Its dimensions and implications. MR Anand GL Gupta Ranjan Dash

Transcription

1 Its dimensions and implications MR Anand GL Gupta Ranjan Dash

2 Optimism and enthusiasm ( ) soon replaced by pessimism and distrust ( ) General origins. 2 main causes, 1 anomaly. 2 causes: 1. US financial crisis: collapse of markets downgrade of rating on public bonds dramatic rise in borrowing costs (PIIGS) fears of sovereign debt default 2. Increasing divergencies in a monetary union with economic and political tensions (growth; deficits and debts; productivity; external accounts etc.)

3 1 anomaly. The Euro crisis was not a typical «currency crisis» Loss of confidence in a country flight of capital high interest rates / exchange rate depreciation collapse of foreign and domestic investments everything goes bad other than exports The external value of the Euro remained stable/strong. Global investors kept reserves in Euro assets. The euro crisis was an attack toward the idea/project of European integration

4 The project was already in the treaty of Rome Attempt #1 of MU failed (Werner plan, ) Attempt #2 was part of the single market process SMP (goods, capitals, labor) led to the Maastricht Treaty MT: 5 convergence criteria )budgetary and monetary rules and no real, fiscal, political convergence January 1, countries decide a single currency (Dk, UK, Swe: opt out) European Central Bank: unique responsability for monetary policy

5 Many oddities: No European budget (very small), no fiscal policy, no tax coordination and harmonization. Very strict mandates for ECB. Two pillars Price stability + all the rest (growth, unemployment, environmental sustainability etc.) that comes after Very strong independence of ECB Independence is important for stability and growth However indepencence of instruments or independence of objectives with non accountability? Very little was done for: Financial crisis and bailouts (no bailout clause but with what credibility?)

6 Symbol of deep political and social integration after WW2: the currency and the army are the symbols of national sovereignty But also widespread expectations for Microeconomic gains Expected to increase cross-border competition, integration and efficiency Reduce transactions costs Reduce currency risks and increase investments Macroeconomic gains Price stability Acquire credibility and attractiveness for investments Increase financial integration. Interest rate convergence Create another reserve currency

7 1. A monetary union without a fiscal (and political) union Spending-fiscal authorities remain national; EU budget for public intervention is small and ineffective No role for the ECB in financing deficits and stability; No role for the ECB as a LLR No role for the ECB in bank supervision 2. US financial crisis provoked new divergencies Varying productivity Structural differencies between countries in terms of wages, unemployment, labor mobility, export surplus. Impossibility to use the exchange rate in case of asymmetric shocks.

8 Bond markets were integrated rapidly; Convergence in interest rates on government bonds Convergence in interest rates offered by banks Reduction of spreads Fall in nominal rates in the peripheral economies toward Germany for credibility.

9 Collapse of the spread. Convergence survives the financial crisis. The spread explodes at the beginning of the debt crisis

10 Between 1998 and 2008 the spread went and remained around 0 as if all government debt issues had the same riskiness: investors had the same level of trust toward Germany, Italy, Spain

11 Euro favoured a boom in the credit and real estate markets As currency risk premium and spread diminished, credit growth surged. It became easier for PIIGS to increase public and private debt Banks borrowed more easily from abroad, increasing their leverage Very strong growth in the Real Estate: property prices increased dramatically and favoured further indebtedness houses were used as collateral for financial operations

12 The rise in the twin deficits The crisis produced a worsening in fiscal decifit (small for Italy, large for Spain and Greece) The crisis was accompanied by a rise in the demand for imports and a larger current account deficit from 2003 (G, P, E) Key country (Germany) was the only «surplus» economy and did not act as a leading country (no increase in expenditure)

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14 From the financial crisis to the Euro Zone crisis The road to EMU: features and anomalies in the Euro construction The US financial crisis triggered the sovereign debt crisis in Europe credit boom ended and interest rates start to diverge Growth declined sharply, Excessive lending increased bad debts and NPL for banks Deficit/GDP and Debt/GDP were aggravated by emergency measures Increased divergence in fundamental indicators (GDP, productivity) and growth of economic imbalances

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17 Before the crisis, large intra EZ capital flows Countries built up external deficits (PIIGS); Countries built up external surpluses (G, NL, B) Poorer nations were attracting investors from richer nations is there anything wrong with that? Nothing, in principle. However A big problem was that foreign capital flows were invested in nontraded sectors (housing, government welfare) Investment did not increase productivity, competitiveness, exports Increase in liabilities for Greece etc. was not sustainable and, worse, it contributed to the housing bubbles that inevitably burst The sudden stop was critical because, in a MU, countries cannot devalue and the EZ had no bailout mechanism

18 Strong countries in surplus, weak countries in deficit It s ok if nations borrow to invest in capacity that helps the economy This was not the case: in all GIIPS funds ended up in non traded sectors Every crisis has a trigger: in Europe it was the revelation of the Greek deficit deceit

19 In October 2009 the newly elected Greek gov. announced that the previous gov. had masked the true size of deficit The Greek crisis acted as a detonator in two ways: Large and hidden violation of common fiscal rules can occur (and did occur) The risk of sovereign default became real and the EU faced it without a mechanism of LLR Fear of debt unsustainability (endless increase of Debt/GDP) Austerity cycle was started only to make things worse

20 Emergency measures were announced after the financial crisis They were successful in the short run and financial crisis was halted; However they worsened fiscal deficits and debt The austerity cycle Tax rises collapse of aggregate demand recession reduction of tax revenues further increase of deficit increase of the ratio «deficit/gdp» Confidence crisis led to a differentiated rise of bond yields and increased costs of risk insurance on CDS (credit default swaps).

21 Confidence crisis: bond yields widened after the Greek deceit (but not after Lehman bankruptcy) CDS are financial instruments that provide an insurance against the risk of debt default CDS exist since 90s After 2010 the fear of default increased and CDS premiums widened Could Europe remain still?

22 European banks exposure in weak countries A large share of public debt is held across borders with European banks. Direct exposure was very high for Germany and France, particularly This produced a strong conflict of interest among European nations Hard to find a solution. Decision making system in the Euro zone: financial assistance requires unanimity

23 Institutional innovation: the European Financial Stability Facility (ESFS) EFSF was created and empowered to defend financial stability and prevent contagion. Provides financial assistance (loans) to countries in difficulty. It is authorised to borrow up to E450bn, issuing EU bonds. 2010: bailout packages for Greece (150bn), Ireland (41bn), Portugal (50bn). EFSF loans at low interest rates conditional on the implementation of austerity measures. To increase growth, support to countries that successfully implemented fiscal programmes; EIB helps countries in absorbing public bonds. However, all these measures failed to convince financial markets; scepticism on their effectiveness. Problems with peripheral countries

24 Who paid for emergency funds? Germany, France, Italy account for almost 75% have they really succeded in convincing financial markets? NO

25 No. Apart from Greece primary surplus increased on average by 0.5%GDP Main reason was a confidence crisis in the debt repayment capacities. Interest rates spreads skyrocketed from 0 to 550bps 1500bps Greek crisis contagion Low competitiveness High debt Fears of debt restructuring Approval of fiscal austerity programmes (Monti gov.) reestablished confidence that was then enhanced by Draghi s turn in monetary policy

26 A debt vortex in the Eurozone Widespread fear triggered a rush to unload debt Sales of the weak nation s debt, drove borrowing costs up to the point where the nation actually goes broke How do you break the vortex? The system needs a debt buyer-of-last-resort: someone who can buy unlimited amounts of debt Fears+suspicion dissolve and investors hold the debt Draghi s speech, July 2012 ECB would do «whatever it takes» to keep the Eurozone together Quantitative easing: purchases of bonds to stimulate the economy and increase liquidity. Change of market expectations: borrowing costs returned to pre-crisis level

27 Ireland: Spain The Celtic Tiger: economy expanded. Rise in property valuations; drastic fall in corporate tax rates Very dynamic economy until housing prices fell and the levels of personal debt rose Collapse in property prices; banks came under pressure (heavy wholesale borrowing) 2009 nationalization of the banking sector Problems that stemmed from an excessive build up of bank lending (vs public debt in Greece) that turned into a fiscal problem On the public finance front, the revenues collapsed, deficit soared but the public debt in 2010 is low by eurozone standards. High foreign exposure to its private debt.

28 Portugal Italy Its fiscal deficit and public debt deteriorated from -3.1% (2007) to -10% (2009). It didn t witness a boom-bust situation. Howewer, a large external CA deficit and external debt fuelled by private sector borrowing. Low productivity because of other social indicators: lowest % of educated population in Europe, unemployment. Chronic low rate of growth Long term decline and 0 growth with low productivity and badquality institutions (bureaucracy, justice, corruption); fiscal deficit is low but public debt is extremely high with rather limited domestic holdings. Unemployment rate lower than the EU average but increasing South- North dualism

29 The EU accounts for 26% of the world GDP, the EuroZone 20% Implications for the advanced countries: Germany and France who face large exposures; also the British banks and close trading links between Europe and the US For the EMEs (Ch, India, Brasil etc.), a downturn in the eurozone will dent their export growth and the globalised banking system could threat their financial stability.

30 Austerity Fiscal Union Euro-exit Fiscal discipline and consolidation, including privatization (default policy choice) Enlarged European budget and transfers from rich to poor EZ countries Breakdown of the currency that could lead to insolvency of several EZ countries Social costs, prospects of low or stagnating growth; it will not address the structural problems of the peripheral economies but it would be a short term palliative Common measures of protection for employment Stimulate greater cross border investments Establish a multi speed Europe rather than hope for complete convergence Contagion effects and instability: inflation and interest rates would increase dramatically The new currencies will be sharply devalued in terms of Euro Protectionism and nationalism increase The end of the European dream

31 1. Ahead, this way 2. Just the single market 3. Variable speed 4.Do less, more efficiently 5. Do more, altogether Foster further integration in all real sectors Deepening in some sectors Who wants more, does more Increase some integration: trade, euro, defence, borders Federal union, one voice, cohesiveness Small steps, ordinary administration Back to national policies in others (foreign policy, migration Differentiated integration Decrease in others (state aids, social and welfare policies) Redistribution policies Search for consensus, case by case Unbalanced integration. Toward a «British» EU Countries that do not agree «ahead this way» Fascinating, though another step backward Greatest surrender of sovereignty Inadequate More conflicts and inequalities Reasonable, realistic but must prepare #5. More conflicts and inequalities Best option, though rather unrealistic