Private loans important factor behind Greek crisis

Greece has several problems. But to understand the big picture, it is interesting to discuss how the problems started around 2008/2009. Greece and other countries’ experiences can tell us a lot about politics in general. Similar crises have occurred in several countries in recent years. Here I make some comparison with especially Ireland, Spain, Portugal and the United States. See graph at bottom.

1. “Lazy Greeks” did not cause the crisis

Greece has several political problems but the argument that “laziness” or similiar, would cause an acute financial crisis, or prevent a country from getting back on its feet, is a strange claim. If retirement ages, high subsidies or something similiar caused the crisis 2008/2009, the crisis should have occurred a long time ago.

Moreover, when I compare data, the Greek people does not seems to be particulary lazy, in comparison with other OECD countries. These graphs show hours worked per capita and per employee. Rather, residents in crisis countries seem to have worked more than many other countries, the years before the crisis occured.


Data from The Conference Board

2. Government debt did not cause the crisis

The Greek government is now short of money. This is a problem – but it does not explain why the crisis started in 2008/2009. The large increases in government debt came after the crisis started. This is obvious when comparing the development of government debt in elation to GDP. The Greek debt was relatively high long before the crisis, but it was at about the same level relative to GDP for 20 years.


Data from AMECO

3. Low taxes did not cause the crisis

Some people on the left seems to believe that Greece’s problems started because taxes are too low. This argument suffers from the same problem as the “Lazy Greeks”-theory. The level of taxes (low / high) or the design, could possibly create problems in the long term – but they do not cause economic meltdown in just a few months.

Greece is also said to have problems getting the tax revenues that is decided by law. Of course it’s important that this kind of stuff works, but any such changes would not solve all of Greece’s problems. Rather, the Greek government probably needs to borrow more money, see below.

4. Psychological shock incomplete explanation

One theory of the crisis is that the world economy suffered a psychological shock, sometime around 2008/2009 in conjunction with the burst of the US mortgage bubble. Banks got into trouble and confidence in the financial market fell rapidely. This would, in theory, also have made investors and consumers so uncertain that the whole economy went into a large crisis (I guess you could call this the New Keynesian theory of the crises?).

Uncertainty can cause problems for the economy. But neither this theory seems like a full explanation. Psychological problems should go away relatievly quickly – but several of the crisis-affected countries still have lower GDP, higher unemployment and lower employment.

And if the uncertainty is the most crucial factor – why were different countries hit so extremely different? In Sweden, unemployment rose by 2 percent. But in many countries, unemployment has doubled or tripled. Is it because the shock affected different countries differently, depending on public finances? That doesn’t hold neither.

5. Private loans major factor behind crisis

What instead seems to be the most important factor behind the crisis in Greece and a number of other countries, is changes in the amount of private loans. Before the crisis, private banks in Greece and many other countries lended big amounts of money to households and businesses, so that they could buy expensive things, which they could not afford in the longer term.

When banks create loans, new money is created that can be used for consumption. When the loans are paid back, money risks being lost from the system, reducing the total possible consumption. When consumption decreases, it means that the demand for goods and services decreases, thus reducing the demand for labor. This is the absolutely most central mechanism behind most of the phenomenon we know as “financial crises” (see here for discussion of the mechanics).

This is true of Greece and many other crisis countries around 2008. The amount of private loans increased for a long time. When the increase of the amount of loans decreased (which can negatively affect consumption) and then started to decline, the crisis started.

Here’s one way to illustrate this for Greece: The graph shows the change in the total amount of outstanding private loans to households and companies; and the development of government debt as percent to GDP. The large increase in Government debt seems to take place only after the amount of private loans started to decline (also, compare the graph on government debt above).


Data from Eurostat and the BIS. Loans deflated with CPI.

6. Private loans covariates with consumption in the EU countries during the 2000’s

The amount of private loans and debt have increased rapidly in most OECD countries in recent decades. In several countries private loans and debt started to decrease around 2008. It was these countries that went into the deepest crisis.

One way to illustrate this: The more household debt increased in an EU country, the years 2000-2007, the more consumption declined in subsequent years. One way to interpret this is that private loans may affect private consumption.

Graph below: Horizontal axis = change in private loans in relation to disposable income 2000-2007. Vertical axis = Percent change consumption per capita 2007-2012. Graph taken from our report for SIEPS (report in Swedish with English abstract). Data from OECD and central banks.


7. What about the Euro?

There are also allegations that the monetary union, EMU, was the main cause of the crisis. For example, because the European Central Bank (ECB) provided an interest rate policy for Germany, which did not suit Greece. This, combined with other factors, seem to have contributed to imbalances in labor costs and productivity (see here ).

This kind of trouble must be delt with if the EMU project shall be able to exists. EMU also means that Greece can not borrow from their own central bank (since they do not have one), which probably would be ideal in this situation. In this way the EMU contributed and still contributes to Greece’s difficulties.

But, as far as I could see in the research and data, the big increase and then decrease in the amount of private loans appear far more critical to explain the emergence and depth of the crisis. ECB monetary policy may possibly have contributed to the rise of private loans – but central banks influence over the amount of private loans is limited and heavily dependent on the rules for banks. Also, the EMU does not seems to able to explain why the crisis occured in the US and other countries outside of Euro. Therefor it seems misleading to describe the EMU as the essential reason for the crisis.

8. What does Greece need?

When the private sector reduces its total amount of debt and loans, the Government must borrow to increase consumption – otherwise unemployment might increase. But if a country does not have its own currency and central bank (Greece is a member of the Euro), the Government must borrow on the private market, which often is more difficult and may sometimes be impossible.

This chart shows that the crises started at different times in different countries, and that the effects vary greatly between countries.


Data from Eurostat


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