Occam’s Razor is a frequently quoted
principle which states that when one is faced with a multitude of
seemingly complex possibilities, the simplest approach or explanation is
best. As the ECB and Greece fight over terms of yet another bailout we
employ this principle to help better grasp Greece’s dire situation.
The ratio of debt to GDP is one of the
most basic and popular measures used to determine the ultimate ability
of a sovereign nation to service its debt. Consider a country which has a
debt to GDP ratio of 100%, and a balanced budget (excluding interest
payments). In this country, it can be said that the interest rate on its
debt and the growth rate of its GDP must be equal for the ratio to stay
unchanged. In this example a 2% interest rate with a 1% GDP growth rate
would result in an increase from 100% to 101% in the debt to GDP ratio.
As the ratio rises above 100%, the interest rate must be lower than
the GDP growth rate or the ratio will continue to rise. At a debt to GDP
ratio of 150%, a 2% interest rate would require a 3% growth rate to
remain stable at 150%.
Greece has a current debt to GDP ratio of
170%, and based on current bailout terms, it will likely grow to well
over 200%. So applying the logic from above, Greece’s GDP growth rate
prior to the current bailout needed to be 1.70 times greater than the
rate of interest Greece pays on its debt just to keep its ratio
constant. Following are some facts which will allow us make judgments on
Greece’s ability to improve or at least sustain its debt to GDP ratio: Since 1970 Greece’s best 5-year annualized
GDP growth rate was +1.50% with an average of +.46%. Over the past 10
years growth has averaged -0.50%.
Since 1997 Greece’s lowest 5-year average
interest rate on 10 year bonds was 3.41% with an average of 7.50%. Over
the past 10 years the average annual 10 year interest rate was 8.16%
Read more: Michael Lebowitz Blog | The Simple Math Behind Greece’s Complicated Situation | Talkmarkets
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