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.

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

Blog Post

Global Imbalances

The recent IMF’s External Sector Report highlighted the persistence of imbalances and a switch of imbalances towards advanced economies. We review recent contributions on this topic.

By: Silvia Merler Topic: Global Economics & Governance Date: September 21, 2017
Read article

Blog Post

How has banking union changed mergers and acquistions?

The aim of the banking union was to break the toxic link between banks and states. One way of achieving this is by increasing cross border banking through mergers and acquisitions. This blog shows that little has changed in M&A activity since the banking union was launched. In fact, we seem to be witnessing a slight re-nationalisiation of banking consolidation.

By: Inês Goncalves Raposo and Guntram B. Wolff Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: September 13, 2017
Read article More on this topic More by this author

Opinion

Hong Kong should add the euro to its dollar peg

Volatility offers an opportunity for the territory to rethink its strategy. With the economy now more synchronised with China than ever before, the dollar peg may no longer provide an accurate reflection of the real value of the Hong Kong dollar.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: September 12, 2017
Read article More on this topic More by this author

Blog Post

Speech by Peter Kažimír at Bruegel Annual Dinner 2017

Peter Kažimír, Slovakia Finance Minister, delivered the keynote speech at Bruegel's Annual Dinner 2017, held on 7 September 2017.

By: Peter Kažimír Topic: European Macroeconomics & Governance Date: September 7, 2017
Read about event

Past Event

Past Event

Bruegel Annual Meetings 2017

The Annual Meetings are Bruegel’s flagship event. They offer a mixture of large public debates and small private sessions about key issues in European and global economics. In a series of high-level discussions, Bruegel’s scholars, members and stakeholders will address the economic policy challenges facing Europe.

Speakers: Carlos Sallé Alonso, José Antonio Álvarez Álvarez, Agnès Bénassy-Quéré, Pervenche Béres, Matthias Buck, Grégory Claeys, Zsolt Darvas, Jean Luc Demarty, Maria Demertzis, Anna Ekström, Lowri Evans, Ferdinando Giugliano, Sandro Gozi, Peter Grünenfelder, Reiner Hoffmann, Levin Holle, Kate Kalutkiewicz, Steffen Kampeter, Peter Kažimír, Emmanuel Lagarrigue, Matti Maasikas, Steven Maijoor, Reza Moghadam, Nathalie Moll, James Murray, Johan Van Overtveldt, Julia Reinaud, André Sapir, Dirk Schoenmaker, Mateusz Szczurek, Marianne Thyssen, Jean-Claude Trichet, Reinhilde Veugelers, Nicolas Véron, Ida Wolden Bache, Liviu Voinea, Guntram B. Wolff and Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Square - Brussels Meeting Centre Date: September 7, 2017
Read article More on this topic

Blog Post

Should the EU have the power to vet foreign takeovers?

Should the EU have the power to vet foreign takeovers? André Sapir and Alicia Garcia-Herrero debate the issue, which has become topical in view of recent Chinese investment in Europe.

By: Alicia García-Herrero and André Sapir Topic: Global Economics & Governance Date: September 1, 2017
Read article More on this topic

Opinion

Europe must seize this moment of opportunity

As the EU enjoys a period of growth and relative stability, there is finally room to undertake long-needed reforms. But it is vital to act soon, and priorities must be set. There are three pillars of reform for the coming months: completing a robust euro area; building a coherent EU foreign policy; and harnessing the single market’s potential to deliver strong and inclusive growth.

By: Agnès Bénassy-Quéré, Michael Hüther, Philippe Martin and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: August 12, 2017
Read article More on this topic More by this author

Blog Post

Italian economic growth and the Euro

While the Euro has frequently been blamed for the poor growth performance of Italy over the years, a long-term analysis shows deteriorating growth before the introduction of the Euro. Additionally, Italy has shown worse performance than other euro-periphery countries, such as Spain, implying deeper structural reasons for Italy’s economic malaise.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: July 26, 2017
Read article More on this topic More by this author

Blog Post

The international effects of ECB’s monetary policy

What’s at stake: the literature on monetary policy spillovers is abundant of studies investigating the impact of the US Federal Reserve’s monetary policy announcements and actions on emerging market economies. More recently, economists have been investigating the effect of the ECB’s credit easing as well.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: July 24, 2017
Read article More on this topic More by this author

Blog Post

Eurozone or EU budget? Confronting a complex political question

This week’s European Commission reflection paper is the latest document to ponder a distinction between EU and euro-area budgets. But do we need to split the two, and what would each budget be used for? In this post, I present an analytical framework for assessing this ultimately political question

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 29, 2017
Read article More on this topic More by this author

Opinion

Nord Stream 2 means gains for Germany but pain for Europe

The proposed Nord Stream 2 pipeline could destabilise European energy cooperation and offer Gazprom excessive influence in Central and Eastern Europe. These disadvantages do not justify the commercial benefits for German companies.

By: Georg Zachmann Topic: Energy & Climate Date: June 23, 2017
Read article More on this topic More by this author

Blog Post

Raising the inflation target: a question of robustness

In an unexpected move, the Federal Reserve Chair Janet Yellen has recently brought up the issue of raising the inflation target. This blog argues that an increase in inflation targets may prove to be beneficial in achieving price stability in the long run. This would increase the credibility of central banks in achieving inflation goals and stave off the distortionary effects of deflation.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: June 22, 2017
Load more posts