ProfessorStefan Collignon
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Rapporto EuropaAdjusting to the crisis
ProfessorStefan Collignon
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Table of Content
1. Europe's adjustment to the crisis2. Exit strategies for what?3. Public deficits and the sustainability of debt4. Private union bonds as an exit from the
Greek drama5. Global imbalances: Europe’s role6. European economic governance. The Lisbon
Treaty, the crisis and possible outlooks
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Rapporto Europa 2010
The world is coming out of its deepest economic crisis in 70 years, but the danger is not over.
Although economic growth has returned, it is weak. The European economy risks falling back into a «double-dip» recession, unless the restocking of inventory translates into sustained investment and job creation.
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Lessons from the Great Depression teach that an early recovery can revert back into recession, when bankruptcies, defaults, currency depreciations, and low assets prices undermine the creditworthiness of borrowers.
The Greek crisis risks to be precisely such an event
Falling bond and stock prices Fiscal restraint Weak euro
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1. Europe's adjustment to the crisis
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The crisis has not only lowered growth, but also affected long term growth potential negatively Investment Employment
Euro Area is less affected than non-euro Exception: Poland
Asia is least affected
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Table 2. Employment AdjustmentColumn 1 2 3 4 5
jobs created 199-2008 job growthjob losses 2008-10 job losses (3)/(1)in thousands in % of 1999in thousands in % of 2008 loss/gain
Euro area16 15,181.8 11.4% -4866.0 -3.3% -32.1%Euro area12 14,803.2 11.5% -4772.6 -3.3% -32.2%Ireland 476.7 29.4% -238.4 -11.4% -50.0%Spain 4,884.7 31.3% -1806.2 -8.8% -37.0%Finland 286.3 12.7% -133.2 -5.3% -46.5%Slovenia 97.1 10.9% -45.4 -4.6% -46.7%Portugal 220.1 4.5% -139.3 -2.7% -63.3%France 2,144.6 9.1% -674.0 -2.6% -31.4%Netherlands 797.3 10.0% -193.3 -2.2% -24.2%Belgium 433.4 10.8% -97.9 -2.2% -22.6%Austria 364.4 9.7% -90.0 -2.2% -24.7%Germany 1,855.0 4.8% -838.3 -2.1% -45.2%Slovakia 175.9 8.5% -45.7 -2.0% -26.0%Italy 2,769.0 12.3% -480.6 -1.9% -17.4%Greece 472.8 11.2% -80.7 -1.7% -17.1%Cyprus 85.3 27.6% -1.9 -0.5% -2.2%Malta 20.3 14.2% -0.5 -0.3% -2.5%Luxembourg 98.9 39.6% -0.6 -0.2% -0.6%
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Rapporto Europa 2010
Okun’s Law claimed a dependable relation between employment
and output. Our estimate (table 3) shows Okun’s law for Europe
Given that the unemployment rate has risen from 6 to 9.5 percent in the crisis:
the European economy would have to grow 8.2 % in one year to return to the status quo ante
or 5.2 % over two years. If it grows at the rate of 3 percent, it will take over 7
year to return to Unemployment rates of 2008
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Competitiveness distortions The PIIG problem? Current account balances vs unit labour cost
levels? Unit labour cost levels determine relative
growth Nominal wages relative to productivity
Degree of distortions measured by Variance
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0.4
0.5
0.6
0.7
0.8
0.9
1.0
99 00 01 02 03 04 05 06 07 08
ULCEU ULCAU ULCBEULCFI ULCFR ULCGEULCGR ULCIR ULCITULCLUX ULCNL ULCSLOVAKULCSP
Unit Labour Cost Levels in the Euro Area
Source: OECD, own calculations
1999Q1: nominal = real ULC
.06
.07
.08
.09
.10
.11
.12
99 00 01 02 03 04 05 06 07 08
Coefficient of Variation: ULC in Euro Area
Levels of ULC
Variance
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How did member states adjust?
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2. Exit strategies for what?
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Policy response to the crisis Low interest rates and monetary easing Fiscal stimulus packages
But when is it time to return to less accommodating policies?
Who should tighten first? Monetary or fiscal policy?
Is there a danger of inflation?
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0
2
4
6
8
10
12
Euro Monetary Aggregates
bn euros
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Despite ample liquidity supply, money supply is not growing No danger of inflation Credit is not growing But also: no growth Danger of deflationary spiral?
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The interaction of monetary and fiscal policy
New issue after Greek bail-out and ECB buying government debt
Keynesian economics: stimulate demand Ricardian economics: Not possible
Savings will increase to cover future tax liabilities
Government bonds are not net wealth
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If Central bank buys government debt, the tax liability of citizens is reduced Seignorage Government bonds are then net wealth
because government spending increases income
Whether the economy is Keynesian or Ricardian depends on open market operations of Central bank
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The optimal exit strategy ECB buys government bonds ECB controls price stability and money
supply, possibly rising interest rates Increases seignorage effects
Governments maintain fiscal stimulus Until corporate sector is borrowing again Like Obama
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3. Public deficits and the sustainability of debt
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Is fiscal policy out of control? The Greek crisis
Excessive spending Or reduced income due to crisis?
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2,400
2,800
3,200
3,600
4,000
4,400
4,800
1980 1985 1990 1995 2000 2005 2010
EURO Expenditure Euro Revenue
Euro Area 12 countries
300
400
500
600
700
800
900
1,000
1,100
1,200
1980 1985 1990 1995 2000 2005 2010
GERMANY ExpenditureGERMANY Revenue
Germany
0
200
400
600
800
1,000
1,200
1980 1985 1990 1995 2000 2005 2010
FRANCE ExpenditureFRANCE Revenue
France
0
20
40
60
80
100
120
140
1980 1985 1990 1995 2000 2005 2010
GREECE Expenditure GREEC Revenue
Greece
10
20
30
40
50
60
70
80
90
1980 1985 1990 1995 2000 2005 2010
IRELAND ExpenditureIRELAND Revenue
Ireland
0
100
200
300
400
500
600
700
800
900
1980 1985 1990 1995 2000 2005 2010
ITALY Expenditure ITALY Revenue
Italy
0
10
20
30
40
50
60
70
80
90
1980 1985 1990 1995 2000 2005 2010
PORTUGAL ExpenditurePORTUGAL Revenue
Portugal
150
200
250
300
350
400
450
500
1980 1985 1990 1995 2000 2005 2010
SPAIN Expenditure SPAIN Revenue
Spain
0
100
200
300
400
500
600
700
800
1980 1985 1990 1995 2000 2005 2010
UK Expenditure UK Revenue
United Kingdom
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50
60
70
80
90
100
110
120
130
99 00 01 02 03 04 05 06 07 08 09 10 11
GREECE ExpenditureGREECE Expenditure forecastGREECE RevenueGREECE Revenue forecast
Bn
euro
Geecejoinseuro
Greece budget trends in euro
Lehmancrisis
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-24
-20
-16
-12
-8
-4
0
4
8
12
90 92 94 96 98 00 02 04 06 08 10
GREECE SURPRISE DEFICITGREECE TREND DEFICIT
KonstantinosMitsotakis
AndreasPapandreou
Kostas SimitisKostas Karamanlis
GeorgePapandreou
Greece Budget Deficitsbi
llion
eur
os
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-80
-60
-40
-20
0
20
40
60
90 92 94 96 98 00 02 04 06 08 10
ITALY SURPRISE DEFICITITALY TREND DEFICIT
AmatoCiampi
ProdiD'AlemaAmato
Berlusconi Prodi
Berlusconi
Italian Deficits
euro
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Is public debt in Europe sustainable? Rising debt/GDP ratios The concept of sustainability
A long term „steady state“ Depends on fiscal policy objectives and growth
rate Convergence to the steady state
Fast or slow? Depends on policy reaction function relative to
growth adjusted real interest rate (r-y)>α
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Our estimates of the policy parameter Growth adjusted interest rate (r-y) hardly
ever exceeded 10% Policy reaction to excessive deficit is well
above these values: α Italy: 20-24 % Greece: 35 % Spain: 28 % Germany: 70-74 % Denmark: 8-13 %
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Hence: public debt is sustainable in Europe
but the steady state rises significantly because of low growth Need to accelerate growth is more urgent
than cutting deficits However, if debt is growing fast and
there is need for refinancing, this could lead to illiquidity and default
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4. Private Union Bonds as an exit from the Greek drama
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On 9 May, Euro Area member states have set up a European Stabilisation Mechanism of € 750 bn Subject to radical austerity packages Is it sufficient? Will it generate non-Keynesian growth
effects? Danger: overly hasty fiscal exit will push
the European economy back into recession
What will happen to bail-out loans?
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The constitutional problem Defaulting on bail-out loans is equivalent to
“assuming a member state’s debt” Forbidden by Lisbon Treaty § 123 German constitutional court
The Transfer Union and moral hazard A way to circumvent the problem:
synthetic Union Bonds
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Private Union Bonds Different from Tremonti’s proposal A Fund or Trust buys government bonds
of all Euro member states in proportion of ECB share capital
Issues Union Bonds in exchange A portfolio of government debt Les risk and volatility Higher return
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Rapporto Europa 2010
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Rapporto Europa 2010
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Private Union Bonds Acceptable as paper for central bank
operation AAA Ensures liquidity for banking system in case
of default Possibility to structure this product to
give greater security to sovereign lenders and higher returns to risk taking private lenders Overcomes the constitutional problem
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5. Global imbalances: Europe’s role
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The Greek crisis has accelerated the fall of the euro
Short term speculation? Long term equilibrium: parity?
Economic stagnation in Europe Accelerating growth in USA High growth in Asia
This poses new difficulties and threats to the global economy
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Global imbalances were a major cause of the financial crisis
Low savings in USA Consequence of bubble
High current account surpluses in Asia Bernanke: Global savings glut
Europe in balance
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-8
-4
0
4
8
12
1980 1985 1990 1995 2000 2005 2010
United States USA TRENDJAPAN JAPAN TRENDCHINA CHINA TRENDEuro area
Current Account Balance as Percent of GDP
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Global imbalances reveal Excessive US deficits of the Bush years
are getting corrected by financial crisis But structural US deficit remains
Euro Area is in balance China will increase its surpluses
Who will absorb them? Symbiotic relationship: USA-Asia
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The three objectives for global adjustment Reduce the American current account
deficit Prevent the crash of the Asian growth
model Avoid putting the burden of adjustment
exclusively on the euro
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The transformation of the world economy
Elastic world labour supply due to globalisation
Unlimited supply of labour (Arthur Lewis) China`s labour force: 25% of world and still
growing But slowing down and will stop in 2015
Anchor for wage and price stability Great Moderation
The new global growth pole is Asia
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The Asian development model Based on stable and competitive exchange
rates Competitive level generates attractive profits Low volatility generates certainty for
investment planning Focus on the USD zone
Similar Europe and Japan under Bretton Woods
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6
7
8
9
10
11
12
99 00 01 02 03 04 05 06 07 08 09
YUAN YUANUSD
CHINA
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Asia’s Dollar Standard Volatility between Asian currencies and
euro is higher than with USD Deters trade and investment between
Europe and Asia Chinese FDI benefits from exchange rate
stability to the United States and Japan with respect to Europe the undervaluation
of the exchange rate compensates for the increased volatility-induced uncertainty
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Economic growth dominates exchange rate effects
Import and Export Elasticities for China and Europe
Coeff t-Stat Coeff t-Statc 0.079 1.476 0.061 0.693trend -0.001 -0.500 -0.005 -4.202GDP growth E 6.604 12.172GDP growth China 2.885 2.381Yuan/euro 0.649 5.683 -0.676 -5.380
R-squared 0.800 0.514Adjusted R-squared 0.774 0.455S.E. of regression 0.077 0.088Sum squared resid 0.228 0.316Log likelihood 53.327 50.868
Imports Exports
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Import and export shares for Asian countries (2008)
Export destinationExporter China Japan Korea India ASEANASEAN+4 USA EU12 RoW WorldChina 8.1 5.2 2.2 6.7 22.2 17.7 14.7 45.4 100.0Japan 16.0 7.6 1.0 12.2 36.8 17.8 10.3 35.2 100.0Korea 21.7 6.7 2.1 9.7 40.1 11.0 8.5 40.3 100.0India 5.6 2.0 2.1 9.5 19.1 11.8 16.2 52.9 100.0ASEAN 12.4 10.3 4.1 2.8 22.9 52.6 10.9 8.8 27.7 100.0ASEAN+4 9.1 6.5 4.7 2.0 12.2 34.5 15.0 11.7 38.7 100.0Usa 5.5 5.1 2.7 1.4 5.0 19.7 15.5 64.8 100.0EU12 2.5 1.3 0.7 0.7 1.6 6.8 6.5 63.9 22.8 100.0EU12 external trade 6.9 3.5 2.1 2.1 4.3 18.9 17.9 63.2 100.0
Import sourceImporter China Japan Korea India ASEANASEAN+4 Usa EU12 RoW WorldChina 9.9 1.8 9.9 34.9 7.2 9.6 48.3 100.0Japan 18.8 3.9 0.7 12.2 35.5 10.4 7.3 46.8 100.0Korea 17.7 14.0 1.5 8.5 41.7 8.9 7.5 42.0 100.0India 10.1 2.5 2.6 7.9 23.1 7.8 10.4 58.7 100.0ASEAN 11.3 11.3 4.8 2.0 21.6 51.1 7.7 8.1 33.1 100.0ASEAN+4 10.0 9.0 5.5 1.4 12.9 38.7 8.3 8.6 44.4 100.0Usa 16.5 6.6 2.3 1.2 4.5 31.2 13.1 55.8 100.0EU12 4.8 1.8 0.8 0.7 1.8 10.0 4.6 60.6 24.8 100.0EU12 external trade 12.2 4.7 2.1 1.7 4.6 25.3 11.7 63.0 100.0
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The need to defuse excessive appreciation pressure for the euro
China bashing China manipulates its currency to gain unfair
trade advantages China should revalue
US need more exchange rate flexibility, not Asia Appreciating RMB would kill growth in Asia
Demand from China for European exports is 3 times as important as the exchange rate
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An alternative proposal
Burden sharing for global adjustment. Asia switches its peg from the dollar to a basket
of euros and Japanese yen Maintain competitive exchange rate to keep growth
going The two main economies
25 % of Chinese exports against 18% of USA 23.% of Chinese imports against 7% of USA
A collective switch would maintain the stability of Asian monetary system
See Europe’s experience
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An alternative proposal
The Euro Area and Japan cooperate to minimize exchange rate volatility
Create a stable environment for investment Japan as leading FDI provider for Asia
Stronger trade and investment relations between Europe and Japan would foster growth
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Reserve management Asian surplus countries place an increasing
share of their reserves in European and Japanese bonds
A gradual shift: old stock remain in USD, new reserves are placed in euro and yen
thereby stimulating financial markets in Europe and Asia
Kickstart for higher domestic demand in these two economies due to wealth effects
Supporting exports from China and other emerging Asian economies
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Reserve management The basket could become a vehicle for a future
international reserve currency The basket composition could change over time Moving away from the Triffin dilemma
The basket is managed by more than 1 country Learning from the ECU experience? PBC governor Zhou Xiaohuan : a new definition of
SDRs?
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Policy implementation a unilateral re-peg? Need for exchange rate stability within the
basket Coordination should be discussed in the G20 but the initiative would best be taken by a
reduced G4 and ASEM. The sleeping beauty Europe could be kissed
awake by Asia The Treaty foresees the possibility of coordinated
exchange rate management. But is Europe capable to govern itself?
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6. European economic governance. The Lisbon Treaty, the crisis and possible outlooks
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Rapporto Europa 2010
1st December 2009, the Lisbon Treaty entered into force.
The economic governance innovations contained in it are only of marginal impact and appear far from providing the answers that are required to overcome the economic crisis quickly. Recognition of Euro-group (art. 136) weak in terms of contents and procedures relating
to the Broad Economic Policy Guidelines (BEPG) (art. 121 TEU)
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First application: European Stabilisation Mechanism (9. May 2010)
Commission now wishes to keep tighter control over member state finances European semester Submit financial programs in advance
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Conclusion: What Europe needs Better governance
Efficiency in administrating our common goods
No diktat Freedom from domination
Democratic legitimacy Equality among European citizens
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Grazie!
Viva la Repubblica europea!
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