Europe's risky moment: the ugly consequences of a Greek exit.

AuthorLachman, Desmond
PositionEconomic reform

Judging by the strong Greek political backlash against budget austerity, European policymakers will soon be faced with a fundamental policy choice. Do they again make Herculean efforts to keep Greece within the euro? Or do they allow Greece to be cut loose and focus their efforts instead on ring-fencing the rest of the European economic periphery from any Greek contagion? How European policymakers answer this basic question will be critical not only for Greece's economic future but also for that of the eurozone as a whole.

After six years of economic recession, which has seen Greece's real GDP reduced by a quarter and its unemployment rate rise to over 25 percent, the Greek public appears to be at the end of its tether with economic policies imposed by the troika of the International Monetary Fund, the European Union, and the European Central Bank, which negotiate in concert the external assistance that they offer to Greece. This was to be seen not only in the recent electoral victory of the far-left Syriza Party, which has promised to tear up Greece's economic memorandum with the troika. It was also seen over the past six months in the reluctance of Antonis Samaras' New Democracy party to carry out the troika's dictates. That reluctance has prevented Greece from completing its long-delayed IMF review.

The recent political turmoil that forced Greece to hold snap elections on January 25 is bound to exert a heavy toll on both domestic and international confidence in the Greek economy. It has resulted in the formation of a weak coalition government vehemently opposed to austerity and without a mandate for economic discipline and structural economic reform. This must be expected to extinguish any hope that the Greek economy might finally have turned the corner on its way to a meaningful economic recovery in 2015. As a consequence, it is also likely to have damaged Greece's already fragile public finances, which will require more budget adjustment measures from a country that has reached the limits of what it can socially bear.

Greece's already battered economy can ill afford a prolonged period of weak coalition government without the back-stop of a troika financial support program. While Greece might now have a primary budget surplus, it has substantial official debt amortization payments to make in 2015 on its sovereign debt that now totals a staggering 175 percent of GDP.

Greece is also very vulnerable to a run on its bank deposits. This...

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