The financial fragility and the crisis of the Greek government sector

Abstract

The purpose of this paper is to develop Minskyan financial fragility indices for the government sector and to examine the financial structure of the Greek government before and after the onset of the sovereign debt crisis in 2009. We provide empirical evidence that clearly shows the growing financial fragility of the Greek public sector in the 2000s. We also assess the effectiveness of the implemented bailout adjustment programmes in Greece and claim that the conducted austerity measures and fiscal consolidation have not significantly improved the financial posture of the Greek government sector. We argue that the implementation of fiscal and wage austerity in an economy that lacks structural competitiveness produces prolonged recession and unemployment with adverse feedback effects on the financial fragility of the government.

Keywords:

• Minsky’s financial fragility
• government sector
• Greek debt crisis

JEL Classifications:

• E12
• E60
• H60

Acknowledgements

The authors would like to thank the editor of this journal, Dimitri Papadimitriou, Eric Tymoigne and an anonymous referee for their constructive comments and suggestions. A preliminary version of this paper was presented at the 15th Conference of the Research Network Macroeconomics and Macroeconomic Policies (FMM), Berlin, October 28–29, 2011. The usual disclaimers apply. Maria Nikolaidi gratefully acknowledges the financial support from the European Union (European Social Fund – ESF) and Greek national funds through the Operational Program ‘Education and Lifelong Learning’ of the National Strategic Reference Framework (NSRF) – Research Funding Program: Heracleitus II. Investing in knowledge society through the European Social Fund. She also acknowledges the partial financial support from the Antonios Papadakis Endowment.

Notes

1. The financial posture of the government sector can also be important in the case of sovereign countries, in as far as the fiscal balance affects the external balance. In particular, under fixed exchange rate regimes, fiscal deficits are likely to cause an undesirable reduction in international reserves (see Wray 2006). Under flexible exchange rate regimes, fiscal deficits can lead to domestic exchange rate depreciation, with potential detrimental effects on inflation and the ability of a country to meet its financial commitments denominated in foreign currency. Furthermore, in both regimes fiscal deficits may have adverse effects on the interest rates. However, in non-sovereign countries the risks stemming from a financially fragile government sector are, arguably, more significant and straightforward.

2. Of course, even if the ECB was authorised to operate as ‘lender of last resort’, this would not eliminate all risks of partial default for bond holders. In particular, both the exchange rate risk and the inflation risk would still exist. However, the main source of default risk would not be present.

3. On 6 September 2012, the ECB announced its Outright Monetary Transactions (OMT) programme. Through this programme the ECB committed to set a floor to the price of government bonds by making unlimited purchases in the secondary sovereign market. The OMT framework has substantially promoted ECB’s role as ‘lender of last resort’ to national governments. However, it has not arguably rendered the ECB a full ‘lender of last resort’ to the public sector basically for two main reasons. First, the ECB continues to be prohibited to intervene in the primary bonds market. Second, a necessary condition for a country to qualify for bond purchases by the ECB is to have previously committed to some kind of austerity programme. The latter implies that the ECB supports the fiscal policies of Eurozone national governments only when it approves them.

4. Although Minsky’s original classification relies on three finance regimes, in the case of government it seems appropriate to extend Minsky’s taxonomy by introducing a fourth finance regime (the ultra-Ponzi one), which reflects the case of a government running a primary deficit. Note that Arestis and Glickman (2002) have used a four financial postures taxonomy in their analysis of an open economy’s financial fragility.

5. The net debt is defined here as the difference between the market value of financial liabilities and the market value of financial assets. The gross debt does not necessarily rise in the case of Ponzi or ultra-Ponzi finance, as the government may, for instance, sell some financial assets in order to reduce its gross debt. Similarly, the gross debt does not necessarily decline in the case of hedge or speculative finance as the government may decide to purchase a significant amount of financial assets, offsetting the favourable effects of fiscal surplus on gross debt. For a detailed analysis of the relationship between gross debt, net debt and fiscal balance see Milesi-Ferretti and Moriyama (2006) and Hartwig Lojsch, Rodriguez-Vives, and Slavik (2011).

6. See also Minsky’s ([1986] 2008, ch. 2) analysis for the budget effects of the ‘Big Government’.

7. See, for instance, the theoretical and the empirical literature on the Laffer curve (e.g. Fullerton 1982; Matthews 2003; Heijman and van Ophem 2005).

8. See also Ferrari-Filho, Terra, and Conceição (2010).

9. Note that the mathematical formula used in the cases of hedge and speculative finance is the same. Moreover, the mathematical formula is almost identical in the cases of the Ponzi and the ultra-Ponzi finance: the only difference is that in the case of the ultra-Ponzi regime, –1 has been added to penalise for the existence of a primary deficit. In this way it is ensured that the index for a government that runs a primary deficit always lies between –2 and –1. This enables a clear distinction between a Ponzi and an ultra-Ponzi regime.

10. In Ferrari-Filho, Terra, and Conceição (2010) when the index is higher than one, the government sector is hedge: total revenues are larger than the sum of total primary expenditures, interest and amortisation. If the index lies between zero and one, the government sector is speculative: the primary budget surplus is unable to cover the sum of interest and amortisation. If the index is negative, the government sector is Ponzi: the public sector runs a primary budget deficit.

11. For further discussion on this issue see Wolswijk and de Haan (2005) and Blommestein, Keskinler, and Flores (2011).

12. An additional index that could be used for the evaluation of government’s financial fragility is the non-financial assets-to-debt ratio. In this paper such an index is not utilised because there are no available data for the non-financial assets of the Greek government sector (see Bova et al. 2013). Note, however, that the role of these assets is to some extent taken into account in our analysis: the proceeds from the sale of non-financial assets affect the fiscal primary balance and thus our liquidity index (see Milesi-Ferretti and Moriyama 2006, 3287 and Appendix 1).

13. At this point certain clarifications are necessary. Greece relinquished its monetary sovereignty in 2001, when it became a member of the European Monetary Union (EMU). Thus, the value of the liquidity index is more important and meaningful for the period since 2001. However, we also present data for the pre-EMU period for two reasons. First, this allows us to show the path dependency of the Greek government sector’s financial posture, since previous regimes affect current debt commitments. Second, as pointed out in Note 1, the financial posture of the government sector can also be important in the case of sovereign countries. For the other financial fragility indices the analysis starts from the year 1999, i.e. the year that the EMU was set up.

14. In Appendix 2 the real pre-tax interest rate has been used instead of the real after-tax interest rate, due to the absence of available data for the tax rate on interest payments.

15. See Papadimitriou, Wray, and Nersisyan (2010).

16. The only countries that report (on average) lower liquid assets-to-debt ratios than Greece over this period are France, Italy and Belgium. On the contrary, Denmark, Spain, Ireland, Luxembourg, Finland and Germany turn out to hold, on average, above 10% of their debt in the form of currency and deposits.

17. In particular, the growth rate of GDP was –4.9%, –7.1% and –6.4% in 2010, 2011 and 2012, respectively. The unemployment rate increased from 9.5% in 2009 to 24.3% in 2012 (see Appendix 2).

18. The exports of Greece were also negatively influenced by the recession or the weak economic growth in its trade partners.

19. An additional reason is the capital transfer expenditures for banks’ resolution, amounted to €8.4 billion in 2012. The recording of these transfers is provisional and subject to revision, since the fair value of the assets of banks under liquidation has not yet been provided (see Hellenic Statistical Authority 2013). However, even if these expenditures are not taken into account the value of the liquidity index is still lower than the expected one.

20. Needless to say, since the main foreign lender of Greece is now the official and not the private sector, the reliance on non-residents for the refinancing of the Greek government debt is of different nature relative to the pre-crisis period. This reliance is now more closely related to political decisions.