What is the role of the EU in matters of fiscal and monetary policy of its member states?
The European Central Bank sets interest rates for the members of the euro, but has no role in the monetary policy of other EU members. Fiscal policy is controlled by the individual Member States, but ostensibly regulated by rules limiting borrowing. Theoretically, Member States can be fined for borrowing too much (the money goes to EU central coffers), but that has never happened and the rules have been broken so many times, and by such wide margins, it is difficult to see that it could now. The normal limit for annual borrowing is 3% of national income, but the euro area as a whole is currently at about 6%, and Greece at about 12%.
Why is Greece currently suffering a severe debt crisis?
They have borrowed a very large amount over quite a long period. Recently, the lenders have been waking up to the fact that it is going to be very difficult for the Greeks to pay them back. One result of that is that when the Greek government seeks to borrow new funds – that 12% of national income that it needs – or to borrow to ‘roll over’ existing debt (ie pay it back with new borrowing), it finds that the interest rate it has to offer is higher than before. From the lenders’ point of view that is their compensation for making a ‘risky’ loan. From the Greek point of view it makes their position even more difficult since they are already faced with a large borrowing requirement, and are now having to do it at higher interest rates. Why have they borrowed so much in the first place? Some of that is bad management, some of it is domestic politics. Some of it is in a way traceable to the inefficiency of the Greek tax system – vast quantities of tax which should be paid, isn’t.
In what way can EU nations provide aid or support?
First, if it comes to it, by being ready to organize the bailout. It would be more sensible to ask the International Monetary Fund (IMF) to help, but for the time being, europride seems to be in the way of that. Fortunately, Greece is a small state. So even though its debt is huge relative to the size of the economy, it is relatively small by international standards. Nevertheless, other countries – their taxpayers – had better be ready for the bill.
The second thing to consider is the effect of announcements by other EU member states and EU institutions on investor confidence. If Greece is going to be able to escape from this position without a bailout – some people think that is possible – then it is certainly going to need the interest rates it pays to stay low. If that is going to happen, it will be because the lenders are not afraid of losing their money, and in practical terms that means they have to be confident there will be a bailout if one is needed. The difficulty with that is that some people think that if they promise a bailout, that takes the pressure off the Greek government to deal with the problem with tax increases and expenditure cuts.
And the third thing is that it might well be better to move sooner rather than later. If a crisis goes on and on, the danger grows that lenders will start to worry about other countries too – and if the interest rates they pay start rising, more countries could quickly be in the same sort of position as Greece.
Were the situation not to be remedied, what would the effects be on the European economy?
If there were a outright default by Greece it would start another round of financial crisis. Much of the Greek debt is owed to banks – both in Greece and in other countries. If it is not going to be paid back those banks take a capital loss, so their solvency would come into question. Even if that was not enough to cause bank failures, the panic that would go with it surely would. Some debt is held by insurance companies and pension funds and they would be in much the same position as the banks. Some of it is no doubt held directly by households, so for them a default would mean a loss of savings. Quite apart from the immediate loss to those households, the resultant fall in their spending would further damage economic prospects.
Not all defaults are ‘outright’. A more likely outcome is that the Greek government would fail to make interest payments; or fail to repay some of its debt; or an international rescue will partially compensate the lenders; or compensate them after a delay. Any of those sorts of things have the same kind of effects as an outright default, but muted.
There is a further ramification because other countries are in only a slightly better position than the Greek one. It is probably fair to say that Spain and Ireland are doing much better than Greece. But on the other hand, Italy and Belgium are not all that much better off. If Greece were allowed to default outright, some or all of these, and possibly others, would surely find a collapse in confidence would make their positions impossible too.
James Forder is economics tutor at Balliol College
