Transcript Euro area governance and the sovereign debt crisis

Euro area governance and the
sovereign debt crisis
Zsolt Darvas
Bruegel
Conference on "Economic Crisis and
Governance”
IOBE - The Foundation for Economic &
Industrial Research, Athens, 16 May 2011
Euro area 12 (excl. Greece up to 2000): number of
countries missing the Maastricht convergence criteria
General government balance
General government debt
Inflation
Interest rate
Missing at least one criterion
12
8
6
4
2
Source: Author’s calculations using data from Eurostat, ECB and May 2011 forecast of the EC
Note: The 2011 data for the interest rate is based only on values up to April.
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
0
1990
Number of countries
10
Causes of the sovereign debt crisis
• Greece: fiscal misbehaviour + structural weaknesses
• Ireland: unsustainable housing booms and banking sector
fragility
• Portugal: weak economic growth before the crisis, reflecting
structural weaknesses
• Yet it is not impossible to have fast and balanced growth inside
the euro area: Finland & Slovakia
• Question 1: Was the pre-crisis euro-area governance
framework (also) responsible?
• Question 2: Will the new euro-area governance framework
resolve the current crisis and avert similar crises in the future?
3
Outline
1. Pre-crisis governance framework
2. The new governance framework and its assessment
3. Transition to the new governance system
4. Fiscal and structural adjustments: examples of Greece,
Hungary, Iceland, Ireland and Latvia
5. Euro crisis?
6. Summary
4
1. Pre-crisis governance framework
Price stability: independent central bank
Prevention/correction:
• Stability and Growth Pact (SGP): Stability and Convergence
Programmes (SCPs), Early warning mechanism, Excessive Deficit
Procedure (EDP)
• Macro imbalances: no formal mechanism; only Commission
warnings
• Macro-financial stability: no mechanism
Crisis management and resolution:
• no mechanism (neither for sovereigns, nor for banks; only facility
for sovereigns outside the euro area)
Structural:
• Lisbon strategy, National Action Plans (NAPs)/National Reform
Programmes (NRPs)
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 Largely failed even before 2008 (apart from overall price stability)
2. Sketch of the new governance framework
Price stability (no change): independent central bank
Prevention/correction:
• Budgets (more teeth to SGP; national fiscal frameworks)
• Macro imbalances: EIP – Excessive Imbalance Procedure
• Macro-financial stability: ESRB – European Systemic Risk Board
Crisis management and resolution:
• Sovereign liquidity assistance (temporary: EU govts, EFSF, EFSM,
permanent: ESM) + IMF
• Sovereign crisis resolution regime: from mid-2013 for newly issued
bonds
• Bank resolution: national frameworks (Euro Pact)
• ECB: targeted bond purchases, collateral policy, lifeline for banks
Structural:
• EU2020, NRPs, European Semester
 Unprecedented number of reforms, couple of good initiatives
 Ability to learn lessons and to reform
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2. Issues 1. – A general observation
• Scope of reforms:
– While ambitious in certain respects, largely fixes current
bugs and maintains the decisive role of intergovernmental
processes and national frameworks
 Not a problem for big countries with history of strong national
frameworks (eg Germany) and for small countries with good
starting positions (eg Finland, Slovakia)
 But will be difficult to achieve a sustainable status (in terms
of fiscal and competitiveness) for countries with bad starting
positions (ie corrective arms request fiscal austerity and
wage moderation in a falling economy)
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2. Issues 2. – Some specific observations
• SGP & EIP:
– Commission proposes, but largely inter-governmental (even
if reverse majority voting rule)
– Strong emphasis on sanctions
• Sovereign liquidity provision:
– Last resort and only if risking ‘euro area financial stability’
– Strong conditionality
– Punitive interest rate (in contrast to non-euro area facility)
 Do these three features adequately address moral hazard?
– Inter-governmental (unanimity)
– Financed/guaranteed by national resources  subject to
national interest
8
2. Issues 3. – Some specific observations
• Sovereign insolvency procedure:
– ‘contractual approach’ (collective action clauses to all bond
issuances from 2013), as opposed to ‘statutory approach’
(international bankruptcy mechanism)
• Bank resolution:
– National frameworks, but no EU-wide mechanism
• Eurobonds (up to a certain % of GDP):
– Rejected by core countries fearing enforcement in the
absence of fiscal integration (a real issue) and interest rate
rise (an unlikely issue)
– Would be better for fiscal discipline, thereby making the euro
area more crisis-proof
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2. Sanctions
• Is the reliance on sanctions the right solution to compensate for
the lack of fiscal/political union?
• If applied before the crisis:
– Greece: perhaps
– Ireland for 25% and Spain 40% pre-crisis debt???
– Italy: high debt and slow reduction???
• During a crisis: makes no sense
• For prevention: Even if Commission proposes and reverse
majority voting, active politicians decide  fruitless debates and
unsettling disputes
• Unwarranted political message: ‘Brussels fines us and does not
understand our situation and social problems’
• Amount of EU fine is dwarfed by interest rate premium imposed
by markets post-crisis  Name and shame, but let markets do
the dirty job
10
3. Transition to the new governance system
• Resolution of banking crisis, including real stress tests (with
stressing the single most important source of stress)
• Sorting our sovereign insolvency from liquidity
• Markets will not lend to current programme countries: Will euro
area partners ready to finance all debt? Would that be desirable?
• What if sovereign debt restructuring before 2013? Continuous
denial is not a good option. Financial stability risks should be
addressed
• ECB: How to get rid of sovereign bond holdings and bank lifeline,
how to normalise collateral policy?
• Revive growth in Southern Europe (structural reform, single
market, EU funds)
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4. Fiscal and structural adjustments: 5 examples
EU
membership
IMF/EU
programme
Exchange
rate regime
Greece
Yes
May 2010
€
Hungary
Yes
Oct 2008
float
Iceland
---
Oct 2008
float
Ireland
Yes
Nov 2010
€
Latvia
Yes
Dec 2008
Peg to €
HIIL = Hungary, Iceland, Ireland, Latvia
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4. Debt and deficit (% GDP), 1990-2012
General government
gross debt
Greece
Hungary
Iceland
Ireland
Latvia
180
160
140
120
General government
balance
10
5
0
100
-5
-10
-15
20
0
Source: May 2011 forecast of the European Commission and EBRD
1995
1990
2010
2005
2000
1995
1990
-20
2010
40
Greece
Hungary
Iceland
Ireland
Latvia
2005
60
2000
80
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Note: the Irish deficit was 32% in 2010, but for better readability of the right-hand side figure, it has a cut-off at -20%
4. GDP and investment, 1995Q1-2011Q1
GDP
Investment
(volume, 2007Q4=100)
(volume, 2007Q4=100)
105.0
120.0
100.0
110.0
100.0
95.0
90.0
Source: Eurostat website
40.0
2006Q1
2005Q1
2011Q1
30.0
14
2011Q1
50.0
2010Q1
2006Q1
2005Q1
70.0
Greece
Hungary
Iceland
Ireland
Latvia
60.0
2009Q1
75.0
2008Q1
80.0
2007Q1
Greece
Hungary
Iceland
Ireland
Latvia
2010Q1
70.0
2009Q1
85.0
2008Q1
80.0
2007Q1
90.0
4. Consumption, 1995Q1-2010Q4
Private consumption
Public consumption
(volume, 2007Q4=100)
(volume, 2007Q4=100)
100.0
95.0
95.0
90.0
90.0
85.0
85.0
Source: Eurostat website
75.0
70.0
2006Q1
2005Q1
2011Q1
65.0
2010Q1
2006Q1
2005Q1
65.0
Greece
Hungary
Iceland
Ireland
Latvia
80.0
2009Q1
70.0
2008Q1
75.0
2007Q1
Greece
Hungary
Iceland
Ireland
Latvia
80.0
15
2011Q1
100.0
2010Q1
105.0
2009Q1
105.0
2008Q1
110.0
2007Q1
110.0
(volume, 2007Q4=100)
(volume, 2007Q4=100)
120.0
120.0
110.0
110.0
100.0
100.0
90.0
90.0
80.0
Source: Eurostat website
2006Q1
50.0
2011Q1
2007Q1
2006Q1
2005Q1
50.0
60.0
2010Q1
60.0
70.0
2009Q1
70.0
2008Q1
Greece
Hungary
Iceland
Ireland
Latvia
2005Q1
80.0
Greece
Hungary
Iceland
Ireland
Latvia
2008Q1
130.0
2007Q1
130.0
16
2011Q1
Import
2009Q1
Export
2010Q1
4. Trade, 1995Q1-2010Q4
4. Current account and employment, 1990-2012
Current account (% GDP) Employment (2007=100)
10.0
110.0
5.0
100.0
0.0
90.0
-5.0
80.0
-10.0
Source: May 2011 forecast of the European Commission
2010
2005
2000
1995
1990
50.0
2010
1990
-25.0
60.0
2005
-20.0
Greece
Hungary
Iceland
Ireland
Latvia
70.0
2000
-15.0
1995
Greece
Hungary
Iceland
Ireland
Latvia
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4. Some structural indicators
Quality of Corruption
institutions perception
Ease of
doing
business
rank
Quality of
Quality of
Goods
Labour
the
scientific
market
market
educational research
efficiency efficiency
system
institutions
Greece
4.1
3.8
109
4.2
3.9
3.3
3.8
Hungary
3.9
5.1
47
4.2
4.2
3.2
5.0
Iceland
5.9
8.7
14
4.9
5.4
5.9
5.0
Ireland
5.4
8.0
7
5.3
5.0
5.6
5.3
Latvia
4.1
4.5
27
4.5
4.7
3.7
3.6
The higher the better for all indicators except the ease of doing
business rank
Sources: Word Economic Forum, Transparency International, World Bank
Note: The index of Quality of institutions is composed of public institutions (75%) (property rights, ethics, undue
influence, government inefficiency, security) and private institutes (25%) (corporate ethics, accountability)
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Euro against the US dollar
4 January 1999 – 13 May 2011
5. Euro crisis?
• Greek 5-year CDS have
risen to a record of about
1500 basis points, implying
a 80% probability of a
default (with 50% haircut)
• But the euro continues to
be very strong
1.6
1.5
1.5
1.4
1.4
1.3
1.3
1.2
1.2
1.1
1.1
1.0
0.9
0.8
Purchasing
Power
Parity
exchange
rate
1.0
0.9
0.8
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
May 2011:
1.6
Market rate (daily data)
PPP conversion rate (annual data)
Source: author’s calculations using data from the IMF and ECB.
6. Summary
• New governance framework: significant steps, but largely fixes
current bugs and unlikely the ultimate solution
• Sanctions and too much inter-governmentalism carry risks
• Lack of Eurobonds: would be a better tool to enforce discipline
and make euro area crisis-proof
• Transition is very unclear; time and growth (in core euro area) will
not solve all issues: banks, solvency, growth, ECB
• Greek adjustment: the country has not suffered as much in terms
of output, consumption and employment as HIIL, yet export is
very weak. Structural indicators are also very weak
• Despite sovereign panic: markets do not expect euro area breakup, even in the likely event of a sovereign default
• But the currently small political risk to the euro can rise
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