school of business and economics studium generale the euro area sovereign debt crisis: causes and...

School of Business and Economics

Studium Generale

The euro area sovereign debt crisis: causes and consequences

Prof. Dr. Olaf Sleijpen

Maastricht, 3 November 2011


Agenda

1) A short (conceptual) history of European monetary integration

2) Fiscal discipline in the Treaty3) Evidence of fiscal discipline in the euro

area4) Lessons to be drawn: the inconsistent

triangle revisited5) A new perspective on nominal and real

convergence in the euro area6) An assessment of the euro area summit

of 23 October7) Concluding remarks


A short (conceptual) history of European monetary integration

Economic and Monetary Union

Maastricht TreatyConvergence approach“Big Bang”

approach

-Inspired by OptimalCurrency Area theory-Full nominal and realconvergence required-Appropriate adjustmentmechanisms in place incase of (asymmetric) shocks-Monetary union is the “crown”on convergence process

-Convergence willfollow automatically afterStart monetary union-Discipline imposed byfixed exchange rates willtrigger nominal and realeconomic discipline

-Nominal convergence required;No real convergence-Strongly embedded monetarypolicy structure in place-Intergovernmental framework to impose fiscaldiscipline; no framework toimpose real convergence


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


Fiscal discipline in the Maastricht Treaty

• Multilateral surveillance procedure• Excessive deficit procedure• Prohibition of priviliged access• No bail-out clause


The Stability and Growth Pact Revisited

• Adopted in 1997 (Amsterdam European Council)

• Reform in 2004• Preventive arm

– Strengthening of the surveillance ofbudgetary positions and the surveillance and coordination of economic policies

• Corrective arm– Speeding up and clarifying the

implementation of the excessive deficit procedure


-8

-6

-4

-2

0

2

97 99 01 03 05 07 09 11

Programme year Realisation Spring Forecast

98

99

00 0

102 0

304

05

07

06

08

09

Source: European Commission, Spring Forecasts 2010 and budgetary plans according to national budgets.

Insufficient compliance …% GDP


-15

-10

-5

0

5

96 98 00 02 04 06 08 10

Germany France Italy Spain

Netherlands Greece Portugal Ireland

Budget deficit% of GDP

…became apparent during the crisis

Source: European Commission, Spring Forecasts, 2010.


60

70

80

90

94 99 04 09

Increase in debt…Gross public debt euro area% of GDP

Source: European Commission, Spring Forecasts 2010.


-2

0

2

4

6

8

10

96 98 00 02 04 06 08 10

France Italy Spain Netherlands

Greece Portugal Ireland

…and late market reaction

Source: Thomson Financial.

Interest rate spread with German government debt (10-year maturity) % points


Consequence: financial stability risk

in EMU

Source: Eurostat and CBS (for The Netherlands).

DE FR IT ES NL GR PT IE

1998 33.8 50.9 26.9 24.2 19.5 29.3 37.9 na

2004 42.7 46.0 38.6 47.3 52.9 53.4 56.4 58.7

2008 49.6 55.6 42.3 45.9 65.5 na 77.1 72.7

Government debt held by non-residents

(% of total)


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


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


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


The importance of enhancing national fiscal rules

and frameworks

FI

SE

UKPT

IE ESNL

IT FR DE

BEAT

EL

DK

-1.00

-0.50

0.00

0.50

1.00

1.50

0.00 0.20 0.40 0.60 0.80 1.00 1.20

FISRUL

Err

or

Su

rplu

s A

dju

stm

ent

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)


200

300

400

500

600

700

800

99 01 03 05 07 09

2

4

6

8

10

12

14

Bn euro % GDP (right scale) % Share in total debt (right scale)

Short-term government debt outstanding (central government)

Source: Hoogduin, Öztürk and Wierts (2010).

More focus on debt financing


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


Economic convergence revisited

• Nominal convergence (interest rate, inflation, public finance)

• Real convergence (labour) market flexibility (assymetric) shock absorption by national

budgets (automatic stabilisers)


-1

0

1

2

3

4

5

91 96 01 06

Inflation euro area: low and stable…


Inflation euro area% changes (y-o-y)


-3

0

3

6

99 01 03 05 07 09

Germany France Italy Spain

Netherlands Greece Portugal Ireland

…but inflation differentials persistent


Inflation (HICP)% changes (y-o-y)


-4

-2

0

2

4

6

91 93 95 97 99 01 03 05 07 09

-2

-1

0

1

2

3

Deficit countries euro areaSurplus countries euro areaDeficit countries - global (right-hand axis)Surplus countries - global (right-hand axis)

Current account balance% euro area or world GDP

Imbalances have increased

Source: IMF.


-20

-10

0

10

20

LUX NL D FI BE AT EMU IT FR IRL PT SP GR

Current account balanceAverage increase house prices 2000 -2007Change real effective exchange rate 1997-2007 (GDP deflator)

% GDP and % changesCauses imbalances

Source: European Commission.


-12

-8

-4

0

4

2007 2009 2007 2009

Actual deficit Structural deficit

Average deterioration of the budgetary position

Budget periphery more affected

-12

-8

-4

0

4

2007 2009 2007 2009

Actual deficit Structural deficit

After crisis(Spring

2010)

Before crisis(Autumn

2007)

Before crisis(Autumn

2007)

After crisis(Spring

2010)

A. Other EMU countries

B. Portugal, Ireland, Italy, Greece and Spain

Source: European Commission, Economic forecasts.


-15

-10

-5

0

5

-20 -15 -10 -5 0 5 10 15

Current account balance 2007

Stru

ctur

al b

udge

t defi

cit 2

007

Crisis reveals relationship imbalances and

budgetary position

-15

-10

-5

0

5

-20 -15 -10 -5 0 5 10 15

Current account balance 2007

Stru

ctur

ak b

udge

t defi

cit 2

009

Before crisis (Autumn 2007)

After crisis (Spring 2010)

R2 = 0,6034

R2 = 0,1647

Source: European Commission, Economic forecasts.


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


Assessment of the 23 October package

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


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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