Analysis of the Responses to the Eurozone Crisisto the Eurozone Crisis

Zsolt DarvasBruegel, Corvinus University, HAS RCERS

’The Eurozone Crisis and Its Impact on the Gl b l E ’ B l KIF fGlobal Economy’, Bruegel-KIF conference

16 January 2013, Seoul

The triple crises of Sothern euro members

• Balance of payments crisis: pre-crisis accumulation of large external debts partly due to excess demand party due loss inexternal debts, partly due to excess demand, party due loss in competitiveness; private capital outflow during the crisis

• Banking crisis: significant asset deterioration due to output loss and asset price decline

• Sovereign debt crisis: permanent loss in previous booming sectors (e.g. construction) reduces tax revenue and output; bank rescue costs

• Consequent growth crisis: The triple crises along with• Consequent growth crisis: The triple crises, along with deficiencies in euro-area level decision making, led to output collapse and unemployment in southern Europe, which spilled-over to ’Northern’ Europe

2to Northern Europe

The EU’s policy response in a nutshell

• Balance of payments crisis: structural reforms supported by intensified policy coordination and advice; sanctions (Macroeconomic imbalances y (procedure, European Semester). Note: none of these exists in the US

• Banking crisis: ECB liquidity to banks; stress tests; European SystemicBanking crisis: ECB liquidity to banks; stress tests; European Systemic Risk Board (ESRB); European Banking Authority (EBA); European banking union project. Note: similarities to the US

• Sovereign debt crisis: many pacts (6-pack, Euro-plus pact, Fiscal Compact, 2-pack) aiming stronger fiscal rules and institutions and sanctions; conditional loans to sovereigns; plus the ECB’s OMT Note: USsanctions; conditional loans to sovereigns; plus the ECB s OMT. Note: US states have strong fiscal rules, but there are no Washington-based sanctions and bail-outs; the Federal Reserve does not purchase state debt

• Specifically for growth: "Compact for Growth and Jobs" agreed at the 29 June 2012 summit; the ’good old’ EU2020; discussion started and then halted on euro area fiscal capacity’ Note: in the US the federalhalted on euro-area ‚fiscal capacity . Note: in the US, the federal government runs automatic stabilisers and decides on fiscal stimulus 3

BoP crisis: gradual adjustment of flows in South (due to ECB financing)

5Current account balance (% GDP) 1995-2017

West: Austria, Belgium, France,

0

Belgium, France, Germany, Netherlands

North: Denmark,

-5

North: Denmark, Finland, Sweden, Ireland, UK

South: Greece,

-10West

North

South: Greece, Italy, Portugal, Spain

Central: Czech

-15South

CentralNote: median values

Central: Czech Rep., Hungary, Poland, Slovakia, Slovenia

-20

995

998

001

004

007

010

013

016

EastNote: median values.

Source: IMF World Economic Outlook October 2012East: Estonia, Latvia, Lithuania, Bulgaria, Romania

19 19 20 20 20 20 20 20

4• East: sudden adjustment in the absence sizeable official money inflow

BoP crisis: increased divergences in stocks

60

80

West North West: Austria, Belgium, France,

Net International Investment Position(% GDP) 1995-2017

20

40 South Central

East

Belgium, France, Germany, Netherlands

North: Denmark,

-20

0

North: Denmark, Finland, Sweden, Ireland, UK

South: Greece,

60

-40

20 South: Greece, Italy, Portugal, Spain

Central: Czech

100

-80

-60 Central: Czech Rep., Hungary, Poland, Slovakia, Slovenia

Liabilities of South are

-120

-100

998

001

004

007

010

013

016

East: Estonia, Latvia, Lithuania, Bulgaria, Romania

mostly debt

19 20 20 20 20 20 20

Note: median values. Source: Eurostat up to 2011. For 2012-2017, we used World Economic Outlook October 2012 projections for nominal GDP and current account balance and assumed that the change in the nominal value of the net IIP equals the current account balance.

5

Banking crisis: Euro area banks are riskier, yet the ECB’s LTROs & OMT had an impact

600Selected Credit Default Swap Spreads; Banks by Region

Bank Credit Default Swap Spreads (basis points)1 January 2007 – 14 January 2013

500

600p p ; y g

Euro‐area banks

UK banks

400

500 UK banks

US banks

300

200

100

01/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013

6Source: Datastream

Banking crisis: debt securities did not compensate for bank loans in the euro area, contrary to the US

Debt liabilities of non-financial corporations, 1999-2012A. Euro area (€ billions) B. United States ($ billions)

8,000

9,000Debtsecurities

12,000

14,000Debtsecurities

6,000

7,000 Bank loans10,000

Bank loans

4,000

5,000

6,000

8,000

2,000

3,000

2,000

4,000

0

1,000

99 00 01 02 03 04 05 06 07 08 09 10 11

0

2,000

999

000

001

002

003

004

005

006

007

008

009

010

011

012

7

199

200

200

200

200

200

200

200

200

200

200

201

201

Q1‐19

Q1‐20

Q1‐20

Q1‐20

Q1‐20

Q1‐20

Q1‐20

Q1‐20

Q1‐20

Q1‐20

Q1‐20

Q1‐20

Q1‐20

Q1‐20

Note: balance sheet data and hence include credit from all sources

Sovereign debt crisis: not at the euro-area level, yet strong focus on consolidation since 2010

1402

General government balance (% GDP) Gen. gov. gross debt

120

130

140

Euro Area

United States2

0

2

100

110

120 United States

‐4

‐2

80

90‐8

‐6

60

70

‐12

‐10 Euro Area

United States50

1990 1995 2000 2005 2010 2015‐141990 1995 2000 2005 2010 2015

8Note: US general gov debt also includes the debt of states and local governments (IMF and EU data only include federal debt)

Consequence: Euro area was hit harder

Growth outlook at different dates (2007= 100)Euro Area USA

120

115

120

115115

110

115

110

105 105

100 100

95

06 08 10 12 14 16

95

06 08 10 12 14 16

9

Source: IMF World Economic OutlooksApril 2008 September 2011 October 2012

Why was Europe hit harder?

• Macro• US: severe bank stress early on; restoring confidence in the

b ki t i i ti t h h ld t d l bbanking sector; giving time to households to deleverage by fiscal expansion; huge monetary stimulus as well

• Europe: delayed and weak stress tests prolonged banking p y p g gwoes; strong focus on fiscal consolidation since 2010 when banks and the private sector wish to deleverage; some parts of Europe lost competitiveness during the pre-crisis boom; the €Europe lost competitiveness during the pre crisis boom; the €exchange rate did not depreciate sufficiently

• Micro• Europe: less flexible economies & less cross-country

adjustment capacity

• Euro exit fears• Euro exit fears• Exit would be a catastrophe for all; fear of exit deter investment

• Executive power10

• Executive power• US: strong; Europe: fragmented and inefficient

Consequence: accelerated divergence in southern Europe

GDP per capita at PPP (US = 100), 1950-2017West: Austria, 90 ,Belgium, France, Germany, Netherlands80

90

West

North: Denmark, Finland, Sweden, Ireland, UK

60

70 North

South: Greece, Italy, Portugal, Spain50

60

South

Central: Czech Rep., Hungary, Poland, Slovakia, Slovenia

40 Central

East: Estonia, Latvia, Lithuania, Bulgaria, 20

30

0 5 0 5 0 5 0 5 0 5 0 5 0 5

East

11

gRomania

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

Source: Author’s calculation using data from the IMF’s World Economic Outlook October 2012, PENN World Tables and EBRD. Note: median values are shown.

Consequence: The Greek downward spiralGDP outlook for Greece five years ahead, as projected

by the IMF at different dates (2007=100)130130

120

April 2008October 2008April 2009

110

April 2009October 2009April 2010October 2010

100October 2010April 2011September 2011

90April 2012October 2012

80

06 08 10 12 14 16• The Greek outlook has worsened in every update of the IMF

World Economic Outlook since April 2008 12

06 08 10 12 14 16

Greek structural reforms: more deterioration than improvement from 2008/09 to 2012/13

Rank Score Rank Score Rank Score2012‐132008‐2009 changeGreece

Light red: worsened

Basic requirementssubindex

51 4.7 98 4.1 47 ‐0.5

1. Institutions 58 4.1 111 3.4 53 ‐0.72 I f t t 45 4 3 43 4 7 2 0 4 rank or

score

2. Infrastructure 45 4.3 43 4.7 ‐2 0.43. Macroeconomic environment 106 4.4 144 2.4 38 ‐2.04. Health and primary education 40 5.9 41 6.0 1 0.2Efficiency enhancers

Light

Efficiency enhancerssubindex

57 4.2 69 4.1 12 ‐0.1

5. Higher education and training 38 4.5 43 4.7 5 0.26. Goods market efficiency  64 4.2 108 3.9 44 ‐0.3

green: improved rank or

7. Labor market efficiency 116 3.9 133 3.6 17 ‐0.38. Financial market development 67 4.3 132 3.1 65 ‐1.29. Technological readiness 59 3.5 43 4.5 ‐16 1.0 rank or

score10. Market size 33 4.5 46 4.4 13 ‐0.1Innovation and sophisticationfactors subindex

68 3.7 85 3.4 17 ‐0.3

11 Business sophistication 66 4 1 85 3 7 19 0 4

13Source: World Economic Forum, Global Competitiveness Report 2008/09 and 2012/13.Note: Ranks out of 134 economies in 2008-09 and 144 economies in 2012-13 and scores measured on a 1-to-7 scale.

11. Business sophistication 66 4.1 85 3.7 19 ‐0.412. Innovation 63 3.2 87 3.0 24 ‐0.2

Spanish structural reforms: more deterioration than improvement from 2008/09 to 2012/13

Rank Score Rank Score Rank Score

Spain2008‐2009 2012‐13 change

Light red: worsened

Basic requirementssubindex

27 5.3 36 5.1 9 ‐0.2

1. Institutions 43 4.6 48 4.3 5 ‐0.32 I f t t 22 5 3 10 5 9 12 0 6 rank or

score

2. Infrastructure 22 5.3 10 5.9 ‐12 0.63. Macroeconomic environment 30 5.5 104 4.2 74 ‐1.44. Health and primary education 35 6.0 36 6.1 1 0.1Efficiency enhancers

Light

Efficiency enhancerssubindex

25 4.8 29 4.7 4 ‐0.1

5. Higher education and training 30 4.8 29 5.0 ‐1 0.36. Goods market efficiency  41 4.6 55 4.4 14 ‐0.3 green:

improved rank or

y7. Labor market efficiency 96 4.1 108 4.0 12 ‐0.18. Financial market development 36 4.9 82 3.9 46 ‐1.09. Technological readiness 29 4.6 26 5.3 ‐3 0.7 rank or

score10. Market size 12 5.5 14 5.5 2 0.0Innovation and sophisticationfactors subindex

29 4.3 31 4.1 2 ‐0.1

11 B i hi ti ti 24 4 9 32 4 5 8 0 4

14Source: World Economic Forum, Global Competitiveness Report 2008/09 and 2012/13.Note: Ranks out of 134 economies in 2008-09 and 144 economies in 2012-13 and scores measured on a 1-to-7 scale.

11. Business sophistication 24 4.9 32 4.5 8 ‐0.412. Innovation 39 3.6 35 3.8 ‐4 0.2

Reasons for optimism

• Endogenous policy response: in front of an abyss, European policymakers always came up with something, even if the impact lasted only for a few

thmonths

• Major quantum leaps in 2012: European banking union project and ECB’s j q p p g p jOMT

• The adjustment has started: improved current account balancesThe adjustment has started: improved current account balances (supported by strong export performance) and unit labour cost falls in Ireland, Spain and Portugal; decline in German surplus toward the euro area

• Promising bail-outs: Ireland and Portugal are on track meeting the conditions

• Markets are happy: stock price increases, decline in spreads of government, banks, non-financial corporations

• Some confidence: increased bank deposits in Greece and Spain15

Reasons for pessimism

• Suffering South: Weak growth social tensions political uncertainty collapse of the Greek government euro exit contagion & spill-over

• Political risk in lenders: general public in eg Finland, Netherlands, andGermany are against further bail-outsy g

• Structural reforms needs to deliver: it’ll take time

• Major stock problems: some over-indebted sovereigns, households and corporations

• Limited access to finance: compromised bank balance sheets & continued financial fragmentation

• No growth: current policy mix is unlikely to revive growth in Europe

16