What led to Greece’s economic problems?
After Greece adopted the euro in 2001, it was able to borrow at much lower interest rates despite its deteriorating competitiveness and public finances. In the decade before the crisis, Greece was able to use this cheap funding to finance a deficit which grew to unsustainable levels. Conditions in the euro area during this period facilitated such lending, despite the build-up of the unsustainable deficit. This meant that Greece could delay difficult structural reforms that had become necessary and may have been unavoidable if cheap funding had not been available during the 2000s.
While government spending and borrowing increased, tax revenues weakened due to poor tax administration. At the same time, wages rising much faster than productivity growth undermined Greece’s competitiveness, while low productivity and existing and significant structural problems also contributed to the increasing economic difficulties. As a result, Greece’s economy contracted and unemployment began to climb to alarming levels.
Greece’s reliance on external financing for funding budget and trade deficits left its economy very vulnerable to shifts in investor confidence. In 2009, the Greek government revealed that previous governments had been misreporting government budget data. Much higher-than-expected deficits eroded investor confidence, causing the yields on Greek sovereign bonds (which correspond to the cost of borrowing money) to rise to unsustainable levels. The situation worsened to the point where the country was no longer able to refinance its borrowing, and it was forced to ask for help from its European partners and the IMF.