XXI. The Birth and Crisis of the Euro

XXI.1 Euro – political or economic project?

Some history• Post-war reconstruction and European integration

– Joint control over basic startegic commodities (ESCS), agricultural production (CAP), strategic R&D (Euroatom) and liberalization and common (later internal) market (EHS)

– European social model– European institutional structures

• Economic success, political legitimacy• Circle of European politicians and intellectuals with

clear goal, determined already during WWI– Federative state with pan-European legislative, judiciary and

executive powers– Common currency was a political goal

Way to EMU• Haag summitt (1969): Werner report

– Neither common currency, neither European Central Bank• Break-up of B-W system 1971, European exchange rates

management (Snake), EMS a ECU (1979)– EMR, parity grid, mandatory intervention, D-Mark supremacy– Economic and political reality in Europe (competitive

devaluations) and globally (Plaza Agreement 1985, see L…)• Strong pro-federal political personalities (Jacques Delors as EC

Chairman since 1986) Hanover summit 1988: road map to EMU – Delors Report

• Clear-cut strategy, common currency still just one of the alternatives

Political trigger: German unification 1990• Concerns about economic power of unified Germany

– DEM and Bundesbank will become decisive European currency and central monetary institution

• Other EU countries, notably France: pressure on Germany to speed up the introduction of Euro

• A political trade-off: support for German unification traded for German support to Euro– Economists, bankers and bureaucrats then simply had to find

a solution– Problem: countries in question did not fulfill the necessary

conditions for the efficiency of common currency (not optimal currency are, OCA)

Solution- concept• Limitation: “impossible trinity“• Three condition for internal market

– Free capital flows– Stable exchange rates– Stable price level

• Theory: on national level, only two policy tools can be pursued at once– Capital mobility is a definitional characteristic of internal market, so either

policy, ensuing price stability (i.e. monetary policy) or policy, stabilizing ExR, had to be transferred on federal, European level

• Recent difficult experience (1970s and 1980s): ExR volatility plus political will to create EMU:– ExR policy: irreversible fix Euro– Pan-European monetary policy ECB

Solution- convergence

• OCA similarity of economic (real and structural), but also cultural, historical a political characteristics of the countries in question– In 1990, it was clear that this will not be fulfilled in

expected time horizon• Instead, nominal criteria substitute the real

convergence – inflation, deficit, debt, interest– Maastricht criteria

Solution- required policies• Creation of ECB• Stability and growth pact and Excessive debt

procedure (SGP, EDP)– Out of original Maastricht criteria, two

remained: 3% deficit/GDP, 60% debt/GDP • Long-term policies at EMU level, steering

the member countries towards real and structural convergence

Decisions• 1.7.1990: fully liberalized capital flows• December 1991: Maastricht summit• 1.1. 1994: start of European Monetary Institute

(predecessor of ECB)• 1.1.1999: ECB assumes control over European

monetary policy• 1.1.2002: termination of national currencies• Superficially, nominal convergence successful

– Survival of EMS 1992 crisis, but problem of creative accounting

– On the background of development and problems of whole EU (enlargement, institutional build-up, slow falling behind other important regions in the world, etc.)

XXI.2 Euro at Ten (2009)

Birthday in the shadow of the crisis• Transition 1999 - 2002

– Technically perfect– Population identified with Euro

• ECB – top central bank of the world• SGP problem: breached by larger countries (D,F) in 2003 and

adjusted• Start of 2009: very optimistic assessment of first 10 years (despite

the global crisis), but also admitting the problems– Fiscal coordination as substitution for OCA– Information asymmetry– “Deficit bias” and free rider problem– How to interpret 3% deficit/GDP required ratio?

Euro GDP growth, avg 1999-07per capita comparable with US

0.0

0.5

1.0

1.5

2.0

2.5

3.0

HDP HDP p.c.

%

Euro US UK JPN

Variance of growth ratesstandard deviations (%): EU 15, US states

•Obr. 3•Zdroj: Eurostat, US BEA

Euro 1998-07stable growth and inflation

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

Inflace Základní sazby

STD

Euro US UK JPN

HICP, EU12

0.0

5.0

10.0

15.0

20.0

25.0

1991 1993 1995 1997 1999 2001 2003 2005 2007

AT BE DE ES FI FR GR IE IT LU NL PT

HICP, EU 12 vs. US regionsstandard deviations

0.00

1.00

2.00

3.00

4.00

5.00

6.00

1991 1993 1995 1997 1999 2001 2003 2005 2007

STD EU12 STD 14 MSA

EDP, EU12

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

AT BE DE ES FI FR GR IE IT LU NL PT

1990 1998 2007

Hidden risks – tricky nominal criteria

• Exceptional period 2003 - 2007– EMU performed well under good economic

conditions• Since the fall of Lehman Brothers

– Most sever recession since WWII– Asymmetric shocks for some countries– Divergence instead of convergence– Problem of nominal criteria

• Vulnerability of peripheral economies: GR, E, P, IRL

Government expenditures: 2000 vs. 2008

-3

-2

-1

0

1

2

3

4

5

6

7

D F E I GR IRL P

% HDP

0

10

20

30

40

50

60% HDP

SGP not respectedpublic finance deficits, % HDP

-15

-10

-5

0

5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

F D GR IRL I P E

Unit labor costsGermany vs. peripheral countries

95

100

105

110

115

120

125

130

135

140

Mar-00

Nov-00

Jul-01

Mar-02

Nov-02

Jul-03

Mar-04

Nov-04

Jul-05

Mar-06

Nov-06

Jul-07

Mar-08

Nov-08

Jul-09

D SA E SWDA GR SWDA IRL NSA P SA

Unit labor costsother countries

95

100

105

110

115

120

125

130

135

140

Mar-00

Nov-00

Jul-01

Mar-02

Nov-02

Jul-03

Mar-04

Nov-04

Jul-05

Mar-06

Nov-06

Jul-07

Mar-08

Nov-08

Jul-09

A SWDA B SWDA DK SWDA D SA F SWDAI SA E SWDA GR SWDA IRL NSA P SA

REER a government expenditure: E

60

70

80

90

100

110

120

Mar-85

Sep-86

Mar-88

Sep-89

Mar-91

Sep-92

Mar-94

Sep-95

Mar-97

Sep-98

Mar-00

Sep-01

Mar-03

Sep-04

Mar-06

Sep-07

Mar-09

REER

14

16

18

20

22

% H

DP

REER, ULC, 2005=100 (levá osa)

REER and government expenditures: D

80

90

100

110

120

Mar-90

Sep-91

Mar-93

Sep-94

Mar-96

Sep-97

Mar-99

Sep-00

Mar-02

Sep-03

Mar-05

Sep-06

Mar-08

Sep-09

REER

17.5

18.0

18.5

19.0

19.5

20.0

20.5

% H

DP

REER, ULC, 2005=100 (levá osa)

BoP deficitsGermany vs. peripheral countries

-15.0

-10.0

-5.0

0.0

5.0

10.0

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

D E GR IRL P

Loss of share on export marketsGermany vs. peripheral countries

70

80

90

100

110

2000 2001 2002 2003 2004 2005 2006 2007 2008

D E P GR

Net investment positionGermany vs. peripheral countries

-100

-90

-80

-70

-60

-50

-40

-30

-20

-10

0

10

20

30

P E GR IRL D

2000 2008

Difficult generalization, but …• Peripheral countries: common macroeconomic

characteristic• Peripheral countries: extremely vulnerable to the

effect of the crisis• Peripheral countries: „home-made“ asymmetric

shocks– GR: creative accounting, public sector profligacy– IRL, E: price bubbles in real estate sector, impact on

unsustainable debt of private banks (and different impact on the real economy)

– P: large, over-ambitious infrastructure projects, general profligacy everywhere

Is the Euro project successful?

• Did Euro help to overcome the lasting economic problems of EU?– No, Europe is still lagging behind in competitiveness

and productivity• Related question: did Euro support positive

economic effect of the integration process?– Period 2002-2007 too short to judge– Euro help to more trade and faster growth– Euro as reserve currency, macroeconomic stability

Is Euro efficient common currency?• Was Euro able to shelter ALL member countries

against internal and external shocks?– Till the Greek crisis the answer was yes.– Different view today

• Could Euro contribute to the crisis of peripheral countries?– Common low interest rate – cheap debt financing– Transfers (and SGP violation by decisive countries)

provided a psychological effect that undermined fiscal discipline

– Very slow REAL convergence (even divergence)

Does Euro have a perspective?

• May 2010 GR, September 2010 IRL, April 2011 P: debt unsustainable, need of external support (EMU, IMF)

• Three possible scenarios:– Onward loss of confidence by markets, unwillingness to

provide enough financial support from strong EMU countries (D), break-up

– Market confidence restored, growth, decrease of indebtedness

– “Muddling through“ – the most probable option: managed bankruptcy of some peripheral countries, emergence of slowly growing South, increasing gap with dynamic North, but political will is going to keep Euro project alive

Conclusions• This is not Euro zone crisis

– It is a crisis of some EMU countries …– … and it is a crisis of a political dimension of the

European integration• Basic lesson: efficient Euro = deeper

federalization• Not realistic in foreseeable time• Euro was a premature project …• … but will survive

Literature to LXXI

• de Grauwe (2005), P., Economics of Monetary Union. Oxford University Press.

• European Commission (1990), One Money, One Market, European Economy, 44.

• Issing, O. (2008), The Birth of Euro. CUP, Cambridge.• McKinnon, R. (1963), Optimum Currency Areas, American

Economic Review 53 (717-725).• Pissani-Fery, J., Posen, A., eds. (2009), The Euro at Ten: The

Next Global Currency? Peterson Institute for International Economics and Breughel, Washington.