Question

In May 2010, the size of the Greece’s budget deficit increased its probability of default and triggered a crisis across the Eurozone. To decrease the budget deficit, the Greek government proposed many measures. A few of them involved decreasing pension and/or benefits payments to retiree. Use the life-Cycle hypothesis to evaluate the impact of an unexpected decrease in the income of the retirees in Greece.

Answer 1

The Greek debt crisis is the dangerous amount of sovereign debt Greece owed the European Union between 2008 and 2018. In 2010, Greece said it might default on its debt, threatening the viability of the eurozone itself.
To avoid default, the EU loaned Greece enough to continue making payments.
Since the debt crisis began in 2010, the various European authorities and private investors have loaned Greece nearly 320 billion euros.
It was the biggest financial rescue of a bankrupt country in history. As of January 2019, Greece has only repaid 41.6 billion euros. It has scheduled debt payments beyond 2060.
In return for the loan, the EU required Greece to adopt austerity measures. These reforms were intended to strengthen the Greek government and financial structures. They did that, but they also mired Greece in a recession that didn’t end until 2017.
The crisis triggered the eurozone debt crisis, creating fears that it would spread into a global financial crisis. It warned of the fate of other heavily indebted EU members. This massive crisis was triggered by a country whose economic output is no bigger than the U.S. State of Connecticut.
Greece Crisis Explained
In 2009, Greece’s budget deficit exceeded 15 percent of its gross domestic product. Fear of default widened the 10-year bond spread and ultimately led to the collapse of Greece’s bond market. This would shut down Greece’s ability to finance further debt repayments. The chart below highlights in red the period when the 10-year government bond yield passed 35 percent until vast debt restructuring forced private bondholders to accept investment losses in exchange for less debt. EU leaders struggled to agree on a solution. Greece wanted the EU to forgive some of the debt, but the EU didn’t want to let Greece off scot-free.
The biggest lenders were Germany and its bankers. They championed austerity measures. They believed the measures would improve Greece's comparative advantage in the global marketplace. The austerity measures required Greece to improve how it managed its public finances. It had to modernize its financial statistics and reporting. It lowered trade barriers, increasing exports.
Most importantly, the measures required Greece to reform its pension system. Pension payments had absorbed 17.5 percent of GDP, higher than in any other EU country. Public pensions were 9 percent underfunded, compared to 3 percent for other nations. Austerity measures required Greece to cut pensions by 1 percent of GDP. It also required a higher pension contribution by employees and limited early retirement.
Half of Greek households relied on pension income since one out of five Greeks were 65 or older. Workers weren’t thrilled paying contributions so seniors can receive higher pensions.
The austerity measures forced the government to cut spending and increase taxes. They cost 72 billion euros or 40 percent of GDP. As a result, the Greek economy shrank 25 percent. That reduced the tax revenues needed to repay the debt. Unemployment rose to 25 percent, while youth unemployment hit 50 percent. Rioting broke out in the streets. The political system was in upheaval as voters turned to anyone who promised a painless way out.
The results are mixed. In 2017, Greece ran a budget surplus of 0.8 percent. Its economy grew 1.4 percent, but unemployment was still 22 percent. One-third of the population lived below the poverty line. Its 2017 debt-to-GDP ratio was 182 percent.

Timeline
In 2009, Greece announced its budget deficit would be 12.9 percent of its GDP. That's more than four times the EU's 3 percent limit. Rating agencies Fitch, Moody's, and Standard & Poor's lowered Greece's credit ratings. That scared off investors and raised the cost of future loans.
In 2010, Greece announced a plan to lower its deficit to 3 percent of GDP in two years. Greece attempted to reassure the EU lenders it was fiscally responsible. Just four months later, Greece instead warned it might default.
The EU and the International Monetary Fund provided 240 billion euros in emergency funds in return for austerity measures. The loans only gave Greece enough money to pay interest on its existing debt and keep banks capitalized. The EU had no choice but to stand behind its member by funding a bailout. Otherwise, it would face the consequences of Greece either leaving the Eurozone or defaulting.
Austerity measures required Greece to increase the VAT tax and the corporate tax rate. It had to close tax loopholes. It created an independent tax collector to reduce tax evasion. It reduced incentives for early retirement. It raised worker contributions to the pension system. At the same time, it reduced wages to lower the cost of goods and boost exports. The measures required Greece to privatize many state-owned businesses such as electricity transmission. That limited the power of socialist parties and unions.

Why was the EU so harsh? EU leaders and bond rating agencies wanted to make sure Greece wouldn't use the new debt to pay off the old. Germany, Poland, Czech Republic, Portugal, Ireland, and Spain had already used austerity measures to strengthen their own economies. Since they were paying for the bailouts, they wanted Greece to follow their examples. Some EU countries like Slovakia and Lithuania refused

to ask their taxpayers to dig into their pockets to let Greece off the hook. These countries had just endured their own austerity measures to avoid bankruptcy with no help from the EU.

In 2011, the European Financial Stability Facility added 190 billion euros to the bailout. Despite the name change, that money also came from EU countries.
By 2012, Greece's debt-to-GDP ratio rose to 175 percent, almost three times the EU’s limit of 60 percent. Bondholders finally agreed to a haircut, exchanging 77 billion euros in bonds for debt worth 75 percent less.
In 2014, Greece’s economy appeared to be recovering, as it grew 0.7 percent. The government successfully sold bonds and balanced the budget.
In January 2015, voters elected the Syriza party to fight the hated austerity measures. On June 27, Greek Prime Minister Alexis Tsipras announced a referendumon the measures. He falsely promised that a "no" vote would give Greece more leverage to negotiate a 30 percent debt relief with the EU. On June 30, 2015, Greece missed its scheduled 1.55 billion euros payment. Both sides called it a delay, not an official default. Two days later, the IMF warned that Greece needed 60 billion euros in new aid.
It told creditors to take further write-downs on the more than 300 billion euros Greece owed them.

On July 5, Greek voters said "no" to austerity measures. The instability created a run on the banks. Greece sustained extensive economic damage during the two weeks surrounding the vote. Banks closed and restricted ATM withdrawals to 60 euros per day. It threatened the tourism industry at the height of the season, with 14 million tourists visiting the country. The European Central Bank agreed to recapitalize Greek banks with 10 billion euros to 25 billion euros, allowing them to reopen.
Banks imposed a 420 euros weekly limit on withdrawals. That prevented depositors from draining their accounts and worsening the problem. It also helped reduce tax evasion. People turned to debit and credit cards for purchases. As a result, federal revenue increased by 1 billion euros a year.
On July 15, the Greek parliament passed the austerity measures despite the referendum. Otherwise, it would not receive the EU loan of 86 billion euros. The ECB agreed with the IMF to reduce Greece’s debt. It lengthened the terms, thus reducing net present value. Greece would still owe the same amount. It could just pay it over a longer time period.
On July 20, Greece made its payment to the ECB, thanks to a loan of 7 billion euros from the EU emergency fund. The United Kingdom demanded the other EU members guarantee its contribution to the bailout.
On September 20, Tsipras and the Syriza party won a snap election. It gave them the mandate to continue to press for debt relief in negotiations with the EU. However, they also had to continue with the unpopular reforms promised to the EU.
In November, Greece's four biggest banks privately raised 14.4 euros billion as required by the ECB. The funds covered bad loans and returned the banks to full functionality. Almost half of the loans banks had on their books were in danger of default. Bank investors contributed this amount in exchange for the 86 billion euros in bailout loans. The economy contracted 0.2 percent.
In March 2016,

the Bank of Greece predicted the economy would return to growth by the summer. It only shrank 0.2 percent in 2015, but the Greek banks were still losing money. They were reluctant to call in bad debt, believing that their borrowers would repay once the economy improved. That tied up funds they could have lent to new ventures.
On June 17, the EU's European Stability Mechanism disbursed 7.5 billion euros to Greece. It planned to use the funds to pay interest on its debt. Greece continued with austerity measures. It passed legislation to modernize the pension and income tax systems. It promised to privatize more companies, and sell off nonperforming loans.
In May 2017, Tsipras agreed to cut pensions and broaden the tax base. In return, the EU loaned Greece another 86 billion euros. Greece used it to make more debt payments. Tsipras hoped that his conciliatory tone would help him reduce the 293.2 billion euros in outstanding debt. But the German government wouldn't concede much before its September presidential elections.

In July, Greece was able to issue bonds for the first time since 2014. It planned to swap notes issued in the restructuring with the new notes as a move to regain investors' trust.
On January 15, 2018, the Greek parliament agreed on new austerity measures to qualify for the next round of bailouts. On January 22, the eurozone finance ministers approved 6 billion to 7 billion euros. The new measures made it more difficult for unions strikes to paralyze the country. They helped banks reduce bad debt, opened up the energy and pharmacy markets, and recalculated child benefits.
On August 20, 2018, the bailout program ended. Most of the outstanding debt is owed to the EU emergency funding entities. These are primarily funded by German banks.
European Financial Stability Mechanism and European Stability Mechanism: 168 billion euros
Eurozone governments: 53 billion euros.
Private investors: 34 billion euros.
Greek government bond holders: 15 billion euros.
European Central Bank: 13 billion euros.
IMF: 12 billion euros.
Until the debt is repaid, European creditors will informally supervise adherence to existing austerity measures. The deal means that no new measures would be created.

Causes
How did Greece and the EU get into this mess in the first place? The seeds were sown back in 2001 when Greece adopted the euro as its currency. Greece had been an EU member since 1981 but couldn't enter the eurozone. Its budget deficit had been too high for the eurozone's Maastricht Criteria.
All went well for the first several years. Like other eurozone countries, Greece benefited from the power of the euro. It lowered interest rates and brought in investment capital and loans.
In 2004, Greece announced it had lied to get around the Maastricht Criteria. The EU imposed no sanctions. Why not? There were three reasons.
France and Germany were also spending above the limit at the time. They'd be hypocritical to sanction Greece until they imposed their own austerity measures first.
There was uncertainty on exactly what sanctions to apply. They could expel Greece, but that would be disruptive and weaken the euro.
The EU wanted to strengthen the power of the euro in international currency markets. A strong euro would convince other EU countries, like the United Kingdom, Denmark, and Sweden, to adopt the euro.
As a result, Greek debt continued to rise until the crisis erupted in 2008.