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How to End the Greek Tragedy

Greece’s debt-service burden is too large, and it must be reduced in one of two ways: sharply cutting the interest rate paid by Greece, or reducing the face value of the debt. European policymakers are leaning towards the second option, but they evidently have not yet fully considered the implications.

SANTIAGO – European leaders, faced with the reality of an insolvent Greece, are reportedly now considering a “Plan B” that would involve reducing the burden of its future debt payments. This is a welcome contrast to the options considered so far, all of which involved – under different guises – foisting more debt onto a country that has too much of it already.

Greek public debt today stands at nearly 160% of the country’s official GDP. Suppose Greece took 25 years to bring it down to the Maastricht ceiling of 60%. If the real interest rate on Greek debt were 4% (more or less what Greece is paying now for the emergency loans from the European Union) and annual GDP grew by 2% on average, the required primary fiscal surplus each year for the next quarter-century would be 5.7% of GDP. That is an unimaginably large burden, and it risks condemning Greece to permanent recession and social unrest.

A possible counterargument is that Greece has a large informal economy, so its actual GDP is larger than the official figure. As a result, the debt ratios commonly applied to Greece could be overstated. But informal output is of little use for debt service if it cannot be taxed. In any case, the scope for tax increases is severely limited in an economy that is shrinking quickly.

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