Transcript Saving the Euro

Saving the
SIMEON DJANKOV
JUNE 14, 2013
What is the Euro?
“The euro is like a bumblebee. This is a mystery of nature
because it shouldn’t fly but instead it does. And now – and I think
people ask “how come?” – probably there was something in the
atmosphere, in the air, that made the bumblebee fly. Now
something must have changed in the air, and we know what after
the financial crisis. The bumblebee would have to graduate to a real
bee.”
Who said this?
Who Said This?
A. Silvio Berlusconi
B. Paul Krugman
C. Mario Draghi
D. Jean-Claude Juncker
This is how Ecofin felt for a long time…
“At every juncture [policymakers] made the minimum
commitments necessary to avoid imminent disaster –
offering optimistic rhetoric, but never taking the steps that even they
believed could offer the prospect of decisive victory. They were
tragically caught in a kind of no-man’s-land – unable to reverse a
course to which they had committed so much, but also unable to
generate the political will to take forward steps that gave any realistic
prospect of success.”
Daniel Ellsberg on the Pentagon Papers
What is the Problem?
o Third consecutive year of recession in the Eurozone
o Average debt burden of around 90% of GDP and rising
o Unemployment at record-high, 12.2% in April 2013
oUnemployment in Greece and Spain at 27%
oYouth unemployment in Spain at 62%
o Ireland, Greece, Portugal, Spain and Cyprus with bailout packages
o Slovenia, Italy next?
What is the Real Problem?
o In 2012 France ran a current-account deficit of €82 billion, Spain €32 billion,
Greece €20 billion, Portugal €11 billion and Cyprus €4.3 billion. Germany ran a
surplus of €170 billion.
o In 2013 it takes 11 procedures and €9,000 to open a small business in Athens. It
takes 735 days and 43 procedures to resolve a simple commercial dispute in
Larnaca, Cyprus. And it takes 59 days and visits to eight different offices to
register a small piece of property in Paris. It is cheaper and faster to do all this in
Berlin.
o In 2012 the share of the population of the ages 25–64 that has completed high
school is: Portugal 38 percent, Spain 54 percent, Italy 57 percent, and Greece 66
percent. In Germany it is 88 percent.
Solution #1: Euro Holidays
o Greece goes off the euro and lets the drachma depreciate to 1 euro
equaling 1.30 drachma.
o The country commits to rejoin at a depreciated exchange rate in the
future (say in 3 years) while in the meantime does the reforms necessary
to keep it competitive in the long run.
o Bank balances remain in euro, so as not to cause a run on the banks.
o Example: Argentina in 2001, ending the dollar peg. In one year, the peso
fell to a quarter of its previous value, imports declined in half, and
inflation rose to 44%.
Issues with Solution #1
o All contracts would have to be re-written in the new currency.
Vending machines and meters would have to be rewired.
o At best, the euro holiday would take a year to happen.
o It would damage the balance sheets of banks (say French banks)
that hold Greek assets.
o The defector would be shunned in European discussions of
nonmonetary issues.
Solution #2: The Northern Euro
o Austria, Finland and the Netherlands exit the euro first and build up
the Northern Euro.
o Germany joins, followed by the Baltics, the Czech Republic, Slovakia
and Bulgaria.
o The Southern Rim countries remain in the existing euro. After initial
inflation they benefit from a strong devaluation.
o That would make their manufacturing exports and tourism
competitive. It would also allow for their own (more expansionary)
monetary policy.
Issues with Solution #2
o German industry and exporters will complain about the strong
Northern Euro.
o The central banks of the Northern Euro and the Southern Euro will
need to work together to prevent a sudden appreciation of the
Northern Euro.
o It is unlikely that the Greeks, Spaniards, Portuguese and Italians will
be able to agree on the policy coordination.
o Europe might be left with a strong Northern euro and a group of
weak southern currencies.
Solution #3: Eurobonds
o The yield of Eurobonds would be 0.5 to 0.6 of a percentage point
above German bunds.
o Italy, for instance, would save up to four percent of its GDP.
o The balance sheets of banks would receive an immediate boost.
o The end of austerity
Issues with Solution #3
o “Interest socialism.”
o Who would issue them? Issuance could be centralized in a single
agency or remain at the national level with co-ordination among the
Eurozone members.
o Who would repay?
o Merkel not a fan. In 2012, at a party congress, she said no
Eurobonds "as long as I live." Several members of parliament
allegedly responded by saying: "We wish you a long life.”
Solution #4: Devaluation
o Several types: External, internal, fiscal
o Struggling Southern Rim economies regain their competitiveness.
o Citroens can appear in Asia or Latin America.
Issues with Solution #4
o External devaluation would extend Germany’s trade surplus with
the rest of the world.
o A weaker euro leads to a sell-off of Southern Rim countries bonds.
o In internal devaluation, if wages and prices fall, nominal GDP could
fall. Thus, the debt to GDP ratio grows.
o The real value of the big outstanding sovereign and company debt
in countries like Cyprus and Greece rises over time.
o In fiscal devaluation the costs accrue mostly to the poor.
Solution #5: Short-term measures
o Reduce the regulatory burden on business
oAsk the question: who would want to start a business in Greece? In what
sector?
o Make ERM2 criteria part of entry into the European Union
oNearly all potential entrants have unilaterally adopted the euro (Kosovo and
Montenegro), are in a currency board (Bosnia) or have a fixed exchange rate
to the euro (Denmark, Macedonia).
o Create a legal option for exit from the Eurozone in the Treaty
oSimilar to Article 50 on exit from the European Union: “Any Member State
may decide to withdraw from the Union in accordance with its own
constitutional requirements.”
Solution #5: Long-term measures
o Educational reform, through vocational training, continuing
education
o Pension reform
o Dealing with youth unemployment
o Southern Rim should learn from the BELLs
o Completing the banking union
Is Fiscal Union Needed in Europe?
o No, if you have a good vetting mechanism at entry (ERM2 part of EU entry
requirements), if the rules of the Fiscal Compact are strictly followed, and if
there is a credible exit option.
o Near impossible to establish since takes significant powers away from national
parliaments.
o Tax harmonization will reduce the possibility of convergence for eastern
Europe.
o Large fiscal transfers will reduce accountability and increase corruption.
o Unelected Brussels bureaucrats will decide on investment priorities
o Example: nuclear power vs. green energy in the European Union