Blog Post

Why a Grexit is more costly for Germany than a default inside the euro area

Direct losses for Germany would be much larger if Greece was to exit the euro.

By: and Date: January 16, 2015 Topic: European Macroeconomics & Governance

A few days ago the influential IFO Institute published a short paper suggesting that a Greek default inside the euro-area would cost Germany €77.1 billion, while a default combined with an exit from the euro would cost €75.8 billion. The two numbers are about the same, yet unsurprisingly, media reports emphasised that a Grexit would be cheaper for Germany by €1.3 billion (see e.g. a Focus report here).

We think that the publication of such numbers falsely suggests that direct losses can be calculated precisely. Even more importantly, we noticed that the calculation did not consider three major factors:

  • the different haircuts likely under the two scenarios,
  • private claims,
  • other second round losses.

All three factors suggest that direct losses for Germany would be much larger if Greece was to exit the euro.

Before assessing the details of the calculations, let us make our view clear: we think that a Greek default and exit are neither likely nor necessary. It is definitely in the interests of both Greece and its euro-area partners to find a comprehensive agreement that would avoid default and exit, which would make everyone much worse-off. Greece would enter another deep recession, which would push unemployment up further and reduce budget revenues, necessitating another round of harsh fiscal consolidation. Euro-area creditors would lose a lot on their Greek claims and private claims on Greece would also suffer. The new depreciating Greek drachma may not revive the Greek economy that much (see on this Guntram Wolff’s recent post here and our 2011 post here). Furthermore, a Grexit would have many broader implications beyond economic issues. What are the prospects for a comprehensive agreement?

  • Concerning Greek debt sustainability, there are relatively painless options, as we recently argued.
  • Agreement on fiscal policy may not be that difficult either. Greece has suffered a lot in the past few years and has implemented major fiscal adjustments. Although the outlook is not too bright, by now the trough in economic activity has perhaps been reached and some economic growth is expected. This should help fiscal accounts and it is likely that no more fiscal adjustment will be necessary. In fact, the EU Commission expects that the cyclical adjusted primary budget surplus of Greece will decline from 8% of GDP in 2014 by about 1 percentage point in both 2015-16, suggesting a fiscal easing: exactly what Greek opposition parties demand. In other words, the new Greek government will be able to reap the benefits of the adjustments made in the past few years.
  • The most difficult step may be to secure an agreement on structural policies, because many of the current plans of the Greek opposition parties are in diametrical opposition to reforms agreed under the financial assistance programme. But a compromise has to be found: both sides have strong incentives to agree and structural reforms have to be part of the comprehensive agreement.

While there are very strong incentives to cooperate and therefore a Grexit is not very likely, for the sake of intellectual exchange, we thought it useful to comment on the IFO calculations assessing the impact of default.

The IFO Institute’s calculations considered the German share of the official assistance to Greece (bilateral German loans, Germany’s share in the EFSF and IMF loans) and various European Central Bank claims. They summed-up all of these claims, assuming that all will be written off in the case of a default. While we have some questions considering central bank related claims (which explains the €1.3 billion difference in IFO’s results), there are three more important issues.

The first major problem with these calculations is that they consider the complete write-off of official claims on Greece in both cases. We doubt that this will be the case: there have been many debt restructurings in recent decades, but claims have never been written off completely. See for example, Juan Cruces and Christoph Trebesch’s dataset , which summarises 187 distressed sovereign debt restructurings from 1970-2013. The average haircut was 38 percent. Moreover, among the two scenarios (default inside versus exit), the haircut would most likely be much higher if Greece was to exit the euro area, since the new Greek drachma would likely depreciate substantially and Greek GDP would contract substantially, thereby reducing Greece’s ability to honour debts, especially those that are denominated in foreign currencies (in this case, the euro would be a foreign currency). The depreciation of the exchange rate of the Argentine peso in 2002 may be indicative of a hypothetical nominal currency depreciation of the new Greek drachma in the case of a Grexit (Figure 1).

Figure 1: The exchange rate of the Argentine peso against the US dollar, January 1992 – January 2015

Source: Datastream ThomsonReuters

Second, the the IFO Institute’s calculations do not consider claims by the private sector (though the IFO paper acknowledges this omission). Again, a Grexit would likely lead to much larger losses for the German private sector than a Greek default inside the euro area, since more Greek banks and non-banks would default on the back of a likely massive depreciation of the new currency and contraction of Greek GDP. The table below shows that while German private sector claims on Greece have been reduced substantially since 2009, they still amount to about €16 billion of debt-type claims (the sum of portfolio debt and banking exposure) and about €3 billion of equity-type claims (the sum of FDI ad portfolio equity).

Source: OECD International direct investment database, IMF Coordinated Portfolio investment Survey, BIS consolidated data (ultimate risk basis), and Eurostat (exchange rate data to convert US dollar figures to euros).

Third, further second round effects should be expected, such as a reduction of German exports to Greece. Moreover, other euro area countries would suffer losses too, which could negatively impact Germany as well.

Overall, we conclude that while calculating the losses in the event of a Greek default is difficult and depends on many assumptions, in all likelihood, the financial losses of Germany and other euro-area countries would be much higher if Greece exits the euro than if Greece remains.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More on this topic
 

Opinion

The ECB needs political guidance on secondary objectives

While EU Treaties clearly stipulate that the ECB “shall support the general objectives of the European Union”, it is not appropriate to simply stand by, wishing that the ECB will use its discretionary power to act on them. Political institutions of the EU should prioritise the secondary goals to legitimise the ECB’s action.

By: Pervenche Béres, Grégory Claeys, Nik de Boer, Panicos O. Demetriades, Sebastian Diessner, Stanislas Jourdan, Jens van ‘t Klooster and Vivien Schmidt Topic: European Macroeconomics & Governance Date: April 22, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

[LIVE] The idea of Europe: more than a feeling?

What can 70 years of news(paper articles) and how we talk about 'Europe' tell us about pan-European identity? Is there even such a thing as a European public sphere?

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: April 16, 2021
Read about event More on this topic
 

Past Event

Past Event

An alpine divide? Comparing economic cultures in Germany and Italy

A discussion of Italian and German macro-economic cultures and performances.

Speakers: Thomas Mayer, Patricia Mosser, Marianne Nessén, Hiroshi Nakaso, Francesco Papadia, André Sapir and Jean-Claude Trichet Topic: European Macroeconomics & Governance Date: April 13, 2021
Read article Download PDF More on this topic
 

Working Paper

Interest in European matters: a glass three-quarters full?

Everything that increases the interest of European citizens in the EU, independently of whether it has a critical or a supportive character, will serve to move the EU closer to its citizens.

By: Francesco Papadia, Enrico Bergamini, Emmanuel Mourlon-Druol and Giuseppe Porcaro Topic: European Macroeconomics & Governance Date: March 23, 2021
Read about event More on this topic
 

Past Event

Past Event

Presentation of the Euro Yearbook 2021

Join us for the launch of the eighth edition of the 'Euro Yearbook'

Speakers: Maria Demertzis, Fernando Fernández, Fiona Maharg-Bravo, Antonio Roldán and Jorge Yzaguirre Topic: European Macroeconomics & Governance Date: March 12, 2021
Read article Download PDF More on this topic More by this author
 

External Publication

When and how to unwind COVID support measures to the banking system?

Study of regulatory measures and supervisory practices that have supported public guarantee schemes and moratoria in euro-area countries prepared for the ECON committee of the European Parliament.

By: Alexander Lehmann Topic: European Macroeconomics & Governance Date: March 9, 2021
Read article Download PDF More on this topic
 

Working Paper

Talking about Europe: exploring 70 years of news archives

This paper aims to contribute to the understanding of Europe as reflected in European media.

By: Enrico Bergamini and Emmanuel Mourlon-Druol Topic: European Macroeconomics & Governance Date: March 2, 2021
Read article Download PDF More on this topic
 

Working Paper

COVID-19 credit-support programmes in Europe’s five largest economies

This paper assesses COVID-19 credit-support programmes in five of the largest European economies, and examines how countries have dealt with trade-offs raised by the programmes.

By: Julia Anderson, Francesco Papadia and Nicolas Véron Topic: European Macroeconomics & Governance Date: February 24, 2021
Read about event
 

Past Event

Past Event

Disruption or transformation: the impact of a digital euro on the financial system

How would a digital Euro impact the financial system?

Speakers: Fabio Panetta and Guntram B. Wolff Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: February 10, 2021
Read article More on this topic More by this author
 

Blog Post

Has the European Union squandered its coronavirus vaccination opportunity?

The European Union’s purchases of frontrunner coronavirus vaccines are insufficient for the population’s near-term needs. The shortfall could have healthcare consequences and might delay economic reopening. Lessons should be learned for future pandemics.

By: J. Scott Marcus Topic: Innovation & Competition Policy Date: January 6, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

The geopolitics of money

The current debate on currencies is driven by politics rather than economics.

By: The Sound of Economics Topic: Global Economics & Governance Date: December 9, 2020
Read article Download PDF More by this author
 

Parliamentary Testimony

European Parliament

Euro area accession countries in the context of the pandemic

Testimony before the European Parliament on the subject of euro area accession.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 19, 2020
Load more posts