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The euro crisis: ways out for the euro zone
and its member states
Vesa Vihriälä
28 November 2012
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Contents
• Where do we stand?
• Why is the euro crisis so stubborn?
• Way(s) out
• Three crises: a comparison
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
The phases of the crisis and
policy reactions
2013
???
2012
2011
2010
2009
2008
2007
Sub-prime
crisis
Systemic
crisis
Fiscal policy
Monetary
policy
Bank support
Great
recession
Stimulus
Liquidity
provision
Cutting policy rates
Sovereign
debt crisis
…crisis
Euro area
confidence…
Consolidation, structural reforms
SMP
LTRO
OMT
Recapitalization and guarantee schemes
Financial
assistance
Bilateral Greek loans
EFSM, EFSF
ESM
Financial
markets
Regulatory and
supervision reforms
Banking union?
Policy
coordination
European semester, Six-pack, Two-pack, Fiscal compact
Where do we stand now?
•
•
•
•
Eurozone is in a double dip recession
Increasing divergence among the MS
Adjustment has started but mostly slow
Also growth potential has been affected
• ECB’s OMT promise has eased pressures
• But the short-term outlook remains weak, and the
crisis still unresolved
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Great divergence in the euro zone
GDP at 2005 market prices
Source: EU Commission projection, autumn 2012
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Unemployment rate, %
Great divergence: Baltic recovery vs. Greek
stagnation (at best)
GDP at 2005 market prices
Source: EU Commission projection, autumn 2012
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Unemployment rate, %
Competitiveness has started to improve
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Strong variations of competitiveness in the Baltics
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Current accounts adjust, but slowly
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Significant fiscal consolidation
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
…which shows up in a gradual reduction of
the headline deficits
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
…, including in the Baltics
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Why is the crisis so stubborn?
• The recessions associated with a financial
crisis always deep and protracted
• Eurozone suffers from a coordination failure
– No automatic stabilisation across MS
– No automatic backing of sovereign debt by the
central bank
– A vicious circle between banking problems and
sovereign debt problems at the MS level
– Decision making on financial assistance difficult
among 17 sovereign nations
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Debt levels high, but not exceptional in
the euro area on average
Sources: Bank of Finland, EKP, Eurostat, OECD, FED, BEA.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Non-solutions
• Massive fiscal easing across the board
– Several MS have too tight borrowing constraints
• Transforming the euro zone into a genuine
federal construct
– Not enough political cohesion; would require a Treaty
change, which time consuming and uncertain
• Dissolution of the euro zone
– Potentially catastrophic macroeconomic
consequences, would wreck the European project
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Way(s) out
• Strengthening the current policies
– Bigger, more flexible ESM
– Expanded ECB action (OMT; QE)
– Ambitious reforms and fiscal consolidation in the problem countries, slowing
down consolidation in fiscally stronger MS
– Most realistic
• A banking union
– Euro level supervision
– Euro level deposit insurance and resolution mechanism
– Very likely too slow to impact on the current crisis
• A broader fiscal union, yet short of a federal state
– Eurobonds, significant euro area budget
– More centralised fiscal policy making
– Not likely (a last resort response if dissolution threat imminent)
• Debt restructurings: Greece for sure, others = ?
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Light at the end of the tunnel?
• In the best case financial conditions could improve by
early 2013, following by a gradual real recovery starting by
mid-2013
• Even then, growth will be slow and uneven across MS
• Experience => major set backs cannot be excluded
• But: EU has proved to be rather resilient in crises
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
A comparison of three crises
• Finland 91-94
• Greece 2009 • Latvia 2008 -
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Finland in the early 1990s
• Credit boom/bust as in Spain and Ireland
• Key policy measures
– Improved price competitiveness through depreciation and wage
moderation
– Relatively strong fiscal consolidation, despite a low debt level
– Growth-enhancing tax reform
– Strong restructuring of the banking sector
– Emphasis on education and R&D; Nokia
– EU membership
• Relatively rapid recovery (GDP), improvement of public
finances, slow but steady improvement of employment
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Greece
• Significant convergence towards EA average based on
domestic demand
• Badly-run public sector, high public debt
• Small export sector, weak competitiveness
• Adjustment has centred on fiscal consolidation, which
largely self-defeating given the high debt level and slow
adjustment of competitiveness
• Difficult to see a sustained recovery without a further
debt restructuring (PSI and OSI)
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Latvia
• A strong credit-financed domestic demand boom prior to
the global crisis; a very high CA deficit
• Strong fiscal consolidation and low debt level helped in
regaining market confidence in the exchange rate and
public finances
• Wage flexibility improved competitiveness quite fast
despite the exchange rate regime
• Political resistance to adjustment policies moderate
compared to Greece, despite (because of?) substantially
lower GDP/capita level
• GDP, CA recovery rapid
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
GDP adjustment fastest in Latvia
GDP index: Finland (1990/Q1=100), Greece (2008/Q1=100), Latvia (2008/Q1=100)
Finland: 1998Q1 89Q1 90Q1 91Q1 92Q1 93Q1 94Q1 95Q1 96Q1
Greece, Latvia: 2006Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1
Source: Eurostat.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Also the UNR adjustment fastest in Latvia
Unemployment rate, %:
Finland, Greece, Latvia
Finland: 1998Q1 89Q1 90Q1 91Q1 92Q1 93Q1 94Q1 95Q1 96Q1
Greece, Latvia: 2006Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1
Source: Eurostat.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Depreciation helpful for restoring competitiveness
but not necessary
Relative unit labour costs (total economy), index
Finland (1990/Q1=100), Greece (2008/Q1=100), Latvia (2008/Q1=100)
Finland: 1998Q1 89Q1 90Q1 91Q1 92Q1 93Q1 94Q1 95Q1 96Q1
Greece, Latvia: 2006Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1
Source: Eurostat.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
CA improves slowly, except in Latvia
Current account, % of GDP:
Finland, Greece, Latvia
Finland: 1998Q1 89Q1 90Q1 91Q1 92Q1 93Q1 94Q1 95Q1 96Q1
Greece, Latvia: 2006Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1
Source: Eurostat.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Finland slowest to reduce public deficit,
thanks to the low level of debt at the outset
General government deficit, % of GDP:
Finland: 1988
Greece, Latvia: 2006
89
07
90
08
91
09
Source: Eurostat. * = EU Commission forecast.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Finland, Greece, Latvia
92
10
93
11
94
12*
95
13*
96
14*
Debt dynamics works against Greece
General government debt, % of GDP: Finland, Greece, Latvia
Finland: 1988
Greece, Latvia: 2006
89
07
90
08
91
09
Source: Eurostat. * = EU Commission forecast.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
92
10
93
11
94
12*
95
13*
96
14*
Greece relatively rich at start of the crisis
GDP per capita, PPP (constant 2005 international USD)
Finland, Greece, Latvia
Finland: 1988
Greece, Latvia: 2006
89
07
90
08
91
09
Source: Eurostat. * = EU Commission forecast.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
92
10
93
11
94
12*
95
13*
96
14*
Some lessons
• Low public debt an essential cushion to limit market
reactions to deficits and to allow time for policies to work
• Significant adjustment of competitiveness possible even
without exchange rate changes, but requires very flexible
labour markets and social acceptance of harsh policies
• Sustained recovery requires also healthy real
competitiveness; while the benefits of policies to this
effect take time to materialize, also positive confidence
effects possible => important not to delay action.
• A diversified supply of financial services probably better
than relying purely on domestic institutions or purely on
foreign institutions.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Thank you!
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLA
THE RESEARCH INSTITUTE OF THE FINNISH ECONOMY