The Greek crisis has divided the 16 eurozone member countries on possible course of action. President Barroso has made efforts to find a compromise on a macro financial assistance instrument which would be coordinated by the EU. Ms Merkel has finally imposed the IMF solution for pure internal reasons and against EU general interest. Though, recent events on financial markets show that the measures decided by the last European Council were not sufficient to provide a durable solution to Greek problems and thereby ensure a more stable governance of the euro area. It is at best a short term compromise for crisis management.
However, IMF aid will not help to resolve Greek problems. A closer look at Greece's economic indicators suggest that we are dealing more with a solvency problem rather than a liquidity one. Greece's public debt to gross domestic product ratio is approaching 120 per cent, its budget deficit has risen to 12,75 per cent and the economy has lost around 30 percentage points in terms of international competitiveness over the past decade. As Latvia and Ireland's recent experience suggests, attempting to bring Greece's budget deficit down towards 3 per cent of GDP limit by savage expenditure cuts and without a recourse to currency devaluation could result in a cumulative contraction in Greece's GDP by 15-20 per cent over the next few years.
At the same time, attempting to correct Greece's large competitiveness loss through deflation will necessarily involve an eventual decline in Greek prices and wages of around 20 per cent.
In that scenario- with a decline of GDP and a sharp fall of prices and wages- the debt to GDP ratios would then overshoot instead of decreasing. If this is plausible, one would then think than it would be better to pursue debt restructuring rather than the IMF kicking Greece down the road.
This means that EU leaders will have to design new (not tougher) rules for economic governance such as burden sharing allowing for temporary solidarity mechanisms for countries running high deficits, especially in times of global crisis.