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Greece has acted as a catalyst for the outbreak of the crisis of the euro area, following the bursting of the big bubble in the Western financial system. It remains today the most vulnerable link of the euro chain, while in the meantime the crisis has extended to other countries. Greece has also served as a test case for national and European policies in response to the crisis: a stress test for the domestic political system, the economy and society at large in the context of economic austerity, recession and reform-induced change, as well as for the capacity of European institutions to devise new policies to deal with problems they had clearly not been prepared for.

Some believe that Greece is the odd man out among the beleaguered countries of the European periphery. If true, the policy options that could follow range all the way from special treatment and patience for a country expected to go through little less than a peaceful revolution in punishing conditions to default and/or forced exit from the euro area, with several other options in between. There are others who suspect or fear that Greece may be the precursor of things to come—as it has already been so in different ways—or possibly the first in a series of domino effects that could eventually lead to the disintegration of the euro area. It is high stakes.

Hence, the disproportionate amount of international attention paid to Greece in comparison to its modest size, although the size of its public debt is certainly less modest. As of March 2011, its public debt had risen to €354 billion held in large part by foreigners, notably banks, other financial institutions and increasingly European governments and the ECB (Graph 1).

The Outbreak of the Crisis

It all began in October 2009 when the newly elected government of Greece, led by George Papandreou of the socialist party (PASOK), announced that the Greek budget deficit of 2009 was going to be much bigger than previously claimed by the outgoing government of the centreright (New Democracy), and well into double digit figures. The announcement was not followed by serious measures to deal with the problem. Jittery markets, still under the spell of the Lehman effect, suddenly focussed on the prospect that the crisis could transform itself into a crisis of sovereign debt, as governments increased their borrowing to deal with the adverse effects on banks and the real economy. Spreads on Greek state borrowing rose fast as the Greek government and EU institutions dithered (Graph 2a).

Greece was the catalyst for the outbreak of the crisis of the euro area, because it had the worst combination of three different deficits: a large budget deficit, which reached 15.4 percent of GDP in 2009 after a number of revisions (Graph 3), being added to an already big public debt (at 127 percent of GDP in 2009, it was already the highest in the euro area); an equally large, indeed unsustainable, deficit in its current account that was almost 15 percent of GDP in 2008 (Graph 4)—a deficit of competitiveness, in other words; and a serious credibility deficit as people realized that Greek politicians had been repeatedly economical with the truth and creative with the use of statistics. Greece was surely not unique with respect to any of those three deficits among members of the euro area and the wider world. But it had, undoubtedly, the worst combination when markets began to panic again, while governments, and notably its own, took their time in trying to take a grip of an, admittedly, very difficult situation.