Since the global financial crisis of 2007-2009, the European Monetary Union (EMU), colloquially known as the “Eurozone,” has experienced significant stresses. The EMU was the next step in the European Union’s movement towards economic and political integration, which began nearly sixty years ago, progressed through the Common Market, and became the European Economic Union. The goal of the European Union is to create political and economic stability for all of Europe. The EU plans to provide this stability by linking economies, and to a certain extent, political systems of its 28 member states; the EMU is the most recent step to further this goal.
The framework for EMU was laid out with the Treaty of Maastricht in 1992, when twelve members of the EU agreed to join the monetary union, while the UK and Denmark opted out. Currently, new members to the EU must join the Eurozone as well. There are currently nineteen members of the Eurozone and member states use a common currency, the Euro, which was introduced for use in 2002. Adopting the Euro requires member nations to give up control over national monetary policy; instead, a common monetary policy is conducted by the European Central Bank (ECB). The Euro lowers transaction costs between member countries and further eases cross-border trade. Membership also implicitly requires a convergence of fiscal policies to keep member economies in sync. The result of EMU was greater integration of financial markets in the union, and convergence of interest rates to the level of the core countries (e.g. Germany), as shown in Figure 1.
A decade of growth ensued in which peripheral countries—e.g. Portugal, Ireland, Italy, Greece and Spain—capitalized on the greater access to liquidity. Low interest rates sparked a surge of borrowing from core countries—such as Germany—leading to soaring current account deficits in peripheral countries. Contemporary thinking prior to the crisis was that growing current account imbalances were to be expected—new membership would grant fellow nations greater credit, prompting spending increases—and should not be considered worrisome. Rather, peripheral countries would use the credit to finance productive investment which would lead to future economic growth and ensure their solvency. Unfortunately, the credit was often not used for such measures. Ireland and Spain accumulated debt to finance a housing bubble, while Greece used their debt to fund politically-popular social programs such as generous pensions for government employees. At the same time, those countries neglected to collect an adequate amount of tax revenue. Indeed, in at least some of those countries, tax evasion is part of the popular culture.
As a result of their unsustainable debt, four of the peripheral countries: Ireland, Portugal, Cyprus and Greece had to accept financial help from the “Troika”—the European Central Bank, the International Monetary Fund (IMF), and the European Commission—placing a political and economic strain on the relationship of those countries with their creditors.
Greece, in fact, has had to accept three large bailouts, starting in 2010, 2012 and 2015. Greece’s general government deficit reached 13.6% of GDP in 2009. This information remained unknown until late due to fraudulent data published by the Greek government. As Greek interest rates rose due to fear of sovereign risk, Greek banks suffered capital losses on the Greek government debt (8% of bank assets) they were holding. These losses reduced the banks’ ability to borrow from the ECB (which required government debt as collateral). The resulting panic lead to the first bank “walk” as depositors withdrew funds in late 2009 and early 2010.
On May 2, 2010 the Troika agreed to a 3-year financial aid program of €110 billion to be repaid over seven years. In return, the Greek government committed to reducing their general budget deficit below 3% of GDP by 2014. This reduction implied that Greece was to maintain a 5.9% of GDP primary surplus. The means to these goals were government spending cuts of 7% of GDP (primarily directed towards government payrolls), and value-added (VAT) and other indirect tax increases of 4% of GDP.
The recession suffered by Greece during the first bailout program was deeper than anticipated. Progress was made, but not enough to meet the program goals. This led to the second Greek bailout in March 2012. The bailout provided €100 billion in addition to the €72.8 billion disbursed under the first bailout. The repayment period was extended from 7 to 15 years and the interest rate on the debt was reduced to 2%. Additionally, private creditors of Greece accepted a 53.3% “haircut”—i.e. debt reduction— in return for trading their Greek debt for public debt of the Eurozone. The net effect of this was to transfer the majority (83%) of the Greek debt outstanding from private to public creditors (the IMF, the ECB, and European governments).
In return, the Greek government committed to another austerity package, reducing the government budget deficit through spending cuts and tax increases. The agreed target was to reduce Greek debt to less than 120% of Greek GDP by 2020, and to achieve a primary government surplus of 4.5% by 2014. Note that this was a lesser target than the first bailout required. The Greek government also committed to labor market and pension reforms.
From 2008-2014, anti-austerity protests took place across the country while the government continued to increase taxes and decrease government spending in exchange for bailout funds. By 2014, the overall unemployment rate had risen to 28%, while the unemployment rate for youth reached 50%. Greece’s economic situation was comparable to the U.S. during the Great Depression where unemployment was at its highest—25%—in 1933. The Syriza—anti-austerity government—took parliamentary control in January 2015. The election of Syriza resulted in the Greeks essentially reneging on their agreements. This led to the most recent Greek financial crisis, as depositors withdrew Euros, and the commercial banking system was closed due to illiquidity. The result in July 2015 was the third Greek bailout.
The third bailout program included further austerity measures, including increases in the VAT, further pension reforms, and instituting “quasi-independent spending restraints” designed to cut government spending if the fiscal target looks to be missed. The program will also create an independent privatization fund to raise €50 billion from sales of “valuable” Greek public assets, restructuring the Greek statistical agency to better insulate it from the political process, as well as a variety of structural reforms, including privatizing the electricity network, modernizing and depoliticizing the Greek government administration and judicial systems.
Two points deserve more attention. It is clear that Greece has failed to reach its fiscal goals during the first two bailouts. Part of this was due to the unwillingness of Greece to follow through with its commitments to align spending with income and thereby reduce its standard of living. Part was also due to the recessionary effects of the austerity policies that increased the deficit as the economy was depressed. Almost certainly both of these were contributing factors, though the relative weights are unclear. At various times over the last decade, the Greek government was found to have reported overly optimistic data on their economic and financial performance. These two points have led to overt skepticism about the extent to which Greece is really prepared to reform. The result was the third bailout program, which has been described as “micromanagement.”
This study will explore whether or not the Eurozone is sustainable in its current configuration. In other words, will the worsening economic and political climate result in a member country’s voluntary or involuntary removal from the European Union? Are the existing laws and regulations sufficient enough to prevent this scenario from happening? While the focus of the study is on Greece, this does not mean that the other peripheral countries are safe from following the same path. These countries are experiencing many of the same problems, but to a lesser degree.
No country has left the Eurozone or EU, and there is no formal procedure to facilitate this process. Leaving the Eurozone calls into question the foundations of the political union; how beneficial is membership in the EMU if core/founding EMU countries will not assist nations in times of economic downtrends? The many recent and tense talks discussing the terms of the Greek bailout show the conflicting opinions and strategies of the Eurozone leaders.
The Greek bailout has, at least for now, prevented Greece from exiting the Eurozone. But at what cost? Greece has been required to give up considerable sovereignty. They no longer control their government budget or many institutional features. One can debate the extent to which they brought this on themselves, but there is no debate that it has happened. Greece has become essentially a vassal state.
As The Economist put it in July 2015, “The summit has deepened the tension between sovereignty and stability that bedevils the euro. If it is to work, the euro zone requires more fiscal centralisation. But the Greek referendum and this week’s deal have laid bare the trade-offs involved, away from national self-determination and towards more intrusive external control. Saving Greece is hard enough; securing the euro will be tougher still.”