Question

1. Explain fully why countries like Greece accumulated sovereign debt. How is this related to the use of fiscal policy in the Keynesian model? How is a foreign debt different from a domestic debt?

Answer 1

In 2009, Greece’s budget deficit exceeded 15 percent of its GDP. The 10-year bond spread and ultimately led to the collapse of Greece’s bond market. That made Greece’s paralyzed to finance further debt repayments. 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 position in the global marketplace. The austerity measures required Greece to improve its public finances by modernizes its financial statistics and reporting. It lowered trade barriers, increasing exports. 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 the Greek households depend on pension income since one out of five Greeks was 65 or older.  The austerity measures forced the government to cut spending and increase taxes.

Explaining the sovereign debt is generally defined as economic and financial problems caused by the (perceived) inability of a country to pay its public debt. This position appears when a country reaches critical high debt levels and suffers from (perceived) low economic growth and economic crisis times.

The Keynesian fiscal policy basically describes the role of government in a time of crisis. How the government can take action to raise up the consumption to increase the demand side and that will automatically increase the output and henceforth rate will bring an increment in economic growth.

Domestic debt is the aggregate level of debt owed by the government of a country. This type of borrowing from within the economy eg selling G-secs. Foreign is debt owed by the government, businesses, and people of a country to foreign countries, IMF, World Bank, foreign banks, and sometimes foreign companies and creditors. The debt mainly taken from outside of the economy can be ECB, multilateral debt, bilateral debt, etc. External long term soft loan is preferred over internal short term loans at high-interest rate.