Can Greece Cut Its Deficit by 10% of GDP?

Greece needs money fast. The International Monetary Fund (IMF) and members of the Euro-zone have that money. But before they lend it to Greece (at very favorable interest rates), they are demanding that Greece get its fiscal house in order.

As a result, Greece is proposing an austerity plan that would reduce its out-of-control budget deficits (currently standing at more than 13% of GDP) by at least 10-11% of GDP.

You might wonder whether that’s possible. History suggests the answer is yes, at least in principle. Indeed, several countries have achieved even larger deficit reductions.

According to an IMF study that I discussed a few months ago, the past three decades have witnessed at least nine instances in which developed nations have cut their structural deficits by at least 10% of GDP:

  1. Ireland (20%, 1978-89)
  2. Sweden (13%, 1993-2000)
  3. Finland (13%, 1993-2000)
  4. Sweden (13%, 1980-87)
  5. Denmark (12%, 1982-86)
  6. Greece (12%, 1989-95)
  7. Israel (11%, 1980-83)
  8. Belgium (11%, 1983-1998)
  9. Canada (10%, 1985-99)

This list demonstrates that large-scale budget improvements are possible. But they don’t always stick. Sweden, for example, makes two appearances in the top nine. Its gains in the 1980s were undone in the financial crisis of the early 1990s, so it had to undertake a second round of austerity. And Greece itself is a repeat offender, as its gains from the early 1990s have all been lost.

Greece faces enormous practical and political challenges in its austerity efforts, and success is hardly guaranteed. The nation can take some encouragement, however, from the fact that other nations have addressed even larger budget holes.

With some hard work and luck, perhaps Greece will join Sweden as a two-time member of the Large Deficit Reduction Club.

6 thoughts on “Can Greece Cut Its Deficit by 10% of GDP?”

  1. Interesting point, but none of those ‘adjustments’ happened with fixed forex rate. I am wrong?
    Thanks anyway for this post!
    (reposted on the most recent article 🙂

  2. Fraxel, most of the above nations were in the European Exchange Rate Mechanism from 1979 onwards.

    1. Actually, I think only Belgium and Ireland were in the ERM from ’79 onwards. I believe Denmark stayed outside. Finland and Sweden were not even EC/EU members until 1995 and Canada and Israel are still not.

      The ERM was not a fixed exchange rate system anyway: it allowed floating within bands and was subject to periodic revision.

  3. Does the larger macroeconomic environment influence whether a country can do a large deficit reduction? In particular, does the larger debt crisis that cuts across many nations make the cuts more difficult to do successfully?

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