12. The European Balance of Payments Crisis. Recall: Macro Background: Interest rates, ten-year government bonds. Greece.

Transcription

1 12. The European Balance of Payments Crisis Recall: Macro Background: % Interest rates, ten-year government bonds Irrevocably fixed conversion rates Introduction of virtual euro Greece Introduction of euro cash 15 Portugal Ireland Italy Spain Belgium France Germany Source: Thomson Reuters Datastream. Professor Dr. Holger Strulik Open Economy Macro 1 / 28

2 12. The European Balance of Payments Crisis Recall: Macro Background: 120 Pricesofthefirstnotation=100 Prices of ten-year government bonds Spain Italy Ireland 60 Portugal Note: Year of issue: 2006; Ireland: Source: Thomson Reuters Datastream. Greece Professor Dr. Holger Strulik Open Economy Macro 1 / 28

3 In the GIPS countries: I Y p Im and Ex credit finance boom (with overshooting, bursting bubble) In Germany: stagnation (labor market) reforms p Ex Slovenia Slovakia Greece Spain Ireland Cyprus Portugal Luxembourg Italy Netherlands Euro area Belgium France Finland Austria Germany % 9 Price developments Note: Price change and exchange rate realignments (before May 1998). Source: Eurostat, Database, Economy and Finance, National accounts,gdp and main components - Price indices; Ifo Institute calculations Real appreciation compared to other euro area countries, trade-weighted: GIIPS: + 30 % Germany: - 22 % Professor Dr. Holger Strulik Open Economy Macro 2 /

4 Conclude: net capital imports and current account deficit are 2 sides of the same coin the trade balance surplus indicates the weakness of Germany s home market Luxembourg Netherlands Germany Austria Finland Belgium France Italy Slovenia Ireland Slovakia Malta Estonia Spain Cyprus Portugal Greece % of GDP Current account balances Source: Eurostat, Ifo Institute calculations. 8.4 Professor Dr. Holger Strulik Open Economy Macro 3 / 28

5 Luxembourg Belgium Germany Netherlands Finland Malta* Austria France Italy Slovenia Cyprus Estonia Slovakia Ireland Greece Spain Portugal Net foreign position relative to GDP % of GDP in End of June *End of December Source: Eurostat, Ifo Institute calculations Professor Dr. Holger Strulik Open Economy Macro 4 / 28

6 Recall: private capital market freezed after Lehman Brothers collapse (2007) so who is paying for the current account deficit in the GIPS countries? the public sector through national central banks (target balances) 600 Billion euros Target balances in NCBs balance sheets (money that seeped across borders) Billion euros GIPS (right-hand scale) Dec Oct Germany (left-hand scale) Italy (right-hand scale) Dec Source: Sinn and Wollmershäuser (2011, Figure 1). Professor Dr. Holger Strulik Open Economy Macro 5 / 28

7 Some History EU fiscal rules (Stability and growth pact, 1997): deficit ceiling of 3 % of GDP maximum debt of 60% GDP medium fiscal target of surplus or close to balance evaluation by Commission (EU bureaucrats) enforcement by Council (Ecofin, national policymakers) measures: non-interest bearing deposits fines (up to 0.5 percent of GDP) until today over 80 violations no enforcement ever. no bail-out clause in Maastricht treaty. Professor Dr. Holger Strulik Open Economy Macro 6 / 28

8 One day, Germany could be threatened by high transfer payments to weak Euro states. (Edmund Stoiber, Bavarian prime minister, 1998) Transfer payments are as absurd as famine in Bavaria. (Jean-Claude Juncker, prime minister of Luxembourg, 1998) Why resistance against fiscal transfers? the Euro area is not (yet) a federal state that would require a common fiscal policy differing national preferences (culture) national fiscal policy. Professor Dr. Holger Strulik Open Economy Macro 7 / 28

9 6 Steps of the Balance of Payments Crisis (Sinn, 2014): 1 The Implicit Bailout Promise (the Euro) 2 Lending of the Printing Press (Target) 3 Buying Collateral (SMP) 4 Change of Shift (ESM & Co) 5 Unlimited Promises (OMT) 6 Banking Union Professor Dr. Holger Strulik Open Economy Macro 8 / 28

10 1. The Implicit Bailout Promise: De jure the Euro eliminated exchange rate risk but not country-risk of bankruptcy so why did interest rates converge? creditors (rightfully!) believed that the Euro eliminates country risk as well Reason: ECB policy the EU treats all banks and governments alike regardless of their credit ratings extensive ECB credit facilities in form of ELA pooling of ECB profits and losses ECB de facto acts as lender of last resort intention: financial stability impact: opportunistic behavior (inflationary credit bubble in the South). Professor Dr. Holger Strulik Open Economy Macro 9 / 28

11 2. Lending of the Printing Press (Target) When the debt crisis hit, the ECB dramatically reduced collateral requirements (from AA- to BB- to any government bond) ELA (Emergency Liquidity Assistance) Notice: target deficits occur because credit is issued in excess of the liquidity needs of the country why? to continue to buy foreign goods (and pay off external debt) Professor Dr. Holger Strulik Open Economy Macro 10 / 28

12 Normally (before the crisis), target balances are approx. balanced money flows also in the other direct (e.g. credit by German banks to Greek banks) after crisis, private lending stopped (sudden stop) money is flowing in one direction only accumulation of target claims and liabilities How is this sustainable? At some point all money should vanish from Greece? Solution: printing of excess money Rule of thumb: target deficit balance of payments deficits (Recall: normally the BOP is balanced, CA = FA in all countries. With target deficit: the rule CA = FA does no longer apply! Professor Dr. Holger Strulik Open Economy Macro 11 / 28

13 Target balances by country (peak values August 2012; D: 25% of GDP, Greece: 50%) Creation of outside money: money originating from GIPSIC (Greece, Ireland, Portugal, Spain, Italy, Cyprus) that is circulating elsewhere... Professor Dr. Holger Strulik Open Economy Macro 12 / 28

14 Inside money and outside money of the GIPSIC countries Professor Dr. Holger Strulik Open Economy Macro 13 / 28

15 What happens with all the money in the North? excess liquidity crowding out of liquidity normally created by asset purchases and refinancing credit in the North banks repay their own refinancing credits lend surplus cash to their NCBs target balances do not increase the monetary base, they shift refinancing credit from the North to the South International Shifting of Refinancing Credit Professor Dr. Holger Strulik Open Economy Macro 14 / 28

16 Step 3: Buying Collateral (SMP) Problem: the value of the collateral that the ECB received for refinance credit eroded quickly (market value of GIPSIC bonds) risk of collapse of the southern banking system ECB turns to buying the collateral in order to stabilize its market value SMP: Securities Market Program with the ECB buying the bonds, countries could issue new ones without driving yields up Problem: North is increasingly unhappy with potentially undemocratic decision about credit provision... Professor Dr. Holger Strulik Open Economy Macro 15 / 28

17 Excursion: Political Economy of the ECB most important: Governing Council consisting of the 6 members of the Executive Board & the governors of the national central banks of the Euro zone members (17 in 2012) single majority voting one-man-one vote are 23 too many voters in a committee? introduction complex rules for voting right rotation? managers of the ECB (bureaucrats) as agenda setter large countries have more personnel at the ECB Professor Dr. Holger Strulik Open Economy Macro 16 / 28

18 Unanimity: officially all ECB decision so far were unanimously goal: prevent confusion on financial markets crucial underlying assumption: the board member are representative of the Euro zone (not of their home countries) no voting weights Trichet: we are one team No transparency: no publication of minutes (cf. Fed in the US) never (official) publication of dissenting minority views occasionally revealed dissent: Axel Weber and ECB chief economist Juergen Stark leave the ECB in 2011 If no unanimity: Club Med has about 70 percent of the votes Bundesbank (Finnish National Bank,...) has no say Professor Dr. Holger Strulik Open Economy Macro 17 / 28

19 Who is represented by the Governing Council? Europe then why care that every country is represented? Euro zone countries (central banks) weighted voting according to capital shares held at the ECB. Professor Dr. Holger Strulik Open Economy Macro 18 / 28

20 Step 4: The European Stability Mechanism (ESM): in force since September 2012 (after ratification in Germany) should replace the EFSF 2013 both are in jointly operative (initial) lending capacity 500 billion Euros countries in financial difficulty can apply for bail out official suspension of the no bail out clause from Maastricht treaty Fiscal Compact should prevent overuse capital stock 700 billion (80 billion in paid-in capital, 620 in committed callable capital) shareholder contribution according to ECB contribution ECB contribution according to country s population and GDP Germany: 190 billion (27% ) Professor Dr. Holger Strulik Open Economy Macro 19 / 28

21 ESM instruments: providing loans to countries purchasing bonds of ESM Member States financing recapitalisations of financial institutions through loans to governments Note: ESM takes not only care of government debt but also of private debt Board of governors: Euro zone financial minister ESM Fund raising: ESM may issue bills and bonds with maturities ranging from 1 month to 30 years Funds raised are pooled and not attributed to a particular country i.e. Euro bonds through the back door. Professor Dr. Holger Strulik Open Economy Macro 20 / 28

22 Political economy of ESM: voting weights within Board of Governors and the Board of Directors proportional countries contributions of capital qualified majority of 80 percent observe: blocking minority for D and F Capital contribution of ESM Member States Capital subscription ( bn) Paid-in capital ( bn) ESM Country Key (%) Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain Total Professor Dr. Holger Strulik Open Economy Macro 21 / 28

23 Critique of ESM and Fiscal Compact (H.-W. Sinn): socializing the debt of South Europe friends and neighbors become borrowers and creditors in case of violations: offenders and judges are the same (in the Council) the debt brake won t work the Euro area is not a nation: no monopoly of violence Compare with US: the US is a nation no bail-out clause for US states enforcement: 9 state bankruptcies in the history of the US the market (interest rate) evaluates state policy Professor Dr. Holger Strulik Open Economy Macro 22 / 28

24 European Fiscal Compact (April, 2014): basically rules from Maastricht with stricter (?) enforcement new: debt brake : criteria, defining how fast debt-to-gdp levels above 60% of GDP shall decline max fine is 0.1% of GDP only countries with a balance budget rule in their legal code by 1 March 2013 will be eligible to apply for bailout money from the European Stability Mechanism (ESM) process is monitored by European Court of Justice in the event of deviation from the balanced budget rule or debt brake rule, an automatic correction mechanism shall be triggered new: reverse qualified majority voting in the Council for most sanctions: a proposal of the Commission is considered adopted in the Council unless a qualified majority of Member States votes against it. Note: not EU law (intergovernmental treaty, concerning only Euro members) Professor Dr. Holger Strulik Open Economy Macro 23 / 28

25 Monitoring: The European Semester: annual cycle of macro-economic, budgetary and structural policy coordination Jan: Commission issues EU priorities for the coming year to boost growth and job creation. March: European Council issues guidance for national policies April: member States submit plans for sound public finances May: Commission assesses the programmes. June: Commission provides country-specific recommendations July: Council formally adopts recommendations Autumn: governments present the budget draft to their parliaments Professor Dr. Holger Strulik Open Economy Macro 24 / 28

26 Problems with the Fiscal Compact: credibility for some countries fines are small compared to outstanding debt why should fines work when countries can borrow to pay the fines (and then let someone else pay)? Professor Dr. Holger Strulik Open Economy Macro 25 / 28

27 Step 5: Unlimited Promises ( Whatever it takes ) problems with fiscal rescue operations: too parsimonious credit, too many constraints (austerity) markets are not impressed, capital flight continues September 2012: ECB promised unlimited government bond purchase for distressed countries that submit themselves to ESM rules Outright Monetary Transactions (OMT) private capital slowly returns (slow decline of target balances) Professor Dr. Holger Strulik Open Economy Macro 26 / 28

28 Step 6: Banking Union Problem: the value of other assets held by banks still deteriorated Banks and therewith the Eurosystem were still at risk The ESM funds, originally foreseen for the support of governments only, were made available for bank recapitalization Eurobonds? A very European Break up: Professor Dr. Holger Strulik Open Economy Macro 27 / 28

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