ECONOMIC AND FINANCIAL CRISES Lecture 4 LIUC 2010
Recent crises • 1997 currency/financial crisis in East Asia • 1998 financial crisis in Russia • 1999 Brazil • 2001 Argentina, Turkey • 2007- Subprime crisis • 2010 Greek crisis
The 2007 subprime crisis • Unlike previous crises, the subprime crisis originated in mature economies • Rapid pace of growth in housing prices, fuelled by: • cheap mortgages; • banking deregulation (financial derivatives that allowed mortgages to be packaged and re-sold (and re-sold again); • households beginning to use real estate as a speculative asset
A global crisis • From the US mortgage sector the crisis spilled over to asset-backed securities all over the world. • Financial crisis entered a more severe phase after the Lehman collapse in Sept 2008, with risk premiums rising sharply and affecting corporate borrowing. • The downturn in asset markets snowballed rapidly across the world, and Europe was one of the most affected, due to the heavy exposure of a number of EU countries to the US subprime problem. • Emerging markets, initially sheltered from the financial turbulence due to limited exposure to US subprime loans, were hit in autumn 2008, as risk aversion spiked.
EU response to the crisis • Came after September 08 • Banking support through: debt guarantees, recapitalization, liquidity support, treatment of impaired assets • A strong expansionary stance • Monetary policy: lower cost of borrowing, provision of liquidity, lower collateral standards. In terms of the euro area GDP the ECB balance sheet rose from 13 to 21% from 97 to 09
EU response to the crisis • A strong expansionary stance • Fiscal policy: European Economic Recovery Program (endorsed by the Council in Dec. 08). 3 principles: country specific packages according to the available fiscal room, measures targeted, timely, temporary The overall fiscal stimulus, including the effects of automatic stabilisers, amounts to 5% of GDP in the EU.
Greek crisis: the facts • Following the Greek elections in Oct 2009, it was realised that the fiscal and public debt positions for 2008 and 2009 were far worse than reported by the previous government. • The deficit jumped to an estimated 13.6% of GDP while the public debt rose to over 115% of GDP in 2009. • After downgrades of government bonds by rating agencies, investors started backing out of Greek bonds, driving up yields. • Banking system affected. Impaired loans are rising while borrowing costs in the interbank and wholesale markets have increased.
International response to Greece • On 2 May 2010 the Eurogroup formally launched a financial assistance mechanism, conditional on the implementation of an adjustment programme and on an assessment by the EC and the ECB of the risks to financial stability in the euro area. • The adjustment programme agreed was negotiated, in liaison with the ECB and the IMF. The overall financing package amounts to €110 billion over three years. • The first review of the programme in Summer 2010 concluded thatGreece has managed impressive budgetary consolidationduring the first half of 2010. It has also achieved progress in major structural reformswhich will help to transform the economy. Some of these reforms have been undertaken ahead of schedule.
Greece: remaining challenges and next steps • Despite the significant progress made, major challenges and risks remain. There is a need to : • Safeguard adequate liquidity and financial stability of the banking sector, also following up on the results of the July 2010 CEBS stress tests. • Avoid slippages in budgetary executionin the second half of the year. • Press ahead the structural reform agenda • Next steps: The next tranche of the loan agreement has been disbursed in September. The euro-area share was €6.5 billion; the IMF added €2.5 billion for a total of €9 billion.
Euro area: the worst has been avoided, but new challenges must be faced "The euro area's governance and coordination of economic policies must be improved. This will involve both deepening and broadening economic surveillance arrangements to guide fiscal policy over the cycle and in the long term and, at the same time, address divergences in growth, inflation and competitiveness." (Commission Communication, 7 May 2008)
Need for reforms • EU needs to develop a crisis policy framework along 3 lines: • Crisis prevention • Crisis control and mitigation • Crisis resolution • A better governance system is necessary for the future. • Some reforms have already been implemented, others are still under discussion.
What has been already done • Reinforcing the preventive dimension of budgetary surveillance: introduction of the "European Semester" (from Jan 2011) to reinforce ex-ante coordination when Member States prepare their national budgets and national reform programs. Will align the processes under the SGP and the Broad Economic Policy Guidelines (BEPGs). • The European Financial Stability Facility (EFSF) has become operational in Aug 2010. Set up by the 16 euro countries to provide financing to Member States in financial difficulties. Will issue bonds guaranteed by euro area members for up to € 440 billion for on-lending, subject to conditions to be negotiated with the European Commission in liaison with the ECB and IMF and to be approved by the Eurogroup.
What is under discussion • In the next months: • Commission’s proposal for strengthening the Stability and Growth Pact (SGP) • Commission’s proposal for preventing and correcting macroeconomic imbalances
Annex 1 – Greece first review of the programme • All budgetary performance criteria for June 2010 have been met • All fiscal measures foreseen to be taken in 2010 have been adopted - In line with the requirements set in the MoU on Specific Economic Policy Conditionality, Parliament has adopted in May measures that generate savings for a total amount of 2.5 percent of GDP in 2010, plus carryovers of 1.1 percent of GDP for 2011. That brings total budgetary measures in four successive packages to around 8 percent of GDP in 2010. • Significant progress has been achieved in structural fiscal reforms: Key reforms include the preparation of the new organic budget law, measures against tax evasion and steps forward in setting up a single payment authority for public wages. Significant progress has also been made in strengthening tax administration and in reforming public administration. Preparations are less advanced in the implementation of a system to monitor and control expenditure commitments. • Major steps forward have also been made in the broader structural reform agenda.Business environment reforms, measures to accelerate absorption of structural and cohesion funds and horizontal legislation to implement the services directive are on track; major labour market and pension reform laws were adopted ahead of schedule, though they may require some further actions. The privatisation and restructuring of state-owned enterprises needs to be sped up and in many cases be more ambitious. • The Financial Stability Fund has been established and the Bank of Greece is committed to strengthen banking supervision. • Efforts to improve the collection and processing of data which is essential for budgetary control need to be accelerated.