In the post of the 17th November, Greece 2: This time it’s Ireland, we looked at the problems of the Irish economy in servicing its debts and whether it would need a bailout. Well, despite protesting that such a bailout would not be necessary, in the end events overtook the Irish government. International loss of confidence forced the government to accept a bailout package. After a weekend of talks, a deal was reached on 28 November between the Irish government, the ECB, the IMF, the European Commission and individual governments.
The deal involves loans totalling €85 billion. Of this, €35 billion will go towards supporting the Irish banking system. The remaining €50 billion will go to supporting government spending. The loans will carry an average interest rate of 5.8%, which is more than the 5.2% on the bailout loans to Greece, but considerably below the rates that Ireland would have to pay on the open market. Being loans, rather than grants, they only delay the problems of dealing with Ireland’s large debt, which has been rising rapidly and is predicted to be around 80% of GDP for 2010 (see Annex Table 62 in OECD Economic Outlook Statistical Annex). They thus provide Ireland with liquidity while it implements policies to reduce its debt.
Ireland itself has contributed €17.5 billion to the loan fund; of the rest, €22.5 billion will come from the IMF, while the European Union and bilateral European lenders, including the UK, Sweden and Denmark, have pledged a total of €45.0 billion, including £3.25 billion from the UK.
One of the main purposes of the loans is to reduce the likelihood of speculation against other relatively highly indebted countries in the EU, such as Portugal, Spain and Italy. The hope is that, by granting Ireland loans, the message would be that similar support would be made available to other countries as necessary. ‘Contagion’ would thereby be halted.
Podcasts and webcasts
Ireland’s €85bn bailout is best deal available, says PM Guardian webcast (29/11/10)
Interview with Jim O’Neill BBC News (29/11/10)
Irish deal ‘better than market rate’BBC Today Programme, Ajai Chopra (29/11/10)
Ireland bailout ‘doesn’t stop pressure building’ BBC Today Programme, Tony Creszenzi and Brian Hayes (29/11/10)
Articles
EU/IMF Irish bailout – the details FT Alphaville, Neil Hume (28/11/10)
Ireland rescue is not a game changer Financial Times, Mohamed El-Erian (29/11/10)
IMF insists Ireland got a ‘good deal’ Irish Times (29/11/10)
Can the eurozone afford its banks? BBC News blogs: Peston’s Picks, Robert Peston (29/11/10)
Irish bailout leaves markets nervous for good reason CNN Business 360, Peter Morici (30/11/10)
Eurozone debt crisis deepens Times of Malta (30/11/10)
Will the Irish crisis spread to Italy? Vox, Paolo Manasse and Giulio Trigilia (29/11/10)
Questions
- Distinguish between liquidity and solvency solutions to sovereign debt problems.
- Is Ireland’s debt problem purely a sovereign one? Explain.
- What will determine whether the bailout for Ireland will halt contagion to other countries?
- Why might the implementation of an austerity package make the sovereign debt problem worse in the short to medium run?
- Will the Irish crisis spread to Italy?
It doesn’t seem that long ago when Greece was in the news regarding its deficit and need for bailing out. Back then, countries such as Spain, Portugal and Ireland were being mentioned as the next countries which might require financial assistance from the EU. It is now the Irish economy that is in trouble, even though the Irish government has not yet requested any financial help. The EU, however, is ‘ready to act’.
The Irish economy experienced an extremely strong boom, but they also suffered from the biggest recession in the developed world, with national income falling by over 20% since 2007. Savers are withdrawing their money; property prices continue to collapse; and banks needed bailing out. Austerity measures have already been implemented – tax rises and spending cuts equal to 5% of GDP took place, but it has still not been enough to stabilise the economy’s finances. All of these problems have contributed to a large and unsustainable budget deficit and a significant lack of funding and that’s where the EU and possibly the IMF come in.
If the Irish economy continues to decline and experiences a financial crisis, the UK would probably be one of the first to step in and offer finance. As our closest neighbour and an important trading partner, the collapse of the Irish economy would adversely affect the UK. A significant proportion of our exports go to the Irish economy and, with Irish taxpayers facing troubled times, UK exporting companies may be the ones to suffer.
One thing that this crisis has done is to provide eurosceptics with an opportunity to argue their case and blame the euro for the collapse of Ireland. With one monetary policy, the Irish economy is tied in to the interest rates set by the ECB and low interest rates fuelled the then booming economy. The common currency also increased capital flows from central European countries, such as Germany, to peripheral countries, such as Ireland, Spain and Portugal. In themselves, capital flows aren’t a problem, but when they are used to fund property bubbles and not productive investments, adverse effects are inevitable, as Ireland found to its detriment.
As prices collapsed and banks simply ran out of money, the government stepped in and rescued not only the depositors of Irish banks, but also their bondholders. Unable to devalue their currency, as it’s the euro, the Irish economy was unable to boost exports and hence aggregate demand and in turn economic growth. Although, the Irish government has not requested any financial help, as the French Finance Minister commented about a potential bailout: “Is it six months or a few days away? I’d say it’s closer to days.” The following articles look at this developing situation in Europe.
EU plays down Irish republic bail-out talks BBC News (17/11/10)
Ireland bailout: the European politicians who will decide Telegraph, Phillip Aldrick (17/11/10)
Don’t blame the Euro for Ireland’s mess Financial Times, Phillipe Legrain (17/11/10)
Britain signals intention to help Ireland in debt crisis New York Times, James Kanter and Steven Erlanger (17/11/10)
Ireland will take aid if ‘bank issue is too big’ Irish Times, Jason Michael (17/11/10)
Irish junior party says partnership strained Reuters (17/11/10)
Ireland resists humiliating bail-out as UK pledges £7 billion Telegraph, Bruno Waterfield (17/11/10)
Markets stable as Ireland bailout looms Associated Press (17/11/10)
The implausible in pursuit of the indefensible? BBC News blogs, Stephanomics, Stephanie Flanders (16/11/10)
Ireland bailout worth ‘tens of billions’ of euros, says central bank governor Guardian, Julia Kollewe and Lisa O’Carroll (18/11/10)
The stages of Ireland’s grief BBC News blogs, Stephanomics, Stephanie Flanders (18/11/10)
Q&A: Irish Republic finances BBC News (19/11/10)
Could Spain and Portugal be next to accept bail-outs? BBC News, Gavin Hewitt (19/11/10)
Questions
- Why will the UK be affected by the collapse of the Irish economy?
- If Ireland were not a member of the eurozone, would the country be any better off? How might a floating exchange rate boost growth?
- The Financial Times article talks about the euro not being to blame for the Irish problems, saying that ‘tight fiscal policy’ should have been used. What does this mean?
- Why is the housing market so important to any nation?
- What are the arguments (a) for and (b) against the euro? Would Ireland benefit from leaving the euro?
- Should the UK government intervene to help Ireland? What are the key factors that will influence this decision? What about the EU – should Ireland ask for help? Should the EU give help?
- Austerity measures have already been implemented, but what other actions could the Irish economy take to increase competitiveness?
Today (16/6/11) in Greece, the Prime Minister is trying to form a new government that will help the country tackle its large and growing debts. Austerity measures have been put in place by the Greek government and these cuts and subsequent job losses (unemployment now stands at 15.9%) have resulted in massive riots.
Critics of the eurozone and Greek membership are suggesting that the price Greece has to pay to remain a member might be too high. Billions of euros have already been given to the bankrupt country and yet it seems to have made little difference – more money is now needed, but Finance Ministers have so far been unable to agree on how best to finance another bailout. These concerns have adversely affected financial markets, as investors sell their shares in light of the economic concerns surrounding Greece. The trends in financial markets over recent weeks suggest a growing feeling that Greece may default on its debt.
If an agreement isn’t reached between European leaders and/or Greece doesn’t accept the terms, then it could spell even more trouble and not just for the Greek economy and the eurozone. Banks across Europe have lent money to Greece and if an agreement isn’t reached, then this will mean losses for the private sector. Whilst these losses may be manageable, further trouble may arise due to contagion. Other countries with substantial debts, including Spain, Ireland and Portugal could mean a significant increase in these potential losses.
As the crisis in Greece continues, doubts remain over whether the European leaders even know how to deal with the crisis and this creates a lack of confidence in the markets. Activities over the coming weeks will play a large part in the future of Greece’s eurozone membership, trends in financial markets and the direction of the UK economy. The following articles consider Greece’s debt crisis.
Greece debt crisis sends financial markets reeling BBC News (16/6/11)
Euro slumps vs Swissie, Greece intensifies concern Reuters (16/6/11)
EU and IMF agree Greek debt deal Financial Times, Peter Spiegel (16/6/11)
Greece crisis: Commissioners fear ‘future of Eurozone’ BBC News, Joe Lynam (15/6/11)
Stocks slump as Greece crisis turns violent Bloomberg Business Week, Pan Pylas (15/6/11)
Euro slides as Greek default fears deepen Financial Times, Peter Garnham (16/6/11)
Germany insists all of EU must pay for Greece bailout Guardian, Ian Traynor (15/6/11)
US stocks slump on US, Greek woes Associated Press (16/6/11)
More time to argue about Greece BBC News, Stephanie Flanders (16/6/11)
Greece: Eurozone ministers delay decision on vital loan BBC News (20/6/11)
Greece crisis: Revolution in the offing? BBC News, Gavin Hewitt (19/6/11)
Greece crisis: Not Europe’s Lehman (it could be worse) BBC News, Robert Peston (20/6/11)
Greek debt crisis: eurozone ministers delay decision on €12bn lifeline Guardian, Ian Traynor (20/6/11)
Eurozone must act before Greek crisis leads to global meltdown, IMF warns Guardian, Larry Elliott (20/6/11)
Greece: Private-sector voluntary aid may be impossible BBC News, Robert Peston (21/6/11)
Greece crisis and the best way to cook a lobster BBC News, Stephanie Flanders (22/6/11)
Questions
- What is meant by contagion and why is this a potential problem?
- What are the options open to European leaders to finance the bail out?
- If an agreement is not reached or Greece do no accept the terms, how might the UK economy be affected?
- What has been the impact of recent events in Greece and Europe on financial markets and currencies across the world? Explain your answer.
- Why are critics suggesting that the price of Greece remaining in the Eurozone might be too high? If Greece was not a member state what would it mean it could do differently to help it deal with its mounting debts?
It was argued in an earlier blog on the Greek debt crisis that a deus ex machina was needed to find a resolution to the impasse between Greece and its creditors. The most likely candidate for such as role was the IMF.
Three days before the Greek referendum on whether or not to accept the Troika’s proposals, the IMF has stepped onto the stage. To the undoubted surprise of the other two partners in the Troika (the European Commission and the ECB), the IMF argues that Greece’s debts are unsustainable and that much more is needed than a mere bailout (which simply rolls over the debt).
According to the IMF, Greece needs €52bn of extra funds between October 2015 and December 2018, large-scale debt relief, a 20-year grace period before making any debt repayments and then 
debt repayments spread over the following 20 years. In return, Greece should commit to supply-side reforms to cut out waste, reduce bureaucracy, improve tax collection methods and generally improve the efficiency of the economic system.
It would also have to agree to the previously proposed primary budget surplus (i.e. the budget surplus excluding debt repayments) of 1 per cent of GDP this year, rising to 3.5 per cent in 2018.
So it this what commentators have been waiting for? What will be the reaction of the Greeks and the other two partners in the Troika? We shall see.
Articles
IMF says Greece needs extra €50bn in funds and debt relief The Guardian. Phillip Inman, Larry Elliott and Alberto Nardelli (2/7/15)
IMF: 3rd Greek bailout would cost €52bn. Or more? Financial Times, Peter Spiegel (2/7/15)
IMF: Greece needs to reform for sustainable debt, financing needs rising CNBC, Everett Rosenfeld (2/7/15)
The IMF has made an obvious point about Greece’s huge debt. Here’s why it still matters Quartz, Jason Karaian (3/7/15)
Greece: when is it time to forgive debt? The Conversation, Jagjit Chadha (2/7/15)
IMF Analysis
Greece: Preliminary Draft Debt Sustainability Analysis IMF (2/7/15)
Preliminary Debt Sustainability Analysis for Greece IMF (25/6/15)
Questions
- To which organisations is Greece indebted? What form to the debts take?
- To what extent is Greece’s current debt burden the result of design faults of the euro?
- What are the proposals of the IMF? What effect will they have on the Greek economy if accepted?
- How would the IMF proposals affect aggregate demand (a) directly; (b) compared with the proposals previously on the table that Greece rejected on 26 June?
- What would be the effects of Greek exit from the euro (a) for Greece; (b) for other eurozone countries?
- What bargaining chips can Greece deploy in the negotiations?
- Explain what is meant by ‘moral hazard’. Where in possible outcomes to the negotiations may there be moral hazard?
- What has been the impact of Greek austerity measures on the distribution of income and wealth in Greece?
- What are the practicalities of pursuing supply-side policies in Greece without further dampening aggregate demand?
The negotiations between Greece and the ‘troika’ of creditors (the IMF, the European Commission and the ECB) have seen many twists and turns before breaking down on 26 June. Throughout, both sides have sought to give as little as possible while seeking a compromise. Both sides have claimed that their position is reasonable, even though a gulf has remained between them.
What has been playing out is a high-stakes game, where the optimum outcome for each side is quite different.
Greece seeks bailout terms that would allow it to achieve a smaller primary budget surplus (but still a surplus in the midst of a deep recession). The surplus would be achieved largely through tax rises on the wealthy rather than further cuts that would hit the poor hard. It is also seeking a substantial amount of debt forgiveness to make servicing the remaining debt possible.
The troika is seeking a larger budget surplus than the Greeks are willing to contemplate. This, it maintains, should be achieved largely through additional cuts in government expenditure, including further reductions in pensions and in public-sector wages.
Both sides used threats and promises as the negotiations became more and more acrimonious.
The troika threatened to withhold the final €7.2bn of the bailout necessary to pay the €1.6bn due to the IMF on 30 June, unless the Greeks accepted the terms of the austerity package put to them. The Greek Prime Minister, Alexis Tsipras, in rejecting the proposals, called a referendum on the package. This threatens the stability of the eurozone as a No vote, if it led to a Greek exit from the eurozone, could undermine confidence in monetary union. After all, if Greece could be forced out, other countries facing severe difficulties might also be forced out at some point in the future. Once a country leaves the eurozone, the monetary union becomes more like a system of pegged exchange rates. And pegged exchange rates are open to destabilising speculation at times of economic divergence.
A Greek exit from the euro (dubbed ‘Grexit’) is seen as undesirable by most Greeks and by most politicians in the rest of Europe. The optimum for both sides collectively would be a compromise, which saw more modest cuts by Greece and the eurozone remaining intact. By both sides seeking to maximise their own position, the Nash equilibrium is certainly not the best outcome.
But as long as the troika believes that the Greeks are likely to vote Yes to the proposed bailout terms, it still hopes to get the outcome that is best from its point of view – an outcome that would probably involve regime change. And as long as the Greek government hopes that a No vote will force the troika to think again and come back with less austere proposals, it still hopes to get the outcome that is best from its point of view. But the outcome of this game of ‘chicken’ could well be Grexit and a Nash equilibrium that neither side wants.
But while the endgame is being played out by politicians, people in Greece are suffering. Policies of severely depressing aggregate demand to turn a large budget deficit into a primary budget surplus have led to the economy shrinking by 26%, overall unemployment of 27% and youth unemployment of over 60%. The Greeks truly believe themselves to be stuck between a rock and a hard place.
The following articles look at the nature of the ‘game’ being played and at the effects on the Greek economy, both of the proposed austerity package proposed by the troika and Grexit. They also look at the knock-on effects for the eurozone, the EU and the global economy.
Can game theory explain the Greek debt crisis? BBC News Magazine, Marcus Miller (26/6/15)
Against the Grain: What Yanis Varoufakis can learn from a real game theory master – Nicola Sturgeon City A.M., Paul Ormerod (24/6/15)
John Nash’s Game Theory and Greece Bloomberg, Mohamed A. El-Erian (29/5/15)
The Greek crisis: that 1931 moment The Economist, Buttonwood column (23/6/15)
How game theory explains Grexit and may also predict Greek poll outcome The Conversation, Partha Gangopadhyay (1/7/15)
Greece debt crisis: Tsipras may resign if Greeks vote yes BBC News (30/6/15)
Greek debt crisis: Is Grexit inevitable? BBC News. Paul Kirby (29/6/15)
Existential threat to euro from Greek exit BBC News, Robert Peston (29/6/15)
How I would vote in the Greek referendum The Guardian, Joseph Stiglitz (29/6/15)
Greece in chaos: will Syriza’s last desperate gamble pay off? The Guardian, Paul Mason (29/6/15)
What happens if Greece defaults on its International Monetary Fund loans? The Telegraph, Mehreen Khan (30/6/15)
For Greece’s international creditors, regime change is the ultimate goal The Telegraph, Jeremy Warner (29/6/15)
Europe has suffered a reputational catastrophe in Greece The Telegraph, Ambrose Evans-Pritchard (2/7/15)
Questions
- What is meant by a primary budget surplus?
- What was the troika’s proposal on the table on the 26 June that was rejected by the Greek government?
- What was the Greek government’s proposal that was rejected by the troika?
- Explain the decision trees outlined in the first BBC article below.
- In terms of game theory, what form of game is being played?
- Are the negotiations between the Greek government and the troika a prisoners’ dilemma game? Explain why or why not.
- Does the game being played between the SNP and the Conservative government in the UK offer any useful lessons to both sides in the negotiations over Greece’s possible bailout and its terms?
- Does a No vote in the referendum on 5 July imply that Greece must leave the euro? Explain.
- What would be the effects of further austerity measures on aggregate demand? What benefits to the Greek economy could be achieved from such measures?
- Why may pegged exchange rates be regarded as the worst of both worlds – a single currency in a monetary union and floating exchange rates?
