ASSIGNMENT 3

MACROECONOMIC THEORY AND POLICIES

SUBMITTED T0 PROF. VISHWA BALLABH
NAME- JAY JHAVERI
ROLL NO.- BD20171

INTRODUCTION
Greece got its independence eight years after the Greek War of Independence started until
which it was under the rule of Ottoman’s Empire until 1829. The Greek economy was not in a
great state even after getting independence and suffered from major economic problems like
Debt, Default and External Dependence. Following Independence Greek has suffered from
three major economic problems

1. Sovereign Debt crisis of 2015

2. The Greek Default of 1893
3. Independence Loans default in 1826

There were some major factors which caused the crisis in the country which include corruption,
clientelism, economic populism and tax evasion. The issues further rose due to Greece joining
the European Monetary Union. A major turmoil uncovered when there was the Global financial
Crisis of 2008 which had severe impact on almost every economy in the world.

GREECE’S DEBT CRISIS

The Greece was able to grow at a sustainable rate and have decent economic growth from the
year 1974 up to 1980. Though there were some problems like Public Debt and excessive
spending, it somehow had decent growth during the period where in 1980 it only had a fiscal
deficit of nearly 2.6 and a debt to GDP ratio of 21.4 percentage. Government in order to look
out for the population of the country and gain popularity among them tried various methods
like higher wages, pensions and deferred tax. The Greece during this period decided to join the
Economic and Monetary Union [EMU]. But they had a condition that Greece before entering
the Union should carry out a fiscal consolidation and structural reforms in the economy so it
could try and come out of the various problem it was in. This was step which was considered
as the Golden period for Greece. There was advancement in the economy with a growth rate
of about 4% and unemployment fell down to nearly 9.8%.
3 issues that lead to Greek Economic crisis
Negligent Imposition of Fiscal Rules
The policies followed by the Greek Government and the way the administration worked, it
could land up in big troubles and eventually that is what happened with the economy. After
evry bailout, Government promised farfetched promises and economic reforms which
eventually it was not able to achieve. In 2010, European Troika extended financial assistance
to Greece but was the country was not able to capitalize on that front. As a result, the economy
kept slipping and there was a sharp downturn.

In the late 1990’s Greece decided to entered the EMU and adopt Euro as its currency. These
were some good indications for the investors and lenders as the Maastricht Treaty’s entry
criterions were very rigid and it would ensure the in-place macro fundamentals of the country
with its peers in the other European regions. But the entry in EMU was not as fruitful as one
would have expected as the public debt kept ok rising and the fiscal deficits kept expanding.
These can be some of the major indicators for the Negligent Imposition of the Fiscal Rules.

Macroeconomic Populism
The Greece Government which came into power from 1980’s cultivated the macroeconomic
populism culture which in turn led to higher wages, pension, higher government spending,
delay in taxes etc. It followed a Socialist type of setting and it resulted in enhanced Public Debt
and deficit
Greece Government held a majority stake in the Public Sector i.e 75% holding. This was one
if the most problematic areas for the economy as these banks were used to engage in vite bank
politics. It was only a front to get votes and have the desired party in power. In order to get
votes and have a clear majority in the Government, political parties used higher wages and
other incentives to get more and more votes without even considering the effect that it would
have on government spending. To get support from the industries, political parties announced
huge subsidies to public industry, higher minimum wages and pension expenditures also rose.
These were some of the major contributing factors to the expansion of fiscal deficit in the
country which was steered by the inefficient Government tactics and personal gains over the
growth of economy.
In the 1980’s, the percentage of public spending increased from 29.7 to 48 of the GDP which
was an alarming number and a wakeup call for the economy as well. Public receipt rose from
27.1 to 32.1 % of the GDP. The primary reason for the fiscal destabilization was higher deficits
in the economy. As Greece secured more and more monetary help from neighbouring
Countries, interest payments also became a major reason for the destabilization of economy.
High debt to GDP ratio also hampered the progress. At a point in 1990, Debt to GDP ratio
increased to 68.21% and recurring Interest payments added to the burden.
High Capital Inflows and Incompetent Planning
With the countries, helping out Greece Financially, the capital Inflow of the country was high
and the management of funds was not up to the mark.
The growth of the country was fuelled by the domestic consumption. Greeks had a tendency to
save money and not spend or invest. They did not invest money to expand their businesses and
did not buy new machineries, equipment or plants. Public sector companies also focussed on
expenditure rather than investment and as a result the Greek Industrial Base could not expand.
The High inflow of capital and access to cheaper loans led the government to hide up the fact
that the tax revenue was low and government did not have enough revenue from the country.
It kept on borrowing which led to the deficits increasing and the borrowed funds were not used
for investments in economy, states for growth and instead of creating new resources and
streams of opportunities for people, the funds were used to foster current consumption that did
not harvest any returns.

Economy Analysis
There are various Indicators which would help us in understanding the Macroeconomic factors
which led to Greece in such an adverse condition. Among them are:
• Inflation Rate
• Public debt
• Gross Domestic Market
• Unemployment
• Interest Rates
• Current Account Deficits
• Exchange rates

Inflation Rate
Greece used austerity measures and reduced inflation during the 1990s in order to comply with
the Maastricht agreement. After a recession in 1986–1987, Greece embarked on an economic
stabilisation programme to improve its balance-of-payments position and lower inflation. From
1999 through 2010, Several times, inflation surpassed 4%. Following the change in currency
denominations in 2002. Inflation has risen from a low of 2.5 percent in 2007 to a high of 4.8
percent in 2008. In 2009, it decreased to 0.9 percent before climbing back to 5% in 2010.
Greece was not immune to the effects of the global recession. Consumers' purchasing power
has diminished. Inflation rates continue to rise in certain locations.
Public Debt
Since 1978, Greek governments have flouted the golden rule of fiscal policy. Throughout the
1980s, governments' socialist populist policies exacerbated this disdain, resulting in huge fiscal
deficits and public debt. The early 1980s recession prompted accommodating macroeconomic
policy. This allowed for a loose money supply, low interest rates, and large government
spending, as well as public debt in 1981.Borrowing in the private sector increased. Prior to the
global financial crisis of 2001–2008, the Eurozone's participation period was from 2001 to
2008.For Greece, it was a "golden age." The national debt-to-GDP ratio was maintained at just
above 100 percent.

Gross Domestic Product

Greece's economy grew rapidly, but it was fuelled mostly by domestic demand and
consumption, which were the key drivers of the country's economic expansion. Borrowing,
both public and private, fuelled this economic expansion. By 2015, the services sector
accounted for approximately 80% of total GDP.

Unemployment
For Greece, the time of Eurozone membership to the global financial crisis of 2001–2008 was
a "golden period." Unemployment had dropped to 9.8% of the workforce. However, with the
global financial crisis of 2010, Greece was severely impacted. In 2013, Greece's unemployment
rate surpassed 27%, with rates of over 60% for those aged 25 and under. By 2014, Greece was
struggling with a 25% unemployment rate. In the second quarter of 2016, consumption fell by
6.4 percent, while exports fell by 7.2 percent. One of the primary issues facing the Greek
economy is the unusually high unemployment rate.

Interest Rates
In the first part of the 1980s, the Bank of Greece accommodated huge government deficits by
implementing low-cost monetary policies, including negative interest rates and strong growth
rates of money supply and credit. Following a recession in 1986–1987, Greece embarked on
an economic stabilisation programme with the International Monetary Fund (IMF). The
country's goal was to improve its balance-of-payments position while also lowering inflation.
As a result of these adjustments, the situation became more stable. Interest rates, both real and
nominal, climbed and became positive as a result of these efforts. Interest rates not only
increased the deficit but also enhanced the attractiveness of Greek bonds, alleviating the debt
burden.

Sovereign Debt Crisis

Borrowing for a short period of time has a lower interest rate than borrowing for a long period
of time. When a government borrows for a short period of time, however, it risks having the
debt rolled over. Every time a government extends its debt, the lender has the opportunity to
say no. Creditors will sometimes roll over debt, but if they believe the debt will be defaulted
on, they will either demand a higher interest rate or refuse to roll over the existing obligation.
The Greek government had the option of either raising taxes or cutting spending, or defaulting
on the debt. However, while defaulting may appear to be a foolish idea, it has been done many
times throughout history, particularly during the reigns of monarchies. In fact, the word
"sovereign debt" comes from the obligation owed by the Kings and Queens. Today, the phrase
refers to any central government's debts. Is there a debt threshold that frequently triggers
default? Actually, governments with moderate levels of debt can default, and countries with
enormous quantities of debt can often sustain large amounts of debt without defaulting.
The financial crisis of 2000 brought everyone's attention to the issue of debt and the ability to
repay obligations, and by 2008 and 2009, they were looking at Greece and realising that its
debt levels were unsustainable. In Greece, a new government came to power, and they quickly
realised that the fiscal position was far worse than the previous administration had indicated.
Because Greece is not the same as Germany, and the prospects of default are considerably
bigger, these two shocks began to open the market size. As a result, interest rates have to be
much higher, and they won't receive their money back if there is a default, thus a rollover has
become a concern.

MACROECONOMIC THEORIES AND TOOLS TO ANALYZE

GREECE’S ECONOMY
Debt to GDP ratio
The debt-to-GDP ratio measures a country's public debt in relation to its gross domestic output
(GDP). The debt-to-GDP ratio is a reliable indicator of a country's ability to repay its debts
since it compares what it owes to what it generates.
Greece's fiscal policy exceeded the EU's fiscal policy cap, it was nevertheless allowed to join
the Eurozone. The Greek sovereign debt crisis is a good example of why you shouldn't invest
in debt from countries with high debt-to-GDP ratios. Many banks owned Greece's bonds, and
when they were due, the government of Greece defaulted. The bonds were downgraded to junk
status by Standard & Poor's. Greece implemented austerity measures, further lowering the
country's earnings and ability to pay its debts.

Multiplier Effect
The multiplier effect describes the increase or reduction in final income caused by the injection
or withdrawal of cash into the economy. Any type of economic injection will have an impact
on economic activity. The multiplier effect aids in calculating the anticipated increase in
revenue per dollar/Euro invested. The multiplier can also be used to estimate a country's
residents' saving and spending patterns.
The main objectives of countries that have implemented austerity programmes, such as Greece,
are to promote economic sectors that produce internationally tradable goods and services, as
well as to strengthen linkages between sectors to maximise positive direct and indirect
multiplier effects and potential synergies.
Learnings
The Greek saga has taught the world one important lesson: in the twenty-first century, current
economic problems can have far-reaching consequences. The Greek debt crisis was caused by
decades of mismanagement of fiscal policy by populist governments. Individuals and nations
alike cannot afford to borrow and live beyond their means. It's tough to tell when debt becomes
unsustainable, and it's much harder to tell when loans become too dangerous. As a result,
countries should exercise caution when it comes to the amount of money they borrow and
spend.
Because of the tremendous economic disaster caused by discretionary spending, the Greek
economy may have to continue with austerity measures for years to regain economic stability.
Another thing to keep in mind is that huge banks do not suffer. Some bondholders received a
haircut, but the majority (including the big French and German banks) had the majority of their
debts repaid by the IMF, the ECB, and other Eurozone countries. Deferment, rollout, and
interest rate reductions were used to solve the Greek debt problem, giving the Greeks ample
money to pay down the debt when it became due while worrying about the new loan when it
became due.