A Tale of Two Euro Zone Countries

by Elaine Schwartz    •    Sep 14, 2011    •    695 Views

Saying, “It is a small step for the euro zone and a big step for Estonia…” the Estonian prime minister celebrated his country’s formal entry into the Western economic world. On January 1, 2011, Estonia switched from the kroon to the euro (and many bought new wallets because the size of their currency had changed). Looking forward to more trade and greater national security, Estonia very much wanted euro zone membership.

The lowest in the euro zone, Estonia’s debt to GDP ratio during 2010 was 6.6%–far below the euro zone rule that national debt could not exceed 60% of GDP. According to this NPR Planet Money podcast, when Estonia experienced a severe recession during 2009, even the president, who grew up in New Jersey, took a 10% salary cut.

And then we have Greece. Switching from the drachma to the euro in 2001, Greece knew, according to this BBC article, that she would have to display more fiscal discipline as a euro zone member. You know what happened. Her 2010 debt to GDP ratio was 142.8%. The story of Greece’s response since 2009 is here.

The Economic Lesson

Monetary policy involves the supply of money and credit. A country’s fiscal policy relates to taxes, spending and borrowing. Estonia and Greece share the same monetary policy while each has its own fiscal policy. And therein lies the problem.

When countries borrow, they are implementing fiscal policy. But who buys their debt? Banks–the same banks that participate in monetary policy. So, because banks link fiscal and monetary policy, if one goes awry, the other is affected.

An Economic Question: How might Estonia experience the impact of Greece’s fiscal policy?

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