Crisis in the Cradle of Democracy

By Kaavya Ramesh, 6/29/11

Today, the Greek Parliament announced that it would adopt austerity measures in order to secure a 50 billion euro bailout ($72 billion) from the European Union. These measures include wage cuts, federal spending cuts, and privatization of government funds and industries.

As the discussion of EU bailouts grows louder and more heated, let's take a moment to look at the big picture. Should Greece even be using the euro? 

The European Union has four convergence criteria to determine whether a member nation should adopt the euro as its currency. If a member nation fails to meet any of these criteria, it cannot adopt the euro (this information credited to Steven J. Matusz, professor of economics at Michigan State University):

1. Price stability (all prospective adopters must have similar inflation rates).

2. Government finance (all prospective adopters have to have low government budget deficits and low national debt).

3. Exchange rate stability (prospective adopters had to have successfully fixed their exchange rates to one another for two years prior to adopting the euro).

4. Long-term interest rates (prospective adopters have to have similar levels of long-term interest rates).

Greece initially met these four criteria in order to begin adopting the euro at all...but are they continuing to meet them? Let's take a look.

1. Price stability

Greece seems to continue to meet this criterion. Looking at their Consumer Price Index, which measures overall prices in a country, the last Greek yearly inflation rate was 3.29%. This is relatively similar to Austria's inflation rate (3.19%), Belgium's inflation rate (3.35%), and Finland's inflation rate (3.31%).

2. Government finance

Greece certainly does not seem to meet this. The Greek government projects that by Fall 2011, the budget deficit will reach 17.1 billion euros ($24.4 billion). Additionally, at the end of 2010, Greek's national debt stood at a colossal 140% of its GDP. The Maastricht Treaty, which lays out the rules for adopting the euro, states that a country's total debt must be less than 60% of GDP. Greece is severely overstepping that boundary.

3. Exchange rate stability

Greece has already met this criterion. Because it is a one-time action (pegging the Greek currency to EU members' currencies before adopting the euro), it cannot be continually evaluated.

4. Long-term interest rates

Greece does not meet this criterion. The Greek long-term interest rate, last measured in May 2011, is 15.94. The country with the interest rate closest to Greece's is Ireland, with a rate of 10.64. By contrast, Belgium's rate (4.21), Germany's rate (3.06), and Austria's rate (3.53) are so far from the Greek rate that Greece should not be using the euro at all.

Conclusions: Greece does not continue to meet two of the four convergence criteria for using the euro. It's time to leave the eurozone.