rapporto europa adjusting to the crisis

ProfessorStefan Collignon

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Rapporto EuropaAdjusting to the crisis


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Table of Content

1. Europe's adjustment to the crisis2. Exit strategies for what?3. Public deficits and the sustainability of debt4. Private union bonds as an exit from the

Greek drama5. Global imbalances: Europe’s role6. European economic governance. The Lisbon

Treaty, the crisis and possible outlooks


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Rapporto Europa 2010

The world is coming out of its deepest economic crisis in 70 years, but the danger is not over.

Although economic growth has returned, it is weak. The European economy risks falling back into a «double-dip» recession, unless the restocking of inventory translates into sustained investment and job creation.


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Lessons from the Great Depression teach that an early recovery can revert back into recession, when bankruptcies, defaults, currency depreciations, and low assets prices undermine the creditworthiness of borrowers.

The Greek crisis risks to be precisely such an event

Falling bond and stock prices Fiscal restraint Weak euro


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1. Europe's adjustment to the crisis


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The crisis has not only lowered growth, but also affected long term growth potential negatively Investment Employment

Euro Area is less affected than non-euro Exception: Poland

Asia is least affected


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Table 2. Employment AdjustmentColumn 1 2 3 4 5

jobs created 199-2008 job growthjob losses 2008-10 job losses (3)/(1)in thousands in % of 1999in thousands in % of 2008 loss/gain

Euro area16 15,181.8 11.4% -4866.0 -3.3% -32.1%Euro area12 14,803.2 11.5% -4772.6 -3.3% -32.2%Ireland 476.7 29.4% -238.4 -11.4% -50.0%Spain 4,884.7 31.3% -1806.2 -8.8% -37.0%Finland 286.3 12.7% -133.2 -5.3% -46.5%Slovenia 97.1 10.9% -45.4 -4.6% -46.7%Portugal 220.1 4.5% -139.3 -2.7% -63.3%France 2,144.6 9.1% -674.0 -2.6% -31.4%Netherlands 797.3 10.0% -193.3 -2.2% -24.2%Belgium 433.4 10.8% -97.9 -2.2% -22.6%Austria 364.4 9.7% -90.0 -2.2% -24.7%Germany 1,855.0 4.8% -838.3 -2.1% -45.2%Slovakia 175.9 8.5% -45.7 -2.0% -26.0%Italy 2,769.0 12.3% -480.6 -1.9% -17.4%Greece 472.8 11.2% -80.7 -1.7% -17.1%Cyprus 85.3 27.6% -1.9 -0.5% -2.2%Malta 20.3 14.2% -0.5 -0.3% -2.5%Luxembourg 98.9 39.6% -0.6 -0.2% -0.6%


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Okun’s Law claimed a dependable relation between employment

and output. Our estimate (table 3) shows Okun’s law for Europe

Given that the unemployment rate has risen from 6 to 9.5 percent in the crisis:

the European economy would have to grow 8.2 % in one year to return to the status quo ante

or 5.2 % over two years. If it grows at the rate of 3 percent, it will take over 7

year to return to Unemployment rates of 2008


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Competitiveness distortions The PIIG problem? Current account balances vs unit labour cost

levels? Unit labour cost levels determine relative

growth Nominal wages relative to productivity

Degree of distortions measured by Variance


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0.4

0.5

0.6

0.7

0.8

0.9

1.0

99 00 01 02 03 04 05 06 07 08

ULCEU ULCAU ULCBEULCFI ULCFR ULCGEULCGR ULCIR ULCITULCLUX ULCNL ULCSLOVAKULCSP

Unit Labour Cost Levels in the Euro Area

Source: OECD, own calculations

1999Q1: nominal = real ULC

.06

.07

.08

.09

.10

.11

.12

99 00 01 02 03 04 05 06 07 08

Coefficient of Variation: ULC in Euro Area

Levels of ULC

Variance


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How did member states adjust?


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2. Exit strategies for what?


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Policy response to the crisis Low interest rates and monetary easing Fiscal stimulus packages

But when is it time to return to less accommodating policies?

Who should tighten first? Monetary or fiscal policy?

Is there a danger of inflation?


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18


0

2

4

6

8

10

12

Euro Monetary Aggregates

bn euros


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Despite ample liquidity supply, money supply is not growing No danger of inflation Credit is not growing But also: no growth Danger of deflationary spiral?


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The interaction of monetary and fiscal policy

New issue after Greek bail-out and ECB buying government debt

Keynesian economics: stimulate demand Ricardian economics: Not possible

Savings will increase to cover future tax liabilities

Government bonds are not net wealth


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If Central bank buys government debt, the tax liability of citizens is reduced Seignorage Government bonds are then net wealth

because government spending increases income

Whether the economy is Keynesian or Ricardian depends on open market operations of Central bank


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The optimal exit strategy ECB buys government bonds ECB controls price stability and money

supply, possibly rising interest rates Increases seignorage effects

Governments maintain fiscal stimulus Until corporate sector is borrowing again Like Obama


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3. Public deficits and the sustainability of debt


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Is fiscal policy out of control? The Greek crisis

Excessive spending Or reduced income due to crisis?


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2,400

2,800

3,200

3,600

4,000

4,400

4,800

1980 1985 1990 1995 2000 2005 2010

EURO Expenditure Euro Revenue

Euro Area 12 countries

300

400

500

600

700

800

900

1,000

1,100

1,200

1980 1985 1990 1995 2000 2005 2010

GERMANY ExpenditureGERMANY Revenue

Germany

0

200

400

600

800

1,000

1,200

1980 1985 1990 1995 2000 2005 2010

FRANCE ExpenditureFRANCE Revenue

France

0

20

40

60

80

100

120

140

1980 1985 1990 1995 2000 2005 2010

GREECE Expenditure GREEC Revenue

Greece

10

20

30

40

50

60

70

80

90

1980 1985 1990 1995 2000 2005 2010

IRELAND ExpenditureIRELAND Revenue

Ireland

0

100

200

300

400

500

600

700

800

900

1980 1985 1990 1995 2000 2005 2010

ITALY Expenditure ITALY Revenue

Italy

0

10

20

30

40

50

60

70

80

90

1980 1985 1990 1995 2000 2005 2010

PORTUGAL ExpenditurePORTUGAL Revenue

Portugal

150

200

250

300

350

400

450

500

1980 1985 1990 1995 2000 2005 2010

SPAIN Expenditure SPAIN Revenue

Spain

0

100

200

300

400

500

600

700

800

1980 1985 1990 1995 2000 2005 2010

UK Expenditure UK Revenue

United Kingdom


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50

60

70

80

90

100

110

120

130

99 00 01 02 03 04 05 06 07 08 09 10 11

GREECE ExpenditureGREECE Expenditure forecastGREECE RevenueGREECE Revenue forecast

Bn

euro

Geecejoinseuro

Greece budget trends in euro

Lehmancrisis


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-24

-20

-16

-12

-8

-4

0

4

8

12

90 92 94 96 98 00 02 04 06 08 10

GREECE SURPRISE DEFICITGREECE TREND DEFICIT

KonstantinosMitsotakis

AndreasPapandreou

Kostas SimitisKostas Karamanlis

GeorgePapandreou

Greece Budget Deficitsbi

llion

eur

os


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-80

-60

-40

-20

0

20

40

60

90 92 94 96 98 00 02 04 06 08 10

ITALY SURPRISE DEFICITITALY TREND DEFICIT

AmatoCiampi

ProdiD'AlemaAmato

Berlusconi Prodi

Berlusconi

Italian Deficits

euro


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Is public debt in Europe sustainable? Rising debt/GDP ratios The concept of sustainability

A long term „steady state“ Depends on fiscal policy objectives and growth

rate Convergence to the steady state

Fast or slow? Depends on policy reaction function relative to

growth adjusted real interest rate (r-y)>α


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Our estimates of the policy parameter Growth adjusted interest rate (r-y) hardly

ever exceeded 10% Policy reaction to excessive deficit is well

above these values: α Italy: 20-24 % Greece: 35 % Spain: 28 % Germany: 70-74 % Denmark: 8-13 %


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Hence: public debt is sustainable in Europe

but the steady state rises significantly because of low growth Need to accelerate growth is more urgent

than cutting deficits However, if debt is growing fast and

there is need for refinancing, this could lead to illiquidity and default


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4. Private Union Bonds as an exit from the Greek drama


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On 9 May, Euro Area member states have set up a European Stabilisation Mechanism of € 750 bn Subject to radical austerity packages Is it sufficient? Will it generate non-Keynesian growth

effects? Danger: overly hasty fiscal exit will push

the European economy back into recession

What will happen to bail-out loans?


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The constitutional problem Defaulting on bail-out loans is equivalent to

“assuming a member state’s debt” Forbidden by Lisbon Treaty § 123 German constitutional court

The Transfer Union and moral hazard A way to circumvent the problem:

synthetic Union Bonds


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Private Union Bonds Different from Tremonti’s proposal A Fund or Trust buys government bonds

of all Euro member states in proportion of ECB share capital

Issues Union Bonds in exchange A portfolio of government debt Les risk and volatility Higher return


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Private Union Bonds Acceptable as paper for central bank

operation AAA Ensures liquidity for banking system in case

of default Possibility to structure this product to

give greater security to sovereign lenders and higher returns to risk taking private lenders Overcomes the constitutional problem


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5. Global imbalances: Europe’s role


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The Greek crisis has accelerated the fall of the euro

Short term speculation? Long term equilibrium: parity?

Economic stagnation in Europe Accelerating growth in USA High growth in Asia

This poses new difficulties and threats to the global economy


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Global imbalances were a major cause of the financial crisis

Low savings in USA Consequence of bubble

High current account surpluses in Asia Bernanke: Global savings glut

Europe in balance


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-8

-4

0

4

8

12

1980 1985 1990 1995 2000 2005 2010

United States USA TRENDJAPAN JAPAN TRENDCHINA CHINA TRENDEuro area

Current Account Balance as Percent of GDP


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Global imbalances reveal Excessive US deficits of the Bush years

are getting corrected by financial crisis But structural US deficit remains

Euro Area is in balance China will increase its surpluses

Who will absorb them? Symbiotic relationship: USA-Asia


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The three objectives for global adjustment Reduce the American current account

deficit Prevent the crash of the Asian growth

model Avoid putting the burden of adjustment

exclusively on the euro


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The transformation of the world economy

Elastic world labour supply due to globalisation

Unlimited supply of labour (Arthur Lewis) China`s labour force: 25% of world and still

growing But slowing down and will stop in 2015

Anchor for wage and price stability Great Moderation

The new global growth pole is Asia


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The Asian development model Based on stable and competitive exchange

rates Competitive level generates attractive profits Low volatility generates certainty for

investment planning Focus on the USD zone

Similar Europe and Japan under Bretton Woods


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6

7

8

9

10

11

12

99 00 01 02 03 04 05 06 07 08 09

YUAN YUANUSD

CHINA


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Asia’s Dollar Standard Volatility between Asian currencies and

euro is higher than with USD Deters trade and investment between

Europe and Asia Chinese FDI benefits from exchange rate

stability to the United States and Japan with respect to Europe the undervaluation

of the exchange rate compensates for the increased volatility-induced uncertainty


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Economic growth dominates exchange rate effects

Import and Export Elasticities for China and Europe

Coeff t-Stat Coeff t-Statc 0.079 1.476 0.061 0.693trend -0.001 -0.500 -0.005 -4.202GDP growth E 6.604 12.172GDP growth China 2.885 2.381Yuan/euro 0.649 5.683 -0.676 -5.380

R-squared 0.800 0.514Adjusted R-squared 0.774 0.455S.E. of regression 0.077 0.088Sum squared resid 0.228 0.316Log likelihood 53.327 50.868

Imports Exports


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Import and export shares for Asian countries (2008)

Export destinationExporter China Japan Korea India ASEANASEAN+4 USA EU12 RoW WorldChina 8.1 5.2 2.2 6.7 22.2 17.7 14.7 45.4 100.0Japan 16.0 7.6 1.0 12.2 36.8 17.8 10.3 35.2 100.0Korea 21.7 6.7 2.1 9.7 40.1 11.0 8.5 40.3 100.0India 5.6 2.0 2.1 9.5 19.1 11.8 16.2 52.9 100.0ASEAN 12.4 10.3 4.1 2.8 22.9 52.6 10.9 8.8 27.7 100.0ASEAN+4 9.1 6.5 4.7 2.0 12.2 34.5 15.0 11.7 38.7 100.0Usa 5.5 5.1 2.7 1.4 5.0 19.7 15.5 64.8 100.0EU12 2.5 1.3 0.7 0.7 1.6 6.8 6.5 63.9 22.8 100.0EU12 external trade 6.9 3.5 2.1 2.1 4.3 18.9 17.9 63.2 100.0

Import sourceImporter China Japan Korea India ASEANASEAN+4 Usa EU12 RoW WorldChina 9.9 1.8 9.9 34.9 7.2 9.6 48.3 100.0Japan 18.8 3.9 0.7 12.2 35.5 10.4 7.3 46.8 100.0Korea 17.7 14.0 1.5 8.5 41.7 8.9 7.5 42.0 100.0India 10.1 2.5 2.6 7.9 23.1 7.8 10.4 58.7 100.0ASEAN 11.3 11.3 4.8 2.0 21.6 51.1 7.7 8.1 33.1 100.0ASEAN+4 10.0 9.0 5.5 1.4 12.9 38.7 8.3 8.6 44.4 100.0Usa 16.5 6.6 2.3 1.2 4.5 31.2 13.1 55.8 100.0EU12 4.8 1.8 0.8 0.7 1.8 10.0 4.6 60.6 24.8 100.0EU12 external trade 12.2 4.7 2.1 1.7 4.6 25.3 11.7 63.0 100.0


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The need to defuse excessive appreciation pressure for the euro

China bashing China manipulates its currency to gain unfair

trade advantages China should revalue

US need more exchange rate flexibility, not Asia Appreciating RMB would kill growth in Asia

Demand from China for European exports is 3 times as important as the exchange rate


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An alternative proposal

Burden sharing for global adjustment. Asia switches its peg from the dollar to a basket

of euros and Japanese yen Maintain competitive exchange rate to keep growth

going The two main economies

25 % of Chinese exports against 18% of USA 23.% of Chinese imports against 7% of USA

A collective switch would maintain the stability of Asian monetary system

See Europe’s experience


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An alternative proposal

The Euro Area and Japan cooperate to minimize exchange rate volatility

Create a stable environment for investment Japan as leading FDI provider for Asia

Stronger trade and investment relations between Europe and Japan would foster growth


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Reserve management Asian surplus countries place an increasing

share of their reserves in European and Japanese bonds

A gradual shift: old stock remain in USD, new reserves are placed in euro and yen

thereby stimulating financial markets in Europe and Asia

Kickstart for higher domestic demand in these two economies due to wealth effects

Supporting exports from China and other emerging Asian economies


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Reserve management The basket could become a vehicle for a future

international reserve currency The basket composition could change over time Moving away from the Triffin dilemma

The basket is managed by more than 1 country Learning from the ECU experience? PBC governor Zhou Xiaohuan : a new definition of

SDRs?


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Policy implementation a unilateral re-peg? Need for exchange rate stability within the

basket Coordination should be discussed in the G20 but the initiative would best be taken by a

reduced G4 and ASEM. The sleeping beauty Europe could be kissed

awake by Asia The Treaty foresees the possibility of coordinated

exchange rate management. But is Europe capable to govern itself?


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6. European economic governance. The Lisbon Treaty, the crisis and possible outlooks


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1st December 2009, the Lisbon Treaty entered into force.

The economic governance innovations contained in it are only of marginal impact and appear far from providing the answers that are required to overcome the economic crisis quickly. Recognition of Euro-group (art. 136) weak in terms of contents and procedures relating

to the Broad Economic Policy Guidelines (BEPG) (art. 121 TEU)


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First application: European Stabilisation Mechanism (9. May 2010)

Commission now wishes to keep tighter control over member state finances European semester Submit financial programs in advance


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Conclusion: What Europe needs Better governance

Efficiency in administrating our common goods

No diktat Freedom from domination

Democratic legitimacy Equality among European citizens


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Grazie!

Viva la Repubblica europea!

rapporto europa adjusting to the crisis

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