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The Credit Crisis and the Euro

The Credit Crisis and the Euro . Ben Broadbent Managing Director & Senior European Economist. September 2010. Summary. Europe recovering but sharp divergence within the Euro-zone. Partly industrial composition: investment-driven cycle so sharpest “V”s in capital-goods-producing countries.

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The Credit Crisis and the Euro

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  1. The Credit Crisis and the Euro Ben BroadbentManaging Director & Senior European Economist September 2010

  2. Summary • Europe recovering but sharp divergence within the Euro-zone. • Partly industrial composition: investment-driven cycle so sharpest “V”s in capital-goods-producing countries. • Credit crunch has also blown away a decade of interest-rate convergence between “core” and “periphery”. • Eurozone needs (i) more fiscal discipline ahead in good times &/or (ii) more support in bad times. Will politics allow this?

  3. Estimated banks’ losses, March 2009 • Eurozone banks: EUR 920bn (10.1% of GDP) • UK banks: GBP 210bn (14.6%) • Total: USD 1.4tn (15.1%)

  4. Domestic Demand and Growth Contributions, Last Decade Source: GS Global ECS Research

  5. Chinese Growth: Not Just Exports

  6. US not as central as it once was Source: GS Global ECS Research

  7. Very aggressive policy response

  8. No comparison with Japan

  9. Not the Great Depression II for output...

  10. ...or for asset prices

  11. Bounce in asset prices has helped banks’ balance sheets

  12. More like other post-war financial crises

  13. Divergence

  14. Partly reflects industrial composition

  15. But markets price of sovereign debt has also diverged significantly

  16. Spill-over impact on banks’ funding costs

  17. Divergence follows years of convergence

  18. No evidence EMU deepened trade integration

  19. But it did help compress bond yields

  20. And as income converged, current accounts diverged

  21. Low rates encourage domestic demand

  22. Strong demand raises domestic costs

  23. …causing declines in the periphery’s export market shares

  24. And sharp deteriorations in external positions

  25. Not a problem for the Eurozone as a whole

  26. Hefty adjustments needed to achieve stabilization of debt levels

  27. Decline in interest rates not restricted to the Eurozone

  28. Reform: The options • Nothing: let countries restructure (if they have to) • Piecemeal: More support/control ex post (EFSF plus EC intervention); tighter standards ex ante (Van Rompouy) • Wholesale: Full fiscal federalism (note US example: political union precedes monetary union). • Euro break-up

  29. Macro rebalancing Keynes (Bretton Woods, 1946): “the process of adjustment is compulsory for the debtor and voluntary for the creditor. If the creditor does not choose to make, or allow, his share of the adjustment, he suffers no inconvenience. For whilst a country’s reserve cannot fall below zero, there is no ceiling which sets an upper limit”.

  30. Disclaimer I, Ben Broadbent, hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by considerations of the firm’s business or client relationships.

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