Transcript 2) the Euro, Europe - Prof. Ruggero Ranieri

The European Union and the single
currency in the global economy
2 – from the euro to the sovereign
debt crisis.
Euro timetable
• 11/09/2001, attack on the Twin Towers reverberates
on the world economy.
• In 2002 national currencies are replaced by the Euro.
The switch was a complex and difficult operation
and was handled with a degree of success.
• In 2003 Duisenburg is replaced as President of the
ECB by the Frenchman Jean Claude Trichet.
• Summer 2007: first signs of the global financial
crisis.
The ECB and the governance of the Euro.
Maastricht Treaty negotiations. Two different views: the full
independence of the Central Bank according to the German
model, or a closer dependence from the political authority
according to the French model. The first view prevails.
Two ruling bodies of the ECB: the Governing Council and the
Executive Board. The Governing Council is composed of
Governors of all the national central Banks. The Executive Board
has six members, elected by the European Council. The President
has a casting vote.
Powers of the ECB
• The ECB sets it own inflation target, its main mandate being the achievement of
price stability.
• Monetary policy is designed to be independent from political pressures. The ECB
President and Executive Board are appointed for eight years.
• National central banks remain in charge of banking supervision.
• On matters relating to the exchange rate of the Euro with other currencies, decision
rests with the Eurogroup and the ECB carries it out.
• Market interventions by the ECB are carried out through national central banks.
• The ECB has no direct power over fiscal policies of the member states, It can,
however, issue recommendations. National governments are barred from
intervening on matters of monetary policy.
• The Treaty forbids monetary financing of public expenditure (art 101)
The Eurogroup.
• The Eurogroup is composed of the finance and economics
ministers of the countries that have adopted the Euro.
Currently they are sixteen. The President of the ECB takes
part in its meetings, which are scheduled once a month.
The Eurogroup:
• A) monitors fiscal policy in the member states.
• B) is in charge of setting the Euro’s exchange rate policy (the
Euro runs a flexible exchange rate)
• C) rules on admitting other countries in the Euro.
• The European Parliament conducts a yearly review on the
policy of the ECB and the Eurogroup
The ECB and its monetary policy.
• The ECB’s stated objective is the achievement of an inflationary
target of below 2% over the medium period (12 to 18)
• The ECB has only one objective: price stability.
• The Fed on the other hand has the objective both of price stability
and of GDP growth. The ECB does not have the political
mandate to pursue objectives outside monetary policy. It is a
federal body but with a limited mandate.
The Euro in the world economy
One of the key issues has been the Euro-dollar exchange rate. It was
first set at 1,19 dollars for a euro.
It first fell dramatically (1999-2002) due to the strength of the US
economy in the late 1990s and the scarce credibility of the Euro in
its initial stage. This weakness brought with it as a consequence
higher Euro interest rates.
After 2003 the Euro appreciated by about 90%, to achieve 1,60 to the
dollar. This was due to the growing balance of payments deficits
in the US which triggered the dollar rate decline. The Euro also
appreciated against all other currencies by about 40%
The Euro and the world economy
• Globalization accelerates, both financially and
technologically.
• 2001-2007 – Emerging economies accelerate in Asia, but
also in Latin America, in some part of Africa and in
Eastern Europe. Rates of growth go up sharply. Strong
growth in world trade.
• Raw material prices shoot up.
• Savings from fast growing emerging nations are
channeled to finance the growing debt of the US and other
developed economies. Low rates of interest world-wide
fuel short term capital movements and highly leveraged
financial activities.
The world economy before the
crisis.
• 1999-2008: average rates of growth remain relatively high.
Eurozone: 2,1% (against 1.9% nel 1993-8);
World: 4% (against 3% in 1993-8);
USA: 2,6% (against 3%).
Provisional balance sheet of the
Euro
• The BCE – succeeds in enforcing a degree of antiinflationary discipline. The inflation rate remains low.
Nominal interest rates in the period 2000-2007 are on
average below 5%.
• The Euro has a positive impact on intra-EU trade and FDI.
• International Status. The Euro becomes the second
international reserve currency.
The discipline of belonging to the Euro
• Members of the Eurogroup have renounced a national monetary
policy. They can not change their interest rates, nor obviously
can they devalue or revalue their currencies.
• Costs need to be kept in line with productivity. If costs raise
above productivity they are not justified and carry the
consequence of a general loss of competitiveness in the natinal
economy. A key indicator of competitiveness is the labour cost
per unit of output
• A loss of competitiveness means relative falls in exports and
increases in imports. This leads to a need for adjustment, which
can only be carried out in real terms and not in nominal terms.
Real term adjustment implies bringing costs in line with
competitors, pushing down inflation, and restructuring of the
economy.
Euro countries’ performance
• The three main Eurogroup countries, Germany,
France and Italy scored a weak economic
performance. Germany, however, accelerated after
2005.
• Peripheral countries, such as Ireland, Finland,
Spain and Greece, grew more rapidly, exploiting
relatively low interest rates. Their growth however
was tied to a high national debt (both state and
privately owned). This made them vulnerable to
the financial crisis of 2008 and its aftershocks.
Italy and the Euro
• Italy benefited from low interest rates inside the
Eurozone. This factor alone accounted for a fall of
4,5% in its annual deficit between 1997 and 2006.
Public expenditure however was not kept in check and
in fact continued to move upwards, making it
necessary to keep taxes high.
• Italy Labor Costs have increased 20% above
Germany’s. This points to a competitive gap which
will threatens Italy’s economic prospects.
Labour costs per unit of ouput.
Stability pact
• The first Growth and Stability Pact among EU members was signed in December
1996, under German insistence.
• Member states committed themselves to
 Balancing their budgets after joining the Euro
 Being fined if they overshot the 3% ceiling set at Maastricht.
The new Stability Pact of 2004
• In 2002-3 Italy, France, Germany and other countries showed
budget deficits of over 3% of GDP. Attempts to fine France
and Germany, the main offenders, were voted down by the
Eurogroup, against the opinion of the European Commission
Ireland and Portugal, however, for the same reason had been
fined one year earlier. This brought into evidence a disparity
between the big and the small members of the Eurogroup,
which was divisive and contributed to the negative responses
of referenda in France and the Low Countries on the new
Constitutional Treaty, preventing its passage into law (a new
revised and scaled down treaty has come into force in 2009).
• In 2004 the Stability Pact was reformed, making it more
flexible in times of economic recession, and more stringent
during favorable economic conditions, during which countries
are supposed to achieve a yearly improvement of 0,5% in the
budget deficit.
Performance in 2006-2007
• Fairly good overall growth rates in 2006 and 2007.
Germany was able to restore its public finances, by
carrying out a considerable fiscal correction. Growth
resumed from 2005. Domestic market reform (labour
market and others) have improved efficiency. Exports
rose rapidly. German export were able to capture an
important share of the Chinese market. Germany was
able to meet the world crisis in 2008 from a position
of relative strength.
• France did not carry out all the needed corrections.
Performance in 2006-2010
• Italy undertook a fiscal correction to its budgetary
deficit in 2007. However it used up public revenue to
boost domestic expenditure. It found itself exposed to
the crisis, which it met with extreme budgetary
prudence. Good performance of Italian exports between
2005 and 2007.
• In 2009-2010 conditions for a new fiscal crisis build up.
All countries build up deficits to offset the effects of the
2008-9 crisis and are then forced to engage in a sharp
tightening of fiscal policies. Under threat from
international hot money flows is the very existence of
the Euro.
The Euro and the 2008 crisis.
• Banks in the UK and Switzerland are severely hit.
• In the Eurozone German banks such as Deutsche Bank and
HypoReal Estate suffer most.
• Some banks belonging to Euro members are heavily exposed
in Eastern European countries. In Italy this was the case with
Unicredit, which had recently taken over the German
HypoVereinsbank (HVB).
• Other banks in trouble are Dexia (French-Belgian) and Fortis
(Belgian-Dutch).
• As a reaction to the crisis, the ECB lowered rates dramatically
on October 2008.
• European governments recapitalized their banks.
• Temporary suspension of the Growth and Stability Pact leads
to mounting deficits which impose a dramatic correction in the
first few months of 2010.
The Euro and the sovereign debt crisis
• Greece joined the Euro in 2001. However in order to meet the criteria
its national account statistics seem to have been «forged». After a few
years new calculations brought its budget deficit up from 3.4 to 13.6 of
its GDP.
• As a result there was a dramatic rise of the spread of Greek bonds,
with immediate effects on the weaker members of the Euro’s
periphery, such as Portugal, Ireland and Spain, the so-called PIGS.
• May 2010. An agreement is reached on a EU aid package to Greece of
110 bn Euros in 3 years, with the IMF also playing a role.
• The financial turmoil spreads to Ireland: the Irish government
intervenes to rescue the Anglo-Irish Bank, the country’s main
financial institution. The EU discusses a permanent rescue fund as
well as new monitoring procedures to check member states accounts.
Great Britain and the Euro
• At Maastricht Great Britain negotiated an opt-out clause.
• Joining the euro would require a referendum in the UK.
• Convergence with the Eurozone. There has always been
imperfect convergence. The UK has enjoyed slightly higher
average growth during 1999-2008, but also higher interest
rates. Its budget deficit has been above 3% and it has run a
balance of payments deficit. If the UK had joined the Euro it
would have determined higher interest rates throughout the
Eurozone, and this might have impacted on overall growth
rates.
• The UK government has blamed the lack of convergence for
its refusal to join the Euro, but there are also underlying
political resistances in the UK body politics.
Great Britain and the euro
• London has retained its status of main financial centre in
Europe. In 2007, 67% of international bonds were issued
in London, and nearly three quarters of euro-denominated
offerings were also issued in London.
• The effects of the financial crisis. The UK economy and
the Uk banking system was hit very severely by the crisis.
Large scale government intervention means the UK has
run a large deficit, which needs a dramatic correction.
• To regain competitiveness the UK economy will be able to
use devaluation. In fact during 2007-8 sterling has lost
16% of its value against the euro and more since then.
New member countries and the euro.
• New member countries enjoyed higher growth rates than EU-15
members. Between 2004 and 2007 the Baltic states grew by between 8
and 10% a year, Poland and the Czech Republic by about 5%, while
the Eurozone only by 2%. The crisis has meant a deep recession for
new as well as old member countries.
• Joining the euro would have meant adopting the same monetary
policy as the founding members of the Eurogroup. Between 2004 and
2008 the ECB has held short term interest rates at around 3,2 % and
long term rates at 4%. These rates would have been too low for
countries growing as fast as the new member countries. Had they
adopted them, they would have suffered inflation. In fact the Baltic
states, having pegged they currencies to the euro, experience high
rates of inflation...
• Joining the euro, would entail for these countries a strong deflationary
policy effect, with drastic fiscal measures likely to endanger their
growth prospects.
The new members and the adoption of the
Euro.
• One option would be to revalue their currencies before
joining the Euro. This is what Slovakia did in 2009.
However this is only a short term solution. Once inside the
single currency they would have to adjust to a different set
of variables.
• The seven EU member states that have not adopted the
Euro are relatively small, economically. There total GDB
is no more than 6% of the total EU GDP. They have an
important stock of FDI from the rest of the EU. The crisis
of 2008-9 has led to some repatriation of FDI. It may also
lead to a closer convergence with the Eurozone, and
encourage early entry in the Single currency. But there are
many big ifs.
Current issues in the Euro area
• Will the current fiscal correction and restructuring lead to a
stronger, centralized Eurozone decision-making, expanding
integration further from monetary to fiscal policies? A stronger
Eurogroup co-ordination seems to be on the cards.
• Tackling the deficit. How will corrective measures impact on
growth rates? Is it possible to sustain a fiscal correction when
recovering after a severe recession, or will this impact on rates
of growth?
• In the medium term, the key factor will be the ability of the
Eurozone to meet the challenge of competition from emerging
countries in the global economy.
• Is the enlargement of the euro area still on the cards? Or has
the crisis postponed it, indefinitely?
Europe in the global economy:
issues
Can the Euro survive?
Can the Euro replace the dollar? In 1999-2002 the
dollar accounted for 67% of global reserves, the euro for
13.4% and yen and sterling respectively for 5% e 4%. The
current crisis has weakened both currencies, but the Dollar
is still the main reserve currency and likely to remain so
for some time.
Fortress Europe or a liberal Europe?
Can the EU adjust to the needs of the global economy?