Greece's Debt Crisis: Causes and Essay

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This flaw creates an incentive for firms to accumulate large sums of unpaid taxes over several years and then enter into negotiations with the tax authorities in order to remit small proportion of taxes. This flaw has been a constant feature of all tax reforms and thus makes the whole tax system less credible and more prone to abuse.

Following the inadequate government intervention, it is clear that, in 2009, the Greek economy was subjected to full blown crisis, where the global market and investors lacked confidence in the monetary regime of Greek economy. As such, it demonstrates the reason why the EU/IMF was not successful in implementing its rescue plan that would have enabled the pressure on Greek government bond yield to subside. The rescue plan was not successful as the Greek government bond yield had a high risk of default and strong expectations from the investors that the Greek government could not bear. In addition, it failed because the cost attributed to reforms was unbearable, making it cumbersome to stay in Euro's. The markets feared that Greece would decide to quit EMU citing voluntary exit; therefore, causing capital losses to bond holders, as the currency will be devalued (Spigelonline, 2010).

The third cause of the debt crisis is the withdrawal of implicit fiscal guarantees in the economy. Krugman (1998) posits that default risk intensifies debt crisis in the economy. In addition, Krugman (1998) purports that government and international liquidity acts as a guarantee to the liabilities of insufficiently regulated financial intermediaries. Under lax supervision and guarantees, the intermediaries -- both within the government and across the globe -- have the necessary incentives required to borrow short-term loans at a given interest rate; normally lower than the interest rate highlighted by the international regulation. Such short-term funds can be used to finance domestic investment funds in an attempt to realize the effectiveness in managing the debt crisis. Ideally, projects having low expected return will, ultimately, realize large gains if financed properly. As such, from these Greek's government guarantees ensure that the investors' risk are subsidized (Arghyrou and Chortareas, 2008).

Finally, it is important to highlight that, apart from these factors; other factors are also beneficial as they determine the trend of Greek's debt crisis. The role in which these factors play is quite decisive. For instance, Greek government bonds yield may involve increasing liquidity premium. However, the current premium denotes the value of the bond as perceived by other countries in the EMU (Arghyrou, 2006). A critical analysis shows that the increase in liquidity premium of Greece is disproportionate, and this may be attributed to the downsizing of Greek bonds caused by the factors explained in the essay.

Solutions to Debt Crisis

Ideally, investors analyze Greek bonds as a venture into an initiative that is risky -- for instance capital restructuring with low level of income in circulation -- under highly-indebted and competitive economy, with two possible scenarios.

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The first scenario involves the Greece government promoting reforms that are competitive, which will boost the economy and reduce the debt crisis. As such, commencing from an economy with low income base, it would be able to grow faster. The government bonds will appreciate in value thereby generating large gains for investors who took the bet. The second scenario is where the Greece government would decide not to articulate to reforms in the economy. Greek government bonds would depreciate in prices; thereby, increasing the chances of investors to incur losses. Consequently, in an unvarnished environment, for instance the environment that prevailed before Greece's accession to the EMU, the global markets were pricing the bonds of Greek government according to the probability of the reform, i.e. future expected Greek fundamentals.

Following the EMU accession, Greece has become one of the members of the single currency countries where it has enhanced the country's flow of funds. Markets believed that EMU countries, German included, had an interest in the undertakings of the Greek reforms and their continued operations in EMU in an attempt to stabilize prices and minimize debt crisis. This sentiment has been reinforced by the political commitment of superpower countries in an attempt to foster European integration. Therefore, Greek accession to EMU was an assurance to investors that it aimed at implicit bail-out guarantee on the government bonds. This resulted to markets stopping to price Greek government bonds using expected fundamentals.

The government should eliminate tax evasion by creating a credible tax audit system of checks-and-balances that identifies tax evaders and tax arrears using automated-computerized methods. Such methods need to be new. They can be borrowed and learned from other EU or North American countries such as Canada and the U.S. Equally vital, the fundamental flaw of the tax system, which allows for the negotiated settlement of tax arrears between the tax payers and the tax auditors, should be dropped, thus eliminating both one of the main incentives for tax evasion (Obstfeld and Rogoff, 1999).

Conclusion

The Greek debt crisis has been a fundamental aspect in the economic growth and development of the economy. It has affected the unemployment rate and the exchange rate in the region. Some of the issues highlighted have been either political or economic. The government needs to enact strategies that will mitigate its adversity. Both fiscal and monetary policies need to be incorporated into the system in order to have a positive perception of Greece economy. However, the strategies highlighted will, ultimately, rescue the debt crisis imminent in Greece government......

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