European Debt Crisis. Lessons Learned and Paths for the Future

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1 European Debt Crisis Lessons Learned and Paths for the Future

2 Eurozone (ish) 19 member states 7 additional to become members upon convergence criteria

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4 Putting the Cart Before the Horse The creation of the EU was a political project In an effort to accelerate the process, which a great political achievement, the signers of the Maastricht agreed to somewhat aspirational financial parameters Debt was supposed to be limited to 60% of GDP and annual deficits were to be no more than 3% of GDP

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7 The Honeymoon Phase As countries joined the Euro, their interest rates converged There was a belief that the Euro was working as investment was flowing into periphery countries Current Account Deficits in the Euro Area: The End of the Feldstein-Horioka Puzzle? by Blanchard and Giavazzi...we discuss whether the current attitude of benign neglect visà-vis the current account in the euro area countries is appropriate, or whether countries such as Portugal and Greece should take measures to reduce their deficits. We conclude that, as a general rule, they should not.

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9 The Crisis Begins World economic instability was initially triggered by the collapse of the real estate market in the United States and resulting subprime mortgage crisis Many peripheral countries in the Euro Zone were experiencing their own housing bubbles in the 2000 s

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11 The Sudden Stop Crisis Greek fiscal deficit comes to light Greece receives an unsuccessful bailout in bond risk premiums continued to rise Concern rose about the borrowing of other Euro area governments, leading to the sudden stop crisis Ireland, Portugal, Spain, and Italy were most affected

12 The Doom Loop Debt begets more debt: bad growth caused banks to teeter on the edge of failure in Ireland, which forced the government to bail them out and take on the debt to prevent a collapse of the banking system Ireland was bailed out in November of 2010 Portugal was bailed out May nd Greek bailout February 2012 Cyprus exposed to 2012 Greek haircut, bailed out March 2013 The troika - The IMF, The European Commission, The European Central Bank Criticisms of the bailout by the general public were that the money was mostly going to private bondholders; debt was reissued and risk was shifted from European banks to European taxpayers

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15 Whatever it takes

16 Slashing budgets and reactionary shock Without the use of monetary policy, members of the periphery had only bad options. Most countries--including those in the core--turned to severe budget cuts, or austerity, dropping the total Eurozone deficit from 350 to only 10 in just four years. Because austerity came in the form of both spending cuts and tax increases, it became a one-two punch to those (especially in the periphery) who had lost their job and then got few unemployment benefits.

17 Enter Mario Draghi The euro area is an investors free-for-all, and the stakes are as high as they get: the survival of the single currency, which for Draghi, like many Europeans, is the emblem of a generation s efforts to bring peace and prosperity to a continent torn apart by two bloody wars. Now, in the early summer of 2012, with financial markets doubtful that the weakest euro zone countries can repay their debts and with an economy plunging back into recession, the flaws of a single currency are all too apparent. From Jean-Claude Trichet to a new brand of activist central bankers Quantitative easing (QE) in Europe 2.6tn bond-buying program (corporate) Easing off in December 2018

18 The Political Quote of the 21st Century A. We don t want the smoking gun to be a mushroom cloud. - Condoleezza Rice B. But going it alone means going it with lots of other nations. - Donald Trump C. There's an old saying in Tennessee I know it's in Texas, probably in Tennessee that says, fool me once, shame on shame on you. Fool me you can't get fooled again. - George W. Bush D. Within our mandate the ECB is ready to do whatever it takes to preserve the euro. Believe me, it will be enough. - Mario Draghi

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20 Doom and Gloom to Happy Days? Draghi s statement shifted public perception of the ECB s role, and more importantly, the perceptions of debt purchasers who now understood the ECB would bail them out if sovereign states could no longer meet their obligations. This action single-handedly helped lower interest rates and bring the intensifying crisis to a simmer. But the crisis continues to simmer today, with Italy teetering.

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22 Looking towards the future...

23 Challenges to address Effect stabilization and reforms difficult, rebuilding trust and cohesion Hardship leads to anti-europe politicians, which complicates EU solutions to public debt Without trust, there is no risk sharing: who owes what to whom? Creating credible commitments on both national and EU level Institutional gaps: idiosyncratic crises

24 Minimal conditions for the survival of the Euro 1st condition: National central banks being able to to backstop self-fulfilling crises 2nd condition: Completing Europe s banking union 3rd condition: Renationalize fiscal policy 4th: Removing debt overhangs, but at national or EU level?

25 What is the public good to protect?

26 References Baldwin, Richard, and Francesco Giavazzi. How to fix Europe s monetary union: Views of leading economists. London: CEPR Press, Baldwin, Richard, and Francesco Giavazzi. The Eurozone Crisis: A Consensus View of the Causes and a Few Possible Solutions. London: CEPR Press, Jacoby, Wade. The Politics of the Eurozone Crisis: Two Puzzles behind the German Consensus. German Politics and Society 32: 2 (111) (2014): Laskos, Christos, and Euclid Tsakalotos. "The Eurozone Crisis in Context." In Crucible of Resistance: Greece, the Eurozone and the World Economic Crisis, London: Pluto Press, Lieberman, Ira W. "The Eurozone Crisis, " In In Good Times Prepare for Crisis: From the Great Depression to the Great Recession: Sovereign Debt Crises and Their Resolution, Washington, D.C.: Brookings Institution Press, 2018a. Lieberman, Ira W. "The Eurozone Crisis: From Banking Crises to Sovereign Debt Crises to Bailouts." In In Good Times Prepare for Crisis: From the Great Depression to the Great Recession: Sovereign Debt Crises and Their Resolution, Washington, D.C.: Brookings Institution Press, 2018b.