The European (Debt) Crisis: Who is the Worse Guy – Germany or Greece?

Ukrainian Academy of Banking of the National Bank of UkraineInternational Competition in Banking: Theory and Practice

Sumy, 24. May 2012

Prof. (FH) Dr. Stephan O. HornigFachhochschule Kufstein Tirol, University of Applied Sciences

Kufstein, Austria1

1. Introduction2. Actual Situation of Public Debt3. Macroeconomic Stabilisation Policies4. Conclusion

2

Contents

1. Introduction

3

• The present crisis is not a currency crisis• The present crisis is a debt crisis• 3 statements:

• Greece is a problem• Germany is a mayor problem• Main problem: The European project lost its compass …

4

1. Introduction

• The present crisis is not a currency crisis• The present crisis is a debt crisis• 3 statements:

• Greece is a problem• Germany is a mayor problem• Main problem: The European project lost its compass …

... what creates serious problems for the rest of the world

5

1. Introduction

• The present crisis is not a currency crisis• The present crisis is a debt crisis• 3 statements:

• Greece is a problem• Germany is a mayor problem• Main problem: The European project lost its compass …

... what creates serious problems for the rest of the world

• Intention of this presentation:• How did we get into this mess?• Bright light on two of the players involved

6

1. Introduction

2. Actual Situation of Public Debt

7

Worldwide situation (2010): gross public debt in % of GDP

8

2. Actual Situation of Public Debt I/III

Situation in Europe (2010): gross public debt in % of GDP

9

2. Actual Situation of Public Debt II/III

Gross public debt in % of GDP (Schnabl, Zemanek 2010, p. 6).

10

2. Actual Situation of Public Debt III/III

3. Macroeconomic Stabilisation Policies

11

• Three types of macroeconomic stabilisation policies:• Fiscal policy (government)• Monetary policy (central bank)• Wage policy (trade unions and employer associations)

• Imbalance in the eurozone:• Full centralisation of monetary policy• Fiscal policies and wage policies on national levels

• Problem:• Absolutely fixed nominal exchange rates• Dramatically divergent real exchange rates• Dramatically divergent real interest rates

12

3. Macroeconomic Stabilisation Policies

• Within a currency union no possibility for national monetary policies• No problem with symmetric shocks• Huge problems with asymmetric shocks

• Main goal of the European Monetary Union (EMU): covergence

13

3.1 Monetary Policy I/II

Long term interest rates in the EMU (Flassbeck, Spiecker 2011, p. 185)

14

3.1 Monetary Policy II/II

• A monetary union is primary an agreement on inflation• Most important determinant of inflation is unit labour cost

growth

(Flassbeck, Spiecker 2011, p. 181) 15

3.2 Wage Policy

• Wage and price differences are at the core of the trouble• Accumulate over time• Higher inflation

1. real exchange rate appreciation loss in competitiveness current account deficit

2. real interest rates fall

• Lower inflation 1. real exchange rate depreciation

gain in competitiveness current account surplus

2. real interest rates raise16

3.2.1 Wage and Price Differences I/V

• Crucial construction error of EMU: inflation convergence in one point of time (1997 for the founding members)

17

3.2.1 Wage and Price Differences II/V

• Crucial construction error of EMU: inflation convergence in one point of time (1997 for the founding members)

• Relative unit labour costs in the eurozone (De Grauwe 2010, p. 4)

18

3.2.1 Wage and Price Differences II/V

Comparison unit labour costs (Flassbeck, Spiecker 2011, p. 182)

19

3.2.1 Wage and Price Differences III/V

Comparison inflation rates (Flassbeck, Spiecker 2011, p. 183)

20

3.2.1 Wage and Price Differences IV/V

• Short reflection:• Inflation target of the ECB: 2 %• average unit labour cost increase per year:

• Greece: 2.7 %• Germany: 0.4 %

21

3.2.1 Wage and Price Differences V/V

• Effect of these wage/inflation-differences: increasing competitiveness-gap• Competitiveness gains: Germany, Austria• Competitiveness losses: Ireland, Greece, Italy, Spain, Portugal

• Consequence: raising imbalances in current accounts

22

3.2.2 Current Accounts I/V

European current account balances (Schnabl, Zemanek 2010, p. 12)

23

3.2.2 Current Accounts II/V

European current account balances (Flassbeck, Spieker 2011, p. 181)

24

3.2.2 Current Accounts III/V

• Current account imbalances accompanied by low interest rate policy• Bust of the new economy bubble• Low interest rates in the USA, then also in Europe• Global credit boom• Huge capital flow to the deficit countries

• Boom in construction sector• General investment boom

• 2 ways out:• Surplus countries become deficit countries and vice versa• Deficit countries reduce imports and pass recession; problem:

Keynes (1920) 25

3.2.2 Current Accounts IV/V

Divergencies in competitiveness lead to budgetary divergencies (De Grauwe 2010, p. 3)

(1999 – 2008)

26

3.2.2 Current Accounts V/V

• Favourable interest rate/ debt conditions applied to both,• Private debtors• Public debtors

• Huge capital flow to the deficit countries• Boom in construction sector• General investment boom• Growth of the public sector

• Effective mechanisms for limiting public and privete debt lacking

27

3.3 Fiscal Policy I/II

• Boom in construction sector develops speculative bubbles• The bursting of these bubbles is threatening the solvency

of banks• This leads to considerable risks for the public finances

• Ireland• Portugal• Spain• Greece

28

3.3 Fiscal Policy II/II

Gross public debt in % of GDP (Schnabl, Zemanek 2010, p. 6).

29

3.3.1 Public Debt I/IV

• 2008: govern. bonds began to include premiums for default risks

• Risk premiums much smaller than in the pre-euro era

30

3.3.1 Public Debt II/IV

• 2008: government bonds began to include premiums for default risks

• Risk premiums:• Much smaller than in the pre-euro era• Help impose fiscal discipline that had been lacking• Necessary for the functioning of the eurozone capital market

• Capital flows are slowed down• Government debtors are effectively disciplined• Overheating is avoided

31

3.3.1 Public Debt III/IV

• Source of exploding public debt levels: unsustainable level of private debt prior to the financial crisis• During the boom years: private sector added a lot of debt• After the bust: governments picked up the pieces:

• Economies were driven into recession Government revenues declined Social spending increased

• Part of the private debt was implicitly guaranteed by the governments (bank debt in particular)

Governments were forced to issue own debt to rescue private institutions

32

3.3.1 Public Debt IV/IV

• De Grauwe (2010, p. 1): Financial Markets have a destabilising role• Periods of euphoria• Periods of depression

overshooting in asset prices that is not related to underlying fundamentals

• Central role of rating agencies in this destabilisation process

33

3.3.2 Role of Financial Markets I/II

• Rating agencies amplify the destabilising movements in financial markets• Systematic „type I“ errors in periods of euphoria

Fail to detect crisis factors, when there are crisis factors• Systematic „type II“ errors in periods of depression

Detect crisis factors, when there is nothing to detect

34

3.3.2 Role of Financial Markets II/II

• The euro is a key element of European integration.• Wage growth and inflation convergence is a key factor.• European integration will be endangered if there is no successful

establishment of more fiscal discipline.• There is an urgent need of a better balance of growth forces in

Europe.• The structural problem in the eurozone is that the monetary union is

not embedded in a political union.

35

4. Conclusion I/II

• 3 statements from the beginning:1. Greece is a problem

2. Germany is a mayor problem

3. Main problem: The European project lost its compass

• Who now is the worse guy?• Inflation target of the ECB: 2 %• average unit labour cost increase per year:

• Greece: 2.7 %• Germany: 0.4 %

36

4. Conclusion II/II

Thank you for your attention

Stephan O. Hornig

37