general » The Grexit Explained by the Global Economic Dynamics Project

The Grexit Explained by the Global Economic Dynamics Project

After the 2009 financial crisis, Greece became the epicentre of Europe’s debt problems. By 2010 it was heading towards bankruptcy, setting off fears of a second financial crisis. Many now see the exit of Greece from the euro, or Grexit as it is also known, as the only solution for the country to end its cycle of borrowing, regain control of its monetary policy, and stabilize the economy.

At the GED Project we analyse the underlying causes and effects of Greece’s debt crisis, uncovering the global economic dynamics using the latest tools and methods.

The Grexit Definition

The Eurozone is a monetary union consisting of 19 countries that have each adopted the euro as their sole currency. It should not be confused with the European Union, which is a politico-economic union with no common currency – though, all members of the Eurozone are also members of the European Union. In order to join the Eurozone, members must meet a set of criteria and, once approved, must adopt a set of fiscal policies – including the EU Stability and Growth Pact. By definition, the Grexit refers to the exit of Greece from this monetary union.

Greece’s Not so Ancient History: The Grexit Timeline

Greece became a part of the Eurozone in 2001. However, it wasn’t until the 2009 financial crisis that the extent of the country’s financial troubles became clear; in 2010 Greece’s debt-to-GDP ratio was 146%. There are several causes of Greece’s debt problems. The first is follows a succession of governmental tax evasion and corruption. This is thought to have taken place over several decades and was misreported in order to keep within the Eurozone monetary guidelines. The second is that when Greece joined the Eurozone, its labour costs went up significantly, making its trade deficit increase. Third: when the financial crisis happened two of Greece’s biggest industries, shipping and tourism, slowed dramatically.

Once Greece’s deficits became clear, investors raised interest rates in exchange for loans that Greece needed to stimulate the economy. This made Greece’s deficit problem worse, which in turn increased interest rates. In 2010, to avoid a Grexit, the European Commission, the European Central Bank (EBC), and the International Monetary Fund (IMF) agreed to a €110 billion loan with conditional austerity measures, structural reforms, and privatization. However, in the following year the recession worsened as the economy began to contract, causing widespread unemployment and economic stagnation. To ease this, in 2012 a second bailout for €130 billion was issued. This appeared to be working until 2014 when the country slipped back into recession.

Following this, the leftist Syriza-led government was elected by the Greek people with a mandate to end austerity which many saw as crippling the economy, and as a result, loan payments were withheld. Greece has since held a number of referendums; on July 5, 2015, Greek citizens voted to reject the bailout terms. This caused stocks to plummet as the perceived probability of a Grexit increased and also resulted in a liquidity crisis, with the EBC continuing to provide Emergency Liquidity Assistance to Greek banks. Should Greece run out of money, it will be forced to print an alternative currency – and this would be the Grexit from the official Eurozone.

Should Greece leave the Eurozone?

Although the Eurozone has its advantages in terms of trade, there are drawbacks to sharing a currency with the 19 other countries. Namely: Greece’s monetary policy, including how much money it can print, is controlled by the European Central Bank. Many countries are concerned that increasing the amount of euros in circulation would result in inflation in other Eurozone countries. By reintroducing the drachma through the Grexit, Greece would regain control of its monetary policy and could implement its own fiscal plans.

Many economists suggest that a Greek default is unavoidable in the long term, and that delaying it hurts the Greek economy and its EU lenders. At GED we use the latest tools and methods to forecast economic dynamics. Our VIEW model simulations predict that a 50% devaluation of the Greek currency would drive up the government debt ratio as expressed in the new drachma because this debt would have previously been denominated in euros. While this might be difficult at first, it would ultimately strengthen the Greek economy, and also reinforce cohesion in the Eurozone – equipping it to face the other financial challenges that remain.

That said, there are issues with changing currency. If, as in the case of the Grexit, the replacement currency is expected to devalue against the euro, this could lead to a bank run as people rush to withdraw the more valuable euro, placing further stress on the economy. The probability of a Grexit and the reintroduction of a devalued drachma have already prompted many people to withdraw their euros from the country’s banks. In the nine months leading up to March 2012, deposits in Greek banks had fallen 13%.

The Domino Effect: The Far-Reaching Impact of the Grexit

From minor economic trembles to a worldwide recession, the projected outcomes of the Grexit are multifarious. In our study ‘Grexit: Analyzing The Potential Economic Impact of Southern European Member States Exiting The Eurozone’ we consider the far-reaching consequences of such an event in terms of four possible scenarios. In the first, only Greece exits the Eurozone (Grexit scenario). In the second, both Greece and Portugal exit (GP-Exit scenario). The third scenario includes the departure of Spain in addition to Greece and Portugal (GPS-Exit scenario). And in the fourth scenario the quartet composed of Greece, Portugal, Spain and Italy exit the Eurozone.

While the initial Grexit impact on the world economy would be relatively minor, it could have long-term consequences, and even create a domino effect among Southern European states, destabilizing the Eurozone. A Grexit could undermine investor confidence in the Portuguese, Spanish, and Italian markets, creating not only a sovereign default in those states, but also serving a worldwide recession resulting in a global GDP decline amounting to roughly €17.2 trillion. This would severely affect the German, US and Chinese economies, as well as drive up unemployment in other European economies.

In addition to this, a Grexit would also impact economic policy, leading to political instability in the Eurozone and lowering the quality of lives for people everywhere. The Grexit would likely result in high write-downs for government budgets across the Eurozone. This would mean the budget deficits of the states to which Greece either directly or indirectly owes money would increase, driving up the sovereign debt of these states. This would, in turn, force these governments to consolidate by cutting expenditures or raising taxes. Such measures would reduce the demand for goods and services, causing the economy to contract and unemployment to increase.

Explore the Grexit and other Issues Further with the Global Economic Dynamics Project

As the Grexit shows, nearly all economic issues have global dynamics at their core. At GED, we focus on these relationships and interdependencies by assessing both the economic and social consequences. We then present these findings using various formats: GED Studies explore cutting-edge topics using sophisticated models; GED Shorts make this information easily accessible to anyone, anywhere; and beyond this our award-winning visualization tools make it possible to engage with the data like never before thanks to interactive filters and our intuitive platforms. GED: helping everyone to contribute to the conversation.

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