Evaluate the use of austerity to reduce a government budget deficit.
4.5.3 · 2.6.4
It worked (eventually)- Deficit from 15.4% of GDP (2009) to a surplus of 1.7% (2025).
- Investment-grade rating regained in 2023.
- Debt falling: 146% of GDP in 2025, from over 200% in 2020.
At a huge cost- GDP fell about 25%; unemployment reached 27.5%.
- Debt ratio rose during austerity because GDP shrank.
- Brain drain and hysteresis damaged long-run supply.
ChainSpending cuts and tax rises → G ↓ and disposable income ↓ → AD ↓ by a multiple → output and jobs ↓ → tax revenue ↓ and welfare spending ↑ → deficit falls less than planned; debt/GDP rises.
JudgmentAusterity works least in a recession, in a fairly closed economy with a large multiplier, and without a currency to devalue. Greece had all three. Pace and timing matter more than the goal.
Discuss the costs of membership of a single currency for a country facing a crisis.
4.1.5 · 4.1.8
Costs- No devaluation to restore competitiveness.
- No own central bank to cut rates or buy bonds (until the ECB acted).
- Euro entry brought cheap credit that fuelled the boom.
Benefits- Three bailouts lent over €250 bn, mostly from eurozone partners at low rates.
- Leaving the euro (Grexit) would have meant bank collapse and very high inflation.
- Low interest costs on debt today.
ChainLoss of competitiveness → cannot devalue → must cut wages and prices (internal devaluation) → real debt burden ↑ and demand ↓ → deep, long recession.
JudgmentThe costs of the euro are greatest when a country's cycle and competitiveness differ from the core and there is no shared fiscal policy. Greece stayed because leaving looked even more costly.
Evaluate the factors that determine whether a high level of public debt is sustainable.
4.5.3
Debt is a risk- 146% of GDP is the EU's highest.
- In 2010 markets refused to lend at any sensible rate.
- Ageing will raise pension and health costs.
Debt is manageable- Mostly official loans: low fixed rates, some maturities to about 2070.
- Primary surpluses and growth are cutting the ratio fast.
- Japan carries far higher debt without crisis.
ChainNominal GDP growth (g) > interest rate on debt (r) → debt grows more slowly than GDP → debt/GDP falls even with a small deficit; add a primary surplus and it falls faster.
JudgmentWho holds the debt, its interest rate and maturity, and growth matter more than the headline ratio. Greece's debt is sustainable on official terms; the risk returns when it must borrow from markets.
Assess whether internal devaluation is an effective way to restore international competitiveness.
4.1.9
Effective- Unit labour costs fell sharply after 2010; minimum wage cut 22% in 2012.
- Tourism exports and market share recovered.
- Current account deficit closed in the late 2010s.
Not effective- Much of the deficit closed because imports collapsed with incomes.
- Goods exports responded weakly: small firms, little to sell.
- Deflation raised the real value of debts.
ChainUnemployment ↑ → wages ↓ → unit labour costs ↓ → prices of exports ↓ relative to rivals → X ↑ (if demand is price elastic).
JudgmentIt works slowly and painfully. It works better in an economy with a large export base, like Ireland. In Greece most of the adjustment came through lower imports rather than higher exports.
Discuss the causes of a sovereign debt crisis.
4.5.3 · 4.4.2
Domestic causes- Persistent deficits and misreported statistics (the 2009 deficit was later revised to 15.4%).
- Tax evasion and a large public payroll and pension bill.
- Wages rose faster than productivity after euro entry.
External / system causes- 2008 global crisis cut growth and tax revenue.
- Lenders mispriced Greek risk: bond yields near German levels before 2008.
- Eurozone lacked a lender of last resort for governments until 2012.
ChainDeficit revealed as much larger → confidence falls → bond yields ↑ → cost of refinancing debt ↑ → deficit widens further → cannot borrow: bailout or default.
JudgmentWeak public finances made Greece vulnerable, but the flaws in the eurozone's design turned a fiscal problem into a crisis. Both matter.
Evaluate the impact of a financial crisis on the banking system and the real economy.
4.4.2 · 4.4.3
Severe impact- Banks held government bonds: the 2012 write-down hit their capital.
- Deposit flight; capital controls and bank closures in 2015.
- Bad loans reached nearly half of all loans; credit dried up.
Contained- ECB emergency lending kept banks open.
- Recapitalised banks survived; bad loans now single digits.
- Capital controls fully lifted in 2019.
ChainGovernment debt losses → bank capital ↓ → depositors withdraw → lending ↓ → I and C ↓ → deeper recession → more bad loans (the "doom loop").
JudgmentThe link between banks and the government made each crisis worse. The ECB as lender of last resort prevented collapse, but its support came with strict conditions.
Assess the effects of high long-term unemployment on an economy.
2.1.3 · 2.3
Serious effects- Peak 27.5% (2013), youth 54.9% (2012).
- Hysteresis: skills lost, long-term unemployed hard to re-employ.
- Emigration of the young and skilled cut LRAS.
Reversible- Unemployment down to 7.4% (Aug 2026).
- Tourism and construction recovery created jobs.
- Labour reforms made hiring easier.
ChainLong spells out of work → skills and motivation decline → structural unemployment ↑ (hysteresis) → lower potential output → LRAS shifts left.
JudgmentThe rate has recovered, but output per head and the workforce have not fully. Part of the fall in unemployment reflects emigration and ageing.
Evaluate whether supply-side reforms imposed by lenders improve long-run growth.
2.6.3 · 4.3
Yes- Privatised Piraeus port is now a major hub.
- Digital public services and e-invoicing cut red tape and evasion.
- Labour market flexibility helped job creation after 2016.
Limited- Imposed during a slump: AD fell, investment collapsed.
- Weak local ownership; some reforms reversed.
- Lost human capital through emigration.
ChainOpening closed markets and privatisation → more competition → efficiency and investment ↑ → productivity ↑ → LRAS shifts right.
JudgmentSupply-side reform works best when demand is stable and the government owns the reforms. Greece shows reforms can help, but timing and sequencing decide the cost.
Discuss the advantages and disadvantages of relying on tourism for growth.
4.3 · 2.1.4
Advantages- Record 38 m arrivals in 2025; big services export.
- Labour-intensive: jobs for lower-skilled workers.
- Uses natural and cultural comparative advantage.
Disadvantages- 2020: tourism collapse helped cause a 9.2% fall in GDP.
- Seasonal, low-wage, low-productivity jobs.
- Wildfires, heat and energy costs; pressure on housing and water.
ChainTourist spending ↑ → services exports ↑ → (X−M) and AD ↑ → jobs in hotels, transport, food → multiplier effects in local economies.
JudgmentTourism is a strong base but a risky single engine. Diversifying into tech, energy and logistics reduces exposure to shocks.
Evaluate the role of international institutions in resolving a country's debt crisis.
4.5.4 · 4.3
Helpful- Three bailouts (€110 bn, then €130 bn plus PSI, then €86 bn) avoided disorderly default.
- ECB support kept banks open.
- Debt relief (longer maturities) in 2012 and 2018.
Harmful- IMF admitted austerity multipliers were underestimated.
- Debt write-down delayed until 2012.
- Conditions seen as a loss of sovereignty; political backlash.
ChainLoans with conditions → government meets debt repayments, avoids default → confidence slowly returns → but austerity conditions cut AD → deeper short-run recession.
JudgmentInstitutions prevented a disorderly collapse but designed a programme that made the recession deeper. Earlier debt relief and slower austerity would likely have cost less.