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The Euro Area Crisis and Reforms Fiscal Discipline and Growth
The document discusses the euro area crisis, highlighting two differing diagnoses: one posits that a political union is necessary for a monetary union to succeed, while the other argues for better adherence to existing rules among sovereign states. It reflects on lessons from the Swedish financial crisis of the 1990s and critiques the European Monetary Union's inability to manage financial stability and sovereign debt responsibly. Key proposed reforms include reducing economic disparities among member states and establishing banking and fiscal unions to address issues of competitiveness and debt in the eurozone.
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The Euro Area Crisis and Reforms Fiscal Discipline and Growth
- 1. The Euro AreaCrisis and Reforms Fiscal Discipline and Growth André Sapir Professor of Economics, Université Libre de Bruxelles Senior Fellow, Bruegel
- 2. 2 Two views aboutwhat went wrong and how to fix it Diagnosis. The system was fundamentally flawed: a monetary union needs a political union Remedy: “more Europe” Diagnosis: The system was not fundamentally flawed: a monetary union among sovereign states can work, provided each state respects the rules Remedy: “better Europe”
- 3. 3 The original incompatible trio You cannot have a situation with » Fixed exchange rates » Financial integration » Monetary autonomy Financial integration was central in the arguments in favor of monetary union, yet its consequences for financial stability was largely ignored. No integration of financial policies. The focus of Maastricht was on price stability. The ECB is a rare case of a CB NOT established in response to a banking crisis » The primary objective of the ESCB is to maintain price stability » The ESCB shall contribute to the stability of the financial system
- 4. 4 Lesson fromthe crisis: the new incompatible trio You cannot have a monetary union with » Financial stability » Financial integration » Inappropriate common fiscal and banking policies and institutions Especially with important economic differences between countries
- 5. 5 An importantbenchmark: The Swedish ‘90s crisis Around the same time as Maastricht, Sweden suffered a major financial and then banking crisis The Swedish response to the crisis is generally regarded as a model for other countries The components of the Swedish strategy: » Comprehensive and rapid banking resolution » Supportive macroeconomic policies Fiscal expansion => Next pages Monetary expansion, including currency depreciation » Structural reforms Fiscal reform Product market liberalization Labor market and social reforms
- 6. 6 Deficit-to-GDP ratio, 1985-2005 -3 Source: Jonung (2009)
- 7. 100 120 140 20 40 60 80 0 1985 1986 1987 1988 1989 1990 Data source: AMECO February 2013 1991 1990: 41% 1992 1993 1994 1995 1996 1997 1996: 74% 1998 1999 2000 2001 2002 2000: 54% 2003 2004 2005 2006 2007 2008 2009 2010 2011 Debt-to-GDP ratio, 1985-2013 2012 2013 SE 7
- 8. 100 120 140 20 40 60 80 0 1985 1986 1987 1988 1989 1990 Data source: AMECO February 2013 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Debt-to-GDP ratio, 1985-2013 2012 2013 SE EA12 8
- 9. 100 120 140 20 40 60 80 0 1985 1986 1987 1988 1989 1990 1991 Data source: AMECO February 2013 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Debt-to-GDP ratio, 1985-2013 2012 2013 IT SE EA12 9
- 10. 10 The system failed Prior to the crisis, surveillance was inadequate » It did not understand well the nature of the risks, including for BOP » Fiscal surveillance: SGP focus on deficit rather than debt » No EZ financial surveillance, inadequate national surveillance Prior to the crisis, adjustment mechanisms were inadequate » The REER channel did not work well: divergences in competitiveness were not corrected automatically or otherwise When the crisis occurred, the system lacked adequate tools to deal with it
- 11. 11 The system allowed huge imbalances Very large current deficits Huge build up of private and public debts, and external debts Loss of competitiveness The music stopped when the financial crisis started
- 12. 12 Effect ofEMU on external imbalances: Current account 6 4 2 0 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 DM GIIPS -2 -4 -6 -8 Correlation (GIIPS,DM) Correlation (GIIPS,DM) 1960-1998: +0.28 1999-2012: -0.73 Data source: AMECO May 2012
- 13. 13 Same for Germany and Greece 10 5 0 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 D -5 GR -10 -15 -20 Averages 1960-1998 Averages 1999-2012 D = 0.9 D = 3.7 Data source: AMECO May 2012 GR = -0.9 GR = -12.1
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- 16. 16 Risk of suddenstop not understood before Lehmann 100 GREECE IRELAND 80 ITALY SPAIN PORTUGAL 60 BELGIUM AUSTRIA UNITED KINGDOM 40 DENMARK NETHERLANDS FRANCE NETHERLANDS SWEDEN SPAIN FINLAND UNITED KINGDOM FINLAND GERMANY 20 GREECE ITALY SPAIN PORTUGAL GREECE IRELAND SWEDEN IRELAND FRANCE BELGIUM DENMARK UNITED ITALY KINGDOM AUSTRIA NETHERLANDS DENMARK GERMANY PORTUGAL FINLAND SWEDEN FRANCE AUSTRIA GERMANY BELGIUM 0 -15 -10 -5 0 5 10 Current Account over GDP 31/12/2006 29/12/2007 20/10/2008
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- 18. 18 Cumulative capital inflowsin €A countries, 2002-12 Greece Portugal Spain Italy
- 19. 19 Sovereign debtcrises possible (likely?) in € area € area governments issue debt in a foreign currency, just like in emerging countries! What EA mechanism could have prevented such crisis? » Debt mutualization: replace national treasury by € area treasury » If no debt mutualization: strict rules to contain sovereign debts, including rules on private debts What EA mechanism could have lessened the effects the crisis? » If government solvent ECB to act as LOLR ESM lending » If government not solvent European Sovereign Debt Resolution Mechanism Debt redemption mechanism
- 20. 20 The response: ASwedish strategy was not feasible Comprehensive and rapid banking resolution: Impossible, no FDIC. Supportive macroeconomic policies Fiscal expansion: Impossible because debt levels were already high and danger of sovereign debt crisis => fiscal austerity, but self-defeating Monetary expansion, including currency depreciation: Impossible Structural reforms: difficult w/t supportive macro policies Fiscal reform Product market liberalization Labor market and social reforms => Limits of a “currency without a state” in a crisis situation
- 21. 21 What then was the € area strategy? Central role of the ECB, but limitations due to absence of a euro sovereign (TPS again: “the loneliness of the ECB”) Banking: each country responsible for his own situation. Future: creation of a banking union, but w/t FDIC? Supportive macroeconomic policies: Not much Fiscal expansion: austerity in deficit countries albeit with EU-IMF assistance; but no expansion in surplus countries Monetary expansion: slow internal devaluation, but external value of the euro remains high Structural reforms: difficult w/t supportive macro policies Fiscal reform Product market liberalization Labor market and social reforms => No real strategy, besides “putting one’s house in order” with some assistance
- 22. 22 Growing surplus/deficit countrydivide Unemployment
- 23. 23 Deficit countries have two problems Obsolete socio-economic model already prior to joining the euro due to » Increased global competition from emerging countries » Increased competition within Europe from the NMS. Model managed to survive thanks to euro adoption of the euro which permitted large net external debt positions, whereas the euro should have been an impetus for reform. Now these countries have two problems » A competitiveness problem, not only intra-€A but also towards the NMS » An external debt problem
- 24. 24 Twin problems of competitiveness and debt Correcting the competitiveness problem requires lower prices in the periphery than in the core But too low prices risk increasing the debt burden in the periphery by lowering nominal GDP In addition austerity measures aimed at lowering public debt also lower nominal GDP Hence correcting competitiveness and public debt risk creating self-defeating debt deflation in the peripheral countries
- 25. 25 Austerity alone is not working Are fiscal contractions expansionary? No, unless accompanied by other policies Do fiscal contractions reduce deficits? Yes, but by less than 1 Note: a positive sign indicates a reduction in the deficit. Source: Martin Wolf, FT 1/5/12
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- 27. 27 The incompatible trio: Reforms 1. Reduction of economic differences between MS in some areas: reforms of national policies (e.g. labor markets) and EU policies (e.g. Structural Funds) 2. Creation of common policies and institutions in some areas: a banking and (?) fiscal union
- 28. 28 Two big question marks It’s relatively easy to design the LT solution, involving economic convergence and the build up of a banking and fiscal union based on a strong political commitment (“A genuine EMU”) But two big questions about how to get from here to there » Are the existing economic, social and political differences between EZ MS really compatible with a commitment in favor of banking and fiscal union? » Is there sufficient political commitment not just for the LT vision but also about how to deal with the twin legacy problems of Competitiveness and asymmetric adjustment (External) debt leading to potentially unsustainable debt and social situations in the periphery?