A few weeks ago, a third bailout package was approved for Greece, with this package totaling up to 86 billion euros over three years. But what happens if Greece needs another bailout? A recent Economic Synopses essay explored possible consequences.
Economist Ana Maria Santacreu noted two possible scenarios that could play out for Greece in the next several months:
Santacreu examined several aspects of the second scenario in her essay.
Santacreu noted that there is some concern about the effect of Greece leaving the eurozone on the remaining members. Specifically, the concern centers on:
Santacreu noted that the first two bailouts shifted exposure from private creditors to official creditors. Now, the European Central Bank, the International Monetary Fund and the European Commission hold around 75 percent of Greek debt.
When the euro was established in 1999, periphery members of the eurozone (such as Greece, Ireland and Spain) were able to borrow at the same low rates as Germany. Many did and began building imbalances. When the fiscal crisis hit Europe a decade later, interest rates went up, making it difficult for these countries to repay their debts. Because these countries are part of the eurozone, they wouldn’t be able to devalue their currency to increase competitiveness and generate growth.
Santacreu noted that, if Greece left the eurozone, another shock to this area could increase the risk premium for other periphery countries. Such a shock could put these countries in a similar situation to Greece, even if their debt currently looks sustainable. Santacreu wrote: “Ireland and Spain, for example, could be in the same position Greece is in now, creating an even worse problem for the EU.”
One argument being made in favor of a “Grexit” is that the ability to devalue currency could lead to an increase in Greek exports and economic growth. However, Santacreu noted that the empirical evidence on the real effect of devaluations is mixed. For example, a devaluation:
She also said that the strength of a country’s financial development can affect the benefits of a devaluation. Exporters tend to depend more on external financing than nonexporters. Thus, a devaluation in a country with poor financial development could end up depressing the economy.
Santacreu concluded: “Therefore, whether a devaluation could drive Greece out of the current crisis remains unclear.”