Causes of the Crisis
The debt crisis itself came to light in 2009 after the Great Recession (2007-2008) that was caused by the banking crisis in the United States. The cause for the European Debt Crisis had its roots at the very beginning of the implementation of the Eurozone in the periphery countries Portugal, Italy, Ireland, Greece and Spain (commonly known under the non-enduring acronym PIIGS) (Piigs.net). The roots for the debt crisis in these nations were caused by their ever expanding government deficit, inability to refinance after the global recession, and incapability to activate a monetary policy (the ECB controlled the exchange rates of the Euro along with other monetary possibilities).
Looking specifically at Greece, as this is the focus of this paper, one can see that Greece’s debt crisis grew out of adopting the Euro despite not meeting the standards necessary as prescribed in the Stability Pact (Greece’s
budget deficit as a percentage of GDP was -6% in 2002 and had a gross government debt of GDP at 105% the same year) (Kindreich). In the ECB’s 2000’s convergence report, they cited that a decrease in the inflation rate during the 1990’s and relatively safe interest rates near the European Union average put it in the realm of Euro membership (ECB Convergence Report 2000, 3-4). Part of the reason for this quick admittance into the Eurozone was due to the structure of the Stability Pact, only observing convergence over two years (rather than a longer period of time), and the fact that some of the European Union’s founding countries also did not meet the criteria laid down in the pact. Had they not allowed Greece into the Eurozone, they would have been hypocrites. However, the data used in the analysis by the ECB to allow Greece into Eurozone was faked. After the 2004 Greek elections, the socialist party was defeated and the new government began an audit into the facts and figures it released to Eurostat, a directorate-general of the European Commission charged with verifying statistical information in the European Union, after Eurostat refused to validate the previously released Greek data in 2002.
After the European Union's Executive Commission announced that the Greek data “had been revised after the discovery of errors in data sent to the union's headquarters in Brussels in recent years,” Finance Minister George Alogoskoufis admitted the former Greek government failed to release truthful data and that the budget deficit released in 2000 should be revised from 2% to 4.1% (Carassava). Although there were falsifications, no real action was taken despite the foundation laid out in the Treaty on European Union’s Title II, Article 104c calling for action to be taken in the case of excessive debt or failure to meet the requirements laid out in the Stability Pact (Treaty on European Union, 27-29). Additionally, 10-Year bond yields did not fluctuate and remained below 4% for the next several years indicating that investment in Greece was still strong (FRED).
Investors bet on a certain level of sustained convergence towards the core countries Germany, France, and Benelux. The belief that there would no longer be currency risk with the adoption of the Euro further drove investment into Greece. This inflow of funds drove down interest rates further than they were when Greece had entered the Eurozone since investors required a lower risk premium for holding Greek debt. Bond yields fell from 24% in early 1993 – Greece was coming out of a recession at this point – to just above 5% by the time it joined the Eurozone in 2001. The sustained interest rates at around this level between 2001 and 2009 encouraged the continual investment of funds to the country (Kindreich). Data on private credit growth supports the evidence of inward consumption and investment. The International Monetary Fund (IMF) reports that from 2001, net domestic credit rose from €153 billion to €274.7 billion by 2009 (The World Bank). The combinations of these factors led Greece to having one of the fastest growing economies in the world with an average GDP growth rate of 4% in the ten years leading up to 2008 and allowed Greece’s economy to grow a total of 50% in real terms.
The Greek government welcomed this economic growth to bring in new investors, for political gains, and bring about convergence in the standard of living in Greece. However, Government spending did not match the revenues it was bringing in each year. With an increase in GDP, and thus an increase to profits and incomes, government tax revenues should have increased proportionately. The fact that this was not the case should have been an early warning sign of possible tax evasion or fraud. Revenue was reduced by scheduled cutbacks in income taxes intended for middle-income earners, despite some of the revenue losses being offset from increases in excise duties. Additionally, the corporate tax rate was deliberated to be abridged from 35% in 2004 to 25% in 2007 (Kindreich).
With the collapse of Lehman Brothers in 2008, and the onset of the 2007-2008 financial crisis, lenders required a larger premium on top of loans, especially in the periphery countries which already had a large amount of debt. In order for Greece to pay off the short term payments of its previous loans, it needed to refinance – essentially taking on more debt to pay off old debt. However, after the government revised the previous deficit percentage of GDP in 2008 and revised its 2009 forecast of its deficit percentage from 3.7% to 12.5%, Greece’s bonds were downgraded by Fitch Ratings and later other credit raters (Smith and Seager). This was the beginning of the Greek debt crisis.