The Breakup of the Euro - Roundtable

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The Breakup of the Euro - Roundtable

  1. 1. The Breakup of the Euro Area:  A Roundtable Trobada X Barcelona GSE October 26, 2012
  2. 2. The Euro and the onset of the crisisEver since debt problems first surfaced in Greece, it has been widely believed that a default by a European country, no matter how small, would threaten the existence of the Euro. To what extent is this view based on sound  economics? What are the most important  economic links between sovereign defaults in  Europe and the sustainability of the common  currency?
  3. 3. The Euro and the buildup of the crisisMany economists claim that the severity of the European crisis is due, at least in part, to the flawed design of the Euro. Do you agree with this view? Are there  institutional aspects of the common currency that  have aggravated the crisis? Or is the problem not  so much in the institutional design of the Euro per  se, but rather in the policies that have been  adopted since the onset of the crisis?
  4. 4. The future of the Euro Is there a future for the common currency? If so,  how do you think the system should be reformed  going forward? If not, how do you think a  breakup will happen? What are the main policy  challenges that such a breakup would pose?
  5. 5. “The%Breakup%of%the%Euro,”%Barcelona GSE Trobada X%% José=Luis%Peydró%%(UPF%and%Barcelona GSE)%•  I"will"talk"about:"" –  Euro"area"heterogeneity"both"in"borrowing"condi6ons"(for"sovereigns," banks,"firms"and"households)"and"in"the"transmission"channel"of" monetary"policy "" •  “Heterogeneous"Transmission"Mechanism:"Monetary"Policy"and" Financial"Fragility"in"the"Euro"Area,”"(coHauthored"with"MaIeo" Ciccarelli"and"Angela"Maddaloni,"both"ECB)" –  Banking"union" Not"talk"exactly"on"Alberto’s"ques6ons"(more"interes6ng"ones)"nor"on"the" lack"of"op6mal"currency"area…"(Krugman,"NBER"Macro"Annual,"2012)" 1"
  6. 6. Main%points%Large"heterogeneity"in"borrowing"condi6ons"and"in"the"Euro"area"monetary"transmission"channel"between"distressed"(PIIGS)"and"other"EA"countries""•  Bank"lending"channel"was"not"key"in"2010H11"(and"2008H09)""•  But,"given"2012,"without"banking"union"it"is"impossible"to"survive"(notably" deposit"insurance,"a"Euro"area"TARP"and"banking"supervision)" –  PIIGS"survive"because"of"the"Eurosystem"liquidity,"but"PIIGS"exposure"is"massively" increasing"and"runs"on"PIIGS"are"happening" –  Poli6cal"problems"(moral"hazard"of"TARGET"debtor"and"creditor"countries)," bargaining"threats,"and"increasing"credit"risk"for"TARGET"creditor"countries" –  Other:"what"about"current"losses,"retail"runs"vs."wholesale"crossHborder"contagion…"•  The"firm"balance"sheet"channel"is"s6ll"very"important"for"PIIGS"in"2010H11"(also" in"2008H09)"and"ECB"policies"very"limited"power"to"reduce"credit"fric6ons"" –  ECB"could"buy"sovereign"and"firm"stuff,"but"poli6cal"limita6ons" –  UK"and"Japanese"alterna6ve"ways"to"increase"credit"supply"for"firms" –  Debt"overhang"and"deleverage:""e.g."Spain"versus"US"and"Sweden"aber"their"crisis" (high"infla6on,"bankruptcy"code"for"banks,"loans"with"full"recourse,"defaults…)" 2"
  7. 7. Outline%of%remaining%presentaKon% Outline%1.  A"brief"narra6ve"of"the"crisis"2.  Standard"monetary"policy"in"a"heterogeneous"context,"the" amplifica6on"mechanism"of"the"credit"channel"and"the"role"of"nonH standard"measures"for"the"period"2007H2011"3.  Back"to"the"main"points"I"wanna"make"and"the"period"2012" 3"
  8. 8. MoKvaKon% QuesKon%that%we%address%in%the%paper%!  Strong"overall"impact"of"the"crisis"on"the"Euro"area"but"with"heterogeneous" consequences"across"member"countries"!  Heterogeneity"throughout"the"crisis"in"economic"ac6vity,"in"credit"condi6ons" and"in"financial"fragility"(of"banks,"nonHfinancial"borrowers"and"sovereign)"!  A"single"monetary"policy"copes"with"this"heterogeneity"across"member"states""  What%are%the%effects%of%the%single%Euro%area%monetary%policy%in%such% heterogeneous%plot?% 4"
  9. 9. A%brief%narraKve%of%the%crisis% Increased%heterogeneity%of%sovereign%risk% Credit Default Swaps across Euro area countries % (difference from the median) 7400 1000 % 1000 800 800 600 countries under. 600 400 % sovereign.stress 400 200 200 0 % 0 =200 other.countries =200 =400 =400 Dec=05 Dec=06 Dec=07 % Dec=08 Dec=09 Dec=10 Dec=11 Italy Ireland Spain % Portugal Austria France Germany Belgium Netherland Finland Greece" Source: Thomson Financial Datastream Note: The credit default swaps (CDS) are calculated for 10=year senior sovereign debt. The CDS forSince"2008"the"credit"risk"of"the"single"Euro"area"countries"started"to"be"effec6vely"priced."We"classify"countries"as:"countries*under*sovereign*stress"(aka"PIIGS)"and"other*countries" 5" %
  10. 10. A%brief%narraKve%of%the%crisis% Heterogeneity%of%bank%recourse%to%central%bank%liquidity%% Long-term central bank liquidity (as percentage of bank assets) 14 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 DecF02 DecF05 DecF08 countriesHunderHsovereignHstress otherHcountries Source: ECB, authors calculations Note: The chart plots the liquidity given by the ECB to banks of euro are countries at refinancingBanks"in"the"stressed"countries"turned"more"to"the"liquidity"provided"by"the"Eurosystem,"especially"longHterm.""Increasing"asymmetry,"demandHdriven,"in"the"implementa6on"of"monetary"policy"across"countries." 6"
  11. 11. A%brief%narraKve%of%the%crisis% The%example%of%Spain%(1):%% Eurosystem%liquidity%to%Spanish%banks% 40%%of%SP%GDP% 7"
  12. 12. A%brief%narraKve%of%the%crisis% The%example%of%Spain%(2):%%Total%divergence%between%public%Eurosystem%liquidity%&%all%the%other%internaKonal%funding% Posición%de%Inversión%Internacional%Neta%de%España% Pos."Inv."Intern."Neta,"no"BdE" TARGET" 200000" Millones%€% 0" JunH93" JunH94" JunH95" JunH96" JunH97" JunH98" JunH99" JunH00" JunH01" JunH02" JunH03" JunH04" JunH05" JunH06" JunH07" JunH08" JunH09" JunH10" JunH11" JunH12" dicH92" dicH93" dicH94" dicH95" dicH96" dicH97" dicH98" dicH99" dicH00" dicH01" dicH02" dicH03" dicH04" dicH05" dicH06" dicH07" dicH08" dicH09" dicH10" dicH11" H200000" H400000" H600000" H800000" H1000000" H1200000" 8"
  13. 13. Chart%1.%Foreign%claims% Sovereign%distress%countries%similar%to%Spain%and%Germany%looks%different% 9"
  14. 14. Chart%3.%%Short=term%interest%rates%on%small%and%large% loans%to%non=financial%corporaKons% Heterogeneity%in%loan%rates%for%firms% Short&term&MIR&rates&on&loans&to&NFCs&&>&1&EUR&million Short&term&MIR&rates&on&loans&to&NFCs&&<&1&EUR&million dispersion DE ES dispersion DE ES FR IT NL FR IT NL euroBarea 7.0 0.37.0 0.3 6.06.0 5.05.0 0.2 0.2 4.04.0 3.03.0 0.1 0.1 2.02.0 1.01.00.0 0.0 0.0 0.0 Jul-07 Jul-09 Jul-11 Jul-06 Jul-08 Jul-10 Jan-06 Jan-08 Jan-07 Jan-09 Jan-10 Jan-11 Jan-12 Jul-06 Jul-09 Jul-10 Jul-07 Jul-08 Jul-11 Jan-06 Jan-10 Jan-07 Jan-08 Jan-09 Jan-11 Jan-12Source: ECB Source: ECB 10"
  15. 15. Chart%4.%%Loan%supply%to%the%private%sector% Heterogeneity%in%loan%volumes%for%firms% Loans(to(non0financial(corporations((adjusted(for(securitisation) ES IT DE FR EU/IMF(programme(countries euro(area 35 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 05 05 010 010 2003 2006 2009 2012 2003 2003 2004 2004 2004 2005 2005 2005 2006 2006 2007 2007 2007 2008 2008 2008 2009 2009 2010 2010 2010 2011 2011 2011 Source:(ECB Note:("EU0IMF(programme"(refers(to(Ireland,(Greece(and(Portugal( 11"
  16. 16. A%brief%narraKve%of%the%crisis% Increased%heterogeneity%in%credit%condiKons%and%standards%(for%all%the%pool%of%borrowers)% Lending standards for business loans in Euro area countries " (net%percentage%of%banks%tightening%standards) " 100 100 " 80 80 " 60 60 " 40 40 " 20 20 " 0 0 " >20 >20 " >40 37621 38717 39813 >40 " other%countries countries%under%sovereign%stress euro%area " Source: ECB, National Central Banks, authors calculationLending"standards"in"countries"under"stress"got"(and"s6ll"get)"6ghter"in"each"quarter"than"in"the"other"countries" 12"
  17. 17. Method%and%data% VAR%model%with%loan%data%•  Standard"VAR"model"es6mated"recursively"on"a"panel"of"12"euro"area"countries" separated"in"PIIGS"and"nonHPIIGS"with"data"on"credit"condi6ons"and"standards," monetary"policy,"macro"and"other"financial"data"•  Responses"by"country"of"the"Bank"Lending"Survey"(BLS):" 1.  BLS"reports"loan"condi6ons"for"all"the"applicants"(including"rejected"borrowers)" 2.  Possible"to"disentangle"subHcredit"channels:"changes"in"credit"condi6ons"due"to" •  bank"balance"sheet"strength"(bankHlending"channel)" •  net"worth,"risk"and"collateral"of"firms"and"households"(balance"sheet"channel)" 3.  We"analyse"for"PIIGS"and"nonHPIIGS:" •  Impact"of"monetary"policy"(MP)"on"GDP"(or"prices)"" •  Impact"of"MP"on"GDP"through"changes"in"loan"condi6ons"due"to"bank"or" borrower"balance"sheet"strength"(mapped"into"BLS"observables)"•  MP"both"through"EONIA"rates"and"longHterm"public"(Eurosystem)"liquidity;" iden6fica6on"with"Cholesky"or"sign"restric6ons" 13"
  18. 18. Monetary%policy%in%heterogeneous%framework% Effec6veness"of"monetary"policy"on"GDP"growth" Recursive"impulse"responses"of"GDP"growth"to"a"monetary"policy"shock" Countries under stress Other countries 0.2 0.3 0.3 0.2 0.2 0.1 0.1 0 0 0 -0.1 -0.1 -0.2 -0.2 -0.3 -0.3 -0.2 -0.4 -0.42007Q3 2007Q3 2008Q4 15 2008Q4 2009Q4 15 10 2009Q4 2010Q4 10 5 2010Q4 5 2011Q4 0 -0.4 2011Q4 0 The"impact"of"a"monetary"policy"shock"is"stronger"during"the"crisis"and"has"stronger"effects" in"countries"under"stress,"which"is"good" 14"
  19. 19. Ra6onalising"the"result"with"the"theory"of"the"credit"channel"of"monetary"policy""The%amplificaKon%mechanism%of%the%credit%channel%%"  Monetary"policy"has"an"impact"on"economic"condi6ons"if"there"are"significant"fric6ons"in" borrowing"due"to"balance"sheet"constraints"(Bernanke"and"Gertler,"1995)""  In"countries"where"financial"fric6ons"in"borrowing"increase"significantly,"the"external" finance"premium"also"increases,"poten6ally"making"the"credit"channel"“more"ac6ve”"and" the"effect"s"on"GDP"and"prices"stronger" "To"check"the"impact"of"different"channels"of"transmission"we"design"counterfactuals"experiments"(Bernanke,"Gertler,"and"Watson,1998;"Sims"and"Zha,"2006)" "  Construct"hypothe6cal"responses"that"features"only"“direct”"impact"of"an"interest" rate"movement"on"GDP"and"neutralise"the"indirect"effects"through"the"BLS"credit" variables" "  Check"the"difference"between"the"impact"in"the"full"system"and"the"impact"without" the"various"credit"channels"" "  The"difference"between"the"two"impacts"quan6fies"the"amplifica6on"effects"of"the" credit"channel" " 15"
  20. 20. The%amplificaKon%mechanism%of%the%credit%channel%% Panel A. Countries under sovereign stress Bank-lending channel Non-financial borrowers balance sheet channel Credit demand channel 0.3 0.3 0.3 0.2 0.2 0.2 0.1 0.1 0.1 -0.0 -0.0 -0.0 -0.1 -0.1 -0.12007Q3 -0.2 -0.2 -0.2 -0.3 -0.3 -0.3 -0.4 -0.4 -0.4 -0.5 -0.5 -0.5 -0.6 -0.6 -0.6 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0.3 0.3 0.3 0.2 0.2 0.2 0.1 0.1 0.1 -0.0 -0.0 -0.0 -0.1 -0.1 -0.12008Q4 -0.2 -0.2 -0.2 -0.3 -0.3 -0.3 -0.4 -0.4 -0.4 -0.5 -0.5 -0.5 -0.6 -0.6 -0.6 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0.3 0.3 0.3 0.2 0.2 0.2 0.1 0.1 0.1 -0.0 -0.0 -0.0 -0.1 -0.1 -0.1 -0.2 -0.2 -0.22009Q4 -0.3 -0.3 -0.3 -0.4 -0.4 -0.4 -0.5 -0.5 -0.5 -0.6 -0.6 -0.6 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0.3 0.3 0.3 0.2 0.2 0.2 0.1 0.1 0.1 -0.0 -0.0 -0.02010Q3 -0.1 -0.1 -0.1 -0.2 -0.2 -0.2 -0.3 -0.3 -0.3 -0.4 -0.4 -0.4 -0.5 -0.5 -0.5 -0.6 -0.6 -0.6 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0.3 0.3 0.3 0.2 0.2 0.2 0.1 0.1 0.1 -0.0 -0.0 -0.02011Q3 -0.1 -0.1 -0.1 -0.2 -0.2 -0.2 -0.3 -0.3 -0.3 -0.4 -0.4 -0.4 -0.5 -0.5 -0.5 -0.6 -0.6 -0.6 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 total effect effect without the channel 16"
  21. 21. Pre=view%of%the%results% Results%1.  The"transmission"mechanism"of"the"single"monetary"policy"has"changed"over" 2007H2011"and"the"impact"is"stronger"during"the"crisis,"especially"for"PIIGS"2.  A"significant"amplifica6on"through"the"credit"channel"in"PIIGS:"the"bankH lending"channel"is"strong"in"2008H09;"the"nonHfinancial"borrowers"balance" sheet"channel"is"strong"throughout"the"en6re"period"3.  Current"policy"framework"is"s6ll"insufficient"to"reduce"credit"availability" problems"stemming"from"deteriorated"firm"net"worth"and"risk"condi6ons," especially"for"small"firms"in"distressed"countries"4.  The"bankHlending"channel"is"par6ally"mi6gated"by"the"ECB"non"standard" measures?""The"laIer"replaces"the"interbank"market"providing"beIer"liquidity" condi6ons"for"banks,"in"turn"sobening"lending"condi6ons"for"borrowers?" 17"
  22. 22. SubsKtuKon%between%private%and%public%provision%of%liquidity% Banks"in"countries"with"sovereign"debt"problems,"which"get"less"funding"from"the"private" interbank"market,"increase"the"long"term"borrowing"from"the"Eurosystem"in"the"next"period." Effects of interbank transactions on long-term central bank liquidity (LTRO) Recursive)panel)estimates 0.4 0.3 0.2 0.1 0 00.1 Fixed)0rate)full allotment) 00.2 Dec007 Aug008 Apr009 Dec009 Aug010 Apr011 countries)under)sovereign)stress other)countries 18"
  23. 23. Impact%of%LTROs%on%bank%behaviour% In"turn,"the"recourse"to"LTRO"soben"credit"standards"and"condi6ons"in"the"next"period" Effects of long-term central bank liquidity (LTROs) on lending conditions and credit demand Recursive)panel)estimates 1)#Changes#in#lending#standards#and#conditions# 2)#Change#in#credit#demand0.3 0.2 Fixed)0rate)full Fixed)0rate)full allotment) allotment)0.2 " starts 0.150.1 0.1 0 0.0500.1 000.2 00.0500.3 00.100.4 00.1500.5 00.2 Dec007 Aug008 Apr009 Dec009 Aug010 Apr011 Dec007 Aug008 Apr009 Dec009 Aug010 Apr011 countries)under)sovereign)stress other)countries countries)under)sovereign)stress other)countries 19"
  24. 24. Main%points%Large"heterogeneity"in"borrowing"condi6ons"and"in"the"Euro"area"monetary"transmission"channel"between"distressed"(PIIGS)"and"other"EA"countries""•  Bank"lending"channel"was"not"key"in"2010H11"(and"2008H09)""•  But,"given"2012,"without"banking"union"it"is"impossible"to"survive"(notably" deposit"insurance,"a"Euro"area"TARP"and"banking"supervision)" –  PIIGS"survive"because"of"the"Eurosystem"liquidity,"but"PIIGS"exposure"is"massively" increasing"and"runs"on"PIIGS"are"happening" –  Poli6cal"problems"(moral"hazard"of"TARGET"debtor"and"creditor"countries)," bargaining"threats,"and"increasing"credit"risk"for"TARGET"creditor"countries" –  Other:"what"about"current"losses,"retail"runs"vs."wholesale"crossHborder"contagion…"•  The"firm"balance"sheet"channel"is"s6ll"very"important"for"PIIGS"in"2010H11"(also" in"2008H09)"and"ECB"policies"very"limited"power"to"reduce"credit"fric6ons"" –  ECB"could"buy"sovereign"and"firm"stuff,"but"poli6cal"limita6ons" –  UK"and"Japanese"alterna6ve"ways"to"increase"credit"supply"for"firms" –  Debt"overhang"and"deleverage:""e.g."Spain"versus"US"and"Sweden"aber"their"crisis" (high"infla6on,"bankruptcy"code"for"banks,"loans"with"full"recourse,"defaults…)" 20"
  25. 25. that US household deleveraging is a little more than one-third complete. Because US interest rates today are lower than interest rates were in Sweden during its deleveraging, US households may be able to sustain somewhat higher levels of Too%slow%deleveraging%in%Spain,%but%a%big%private%(&%public)%debt% debt (Exhibit E3). ExhibitE3 US households are about one-third of the way to Sweden the Swedish level of debt reduction (Year 0 = 1988) Household debt United Kingdom (Year 0 = 2008) % of disposable income Peak United States household (Year 0 = 2008) debt Spain Credit boom Deleveraging (Year 0 = 2007) 160 150 -10 p.p. 140 130 -6 p.p. 120 -15 p.p. 110 -41 p.p. 100 90 80 70 0 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 Years NOTE: 2011 figures are as of Q2 2011. SOURCE: Haver Analytics; Statistics Sweden; McKinsey Global InstituteThis"is"household"leverage"but"the"big"credit"“bubble”"in"Spain"was"on"banks’"and"firms’"debt" Even when US consumers finish deleveraging, however, they probably won’t be as powerful an engine of global growth as they were before the crisis. One 21" reason is that they will no longer have easy access to the equity in their homes to use for consumption. From 2003 to 2007, US households took out $2.2 trillion in home equity loans and cash-out refinancing, about one-fifth of which went to
  26. 26. 1. Connection between sovereign defaults and the euro The Stability and growth pact said de…cits below 3%, debts below 60% and ‘ bailout’clause! no The key issue was governance, endow the ECB with credibility. There was little discussion of other motives such as: –Externalities (tax competition, TOT e¤ects) –Have room to …nance regional bad shocks when exchage rates are not avialable (paternalistic? ex- ternality too?) When Greece reveals serious debt problems at the end of 2009, the reaction is that avoiding default is key for the survival of the euro. The same view is kept as Ireland, Portugal, Spain and Italy start showing weak …scal numbers and growing debt. Soft rescue packages …nanced in large part by the EU and ECB (also the IMF) are given to Greece, Ireland and Portugal. Spain is coming next. Italy might follow. Why this generosity? Why defaults are connected to the euro? –The germans originated this mess for internal reasons :) –A¤ected countries will leave the euro and try to solve their …scal problems with in‡ation and this is even more costly –Taxpayer is local vs. creditors are foreign? Why do markets not price this? Too big to fail’in another arena (not well articulated?) –‘
  27. 27. Rescue packages from EU/ECB/IMF: –Greece: 110 b. May 2010 and 130b. October 2011 (GDP 215b. pop. 11.3) –Ireland: 85b. November 2010 (GDP 156b. pop 4.4m. ) –Portugal: 78b. May 2011 (GDP 171b. pop 10.6m.) –Spain: ?? October 2012 (GDP 1057b. pop 46m.)Details: –Much longer than usual IMF packages, which usually last only 3 years. These packages have been from 7 to even 30 years in the case of Greece. –Slow …scal adjustment due to the feeling that this would keep growth –Initially they held a penalty rate (300 basis points) but the EU and ECB eliminated this in later periods –Packages used for both re-capitalize banking systems and cover budget de…cits –Only if debt path is deemed sustainable. Otherwise, restructuring is required (“private sector involve- ment” This happened in the second Greek bailout, with a haircut of about 50%. ).Euro-wide initiatives: –ECB liquidity for banks and other …nancial institutions 200b. –European Financial Stability Fund 750b.
  28. 28. 2. Flaws in the design of the euro Keynes and Mundell took over and displaced all other considerations: –Liquidity management in normal times: dealing with nominal rigidities –Liquidity management in crisis periods: dealing with systemic risk The need for a banking union –Otherwise we have the current mess in which a …nancial crisis leads to a sovereign crisis –Magni…ed by liquid secondary markets: Self-ful…lling crises of a new type Excessive borrowing when institutions are unclear Do we need a …scal union? –Countercyclical transfers, that is, Mundell is back! –But the problem is not asymmetric shocks, but regional banking regulation/supervision.3. Where are we now? What should we do? We need to reform the euro, but implementing the banking union now is tricky: –(Banking) We are all in favor of insurance. But this is like purchasing insurance as the house is burning –(Fiscal) Fiscal union for European expenses. Beyond this, we need to articulate a ‘ big to fail’ too argument for sovereigns. It will not be politically correct.

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