Greece and the Euro area.

Armstrong, Angus ; Carreras, Oriol ; Kirby, Simon 等

Introduction

Greece's second international bailout programme ended tumultuously with the Troika (EU Commission, ECB and IMF) refusing to disburse the bailout's final instalments, Greece delaying two payments to the IMF and Greece on the verge of an exit from European monetary union. The introduction of capital controls and apparent acceptance of bailout terms seemingly unacceptable to the Greek government earlier in the year appears to have stopped an exit, at least for now.

It is within this context that we present our modal forecast. Crucially we assume that agreement on a third bailout is reached and this ensures the Greek government is able to meet its obligations to creditors in the short term. In the absence of such a bailout, the government will almost certainly default on its mammoth debt stock, and with a banking system requiring recapitalisation, in all likelihood introduce a new currency.

Further bailouts in themselves do not mean Greece's public finances are sustainable. Transitioning to a sustainable debt position will require reductions in Greece's national debt. One would expect that Greece, a country which accounts for less than 2 per cent of Euro Area GDP, could be supported and restructured without extreme cost, however serious the initial over borrowing/lending. The IMF (2015) has suggested a reduction of at least 30 per cent of GDP. On the basis of our forecast, Greece needs a reduction of at least 55 per cent of GDP to lower the debt stock to around 130 per cent of GDP. From such levels a target of 120 per cent GDP for general government debt is at least possible. We have not factored in a haircut for Greek government debt, as the magnitude or timing of such an event is unclear. The majority of the European Financial Stability Fund's (EFSF) loans have had their interest payments deferred until after 2022. The EFSF will surely need to be involved in any meaningful restructuring of outstanding debt, and as such this has little bearing on the government's budgetary position in the short term. However, the continued insistence on inappropriately large primary surplus targets while the economy remains depressed will not allow meaningful growth to resume and undermine the overarching ambition of ensuring the irreversibility of the Euro project.

Greek banks: ongoing capital flight

Since November last year household and businesses deposits have flowed out of the banking system at an increasing rate. Figure 1 shows a 40bn [euro] decline in deposits in the first half of this year, equivalent to 23 per cent of GDP. Figure 1 also shows the decline in credit to the domestic private non-financial sector has accelerated. As an indication of the state of the banking system, they are unable to replace deposit finance with money or capital market finance. Banks have resorted to ELA by pledging collateral to the central bank at an appropriate discount which can then borrow from the Euro system. Bank of Greece liabilities through ELA have increased by 71 bn [euro] while a substantially greater share of banking system assets have become encumbered. ELA now accounts for approximately 33 per cent of the overall liabilities of the Greek banking system (see figure 2).

A critical question is how long this process can continue. Capital controls were introduced forbidding the outflow of capital without Ministry of Finance approval and limited deposit withdrawals. Assuming that the ECB continues to permit ELA (supposedly for solvent banks) then the key questions are the rate of deposit outflow, the value of unencumbered eligible collateral remaining, the amount of bank capital, which itself is eroded by rising provisions for non-performing loans and discounts (or 'haircuts') applied by the ECB. Non-performing loans have risen substantially (see figure 3). Market estimates of unpledged collateral are 25-3 Obn [euro], the average deposit outflow in the second quarter was 5.7bn [euro] and a non-performing loans rate of 35 per cent.

[FIGURE 1 OMITTED]

The Euro Summit of 12 July recognised the need to restore financial sector stability under the European Stability Mechanism (ESM). As we note below, one of the pre-conditions is for the Greek Parliament to transpose the Bank Resolution and Recovery Directive (BRRD) into law. This allows the ECB in its role as Euro Area bank regulator to resolve failing banks and implement bail-in procedures where unprotected creditors (unsecured creditors and large depositors) are converted into equity.

The outlook for the Greek economy

Our forecast for the Greek economy presented in table 1 is a more detailed version of that published in the World chapter of this Review. The outlook has deteriorated significantly since our last forecast. The evidence from recent indicators of economic conditions and sentiment suggest a significant contraction of output in both the second and third quarters of this year although we have assumed that the rate of contraction eases towards the end of the year. This implies a decline of 3 per cent of GDP in 2015. Given recent events, one could envisage a rather more substantial contraction in output. A significant offsetting factor is a rapid decline in import volumes related to capital controls. Uncertainty about the near-term path of the economy is large, even before we factor in the political uncertainty around Greece's continuation as a Euro Area member. It must be stressed that under our central forecast Greece does not withdraw from the monetary union, however the probability of such an outcome is significant and represents a substantial risk.

[FIGURE 2 OMITTED]

[FIGURE 3 OMITTED]

The recession is forecast to end in the second quarter of 2016. However, GDP then remains broadly flat through the rest of the year. This leaves the level of GDP in 2016 around 2 per cent lower than in 2015. All in all this would mean that the Greek economy would be over 30 per cent smaller than at its peak in 2007, and incredibly around 7 per cent smaller than when it first joined the Single Currency in 2001 (figure 4). Over our forecast period Greece is not expected to make up even this preEuro Area size, let alone the heights of 2007.

Unemployment rates have risen dramatically since 2009 and are currently around 25 per cent. The anticipated recession is likely to intensify this situation, with unemployment increasing in 2016. But more worrying perhaps is that with persistently weak output growth there is little chance of significant job creation over the medium term and unemployment is expected to remain extremely elevated for a prolonged period (figure 5). This has serious implications, especially for the young unemployed as they have so far been hit the hardest and are at risk of hysteresis which may leave a permanent scar on their employability and on Greece's productive capacity.

The fall in output is expected to be broadly based across expenditure components, with consumption and investment both contracting significantly. Households' ability to consume will have been constrained by the withdrawal limits imposed on bank accounts since early July. 60 [euro] a day or 420 [euro] a week is not far from the average income in Greece, which means a significant proportion of the population finds itself with a tighter budget constraint while the restrictions remain in place. What is more, the uncertainty around the ability to withdraw funds, and the time cost involved, will amplify this effect. As shown in Box A, consumption will also be adversely affected by the recent changes to VAT rates. The increase in VAT rates actually prolongs the period of recession in Greece.

[FIGURE 4 OMITTED]

Box A. Implications of recent changes in VAT

On 20 July 2015 legislation was passed which changed the rate of
VAT payable on a number of goods and services. Although Greece's
three tax bands remained--headline VAT at 23 per cent, a reduced
rate at 13 per cent and a super reduced rate of 6 per cent1- a
number of goods and services were moved from a reduced rate to the
headline, or from the super reduced to the reduced, with immediate
effect. The increased tax rates are payable on a number of
relatively essential items. These included an increase to the
headline rate for certain meats, clothing and even salt and to the
reduced rate for hotels and restaurants. All else equal, this will
lower consumers' disposable income available to spend on other,
non-essential items.

To analyse the impact of this change on the economy we must first
calculate the implied increase in the effective average VAT rate
paid on the consumption basket. To do this we weight the changes in
tax rates of specific goods and services by their weighting in the
Harmonised Consumer Basket. This implies that the average VAT rate
paid has increased by approximately 3.4 percentage points.

The second change to the VAT regime is the abolition of the 30 per
cent tax break for the Greek Islands. 2 Currently the Islands are
subject to the same three VAT bands as the rest of the country, but
each is reduced by just under a third compared to the rates paid on
the mainland, so 5, 9 and 16 per cent respectively. As of 1 October
this concession will be removed and Greek Islands will pay the same
rates as the rest of Greece.

To convert this into a shock to the economy we weighted the 30 per
cent increase in VAT by the contribution the Islands (excluding
Crete) make to total Greek GDP. Given that as of 2013 the Islands
represented around 8/2 per cent of Greece's output, then this
equates to an increase in the effective VAT rise of just over 2 1/2
percentage points on top of the general increase already
implemented.

Both shocks were then applied to the National Institute's Global
Econometric Model (NiGEM) with the first being introduced in the
third quarter of 2015 and the secondary increase implemented in the
fourth quarter. Both consumption and output are negatively
affected, with the VAT rise weighing down on output by 1/4 per cent
this year and almost 1 per cent next. Inflation is pushed up this
year by around 1 percentage point as the VAT increase is passed on
to consumers. This rises to 3 percentage points in 2016, before
price growth quickly falls back as the change in tax rate drops out
of the year- on-year comparisons. In the medium term, output and
consumption remain subdued as weak demand bears down on employment
and household incomes.

[FIGURE A1 OMITTED]

Notes

(1) This rate was actually lowered from 6 1/2 per cent under the new
legislation, though it only applies to a very limited number of
goods.

(2) Crete does not have a VAT tax break.

Private sector investment is expected to contract this year because of uncertainty on a number of fronts. This includes uncertainty around the banking system, the political environment, prospects for future demand and Greece's membership of the euro. While this will all dramatically curtail the demand for credit, supply has also been limited by an embattled banking sector increasingly reliant on liquidity support from the ELA. Given the low level of investment, currently half the fraction of GDP it was in 2009, one would expect investment opportunities to exist, simply to maintain the desired capital stock for the economy, and when uncertainties subside we expect a strong rebound in investment to be one of the first signs of returning growth. Private sector investment growth of close to 33 per cent in 2017 may look high, but in reality it is a modest 1 1/4 billion [euro] increase.

[FIGURE 5 OMITTED]

The outlook for inflation is complicated by the recent and impending VAT changes. Weak demand and high unemployment will weigh down on inflation over our forecast horizon, but the increase in the effective VAT rate paid on the consumption basket should act to elevate price growth in a mechanical sense, both this year and next, leading to a shallower deflation than we would otherwise expect this year, and inflation of over 2 per cent per annum for 2016. Our simulations suggest that without the VAT changes, prices in Greece would be forecast to fall by 2.5 and 0.6 per cent per annum in 2015 and 2016, respectively. Once the temporary upward effects of the VAT changes on the rate of inflation subside, deflation in a heavily depressed economy is expected to resume.

Public sector spending and investment will be weak this year and next as the government aims to achieve its primary surplus targets in the context of a contracting economy. The improved budget position recorded in the first quarter of 2015 was achieved largely through the delaying of government expenditures due and these will still need to be honoured. Given this, and the worsening economic outlook, we expect the budgetary position to deteriorate throughout 2015, averaging -2 per cent of GDP. Since the grace period for interest payments on government bonds held by large institutions is keeping Greece's government interest payments artificially low, the outlook for the primary balance is similar and we do not see much chance of Greece achieving the primary surplus targets set for it under current plans (see figure 6). In order to do so, they would have to remove a significant amount of further demand from the economy at a time when growth is weak. On our current forecast, this would amount to primary surplus increases of around 2-3 per cent of GDP each year from 2017 onwards. This is of particular importance as the fiscal multipliers in Greece at the moment are likely to be particularly large. As discussed in Bagaria et al. (2012), an economy which has experienced a prolonged period of depression will be particularly sensitive to fiscal contractions, as will an economy with central bank rates at the lower bound and unable to provide a monetary offset, both of which apply to Greece. Under these conditions, fiscal contractions which aim to lower the debt to GDP ratio can be self-defeating as they damage the denominator of the ratio by more than they alleviate the numerator.

[FIGURE 6 OMITTED]

[FIGURE 7 OMITTED]

Box B. The proposed third bailout

The government has requested a third bailout of around 86 billion
[euro] to cover 2-3 years. Initially it had been hoped that this
would be provided jointly by the European Stability Mechanism, the
IMF and proceeds from the sale of state assets. However, the
involvement of the IMF, which it had been hoped would supply around
20 billion [euro] of the total amount, has been called into
question after it announced on 30 July that it is unable to extend
a loan to Greece as things currently stand because it fails to meet
two of the Fund's qualifying criteria, namely that "there is a high
probability that the member's public debt is sustainable in the
medium term" and that "there is credible political will to
implement the required structural changes". In essence, this means
that to qualify for IMF assistance, Greece would require both a
substantial haircut on its debt stock and a show of commitment to
making the reforms asked of it.

Without IMF involvement, the remainder of the bailout funding would
appear to be in jeopardy as this was seen as a vital condition for
the German parliament to authorise further funds. However, at the
time of writing, negotiations continue between Greece and the
Eurogroup on the detail of the third bailout, and so it may be that
a revised plan emerges soon.

In order to ensure the Greek government can meet its obligations to
creditors, a 7.1 billion [euro] bridging loan was provided by the
European Commission. This ensured that the Greek government was
able to make immediate payment for the Greek bonds maturing on the
ECB's balance sheet (acquired through the Securities Market
Programme) and repay the accumulated arrears with the IMF. Unless a
bailout is agreed soon it is almost inevitable that a second
bridging loan of around 5 billion [euro] will be needed before 20
August.

The Eurogroup have imposed conditions on the Greek government in
exchange for the bailout, which has been agreed in principle. The
first half of this year saw the significant depletion of trust
between the two sides of the negotiating table. In order to garner
trust, the Greek government is undergoing the process of
introducing a series of measures before negotiations--measures, we
might add, that the Greek Prime Minister has publicly stated he
does not believe in. The headline elements of these measures are:

* An increase in the VAT paid on many "reduced rate" goods and
services from 6 per cent or 13 per cent to the main rate of 23 per
cent (already implemented).

* A removal of the 30 per cent reduction of tax rates paid by Greek
islands so they are in line with main land rates (planned for
October 2015).

* A range of pension measures including an increase to retirement
age to 67, nominal freeze in pension payouts until 2021 and an
increase in the health contribution for pensioners from 4 per cent
to 6 per cent.

* Legislation to ensure legal independence of national statistics
office, ELSTAT.

* Passing of legislation on the Bank Resolution and Recovery
Directive (BRRD).

The Greek Government must also create a fund which would monetise
(sell) Greek state assets and is expected to generate 50 billion
[euro]. Of this:

* 25 billion [euro] would be used to recapitalise banks.

* 12.5 billion [euro] would be used to make debt payments (part of
which contributes to the third bailout package).

* The remaining 12.5 billion [euro] would be used for investment.

Our modal forecast is for the government debt ratio to increase substantially this year, to 187 per cent of GDP, as both falling prices and contracting output lower the denominator which increases further through a combination of bridging loans and the disbursements from a third bailout programme. However, the increase in prices that results from the VAT changes acts to inflate away some of the debt burden and hold the debt to GDP ratio stable in 2016. What seems almost certain is that, on current projections, there is no chance that Greece will manage to reduce its debt stock to 120 per cent of GDP by 2020 (figure 7 and below).

Box C: Wider issues for the Euro Area

The primacy of political union

In a fixed exchange rate structure governments no longer have
direct control of monetary policy or an exchange rate which to
share the burden of adjustment. This leaves only fiscal policy.
However, if public debt is judged to be unsustainable, then fiscal
policy also cannot be used. The outcome is that the exchange rate
link is abandoned in anticipation that the national central bank
resorts to money creation. Members of a monetary union can mitigate
the risk of insolvency by creating a fiscal union. If one nation
faces a shock which threatens its solvency, a cross-border transfer
can ease this constraint. Indeed, all effective monetary unions
have some degree of fiscal union. The difficulty in establishing a
fiscal union is that it can only follow from political union; there
must be a governance structure for the pooling or transfer of tax
revenues from one sovereign state to another. Chancellor Kohl, one
of the architects of the Maastricht Treaty, was clear that "the
idea of sustaining an economic and monetary union over time without
political union is a fallacy". (1)

Since the gravity of the crisis in Europe emerged, the response of
the ECB has gradually become less, rather than more, consistent
with political union and therefore fiscal union. In 2010, the
Securities Market Programme was introduced to buy high grade
securities of member states. Most importantly, any profit or loss
made was to be 'shared' according the ECB's capital structure
(those countries with the largest economy and population take most
profit or loss). In June 2012 the EU announced its commitment to a
full European Banking Union. This is a very ambitious project.
While original plans for a common deposit insurance programme were
ditched, the creation of the European Stability Mechanism (ESM), a
single regulator (ECB) and single rulebook appeared to cross the
Rubicon of fiscal risk sharing. All steps in the right direction.

As the recovery failed to broaden out, and the risk of deflation
began to rise, the next major initiative was the Public Securities
Purchase Programme (the ECB's quantitative easing). Here policy
began to change. There is no doubt about the size and ambition of
the programme; over 1.1 trillion [euro] of assets to be bought by
September 2016. Within an expanded asset purchase programme, assets
available for purchase now include investment grade European
government, agency and EU institution bonds as well as covered
bonds and asset backed securities, (2) all in proportion to the ECB
capital share, subject to a constraint of the ECB holding less than
30 per cent of the eligible stock of a given member state. However,
the ECB itself will only hold 20 per cent of the assets, including
the virtually riskless EU institution bonds. The remaining assets
are to be held on the balance sheets of national central banks.
This is a limitation on risk sharing. Rather than share the risks
across members of the Euro Area, the design of the quantitative
easing programme concentrates risk in national central banks. This
merely re- introduces the solvency links between the financial and
government sectors in each member state.

This retrograde step is not isolated to quantitative easing.
Several Finance Ministers and even central bankers have warned
about the potential fiscal consequences of losses at the ECB.
Bundesbank President Weidmann has mentioned that losses from a
Greek exit from the Euro would pass to the Federal budget and be
more than the 14.4 billion [euro] discussed thus far. (3) Comments
by Dutch and Slovak central bankers raise similar concerns. An
important point is that the ECB could be recapitalised, if
necessary, by monetary financing as long as this does not violate
its price stability environment. There would be no cost to the
national governments. Given that the motivation for quantitative
easing is to negate the risk of deflation, the inflationary risks
are on the down rather than upside. Therefore, the movement away
from risk sharing does not appear to be driven by necessity but
rather by politics.

Eurozone: system of pegged exchange rates?

One of the most durable insights on currencies is Professor Mike
Dooley's observation that "international monetary regimes have been
born at a conference table and laid to rest in foreign exchange
markets." It seems that the Euro Area may become the latest
demonstration of the validity of this statement.

The European Monetary System is a highly impressive currency
arrangement. If all member states agree to share any losses and
re-capitalise the ECB if necessary, and as long as inflation
expectations remain stable, then the system cannot fail. It is
essentially the same as the Federal Reserve Board with Federal
Reserve District Banks or any other national central bank with its
own currency. It has one instrument (currently the central bank
balance sheet) to achieve its inflation target. Of course, policy
makers must take account of the effects of monetary policy on
financial stability through its impact on risk premia and there may
be a need for the temporary creation of reserves to support
financial stability. (4) But as long as this does not threaten the
inflation target, there is no inconsistency and the monetary
system.

Once member states seek to limit or constrain potential losses at
national central banks or the ECB, the Euro Area converts to a hard
pegged exchange rate system. There are now two targets: an
inflation target and an implicit central bank profitability target.
This creates the instabilities illustrated by the so-called 'second
generation speculative attack' (see Flood and Garber, 1984). For
example, when the UK's was forced out of the ERM it was revealed
that the government was implicitly targeting both the exchange rate
and domestic economic conditions with the interest rate. In this
case, central bank profits act in the same way as an exchange rate
target. It becomes a limit on the size of the central bank balance
sheet. The correspondence with domestic economic conditions is
inflation. The one instrument and two target regime will eventually
lead to inconsistent policy. Members of the Euro Area all use the
same currency. However, this is of little importance if market
participants perceive a different 'shadow price' of the currency
and a mechanism by which a country might be forced to leave the
monetary union. Once the twin objectives become clear, then funds
can be moved across borders to express any divergence between the
actual and shadow price of the currency. Dooley's foreign exchange
market is simply households and firms moving money outside the
national border to avoid being reduced in value by a write-down or
inflation. Unless the latest emphasis limiting risk sharing and
emphasising the importance of central bank profitability is
reversed, the nature of the monetary union has changed and is
vulnerable.

Notes

(1) Quoted By Otmar Issing, Financial Times, 29 June, 2012.

(2) The latter two categories of assets were already eligible for
purchase under the existing Third Covered Bonds Purchase Programme
(CPBPP3) and Asset-Backed Securities Purchase Programme (ABSPP),
both introduced in the fourth quarter of 2014.

(3) Reported in Handelsblatt, 5 July, 2015.

(4) The ability to provide liquidity in this way independently of
setting policy consistent with the monetary objective is discussed
in Goodfriend (2002) and Box C in the UK section of this Review.

References

Dooley, M. (1998), 'Speculative attacks on a monetary union',
International Journal of Finance and Economics, Vol., No. pp.

Flood, R.P. and Garber, P.M. (1984), 'Collapsing exchange rate
regimes: some linear examples'. Journal of International Economics,
78, pp. 200-24.

Goodfriend, M (2002), 'Interest on reserves and monetary policy',
Economic Policy Review, Federal Reserve Bank of New York, issue
May, pp. 77-84.

The situation in Greece raises some fundamental issues regarding the design and implementation of the European Monetary Union. Irrespective of whether Greece receives substantial debt relief and remains as a Euro Area member, these issues will need to be addressed if the Euro Area is to operate as a coherent monetary union (see Box C).

Debt restructuring

The current public debt stock of 320 billion [euro] (187 per cent of GDP) is unsustainable. A 55 per cent of GDP reduction would lower the current debt stock by around 95 billion [euro], reducing the debt to GDP ratio to around 131 per cent of GDP (returning the ratio to 2010 levels). From such levels, the target of a debt to GDP ratio of 120 per cent of GDP by 2020 may just be achievable.

An important question is which creditor would bear the cost of the debt restructuring. As table 2 shows, private holdings of Greek government debt, both foreign and domestic, account for 18 per cent of the outstanding stock, at most. If we assume that the loans provided by the IMF are not subjectr to a restriction and the authorities prefer to avoid imposing losses on the ECB and Bank of Greece, then the Euro agencies, and in particular the EFSF, must be involved. This seems to suggest that restructuring of EFSF loans consistent with a debt stock reduction of 38 billion [euro] would be needed. Since the Eurogroup have ruled out 'haircuts' this would seem to imply further maturity or reduction in interest rates that are already extremely low (EFSF lending rates to Greece are less than 2 per cent per annum). (1) If the EFSF member nations were to accept a reduction in the value of loans to Greek of 95 billion [euro], then this would amount to a permanent transfer of approximately 1 per cent of EFSF members' GDP. Given that the restructuring affects loans that mature over the period 2022 to 2054, the implied permanent fiscal transfer amounts to a relatively modest sum.

Even if haircuts were to be introduced on EFSF loans, the impact on the primary balance would be minimal. The EFSF has already deferred interest payments on the majority of its lending to Greece until 2022 (on 109 billion [euro] of the outstanding stock of loans). Estimates suggest this will lower Greek interest payments by a cumulative 12.9 billion [euro] between 2012 and 2022 (equivalent to 7.2 per cent of GDlP in 2014 terms). (2) However, from 2022 the Greek government is expected to start repaying these deferred payments as well as the 'normal' interest payments on EFSF loans.

The amount of debt relief extended to Greece is important. The critical issue is whether investors and citizens perceive the debt relief to be enough to put Greek finances on a sustainable footing. The public are often far more astute than regulators or politicians credit; nothing focuses the mind better than losing one's savings. This will depend on the trajectory of the economy and the outlook for non-performing loans. Based on a reasonable assumption of loan deterioration, a return to growth is essential for the stabilisation of the financial system. The sustainability of the sovereign debt position is also intertwined with the economy's growth. Given the uncertainties involved, the authorities do not appear to have heeded one of the the lessons of earlier financial crises: it can turn out to be a lot cheaper to buy too much insurance than too little.

This prompts the question of what happens if the third package is not enough to stabilise the banks. Once the eligible collateral is exhausted, the next line of defence is the recapitalisation fund from the ESM. If that too is exhausted then the financial asset holdings of the Greek government would seem the next likely candidate. Since deposits are needed for the normal course of governing, this would leave assets such as equity and investment fund shares. At the end of the first quarter of this year, estimates suggest the Greek government held approximately 36 billion [euro] of these. What proportion would be available depends on the amount that has been allocated to the privatisation fund as part of the third bailout. At the extreme, once all avenues have been exhausted, the final option would be to default. Without access to any new euros we would expect this to coincide broadly with the introduction of a new currency.

Our central forecast is predicated on substantial debt restructuring forthcoming and therefore Greece remaining in the Euro Area. However, if this restructuring does not occur by the amounts suggested in this note then Greece will default on its obligations and be required to introduce a new currency. While Greece would have the ignominy of being the first country to leave the Euro Area, the belief that the Euro Area is an irreversible monetary union would be lost forever. How a Greek exit might occur is extremely uncertain and, as discussed in Holland and Kirby (2011), this fundamentally determines the implications for the Greek economy.

As the prospects for Greece inside the Euro Area deteriorate, the government would be remiss if it did not consider what a future outside the Euro Area might entail. There are numerous examples of countries which have introduced a new currency. It is likely that the IMF and EU would seek to stabilise the economy as the geopolitical risks move against the EU. This outcome is clearly fraught with risks, but there may come a point where the calculus no longer favours remaining within the Euro Area. It may seem surprising that Germany, in particular, appears prepared to accept these risks. However, this is consistent with the behaviour of creditor nations in monetary unions in the past: creditor rather than debtor nations are always the ones to determine the final outcome of monetary unions. The irony is that if Greece is forced to leave the single currency, the losses which creditors would face are greater than the debt write-down required to stay in the Euro Area.

NOTES

(1) The domestic political and legal wrangling poses a significant hurdle to any haircuts on EFSF or other loans by European agencies.

(2) For details, see http://www.efsf.europa.eu/about/operations/ esm_efsf_and_greece.htm.

REFERENCES

Bagaria, N., Holland, D. and Van Reenen, J. (2012), 'Fiscal consolidation during a depression', National Institute Economic Review, 221, pp. F42-54.

Holland, D. and Kirby, S. (2011), 'Is there a resolution to the Euro Area debt crisis?', National Institute Economic Review, 218 pp. F45-F53.

IMF (2015), IMF Country Report No. 15/165: Greece: Preliminary Draft Debt Sustainability Analysis.

Angus Armstrong, * Oriol Carreras, ** Simon Kirby, * Jack Meaning ** and Rebecca Piggott **

* NIESR and Centre for Macroeconomics. E-mail: s.kirby@niesr.ac.uk; a.armstrong@niesr.ac.uk. ** NIESR. Thanks to Graham Hacche and James Warren for helpful comments and suggestions.

Table 1. Summary of the forecast

Percentage change

                              2011    2012    2013    2014

GDP                           -8.9    -6.6    -4.0     0.7
Consumption                   -10.7   -7.9    -2.2     1.4
Private Investment            -13.8   -30.4   -9.1     3.5
Government : consumption      -6.3    -6.6    -5.2    -0.8
           : investment       -29.9   -19.5   -11.6    0.2
Stockbuilding (a)              0.1     1.3    -1.0    -0.6
Total domestic demand         -10.8   -9.5    -4.7     0.5
Export volumes                 1.0     1.0     1.5     8.7
Import volumes                -7.8    -9.4    -2.9     7.4
Average earnings              -4.4    -3.5    -6.7    -5.3
Harmonised consumer prices     3.1     1.0    -0.9    -1.4
RPDI                          -10.0   -10.6   -12.8   -2.5
Unemployment, %               17.9    24.5    27.5    26.5
Govt, balance as % of GDP     -10.2   -8.7    -12.3   -3.6
Govt, debt as % of GDP (b)    171.2   156.8   175.1   177.4
Current account as % of GDP   -9.9    -2.3     0.6     0.8

                              2015    2016    2017

GDP                           -3.0    -2.3     0.8
Consumption                   -2.5    -5.1    -1.7
Private Investment            -6.5    -9.1    32.6
Government : consumption      -1.9    -4.9    -1.8
           : investment       -4.5    -0.3     11.9
Stockbuilding (a)              0.5     0.3     0.6
Total domestic demand         -2.3    -5.0     2.0
Export volumes                 0.2    11.8     2.7
Import volumes                -1.8     2.2     6.5
Average earnings              -4.9     0.4    -2.7
Harmonised consumer prices    -1.3     2.4    -0.7
RPDI                          -3.0    -4.0      1.1
Unemployment, %               26.4    27.3    24.8
Govt, balance as % of GDP     -1.9    -2.3    -1.9
Govt, debt as % of GDP (b)    186.9   186.9   184.3
Current account as % of GDP    0.2    -0.2     0.0

Note: (a) Change as a percentage of GDP. (b) End-of-year basis;
Maastricht definition.

Table 2. General government debt ([euro] billion)

General Government            2014Q4   Share (%)

Total financial liabilities    319       100.0
Bank of Greece (BoG)            13         4.1
Domestic excluding BoG          35        11.1
Rest of the world              271        84.8
    of which:
  ECB loans                     27         8.5
  EU loans                     197        61.8
  IMF loans                     24         7.5
  Other rest of the world       23         7.1

Source: Greek Finance Ministry.