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S. HRG. 114–110 

ECONOMIC CRISIS: THE GLOBAL IMPACT OF A 

GREEK DEFAULT 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

NATIONAL SECURITY AND INTERNATIONAL TRADE 

AND FINANCE 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED FOURTEENTH CONGRESS 

FIRST SESSION 

ON 

EXAMINING THE SYSTEMIC RISKS GREECE COULD POSE TO THE REST 

OF THE EUROZONE AND THE BROADER INTERNATIONAL ECONOMY 

JUNE 25, 2015 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

RICHARD C. SHELBY, Alabama, Chairman 

MICHAEL CRAPO, Idaho 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

DEAN HELLER, Nevada 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

TOM COTTON, Arkansas 

MIKE ROUNDS, South Dakota 

JERRY MORAN, Kansas 

SHERROD BROWN, Ohio 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

JOE DONNELLY, Indiana 

WILLIAM D. DUHNKE III, Staff Director and Counsel 

MARK POWDEN, Democratic Staff Director 

DAWN RATLIFF, Chief Clerk 

TROY CORNELL, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON NATIONAL SECURITY AND INTERNATIONAL TRADE AND FINANCE

MARK KIRK, Illinois, Chairman 

HEIDI HEITKAMP, North Dakota, Ranking Democratic Member 

TOM COTTON, Arizona 

BEN SASSE, Nebraska 

MARK R. WARNER, Virginia 

BRYAN BLOM, Senior Policy Advisor and Subcommittee Staff Director 

JILLIAN FITZPATRICK, Democratic Subcommittee Staff Director 

(II)

C O N T E N T S 

THURSDAY, JUNE 25, 2015 

Page 

Opening statement of Chairman Kirk ................................................................... 2 

Opening statements, comments, or prepared statements of: 

Senator Heitkamp ............................................................................................ 1 

WITNESSES 

Desmond Lachman, Resident Fellow, American Enterprise Institute for Public 

Policy Research .................................................................................................... 3 

Prepared statement .......................................................................................... 17 

Responses to written questions of: 

Senator Sasse ............................................................................................ 40 

Matthew J. Slaughter, Incoming Paul Danos Dean, Tuck School of Business, 

Dartmouth College ............................................................................................... 4 

Prepared statement .......................................................................................... 25 

Carmen M. Reinhart, Minos A. Zombanakis Professor of the International 

Finance System, John F. Kennedy School of Government, Harvard 

University ............................................................................................................. 6 

Prepared statement .......................................................................................... 30 

Jacob Funk Kirkegaard, Senior Fellow, Peterson Institute for International 

Economics ............................................................................................................. 8 

Prepared statement .......................................................................................... 32 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Wall Street Journal chart of Greek debt due 2015–2055 ..................................... 45 

CRS/NATIXIS chart of total Greek debt owed ...................................................... 46 

(III)

(1) 

ECONOMIC CRISIS: THE GLOBAL IMPACT OF 

A GREEK DEFAULT 

THURSDAY, JUNE 25, 2015 

U.S. SENATE, SUBCOMMITTEE ON NATIONAL SECURITY

AND INTERNATIONAL TRADE AND FINANCE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Subcommittee convened at 1:36 p.m., in room 538, Dirksen 

Senate Office Building, Hon. Mark Kirk, Chairman of the Subcommittee, presiding. 

Chairman KIRK. We will begin. I will recognize my Ranking 

Member, Ms. Heitkamp, for an opening statement. 

STATEMENT OF SENATOR HEIDI HEITKAMP 

Senator HEITKAMP. Thank you. I want to thank you, Chairman, 

for arranging this hearing on Greece’s financial situation, and 

thank you to all of our witnesses for offering your expertise in this 

area. Your perspectives and opinions are incredibly important as 

Congress monitors the global financial system and I look forward 

to hearing those opinions. Barring consideration of reauthorization 

of the Export-Import Bank, which both me and the Chairman are 

leading on, I cannot think of a more timely topic. 

The United States and Greece are a tale of two economies. In 

2007, our country experienced a housing crisis driven by low interest rates, poor underwriting, and outright fraud, and then a financial crisis driven by lax oversight and regulation and a complex financial system we did not understand. The Nation’s real GDP fell 

by 2.6 percent in 2009, the largest decline in six decades. Our unemployment rate rose to 10 percent in October of 2009. And, fortunately, we have a mature economic recovery, in part because of 

Federal efforts to buoy the economy and actions taken by the Federal Reserve. 

Five years after the onset of the global financial crisis, however, 

Greece’s economy remains in turmoil. The country has experienced 

what is essentially a second depression. Since 2007, the Greek 

economy has contracted by nearly 25 percent. Unemployment has 

tripled, to nearly 25 percent. Youth unemployment is over 50 percent. And public debt has risen to 173 percent of GDP. 

The causes of Greece’s precarious situation are multiple and complex and I look forward to our witnesses shedding some light on 

how we got here and where we go from here. 

Much has changed since Greece negotiated its second financial 

assistance package. Ireland and Portugal, countries who also turn 

to the Eurozone and the IMF for financial assistance, successfully 

2 

concluded their programs and have returned to capital markets 

and are in the process of repaying the IMF early. The economies 

of the Eurozone, barring Greece, have strengthened, and importantly for the United States, private financial institutions have 

substantially reduced their exposure to Greece and policy measures 

adopted over the last several years have lessened the chance that 

a Greek default or an exit from the Eurozone results in another 

global financial crisis. 

As Greece and its creditors negotiate a third and, hopefully, final 

financial assistance package, several points appear clear to me. 

First, we must balance fiscal responsibility with economic development. The Greek people have suffered an unimaginable hardship. 

The economy will remain in shambles for years, and unfortunately, 

likely decades to come, because of poor decisions and potentially because of severe austerity policies. 

Second, we must continue to develop and implement a sound regulatory framework for viable global financial systems through 

international cooperation. I am hopeful that Greece and its creditors will reach a pragmatic compromise to prevent more hardship 

for the Greek people and calm the situation in Europe. 

Thank you, Mr. Chairman, for bringing this hearing together on 

this very important topic and I look forward to hearing from our 

witnesses. 

OPENING STATEMENT OF CHAIRMAN MARK KIRK 

Chairman KIRK. I will recognize myself for a quick opening statement before introducing the witnesses. 

I will say that I have been wanting to call this hearing since I 

became the Chairman of the Subcommittee. The Greek situation 

serves as a warning for local and State governments around America that are now running out of money. 

Many of us can recall the names of these Governments that are 

struggling with some of these issues. The American governments 

that we are worried about in the credit situation include Detroit, 

Michigan, and Stockton, California, Harrisburg, Pennsylvania, plus 

my own home State of Illinois, including our Chicago Public School 

System. 

As policymakers, Senators must make sure that these credit crises are reduced. I will note that issues arising from German reparations after World War I did play a role in sparking the Great 

Depression and ensuing Second World War. Luckily, the greatest 

generation did found a financial firefighting team that included the 

IMF and World Bank and other Bretton Woods institutions. 

This hearing is intended to calm fears by outlining what implications there are for America’s economy in the face of the Greek credit crisis. I look forward to hearing from our distinguished witnesses, all doctors, I would note, to tell us what the effect could be 

on the U.S. economy. 

Let me start with some introductions. I would like to introduce 

some of our witnesses. We are very happy to have Dr. Desmond 

Lachman, the Senior Resident Fellow for the American Enterprise 

Institute for Public Policy. 

Dr. Carmen Reinhart is the coauthor of this best selling New 

York Times book, ‘‘This Time Is Different’’. Carmen is also the 

3 

Minos A. Zombanakis Professor of International Financial Systems 

at the John F. Kennedy School of Government at Harvard University. 

We also have with us Dr. Matthew Slaughter, the incoming Dean 

of the Dartmouth Business School, otherwise known as the Tuck 

School of Business at Dartmouth College. 

And, we also have Dr. Jacob Kirkegaard, a Senior Fellow at the 

Peterson Institute for International Economics. 

Let us start with Desmond. Why do you not deliver your testimony. 

STATEMENT OF DESMOND LACHMAN, RESIDENT FELLOW, 

AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC POLICY 

RESEARCH 

Mr. LACHMAN. Thank you very much, Senator Kirk and Ranking 

Member Senator Heitkamp, for giving me the honor to testify before you this afternoon. 

I would like to make five basic points. First, Greece is very likely 

to exit and default within the next 12 months. Now, while an 

agreement between Greece and its official creditors still appears 

possible that could release the funds that Greece needs to avoid defaulting to the IMF next week, it is highly questionable how long 

such an agreement will last. 

An essential component of such an agreement would likely appear to be yet more of the same failed policies that Greece has pursued under IMF tutelage of the past 5 years. Namely, it would involve substantial fiscal policy tightening within a Euro straightjacket that relies almost exclusively on tax increases to achieve its 

budget objectives. Judging by the dismal results of the past, one 

would think that such an amount of budget tightening in a Euro 

straightjacket that does not allow currency depreciation is almost 

certain to deepen Greece’s economic depression. That, in turn, risks 

spreading the Syriza party and throwing the country into a new period of political turmoil that will, in the end, force Greece to exit 

the Euro. 

The second point I would make is that today, fortunately, Europe 

is in a very much better position to deal with the immediate fallout 

from a Greek event than it was in 2012. Europe now has in place 

a European stability mechanism with 500 billion Euros that can 

provide adequate financing to any Eurozone member that might 

come under market pressure. More important yet, the European 

Central Bank now has in place an outright monetary transaction 

facility that should allow it to do whatever it takes to maintain 

market stability in the event of a Greek exit. This should prove sufficient to reinvent Greece in the very short run. 

The third point I would make is that while European policymakers appear in a good position to deal with the immediate fallout from a Greek event, they do not appear to be in a good position 

to deal with the longer-run damage that a Greek exit might cause 

to the Euro project. A Greek exit would signal very clearly to markets that Euro membership was no longer irrevocable. In addition, 

it would become apparent to bank depositors and the rest of the 

European economic periphery that the ECB was not always there 

to backstop the safety of their deposits. 

4 

Heightening the longer-run risk of a Greek exit on the rest of the 

European periphery is the fact that countries like Italy, Portugal, 

and Spain are all now characterized by significantly high public 

debt levels than they were in 2012. They also have very low economic growth and are experiencing strong politically based austerity backlashes. This will make these countries especially vulnerable to speculative attack when global liquidity conditions are not 

as ample as they are today. 

The fourth point relates to the impact of a Greek exit on the 

United States economy. And here, I would say that there are three 

basic channels where the United States could suffer considerable 

economic and geopolitical costs. 

The first is that in the immediate aftermath of a Greek exit, one 

must expect a significant further depreciation of the Euro as the 

ECB took more forceful measures to deal with the Greek crisis and 

as investors fled to the safety of the U.S. dollar. The resulting dollar appreciation could continue—constitute a significant headwind 

to the U.S. economic recovery, particularly considering that we 

have already had a 15 percent effective appreciation of the dollar 

over the past year. 

Second, over the longer term, any eventual spread of the 

Eurozone debt crisis to other countries in the European periphery 

could roil global financial markets. This would be bound to impact 

the U.S. economic recovery, considering how integrated is the 

United States in the global financial system, and how important 

Europe is to the United States as a trade partner. 

The third way that a Greek exit could impact the United States 

is of a geopolitical nature. If a Greek exit leads to a souring of European and Greek relations and to the further erosion of Greek political stability, one could see a failed Greek State increasingly 

coming into the Russian orbit. This would give Russia a firmer and 

unwelcome foothold in the Balkans. 

The last point that I would like to make is in relation to the 

IMF, and I would say that a Greek exit would have considerable 

implications for the IMF’s credibility. It would inevitably raise 

questions as to the design of the IMF’s Greek lending programs 

and as to the IMF’s wisdom in loaning unprecedented amounts of 

money to Greece to keep it in the Euro at all costs, thereby putting 

the global taxpayer at risk. 

It will also be asked why the IMF did not foresee the depth of 

the Greek economic collapse as well as to what end was Greece put 

through years of austerity within a Euro straightjacket at the cost 

of sending its economy into the deepest of depressions when in the 

end it was forced to exit the Euro. 

Thank you, Mr. Chairman. 

Chairman KIRK. Professor Slaughter. 

STATEMENT OF MATTHEW J. SLAUGHTER, INCOMING PAUL 

DANOS DEAN, TUCK SCHOOL OF BUSINESS, DARTMOUTH 

COLLEGE 

Mr. SLAUGHTER. Chairman Kirk, Ranking Member Heitkamp, 

and fellow Members, thank you very much for inviting me to testify 

on these important and timely issues. My testimony will make 

5 

three main points about Greece, one focused on the short-term, one 

focused on the medium term, and one on the long term. 

In the short term, a Greek default would surely inflict additional 

pain on the Greek economy and on the broader world. One force 

driving the downturn would likely be the turmoil of reintroducing 

the Greek Drachma when there are no treaties, laws, or precedents 

for how to do this. The Greek contraction would dampen economic 

activity in Europe and, to a lesser extent, the rest of the world, as 

well. 

Through the usual linkages of international trade, however, this 

scale of dampening would be slight. The basic reason for this is 

that the Greek economy is quite small. Last year, Gross Domestic 

Product in Greece was about 240 billion dollars. This was only 

about one-third of 1 percent of worldwide GDP. In economic terms, 

Greece is only about the size of Louisiana or Connecticut, fine 

though those two States are. 

The one possible economic impact of a Greek default that might 

be quite important is the chance that default triggers another 

world financial crisis. There are sound reasons not to expect such 

a crisis. For example, today, the majority of Greek sovereign debt 

is owned not by banks, but rather by public entities. But, no one 

really knows what will happen in global capital markets if Greece 

defaults and/or exits the Eurozone. There is simply no historical 

precedent as a guide. 

Before Lehman Brothers died in 2008, wise voices intoned that 

a medium-size U.S. bank could do little damage. Those wise expectations were proven very wrong. No one can completely rule out 

such destabilization in the wake of a Greek default. 

In the medium term, a Greek default accompanied by an exit 

from the Eurozone would set a precedent that had been intended 

to be an impossibility, of a Eurozone member reverting to its own 

sovereign currency. The main advantage of currency unions like 

the Eurozone is, or so it is hoped by their creators, eliminating the 

possibility of the speculative attacks that have so often bedeviled 

fixed exchange rate regimes, like in the early 1990s turmoil in Europe’s exchange rate mechanism, which was a major impetus for 

creating the Euro in the first place. A ‘‘Grexit’’ would shatter the 

intended permanence of the Euro and would revive the possibility 

that Eurozone countries can print their own currencies. 

The pressures for additional exits would arise from two forces, 

potentially interrelated. One is investors demanding higher interest rates from countries they perceive to be possible exitors. The 

other is fringe political parties, already surging in countries such 

as Spain’s Podemos, that might follow poor policies. The combination of higher interest rates and all the related uncertainty could 

tend to depress economic growth in certain countries and thereby 

could trigger a dynamic not unlike that of Greece in recent years. 

And any future exits from the Euro would surely bring greater 

chances of triggering the financial crises described above because 

of how much larger and interconnected other countries are compared to Greece. Yes, a Grexit might not spark a crisis today, but 

what about an exit by larger Spain tomorrow or by an even larger 

Italy? 

6 

In the long term, a Greek default is largely irrelevant to the fundamental challenge still facing Greece and every other advanced 

country, how to foster growth of output, jobs, and incomes in societies with aging populations and looming entitlement pressures. In 

this sense, the default question is not the most important question 

facing Greece today. Rather, that honor goes to a different question: Who will be able to foster growth in Greece? 

For any country, long-run economic growth requires an ability to 

accumulate some combination of labor, of capital, and of productivity. What will ultimately create sustainable recovery and hope in 

Greece is growth in some combination of these factors. For example, Greece’s total population fell by about 200,000 over the past 

decade. Greece today is also saddled with very low levels of innovation and very low levels of research and development spending. 

Greece’s growth problems are a potent reminder to many other 

countries that poor policies today have consequences that can accumulate far into tomorrow, and those consequences are intensified 

when talent, capital, and ideas can easily move around the world 

to where they are welcomed and rewarded. 

Lest we all wag our fingers at Greece as uniquely profligate, 

keep in mind that the dynamic of slowing growth, aging populations, and looming entitlement pressures face many countries, including the United States, where productivity growth has slumped 

in recent years to many decade lows. In this sense of needing 

progrowth policies, we in America and in many other countries are 

not unlike Greece. 

In conclusion, wise leaders will reflect on Greece not as a unique 

outlier, but rather as a sobering leading indicator for the challenges that are approaching many advanced countries around the 

world, including the United States. 

Thank you again for your time and interest in my testimony and 

I look forward to answering any questions that you may have. 

Chairman KIRK. Dr. Reinhart. 

STATEMENT OF CARMEN M. REINHART, MINOS A. 

ZOMBANAKIS PROFESSOR OF THE INTERNATIONAL FINANCE SYSTEM, JOHN F. KENNEDY SCHOOL OF GOVERNMENT, HARVARD UNIVERSITY 

Ms. REINHART. Thank you, Chairman Kirk and Ranking Member 

Heitkamp, for the opportunity to comment on the crisis in Greece 

and its global ramifications. 

I will organize my remarks around three topics: Developments in 

Greece, the impacts of a Greek exit on the European economies, 

and the repercussions on the United States and global currency 

markets. My focus is on the near term. 

Greece—even if the Greek Government meets its obligations next 

week, the probability of a default over the summer looms large. I 

will focus on two reasons why default appears probable. 

First, there is a widespread loss of confidence in the sustainability of the status quo that has led to a sharp escalation in internal arrears. The private sector, concerned about the likelihood of 

an exit from the Euro, has increasingly defaulted on its existing 

debts. If credit cards are included, three-quarters of the loans in 

the banking sector are nonperforming. Tax payments are being 

7 

postponed. Citizens are hoarding Euros. Bank deposits have fallen 

around 45 percent since 2009. Banking sector is near a bank holiday. The Government is financing itself by not paying its bills, 

similar to what transpired ahead of the Russian default of 1998 or 

Argentina 2001. Government deposits in banks are off around 40 

percent. 

Second, the 1.6 billion payment due to the IMF next week is only 

a fraction of the amounts that are coming due in the next 3 

months, 20 billion Euro, approximately, some of that to the private 

sector, largely to the official sector. These payments are a multiple 

of the cash balances of the central Government and even a multiple 

of the cash balances of general Government. 

Implications for Europe. In my work on contagion, I found that 

fast and furious financial contagion is more likely when the triggering crisis takes investors and Governments by surprise. There 

is no surprise here. The Greek drama has been unfolding over 

years and private sector exposure to Greece, as has already been 

mentioned, has declined sharply. Prior to the crisis, most Greek 

debt was held by private external creditors. Such financial links 

significantly increase the odds of spillovers. Since then, however, 

official creditors have absorbed the Greek debts. 

Real-side exposure to Greece via trade, which is another channel 

of transmission, as noted, is not a new factor. Greek GDP has already contracted by about 25 percent, and imports, Greek imports, 

have fallen by even more. 

Now, whether investors become indiscriminate and pull out altogether of other European periphery countries remains a risk. However, I would argue that this risk is mitigated by the fact that also 

a significant share of sovereign periphery debt is in official hands, 

especially for Portugal and Ireland, and also in the event of such 

a shock to periphery Europe, I think the official community would 

support them. 

The U.S. The effects of a Grexit on the United States are, in my 

view, likely to be limited. Financial exposure, which was marginal 

in the first place, is not a source of concern for financial institutions. Nor is the Greek market a major destination for U.S. exports. 

Now, predicting currency fluctuations is an elusive goal for 

economists, so take my observations with a dose of skepticism. If 

a Greek default triggers turmoil in Europe, we would expect to see 

a flight to safety into U.S. dollar assets, notably Treasuries. This 

has been the response in past waves of global volatility. Further 

appreciation in the dollar vis-a-vis the Euro and most other currencies would follow. The potential adverse effects of an appreciating dollar would be felt by U.S. manufacturing, not unlike the 

impact seen already this year. 

An appreciating dollar may also act as a headwind in the Fed’s 

efforts to withdraw monetary stimulus and normalize monetary 

policy. Emerging markets, which we have not mentioned, with dollar denominated debt, would be increasingly vulnerable to further 

dollar appreciation, as well. 

Greece is close right now to financial autarky. The gap between 

what is a de jure default and a de facto one has narrowed. The 

8 

next stage in this crisis may have limited immediate consequences 

for the global economy. 

Thank you. 

Chairman KIRK. Thank you. 

Dr. Kirkegaard. 

STATEMENT OF JACOB FUNK KIRKEGAARD, SENIOR FELLOW, 

PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS 

Mr. KIRKEGAARD. Chairman Kirk, Ranking Member Heitkamp, it 

is a pleasure for me to appear before you to testify on the global 

impact of what I will say is still a hypothetical Greek default. 

In my oral testimony, I will focus on three issues: The near-term 

situation in Greece; the political nature of the Greek debt structure; as well as the implications of a default on Euro membership 

and the rest of the global economy. 

The current situation in Greece remains in limbo. Negotiations 

between Greece and the Troika are ongoing and will continue into 

the weekend. There is, as a result, some risk that Greece will go 

into arrears against the IMF as early as next week. 

However, it remains, in my opinion, a near certainty that an 

agreement between the Greek Government and the Troika will 

eventually be found in the coming weeks. The principal question is 

really whether reaching an agreement will require a brief period of 

restrictions on deposits in the Greek banking sector or not. Consequently, as things stand now, in the unlikely event that there is 

no agreement by Sunday evening, we should not, in my opinion, expect Greek banks to open normally on Monday. 

The political effects of deposit access control on the Greek economy and financial system would likely be dramatic, and in all probability, in a matter of a few days, lead to significant or sufficient 

domestic political pressure on the Government to reach an agreement with the Troika. 

Given that the Euro area has sufficient retained profits from the 

security markets program available for potential immediate release, that means without the need to consult national parliament 

in the Euro area, to the Greek Government in the event an agreement is being reached, any arrears run-up against the IMF would 

be quickly settled. In my opinion, therefore, any actual default by 

the Greek Government in the coming days would be of very short 

duration, measured in only a few days. 

Substantial amounts of political brinkmanship are currently 

being utilized to achieve a negotiated outcome consisting of a quid 

pro quo agreement between Greece and the Troika of reforms, fiscal consolidation, in return for ongoing financial support. This ultimate ability to find a political agreement with the Greek Government is of the utmost importance, as it suggests that the Greek 

Government debt levels are today and will most likely in the future 

remain sustainable, despite the country’s extremely high gross 

Government debt levels and uncertain future growth prospects. 

This conclusion follows from the particular current structure of 

Greek Government debt, which is overwhelmingly owned by the 

other Euro area Governments and the IMF, while remaining privately held debt is structured at very long maturities with low 

nominal interest rates. Consequently, the cost of servicing and, 

9 

therefore, the financial sustainability of Greek Government debt is 

largely unrelated to the size of the gross debt or, indeed, financial 

market fluctuations. Greece already has a substantially longer debt 

maturity profile and substantially lower implied rates of interest 

on its debt than, for instance, does the United States Federal Government. 

Rather, Greek debt sustainability and ability to avoid a future 

default is dependent on principally two things: The Greek Government’s ability to restore economic growth in the country, or, in 

other words, the continuation of growth-friendly structural economic reforms; and the country’s ability to reach an ongoing political agreement with its official sector creditors in the Euro area 

and the IMF. 

Unlike the rules-bound IMF, the Euro area, which has already 

been done in June 2011, March 2012, and November 2012, has the 

political freedom to ex post restructure its holdings of Greek Government debt in a manner sufficient to maintain debt sustainability for the country and closely calibrated to the preceding degree of Greek Government delivery of agreed structural reforms 

and fiscal targets. In short, Greece is and will remain solvent if its 

own Government and the Euro area wants it to be. 

Now, in the event that a Greek Government nonetheless does default, it will quickly prove an economic disaster for the country, as 

it loses not only ECB banking sector liquidity support, ongoing financial support from the Troika, but also net ongoing budgetary 

transfers from the EU budget consisting to roughly about 3 percent 

of GDP on an annual basis. 

At the same time, it is important to recognize that any default 

by Greece will not likely lead to an exit from the Euro area as 

there, first of all, is no public support for such a momentous decision in Greece, and under any scenario it likely will prove impossible for the Greek Government to successfully reintroduce a new 

national currency side-by-side with the Euro. Rather, in my opinion, the country risks ending up a little bit like the country of Montenegro, which unilaterally Euro-ized its economy in 2002 in a 

manner similar to, for instance, how Ecuador and El Salvador have 

fully adopted the United States dollar. Attempts at implementing 

a Grexit, therefore, will de facto mean that Greece will only leave 

the institutions of the Euro area and the EU, not the currency 

itself. 

Finally, let me quickly note that Greece is a small country consisting of only 1.8 percent of Euro area GDP, and, therefore, as a 

result of also improving Euro area economic performance, a more 

resilient institutional structure in the Euro area, and not least, additional likely ECB monetary stimulus in the event of a default by 

Greece, any cross-border contagion spillover is likely to be contained. As a result, therefore, a hypothetical Greek default does not 

pose systemic risks to either the Euro area or the global area at 

large. 

Thank you very much. 

Chairman KIRK. Let me ask the first question to the panel. I 

wanted to ask you what we would call in the John McLaughlin 

days the mega-question. How likely is the Greek crisis to actually 

hurt the U.S. economy, in your view? 

10 

Mr. KIRKEGAARD. Well, following from my testimony, I believe 

that probability is very, very low, because I do not believe, as I 

said, that there will be a default by Greece, but rather that—— 

Chairman KIRK. Let me follow up on that. Understand this crisis 

right now is a crisis of Greece being unable to repay the IMF 1.7 

billion dollars that they owe on the latest 25 billion dollar loan that 

the IMF extended to Greece, and that payment is due on June 30. 

To fuzz over the differences, I think IMF will declare that Greece 

is in arrears. They will not use the ‘‘d’’ word, which might be too 

alarming. Is that what we are facing? 

Mr. KIRKEGAARD. In my opinion, that is correct, yes, and I think 

running into arrears against the IMF does not, in my opinion, have 

any implications, really, for the short-term operation of the IMF. 

You know, we are basically—and this is in my written testimony— 

it will merely—merely, I say—double the current outstanding arrears that the IMF memberships to the institution so that we go 

back to levels of actual arrears by the membership at the IMF that 

we saw last in the early 1990s. So, it would not be an unprecedented situation, by any means. 

Chairman KIRK. If we look at the forward commitment authority 

for the IMF to be able to take on further and make other loans, 

my understanding, they have about 421 billion dollars left in their 

forward commitment authority. Is there any chance that a European crash that could wipe out IMF’s forward commitment authority, basically making them unable to respond in a major way to a 

big crisis? 

The thing that I worry about is—you guys are far more expert 

on this. I remember in the Mexico crisis when the Mexican collapse 

was so big that it exceeded the abilities of the international financial institutions to help out. And, you can correct me if I am wrong. 

I remember it was the U.S. Fed that had to step in directly. Is that 

wrong? 

Mr. KIRKEGAARD. [Off microphone.] 

Chairman KIRK. Yeah. At that point, we would think that in the 

case of contagion or collapse, then the U.S. exposure is high. 

Ms. REINHART. I do not really see the U.S. exposure in the current context as being high on the financial side or on the real side. 

I think the greatest risk are those that some of us have already alluded to, which is another round of dollar appreciation in the context of a flight to U.S. assets. 

Chairman KIRK. Just let me point out that I mentioned the case 

of official debtors like Stockton, California, and Detroit, Michigan, 

and the State of Illinois, and the Chicago Public School System. 

How much does this Euro problem interfere with municipal and 

State debt overhanging the bond market in the United States? 

Ms. REINHART. I am not an expert on the municipal market or 

the subsovereign debt, but the parallel—there are important parallels and differences. The biggest difference is, of course, no State 

in the United States is facing the bank runs prospects that Greece 

currently has. The biggest parallel is the need to avoid the hidden 

debts or the arrears which are a major issue internally in Greece 

now. So, technically, one could say, Greece has domestic default already. 

11 

Chairman KIRK. Desmond, I would note that under U.S. bankruptcy law, a United States State cannot declare bankruptcy. There 

is no provision in our code. 

Mr. LACHMAN. Yes. Let me just say that I do not share the sanguine view being expressed that this does not have the potential 

to cause real problems for the United States, not immediately, but 

down the road. We are talking about something hugely significant, 

is that one member of the Euro could be leaving the Euro as a currency. That shows that the Euro does not last forever, and that can 

throw focus in times of different liquidity conditions on a country 

like Italy that has 2.5 trillion dollars of debt. It is the third-largest 

debtor, and by any means, Italy’s debt is not sustainable. This is 

a country that has not grown for 15 years. It has got a debt-to-GDP 

level of 135 percent. 

In regard to your question on the municipal market, what has to 

be of concern is that these Greek events are playing out at the 

same as events are playing out in Puerto Rico. Puerto Rico has 73 

billion dollars of debt. It is going to have payments due in July to 

its electric company. It has got other payments to the National 

Bank in September. Markets are thinking that the chances of Puerto Rico making these payments are very slim. So, what you could 

get is you could get two big bankruptcies playing simultaneously, 

and I do not think any of us knows how that might affect the municipal market, but it is an event that I do not think we can just 

gloss over. 

Mr. SLAUGHTER. Senator—— 

Chairman KIRK. When you mentioned Puerto Rico, you are now 

kind of scaring me a bit. I was just watching the European situation. If we look at the market and how it would see a Puerto Rican 

default around the same time of a Greek default, do you have potential contagion there? 

Mr. LACHMAN. Yes, that markets—you know, that you think that 

there is going to be a repricing in the markets. You know, that is 

just looking at the electric company in Puerto Rico, that has alone 

got nine billion dollars of debt. That is a bigger default—would be 

a bigger default than was for Detroit. You know, you have got another 73 billion dollars there. So, markets—this is widely held, and 

it looks like that is another intractable situation. 

Mr. SLAUGHTER. Senator, if I could add to that, the one thing 

that is not known well is when you start to think about these capital market price changes, who owns what assets and whether it 

is a pension fund or a hedge fund or a particular bank, how leveraged they might be. I think a common theme here is through the 

usual flows of international trade in goods and services, there is 

not that large of a risk to the U.S. economy. The small probability 

of a potentially very large risk comes through these capital market 

linkages. 

Chairman KIRK. Anybody else? Desmond Lachman. 

Mr. LACHMAN. I think I would add that I very much agree with 

Carmen that the usual channels of contagion might not be in play 

immediately in the case of Greece, but you do have problems with 

bank deposits that could be moving on a big scale. You know, if one 

sees that the Greek bank depositors lose their money, that the European Central Bank was not there to backstop them, you would 

12 

expect that deposits will start leaving the other countries in the periphery, namely Italy and Spain, and that could cause a huge problem. So, contagion can take place in different ways in this crisis. 

I am not expecting this to occur immediately, but just looking at 

Europe with all of its political problems, with a series of elections 

the next 6 months, I do not think that one can dismiss the chances 

that something could go very wrong. 

Chairman KIRK. Ms. Heitkamp. 

Senator HEITKAMP. Thank you, Mr. Chairman. 

You know, there is an old expression, do not go looking for trouble. Trouble will find you. And, I think, in part, we are in that spot 

where what we look at when we look at numbers is that this is the 

chance of catastrophic contagion in the near term. Certainly by the 

majority of testimony here, it does not exist. 

I am intrigued by the dollar value, which has obviously a very 

dramatic impact on any State that produces commodities and relies 

on exports. We are already challenged in the export area because 

of a high dollar value. I am intrigued by that. 

I have been thinking all along about this hearing and about the 

significance of trying to track the impact on the American economy, 

and it seems to me that of all the things that I have heard today, 

that is probably the thing that raises the—again, another rush to 

a safer currency, a safer economy, which is right now the American 

economy. 

But, Dr. Kirkegaard, if I can ask you to kind of respond to some 

of what you have heard here as it relates to the immediate impact. 

I know you have already testified, but if you were going to look 

more than the near term, which is a lot of what the discussion that 

we have had, and look down the road a couple years into the future, what needs to change to stabilize the overall Eurozone, but 

particularly those economies like Greece that are challenged at this 

point with low growth rates? What do we need to do? 

Mr. KIRKEGAARD. Well, I think, first of all, what Greece needs to 

do is to avoid defaulting, because if it defaults, it will lose access 

to the European Central Bank very quickly, as I said. If there is 

no agreement over the weekend, I will predict you will have deposit 

controlled in the country, which sets in motion another very, very 

dramatic economic decline. 

Senator HEITKAMP. And as we have heard earlier from earlier 

testimony on this panel, we are already seeing some of that flow. 

We are already seeing some of that withdrawal from regular banking institutions, correct? 

Mr. KIRKEGAARD. Yes. But, I will stress, though, that in some 

ways, in my opinion, what is actually remarkable is that there is 

still by the latest data approximately 120 billion Euros left in the 

Greek banking system and it has not—we have not seen deposit 

withdrawals in any of the other Euro area countries. 

And, I must say that I am personally quite skeptical that we will 

see this, even in the event that there is a Greece default, because 

I think as we look forward, we have to recognize that this will be 

a very dramatic and traumatic experience for the Greek economy 

and the Greek population, despite that they have already, of 

course, suffered tremendously. If they default, things will get a lot 

worse. 

13 

But, if you are looking at Greece in other countries, and I mean 

Podemos and other political movements in Spain and elsewhere 

were mentioned, we have to ask ourselves, what is the lesson that 

you then draw from events in Greece? Is it that you should follow 

the policies of the current Government and take your country into 

such a catastrophic path? I would argue that it is not, that, in fact, 

if Greece is going to default, which, as I said, is not what I think 

will happen, but were to happen, I think other populations in Europe will look at that and they will draw the conclusion that this 

is not the right way to go. So, I think we should be very careful 

in over-dramatizing the political contagion from current events in 

Greece. 

And, I would also say that the sometime expressed notion that 

if Greece were to leave the Euro area, it would automatically turn 

the Euro into a so-called fixed exchange rate regime, which is, of 

course, a much brittler or less solid entity I also believe to be conceptually flawed, because what we are looking at here is actually 

not the collapse, inevitable collapse of the Euro area following one 

country’s exit, but it is actually rather the difficulties, as I alluded 

to in my initial testimony, of Greece actually succeeding in introducing a new currency, because the Euro will still be there and you 

are trying to institute a new currency, the new Drachma or whatever we call it, side by side with the Euro. 

And, I do not think the current Greek Government is going to be 

able to institute anything, any new currency, that actually retains 

the function as a store of value in that currency—— 

Senator HEITKAMP. Right. 

Mr. KIRKEGAARD. ——which means that we are not looking, 

therefore, from experiences from previously collapsing currency 

unions, you know, the Soviet Union or Yugoslavia or things like 

that, but, rather, we are looking at something which has not happened before in history. As far as I know, there is no example of 

a country that have fully dollarized, for instance, and actually reversed that decision. 

Senator HEITKAMP. OK. I think those are all important parts. 

And, if I can just make another point from the original panel’s 

testimony. Dr. Slaughter, I think you mentioned the lack of innovation, the lack of investment in, you know, aging populations, the 

lack of investment in research and development, and part of that 

is driven by this immediate move toward austerity. And, so, when 

we look at the austerity measures, it is kind of, like, where is the 

appropriate balance? Obviously, we all know that in a spending crisis, in a fiscal crisis, you need to make those adjustments. But, one 

of the things that you said that concerns me is the amount of GDP 

that is spent in investment and the things that we normally say 

will be leading indicators for growth in the future. 

Looking at this, what is happening in Greece and looking across 

kind of all the economies, how do you measure that balance between austerity and fiscal responsibility? 

Mr. SLAUGHTER. Great question, Senator. I think a couple things 

come to mind. One is, and it connects with your earlier question 

about what happens in the next year or two, in some basic sense, 

I think, part of the challenge for Greece is of its elected and appointed Government officials, all of their time and energy and then 

14 

some is spent kind of day to day with the crisis issues that we have 

been speaking to here. And I think the policy issues that speak to 

more sustainable economic growth—no fault, but an observation— 

simply are not being talked about there. 

So, what ideally would happen in the near term of the next couple years is some regulatory form would be put into place by the 

Greek parliament to introduce private capital, in particular, to help 

stimulate some of the research and development and economic activity that we are talking about. 

To their credit, Greece has made some substantial progress on 

this in the past couple years despite the crisis. So, the World Bank 

has—it is doing business rankings that it assembles. Greece’s position in the World Bank’s doing business rankings has risen from 

109 in 2011 to 61 today, one of the largest increases of any country 

on the planet. So, they have made some progress, and many countries in Europe and elsewhere think of the Irish experience over 

the past 30, 40 years. A lot of the growth in jobs and opportunity 

come from international investors coming in to build new businesses, to make those investments in jobs. 

So, you have got agriculture, you have got tourism, you have got 

some industries in Greece that have more potential, and hopefully, 

that is something that will flourish more in the years ahead. 

Senator HEITKAMP. Well, and that is the challenge, not destabilizing the economy to the point that you cannot attract—— 

Mr. SLAUGHTER. Exactly. 

Senator HEITKAMP. ——international investment—— 

Mr. SLAUGHTER. Exactly. 

Senator HEITKAMP. ——and there we are. 

Mr. SLAUGHTER. Yes. 

Senator HEITKAMP. And, I only say this, not that it is our job 

here in the U.S. Congress to try and help Greece achieve the appropriate balance, but I think in a much smaller scale, we are in that 

same discussion here with the American economy, which is how do 

we—with sequestration, which is a form of austerity—— 

Mr. SLAUGHTER. Right. 

Senator HEITKAMP. ——how do we make those appropriate balances. And, so, it is informative and I really appreciate your testimony. I thought it was very timely and topical and important to 

hear. 

Chairman KIRK. Thank you. 

Senator HEITKAMP. I think Dr. Lachman—— 

Chairman KIRK. Let me ask Desmond, who was about to jump 

in here—— 

Senator HEITKAMP. Yes. 

Chairman KIRK. If you look at this chart, you will see the debt 

list through 2055. Do we look at a grim long-term future of almost 

no economic growth in this market overhung by debt? 

Mr. LACHMAN. Yes. Greece’s debt, you know, the level that it has 

reached, now it is 175 percent of GDP. By any measure, the country is insolvent. It really needs debt relief of one sort or another. 

You need not write down the face value. You could extend the maturities 100 years and give them interest rates of zero, you would 

get the same kind of effect. 

15 

But, the point I just wanted to make on fiscal austerity, which 

I think is really crucial and it is the lesson of Greece, is that it is 

very difficult to balance one’s budget to bring down big deficits 

when you are in a fixed exchange rate system and you do not have 

monetary policy that is an offset to the fiscal tightening. So, what 

has occurred in Greece is that they have tried to tighten the budget, but they cannot devalue the currency to boost exports or to 

pump money into the system to offset the effect of the belt tightening, and that has proved to be counterproductive. 

And, my fear is that the kind of policies that they are discussing 

with Greece right now are very much more of the same. They are 

looking for as much as 2 percentage points of GDP or fiscal adjustment over the next 12 months and another 4 percent of GDP over 

the medium term and they are going to be again doing it in a European Euro straightjacket that does not allow it to—an offset, and 

that is, I think, a very big difference than our situation in the 

United States. I am not saying that getting the budget into balance 

is an easy thing in the United States, but it is a lot easier if you 

have got a Federal Reserve that is pumping money into the system, 

cheapening the dollar, making this thing possible. 

Senator HEITKAMP. So, it is a lot easier when you control both 

the fiscal policy and the monetary policy. 

Mr. LACHMAN. Absolutely, that if you are trying to do this—if 

you are just putting your foot on the brake and the car already is 

slowing down at a rapid rate, and, you know, you talk about a 

country that has had GDP declining by 25 percent and they have 

not brought down their debt, it has been counterproductive, what 

they have been doing. 

Senator HEITKAMP. I think, Dr. Reinhart, you had a comment 

you wanted to make. I could see you kind of leaning in there. 

Ms. REINHART. One piece of information that I think is relevant 

to this discussion is we are treating the Government in Greece as 

if what the Government will do. We really have little idea what the 

Government may be. Argentina had five different Governments 

within a year-and-a-half during its major crisis. So, that is another 

source of uncertainty. And, so, I think that the larger issue of restoring growth is also very, very deeply rooted to all the levels of 

uncertainty that we are dealing with, not just economic, but political, as well. 

Chairman KIRK. Dr. Reinhart, let me follow up by talking about 

the foreign policy implications here. When we look at Russia and 

her position as a creditor, does she have a significant ability to 

come in as a white knight asking for ridiculous things, like 

Greece’s departure from NATO or something like that? Do they 

have that flexibility? 

Ms. REINHART. Russia has its own significant—significant, let me 

reiterate—economic problems. They have lost a massive amount of 

reserves. They still have quite a reserve stockpile, but they are in 

deep recession. The ruble depreciation has not really helped them, 

given sanctions, given oil prices. And, I would say that if we were 

to look back to what position Russia was in 3 years ago, that might 

have been the case. But, I think, in the current context, I do not 

see them giving away their precious reserves, or what remains of 

them, to assist the Greek Government. 

16 

Chairman KIRK. Dr. Lachman. 

Mr. LACHMAN. I am not sure that the Greek Prime Minister 

shares that view, because otherwise, I am not sure what he is 

doing so frequently in Moscow, talking about building of a pipeline 

that is going to go through Greece to take the gas, talking about 

possible loans from Russia. Russia has got a lot in this game, is 

that Greece is a member of Europe and in order for Europe to 

maintain sanctions on Greece—on Russia, they need Greece’s consent. So, there is a trade in the making and the Russians will play 

a long game. 

Russia right now is hurting because the price of oil is where it 

is, but one does not know whether the price of oil is going to stay 

here for a long time and Russia will play a long game with the 

Greeks. I am not sure that we should just disregard what can occur 

in so strategic a part of the world as the Balkans. 

Senator HEITKAMP. Dr. Kirkegaard. 

Mr. KIRKEGAARD. I think I would just strongly support what Carmen said, which is that Russia does not have the financial capacity, in my opinion, to really provide the kind of financial assistance 

that Greece would need if it were to default against its current 

Troika members, because it will lose literally hundreds of billions 

of Euros in liquidity support from the European Central Bank, and 

that kind of money, Vladimir Putin does not have. 

And, I would also say that with respect to the sort of ongoing diplomacy that we see, I regard it as politically not very wise of the 

Greek Prime Minister to fly to Moscow that often. But, if we look 

back at previous instances of this kind of flirtation between European countries and the Russian Government, we say it in Cyprus 

in 2013, where the then-Cypriot president tried to fly to Moscow 

and ask for—and this was when Vladimir Putin was in a much better financial position to provide that support—and ask for Russian 

money rather than take a Troika bailout and he got nothing. So, 

I would very strongly caution that actually Vladimir Putin is going 

to put any money into this. I do not think he is going to do that 

under the current circumstances. 

And, therefore, this geopolitical threat that Russia poses in 

Greece, I think it should also be kept in mind that the EU sanctions were, in fact, extended by 6 months just a few years—a few 

days ago during a process in which the Greek Government did not 

pose any problems of any kind actually at the negotiating table. 

And, so, I think this is a little bit getting ahead of ourselves if we 

think there is a real risk here. 

Chairman KIRK. Well, I would like to thank all of our witnesses 

very much for everybody coming. I thank my Ranking Member for 

participating in what has been a very good hearing to make sure 

the markets are not surprised and we can limit contagion in this 

problem. 

With that, I would like to adjourn here. 

[Whereupon, at 2:30 p.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

17 

PREPARED STATEMENT OF DESMOND LACHMAN 

RESIDENT FELLOW, AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH

JUNE 25, 2015 

Thank you Chairman Kirk, Ranking Member Heitkamp, and Members of the Subcommittee for affording me the great honor of testifying before you today. My name 

is Desmond Lachman and I am a Resident Fellow at the American Enterprise Institute. I am here in my personal capacity and I am not here to represent the AEI’s 

view. 

Introduction 

Recent economic and political developments in Greece suggest that it is only matter of time before that country both defaults on its large public debt and imposes 

capital controls. Those developments could very well pave the way for Greece’s exit 

from the Euro within the next 12 months. Were that to occur, one must expect that 

Greece’s economic and political crisis will deepen, which could lead to that country 

becoming a failed State. 

Europe is in a very much better position today than it was in 2012 to handle the 

immediate fallout from a Greek exit. However, a number of countries in the European economic periphery continue to experience weak economic growth at a time 

that they still have very high public and private sector debt levels. This makes them 

especially vulnerable to swings in investor sentiment once global liquidity conditions 

are normalized and once the perception becomes widespread that Euro membership 

is no longer irrevocable. 

The implications of a Greek default for the United States are not to be underestimated. Immediate action by the European Central Bank (ECB) to limit contagion 

to the rest of the European periphery must be expected to further significantly 

weaken the Euro against the dollar that could have a material impact on the U.S. 

trade balance. From a longer term perspective, should market financing for a country as highly indebted as Italy dry-up in the wake of a Greek exit, one should expect 

renewed tensions in global financial markets that could constitute a significant 

headwind to the U.S. economic recovery. In addition, were Greece to become a failed 

State, a geopolitical price might be paid in the sense that Russia would have an 

opportunity to gain a firmer foothold in the Balkans. 

A deepening of Greece’s economic and political crisis would further dent the credibility of the IMF, which has provided major financial support to Greece over the 

past 5 years and which has consistently underestimated the depth of the Greek economic depression. It could also result in Greece’s defaulting on the US$24 billion 

it owes to the IMF, which could have implications for the U.S. taxpayer. 

18 

Greek Economic and Political Backdrop 

Over the past 6 years, Greece has experienced an economic depression on the 

scale of that experienced by the United States in the 1930s. Its economy has contracted by around 25 percent, its unemployment rate has exceeded 25 percent, and 

its youth unemployment has risen to over 50 percent. At the same time, despite 5 

years of budget austerity and a major write-down of its privately owned sovereign 

debt, Greece’s public debt to GDP ratio has risen to 180 percent. 

19 

At the heart of Greece’s economic collapse has been the application of draconian 

budget austerity within a Euro straitjacket. That straitjacket has precluded exchange rate depreciation or the use of an independent monetary policy as a policy 

20 

offset to the adverse impact of budget belt-tightening on aggregate demand. To its 

credit, the IMF has conceded that in designing its economic program for Greece it 

had grossly underestimated the size of the Greek fiscal multipliers. 

The deterioration in Greece’s economy has given rise to the fragmentation of its 

politics and to a major anti-austerity backlash. This has been underlined by the decline in support for, Greece’s two establishment political parties, New Democracy 

and PASOK from 70 percent in 2010 to around 25 percent at present. It has also 

been underlined by the rise of extreme political parties on both the right and the 

left side of the political spectrum as well as by the coming into office of the far-left 

Syriza Government in January 2015. That Government came into office on a platform of reversing the policies of budget austerity and structural economic reform 

that have been imposed on Greece by the IMF and Greece’s European partners. 

Negotiations With Its Creditors 

Over the past 5 months, the Syriza Government has been engaged in difficult negotiations with the IMF and EU on the release of much needed funds from its borrowing arrangement with those institutions. Until very recently, those negotiations 

have been characterized by large differences in positions over additional budget austerity and over pension and labor market reform that Greece’s creditors are demanding of Greece in return for the release of those funds. 

Since end-2014, in an atmosphere of heightened political uncertainty, Greece’s 

economy has taken a renewed downturn while its public finances have moved from 

a small primary budget surplus to a primary budget deficit. At the same time, the 

Greek banking system has experienced a slow run on its bank deposits. These deposits have now fallen by around 20 percent since the start of the year and have 

required substantial European Central Bank support to keep the Greek banking 

system afloat. 

This week the outlines of an agreement between Greece and its official creditors 

finally appears to be emerging that could release the funds so desperately needed 

to avoid a Greek default on the IMF and the ECB. However, it is highly questionable how long such an agreement will last. An essential component of that agreement appears to be yet another 2 percentage points of GDP in fiscal tightening over 

the next year and as much as 41⁄2 percentage points of GDP in tightening over the 

medium term. A further weakness of that agreement is that it relies almost exclusively on tax increases to achieve its budget objectives and that it sorely lacks either 

pension or labor market reform that are much needed to promote economic growth. 

21 

If past is prologue to the future, such an amount of budget tightening in a Euro 

straitjacket and such a high reliance on tax increases is almost certain to deepen 

Greece’s economic depression. That in turn again risks putting the country’s budget 

objectives out of reach. It also risks splitting the Syriza Party, which is already divided on the question of persisting with budget austerity and structural economic 

reform. 

Containing Contagion 

Europe is in a very much better position today than it was in 2012 to handle either a Greek default or a Greek exit from the Euro. It now has in place a EUR 500 

billion European Stability Mechanism that can provide adequate financing to any 

Eurozone member that might come under market pressure. More important yet, the 

ECB now has in place an Outright Monetary Transaction facility that should allow 

it to do ‘‘whatever it takes’’ to maintain market stability in the event of a Greek 

exit. This should enable European policymakers to ring-fence the initial fallout from 

any eventual Greek exit, albeit at the probable cost of having to resort to the ECB’s 

printing press. 

While European policymakers now appear to be well-equipped to handle the immediate fallout from a Greek exit, they do not appear to be so well positioned to 

deal with the longer run damage that a Greek exit might cause to the Euro project. 

A Greek exit would signal very clearly to markets that Euro membership was no 

longer irrevocable. In addition, in the wake of large losses by Greek bank depositors, 

it would become apparent to bank depositors in the rest of the European economic 

periphery that the ECB was not always there to backstop the safety of such deposits. 

Heightening the longer-run risks of a Greek exit on the rest of the European periphery, is the fact that the periphery is now characterized by significantly higher 

levels of public debt to GDP ratios than in 2012. It is also of concern that these 

countries remain characterized by very low growth rates and by price deflation, 

which makes it very difficult for these countries to grow their way out from under 

their debt mountains. In that respect, it does not help that countries in the economic periphery are all experiencing political backlashes against further budget 

austerity and structural economic reform. 

Italy’s present position is particularly disturbing considering that the country has 

more than US$21⁄2 trillion in public debt, making Italy the world’s third largest sovereign debt market. Whereas at the start of the debt crisis in 2010, Italy’s public 

22 

debt to GDP ratio was 115 percent, today that ratio is around 135 percent. Meanwhile, since 1999 the Italian economy has shown no growth. It should perhaps come 

as no surprise that all of Italy’s major political parties, other than the governing 

Democratic Party are now opposed to Euro membership. This is bound at some 

stage to turn the market’s focus on Italy’s shaky public debt dynamics. 

Implications for the United States 

Over time, a Greek exit could impose considerable economic and geopolitical costs 

on the United States. This could occur through the following three channels: 

a. In the immediate aftermath of a Greek exit, one must expect a significant further depreciation of the Euro as the ECB took more forceful measure to prop 

up the European periphery and as investors fled to the safety of the dollar. 

This would have the effect of causing a further effective appreciation of the dollar that would come on top of a 15 percent such appreciation over the past 

year. As the Federal Reserve has noted, a strong dollar appreciation could constitute a significant headwind to the U.S. economic recovery and could exert 

significant downward pressure on U.S. headline inflation. 

23 

b. Any eventual spread of the Eurozone debt crisis to other countries in the European periphery, like Italy, Portugal, and Spain, could roil global financial markets and dent European household and investor confidence. This would be 

bound to impact the U.S. economic recovery considering how integrated is the 

global financial system and how important the European economy is to U.S. 

trade. 

c. Should a Greek exit lead both to a souring of European-Greek relations and 

to the further erosion of Greek political stability, one could see a failed Greek 

State increasingly coming into the Russian orbit. Already the Syriza Government is actively engaged with Moscow about the construction of a Russian gaspipeline through Greece despite the U.S. Administration’s objections. A deepening of the Greek economic crisis is all too likely to bring Athens and Moscow 

closer together. 

Consequences for the IMF 

A Greek exit would have considerable implications for the IMF’s credibility. It 

would inevitably raise questions as to the design of the IMF’s Greek lending programs and as to the IMF’s wisdom in loaning unprecedented amounts of money to 

Greece to keep it in the Euro at all costs. It will also be asked why the IMF did 

not foresee the depth of the Greek economic collapse as well as to what end was 

Greece put through years of austerity within a Euro straitjacket at the cost of sending its economy into a deep depression, when in the end it was forced to exit the 

Euro. 

24 

A Greek exit is also likely to involve Greece defaulting on the US$24 billion that 

the IMF has loaned to it. This would be of considerable concern considering that 

Greece together with Portugal and Ukraine account for around two-thirds of the 

total IMF loans presently outstanding. This will make it difficult for the IMF to 

make the case to Congress that U.S. taxpayer money was not put at considerable 

risk by the IMF’s lending practices. 

25 

1 In the past 2 years, I have not received any Federal research grants. In addition to the 

above Tuck positions, currently I am also a Research Associate at the National Bureau of Economic Research; an adjunct Senior Fellow at the Council on Foreign Relations; a member of the 

advisory committee of the Export-Import Bank of the United States, a member of the academic 

advisory board of the International Tax Policy Forum; and an academic advisor to the McKinsey 

Global Institute. For many years I have consulted both to individual firms and also to industry 

organizations that support dialogue on issues of international trade, investment, and taxation. 

Continued 

It will also make it difficult for the IMF to defend its ‘‘exceptional access’’ lending 

policy that in effect removes limits on how much money the IMF can loan to an individual country. This will be particularly the case considering that over the past few 

years, very large scale IMF lending to Greece forestalled much needed debt restructuring in that country. In the process, it facilitated the exit of private sector creditors from that country by placing the global taxpayer very much on the hook in the 

event of a Greek default. 

PREPARED STATEMENT OF MATTHEW J. SLAUGHTER 

INCOMING PAUL DANOS DEAN, TUCK SCHOOL OF BUSINESS, DARTMOUTH COLLEGE

JUNE 25, 2015 

Introduction 

Subcommittee Chairman Kirk, Ranking Member Heitkamp, Committee Chairman 

Shelby, Ranking Member Brown, and fellow Members, thank you very much for inviting me to testify on these important and timely issues of how a default by Greece 

on its sovereign debt would impact the United States and overall global economy. 

My name is Matt Slaughter, and at the Tuck School of Business at Dartmouth 

I am the incoming Paul Danos Dean, the Earl C. Daum 1924 Professor of International Business, and the founding Faculty Director of the Center for Global Business and Government. From 2005 to 2007 I also served as a Senate-confirmed Member on the President’s Council of Economic Advisers, where my international portfolio spanned topics such as currencies, international trade and investment, and the 

competitiveness of the U.S. economy. 1 More recently I was a founding member of 

26 

For a listing of such activities, please consult my curriculum vitae posted on my Web page maintained by the Tuck School. 2The book our Group coauthored that discusses the challenges in understanding and aiming 

to prevent financial crises is The Squam Lake Report: Fixing the Financial System, with Kenneth R. French, Martin N. Baily, John Y. Campbell, John H. Cochrane, Douglas W. Diamond, 

Darrell Duffie, Anil K. Kashyap, Frederic S. Mishkin, Raghuram G. Rajan, David S. Scharfstein, 

Robert J. Shiller, Hyun Song Shin, Matthew J. Slaughter, Jeremy C. Stein, and Rene M. Stulz; 

Princeton University Press, June 2010. 

the Squam Lake Group, a nonpartisan group of 15 academics who came together 

to offer guidance on reform of financial regulation amidst the World Financial Crisis. 2

At the time of writing this testimony, the outcome of the latest chapter of the 

Greek-debt saga is still being written. Prime Minister Alexis Tsipras has just flown 

to Brussels to meet with fellow Government leaders, at least some of whom have 

objected to his latest compromise offer. There are many fluid and undefined issues 

about the immediate situation, none of which this testimony will address. Rather, 

I will make three main points about the consequences of a Greek default: one focused on the short term, one focused on the medium term, and one on the long term. 

1. In the short term, a Greek default would surely trigger additional short-term 

pain on the Greek economy. Through various channels, it would very likely 

dampen overall economic activity in the Eurozone—and thus, albeit to a lesser 

extent, the rest of the world. And, there is some small but nonzero chance that 

it would trigger another world financial crisis of the magnitude of the World 

Financial Crisis of 2008–2009 triggered by the default of the U.S. investment 

bank, Lehman Brothers. 

2. In the medium term, a Greek default would raise the risks of additional highly 

indebted and struggling countries exiting the Eurozone. This elevated risk 

would tend to dampen economic activity within Europe and beyond, through 

channels similar to those cited above. And, arguably even more than Greece— 

because of how small it is—these future exits would bring greater chances of 

triggering financial crises. 

3. In the long term, a Greek default is largely irrelevant to the fundamental challenge still facing Greece and every other advanced country: how to foster 

growth of jobs, incomes, and output in societies with aging populations and 

looming entitlement pressures. The current Greek crisis, however it is resolved, 

does nothing to address this fundamental long-term problem facing much of 

the global economy. Indeed, by crowding out the attention of policy and business leaders, the current crisis aggravates this looming long-term problem. 

The Short-Term Default Consequences: Definite Economic Downturn, Possible Crisis 

In the short term, a Greek default would surely trigger additional short-term pain 

on the Greek economy. In the past 5 years Greece has sustained a Great Depression-scale contraction. Gross Domestic Product has fallen by nearly 30 percent. Unemployment spiked to about 26 percent, with unemployment of those aged 25 and 

younger peaking at a staggering 50 percent. Nearly all wages have fallen by doubledigit percentages. That said, in the past year many economic indicators have stabilized and some have turned positive. For example, GDP has expanded slightly. 

In whatever form it might take, a default would contract the Greek economy further. A main contractionary mechanism would likely be a wave of bank runs and 

thus bank closures, with knock-on bankruptcies beyond the financial sector, amidst 

the turmoil of reintroducing the Greek Drachma when no treaties, laws, or precedents for how to reconvert all payment flows, assets, and liabilities out of Euro denomination. This turmoil would sharply curtail consumption and investment demand in Greece, which in turn would drive down short-term output and employment. The scale of this contraction is difficult to predict, but double-digit declines 

are conceivable. Over time, recovery in Greece would be facilitated by a sharp devaluation of the drachma relative to the Euro and to other global currencies—and 

thus a boost in export demand as Greek goods and services (such as tourism) become less expensive to foreign customers. This export fillip would almost surely be 

swamped in the short term, however, by contractions in consumption and investment demand. 

This Greek economic contraction would very likely dampen overall economic activity in Europe—and thus, albeit to a lesser extent, the rest of the world. Through 

the usual linkages of international trade and investment, however, the scale of this 

worldwide dampening would be slight. The basic reason for this is that the Greek 

economy is quite small. 2014 GDP in Greece was about $244 billion (down from a 

27 

precrisis peak of about $342 billion). This was about one third of 1 percent of worldwide GDP in 2014 ($77.3 trillion, according to the International Monetary Fund). 

Greece is about the size of the economy of Louisiana or Connecticut. As such, however large a default-induced contraction in Greece might be, it simply would not be 

very large relative to the overall world economy. A further 10 percent contraction 

of the Greek economy would be about 1⁄30th of 1 percent of the total world economy. 

The knock-on effects of reduced European or U.S. exports to Greece—and thus reduced capital investment in these countries—would be similarly quite small. In 2014 

the United States exported $205.9 billion in goods to the Eurozone. This amount 

was about 12.8 percent of total U.S. goods exports—which, in turn, were about 9.3 

percent of total U.S. 2014 GDP of $17.4 trillion. Imagine that a default shrinks by 

10 percent all spending by Greek households and businesses—and that, implausibly, 

all that spending reduction came in the form of fewer purchases from U.S. exporters. This drop in U.S. exports of about $20 billion would constitute only about 1⁄10th 

of 1 percent of U.S. GDP. Yes, that would be a lot of money to the American businesses hit with canceled orders. But for the economy overall, this drop in exports 

would fall within the usual measurement error in the GDP measures produced by 

the U.S. Bureau of Economic Analysis. 

The one possible economic impact of a Greek default that paradoxically might be 

most important yet is most difficult to quantify is there is the small but nonzero 

chance that default triggers another financial crisis of the magnitude of the World 

Financial Crisis of 2008–2009 triggered by the default of the U.S. investment bank, 

Lehman Brothers. 

There are sound reasons not to expect such a crisis. Today the majority of Greek 

sovereign debt is owned not by banks and other private investors but rather by public entities: other sovereign Governments, the IMF, and the ECB. Eurozone banks 

today have stronger balance sheets than in years, thanks to changes including capital accumulation as part of regulatory stress tests. And, the ECB is currently implementing its own ‘‘quantitative easing’’ program of buying substantial amounts of 

member-country sovereign debt, one impact of which is to support confidence in financial markets and in the broader economy. All of this means that the losses of 

default would be borne by other Governments (and, implicitly, their taxpayers) rather than by banks—and, to the extent that banks would incur some losses, they are 

better positioned today to absorb those losses without destabilizing runs and/or 

sharp credit contractions. 

All this said, no one really knows what will happen in global capital markets if 

Greece defaults and/or exits the Eurozone. All the world’s ex ante analysis, meticulous and thoughtful though it may be, simply has no historical precedent as a guide. 

Before Lehman died, as its stock price slid and as creditors and other counterparties 

jogged, wise voices intoned that a medium-sized U.S. investment bank could do only 

so much damage. Those wise expectations were proven very wrong as traders and 

counterparties reacted in diverse and unexpected ways, which in turn triggered 

asset-price movements and comovements that even today we do not fully understand. No one can plausibly rule out such destabilization in the wake of a Greek 

default. Imagine a massive post-default panic to sell the debt of Spain, Portugal, 

and Italy—and to then buy U.S. Treasurys—that leaves illiquid one of the world’s 

largest and most-heavily leveraged hedge funds. As all its counterparties lose confidence in it and in each other, a post-Lehman lending freeze could again materialize around the world in another financial crisis. 

The Medium-Term Default Consequences: Greater Risks of Further Euro 

Exits 

In the medium term, a Greek default would raise the risks of additional highly 

indebted and struggling countries exiting the Eurozone. A Greek default accompanied by an exit from the Eurozone would set a precedent that had been intended 

to be an impossibility: of a Eurozone member reverting to its own sovereign currency. 

Currency unions such as the Eurozone function much like regimes in which member countries fix their currency values yet maintain separate currencies. For example, in either regime each member country cannot freely increase or decrease its 

money supply based on conditions in its own country alone. The main advantage 

of currency unions is—or so it is often hoped by their creators—irrevocability that 

eliminates the possibility of the speculative attacks that so often have bedeviled 

fixed exchange-rate regimes. Indeed, a major impetus for creating the Euro in the 

late 1990s was the early-1990s turmoil of waves of speculative attacks against the 

Exchange Rate Mechanism (in which many member countries effectively chose to fix 

the value of their currencies to the German Deutschmark). The British Pound, for 

example, was ejected from the ERM and floated in September of 1992 when specuVerDate Nov 24 2008 12:48 Dec 21, 2015 Jkt 046629 PO 00000 Frm 00031 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\06-25 ECONOMIC CRISIS - THE GLOBAL IMPACT OF A GREEK DEFA
28 

3Much of this sub-section is excerpted from ‘‘The Most Important Question Facing Greece’’, 

The Slaughter & Rees Report, February 2, 2015, available at http://cgbg.tuck.dartmouth.edu/ 

news-events/blog/slaughter-rees-report-the-most-important-question-facing-greece. 

lators such as George Soros forced the Bank of England to relent its fix after sustaining losses of tens of billions of Pounds. 

A ‘‘Grexit’’ would shatter the intended permanence of the Euro and would revive 

the idea that Eurozone countries can create and print their own currencies. Quite 

simply, afterward no Government official could credibly claim that the Grexit was 

a one-off event never to be repeated. Investors and politicians alike would focus 

more on the actions of the Grexit, not on any words thereafter. 

How likely is it that in the years ahead another Eurozone country would exit the 

Eurozone? That is impossible to predict, but surely post-Grexit this likelihood would 

be higher than before. And, the pressures for additional exits would arise from two 

forces—potentially interrelated. One is investors demanding higher interest rates 

from countries they perceive to be possible exitors. The other is fringe parties—already surging in countries such as Spain, with radical party Podemos—that might 

speak favorably about, and follow the polices of, Syriza in Greece. 

One important indicator will be whether or not Eurozone countries manage to 

spur faster economic growth, as is discussed below. Countries lacking such policies— 

perhaps partly because of fringe parties coming to power—will be countries where 

interest rates rise, as they did in many weak Eurozone countries in 2010 and 2011. 

The combination of higher interest rates and all the related uncertainty would tend 

to depress hiring and economic growth, and thereby would trigger a dynamic not 

unlike that of Greece in recent years. The broader global economy would suffer from 

slowdowns (or outright recessions) in these countries, through the trade and investment linkages outlined above. 

And any future exits from the Euro would surely bring greater chances of triggering the financial crises described above, because of how much larger and interconnected other countries are compared to Greece. Yes, a Grexit might not spark 

crisis. But what about an exit by Spain or by Italy? 

The Long-Term Default Consequences: From Where Will Growth Come?3

In the long term, a Greek default is largely irrelevant to the fundamental challenge still facing Greece and every other advanced country: how to foster growth of 

jobs, incomes, and output in societies with aging populations and looming entitlement pressures. In this sense, the default question is not the most important question facing Greece today. Rather, that honor goes to a different question: Will the 

Syriza Government—or any Government after it—be able to foster growth in 

Greece’s labor force, capital investment, and productivity? 

For any country on the planet, long-run economic growth requires an ability to 

accumulate some combination of labor, capital, and productivity. Yes, policy to support aggregate demand through efforts like ECB quantitative easing is important 

to employ currently idle people and capital. And, yes, the outcome of this week’s 

debt-renegotiation game of chicken will influence companies’ investments and innovativeness in Greece. But what will ultimately create sustainable economic recovery 

and hope in Greece is growth in its economic potential thanks to growth in some 

combination of these three factors. Without policies to spur their growth, no amount 

of debt renegotiation or forgiveness will matter. 

It is useful to remember precisely how and why the Greek economy plummeted. 

There were years and years of economic mismanagement, which was never reflected 

in the country’s official statistics (statistics that were later revealed to be highly 

compromised). A handmaiden of the mismanagement was widespread corruption 

and highly restrictive regulation that protected well-connected groups and stifled entrepreneurship. Here is one example among many: in 2013, the Government acknowledged 343 professions had been effectively closed to outsiders. 

Syriza tapped into a wellspring of resentment over the country’s economic woes; 

Prime Minister Alexis Tsipras has pledged to ‘‘bring an end to the vicious circle of 

austerity.’’ But the reforms announced thus far since his recent election are not obviously policies aimed at long-run growth: raising the minimum wage by 10 percent, 

reversing public-sector layoffs, and halting privatization. There has been discussion 

of raising taxes on hotels—one of the few sectors that remains healthy—and even 

restricting their ability to offer all-inclusive packages. 

Regardless of how Greece and its creditors resolve their differences, the country 

will still face long-term growth challenges that must somehow be addressed. For example, its total population fell by about 200,000 people between 2001 and 2012 (and 

has surely declined even more since then)—a function of low birthrates, low immigration, and high out-migration. The median age is also projected to be 43.5 this 

29 

year (an increase of 10 years since 1970), which is one of highest in the world. Demographically, Greece has quickly become like already-shrinking Japan. And who 

is fleeing Greece are almost surely the more-talented, more-dynamic of its workers. 

Greece is also saddled with low levels of innovation and very low spending on research and development. Increasing that spending—e.g., by continued deregulation 

of the economy to incentivize private R&D spending and investment—could deliver 

a number of benefits: spurring domestic innovation, keeping Greek companies in 

Greece, attracting immigrants and foreign direct investment, and perhaps even persuade some of the millions of Greeks living abroad to return to their ancestral home. 

Greece has made some growth progress; for example, it has improved its position 

in the World Bank’s Doing Business rankings from 109 in 2011 to 61 today. No 

other country has come close to achieving this improvement over the past 4 years. 

One encouraging sign: Uber, which is in the crosshairs of regulators throughout the 

world, has been operating freely in the country thus far in 2015. 

But so much work remains if Greece is to raise its potential for long-term growth 

in output, jobs, and incomes. One place to start would be working through the 555 

regulatory restrictions that the OECD, working in partnership with Greek authorities, identified as undermining competition and handicapping the Greek economy. 

Greece’s experience over the past few years is a potent reminder to countless 

other countries that anti-growth public policies today have consequences that can 

accumulate far into tomorrow. And those consequences are intensified when capital 

and labor can move around the world to where it is welcomed and rewarded. Lest 

we all wag our fingers at Greece as uniquely profligate, keep in mind that the dynamic of aging populations and looming entitlement pressures—all approaching 

when in recent years public debt has already spiked and economic growth has already slowed—faces many advanced countries today. 

According to the IMF, gross public debt as a share of GDP has surged pretty 

much everywhere in the wake of the World Financial Crisis. From 2007 to 2014 it 

increased in the United States from to 67.2 percent to 104.8 percent, in the 

Eurozone from 66.4 percent to 94.0 percent (e.g., in Italy from 103.1 percent to 132.1 

percent), and in Japan from 183.0 percent to a staggering 246.4 percent. 

What is Europe, for example, to do? Even ECB President Mario Draghi knows 

that ballooning the ECB balance sheet would accomplish only so much. Economic 

sluggishness across the continent reaches back decades. Consider this stunning statistic: total factor productivity (TFP)—which reflects the efficiency of capital and 

labor used together, and growth of which is central to long-run growth in output, 

jobs, and wages—is lower today in France, Italy, Spain, and Germany than it was 

in 1980. The U.S. TFP increase during this period has been about 35 percent. 

Boosting TFP tends to require long-term, wise investments in areas including 

education, skilled immigration, and competition—both domestic and international— 

in product markets, labor markets, and capital markets. In a recent interview Mr. 

Draghi acknowledged that ‘‘progress on the important structural reforms—more 

flexible labor markets, less bureaucracy, lower taxes—is clearly too slow.’’ Asked to 

specify which Eurozone countries need to prioritize these reforms, he didn’t mince 

words. ‘‘All of them.’’ 

And what is the United States to do? U.S. productivity growth has slumped in 

recent years to many-decade lows. Output per worker hour in the U.S. non-farm 

business sector grew in the 4 years of 2011–2014 by just 0.2 percent, 1.0 percent, 

0.9 percent, and 0.7 percent, respectively. Contrast this with the late 1990s and 

early 2000s: in the decade of 1995–2005, productivity growth averaged 3.0 percent 

per year. This surge was widely visible in accelerated growth in U.S. GDP, jobs, and 

worker earnings. At one point in 2000, U.S. unemployment dipped to just 3.9 percent and for several years during this period earnings rose briskly for all U.S. workers—even less-skilled workers including high-school dropouts. These large economic 

gains spread even to the U.S. Government, for which unexpected surges in tax receipts led to Federal-budget surpluses from 1998 through 2001, the first in generations. 

America today continues to confront a competitiveness challenge of too little economic growth, of too few good jobs, and of real earnings for most of those working 

not rising. The good news is there is a future in which America can create millions 

of good jobs connected to the world via international trade and investment. Doing 

so will require bold and thoughtful U.S. policies, however, that extend beyond fiscal 

and monetary stimulus whose viability and impact are questionable. Productivity 

growth to spur growth in output, jobs, and incomes for American workers is within 

reach—but only if America finds a way to pursue wise policies such as businesstax reform that reduces rates and complexity, high-skilled immigration expansion, 

trade and investment liberalization, and sound investments in public infrastructure. 

30 

Conclusion 

Greece has a glorious past. If it can use the ongoing crisis as an opportunity to 

transform its economy, and unlock economic opportunity, it could have a glorious 

future as well. Debt discussions of today must not obscure the deeper reforms that 

are needed for attaining that future. The current Greek crisis, however it is resolved, does nothing to address the fundamental long-term problem of how to accelerate economic growth. Indeed, by crowding out the attention of policy and business 

leaders, the current crisis aggravates this looming long-term problem. 

The same is true for so many other advanced countries in the world, including 

the United States. Wise leaders will reflect on Greece, not as a unique outlier but 

rather as a sobering leading indicator for the challenges that are approaching. 

Thank you again for your time and interest in my testimony. I look forward to 

answering any questions you may have. 

PREPARED STATEMENT OF CARMEN M. REINHART 

MINOS A. ZOMBANAKIS PROFESSOR OF THE INTERNATIONAL FINANCE SYSTEM, JOHN

F. KENNEDY SCHOOL OF GOVERNMENT, HARVARD UNIVERSITY

JUNE 25, 2015 

Thank you, Chairman Kirk and Ranking Member Heitkamp, along with the other 

Members of the Subcommittee, for the opportunity to comment on the unfolding crisis in Greece and its global ramifications. I am currently a professor at Harvard 

Kennedy School. I suspect that I was invited today because, for more than a decade, 

my research has focused on various types of financial crises and their economic consequences, including international contagion. One of the main lessons emerging 

from this work is that, across countries and over time, severe crises follow a similar 

pattern. 

I will organize my remarks around three connected topics: (i) developments in 

Greece, as these relate to the Greek Government’s potential default later this month 

or sometime this summer and the country’s likely exit from the Eurozone in that 

event; (ii) the repercussions of such an exit on European economies, particularly periphery countries (Ireland, Italy, Portugal, and Spain); (iii) the possible broader repercussions of the crisis on the United States, global currency markets, and emerging market economies. 

The Situation in Greece 

I will focus on the multiple possibilities of default. Even if events are arranged 

so that the Greek Government meets its obligations to the International Monetary 

Fund at the end of this month, the probability of a default over the course of the 

summer looms large. There are many reasons why default appears probable. Consider the top two. 

First, the widespread loss of confidence in the sustainability of the status quo has 

led to a sharp escalation in internal arrears (public and private). The private sector, 

concerned about the likelihood of an exit from the euro and a renewed contraction 

in economic activity, has increasingly defaulted on existing debts; about half of the 

bank loans are nonperforming and the share rises to more than 3⁄4 if credit card 

debt is included. Tax payments are postponed or avoided, aggravating an already 

precarious fiscal position. The attempt to hoard euros by the citizenry is also manifest in the sharp escalation of deposit withdrawals. A very conservative estimate 

would indicate that deposits have fallen by around 45 percent since their peak in 

2009. The combination of a rapidly shrinking deposit base and a staggering share 

of nonperforming loans imply that the banking sector is near a bank holiday. The 

Government is financing itself by not paying its bills, similar, for instance, to what 

transpired ahead of the Russian default of August 1998 or Argentina at the end of 

2001. Also, general Government deposits in the banking sector were off more than 

40 percent at the end of April. 

Second, the approximate 1.6 billion euro payment due to the IMF at the end of 

this month is only a fraction of the amounts coming due in July, August, and September, which total about 7, 5.6, and 6 billion euro, respectively. These payments 

are a multiple of current Government cash balances. At present, Greece is allocating 

less than 2 percent of GDP to interest payments, so even another round of compromise from official creditors that would delay such payments would not free up 

significant resources, so at to deal with domestic arrears and external payments on 

maturing debts. 

31 

1See Kaminsky, Graciela L., Carmen M. Reinhart, and Carlos A. Vegh, ‘‘The Unholy Trinity 

of Financial Contagion’’, Journal of Economic Perspectives, Vol. 17(4), Fall 2003, 51–74. 

European Contagion 

A point of departure in assessing the current scope for contagion from a Greek 

default is the absence of the ‘‘surprise’’ element. 1 In my work on contagion, I have 

found that ‘‘fast and furious’’ financial contagion is far more likely when the triggering crisis takes investors and Governments by surprise. 

There is no surprise here. Because the Greek drama has been unfolding over several years, private sector exposure to Greece (that is to say, outside of Greece) has 

declined sharply since the spring of 2010. Prior to the financial crisis, most Greek 

debt was in the hands of private external creditors (banks and nonbanks, as shown 

in Figure 1). Such financial links increased the odds of significant spillovers. During 

the past 5 years, official creditors (including the IMF and the European Central 

Bank) have absorbed Greek sovereign debts. Thus, at this time the scope for contagion via financial channels is limited. Real-side exposure to Greece via trade is 

not a new factor to consider, as Greek GDP has approximately contracted by 25 percent since the outset of the crisis, which an even bigger contraction in imports from 

the rest of Europe. Whether investors become indiscriminate and pull out of other 

European periphery countries in the event of a Greek default still remains a risk. 

The likelihood of such a scenario, however, is mitigated by the fact that a significant 

share of sovereign periphery debt (particularly Portugal and Ireland) is also in official hands, that these countries have been recovering much more rapidly than 

Greece, and that in such an event periphery Europe would receive support from the 

center and from the IMF. 

Implications for the United States, Global Currency Markets, and Emerging 

Market Economies 

The effects of a Greek default, probably in the context on an exit from the 

eurozone, on the United States are likely to be very limited in scope. Financial exposure, which was comparatively marginal in the first place, is not a prevalent source 

of concern for U.S. financial institutions. Nor is the Greek market a major destination for U.S. exports. Predicting currency fluctuations is an elusive goal for economists, so take my observations with a healthy dose of skepticism. If a Greek default 

triggers substantial turmoil in Europe, we would see a flight to safety into U.S. dollar assets, notably Treasuries. This has been the ‘‘standard’’ pattern of response in 

past waves of global volatility. If so, further appreciation in the U.S. dollar vis-avis the euro and most other currencies follows. In this setting, the potential adverse 

effects of an appreciating dollar would be largely felt by U.S. manufacturing, not 

unlike the impacts already seen earlier this year. 

In terms of broader consequences, an appreciating dollar may act as a headwind 

in the Federal Reserve’s efforts to begin the process of pulling its policy interest rate 

off the zero lower bound. Also, many emerging markets with dollar-denominated external debt (whether these are public or private) would be other things equal, we 

worse off with further dollar appreciation. 

Greece is already close to financial autarky. It relies almost entirely on support 

provided by the ECB and other official lenders. The gap between a de jure default 

and a de facto one has narrowed significantly. As a result, the next stage in this 

crisis may have limited consequences for the global economy. 

32 

1 I am grateful to my colleagues at the Peterson Institute for ongoing and highly rewarding 

discussions of this and related issues, in particular Edwin Truman, Avinash Persaud, Joe 

Gagnon, Douglas Rediker, Angel Ubide, William Cline, Nicolas Veron, and Adam Posen. Any 

remaining errors conveyed are solely mine. 2Sometimes officially now referred to as the ‘‘Brussels Institutions’’, consisting of the IMF, 

the European Commission and the ECB, with the EuroGroup functioning as the European entity politically agreeing to the technical proposals of the Troika. 

PREPARED STATEMENT OF JACOB FUNK KIRKEGAARD 

SENIOR FELLOW, PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS

JUNE 25, 2015 

Subcommittee Chairman Kirk, Ranking Member Heitkamp, Members of the Subcommittee on National Security and International Trade and Finance, it is a pleasure to testify before you today on the global impact of a—hypothetical—Greek default. 1 In my written testimony, I will address two issues; the probability of a Greek 

default and its implications on the eurozone and the global economy, and the exposure to the U.S. taxpayer from loans given to Greece by the IMF. 

The Probability and Implications of a Greek Government Default on 

Greece, the Euro Area, and the Global Economy 

In light of ongoing negotiations in the euro area, it is at the time of writing an 

open question if the Greek Government can avoid a default against its official sector 

creditors, as well as whether the IMF gets paid on time on June 30th and arrears 

to the organization thus averted. 

Substantial amounts of political brinkmanship are being utilized to achieve a negotiated outcome, which aims to see a self-identified radical leftist anti-austerity 

Government agree to a reform package with the Troika in exchange for the continuation of financial support. 2 Whatever today’s negotiation situation is, it remains a 

near certainty that an agreement will eventually be found in the coming weeks. The 

principal question is whether an agreement will require a brief period of restrictions 

on the Greek banking sector to be sealed or not. 

This ultimate ability to find an agreement with the current or a new Greek Government is of the utmost importance, as it suggests that Greek Government debt 

33 

3 Eurostat data at http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init 

=1&language=en&pcode=teina225&plugin=1. 4See ESM (2015:29) for the details of these earlier restructurings of euro area holdings of 

Greek debt. Available at http://www.esm.europa.eu/pdf/204204lESMlRAl2014lweb.pdf. 5 Eurogroup Statement on Greece, November 27th 2012, available at http:// 

www.consilium.europa.eu/uedocs/cmsldata/docs/pressdata/en/ecofin/133857.pdf. 6 Available at http://www.imf.org/external/np/pp/eng/2012/082012.pdf. 7Latest available data for May 2015 indicates ELA had reached approximately $87bn (up 4bn 

from April). See http://www.reuters.com/article/2015/06/24/eurozone-greece-ecb-idUSA8N0Z 

300J20150624. 

is and will most likely in the future remain sustainable, despite the country’s extremely high gross Government debt levels of 177 percent of GDP in 2014 3 and uncertain future growth prospects. 

This conclusion follows from the particular current structure of Greek Government debt, which is overwhelmingly held by the other euro area members, the IMF 

as a super-senior creditor, and with remaining privately held debt at very long maturities and low nominal interest rates (See Figures 1 and 2). Consequently, the cost 

of servicing and therefore the financial sustainability of Greek Government debt is 

largely unrelated to the size of gross debt or financial market fluctuations. The 

country currently faces very small debt payment obligations until at least 2023, and 

already has a substantially longer debt maturity profile and substantially lower implied rate of interest on its debt than for instance the United States Federal Government (Figure 3). 

Rather Greek debt sustainability and ability to avoid a future default is dependent on two things; the Greek Government’s ability to restore economic growth in the 

country, or in other words the continuation of growth-friendly structural economic 

reforms, and the country’s ability to reach an ongoing political agreement with its 

official sector creditors in the euro area and the IMF. Unlike the IMF, the euro area 

has—as has already been done in June 2011, March 2012 and November 2012 4— 

the political freedom to restructure its Greek Government debt holdings in a manner closely calibrated to the preceding degree of Greek Government delivery of 

agreed structural reforms and fiscal targets. Provided the Greek Government in the 

future offers politically satisfactory implementation of an agreed program, the euro 

area will, in accordance with earlier promises to consider ‘‘further measures and assistance, including inter alia lower cofinancing in structural funds and/or further interest rate reduction of the Greek Loan Facility, if necessary, for achieving a further 

credible and sustainable reduction of Greek debt-to-GDP ratio’’, 5 offer the country 

further debt restructuring. Such additional restructuring of the euro area holdings 

of Greek Government debt will, however, only be contemplated once the Greek Government has proven its commitment to faithfully implementing a program agreed 

with the Troika. Ex ante debt relief to Greece will not be granted. 

Recalling that Greece is a small country, accounting for only 1.8 percent of total 

euro area GDP, and hence does not pose a material risk to overall euro area financial stability (see also Table 1), Athens’ ability to avoid a future default is a question 

of the Government’s domestic reform capability and internal euro area politics, not 

objective debt sustainability criteria or financial markets. 

In short, Greece is and will remain solvent if the euro area wants it to be. 

Discussions about the implications of a Greek Government default are per the 

above likely to remain hypothetical. If the Greek Government were nonetheless to 

default, the precise circumstances and against which creditors it did so would determine the consequences. Failure to for instance pay the IMF on time on June 30th, 

2015, would not immediately and independently have any real consequences for 

Greece, as it per IMF (2012:21) would merely initially result in: ‘‘Staff sends a cable 

urging the member to make the payment promptly; this communication is followed 

up through the office of the concerned Executive Director. The member is not permitted any use of the Fund’s resources nor is any request for the use of Fund resources placed before the Executive Board until the arrears are cleared.’’ 6

Only following a lengthy internal procedure lasting up to 24 months could Greece 

face expulsion from the IMF. 

However, were Greece to go into arrears against the IMF on June 30th, 2015, as 

a result of a failure to reach an agreement with the Troika, the European Central 

Bank (ECB) would in all probability almost immediately stop, or at least substantially scale back the ongoing provision of emergency liquidity assistance (ELA) to 

the Greek banking system. 7 This would make it impossible for the Greek banks to 

operate and necessitate the imposition of a bank holiday, or at least severe deposit 

access controls at the institution level, which again would throw the Greek economy 

into another dramatic economic decline. 

34 

8See European Commission data at http://ec.europa.eu/budget/mycountry/EL/index 

len.cfm. 

9See latest Greek Government budget implementation data at http://www.mnec.gr/?q=en/ 

content/state-budget-execution-january-may-2015. 10See discussion here http://blogs.piie.com/realtime/?p=4756. 

The political effects of deposit access controls—which importantly under new 

Banking Union regulations could potentially be imposed by the central euro area 

banking supervisors at the ECB against the will of the Greek Government—on the 

Greek economy and financial system would likely be dramatic, and in all probability 

sooner or later lead to sufficient domestic political pressure for the Government to 

reach an agreement with the Troika. This would restore ECB support for the Greek 

banking system and broader Troika financial support. As such, any actual default 

by the Greek Government against any official sector creditor is likely to be of relatively short duration. 

Notions that it, given its current projected small primary fiscal surplus, would be 

in Greece’s economic interest to declare a sudden unilateral and total default 

against its public and private creditors are based on a dangerously simplistic understanding of the close financial, political, economic and budgetary ties between 

Greece and especially its euro area and EU partners. 

Such a unilateral default against its creditors would for instance result in the immediate loss of ECB support for the banking system and thus cause the instant closure of Greek banks system and a highly probable loss of ongoing EU budget support of around 3 percent of GDP. 8 Any current projected Government primary surpluses in Greece would quickly as a result of slumping growth, disappearing net 

budget transfers and declining Government revenues be converted into likely sizable 

Greek Government primary deficits. Any defaulting Greek Government would ultimately not be able to pay even the claims of its domestic Greek stakeholders, undermining its political support. Moreover, it should be emphasized that the lessons 

from economic history concerning the aftermath previous sovereign defaults are of 

relative limited predictive value for the likely effects in a country like Greece, which 

is a relatively closed economy with limited export potential, has a far older population, a much larger Government share of GDP than earlier recorded sovereign default cases. 

A Greek sovereign default would have very, very severe domestic economic consequences for Greece, yet a Greek default does not imply an automatic, or even 

probable, departure of Greece from the euro area (the so-called Grexit). Default 

against some or all its official sector creditors could be implemented by any incumbent Greek Government simply by failing to pay its dues on time, in the same manner the current (and previous) Greek Government has gradually run into sizable arrears against many of its domestic Government suppliers. 9 Leaving the euro, however, would represent a reversal of nearly 40 years of Greek economic and political 

participation in European integration. It would in all probability require an explicit 

public mandate to the Government to undertake such a momentous volte face. 

Given how a large majority of at least two-thirds of the Greek public and over 80 

percent of Greek MPs (including both parties in the current governing coalition) has 

consistently supported staying in the euro, 10 such a public mandate look politically 

impossible in Greece for the foreseeable future. 

Occasionally researchers seek insights into what a Grexit might involve from previous recent dissolutions of currency unions in for instance the Soviet Union, Yugoslavia, or Czechoslovakia. Such historical comparative work though is of limited relevance, as Grexit would not involve the dissolution of the euro, but rather attempts 

by a Greek Government to (re)introduce its own national currency, while the euro 

would continue to function more or less as before. 

Concerns expressed by some that the departure of one member of the euro would 

invariably result in the collapse of the common currency are excessively alarmist for 

at least two reasons. First, it is highly unlikely that populations in other euro area 

members would attempt to emulate what would for certain be a highly disruptive 

and economically destructive Greek departure from the euro. And secondly, it does 

in light of the institutional deepening witnessed in the euro area since 2010 seem 

probable—if politically very challenging—that the remaining euro area members 

would following a Grexit implement additional integrative measures among themselves, including additional political and fiscal integration, in order to counter renewed centrifugal political and economic forces inside the common currency area. 

The fact that any Greek Government would seek to (re)introduce its own currency, while the euro would still be in normal circulation has important implications 

for the likelihood of success of such a new currency. Recalling how a large majority 

of the Greek population wishes their country remains in the euro, and that any new 

35 

11The store of value function of a currency is one of three key attributes. The other two are 

the functions of medium of exchange and unit of account. To successfully function as a store 

of value, a currency has to be capable of being predictably saved, stored, and retrieved for 

(roughly) the same value. In other words, any currency inflation affecting it must be kept within 

a certain range. 12The Greek Government might for instance pay wages or accept payments from residents 

only in a new currency, or require that bank deposits covered by any deposit guarantee scheme 

in Greece be held in their new currency. 

Greek currency would be backed solely by the credibility of Greek governing institutions, it seems highly unlikely that a new Greek currency would be imbued with 

the key currency function as a ‘‘store of value’’. 11 When presented with a choice between a new national currency and the still circulating euro, Greek residents are— 

when not potentially legally prevented from doing so 12—overwhelmingly likely to 

demand euros. This suggests any new Greek currency will quickly decline in value 

relative to the euro and the country suffer a rapid nominal currency depreciation. 

Being a relatively small economy, which imports many essentials (energy, food, 

medicine, etc.) and exports only a relatively limited number of often volatile items 

(tourism and shipping services), Greece has a more limited scope for import substitution and dramatic changes in exports than larger and more diversified economies. 

The pass-through from a declining nominal exchange rate to domestic inflation in 

Greece following the introduction of a new currency is thus likely to be strong. This 

again means that achieving a lasting reduction in the Greek real exchange rate 

from introducing a new currency will be difficult and only potentially achievable in 

conjunction with a material—and highly regressive—increase in the domestic inflation level. All told, attempt by the Greek Government to implement Grexit by introducing a new currency is likely to fail to improve the economic outlook for the Greek 

population and fail to displace the euro as the dominant currency in circulation in 

the Greek economy. 

Consequently, the actual effect for a defaulting Greece of losing access to banking 

sector support from the ECB, financial aid from the Troika and budgetary transfers 

from the EU budget, is not a smooth transition to a new national currency. Rather, 

it is a disastrous high domestic inflation scenario. Unable to successfully switch to 

a new national currency, the country ends up a bit like Montenegro, which unilaterally euro-ized its economy in 2002. Attempts at Grexit will de facto mean that 

Greece has only left the institutions of the euro area/EU, not the currency itself. 

Highlighting the dramatic difficulties of actually (re)introducing a national currency by a Government with low institutional credibility, when the previous anchor 

currency remains in circulation, is also witnessed in the ongoing usage of the U.S. 

dollar. No modern economy that has ever fully adopted the U.S. dollar (e.g., full currency substitution as for instance seen in Ecuador, Panama and El Salvador)—has 

ever undone the decision and re-introduced their own national currency. There is 

little reason to believe that Greece now in the euro would manage to do so either. 

A Greek default would prove devastating to the Greek economy even without a 

Grexit, and the costs passed on to the euro area would be sizable, but not economically or financially catastrophic. Private sector exposures to Greece through trade 

(Figure 4) and the banking sector (Figure 5) are today limited and manageable. Public sector exposures in the euro area from financial assistance (excluding IMF loans) 

and liquidity assistance provided to Greece amount to about 3.3 percent of euro area 

GDP, ranging from 1.4 percent in Ireland to 5 percent in Malta (Table 1 provides 

total ‘‘worst-case’’ exposures assuming a recovery rate of zero). These exposures are 

large and would in already fiscally challenged countries, such as Italy, Portugal, or 

Spain, prove a material additional burden on Government finances. They will not, 

however, in all probability cause any other euro area sovereign to risk losing market 

access. 

The most pressing economic policy problem arising from a Greek default for the 

euro area would be for the ECB, as it would dramatically complicate plans ongoing 

asset purchases, currently scheduled to end in September 2016. It would first and 

foremost be up to the ECB to ensure that any potential financial market cross-border contagion effects—likely only at a magnitude far below what was seen in 2012 

in the euro area—would not pose a threat to euro area growth. The ECB is likely 

if required to act decisively and be successful in this task. 

Most likely, the ECB would in a Greek default scenario feel compelled to expand 

current levels of asset purchases (÷60bn/month), as well as potentially postpone any 

exit. Given the relatively limited level of financial asset purchased to date by the 

ECB in comparison with other major central banks like the Federal Reserve, such 

additional monetary stimulus would not pose any noteworthy financial risk or economic problems. 

36 

13http://www.markiteconomics.com/Survey/PressRelease.mvc/986c020abdb0457 

f9574c56ff8a80e79 14Owed to the IMF by Somalia, Sudan, and Zimbabwe. Data from May 31st 2015 at https:// 

www.imf.org/external/np/fin/tad/extdbt2.aspx?valueDate=2015-05-31. 15Table 5 in IMF (2012) available at http://www.imf.org/external/np/pp/eng/2012/ 

082012.pdf. 16See overview of Greece’s financial position in the IMF at http://www.imf.org/external/np/ 

fin/tad/exfin2.aspx?memberKey1=360&date1key=2015-06-25. 

Recalling the limited present day private sector exposures to Greece, direct risks 

to global growth beyond the euro area from a default are relatively limited and 

linked to threats to the euro area regional growth outlook. However, given likely 

ECB policy activism, the generally robust euro area economic performance to date 

(short-term Q2 indicators point to around 1.6 percent growth annualized with June 

composite PMIs at 49-month high 13), the lower levels of external and budget deficits 

now found in the euro area, and new euro area institutions put in place since 2010, 

the regional fallout from a Greek default is likely to be contained and not derail 

the current euro area cyclical recovery. 

In sum, a default by the Greek Government will quickly prove an economic disaster for Greece, though for that reason domestic political pressures to seal a deal 

with the Troika will keep any failure to pay international creditors brief. Any default by Greece will not automatically lead to Grexit, and it will under any scenario 

likely prove impossible for a Greek Government to successfully reintroduce a national currency. Improving euro area economic performance, a more resilient— 

though still incomplete—institutional structure in the euro area, and not least additional ECB monetary stimulus is likely to contain any cross-border spillovers from 

a Greek default. As a result, a Greek default does not pose systemic risks to either 

the euro area or the global economy. 

The Exposure of the U.S. Taxpayer to Loans Provided to Greece by the IMF 

As noted in the previous section, any actual default by the Greek Government is 

likely to be relatively short-lived. The domestic economic implications would be very 

negative through the rapid introduction of a bank holiday/bank deposit controls, 

while the domestic political reactions hereto would in all probability produce the required domestic political pressure on the Greek Government to seal a deal with the 

Troika. As a result, any financial risks for the IMF appear quite limited, as Greece 

would eventually secure the required funding from the euro area or from own funds 

to repay the IMF. 

It appears a relatively high risk, but not the base case, that Greece may not pay 

the IMF the approximately $1.7bn due on June 30th, precipitating the serious domestic economic and political implications discussed above. However, from the perspective of the IMF, new Greek arrears of this magnitude would not pose any financially material risk and would only approximately double the IMF’s current levels 

of arrears of $1.8bn. 14 This would take total member State arrears to the IMF back 

to levels of the early 1990s, 15 but not in any way affect the operations of the IMF 

or pose any threat to its shareholders, including the United States. 

Total current IMF exposures to Greece from the 2010 Stand-By Arrangement and 

2012 Extended Fund Facility amount to approximately $39bn, 16 currently scheduled to be fully repaid only by 2026 (Figure 2). The IMF is Greece’s super-senior 

creditor, and any potential future euro area additional debt restructuring of its 

Greek debt holdings are likely to include a conversion of costlier IMF loans into 

longer maturity and cheaper ESM loans, implying that the IMF’s exposure to 

Greece is likely to be eliminated before 2026. Both issues suggest that the actual 

financial risk to the IMF and its shareholders from lending to Greece is relatively 

limited, as the IMF will ultimately get fully paid back, even as euro area taxpayers 

will surely not in net-present-value terms. 

Consequently, estimates of potential liabilities to the U.S. taxpayer from IMF 

lending to Greece should be treated as a very low-probability worst-case scenario. 

The United States’ IMF quota stands at 16.74 percent, implying that the United 

States’ share of total current Greek IMF exposure of about $39bn is approximately 

$6.5bn. 

In relation to the U.S. Government and economy, this is a very small number, 

amounting to 0.2 percent of 2014 Federal Government outlays and 0.04 percent of 

U.S. 2014 GDP. 

37 

38 

39 

40 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE 

FROM DESMOND LACHMAN 

Q.1. I’d like to hear more about the policy choices Greece made 

that led to their debt crisis, prior to Greece’s 2009 announcement 

that it had been understating its deficits. 

My understanding is that Greece’s public employment grew fivefold from 1970 through 2009, at a growth rate of 4 percent. Over 

the same time period, private sector employment increased by only 

27 percent, at an annual growth rate of less than 1 percent. How 

much did Greece’s expanding public sector contribute to their debt 

crisis? 

A.1. Greece’s expanding public sector was one of the principal factors in Greece’s public deficit ballooning between 2000 and 2010. 

It has also been one of the major factors that has sapped vitality 

from the Greek economy. As such it has to be regarded as a primary contributor to the country’s sovereign debt crisis. 

Q.2. Beyond debt payments and public sector employment, are 

there other particular sectors—for example such as defense spending—during the lead up to their debt crisis where Greece’s Government spending levels were imprudent? 

A.2. Aside from public wages, the uncontrolled increase in pension 

payments has been a major factor in the deterioration of Greece’s 

public finances. Currently pension payments in Greece account for 

over 17 percent of Greek GDP and they are very much more generous than in other European countries. 

Q.3. What is Greece’s labor participation rate, how does it compare 

to other Eurozone countries, and did it contribute to Greece’s fiscal 

crisis? Are these statistics similar to those found in other Eurozone 

countries? 

A.3. According to the World Bank, Greek labor participation is only 

53 percent. While low, it might be noted that other European countries like Italy also have very low participation rates. Meanwhile 

the participation rate in Germany is only 60 percent. 

Q.4. Beyond a generally underperforming economy, what else explains Greece’s low labor force participation rate? For example, 

does their welfare and entitlement system encourage such a low 

participation rate? 

A.4. Besides generous welfare and entitlement programs, a major 

contributor to low participation is Greece’s very rigid labor market 

and onerous labor market regulations which make it difficult to 

hire and fire workers. In that respect, Greece is not alone in Europe in needing major labor market reform. 

Q.5. How much of the blame for Greece’s debt crisis can be blamed 

on tax evasion? 

A.5. Tax evasion in Greece is rampant and is certainly a contributory factor in the debt crisis. Asides from directly impacting the 

public finances, it means that tax rates are very high and onerous 

on that small part of the population that does pay taxes. This is 

hardly conducive to economic growth. 

Q.6. How much of the blame for the crisis can be placed on 

Greece’s membership in the Eurozone, either because of the conVerDate Nov 24 2008 12:48 Dec 21, 2015 Jkt 046629 PO 00000 Frm 00044 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\06-25 ECONOMIC CRISIS - THE GLOBAL IMPACT OF A GREEK DEFA
41 

straints Eurozone membership places on Greece, or because of efforts Greece underwent to secure Eurozone membership? 

A.6. Euro membership is at the core of the Greek crisis for many 

reasons. From the very outset, placing a highly sclerotic country 

like Greece in a currency arrangement with an economic powerhouse like Germany was to invite problems in the competitiveness 

field. In addition, Euro membership had the effect of lowering interest rates at which the Greek Government could borrow to German levels. Those low borrowing rates facilitated Greece’s public 

sector going on a spending spree. When the music stopped, Greece 

found that attempting to redress domestic and external balances in 

a Euro straitjacket contributed importantly to sinking the economy 

into a 1930s style economic depression. That in turn contributed to 

Greece’s rising public debt to GDP ratio. 

Q.7. What other significant factors, demographic or otherwise, contributed to Greece’s debt crisis? 

A.7. Greece certainly engaged in reckless borrowing that got the 

country into its debt crisis. However, it is a truism that one cannot 

have reckless borrowing without there also being reckless lending. 

In the Greek case, Greece could never have got into its monumental debt problem to the degree that it did without the willing 

help of the German and French banks, which lent recklessly to the 

Greek Government. 

Q.8. How far back in time would Greece have to go to prevent this 

debt crisis, and what policy changes would be necessary then to 

place Greece on a stable footing now? 

A.8. It is difficult to overstate how many major policy changes 

would be required to put the Greek economy on a stable footing. 

The economy would need to be modernized through fundamental 

reform to the labor market, the pension system, to tax administration, and to the privatization of State assets. Greece would also 

need to be accorded major debt relief by its official creditors. The 

country would also need to engineer an orderly exit from the Euro 

that would provide the conditions for a recovery in the economy. 

Q.9. This hearing touched on the impact of austerity on Greece’s 

dire economic situation. For example, Mr. Lachman argued that ‘‘at 

the heart of Greece’s economic collapse has been the application of 

draconian budget austerity within a Euro straitjacket,’’ which ‘‘preclude exchange rate depreciation or the use of an independent monetary policy.’’ While I understand this argument, Greece’s irresponsible fiscal policy is what led to their debt crisis in the first place. 

It seems reasonable to expect Greece to make structural changes 

to their economy before they can receive help from other creditors. 

How significant of an economic drag has ‘‘austerity’’ been on 

Greece? Why? 

A.9. While Greece might have lagged in the area of structural reform policy, the size of its fiscal adjustment over the past 5 years 

has been enormous. Despite an economic depression, Greece has reduced its budget deficit from around 15 percent of GDP in 2010 to 

around 3 percent of GDP at present. There can be no doubt that 

this constituted an enormous amount of fiscal drag. 

42 

Q.10. Has austerity been particularly hard on Greece, as compared 

to other countries? Why? 

A.10. Other European countries like Ireland, Portugal, and Spain 

did massive budget adjustment as well but not on the scale of that 

of Greece. In addition, an economy like that of Ireland displayed 

much greater labor market flexibility than did Greece and, having 

a large export sector, Ireland was able to offset at least in part 

some of the negative effect of budget tightening on aggregate demand. 

Q.11. Couldn’t you argue that some form of austerity was inevitable, because of the deep fiscal hole that Greece had dug itself in? 

Shouldn’t any country with a structural fiscal deficit exceeding 18 

percent of its GDP—as Greece had in 2009—go through austerity 

measures? 

A.11. There is no question that Greece needed major fiscal adjustment. However, it was unreasonable to expect that this degree of 

fiscal adjustment could be effected in a Euro straitjacket without 

sending the economy into the deepest of economic recessions. As 

the IMF itself now recognizes, Greece’s situation would have been 

more manageable had the country restructured its privately owned 

sovereign debt very much earlier than it did. The country’s situation would also have been made more manageable had it exited the 

Euro as soon as the very large size of its domestic and external imbalances became apparent. 

Q.12. Will austerity lead to longer-term economic growth, even if 

it may be difficult in the immediate-term? 

A.12. The latest round of austerity imposed on Greece by its European partners within a Euro straitjacket is misguided and is bound 

to end up in tears. It basically repeats the policy approach of the 

past that contributed to Greece’s economic depression. There is no 

reason to think that such policies will work this time around. 

Q.13. Are there other structural economic reforms in the public 

and private sector that Greece could enact alongside austerity, to 

create the best conditions for growth? 

A.13. Greece has to modernize its economy if it is to have sustainable economic growth. In addition to basic reform of pensions, the 

labor market, and tax administration, Greece needs to move away 

from its patronage system and to improve its basic governance. 

Q.14. This hearing contained a lot of discussion about the sustainability of Greece’s debt levels. On the one hand, Greece has more 

than a 175 percent debt to GDP ratio and has a significant amount 

of debt due over the next 3 months. On the other hand, others 

argue that Greece has a relatively low interest rate burden, a favorable debt repayment timetable, and low borrowing rates from 

the bailout fund. Is Greece close to insolvency? Or is it only illiquid, 

but solvent? 

A.14. A fundamental mistake made by the IMF at the start of the 

Greek sovereign debt crisis in 2010 was to treat Greece’s problems 

as one of liquidity and not of solvency. Greece’s situation is very 

much worse today than it was in 2010 and the country is patently 

not able to repay its debt. That is not to say that Greece necVerDate Nov 24 2008 12:48 Dec 21, 2015 Jkt 046629 PO 00000 Frm 00046 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\06-25 ECONOMIC CRISIS - THE GLOBAL IMPACT OF A GREEK DEFA
43 

essarily needs to have its debt written down through reducing its 

face value. However, it is to say that Greece needs to have its debt 

maturities extended and its interest rates reduced in a major way. 

Q.15. I’d like to focus on Russia’s influence in this debt crisis. Russia has said that it is considering giving Greece a bailout. Russia 

has also announced that Greece has agreed to let the Russian 

State-owned energy giant, Gazprom, build the Turkish Stream natural gas pipeline in Greece. 

How significant of a possibility is it that Russia will step in at 

some point in the near future to resolve Greece’s debt problems? 

A.15. Russia should not be expected to step in and resolve Greece’s 

debt problems. However, should the Greek crisis deepen and should 

anti-European sentiment in Greece grow, one must expect Russia 

to take advantage of the political opportunity of gaining a firm foothold in the country. 

Q.16. What is Russia’s strategic interest in developing stronger ties 

to Greece? 

A.16. In 1947, the Truman doctrine recognized Greece’s geopolitical 

importance as a gateway to the Middle East as well as to the Mediterranean. Today Greece retains that strategic importance. The 

warm welcome Vladimir Putin has accorded to Alexis Tsipras in 

Moscow should be a reminder that Russia has real interests in the 

Balkans. 

Q.17. What would Greece have to give Russia in exchange for accepting Russia’s support? 

A.17. The immediate prize that Mr. Putin is seeking is to build a 

pipeline that would carry Russian gas to Europe through Greece 

and Turkey. One would also think that Russia would have an interest in Greece’s ports. 

Q.18. Could Russia afford to bail Greece out, economically? 

A.18. Russia is known to play a long game. While low international 

oil prices are placing a strain on the Russian economy at present, 

this is not expected to last forever. In addition, the amounts of 

money that it would cost Russia to gain real influence in Greece 

are not inordinately large. 

Q.19. Would Putin have to worry about internal political dynamics 

that could constrain him from bailing out Greece? 

A.19. Judging from Mr. Putin’s behavior in Ukraine, it would seem 

that Mr. Putin is very much in control of Russia’s external policies. 

Q.20. Would Russia’s increased influence in Greece prove to be a 

destabilizing factor in the region or in the broader Eurozone? 

A.20. At a time that Russia is proving itself to be a major menace 

in Ukraine, the last thing that Europe and the United States need 

is having Russia gain an opening in Greece. 

Q.21. How significant of a hindrance has Eurozone membership 

been for Greece? Does this call into question the viability of the 

Eurozone model for smaller countries? 

A.21. For reasons explained above, Eurozone membership has been 

a major mistake for Greece. There are many lessons for the other 

highly indebted European countries like Italy, Portugal, and Spain. 

44 

Among the most important of these lessons is that those countries 

have to effect major structural reform and soon in order to get their 

economies moving if they are successfully to resolve their debt 

problems in a Euro straitjacket. 

45 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

WALL STREET JOURNAL CHART OF GREEK DEBT DUE 2015–2055 

46 

CRS/NATIXIS CHART OF TOTAL GREEK DEBT OWED