Greece’s Soft Budgets in Hard Times

BRUSSELS – The first de facto default of a country classified as “developed” has now taken place, with private international creditors “voluntarily” accepting a “haircut” of more than 50% on their claims on the Greek government. As a result, Greece now owes very little to private foreign creditors.

Greece also agreed to even more stringent budget targets and, in return, received financial support of more than €100 billion ($134 billion). The purpose of the entire package is to avoid a full-scale default and allow the country to complete its financial adjustments without overly unsettling financial markets. But this approach (a haircut on private-sector debt plus fiscal adjustment) is unlikely to work on its own.

The real problem in Greece is no longer the fiscal deficit, but a combination of deposit flight and continuing excessive consumption in the private sector, which for more than a decade now has been accustomed to spending much more than it earns. This over-consumption had been financed (at least until now) by the government, and, as a consequence, most of the foreign debt comprised public-sector liabilities. The official line is that Greek over-consumption will cease once the government reins in expenditure and increases taxes.