Transcript alanahearneDebtChallengeoct252011x

The Debt Challenge in Europe
Alan Ahearne and Guntram Wolff
October 2011
Outline
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The challenge: debt overhang and price adjustment.
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Large increase in private debt prior to the crisis.
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Balance-sheet adjustments underway.
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Examine previous experiences with corporate and household
deleveraging.
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Options for policymakers.
Adjustment mechanisms in EMU
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Membership of euro imposes constraints on macroeconomic policy.
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Smooth economic adjustment depends crucially on the adjustment of
intra-area real exchange rates and factor mobility (European
Commission, 2006 and 2008).
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Competitiveness channel (EC, 2008; Honohan and Lane, 2003).
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Real interest rate channel (Walters critique).
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Factor mobility and Optimum Currency Areas (Mundell, 1961;
McKinnon, 1963; and Kenen, 1969).
Competitiveness channel versus real interest rate channel
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The competitiveness channel is expected to outweigh the real interest
rate channel over the longer haul. (European Commission, 2006).
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“What is lost when inflation is above the average is much greater than
what you could theoretically gain with a lower level of real rates. This is
very important” (Jean-Claude Trichet, 2006).
But what about debt?
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Interaction between public debt and private debt.
–
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Interaction between needed improvements in competitiveness and high
levels of private indebtedness.
–
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Large-scale fiscal consolidation → reduce income → financial distress and banking
problems → further depress economic growth (Eggertsson and Krugman, 2010).
Depreciation of the real exchange rate through cuts in nominal wage rates and prices
eventually boosts incomes. But there’s a timing issue. (Fisher, 1933).
Labour mobility and mortgage debt.
High debt levels in crisis countries
Figure 1: Net external financial assets as % of GDP
(2009)
Figure 2: Net assets in the different domestic sectors as
% of GDP (2009)
0 250 200 ‐20 150 100 ‐40 %GDP 50 ‐60 0 ‐50 ‐100 ‐80 ‐150 ‐200 ‐100 ‐250 ‐300 ‐120 Ireland Greece Portugal Spain Italy Ireland Greece Spain Italy Non‐financial corpora ons Financial corpora ons General government Source: EUROSTAT
Source: EUROSTAT
Portugal Household and NPISH Significant competitiveness adjustments required
Fiscal deficits have offset increases in corporate net lending
Table 1: Changes in non-financial
corporations and government net
lending
(% of GDP)
EA 17
Ireland
Greece
Spain
Italy
Portugal
Corporate sector
2.7
3
4
8.9
1.9
5.4
Government
sector
-3.9
-11.9*
-3.7
-11.2
-3
-5.6
Start year
2008
2007
2007
2007
2007
2008
Note: Adjustment in net lending since the year at which corporate borrowing was largest.
*Excludes banking support.
Source: EUROSTAT
Effects of corporate deleveraging
Table 2: Consequences of corporate balance sheet adjustment
Average
change in
entire sample
Effect of balance
sheet
adjustment
Number of
episodes
t=0
t=4
Actual change
(2)
(A)
(B)
(C)=(B)-(A)
(D)
(E)=(C)-(D)
(F)
Debt / GDP
60.3
58.4
-1.9
5.2
-7.1
12
Leverage
101.2
85.3
-15.9
-1.2
-14.7
12
Liquidity / VA
30.0
33.4
3.4
0.9
2.5
10
Investment / VA
26.1
23.2
-2.9
-0.2
-2.8
16
Savings / VA
17.2
22.3
5.0
0.4
4.6
16
Compensation
of employees /
VA
60.2
55.6
-4.6
-0.9
-3.7
20
6.6
9.9
-3.3
24
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Large increases in household indebtedness
Household debt as % of disposable income
300
1999
2009
250
200
150
100
50
0
Why has household indebtedness risen?
Permanent income (or life-cycle) model of consumption and saving relates
decisions on savings and borrowings to life-cycle factors.
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Savings are typically low or negative during an individual’s early working years and
during retirement when income is low. Households save at a higher rate during late
working years when income is highest.
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Real interest rates.
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Future income expectations.
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Demographics.
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A major driver of the rise in indebtedness has been the growth in
mortgage debt.
Interaction between government and household debt
Gross government and household debt
% of GDP
140
Ireland
120
Portugal
Households' gross debt
100
Spain
80
Euro area
France
Greece
Germany
60
Belgium
Italy
40
20
0
0
20
40
60
80
Government gross debt
100
120
140
160
Interaction between government and household debt
Net government and household debt
% of GDP
0
0
20
40
60
80
100
120
-50
Ireland
Households' net debt
Spain
-100
Germany
Euro area
France
Portugal
-150
Italy
-200
Belgium
-250
Government net debt
Household deleveraging during the current crisis
Table 3: Household debt, 2007-2009 (% of
disposable income)
Austria
Belgium
Denmark
Euro area
Finland
France
Germany
Ireland
Italy
Netherlands
Norway
Portugal
Spain
Sweden
Switzerland
U.K.
2007
86
77
255
94
97
73
93
194
57
222
177
128
130
131
170
152
2008
87
79
262
95
98
76
89
198
57
230
177
129
127
133
168
153
2009
87
83
275
97
101
77
89
199
61
241
n.a.
131
125
140
n.a.
149
Previous episodes of household deleveraging
Household debt as a % of disposable income
120.0
Finland
Sweden
UK
100.0
80.0
60.0
40.0
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
Growth was key to previous episodes of deleveraging
Real GDP growth
1989
1990
1991
1992
1993
1994
Finland
5.4
0.1
-6.0
-3.6
-0.9
3.7
Sweden
2.8
1.0
-1.1
-1.2
-2.1
3.9
UK
2.3
0.8
-1.4
0.1
2.2
4.3
2007
2008
2009
2010
2011f
2012f
Greece
4.3
1.0
-2.3
-4.4
-5.0
-2.0
Ireland
5.2
-3.0
-7.0
-0.4
0.4
1.5
Italy
1.5
-1.3
-5.2
1.3
0.6
0.3
Portugal
2.4
0.0
-2.5
1.3
-2.2
-1.8
Spain
3.6
0.9
-3.7
-0.1
0.8
1.1
Policy options
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Successful deleveraging questionable unless growth is restored in the euro
area as a whole.
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•
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Financial market conditions must be normalised.
Interest rate cuts by the ECB.
Improved incentives for investment in Germany.
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Unused structural funds could be spent on targeted wage subsidies in the
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tradable sector → job creation in the export sector.
Structural reforms to facilitate the re-allocation of the work force to the
tradable sector.
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Fiscal consolidation should take into account heavily indebted cohorts.
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Debt relief, where necessary.