european economic outlook a.boltho magdalen college university of oxford and oxford economics oxford...
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European economic outlook
A.BolthoMagdalen College
University of Oxford and Oxford Economics
OXFORD ECONOMICS USA
World Outlook Conference
(Washington, 16 September 2010) (New York, 17 September 2010)
The Outlook for Europe
REVISIONS TO OXFORD ECONOMICS FORECASTS
(GDP; percentage changes)
2010 2011 2012
Euro Zone 1.0 1.6 2.1
U.K. 1.1 2.3 3.0
East. Eur. 1.5 3.7 5.1
Euro Zone 1.5 1.4 1.8U.K. 1.6 2.1 2.7
East. Eur. 1.5 2.4 4.6
Euro Zone 0.5 -0.2 -0.3
U.K. 0.5 -0.2 -0.3
East. Eur. 0 -1.3 -0.5
March 2010
September 2010
Differences
RECESSION AND RECOVERY(GDP; per cent changes; 3 qtrs. mv. avrgs.)
2007 2008 2009 2010 2011 2012 2013
0
2
4
6
-2
-4
-6
UnitedStates
Eurozone
EasternEurope
U.K.
Why has Europe outpaced the US?
• Confidence benefits from fiscal austerity measures?
• Weaker euro
• Dependence on trade
• Depth of downturn
0.8
1.0
1.2
1.4
1.6
1995 1997 1999 2001 2003 2005 2007 2009
70
80
90
100
110
120
130
Source: Haver Analytics
US$/€
Eurozone: Exchange rates1999=100
Effective exchange rate (RHS)
Exchange rate (LHS)
-40
-30
-20
-10
0
10
20
30
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
$ export growth3mma, % year
Source : Oxford Economics/Haver Analytics
US
GermanyEurozone
0
1
2
3
4
5
6
7
8
9
10
US UK Eurozone Germany France
Exports to Emerging Markets% of nominal GDP, 2009
Source : Oxford Economics/Haver Analytics
-40
-30
-20
-10
0
10
20
30
40
50
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10Source: Haver Analytics
3mma, % year
Exports: From Germany
Asia
USUK
Eurozone
RECESSION AND RECOVERY(GDP; levels; 2007 Q1 = 100)
2007 2008 2009 2010
95
97
99
101
103
Eurozone
UnitedKingdom
UnitedStates
Germany
THE MAJOR RISKS
Deficits, debts and fiscal policy
Can Germany save Europe ?
The Euro's longer-run future
PUBLIC SECTOR DEBT(in per cent of GDP)
1999 2001 2003 2005 2007 2009 2011 2013
30
40
50
60
70
80
90
100
Eurozone
UnitedKingdom
BUDGET DEFICITS(General government; in per cent of GDP)
1999 2001 2003 2005 2007 2009 2011 2013
0
-3
-6
-9
-12
Eurozone
UnitedKingdom
OECD COUNTRIES: PUBLIC DEBT AND GROWTH, 1946-2009
5
4
3
2
1
0
-1
Aver. Med. Debt/GDPbelow 30%
Aver. Med. Debt/GDP 30 to 60%
Aver. Med. Debt/GDP 60 to 90%
Aver. Med. Debt/GDP above 90%
Source: C.Reinhart and K.Rogoff, NBER Working Paper No.15639, 2010.
Note: Central government debt only; 20 countries,1186 observations.
GDP growth
CROWDING-OUT
The standard crowding-out effects could be stronger at present because of:
i) The possible presence of a non-linear relation between deficits and interest rates given that all major OECD countries are in debt today
ii) Debt levels could be less sustainable than in the past given that potential growth is almost certainly lower
iii) Rapidly rising deficits raise the danger of monetary accommodation and/or currency depreciation
iv) There are fears of sovereign default, at least in countries such as Greece, Ireland, Portugal and possibly others
EUROZONE - BOND YIELDS AND SHORT-TERM INTEREST RATES
0
2
4
6
1999 2001 2003 2005 2007
Bond yields
Short rates
2009
LONG-TERM INTEREST RATES(bond yields; 3 quarter moving averages)
1999 2001 2003 2005 2007 2009
2.5
3.5
4.5
5.5
Italy
Germany
France
UnitedKingdom
HOUSEHOLDS DEBT/GDP RATIOS
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
50
70
90
110
UnitedStates
Eurozone
U.K.
NON-FINANCIAL CORPORATIONS
DEBT/GDP RATIOS
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
50
70
90
110
130
UnitedStates
Eurozone
U.K.
CHANGES IN CYCLICALLY ADJUSTED BUDGET BALANCES
(in per cent of GDP)
2010 2011 2015 2010 2011 2015 2010 2011 2015 2010 2011 2015
0
1
2
3
-1
-2
-3
Germany France Italy UnitedKingdom
CHANGES IN CYCLICALLY ADJUSTED BUDGET BALANCES
(in per cent of GDP)
2010 2011 2015 2010 2011 2015 2010 2011 2015 2010 2011 2015
0
1
2
3
4
5
6
7
8
Spain Greece Portugal Ireland
FISCAL POLICY SIMULATION
A very simple simulation was carried out on the Oxford Economics global model:
Public expenditure in each OECD country was cut by the equivalent of ½ a percentage point of GDP at the beginning of 2011, 2012 and 2013, so as to achieve a reduction in the budget deficit, ex ante, of 1½ percentage points of GDP by 2013
Interest rates and exchange rates were left to be endogenously determined by the model
FISCAL POLICY SIMULATION
Euro Zone
1.7 1.4 -0.3
U.K. 2.7 2.5 -0.2
Euro Zone
-4.2 -3.2 1.0
U.K. -6.3 -5.4 0.9
2010-13 2010-13Differnc.
Base forc. Simulat.
Effect on GDP growth(average annual percentage changes)
Effect on budget balance*
(in per cent of GDP)
* In 2011-13.
WESTERN EUROPE'S PROSPECTS(GDP; percentage changes)
2009 2010 2011 2012 2013
Eurozone -4.0 1.5 1.4 1.8 2.0
Germany -4.7 3.1 1.8 1.7 2.0
France -2.5 1.5 1.6 2.0 2.1
Italy -5.1 0.8 0.9 1.4 1.4
Spain -3.7 -0.5 0.4 0.9 1.5
U.K. -4.9 1.6 2.1 2.7 3.2
GERMANY - BUSINESS CONFIDENCE AND GDP GROWTH
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
80
85
90
95
100
105
110
0
2
4
-2
-4
-6
ifo index(l.h.scale)
GDP growth (3 qtrs.mv.av. r.h.scale)
4.0
2007 2008 2009 2010 2011
94
96
98
100
102
104
106
Employment
GDP
Employment
GDP
2007-11
2007 2008 2009 2010 2011
94
96
98
100
102
104
106
2007-11
Employment
GDP
GERMANYUNITED STATES
(Indices; 2007 Q1=100) (Indices; 2007 Q1=100)
HOUSEHOLDS DEBT/GDP RATIOS
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
20
40
60
80
100
Italy
FranceGermany
U.K.
Spain
GERMANY - GROWTH IN LENDING
(per cent changes; 3 mnths. mov.avrgs.)
0
3
6
9
12
15
-3
2006 2007 2008 2009
Lending to households
2005
Lending to companies
2010
Eurozonelending to companies
GROWTH IN LENDING TO CORPORATE SECTOR
(per cent changes; 3 mnths. mov.avrgs.)
0
4
8
12
16
20
24
-4
-8
-12
-16
-202006 2007 2008 20092005 2010
UnitedStates
UnitedKingdom
Germany
GERMANY - MANUFACT. ORDERS AND INDUSTRIAL PRODUCTION
(per cent changes; 3 months mov. avrgs.)
0
10
20
30
-10
-20
-30
-40
0
10
20
-10
-20
2006 2007 2008 2009 2010
Foreignorders(t-3)
Domestic orders (t-3)
Industrial product.
FOREIGN TRADE/GDP SHARE(exports and imports of goods and services; constant prices)
0
10
20
30
40
50
60
70
80
90
100
U.K. France Italy Spain Germany
1990 1995 2000 2008 -91 -96 -01 -09
1990 1995 2000 2008 -91 -96 -01 -09
1990 1995 2000 2008 -01 -06 -01 -09
1990 1995 2000 2008 -01 -06 -01 -09
1990 1995 2000 2008 -01 -06 -01 -09
GERMANY - TRADE WITH EASTERN EUROPE*
(percentage shares in total exports plus imports)
1980-81 1985-86 1990-91 1995-96
0
5
10
15
2000-01 2005-06 2008-09
GROWTH OF EARNINGS(1999 Q.1 = 100)
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
100
110
120
130
140
Germany
France
Spain
Italy
PRODUCTIVITY GROWTH(GDP per employee; 1999 Q.1 = 100)
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
95
100
105
110
Germany
France
Spain
Italy
TOTAL REAL EXCHANGE RATES
(1999 Q.1 = 100)
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
80
90
100
110
120
130
140
Germany
France
Spain
Italy
U.K.
Source: IMF.
INTRA EUROZONE REAL EXCHANGE RATES
(1999 Q.1 = 100)
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
80
90
100
110
120
130
140
Germany
France
Spain
Italy
Source: EU Commission.
EXPORT PERFORMANCEDifference between growth of exports and growth of markets for goods and services;
volumes, annual averages, 1998-2009
US Japan Germ. Fr. Italy Spn. U.K.
0
-2
-4
REAL WAGE GROWTH(1999 Q.1 = 100)
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
95
100
105
110
115
Germany
France
Spain
Italy
CONSUM. PRICE INFLATION(1999 Q.1 = 100)
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
100
105
110
115
120
125
130
135
140
Germany
France
Spain
Italy
U.K.
EUROPE - GROWTH OF PRIVATE CONSUMPTION
(2001 Q1 = 100)
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
95
110
125 Spain
U.K.
France
Italy
Germany
EUROPE - GDP LEVELS(1999 Q1 = 100)
1999 2001 2003 2005 2007 2009
100
110
120
130
140
Spain
U.K.France
Italy
Germany
GERMANY - GROWTH AND FOREIGN BALANCE
CONTRIBUTION(three years moving averages)
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
0
1
2
3
4
-1
GDP Growth
Foreign Balance Contribution
Averages 1990-2015:GDP growth 1.5For. bal. contrib. 0.2
GERMAN-"CLUB MED" BOND YIELD DIFFERENTIAL
0
1
2
3
4
5
6
7
8
9
2007 2008 2009
Italy-Germ.
Fr-Germ.
2010
Spain-Germ.
GERMAN-"CLUB MED" BOND YIELD DIFFERENTIAL
0
1
2
3
4
5
6
7
8
9
2007 2008
Greece-Germ.
2009
Ireland- Germ.
Portugal-Germany
2010
THE EURO ISSUE
The immediate problem is one of public sector deficits and debt which are seen as excessive by financial markets (at least in some countries)
But Greece (and other Eurozone members) also face a longer-run low competitiveness problem, generating external deficits
Since financing both domestic and external deficits in these countries has become much more difficult, they must be reduced, but, absent devaluation, this could be very painful
Could EMU fall apart ? Very unlikely given the huge political capital invested
Yet, this is no longer totally impossible
EUROZONE - BUDGET BALANCES
(in % of GDP; annual averages; 2008-10)
Germ. Neth. Italy Spain Grec. Port. Irel.
0
-3
-6
-9
-12
EUROZONE GROSS NATIONAL SAVINGS
(in % of GDP; 2008-10)
Germ. Neth. Italy Spain Grec. Port. Irel.*0
5
10
15
20
25
30
* In per cent of GNP.
EUROZONE CURRENT BALANCES
(in % of GDP; 2008-10)
Germ. Neth. Italy Spain Grec. Port. Irel.
0
3
6
-3
-6
-9
-12
INTRA EUROZONE REAL EXCHANGE RATES
(1999 Q.1 = 100)
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
80
90
100
110
120
130
140
Germany
Spain
Italy
Portugal
Netherlands
Ireland
Source: EU Commission.
EXPORT PERFORMANCEDifference between growth of exports and growth of markets for goods and services;
volumes, annual averages, 2004-2009
Germ. Neth. Italy Spain Grec. Port. Irel.
0
2
-2
-4
-6
WHAT'S WRONG WITH THE EUROZONE ?
A simple view:
"The fiscal (policy) rules are good, but ... implementation has been weak"
Jean Pisany-Ferry, FT 17.06.10
A more complicated view:
The fiscal policy rules are a necessary, but not sufficient, condition for a successful monetary union
What else is needed ?
For some, fiscal transfers (i.e. political union)
For others, similar policies for deregulation, the labour market, the welfare state, etc. so as to avoid real exchange rate misalignments
HOW TO LEAVE THE EURO ?
Europe's Monetary Union does not foresee defections. On the other hand, a sovereign country should be able to leave the Union if it so wished
How can it be done ? The issue is not just legally complex, but involves, in particular, some serious financial dangers
Thus, if financial markets were to anticipate that a country wanted to leave EMU, they might well raise bond spreads to levels that would quickly become unsustainable
And if the citizens of that country were to harbour similar expectations, they could, almost costlessly, transfer their liquid balances to banks in other Euro members, leading to what has been called "the mother of all (domestic) banking crises"
Both such events would make exit from the Union both inevitable and ... chaothic !
WHAT WOULD GREECE GAIN BY LEAVING THE MONETARY UNION ?
Monetary independence: Hence lower short-term interest rates (as long as the Central Bank agrees)
Opportunity to devalue the currency
But also: A massive increase in its debt burden (unless debt was redenominated) Almost certainly an increase in inflation and in inflationary expectations
Hence a rapid erosion of any short-run competitiveness gain Hence a likely increase in long-term interest rates
And, in addition, almost certainly, much greater economic instability
This would be very popular with public opinion which overwhelmingly believes that EMU is a burden for the country
It would be less popular with business
The country's new currency would appreciate massively overnight
Companies would be facing significant menu costs as all prices and contracts had to be redefined
Frankfurt would lose importance as an international financial centre relative, in particular, to London
WHAT WOULD GERMANY GAIN BY LEAVING THE MONETARY UNION ?
GROWTH IN THE EUROZONE(per cent changes; 3 years mov. avrgs.)
1999 2001 2003 2005 2007 2009 2011 2013
0
1
2
3
4
5
-1
-2
Periphery*
Core**
* Spain, Greece, Ireland and Portugal.** Germany. Austria, Belgium, Finland and Netherlands
INFLATION IN THE EUROZONE(per cent changes; 3 years mov. avrgs.)
1999 2001 2003 2005 2007 2009 2011 2013
0
1
2
3
4
Periphery*
Core**
* Spain, Greece, Ireland and Portugal.** Germany. Austria, Belgium, Finland and Netherlands