Two lessons from the Greek crisis

Paolo Manasse 10 March 2012



The new rescue plan for Greece, signed in Brussels last week and accepted yesterday by private investors, combines "new money" (around €130 billion from the EU and the IMF) with a "debt forgiveness”. Private holders of the €177 billion Greek debt issued under Greek law (out of €206 billion of private debt) will take a 53.5% haircut on the debt’s nominal value, with the remaining 46.5% will be swapped for cash (15%) and for new, longer-term Greek debt (31.5%), with an estimated present value cut of 75%. This is good news, in the sense that a messy default will be avoided and that European taxpayers will not be the only ones to carry the burden of banks’ bad loans. Yet, as pointed out by a few observers (Roubini 2012), the direct Official Sector Involvement is also going to be considerable – the estimated €100 billion of total debt relief imposed on private creditors will be partly offset by the new €130 billion of official money, which will go largely to private investors (€15 billion in EFSF guarantees and about €30 billion for banks’ recapitalisation). And this comes after a considerable “restructuring” of official debt (maturity extension and interest reduction) has already happened.

The new package, despite its emphasis on stronger enforcement (the permanent monitoring of the EU-IMF-ECB “troika”, the escrow account), will not put an end to the Greek saga. Even in the favourable scenario where the plan would achieve its objective of reducing the Greek debt-GDP ratio to 120% by 2020, it would leave about three quarters of the remaining Greek debts in public hands, so that new issues would become effectively junior debt. Moreover, in the unlikely case that it were successful in restoring the country’s market access, such a level of indebtedness would leave Greece extremely vulnerable to changes in risk attitudes. The “grey” (virtual) market prices of the new swapped bonds put them in the range of 22-17 cents to the euro, implying a similar default risk to the asset they replace. Compared to their book values, therefore, private investors have struck quite a good bargain.

More generally, though, there are two lessons we can learn from the way the EU has dealt with Greece.

  • Delay is costly.

The logic behind “debt forgiveness” is that investors may realise that the debtor country will not be able and/or willing to repay, because at such a level of indebtedness, the benefits from the debtor’s painful adjustment will only marginally accrue to him. Thus, by forgiving part of the debt, creditors may actually enhance repayments by providing the right incentives to debtors. Clearly, a restructuring agreement should be reached as soon as possible, not after the debtor’s economy has been shattered by the measures imposed by creditors. With Greece, it took about four years to reach the agreement: the sluggish adjustment led to a sharp contraction in the economy’s growth (red line, left scale in Figure 1 below) and to the explosion of the debt burden (blue line, right scale), while the ambitious targets were never fully met. So why wasn’t an agreement reached at the outset? In short, it was Europe’s fault.

Figure 1. Greece: GDP growth and the debt-GDP ratio

  • “More Europe” is (not) the solution.

We have heard the story over and over - “since the crisis is European, the solution must be ‘more Europe’”. The consequences of this ill-conceived idea are for everyone to see. Instead of choosing a realistic option of increasing the IMF’s endowment and letting it deal with troubled EU countries, Europeans decided to create new ad hoc institutions (EFSF, the ESM). With insufficient funding, clumsy voting rules (requiring, in some cases, unanimity), and a payment system “by instalments” possibly propagating contagion (see my article on this site, Manasse 2011), the new institutions achieved the following unenviable results.

  • They made technical decisions the hostage of national politics (German state and French general elections, German Constitutional Court pronouncements, Finnish government coalitions, approvals of national parliaments, a referendum in Ireland);
  • They introduced dangerous conflicts of interest within countries, between European taxpayers and European banks on the one hand, and between European countries, the creditors and debtors, on the other. This made national governments’ positions erratic and uncertain (see Germany). The result was a much-delayed restructuring and heightened contagion risk.

Economists know all too well that if an institutional setting A (say a unified EU-wide budget) is preferable to a another, B (say the current system of national budgets), a marginal reform of B towards A (such as the EFSF, the “fiscal compact”, or “Eurobonds”) may actually reduce welfare. The typical example is labour market institutions (Calmfors and Driffill 1988). Both a decentralised and a fully-centralised system of wage bargaining may outperform an intermediate system in achieving wage moderation and low unemployment – the first by making the country-wide union internalise the macro implication of wage setting, the second by generating competition between local unions. Very often the worst lies in the middle. The newly created EU institutions fit the picture. Germany does not internalise the positive EU-wide externalities of its choices, so that institutions’ funding is sub-optimal and markets are not re-assured; Greece does not bear the full responsibility of its actions, so that the adjustment is delayed. Unrolling and dismantling or fixing the new institutions is not going to be any easier politically than jumping to a fully-fledged political union. Thus the Eurozone will linger on, despite the debt restructuring, keeping its fingers crossed that larger countries such as Italy and Spain will somehow get themselves out of the debt crisis.


Calmfors and Driffill (1988), “Centralizazion of Wage Bargaining”, Economic Policy, April.
Manasse, Paolo (2011), “The trouble with the European Stability Mechanism”,, 5 April.
Roubini, Nouriel (2012), “A Sweet Greek PSI Deal Transfers the Bulk of Future Losses to the Official Sector”,



Topics:  Europe's nations and regions

Tags:  Greece, Eurozone crisis

Professor of Macroeconomics and International Economic Policy, University of Bologna


CEPR Policy Research