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 European Macroeconomics & Governance Tags & Topics

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.

View comments
Read article More on this topic More by this author

Blog Post

DSC_0794

Why was the last TLTRO take-up unexpectedly high?

The final round of TLTRO financing was an unexpected hit with euro area banks. The aim of the programme is to encourage banks to increase lending to the real economy. However, with many now expecting a hike in deposit rates, banks’ enthusiasm might be driven largely by the chance to make a profit from the cheap loans.

By: Justine Feliu Topic: European Macroeconomics & Governance Date: March 27, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

The inflation basket case

Inflation in the euro area has finally reached 2%. But Draghi is right to warn that the underlying dynamics do not point to this being a self-sustaining trend. Breaking down the numbers shows that many inflation basket items are still showing weak price growth or even deflation.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: March 17, 2017
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

What future for Europe?

The Commission's White Paper on the future of the EU sets out five scenarios, but misses the fundamental questions facing Europe. How should the EU interact with its neighbourhood? How can we manage the tensions created by multi-speed integration? And above all how can the Euro be made sustainable in the absence of a major step towards fiscal union?

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: March 16, 2017
Read article More on this topic More by this author

Blog Post

Grégory Claeys

Debunking 5 myths about Frexit

French elections are fast approaching and the debate on euro membership is now in full swing. ‘Frexit’ supporters promise that the benefits of leaving the euro would be substantial for the French economy, that economic policy would be greatly improved, and most importantly that the exit process would be a piece of cake. This blog post shows that these claims are greatly exaggerated if not outright lies.

By: Grégory Claeys Topic: European Macroeconomics & Governance Date: March 10, 2017
Read article Download PDF More on this topic

Working Paper

WP_01_17 cover

Fundamental uncertainty and unconventional monetary policy: an info-gap approach

This paper applies the info-gap approach to the unconventional monetary policy of the Eurosystem and so takes into account the fundamental uncertainty on inflation shocks and the transmission mechanism.

By: Yakov Ben-Haim, Maria Demertzis and Jan Willem van den End Topic: European Macroeconomics & Governance Date: February 28, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Should we worry about Greek banks?

Earlier this month, the IMF and the European institutions clashed over conditions for sustainability of the Greek debt. One of the main disagreements seems to be the evaluation of the Greek banks’ health. Whose assessment should be trusted and are there reasons to worry?

By: Silvia Merler Topic: European Macroeconomics & Governance Date: February 23, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Is Germany a currency manipulator?

What’s at stake: the Financial Times reports that Peter Navarro, head of the US’s National Trade Council, has accused Germany of currency manipulation. He claims that the country uses a 'grossly undervalued' Euro to 'exploit' its trading partners. Angela Merkel replied that the Euro is managed by the European Central Bank, on which Germany does not exert influence. We review what the economic blogosphere thinks of this.

By: Silvia Merler Topic: Global Economics & Governance Date: February 6, 2017
Read article More on this topic More by this author

External Publication

9781785369315-thumb

EU economic governance: euro area periphery lessons for Central and Eastern European countries

An analysis of macroecnomic developments shows that Central and Eastern European (CEE) EU member states fared much better in the aftermath of the crisis compared to euro-area periphery countries. Furthermore, they have a better chance to avoid the problems that the euro-periphery countries faced before the crisis.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 9, 2016
Read about event More on this topic

Past Event

Past Event

Game Over – The Inside Story of the Greek Crisis -Drawing the broader lessons for Europe

Solvay Brussels School and Bruegel are co-organizing an event at which George Papakonstantinou and André Sapir will discuss the Greek crisis and its social and economical impact over the last 6 years.

Speakers: André Sapir, Guntram B. Wolff and George Papakonstantinou Topic: European Macroeconomics & Governance Location: Avenue Franklin Roosevelt 42 Brussels, 1050, Ixelles Date: December 6, 2016
Read article Download PDF More by this author

Policy Contribution

pc-23-12European Parliament

The impact of the legal and operational structures of euro-area banks on their resolvability

Following the financial crisis, the question of how to handle a big bank’s collapse has come to the fore. This Policy Contribution evaluates the obstacles to resolvability that the legal and operational structures of the large euro-area banks could pose to the European Union’s new resolution regime.

By: Dirk Schoenmaker Topic: European Parliament, Finance & Financial Regulation, Parliamentary Testimonies Date: December 6, 2016
Read article Download PDF More on this topic More by this author

External Publication

cover-ep

The impact of the legal and operational structures of euro-area banks on their resolvability

This paper evaluates the obstacles to resolvability that the legal and operational structures of the large euro-area banks could present, assuming that it is possible to liquidate smaller and medium-sized banks through a transfer of the relevant activities to other banks.

By: Dirk Schoenmaker Topic: Finance & Financial Regulation Date: December 6, 2016
Read article More on this topic More by this author

Blog Post

Nicolas Véron

Not so low: A review of Paul Blustein’s book on the IMF and the euro area crisis

"Laid Low" is an important addition to the burgeoning literature on the euro-area crisis and its main contribution is to assemble essential factual material for further analysis.

By: Nicolas Véron Topic: European Macroeconomics & Governance Date: November 3, 2016
Load more posts