The Impact of the Greek Sovereign Debt Crisis on the European Monetary Union

Chapter One Introduction 1.1 The Sovereign Debt Crises in the Eurozone, Introductory Remarks The sovereign debt crisis erupted in Greece in the autumn of 2009. From Greece, it then expanded to other countries of the Euro area, namely Portugal and Ireland. To prevent a risk of contagion to other bigger Eurozone member states, such as Italy and Spain, Heads of States of the European monetary union, with the help of the International Monetary Fund, agreed to develop a rescue plan to bailout Greece, Portugal and Ireland. Before continuing the narration of the events, it may be worth explaining the terms. Every year governments create a budget to determine the amount of money required to spend on running the nation. However, there exists the possibility that a government may run a budget deficit. This happens when a government expenditure exceeds the revenues coming from tax revenues. In order to finance its deficit and increase the amount of money supply in the national banking system which will be used to foster the country's growth, the government can decide to issue bonds on the capital market which represent the public debt. In summary, a budget deficit is financed through the public debt. The term “sovereign” is used to refer to a State, so as to distinguish a debt of a sovereign state from that of any other private institution on the capital market. A sovereign debt is often quantified in relation to a country's growth. Hence, a sovereign debt is expressed in a percentage as a share of a country's annual GDP. In this perspective, a “sovereign debt crisis” occurs whenever the debt to GDP ratio is positive. However, a certain amount of public debt is always acceptable, for it is assumed that a country which issues debt bonds is able to repay its obligations. Instead, when a country does not have the financial resources to repay its debts on the capital market, it faces a sovereign debt crisis. If the debt is too big, the highest risk faced by the country is that of a debt default. To prevent the rising of these insolvency crises, the European Monetary Union (EMU) has introduced an instrument which sets 1