The government can't pay its creditors in a parallel currency, but it could pay pensioners, contractors and public servants. The cash alternative would hold value in the same way that any other modern money holds value — because it's backed by the government. Although in this case, while euros are backed by a European institution the ECB , the IOUs would be backed by the Greek government alone, and would likely be worth very little outside of the country.
Here's how Capital Economics think that would play out:. Shopkeepers and other economic agents would find themselves obliged to accept these IOUs as payment whether or not they were declared as legal tender. But they would not be obliged to accept them on equal terms with euros proper, and they surely would not want to. A dual pricing system would develop; a good or service would cost euros but, say, IOUs.
Of course, anyone being paid in IOUs would then demand a pay rise. A parallel market would likely open up too, with holders of the IOUs bidding for euros. It's easy to see how hard it would be for Greece to get back into the eurozone properly after this without controls — but a Grexit scenario would likely mean even more social unrest, spiking inflation and financial outflows. The halfway house of a frozen banking system and a strange shadow currency might actually be the best option in that case.
In this scenario almost everything depends on how the ECB behaves. If it's willing to turn a blind eye to a technical default and keep holding the banking system up, thing could keep going as they are — but if it isn't, Greece's situation could get much worse, and quickly. For you. World globe An icon of the world globe, indicating different international options. German Finance Minister Wolfgang Schaeuble dismissed the Greek proposal, telling broadcaster ZDF on Tuesday evening: "It's not about extending a credit programme but about whether this bailout programme will be fulfilled, yes or no.
Unable to borrow from anyone not even other European governments , the Greek government would simply run out of euros. It would have to pay social benefits and civil servants' wages in IOUs if it pays them at all until a new non-euro currency can be introduced. The government would have to impose a freeze on withdrawals and on people taking money out of the country. This could lead to queues of ordinary Greeks trying to empty their bank accounts before they get converted into a new currency worth substantially less than the previous one.
In the longer run, Greece's economy should benefit from having a much more competitive exchange rate. But the devaluation would not solve underlying problems in the economy, including poor tax collection and a struggle to control government spending. There is also a real possibility of a surge in inflation. Tax receipts would probably fall as the economy contracted, so the government might finance spending by printing money. The likely currency depreciation would also be inflationary.
It would make imported goods - which in Greece includes a lot of its food and medicine - more expensive. There is a danger that a Greek departure from the euro might do wider economic damage, but the risk is generally thought to be much reduced since , the last time such speculation was rife.
Actions by the European Central Bank are a key element behind this change. First of all, there is the ECB's commitment to do " whatever it takes to preserve the euro ". That promise, made by the ECB's President Mario Draghi in July , was later fleshed out to include a commitment to buy the debts of governments whose borrowing costs were affected by fears of them leaving the euro. The ECB has not acted on that promise, but its existence was enough to calm eurozone financial markets.
And the ECB could use this initiative if the fears were to re-emerge in the wake of a Greek exit. There is also quantitative easing, the programme of buying government debt across the eurozone, announced by the ECB in January. It had to close tax loopholes.
It created an independent tax collector to reduce tax evasion. It reduced incentives for early retirement. It raised worker contributions to the pension system. At the same time, it reduced wages to lower the cost of goods and boost exports. The measures required Greece to privatize many state-owned businesses such as electricity transmission. That limited the power of socialist parties and unions.
Why was the EU so harsh? EU leaders and bond rating agencies wanted to make sure Greece wouldn't use the new debt to pay off the old. Germany, Poland, Czech Republic, Portugal, Ireland, and Spain had already used austerity measures to strengthen their own economies. Since they were paying for the bailouts, they wanted Greece to follow their examples. Some EU countries like Slovakia and Lithuania refused to ask their taxpayers to dig into their pockets to let Greece off the hook.
These countries had just endured their own austerity measures to avoid bankruptcy with no help from the EU. In , the European Financial Stability Facility added billion euros to the bailout.
Despite the name change, that money also came from EU countries. The government successfully sold bonds and balanced the budget. In January , voters elected the Syriza party to fight the hated austerity measures. On June 30, , Greece missed its scheduled 1. Both sides called it a delay, not an official default. Two days later, the IMF warned that Greece needed 60 billion euros in new aid. It told creditors to take further write-downs on the more than billion euros Greece owed them.
On July 5, Greek voters said "no" to austerity measures. The instability created a run on the banks. Greece sustained extensive economic damage during the two weeks surrounding the vote. Banks closed and restricted ATM withdrawals to 60 euros per day. It threatened the tourism industry at the height of the season, with 14 million tourists visiting the country.
The European Central Bank agreed to recapitalize Greek banks with 10 billion euros to 25 billion euros, allowing them to reopen. Banks imposed a euros weekly limit on withdrawals. That prevented depositors from draining their accounts and worsening the problem. It also helped reduce tax evasion. People turned to debit and credit cards for purchases. As a result, federal revenue increased by 1 billion euros a year. On July 15, the Greek parliament passed the austerity measures despite the referendum.
Otherwise, it would not receive the EU loan of 86 billion euros. It lengthened the terms, thus reducing net present value. Greece would still owe the same amount. It could just pay it over a longer time period. The United Kingdom demanded the other EU members guarantee its contribution to the bailout. On September 20, Tsipras and the Syriza party won a snap election. It gave them the mandate to continue to press for debt relief in negotiations with the EU. However, they also had to continue with the unpopular reforms promised to the EU.
In November, Greece's four biggest banks privately raised The funds covered bad loans and returned the banks to full functionality. Almost half of the loans banks had on their books were in danger of default.
Bank investors contributed this amount in exchange for the 86 billion euros in bailout loans. The economy contracted 0. In March , the Bank of Greece predicted the economy would return to growth by the summer. It only shrank 0. They were reluctant to call in bad debt, believing that their borrowers would repay once the economy improved.
That tied up funds they could have lent to new ventures. It planned to use the funds to pay interest on its debt. Greece continued with austerity measures. It passed legislation to modernize the pension and income tax systems.
It promised to privatize more companies, and sell off nonperforming loans. In May , Tsipras agreed to cut pensions and broaden the tax base. In return, the EU loaned Greece another 86 billion euros. Greece used it to make more debt payments. Tsipras hoped that his conciliatory tone would help him reduce the But the German government wouldn't concede much before its September presidential elections. In July, Greece was able to issue bonds for the first time since It planned to swap notes issued in the restructuring with the new notes as a move to regain investors' trust.
On January 15, , the Greek parliament agreed on new austerity measures to qualify for the next round of bailouts. On January 22, the eurozone finance ministers approved 6 billion to 7 billion euros. The new measures made it more difficult for unions strikes to paralyze the country. They helped banks reduce bad debt, opened up the energy and pharmacy markets, and recalculated child benefits.
On August 20, , the bailout program ended. Most of the outstanding debt is owed to the EU emergency funding entities. These are primarily funded by German banks. Until the debt is repaid, European creditors will informally supervise adherence to existing austerity measures. The deal means that no new measures would be created. How did Greece and the EU get into this mess in the first place?
The seeds were sown back in when Greece adopted the euro as its currency. Greece had been an EU member since but couldn't enter the eurozone.
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