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Straining the Bond: Europe in Crisis
Evening at the Fed
December 2012
Mark A. Wynne
Vice President FRB Dallas
Director Globalization & Monetary Policy Institute
Overview
• The story so far…
• The (increasingly global) fallout
– Contagion from periphery to core
– Contagion to the rest of the world
• The fundamental challenges
– Burned ships (the Cortes strategy)
– The world’s greatest game of chicken
• Lessons from history
• End game
– Move to a political union?
– Or lost decade(s) à la Japan?
The euro crisis: a chronology
•
•
•
•
•
•
•
May 2010: Greek bailout €110 bn
November 2010: Irish bailout €85 bn
April 2011: Portuguese bailout €78 bn
July 2011: Second Greek bailout €130 bn
December 2011: Fiscal compact agreed; ECB LTROs
April 2012: Greek default
Summer 2012
–
–
–
–
Yields on Spanish government debt reach record highs
€100 bn bailout of Spanish banks
Yields on stronger sovereigns go negative on safe-haven flows
ECB cuts deposit rates to zero
• July 26: “…the euro is irreversible…. Within our mandate, the ECB is ready
to do whatever it takes to preserve the euro. And believe me, it will be
enough.”
– ECB President Mario Draghi
Major developments AugustDecember 2012
• September
– ECB announces plans to conduct Outright Monetary Transactions (OMTs) “…to
safeguard the monetary policy transmission mechanism in all countries of the
euro area” and “…address severe distortions in government bond markets
which originate from, in particular, unfounded fears on the part of investors of
the reversibility of the euro”
• One dissenting vote: Bundesbank President Weidmann
– German constitutional court rules that Germany can contribute to the
European Stability Mechanism
– European Commission publishes proposals for a European banking union
• Focus on bank supervision; issues of deposit insurance and bank resolution unaddressed
• October
– S&P downgrades Spain to BBB– European Union wins Nobel Peace Prize
• November
– Third Greek “bailout”
• Lower interest rates & extended terms on loans; recycling of SMP profits back to Greece
The story so far
(10-year government interest rates)
Percent
30
Greece
Jan 1, 1999
Euro launched
25
Portugal
Spain
Jan 1, 2001
Greece joins
20
Ireland
Italy
15
Belgium
France
10
Austria
Netherlands
5
Finland
0
1990
Germany
1995
2000
2005
2010
Greece: in depression
Millions
4.6
Bil. Ch. 2005 euros
220
Peak-to-trough
decline through
2011: 10.2%
200
4.4
Peak-to-trough
decline through
2011: 14.6%
4.2
180
4.0
160
Aug 2012 UR: 25.4%
Aug 2012 youth UR: 57.0%
3.8
140
3.6
120
Employment
GDP
3.4
100
1999
2001
2003
2005
2007
2009
2011
Note: Diamonds indicate OECD November 2012 forecasts. Dashed lines indicate
OECD forecasts in June 2012.
2013
Gross government debt as a
percentage of GDP
Greek budget report
Oct. 31, 2012
IMF's World Economic
Outlook
October 2012
Review of bailout program
March 2012
(Estimates overlap with
2012 IMF data for 20092011)
Original bailout program
May 2010
Percent
200
Estimates
Projections
180
160
140
120
100
2009 2010 2011 2012 2013 2014 2015 2016
Ireland: life after austerity?
Millions
2.2
Bil. Ch. 2009 euros
180
Peak-to-trough
decline through
2011: 6.9%
160
July 26, 2012: Ireland
returns to financial
markets for first time
since September 2010
2.0
Peak-to-trough
decline through
2011: 14.5%
Sep 2012 UR: 15.1%
Sep 2012 youth UR: 34.5%
1.8
Employment
140
120
GDP
1.6
100
1999
2001
2003
2005
2007
2009
2011
2013
Note: Diamonds indicate OECD November 2012 forecasts. Dashed lines indicate
OECD forecasts in June 2012.
Portugal: further contraction expected
Bil. Ch. 2006 euros
165
Millions
5.2
Peak-to-trough
decline through
2011: 7.0%
5.0
160
Peak-to-trough
decline through
2011: 3.2%
4.8
155
Sep 2012 UR: 15.7%
Sep 2012 youth UR: 35.1%
4.6
Employment
150
GDP
4.4
145
1999
2001
2003
2005
2007
2009
2011
2013
Note: Diamonds indicate OECD November 2012 forecasts. Dashed lines indicate
OECD forecasts in June 2012.
Spain: latest bailout request
Millions
21
Bil. Ch. 2008 euros
1125
Peak-to-trough
decline through
2011: 3.7%
1050
20
19
Peak-to-trough
decline through
2011: 11.1%
18
17
975
900
16
Sep 2012 UR: 25.8%
Sep 2012 youth UR: 54.2%
15
Employment
825
GDP
14
750
1999
2001
2003
2005
2007
2009
2011
2013
Note: Diamonds indicate OECD November 2012 forecasts. Dashed lines indicate
OECD forecasts in June 2012.
OECD NEET Ratios, 15 to 24 Years
Percent
Change Q1 2007 to Q1 2011
Q1 2007
Q1 2011
1.0
0.3
0.6
1.4 1.1
0.8 1.4 0.3
0.4 2.1
1.2 3.5 1.0
2.7 2.7
2.0
2.1 1.8 1.7
1.0 0.4 1.7 1.9
1.0
-0.1 -0.3
7.4 5.9 2.5
3.4
-0.9
-4.1
-8.1
Netherlands
Denmark
Iceland
Switzerland
Sweden
Austria
Slovenia
Luxembourg
Finland
Norway
Germany
Japan
Canada
Czech Republic
Estonia
Poland
Australia
France
Portugal
Euro area 17
EU27
Britain
Hungary
New Zealand
USA
Slovakia
Belgium
OECD
Ireland
Spain
Greece
Italy
Mexico
Turkey
40
35
30
25
20
15
10
5
0
-5
-10
OECD = Organization for Economic Cooperation and Development
NEET = not in education, employment, or training
Source: OECD Employment Outlook 2012
Housing booms and busts
Residential investment as a share of GDP
Percent
14
12
10
8
6
4
U.S.
2
1980
1985
1990
1995
2000
2005
2010
Housing booms and busts
Residential investment as a share of GDP
Percent
14
Nevada
12
10
8
6
4
Arizona
Florida
2
U.S.
1980
1985
1990
1995
2000
2005
2010
Housing booms and busts
Residential investment as a share of GDP
Ireland
Percent
14
Nevada
12
10
8
6
4
Spain
Arizona
Florida
2
U.S.
1980
1985
1990
1995
2000
2005
2010
Germany PMI in contraction phase
Index
65
60
Expansion
55
50
45
Services
Composite
Contraction
Manufacturing
40
35
30
2005
2006
2007
2008
2009
2010
2011
2012
Broader euro-area PMI also
in negative territory
Index
65
60
Expansion
55
50
45
Services
Composite
Contraction
Manufacturing
40
35
30
2005
2006
2007
2008
2009
2010
2011
2012
Global fallout
Exports to the U.S. and euro area: share of world total
Percent
18
16
Euro area
14
12
10
U.S.
8
6
1980
1985
1990
1995
2000
2005
2010
Global fallout
• United Kingdom
– 50 percent of exports to euro area
– “The greatest threat to the recovery stems from the risk that an
effective policy response is not implemented sufficiently
promptly in the euro area” (Bank of England)
• China
– EU is China’s largest export market, overtaking U.S. in 2007
– “capricious development of the European debt crisis” as drag on
growth (People’s Bank of China)
• United States
– 20 percent of exports to Europe
– “…strains in global financial markets continue to pose significant
downside risks to the economic outlook” (FOMC)
German cross-border lending
Net Balance
Bil. euros
500
450
400
350
300
250
200
Ireland
150
Portugal
100
Greece
Italy
50
Spain
0
1999
2001
2003
2005
2007
2009
2011
The story so far
(10-year government interest rates)
Percent
30
Greece
Jan 1, 1999
Euro launched
25
Portugal
Spain
Jan 1, 2001
Greece joins
20
Ireland
Italy
15
Belgium
France
10
Austria
Netherlands
5
Finland
0
1990
Germany
1995
2000
2005
2010
One-size-fits-all monetary policy:
Euro & U.S.
(Taylor rate range)
Percent
20
Euro area average range (1999-2011) = 10.6
U.S. regions average range (1987-2011) = 5.2
15
10
5
0
-5
-10
Euro area Taylor rate range
U.S. regions Taylor rate range
ECB policy rate
Federal funds rate
-15
1999
2001
2003
2005
2007
2009
2011
Labor mobility a hindrance to
a common monetary policy
(Regional variation in unemployment rates)
Percent
30
Euro area average range (1999-2012) = 10.0
U.S. regions average range (1999-2012) = 2.6
25
20
15
Euro area unemployment range
U.S. regions unemployment range
10
5
0
1999
2001
2003
2005
2007
2009
2011
Fixes
• Monetary union can exist without a fiscal
union
– But need rules to make it work
– Tried and failed in Europe
• Fiscal & political union along U.S. lines
– Tighter constraints on ability of member states to
run deficits
– Pooling of regional risks, especially of banking
system risks
Lessons from history
• The United States in 1780s
– Fiscal crisis associated with servicing debt incurred
during Revolutionary War
• Solution: strengthen powers of federal
government (replace Articles of Confederation
with U.S. Constitution)
– Federal government assumed debts of states
– One-time bailout: states allowed to default in 1840s
– States adopted balanced budget rules thereafter
Deficits in peripheral European
countries comparable to U.S. deficits
Budget deficits as a share of GDP
Percent
4
2
0
Peripheral Europe:
GDP-weighted fiscal
balance
-2
-4
-6
-8
-10
U.S.
-12
-14
1999
2001
2003
2005
2007
2009
2011
Fiscal situation of Europe
as a whole relatively sound
Percent
Government debt as a share of GDP
100
U.S.
90
80
70
60
Euro area
50
40
30
1999
2001
2003
2005
Note: Diamonds indicate OECD forecasts.
2007
2009
2011
2013
Disunion
• Declining trust in European institutions
– Just 31 percent compared to 57 percent before
crisis
• Less favorable image of the EU
• Majority (52 percent) still support the single
currency
– Down from 61 percent before crisis
Conclusions
• Euro crisis is spreading from the periphery to the core, and increasingly
weighing on global economic activity
• LTROs of December 2011 and February 2012 have bought time
– ECB rate reduction and possible revival of securities market program can ease
strains
– ECB is involved in a game of chicken with national governments
• OMTs will also buy time when implemented
• New “fiscal compact”
– A significant improvement over earlier Stability and Growth Pact?
– EMU 2.0 workable?
• Challenges
–
–
–
–
Achieving consensus on new rules: loss of sovereignty
Market rigidities
Austerity programs
Potential for social unrest
• Europe 1914