An econometric analysis of the eurozone sovereign debt crisis : the case of Greece

Abstract

The European sovereign debt crisis started. in 2008 with the collapse of Iceland's banking system. Subsequently, several European countries faced the implosion of financial institutions, high government debt and rapidly rising bond yield spreads in government securities. In this context, Greece is an example of a country whose government debt is a matter of grave concern since it has received the second bailout but still threatens to default. This is ironic since a developed economy like Greece is considered to aide developing economies. The main aim of this dissertation is to conduct an econometric analysis of the determinants of the Greek sovereign debt crisis while the secondary aim is an extensive literature review of the Eurozone sovereign debt crisis. Regarding the former aim, the variables selected include the government deficit, current account balance, inflation, gross savings and general government debt of Greece. This annual data (from 1976 to 2010) was collected from the World Development Indicators, European Commission data base and the International Monetary Fund. The Vector Error Correction Model framework was used to estimate our model. Also, the Granger causality analysis helped to identify the direction of causation. Furthermore, the Variance Decomposition and the Generalized Impulse Response Function were employed to analyze the shocks of all our variables on each other. Finally, for the latter aim, we critically review the evolution, causes, consequences and cures of the Eurozone sovereign debt crisis and then formulate some suggestions on how to mitigate the effects of this crisis. The results of the econometric analysis show that there is a significant negative relationship between general government debt with government deficit and inflation. However, a significant positive relationship between general government debt and current account balance was found. There is an insignificant negative relationship between gross savings and general government debt. The past value of the general government debt and government deficit has the ability to determine the present value of inflation; and in turn, pass value of inflation, can predict the present value of current account balance and gross savings. Variation in most of our variables is highly explained by our variables itself, with the exception of current account balance where variation is explained mostly by general government debt. The response of general government debt to itself is positive. Gross government debt to government deficit and general government debt to current account balance is negative. General government debt to inflation is positive. A shock of gross government debt has an increasing negative effect on gross savings over the study period. Among the causes of the Eurozone sovereign debt crisis is the rapid growth of government debt levels, trade imbalances, monetary policy inflexibility, and loss of confidence. Consequences of this crisis involve disrupted bond markets and the banking sector, depreciation of the Euro, reduced economic growth, loss of confidence, reduced remittances and tight fiscal measures. Some measures were taken and many are proposed as a cure for this crisis. This dissertation recommends that policies aimed at decreasing the level of general government debt should increase expenditure hence deficit in an income generating investment, increase inflation while decreasing current account balance.