Readers Question: Greece has a current account deficit of almost 14% (!) of GDP and Greece is a member of the EU. How can it resolve the problem if it cannot devalue the currency ( the quick way out, which was used in the past when the greek drachma was around) and when productivity is so low and consumer spending is holding up due to EU money/subsidies and “black” money? Are we in for a crisis and if so what does it mean for the EU?
It is a good question.(see also: Irish economy facing recession)
Source: OECD Statistics (2010)
The other big problem facing Greece is a large public sector deficit. In 2007, it stood at 94% of GDP. (twice the size of the UK’s national debt) The size of the national debt is now starting to put off international investors. The bond yield on Greek debt is increasing. This means investors demand a higher interest rate to compensate for the decreased credit worthiness of the Greek economy. This is important because if Greece credit worthiness decreases, then it will be more difficult to attract capital flows to buy Greek government debt.
How To Reduce Current Account Deficit?
As you mention usually, a large deficit like the Greek current account deficit, would typically cause a devaluation in the exchange rate. However, that cannot occur because Greece is in the Euro which has retained its strength. It means that Greek goods are relatively more expensive (Greece used to be an attractive option for British tourists, but, now Greece is becoming quite expensive)
1. Lower Consumer spending. The main factor which will reduce the current account deficit in the forthcoming years is lower consumer spending. This will mean demand for imports will have to fall as their is insufficient income to buy it. This is likely to lead to economic stagnation.
2. Improved Competitiveness. The decline in demand for exports may force Greek firms to become more efficient. But, this is uncertain and it may take quite a while.
What does it mean for the EU?
The ECB is likely to perserve with monetary policy which is right for the core of the Eurozone – Germany, France, Netherlands. However, the fringe Eurozone members like Greece, Spain and Ireland may struggle with strong euro and relatively high interest rates. The spread in bond yields already highlights the difficulties the eurozone may face.