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Can the Euro Hold? Michael A Landesmann

Can the Euro Hold? Michael A Landesmann. IDEAS Tenth Anniversary Conference, Chennai, 24-26 January 2012. Main Issues. Why has the crisis in the Eurozone escalated that much? Where are we at the moment? Is there a policy master-plan? Is the Euro-zone going to pull through? In which shape?

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Can the Euro Hold? Michael A Landesmann

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  1. Can the Euro Hold?Michael A Landesmann IDEAS Tenth Anniversary Conference, Chennai, 24-26 January 2012

  2. Main Issues • Why has the crisis in the Eurozone escalated that much? • Where are we at the moment? Is there a policy master-plan? • Is the Euro-zone going to pull through? In which shape? • What is the predicament of Europe’s ‘periphery’?

  3. Why has the crisis in the Eurozone escalated that much? • Pronounced developments of external imbalances within the Euro-zone, driven by financial market integration and – mostly – fast private sector debt accumulation • Policy-mechanisms to deal with these imbalances non-existent or in-effective: financial markets insufficiently (and nationally) regulated; real exchange rates diverge persistently driven by capital inflows (interest rate convergence before the crisis); relative price adjustment very slow – hence rebalancing through incomes; no established crisis management mechanism at EU/Euro level (ECB mandate, no pooling of debt responsibility; no fiscal stabilisation function) • Banks very weak; no effective re-capitalisation; implicit liability of states – sovereign debt problem and feed-back processes; national segmentation of responsibility • Fiscal policies, deleveraging and weak banks generate stagnation; sustainability of debt of both private and public sectors judged (by markets) as unresolved

  4. Public and private debt in % of GDP Public debt Private debt Corporations Banks Households Source: wiiw Annual Database incorporating Eurostat statistics.

  5. Public and private debt in % of GDP Public debt Private debt Corporations Banks Households Source: wiiw Annual Database incorporating Eurostat statistics.

  6. Where are we at the moment? Is there a policy master-plan? • Exclusive focus on fiscal consolidation: Germany sees this as a pre-condition for any move towards joint action/mutualisation on the debt problem and widening ECB’s mandate – focus to bring long-term public debt ratios down (constitutional amendments; tightening of fiscal control) • Recapitalisation of banks asked for, but happens through shrinkage of balance sheets – credit crunch • Some moves towards EU-wide regulatory and supervisory bodies; but lacking teeth so far; in the short-run more national segmentation of banking • Measures to monitor development of competitiveness in the future; details to be worked out; unlikely to be very effective • No growth strategy, except lip-service to change revenue and expenditure structures in ‘growth enhancing’ manner; plus liberalisation

  7. Is the Euro-zone going to pull through? In which shape? • Economic issues: - recession(s) 2012/13; then medium-term stagnation/low growth - unfolding of fiscal consolidation; widening of ECB activity – important transitory role; slow build-up of EFSF/ESM (role vis-a-vis banking system and sovereign debt); Greek default – contagion effects – ‘ring-fencing’; access to capital markets will remain/become very problematic for a range of countries (IT,SP,PO,GR,HU, Ro,...) • Political issues: - How are polities going to react? espec. in high austerity countries - Technocratic handling of the crisis; reaction against MerkMontozy; tensions in and towards inter-governmental processes; reactions in national parliaments/polities; field for populist/nationalist parties; little debate on alternative strategies

  8. What is the predicament of Europe’s ‘periphery’? • In many countries (Southern and Eastern periphery) high debt levels of private sectors (corporate and household sectors) – deleveraging processes; public sector debt has significantly increased • Foreign banks in retrenchment – credit constraints severe; cross-border banking goes through a process of re-nationalisation • Current accounts adjust strongly – mechanisms different in fix- and flex-exchange rate countries; big differences across countries in underlying strength of export sector; in a range of economies strong legacy of distorted tradable/non-tradable sector structures • The strong slowing down/contraction of German, Italian etc. growth affects peripheral region strongly • FDI and inward capital flows sharply down – ‘catching-up model’ (‘downhill capital flows’) will have to be significantly rethought (stronger focus on industrial policy; emphasis on tradable sector; less reliance on fixed exch. regimes; EMU?)

  9. Composition of the current account of the balance of payments, 1995-2009 Note: ASIA-6 excl. Taiwan.Source: IMF International Financial Statistics and IMF WEO October 2010.

  10. Net private financial flows in % of GDP, 1993-2009 LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 SEE-2 B-3 WB-6 TR Source: IMF Balance of Payments Statistics. ASIA-6 excl. Taiwan.

  11. Is the Eurozone/the EU likely to disintegrate? • Analytical approaches to this question: Bolton/Roland; Alesina et al; Rodrik - heterogeneity issues; impact of international liberalisation; importance of EU wide public goods (and scale effects in their supply); problems with transfer Union; role of mobility • 2008-2012 crisis is an historical threshold event for the EU: - weakness of the institutional/policy set-up has become very apparent - a large number of institutional reforms are emerging: fiscal policy frameworks (‘fiscal compact’; six-pack); EU wide regulation and supervision; increased tax base of EU?; evolution of crisis and risk management (EFSF/ESM; Bank Risk Fund?; sovereign default procedures); widening of ECB mandate also de jure? • Political commitment of European elites (is it changing?); popular resentment towards crisis management/technocratic/legitimacy issues

  12. ‘... As it is, men have devised ways to impoverish themselves and one another; and prefer collective animosities to individual happiness.’ J.M. Keynes: The Economic Consequences of the Peace, 1920

  13. Economic Integration and Emerging Economies: Main lines of the argument • International financial markets integration can strongly accentuate the possibility of external and internal imbalances • Exchange rate regimes are very important in this context • Catching-up processes can be seriously derailed due to the build-up of imbalances • Impact on distorting economic structures (domestic savings behaviour, capital allocations across tradable/non-tradable sectors, asset prices, competitiveness, etc.) • The setting for catching-up economies in (EU)rope is special: affects not only EU members but also economies in the neighbourhood (e.g. Balkans)

  14. Comparing emerging market economies (EMEs) • European EMEs: CE-5; B-SEE (B-3, SEE-2; WB-6); EU-COH; Turkey • Non-European EMEs: ASIA-6 (w/o China, India); LATAM-8; MENA-6 (non-oil) • Focus areas: specific characteristics of European integration; European vs. global capital market integration; evolution of disequilibria; policy environment and policy choices

  15. Comparing emerging market economies (EMEs) • CE-5: Czech Republic, Hungary, Poland, Slovakia, Slovenia • B-3: Estonia, Latvia, Lithuania • SEE-2: Bulgaria, Romania • WB-6: Albania, Bosnia and Herzegovina, Croatia, Former Yugoslav Republic of Macedonia, Montenegro, Serbia • B-SEE: B-3 + SEE-2 + WB-6 • EU-COH: Greece, Portugal, Spain, Ireland • Turkey • ASIA-6: Indonesia, Korea, Malaysia, Philippines, Taiwan, Thailand • LATAM-8: Argentina, Brazil, Chile, Columbia, Ecuador, Mexico, Peru, Uruguay • MENA-6: Egypt, Jordan, Lebanon, Morocco, Syria, Tunisia

  16. Capital market integration and emerging economies • The question of ‘downhill’ vs. ‘uphill’ capital flows in the global economy (see e.g. Prasad/Rajan/Subramanian, 2006; Gourinchas/Jeanne, 2009; Abiad/Leigh/Mody, 2009) • The issue of financial and monetary integration and catching-up economies (‘threshold’ effects, ‘institutional anchoring’) • The nature of external disequilibria and the composition of capital (in)flows; role of exchange rate regimes • Which disequilibria are ‘sustainable’ and under which external circumstances? • The available spaces for policy choices

  17. The European integration model of catching-up • targeted at integration with the EU/Euro area • associated with very far-reaching internal and external liberalization (trade, capital transactions, financial market integration, labour mobility) • benefits: ‘downhill’ capital inflows, trade integration, ‘technology’ transfer; institutional convergence • the model worked - ‘convergence process’ – but emergence of severe structural imbalances in important groups of European EMEs; heterogeneity of pre- and post-crisis experience of European EMEs

  18. Growth - GDP at constant pricesAverage annual growth rates, 1995-2010, in % Source: IMF World Economic Outlook, October 2010. EBRD and wiiw Annual Database incorporating national statistics, Eurostat..

  19. Quarterly GDP developments3rd quarter 2008 = 100 ASIA-6 LATAM-8 CE-5 EU-COH SEE-2 + HR B-3 Source: Eurostat, wiiw calculations.

  20. Differentiating features of EMEs • Degree of openness: - trade integration; financial market integration • Private sector borrowing and debt • External disequilibria: current accounts, composition of capital flows; real exchange rate developments • Sectoral ‘distortions’ (tradable/non-tradable sectors); FDI allocation • Fiscal policy during the crisis; public debt development • Recovery from the crisis: level and trend effects

  21. Openness indicators: trade and financial integration, 2007in % of GDP Note: Assets and liabilities: EU-COH: 618.1%; ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon. Source: IMF International Financial Statistics.

  22. Financial integration - Changes in: (i) assets plus liabilities; (ii) credit to private sector in % of GDP (percentage point change), 2001-2007 Note: Assets and liabilities: EU-COH: 265.82%; WB-6: 212.14%. Source: IMF International Financial Statistics. ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon.

  23. Foreign bank ownership, 1998-2005(assets owned by foreign banks as % of banking system assets) B-3 WB-6 CE-2 SEE-2 LATAM-8 ASIA-6 MENA-6 Turkey Note: ASIA-6 excl. Taiwan, MENA-6 excl. Syria.Source: from Claessens et al (2008).

  24. Industrial Production - Index 1993=100, 2000, 2008 Note: ASIA-6 excl. Taiwan. B-SEE excl. Bosnia and Herzegovina, Montenegro and Serbia.Source: World Bank.

  25. Change in openness to trade, 1995-2008in % of GDP (percentage point change) Source: IMF International Financial Statistics.

  26. Summarizing some of the features of European EMEs compared to other EMEs • High growth prior to the crisis • High indicators for openness: trade and particularly strong growth in international financial integration • Much greater role of foreign banks in European EMEs compared to other EMEs • Fast growth of credit to private sector in many European EMEs • Differences in industrial production growth and the build-up of export capacity in different EMEs • Next: the build-up of significant disequilibria before the crisis

  27. Composition of the current account of the balance of payments, 1995-2009 Note: ASIA-6 excl. Taiwan.Source: IMF International Financial Statistics and IMF WEO October 2010.

  28. Net private financial flows in % of GDP, 1993-2009 LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 SEE-2 B-3 WB-6 TR Source: IMF Balance of Payments Statistics. ASIA-6 excl. Taiwan.

  29. Real exchange rate developments, 1995 to 2010 Misalignment in the Baltics/Balkans Appreciation hand-in-hand with catching-up in Central Europe Stable real X-rate in Asia post crisis

  30. Differences in the composition of FDI Large part in real estate, finance in Baltic region Large part in manufacturing, infrastructure, trade in central Europe 35

  31. Relationship between pre-crisis credit growth and current account balances average CA/GDP 2004-2007 Change in credit/GDP 2004-2007 Source: IMF World Economic Outlook.

  32. Real lending NB/ECB interest rates, 2003-2010 CPI-deflated, in % p.a. SEE-2 EU-COH B-3 Source: IMF International Financial Statistics. ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon.

  33. Debt in % of GDP Gross external debt Public debt Private debt Source:wiiw Annual Database incorporating Eurostat statistics.

  34. Debt in % of GDP Gross external debt Public debt Private debt Source:wiiw Annual Database incorporating Eurostat statistics.

  35. Debt in % of GDP Gross external debt Public debt Private debt Source:wiiw Annual Database incorporating Eurostat statistics.

  36. CESEE: GDP growth was well above the interest rate before the crisis Nominal interest rate on government debt and nominal GDP growth (%), 2000-2010 Note: Interest rate = government interest expenditures / previous year gross debt.

  37. General government balance and gross debt (% GDP), 2000-2010 CESEE: low debt (on average), even after the crisis

  38. External debt: public and private (% of GDP), 2008 Note: ASIA-4 excl. PH, TW. MENA-4 excl. LB, SY. B-3 excl. FYROM, BA, RS. Source: World Bank, World Databank.

  39. External debt: public and private (% of GDP), 2008 Note: ASIA-4 excl. PH, TW. MENA-4 excl. LB, SY. B-3 excl. FYROM, BA, RS. Source: World Bank, World Databank.

  40. Structural features: European and other EMEs Source: wiiw calculations.

  41. Summarizing the build-up to the crisis – differentiated patterns in the EMEs • Different developments amongst European EMEs EU-Coh, CE-5, B-SEE and compared to other EMEs • Current account developments; real exchange rate appreciation • Composition of net capital inflows (credits, portfolio, FDI) • Credit growth to the private sector; low (partly negative) real interest rates • Public debt situation not that different between European EMEs and other EMEs • Clear link between private credit growth and current account deterioration; and hence foreign debt positions

  42. The impact of the crisis and patterns of recovery

  43. Pre-crisis credit growth and GDP growth in 2009 GDP growth in 2009 Change in credit/GDP 2004-2007 Source: IMF World Economic Outlook.

  44. Pre-crisis credit growth and GDP growth in 2010 GDP growth in 2010 Change in credit/GDP 2004-2007 Source: IMF World Economic Outlook.

  45. Structural features: the role of exchange rate regimes ‘Fixers’ and ‘floaters’ amongst the CESEEs Source: wiiw calculations.

  46. Fiscal policy reaction: huge adjustment in CESEE Average annual changes in total general government expenditures, 2008-2010 Note: Nominal fromdata in EUR.Source: IMF World Economic Outlook, wiiw Database and Eurostat.

  47. GDP development, 2005-20122008=100 ASIA-6 LATAM-8 TR WB-6 CE-5 SEE-2 EU-COH B-3 Source: wiiw forecast and IMF World Economic Outlook, October 2010.

  48. Summarizing the crisis impact • Stronger impact of the crisis on European EMEs than on other EMEs (level and – medium-term – trend effect) • Countries with high current account deficits and high credit growth prior to the crisis have stronger downturn • Significant differences between ‘fixers’ and ‘floaters’ amongst European EMEs • Substantial pro-cyclical contraction of real government spending in European EMEs during the downturn

  49. Summary: Specific features of European EMEs • Opening of the capital account: a rule of the game in the EU; deep financial integration • Reliance on massive imports of capital; only 4 CESEE-countries could avoid skyrocketing external (private) debt • Bank credit: the overwhelming source of external funding • Financial integration: major channel for transmitting shocks (EU-Coh, B-SEE regions hit hardest by the crisis) • In general no meltdown of financial systems in CESEE (advantage of the presence of foreign banks? Implies also less socialization of private debt in CESEE – i.e. lower public debt effects); difference to EU-Coh in which there was massive nationalisation of private sector debt

  50. The outlook on recovery after the crisis • Which pattern of recovery after the crisis? European EMEs show level and trend effect of crisis impact • Fiscal policy: less room for manoeuvre because of reduced growth expectations and higher interest rates; in EU-Coh socialisation of private debt; full blown sovereign debt crisis • Household deleveraging process and fragile banks (lasting credit constraint); some countries banking system on the brink • Capital flows to European vs. non-European EMEs: pattern reversed from before the crisis; depending on built-up debt positions and (revised) growth expectations

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