Download tu-91-116 economics of european integration - MyCourses

Financial Crisis 2008
 Started from the U.S.
- Housing market and subprime loans turned into
investment instruments
- Defaults and declining prices caused huge losses
for banks and investors
 Problem: trust between banks disappeared
- Interbank money market froze
- Banks couldn’t get money so they could not lend
it to firms or consumers
• No invesments, low confidence => recession
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ECB in the Financial Crisis
 ECB took emergency measures
- Acting as an intermediary in the interbank money
market
- Longer term financing guaranteed for banks
- Decrease in the interest rate
 New duties for the ECB: regulation of
financial institutions, e.g. ”stress tests” for
banks
- Discussion on more regulation of the financial
markets
2
Debt Crisis since 2011: Implications
for ECB
 Although a problem of national governments, the debt
crisis affects ECB
 Insolvency of one member can affect the credibility of
other members
- Also the credibility of the ECB is at risk: can it maintain price
stability?
 Problems for commercial banks
- Banks use their ”low risk” investments as collateral when
borrowing from ECB
- When banks incur losses, their ability to gain finanancing is
compromised
• Potential liquidity problem similar to the financial crisis
 ECB has had to purchase government bonds to calm the
markets
- The ECB is not supposed to purchase government bonds to
maintain its independence from national governments
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Today’s Agenda
 Fiscal Policy
- Goals and tools
 National fiscal policies in a monetary
(currency) union
 The Stability and Growth Pact
- Content and reasons for the pact
- Problems with the pact
 Public debt levels and annual budget deficits
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Fiscal Policy
= activities controlling the government budget
 Government spending
- Provision of public goods and services
- Investments
- Subsidies and income transfers
 Government income
- Taxes
- Returns on investment
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Goals of fiscal policy




Income redistribution
Provision of public goods
Dealing with externalities
Investments to enable long term economic
growth
 Dampen business cycle fluctuations
6
National fiscal policies in a
monetary union
 Good to have flexible national fiscal policies in
case of asymmetric shocks…
BUT
 Large debt = large interest payments
- Pressures on central bank to inflate
- Lower credit rating  higher interest rate
 Crowding out effect of fiscal policy of a small
country is diminished in a large union
- Incentive to increase budget deficit
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Crowding out of fiscal policy
 Increased government spending to stimulate
demand increases money demand (government
a major player in the domestic money market)
=> Md  => i  => (C+I) => AD  (!)
 When a country enters a monetary union, it
becomes a small player => Md increases only
little
- Less crowding out for one country => incentive to
spend more
- When all countries do the same thing, interest
rates increase a lot
- When one country in a union spends more,
interest rates increase for everybody!
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Solution: restrict fiscal policy
 Countries should not have public debt over 60%
of GDP when entering EMU
 Stability and Growth Pact in the EMU
- Annual deficit limited to 3%
• Council can impose a sanction on a country
unless mitigating circumstances (e.g. natural
disaster or GDP decreases)
– A deposit of max 0.5% of GDP, which turns
into a fine if deficit not corrected in two years
- Balanced budgets in the medium term (= over the
business cycle)
• I.e. in the long run no new debt!
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”Stupidity Pact”?
 The Stability and Growth Pact has received
arguments for and against
- Romano Prodi called it the ”Stupidity Pact” in
2002
 In groups, try to come up with arguments for
and against the pact!
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Arguments for
11
Arguments against
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2007 2008 2009 2010 2011 2012 2013 2014
Greece
107,2
112,9
Italy
103,1
105,7
116
118,6 120,1
127
128,5 132,1
Belgium
84
89,3
95,7
95,6
97,8
99,6
101,5 106,5
Ireland
25
44,5
64,9
92,2
106,5
117,6
123,7
109,7
Portugal
68,3
71,6
83,1
93,3
107,8
123,6
129
130,2
Germany
65,2
66,7
74,4
82,4
80,6
81,9
78,4
74,7
France
64,2
68,2
79,2
82,3
86
90,2
93,5
95
Austria
60,2
63,8
69,2
71,8
72,3
73,4
74,5
84,5
Spain
36,3
40,2
53,9
61,3
69,1
84,2
93,9
97,7
The
Netherlands
45,3
58,5
60,6
62,8
65,2
71,2
73,5
68,8
Slovenia
23,1
22
35
38,6
46,9
54,1
71,7
80,9
Finland
35,2
33,9
43,5
48,6
49,1
53
57
59,3
Luxemburg
6,7
14,4
15,3
19,2
18,3
20,8
23,1
23,6
Estonia
3,7
4,5
7,2
6,7
6,1
10,1
10
10,6
Source: Eurostat
129,7 148,3 170,5 156,9 175,1
177,1
Public
debt (%
of GDP)
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Budget surplus (deficit) % of GDP
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Austria
-0,7
-1,5
-4,4
-1,7
-1,5
-0,9
-0,9
-4,1
-4,5
-2,5
-2,5
-1,5
-2,4
Ireland
-0,4
0,4
1,4
1,7
2,9
0,1
-7,4
-13,9
-30,8
-13,4
-7,6
-7,2
-4,1
Greece
-4,8
-5,6
-7,5
-5,2
-5,7
-6,5
-9,8
-15,6
-10,7
-9,5
-10
-12,7
-3,5
Germany
-3,8
-4,2
-3,8
-3,3
-1,6
0,2
-0,1
-3,1
-4,1
-0,8
0,2
0
0,7
France
-3,1
-4,1
-3,6
-2,9
-2,3
-2,7
-3,3
-7,5
-7,1
-5,3
-4,8
-4,3
-4
Finland
4,2
2,6
2,5
2,9
4,2
5,3
4,4
-2,5
-2,5
-0,8
-1,9
-2,1
-3,2
Portugal
-3,4
-3,7
-4
-6,5
-4,6
-3,1
-3,6
-10,2
-9,8
-4,4
-6,4
-4,9
-4,5
Estonia
0,3
1,7
1,6
1,6
2,5
2,4
-2,9
-2
0,2
1,2
-0,3
-0,2
0,6
Italy
-3,1
-3,6
-3,5
-4,4
-3,4
-1,6
-2,7
-5,5
-4,5
-3,8
-3
-2,9
-3
Netherla
nds
-2,1
-3,1
-1,7
-0,3
0,5
0,2
0,5
-5,6
-5,1
-4,5
-4,1
-2,5
-2,3
Spain
-0,2
-0,3
-0,1
1,3
2,4
1,9
-4,5
-11,2
-9,7
-9,4
-10,6
-7,1
-5,8
Source: Eurostat
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Current debt crisis
 Slow growth and negative growth (partly due to financial
crisis) has worsened the situation in countires with large
debt to begin with
- Financial crisis affected banks and govenrments needed to
support them
 Larger inflation in some countries (like Greece) without
the possibility of devaluation of currency has led to poor
competitiveness
 Also, as capital leaves the country, it does not affect the
exchange rate (as it would if the country had its own
currency), so there is no boost for the export industry
 If investors start questioning a country’s ability to pay
back its debt, the interest rate will rise (risk premium),
which increases the government expenditures and
makes it more difficult to pay back the loans
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Labor costs in crisis countries
increased
16
Government bond rates
35
30
25
Belgium
Germany
Ireland
20
Greece
15
Spain
10
5
0
France
Italy
Portugal
Slovenia
Finland
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How to reduce deficit and debt?
 When GDP decreases or increases slowly, government
income decreases or increases very slowly (unless taxes
are increased, which in turn reduces GDP growth)
 At the same time government expenditures increase
- For example, more unemployed people to support
 Many expenditures are ”structural” and need shanges in
legislation and therefore are difficult to cut
- Government cost (salaries, ongoing investments, public
services like healthcare and education)
- Benefits and income transfers (unemployment benefits,
income support, child benefits etc.)
 Also, when GDP decreases, even with no extra debt,
ratio of debt to GDP increases
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Pre-Lecture Assignment
1. How can a country join the EU?
2. How can a country join the EMU?
(What are the criteria and procedures of
entry into EU or EMU)?
3. Do you think it is difficult to become a
member of the EU or EMU?
4. When thinking about the theory related to
trade areas and the theory of OCA’s
presented during this course, do you think
that the criteria for enlargement were chosen
well?
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