now
GDP = C + I + G + NX

C = Consumption

I = Gross investment

G = Government spending

NX = Net exports

As the Greek government is lagging to generate revenue from

consumption, government should think about generating another revenue
stream by investing. As investing money is another issue which can be
seeing using GDP, government should start public ventures rather than
lending money to private business owners.

2. GDP Price deflator

This can measure the fluctuation in the prices of goods and services
produced within the country. As the spending money was a habit but
when we strictly impose taxes and lend money on positive interest rates
then the spending behaviour of the population will change and that
behaviour can be measure by price deflator and would be very helpful to
change policies according to the situation of the economy.

3. Public expenditure vs Revenue

The Greek fiscal deficit case can be analysed by using public expenditure
vs revenue. The public expenditure of Greece was increasing rapidly
from 10.3% in 1980 to 23.5% in 2011 whereas the Germany increased
from 22.1% in 1980 to 26.2% in 2011. Though Greece is very close to

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 Germany in terms of public expenditure but it is far behind in terms of
revenue generation from the expenditure. Greece’s high fiscal deficit
reason is justified with public expenditure vs revenue.

Learnings

As manager, Greek fiscal mismanagement teaches me that you do not have to

think about yourself, you have to think about others as well. If governments of
Greece did not think about themselves being in power and more focused on
growth and development of the Greece then it would be comparable power in
European union.

One has to true others and own self as well, then only you can manage any
crises and situation that lies ahead. Greece would have managed the 2008 crises
better if they did not have fudged the fiscal deficit reports to enter into
eurozone and could have done better as a nation.

Sometimes you have to change the flow, as government of Greece was fuelling
up the spending behaviour of the Greek population, there was no focus on
savings and investment. If they would have slowed it down and shift the
population towards investment and savings that would help in generating
revenue, earn tax and development too.