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CRS: Greece's Debt Crisis: Overview, Policy Responses, and Implications

Authors: Rebecca M. Nelson, Paul Belkin, and Derek E. Mix
May 14, 2010


Over the past decade, Greece borrowed heavily in international capital markets to fund government budget and current account deficits. The profligacy of the government, weak revenue collection, and structural rigidities in Greece's economy are typically cited as major factors behind Greece's accumulation of debt.

Historically, financial crises have been followed by a wave of governments defaulting on their debt obligations. Financial crises tend to lead to, or exacerbate, sharp economic downturns, low government revenues, widening government deficits, and high levels of debt, pushing many governments into default. As recovery from the global financial crisis begins, but the global recession endures, some point to the threat of a second wave of the crisis: sovereign debt crises.

Greece is currently facing such a sovereign debt crisis. On May 2, 2010, the Eurozone members and International Monetary Fund (IMF) endorsed a historic €110 billion (about $145 billion) financial package for Greece in an effort to avoid a Greek default and to stem contagion of Greece's crisis to other European countries, particularly Portugal, Spain, Ireland, and Italy. On May 9, 2010, the European Union (EU) announced an additional €500 billion (about $636 billion) in financial assistance that could be made available to assist vulnerable European countries.

Greece's debt crisis has raised a host of questions about the merits of the euro and the prospects for future European monetary integration, with some calling for more integration and others less. Of heated debate, in particular, is the viability of an economic union that has a common monetary policy but diverse national fiscal policies. Some economists have suggested that Greece could benefit from abandoning the euro and issuing a new national currency, although doing so would raise the real value of Greece's external debt and possibly trigger runs on Greek banks and contagion of the crisis more broadly within the Eurozone.

The United States and the EU have strong economic ties, and a crisis in Greece that threatens to spill over to other Southern European countries could impact U.S. economic relations with the EU and the general economic recovery from the financial crisis. Additionally, the exposure of U.S. banks is estimated at $16.6 billion. The Obama Administration was reportedly supportive of the EU and IMF's decision to offer financial support to Greece and other vulnerable Eurozone economies. Indeed, at least one press report indicates that Administration officials began urging their European counterparts to take decisive action to prevent the possibility of Greek default as early as February. President Obama is reported to have called German Chancellor Angela Merkel and French President Nicolas Sarkozy on May 9, 2010, to encourage them to structure a broader package of financial assistance in an effort to stem possible contagion of the Greek crisis to other Eurozone Members. On May 10, 2010, the U.S. Federal Reserved reopened credit swap lines with the European Central Bank (ECB), among other major central banks, to help ease economic pressures resulting from the crisis in Europe.

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