For the last five months, issues regarding Greece and the European Union have been front page news across the globe. While everyone realizes that there is a problem, and differing sources cite different causes for it, the possible solutions suggested have brought to the forefront several interesting economic terms. Since not everyone is familiar with these terms in a financial sense, let’s examine what exactly the terms bailout, haircut, and payment extension mean in order to better understand what’s going on.
Without spending too much time discussing how we arrived at this juncture, let’s consider the basics. Greece is currently €323 billion in debt, approximately 175% of its gross domestic product (GDP). To try and improve the overall economic condition of the EU following the recession of 2009, many EU countries started cutting back on their spending, which is known as austerity. Since Greece has the highest debt to GDP ratio in the EU, it needed to make the most significant changes to its spending, so austerity measures were put into place to deal with the worsening debt. Unfortunately, these changes have had a devastating effect on the Greek economy over the last five years: the overall economy has shrunk by 25%, unemployment has increased to 25%, and the number of people below the poverty line has dramatically increased.
During the latter stages of the 2009 recession, the Greek economy was already showing signs of being highly stressed, compared to other nations in the EU. Worried about the possibility of a domino effect on the economies of Spain, Portugal, Ireland, and Italy, as well as dramatic impact the euro, the European commission, the European Central Bank, and the International Monetary Fund, also known as the Troika, initially offered Greece a bailout loan. While a typical bailout is defined as financial assistance to prevent an economic collapse, this bailout was intended to fund the Greek banks and government until the spending cuts and restructuring could have a positive effect.
As we now know, however, a sluggish EU economy and slowed global economic growth since 2009 led to the opposite effect in Greece: spending cuts, higher taxes, and restructuring without the ability to cope with a lethargic economy have turned austerity into what seems like an ever-worsening economic depression. Increasingly unable to repay its debts and with social unrest on the rise, Greece is now asking for either a “debt haircut” and/or a payment extension. In economic terms, much like with a barber or stylist, a haircut means that Greece wants an overall reduction in the amount of debt it owes, either through debt forgiveness or accepting less than the full repayment. Moreover, a payment extension simply means that, while Greece is willing to pay the full amount of its debts, it would prefer to pay them over a longer period of time, thus lowering debt payments.
Both options, either separately or together, would be beneficial for Greece. However, the EU seems divided on whether or not this would help Greece or just encourage further spending while sending the wrong message to other EU economies. Though we don’t know how this issue will finally be resolved, we have, at least, shed light on some difficult terminology.