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TABLE OF CONTENTS
ABSTRACT.................................................................................................................................... 1
CHAPTER 1: RELATED CONCEPT ............................................................................................ 2
1.1 The concept of monetary policy ....................................................................................... 2
1.2 System of monetary policy tools ...................................................................................... 2
1.2.1 Main tools include: ................................................................................................... 2
1.2.2 Additional tools include: ........................................................................................... 2
1.3 Crawling peg .................................................................................................................... 2
CHAPTER 2: THE IMPACT OF MONETARY POLICY ON THE GREEK DEBT CRISIS
BEFORE THE EURO..................................................................................................................... 3
2.1 Expansion of Social Programs: 1974-1993.......................................................................... 3
2.2 Maastricht Treaty and Convergence: 1993-2001 ......................................................... 4
CHAPTER 3: THE IMPACT OF MONETARY POLICY ON THE GREEK DEBT CRISIS
AFTER THE EURO ....................................................................................................................... 8
3.1 Accession, Growth, and Crisis: 2002-2012...................................................................... 8
3.2 Impact of the monetary policy during the Greek debt crisis ............................................ 8
CHAPTER 4: THE LESSONS AND THE CONCLUSION ........................................................ 10
4.1 Lesson learned: Monetary policy integration must be accompanied by some form of
fiscal policy integration. ............................................................................................................ 10
4.2 Conclusion...................................................................................................................... 11
REFERENCES ............................................................................................................................. 12
 TABLE OF FIGURES
Figure 1. Prior to the sovereign debt crisis, real GDP growth in Greece outpaced that in the other
European OECD member countries................................................................................................ 4

Figure 2. The drachma depreciates against the euro and the inflation differential against the EMU
average. ........................................................................................................................................... 5

Figure 3. CPI inflation and money market interest rates. ............................................................... 5

Figure 4. Real interest rate. ............................................................................................................. 6

Figure 5. Yields on long-term government bonds. ......................................................................... 6

Figure 6. The deviation of the drachma from the value predicted by purchasing power parity
(PPP) and the flexible price money model (FPMM). ..................................................................... 7
 TABLE OF ACRONYMS

Keyword Meaning

GDP Gross Domestic Product

OECD Organization for Economic Cooperation and Development

EMU European Economic and Monetary Union

PPP Purchasing Power Parity

ECU The Euro after 1999

FPMM Flexile Price Monetary Model

 ABSTRACT
The sovereign debt crisis in Greece has posed major problems in financial markets and has
nearly caused the breakup of the euro. It would be worthwhile to study the causes of the crisis.
Much of the media coverage of the economic crisis in Greece has highlighted unsustainable fiscal
policies as the leading cause. Moralization stories depicting a lavish Greece using deficit spending
on unsustainable social programs have contributed to the reluctance of stable nations like Germany
to provide bailouts. Austerity measures and fiscal consolidation in Greece are widely prescribed
as a necessary remedy.
Fiscal policy, however, only tells part of the story of the crisis. By adopting the euro and
joining the European Economic and Monetary Union, Greece ceded control of its monetary policy
to the European Central Bank in Frankfurt, which sets the euro's interest rate. based on conditions
throughout the euro area. Therefore, this report aims to analyze the monetary policy of Greece
before and after using the euro to clearly see the impact of monetary policy on the Greek debt
crisis and draw lessons.

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 CHAPTER 1: RELATED CONCEPT
1.1 The concept of monetary policy
Monetary policy is the macroeconomic policy laid down by the central bank. It involves
management of money supply and interest rate and is the demand side economic policy used by
the government of a country to achieve macroeconomic objectives like inflation, consumption,
growth and liquidity.
1.2 System of monetary policy tools
1.2.1 Main tools include:
Reserve required: Through the reserve requirement ratio tool, the central bank affects the
quantity and price of credit of commercial banks, which in turn affects the credit supply capacity
and capacity. the money creation capacity of the commercial banking system.
Refinancing: The central bank adjusts the refinancing and rediscount rates up or down
depending on the monetary policy objective of tightening or expanding the currency, thereby
reducing or increasing the amount of money. money in circulation. In addition to the impact
through the refinancing interest rate, the central bank also uses the refinancing limit to directly
affect the number of reserves of the commercial banking system.
Open market operations: Impact on the Reserves of the Banking System: The buying and
selling behavior of securities on the open market by a central bank has the potential to have an
immediate effect on the reserve status of banks. commercial banks by affecting deposits of banks
at the central bank and deposits of customers at commercial banks.
1.2.2 Additional tools include:
Interest rates: Through the refinancing mechanism (discounting, rediscounting, lending,
pledging valuable papers, etc.) of the central bank to credit institutions, the central bank manages
it. indirectly, lending interest rates of commercial banks to the economy.
Credit limit: Used to control the total credit balance, thereby controlling the total money
supply for the economy. Therefore, its mechanism of action is imposed by the central bank on the
banking system.
Exchange rate: The central bank or the foreign exchange agency of the state uses the direct
operation of foreign currency trading to adjust the exchange rate to suit the country's development
conditions and policy goals for the country. foreign. When the exchange rate rises, the central bank
sells foreign currency to relieve the pressure of increasing demand for foreign exchange, causing
the exchange rate to decrease and vice versa.
1.3 Crawling peg
Crawling peg is a method of controlling exchange rates by adjusting exchange rates
gradually as fluctuations in the foreign exchange market tend to cause the exchange rate to fall.
The fixed exchange rate of the domestic currency does not accurately reflect changes in the market.

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 Reasons to use Gradual Adjustment Anchor Mode:
Gradual adjustment is used to provide exchange rate stability among trading partners,
especially when there is currency weakness. Typically, Gradual Adjustment Peers are established
by developing economies whose currencies are pegged to the US dollar or euro.
Gradual adjustment of the exchange rate anchor is set by two parameters. The first is the
denomination of the anchor coin. This denomination is then set within an exchange rate range.
Both of these components can be adjusted, hence the term adjusted exchange rate because it
changes depending on market or economic conditions.
Disadvantages of Gradual Adjustment Anchor Mode:
Since currency anchoring can result in fake currency exchange rates, there is a danger that
speculators, currency traders, or the market may overwhelm established mechanisms for currency
stability. A broken pegged rate refers to when a country's inability to protect its currency leads to
a sharp devaluation ranging from a high fake price to turmoil in the domestic economy.
CHAPTER 2: THE IMPACT OF MONETARY POLICY ON THE GREEK DEBT
CRISIS BEFORE THE EURO
2.1 Expansion of Social Programs: 1974-1993
In the year 1974, momentous changes swept through Greece: the authoritarian regime
collapsed, King Constantine II was deposed, and a new democratic government was established.
Prior to this period, Greece had attained low inflation and a credible peg to the United States dollar.
However, inflation rose with the elimination of the Bretton Woods constraints; the first oil shock;
and internal populist pressure for income redistrict bution, full-employment policies, and
expansionary fiscal policy.
Inflation, which averaged 3.8% annually from 1954 to 1973, rose to an average of 18.1%
from 1974 to 1993. Output growth, which averaged 7.1% from 1954 to 1973 (the so-called “Greek
Miracle”), fell to an average of 2.1% from 1974 to 1993.
The result was a lengthy period of stagflation; several industries were nationalized, calling
into question the security of property rights in Greece.
The Bretton Woods peg gave way to a “crawling” peg, with several devaluations and failed
attempts to regain credibility (Panagiotidis and Triampella 2006). Government fiscal deficits,
intended to accomplish income redistribution, were financed by debt and seigniorage.

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 Figure 1. Prior to the sovereign debt crisis, real GDP growth in Greece outpaced that in the
other European OECD member countries.
2.2 Maastricht Treaty and Convergence: 1993-2001
In 1993, Greece signed the Maastricht Treaty, pledging economic convergence with its
future monetary partners. To achieve convergence, Greece tightened fiscal policy and contained
inflation according to a plan adopted in March 1993; The government abandoned the plan before
the end of the year and adopted a more gradual plan in June 1994.
In parallel with fiscal reform, Greece also carried out monetary reform. Inflation fell from
23.3% in October 1990 to 3.9% in December 2000. As part of a convergence program. The
monetary policy framework is defined by the policy objectives; intermediate target; operational
goals; and policy tools. The Bank of Greece's policy objective in the 1990s was to meet the
Maastricht Treaty's inflation criterion (The Maastricht Treaty said that inflation was 3%, monetary
fluctuations at 2.5%, the long -term interest rate was about 9%, the highest public debt was 60%,
the 3% budget deficit was stable. Economy.). This is pursued through a strategy of intermediate
exchange rate targets, known as the “hard drachma policy” in relation to the nominal devaluation
of the Greek drachma relative to the ECU (the Euro after 1999) is getting smaller and smaller than
the inflation gap between Greece and the EU average.
During the first phase of the convergence program, 1995-1997, inflation halved and GDP
growth accelerated. They argue that both of these results have high confidence for the Bank of
Greece fixed exchange rate. Previously, the Bank of Greece did not announce specific exchange
rate targets; The drachma has experienced decades of devaluation since the collapse of Bretton
Woods. However, the drachma appreciated in value against the PPP and became increasingly
overvalued until the exchange rate crisis in 1998. Even after the announcement of a fixed exchange
rate target, in 1995, inflation disparities still existed between Greece and the rest of Europe.

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 Figure 2. The drachma depreciates against the euro and the inflation differential against the
EMU average.
The main operating variable used by the Bank of Greece in the 1990s was the interbank,
money market which controls the liquidity of the domestic banking sector. To achieve its
operational objectives, the Bank of Greece used a number of policy tools, the main of which is the
daily (overnight) short-term interest rate. Very closely correlated with fluctuations of interbank
money market rates.

Figure 3. CPI inflation and money market interest rates.

This is the largest fluctuation, a reliable indicator of the general direction of the Greek
monetary policy. Despite sharp increases during periods of speculative pressure in 1994 and 1997,
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both rates gradually declined and converged (but did not become equal before joining the EMU)
with the German and Eurozone money market rates bad. Throughout the 1990s, still higher
nominal interest rates occurred. Although yields on long-term Greek government bonds have fully
converged CPI inflation, resulting in a strongly restrictive monetary policy. Greece's real interest
rates converged but remained above Germany's rates throughout the 1990s becoming increasingly
overvalued, leading to a significant decline in Greece's current account becoming equal to it and
the average of EMU just before joining EMU.

Figure 4. Real interest rate.

A strong drachma policy achieves inflation that converges but does not fully equilibrate
with the EMU average. This was accompanied by a steady long-term decline in Greek government
bonds.

Figure 5. Yields on long-term government bonds.

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 Previously, the Bank of Greece had not announced specific exchange-rate targets; the drachma
had experienced decades of devaluation since the collapse of Bretton Woods. Nevertheless, the
drachma increased in value with respect to PPP and became increasingly overvalued until an
exchange-rate crisis in 1998. Even after the 1995 announcement of a fixed exchange-rate target,
an inflation differential persisted between Greece and the rest of Europe. Arghyrou (2009) uses an
Uncovered Interest Parity model to estimate that markets demanded a 9-11% risk premium on
drachma denominated assets from 1990 through 2000. Tavlas and Papaspyrou (n.d.) identify
several obstacles to the strong drachma policy. High interest rates, necessary to suppress domestic
inflation, led to capital inflow, which was costly to sterilize for the Bank of Greece. Furthermore,
a current account deficit widened as the drachma became increasingly overvalued. These factors,
combined with international financial turbulence following the devaluation of the Thai Bhat in
July 1997, strained the Greek money market, ultimately leading to the collapse of the drachma’s
peg in March 1998.

Figure 6. The deviation of the drachma from the value predicted by purchasing power parity
(PPP) and the flexible price money model (FPMM).
The policy collapsed in March 1998 when the drachma devalued against the ECU by 14%
and became a member of the broad band (15%) ERM-II 5 with a central parity of 357 drachma per
ECU. In 1998-2000, the Bank of Greece resumed a policy of exchange rate stability around this
central parity rate, which was revalued in 2000 to 340.75 drachma per Euro, the rate at which
Greece joined the EMU on January 1, 2001.
=> To summarize, Greece's monetary policy during the converging era, which lasted
from 1993 to 2000, was characterized by external constraints on foreign exchange targets. which
historically have been important in Greece; during the Greek Miracle period, 1954-1973, the
Bretton Woods system had provided such a constraint. The experience of Greece shows that
monetary policy based on an exchange rate target can lead to a reduction in inflation and,
ultimately, accession to the EMU. At the same time, however, it suggests that such a policy could

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lead to significant side effects leading to reliability problems and destabilizing exchange rate
turmoil.
CHAPTER 3: THE IMPACT OF MONETARY POLICY ON THE GREEK DEBT
CRISIS AFTER THE EURO
3.1 Accession, Growth, and Crisis: 2002-2012
Greece formally adopted the euro on January 1, 2001. Drachma overnight interest rates,
continuing their downward trend from the 1990s, had fallen to 6.16% in December, 2000; and
when Greece adopted the euro in January, euro overnight rates were at 4.76%, then fell over the
course of several years, reaching a low of about 1.97% in November, 2003, then rising slowly to
a high of 4.3% in August, 2008, as the financial crisis was breaking. Greece, both in money markets
and in the sale of government debt, enjoyed considerably lower interest rates than it experienced
under the drachma regime. A Taylor-rule counterfactual analysis by Arghyrou (2009) suggests
that, during this period, the ECB set interest rates lower than the Bank of Greece would have.
Arghyrou argues that such lower interest rates could potentially cause inflation in Greece, resulting
in overheated demand, real-exchange-rate overvaluation, and current account deficits.
Furthermore, he argues, Greece’s accession to the euro eliminated the risk premium of drachma-
denominated assets. The elimination of this risk premium would increase inflation and current-
account deficits in the short term, but the inflation and deficits would subside in the medium-term.
Problems began to emerge in Greece during the late 2000’s financial crisis and economic
downturn, with the sovereign debt crisis beginning to unfold in 2010. Specifically, the government
of Greece had accumulated large debts, saw declining tax revenues as a result of the recession,
faced unsustainable interest rates in bond markets, and was on the brink of insolvency. The Greek
government default would be catastrophic for Greece, and for not only the banks in Greece, but
also those in the rest of Europe. So far, European leaders have addressed this situation through a
combination of additional bailout loans, debt renegotiations and “haircuts,” and austerity measures
for the Greek government. The process of dealing with Greece has been particularly difficult
because of the conflicting viewpoints: some, especially in fiscally strong countries like Germany,
hold that Greece was a profligate country and deserves to default; others support bailouts because
of the enormous risks facing the European financial system as a whole, even in sound countries
like France and Germany; and still others would support bailouts but worry about the problem of
moral hazard. The Greek debt crisis has even, at times, called into question the very survival of
the euro as a common currency.
3.2 Impact of the monetary policy during the Greek debt crisis
The usual way a country like Greece would deal with these kinds of problems is to
drastically devalue their currency to boost tourism and exports. But because Greece is part of the
euro, and because it doesn't control the eurozone's monetary policy, it can't devalue the euro. The
monetary policy of the Eurozone is controlled by the European Central Bank, which is more or
less controlled by Germany, and therefore it is not surprising that the monetary policy of the

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Eurozone the euro is much better for Germany than it is for Greece. So being a member of the
eurozone hit Greece hard: It led to insane lending rates, it sparked the crisis, and then it making
the crisis much more painful for Greece.
Monetary policy in Greece has been exceptional in the past nineteen years. Monetary
policy, as practiced by the Federal Reserve, for example, is often intended to stabilize inflation at
a low level, and to mitigate the business cycle. From 1993 until 2000, however, Greece’s monetary
policy was focused not only on inflation and stabilizing output, but also on maintaining a foreign-
exchange peg (under tremendous speculative pressure) and converging to the requirements of the
Maastricht Treaty with respect to several indicators, including inflation. From 2001 to the present,
Greece’s monetary policy has been determined not by a Bank of Greece in Athens setting interest
rates with only the Greek economy in mind, but by the European Central Bank in Frankfurt setting
interest rates for the entire eurozone.
The difference between the ECB's actual target rate and the BOG's expected target rate
can reflect two potential effects:
First, Greece needs a monetary policy tighter than the one followed by the ECB. This may
be so because in 2001-2005 the Greek economy grew significantly faster than the EMU average,
in which case Greece needed higher nominal interest rates to control inflation more effectively.
Instead, according to this explanation, the low interest rates set by the ECB over-stimulated Greek
domestic demand, fueled inflationary pressures, increased real exchange rate overvaluation and,
ultimately, resulted in historically high current account deficit levels.
The second effect may be the elimination of the risk premium embodied in Greek interest
in the 1990s, caused by the replacement of the Greek drachma by the euro. Due to the increased
confidence level due to the accession of Greece to the euro. Such a reputational boost in the short
term could lead to too low interest rates, rising inflation, and higher-than-normal current account
deficits. In the medium term, however, losses in competitiveness then lead to lower inflation, so
that the economy will eventually fall into a sustained current account deficit.
The majority agreed that one of the reasons for Greece's public debt crisis was weak fiscal
policies, with the Greek government running a budget deficit to fund social programs. In the past,
Greece was used to doing this without serious consequences because it was able to get out of debt
through fiscal inflation and currency devaluation; that is, accommodative monetary policy creates
a counterweight to fiscal policy. Today, however, Greece cannot unilaterally devalue its currency
because it shares a currency with countries like Germany. Greece's lack of a country-appropriate
monetary policy exacerbated the crisis.
Thus, in addition to the often-emphasized fiscal factor, Greece's economic crisis was the
result of monetary policy deviations between the European Central Bank and Greece. Greece's
participation in the Eurozone means accepting the monetary policy set out by the ECB to pursue
the goal of controlling inflation. The monetary policy offered by the ECB is reasonable when it
comes to stabilizing the euro in the region. However, it makes it difficult for the governments of

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member countries to develop fiscal policies in accordance with their own economic conditions.
Specifically, interest rates in the money market depend on the interest rate policy determined by
the ECB. A period of low nominal interest rates and persistently negative real interest rates could
exacerbate a government debt bubble, which Greece, as a member state of the eurozone, cannot
simply inflate it. Government bond interest rates are determined by the finance ministry of each
country. The decision of the finance ministry depends on the fiscal policy of each country. For
Greece, as well as some countries with less competitiveness, larger budget deficits than other
countries in the euro area, to stabilize their economies, these countries often choose the method of
economic stability. government bonds with higher interest rates. Therefore, debt crisis due to
insolvency is only a matter of time.

CHAPTER 4: THE LESSONS AND THE CONCLUSION

4.1 Lesson learned: Monetary policy integration must be accompanied by some form of
fiscal policy integration.
Many people believe that Greece should not have joined countries with different economic
structures such as Germany and France. But the weakness of the Euro bloc is not that countries
should not integrate, but that they have not integrated enough. By using the same currency,
countries reduce transaction costs and price volatility by eliminating exchange rate instability,
thereby increasing trade between countries in the bloc. But in ceding to the European Central Bank
the power to print money, influence interest rates, and so on, the eurozone countries abandoned
independent monetary policy. This constraint has a good effect for the bloc as it does not allow a
country to devalue its own currency to stimulate demand for its own goods. At the same time,
without the option of printing money, a country cannot use inflation (a form of tax collection) to
reduce its real debt. This second constraint forms the anchor for the market's expectations for that
country's inflation, keeping it from rising.
However, the downside is that monetary integration puts pressure on a country to increase
its public debt. In the absence of monetary policy tools, a government can only resort to fiscal
policy to stimulate demand when the economy is in a cyclical recession, but during a recession,
tax revenues decrease, major spending increases. Government to stimulate demand, can only rely
on the option of increasing public debt. If the public debt of members of the bloc is too high, it
will lead to a debt crisis and may lead to a currency crisis for the whole bloc. To reduce the above
pressure, monetary integration must be accompanied by some form of fiscal integration. This
major shortcoming stems from the lack of fiscal integration among the eurozone countries, which
can be seen by everyone but is not easy to solve, because it is difficult for the people of Germany
or Austria to agree to include the increase in the tax rate. taxes to feed retired and unemployed
people in Greece, Italy, and Portugal. This is the difficulty of the EU and is the reason why the
Euro crisis will continue in the future.

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4.2 Conclusion
A period of low nominal interest rates and persistently negative real interest rates could
exacerbate a government debt bubble, which Greece, as a member state of the eurozone, cannot
simply inflate it. In addition to the often under-emphasized fiscal factor, we now add that
monetary policy may also have contributed to Greece's sovereign debt crisis. We argue that
the monetary policy of the Bank of Greece meets several criteria for a good monetary policy.
On the other hand, the ECB's monetary policy exhibits characteristics that suggest it has a
destabilizing effect on the Greek economy. While the ECB may have balanced excessive fiscal
stimulus with tight monetary policy, the ECB's actual expansionary monetary policy may have
stimulated fiscal and led to further destabilization.

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REFERENCES
(1) Panagiotidis, T., & Triampella, A. (2006). Central Bank Independence and inflation: the
case of Greece. Revista de Economia del Rosario Bogota (Colombia), 9(1), 95-109.
(2) Vayanos, D., & Vila, J. L. (2009). A preferred-habitat model of the term structure of
interest rates (No. w15487). National Bureau of Economic Research. doi, 10, w15487.
(3) Giavazzi, F., & Spaventa, L. (1990). The" new" EMS (No. 86). Quaderni-Working Paper
DSE.
(4) Arghyrou, M. G. (2006). Monetary policy before and after the euro: Evidence from
Greece (No. E2006/26). Cardiff Economics Working Papers.
(5) Lazaretou, S. (2005). Greek monetary economics in retrospect: the adventures of the
drachma. Economic Notes, 34(3), 331-370.
(6) Arghyrou, M. G., Gregoriou, A., & Kontonikas, A. (2009). Do real interest rates
converge? Evidence from the European Union. Journal of International Financial
Markets, Institutions and Money, 19(3), 447-460.

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