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Agenda

Studium Generale The euro area sovereign debt crisis: causes and consequences Prof. Dr. Olaf Sleijpen Maastricht, 3 November 2011. Agenda. A short (conceptual) history of European monetary integration Fiscal discipline in the Treaty Evidence of fiscal discipline in the euro area

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Agenda

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  1. Studium Generale The euro area sovereign debt crisis: causes and consequences Prof. Dr. Olaf SleijpenMaastricht, 3 November 2011

  2. Agenda • A short (conceptual) history of European monetary integration • Fiscal discipline in the Treaty • Evidence of fiscal discipline in the euro area • Lessons to be drawn: the inconsistent triangle revisited • A new perspective on nominal and real convergence in the euro area • An assessment of the euro area summit of 23 October • Concluding remarks

  3. A short (conceptual) history of European monetary integration Maastricht Treaty Convergence approach “Big Bang” approach -Nominal convergence required; No real convergence -Strongly embedded monetary policy structure in place -Intergovernmental framework to impose fiscal discipline; no framework to impose real convergence • Inspired by Optimal • Currency Area theory • -Full nominal and real • convergence required • -Appropriate adjustment • mechanisms in place in • case of (asymmetric) shocks • -Monetary union is the “crown” • on convergence process -Convergence will follow automatically after Start monetary union -Discipline imposed by fixed exchange rates will trigger nominal and real economic discipline Economic and Monetary Union

  4. Why fiscal discipline matters in a monetary union • Preventing spillovers from fiscal to monetary policy • Preventing spillovers from national fiscal policies to other Member States • Absorption of asymmetric shocks at the national level • Market discipline flawed • Macro-economic and financial stability

  5. Fiscal discipline in the Maastricht Treaty • Multilateral surveillance procedure • Excessive deficit procedure • Prohibition of priviliged access • No bail-out clause

  6. The Stability and Growth Pact Revisited • Adopted in 1997 (Amsterdam European Council) • Reform in 2004 • Preventive arm • Strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies • Corrective arm • Speeding up and clarifying the implementation of the excessive deficit procedure

  7. Insufficient compliance … % GDP 00 07 01 99 02 03 04 06 08 98 05 09 Source: European Commission, Spring Forecasts 2010 and budgetary plans according to national budgets.

  8. …became apparent during the crisis Budget deficit % of GDP Source: European Commission, Spring Forecasts, 2010.

  9. Increase in debt… Gross public debt euro area % of GDP Source: European Commission, Spring Forecasts 2010.

  10. …and late market reaction Interest rate spread with German government debt (10-year maturity) % points Source: Thomson Financial.

  11. Consequence: financial stability risk in EMU Government debt held by non-residents (% of total) Source: Eurostat and CBS (for The Netherlands).

  12. The (new) inconsistent triangle • The inconsistent triangle (Padoa-Schioppa, 1985) • Incompatibility between fixed but adjustable exchange rates, full capital mobility and independent monetary policies • This inconsistent triangle prooved to be true in the EMS Crisis (1992-1993) • The new inconsistent triangle • Incompatibility between single monetary policy, full capital mobility and independent fiscal policies • Reflected by the current crisis in the euro area

  13. What doe this inconsistent triangle imply? • Fiscal consolidation is necessary, but will take time • And will not reassure financial markets in the short term • If the (new) inconsistent triangle is true, a major overhaul of the institutional set-up of the euro area is necessary • A major reform of the institutional set-up may not sooth financial markets • Enlarged and flexible EFSF as temporary solution

  14. Strengthening economic governance – the view of the EU • Towards greater fiscal discipline • Broadening economic surveillance: a new surveillance mechanism • Deeper and broader coordination: the “European Semester” • Robust framework for crisis management • Stronger institutions for more effective economic governance

  15. The importance of enhancing national fiscal rules and frameworks Relationship between plausibility of projections stability programmes and national fiscal rules, after taking into account other explanatory variables. Source: Beetsma, Giuliodori and Wierts (2009, Economic Policy)

  16. More focus on debt financing Short-term government debt outstanding (central government) Source: Hoogduin, Öztürk and Wierts (2010).

  17. An assessment of the economic(fiscal) governance • Excessive deficit and follow-up should be called by Community institution • Framework should become less intergovernmental • Sanctions should be efficient and effective • Value-added of fines, etc. is limited • Financial support limited to strong conditionality

  18. Economic convergence revisited • Nominal convergence (interest rate, inflation, public finance) • Real convergence • (labour) market flexibility • (assymetric) shock absorption by national budgets (automatic stabilisers)

  19. Inflation euro area: low and stable… Inflation euro area % changes (y-o-y) Source: Thomson Financial.

  20. …but inflation differentials persistent Inflation (HICP) % changes (y-o-y) Source: Thomson Financial.

  21. Imbalances have increased Current account balance % euro area or world GDP Source: IMF.

  22. Causes imbalances % GDP and % changes Source: European Commission.

  23. Budget periphery more affected Average deterioration of the budgetary position B. Portugal, Ireland, Italy, Greece and Spain A. Other EMU countries Before crisis (Autumn 2007) After crisis (Spring 2010) Before crisis (Autumn 2007) After crisis (Spring 2010) Source: European Commission, Economic forecasts.

  24. Crisis reveals relationship imbalances and budgetary position Before crisis (Autumn 2007) After crisis (Spring 2010) R2= 0,1647 R2= 0,6034 Source: European Commission, Economic forecasts.

  25. What has been agreed on 23 October? European Council • Banking package Euro Summit • Sustainable public finances and structural reform • Refining the Greek programme • Monitoring • PSI and credit enhancement • EFSF • Leverage resources of the EFSF • Economic governance

  26. Pro’s Increase in “fire power” of the EFSF Package necessary to sooth markets Further enhancement of economic governance Con’s PSI not clear Leverage: will it work? Enhanced economic convergence: not enough? Implementation lag Assessment of the 23 October package

  27. Concluding remarks • Financial crisis has revealed weak compliance with and enforcement of fiscal and economic policy rules in EMU • Insufficient fiscal discipline; insufficient real convergence • “Every cloud has a silver lining”: broadening and deepening of policy framework necessary • But more ambition necessary

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