Fair debt relief for Greece: New calculations

Thomas Philippon 10 February 2015



Fairness is a loaded word, but, whether we like it or not, it is at the heart of the political economy of debt restructuring in Europe. Until we reach some understanding on this issue, the conversation will continue to run in circles. Clearly the odious debt argument does not apply to Greece (Beck 2015). Greece was and is a democracy. Greek citizens elected the governments that ran the reckless fiscal policy that drove Greece into a deep financial crisis.

With Philippe Martin we have estimated the proximate causes of the crisis in each Eurozone country. We find that Ireland was brought down by reckless bank lending, Spain by the sudden stop, and Greece by reckless government spending during the boom years. So there should be no question that Greece is first and foremost responsible for its own demise.

But we – governments, households, investors – all make mistakes, and this is why debt restructuring exists. The problem is that Greece’s debt restructuring was hampered by the risk of contagion. The current firewalls (ESM, etc.) did not exist then. There was no banking union, no OMT. It was obvious to every observer in 2010 that Greece’s debt was not sustainable. Many advocated an early debt restructuring, coupled with strong fiscal consolidation, but the perceived risk of contagion made it impossible to implement. Eventually, in 2012, Greece’s debt was restructured. But this was clearly too late – much of the macroeconomic damage was done.

Here are my central points:

  • Greece ran a reckless fiscal policy during the boom years, wasting much of the money that it received. There is no question that Greece needs a strong dose of fiscal consolidation.
  • However, Greece’s debt should have been restructured much earlier. This restructuring was prevented by legitimate fears of contagion, and it is not fair to ask Greece to pay for that delay, which reflected a general lack of preparedness among Eurozone policymakers.

If one accepts these two points, then it follows that one should consider an alternative history – with an earlier debt restructuring – as a benchmark for Greece’s debt negotiation. This is what I do.

An alternative history for Greece

This section is based on structural model developed with Philippe Martin. The model takes into account:

  • Private and public debt dynamics,
  • Sudden stops of capital flows,
  • Feedback from private and public debt onto the cost of funds for households and firms,
  • Fiscal policy and spending multipliers,
  • Unit labour costs and competitiveness.

I now present results from some simulations we ran.

Figure 1 shows the actual path of Greece’s debt (2000-2012) and the path under the ‘early debt relief scenario’. The early debt relief has the same size as the eventual debt relief of 2012, but it happens 2 years earlier, in 2010.1 There is still a recession in 2011 and 2012, which is why debt goes up in 2012 under the alternative scenario.

Figure 1. Greece’s stock of debt, actual and early restructuring scenario

Figure 2 shows the actual and alternative path of fiscal consolidation. It is obvious here that fiscal consolidation was necessary under any scenario.

Figure 2. Government spending, actual and early restructuring scenario

Figure 3 shows the path of GDP. Under the alternative scenario, Greece’s fiscal consolidation is a bit slower. Debt is more sustainable so the cost of fund does not increase as much and private spending does not collapse as much.

Figure 3. Greece’s GDP, actual and early restructuring scenario

Under the alternative scenario, Greece avoids neither fiscal austerity nor a deep recession. But, depending on the details of the simulation, its GDP ends up 5 to 10% higher, and its debt 20% to 25% lower. Overall, the debt of GDP is reduced by about 30 points.

Under a tough but early debt-restructuring scenario, Greece’s debt to GDP ratio would have been 30 points lower. These 30 points reflect deep issues with the way the Greek crisis was handled; they cannot be blamed on Greece alone.

In practice, there are many ways to implement this effective debt relief. The simplest is via a combination of extended maturities and lower interest rates. A simple back-of-the-envelope calculation suggests that this corresponds to lowering the required primary surplus from 4.5% down to 3%. Suppose an annual growth of 2%, an interest rate of 2.5%, and a current debt to GDP ratio of 1.9. Then a primary surplus of 4.5% brings the debt down to 120% in 20 years. If we started from 1.6 instead of 1.9, the same target could be achieved by a primary surplus of roughly 3% of GDP.

Concluding remarks

One can, of course, disagree about what I call a fair relief. For instance, it does not fully compensate for the welfare loss during the recession: consumption, unemployment, etc. On the other hand, I take the extreme view that all the spillover costs should be mutualised. One could argue instead that Greece should have known that it would be harder to restructure under a common currency so it should have been more careful. It is also clear that the arguments presented above would also apply to the case of the banks’ bailouts in Ireland. We will never have a complete counterfactual to define what is really ‘fair’, but at least I hope to have provided a useful benchmark where we can objectively discuss various hypotheses.


Thorsten Beck (2015), “Groundhog day in Greece”, VoxEU.org, 2 February.

Philippe Martin and Thomas  Philippon (2014), “Inspecting the Mechanism: Leverage and the Great Recession in the Eurozone, NBER working paper No.20572.

Philippe Martin and Thomas Philippon (2014), “What caused the great recession in the Eurozone? What could have avoided it?” VoxEU.org, 11 November.


1 These figures will be updated to 2014 as soon as all the data are available. The figures do not show it but Greece debt dynamics tend to diverge again in 2013 and 2014 under the actual ‘late’ debt relief. Under the early debt relief scenario, these dynamics can be stable, but that still requires fiscal consolidation, as discussed below.



Topics:  EU policies Europe's nations and regions Macroeconomic policy

Tags:  Greece’s debt restructuring, eurozone, Greece

Professor of Finance, Stern School of Business, NYU and CEPR Research Affiliate

Vox Talks