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Economic Research

Demystifying Sovereign Debt in Greece: Why It Matters to Us

Greece's fiscal crisis has caused political and civil unrest within the small European country and prompted concerns about the stability of the euro and possible repercussions for the global economy.

In "Demystifying Sovereign Debt in Greece: Why It Matters to Us," featured in the second-quarter issue of EconSouth, economic analyst Andrew Flowers explains the Greek crisis, the potential spillover effects of the crisis on the euro area and world economy, and what it could mean for other countries grappling with large budget deficits.

While Greece has led the pack among euro countries in terms of running large budget deficits and carrying a high debt-to-GDP ratio, it is not alone in its fiscal problems, notes Flowers. Several other countries, including Italy, Ireland, Spain, and Portugal, are also dealing with large deficits.

When the newly appointed Greek finance minister revealed the severity of Greece's fiscal crisis in October 2009, investors began to lose confidence in the country's sovereign debt, resulting in widening bond and credit default swap spreads. The government almost immediately proposed the first of several austerity measures to help lower the budget deficit, which was met with investor skepticism and objections from protestors. "The political and financial drama in Greece has since oscillated between greater protests and renewed, bolder austerity plans," explains Flowers.

The Greek crisis could also affect other European countries, he writes, especially if a large European financial institution were to fail. Further, this contagion could spread outside of Europe. Flowers points to worrisome signs of strain in the interbank lending market, which could feed through to businesses and consumers around the globe.

Concerns over contagion to other fiscally troubled countries in the euro area prompted a pan-European response to the crisis. In early May, the European Commission unveiled a rescue package to the tune of $957 billion for distressed European governments. But euro-area countries must still enact tough budget and labor reforms to successfully stabilize their economies, says Flowers.

The Greek crisis holds several lessons for the European Union, as well as countries around the world battling large deficits. But, as Flowers concludes, "time will tell how Greece and its European partners will regain stability and the confidence of investors. For other countries, the Greek fiscal crisis has been a sobering reminder of how precarious government finances are in this postrecession world."