Margaret Scott

Greece’s Soft Budgets in Hard Times

Having gone through a de facto default on its foreign debt, real problem in Greece is no longer the fiscal deficit, but a combination of deposit flight and continuing excessive consumption in the private sector. As long as inflows of cheap ECB financing continues, the necessary adjustment in consumption will not take place.

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.

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