Transcript Euro area policy options to combat the debt crisis

Euro area policy options to
combat the debt crisis
Christian Dreger, DIW Berlin
Euro area outlook
• Period of low growth ahead in the euro area
– Stagnation or recession in core countries (Germany 0.2,
France 0.2, Spain -0.3, Italy -0.2)
– German growth vulnerable, almost 50 percent of exports
delivered to euro area countries
• Fiscal consolidation due to government debt crisis
reduces growth perspectives
– Low confidence and high unemployment limit expansion
of domestic demand in most countries
– Consolidation period might be long lasting, especially in
Southern countries
Spillovers to global economy
• Euro area crisis risk for sustainable development
of global economy
– China heavily affected by crisis, no stand-alone pillar
for global growth
– Postpone economic reforms in emerging markets
• Higher risk for protectionism and disintegration in
global economy
– Race towards currency depreciation, exports become
more important in growth strategies
• Stagnation difficult to combat, as policy measures
seems to be exhausted
Public debt and GDP growth
• Negative impact of debt to GDP ratio on per capita
GDP growth in euro area
– Especially in periods of non-sustainable debt
– Effects are not detected for non EA countries
– See Dreger and Reimers (2012)
• Participation in monetary union may entail specific
risk for its members
• Higher risk of sovereign default due to no bail out
rule, prohibition of ECB to finance governments
• Improved system of macroeconomic governance
Fiscal consolidation strategy
• Population ageing implies higher financial burden on
social security systems
– Pressure especially in pensions and healthcare
• Long run growth perspectives can improve if public
finances are on sustainable path
– Increased reliability of plans of households and firms
– Willingness to consolidate underpinned by fiscal pact
• Benefits related to the long run, short and medium
run effects are negative
• Consolidation strategy indispensable, but need to be
extended by other measures to ensure its success
Towards a new policy mix
• Sustained consolidation over long periods not very
plausible
– Voters will not re-elect their governments
• Collective austerity measures can undermine the
EU2020 strategy
– Short run effects limit long term growth perspectives
• Less strict consolidation may stimultate growth in
euro area
– Option exists especially in healthy countries
– Special economic zones to reintroduce growth in the
Southern states
Role for monetary policy
• Fiscal expansion can increase risk premia in
financial markets
– Not feasible without support from monetary side
• Governments issue debt in a currency beyond their
control
– Cannot guarantee the repayment of debt
• Lower confidence in financial markets can raise
interest rates to levels high enough to make any
country insolvent
• Lender of last resort for the individual countries
Lender of last resort
• Should buy bonds in capital markets when solvent
countries come under attack
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Outright monetary transactions (OMT) started Sep 2012
No spirals of eroding confidence and higher interest rates
Lender acts if interest rates reach critical levels
Control by ESM might serve as an obstacle for countries
• EFSF/ESM funds may assist, but no major role
– Size not sufficient, designed for crisis at the periphery
– Increasing size could lead to lower country ratings
– Conditionality implies overshooting of reforms if market
rates are driven by speculative runs
Redesigning the EU budget
• Structural funds not optimally used in past
– Effects on economic convergence unclear, evidence
depends on empirical methods
– Despite additionality principle, funds seem to crowd out
national activities
– Funding agriculture has high opportunity costs
– Co-financing impediment in periods of consolidation
• Potential conflict between convergence and growth
– Poor institutions in suffering countries
• Stronger evaluation of growth effects required
Conclusions
• Integrated euro area approach to combat the debt
crisis
– Precondition is decision to keep the euro area as it is
– Better coordination than fiscal packages in financial crisis
• Implementation of a new policy mix on the agenda
– Less tight fiscal consolidation in healthier states
– Fiscal union can reduce adjustment capacities to respond
to country-specific shocks
– Stimulus programs in the Southern member states
– ECB as a lender of last resort for euro area countries
– Common budget focuses on growth, less on convergence