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The €uro Needs Rehab
...but it will survive
Pierre L. Siklos
CIGI, VERC & BSIA
A Political Experiment Gone Bad?
• Well before EMU, the concept was likened as an experiment
in international policy coordination (convergence followed by
a single exchange rate between sovereign states) enforced by
rules (Maastricht): Eichengreen (1992)
– …but the main policy actors are Finance Ministers NOT central bankers
• The former group makes policy while the latter ‘cleans up the mess’
– Many of the rules could not easily be defended on purely economic
grounds, and little effort was devoted to enforcement after the fact
• The implication? It is fiction to suggest that economics that will save the €; it’s
politics
It Gets Worse
• Too few escape clauses in case of stresses in the system
• The EU is a weak institution incapable of properly monitoring,
imposing sanctions in case of bad behaviour, and the need for
a lender of last resort was wished away
• A tangled web of bank regulation based on national financial
market regulators must operate under a single monetary
policy
• Was it a mistake? Economically, MAYBE; Politically, NO
What Were They Thinking?
• ECB not designed as a lender of last resort but
articles 122/125 of Maastricht (&
successors)Treaty does provide a way out
– Existing national institutions were left in place
(were they hedging their bets?), weak supranational fiscal and policy coordination tools
Article 125
Relieving the Pressure: TARGET 2 & LTRO
LTRO
€1,200,000
€1,000,000
Millions
€800,000
€600,000
€400,000
€200,000
€0
2000
Reflects
Deposit shifts
South to North
+
Inter-bank
Lending
difficutlies
2002
2004
2006
2008
2010
Source: Davies, FT May 20, 2012 “The Anatomy of the
Eurozone Bank Run” & ECB
Breaking up is Hard to Do?
• Is an exit strategy essential? Seems exceedingly difficult
– Candidates for expulsion – not currently possible on legal grounds - or ones
seeking to leave the € area – nothing to prevent this in law - are already euroized
– There are untold legal implications and potentially costly litigation
– Ironically, an orderly exit would require the kind of international cooperation
that has since almost vanished
– Late night & early morning decisions hardly add trust & credibility to the
possibility of an orderly exit
– History of MU – especially in Europe – is littered with break-ups
• Our experiences are with complete break-ups not partial ones
…But no longer impossible?
•
•
•
•
“…a substantial breach of the existing treaty” …with incalculable consequences
for the bloc, Mario Draghi, ECB President [December 2011]
“I guess an amicable divorce – if that was ever needed – would be possible, but I
would still regret it,” Luc Coene, Governor National Bank of Belgium [May 2012]
“Things can happen that are not imagined in the treaties. ... Technically, it [a Greek
exit] can be managed. … It is not necessarily fatal, but it is not attractive.” Patrick
Honohan, Governor of the Central bank of Ireland [May 2012]
“The consequences for Greece [of a eurozone exit] would be more serious than for
the rest of the eurozone.” Jen Weidmann, President of the Bundesbank [May 2012]
If a (partial)‘break-up’ is Inconceivable,
Then What?
• A ‘quantum leap’ is needed in developing and
maintaining a sound framework for governance
–
–
–
–
Rethinking role of ECB
Rethinking the possibility of default, exit & expulsion
Rethinking enforcement of fiscal policy performance
Override provisions in MP , fiscal policy, & a debt strategy
• But this requires the ‘thinking slow’ option; the ‘thinking fast’
option is a break-up
Fast & Slow Thinking About €
• Fast thinking = continued austerity, threats against those who
want to weaken fiscal compact, maintenance of existing MP
strategy
• Slow thinking = recognition that imminent € area collapse
requires ‘adjustments’
– “Jens Ulbrich, head of the Bundesbank’s economics department, told the
finance committee of the German parliament that Germany is likely to have
inflation rates “somewhat above the average within the European monetary
union” in the future and that the country might have to tolerate higher
inflation for the sake of rebalancing within the euro zone.” May 11, 2012
REAL EXCHANGE RATE
IMF def'n real effectice depreciation (2005=100)
Unit labor costs
115
110
105
100
95
90
85
80
75
2000
2002
2004
Germany
Italy
2006
Greece
Portugal
2008
Ireland
Spain
2010
A POST – EMU PHENOMENON?
SOURCE: De Grauwe (2012),
CEPS Policy bBief 268
“I am especially wary of analysis that shows a divergence of unit
labour costs, or other national price indices, since 1999 when the euro
was introduced. Germany entered the eurozone with an overvalued
exchange rate, which has exaggerated the extent of the subsequent
adjustment made by Germany compared with others.”
Münchau FT “The Only Way to Stop a Eurozone Bank Run”, 21
May 2012
INFLATION RATES
HICP inflation (% change annual)
6
4
2
0
-2
-4
-6
2000
2002
euro area
Ireland
Spain
2004
2006
Germany
Italy
2008
2010
Greece
Portugal
Source: Author’s calculations
using IFS CPI data
Euro-zone in Balance Sheet Recession:
Euro-zone Private Sector Increased Savings Massively after the Bubble
Financial Surplus or Deficit by Sector
(as a ratio to nominal GDP, %)
6
(Financial Surplus)
Households
Shift from
3Q 2008 in
private sector:
3.66% of GDP
4
Corporate: 3.12%
Households: 0.54%
Rest of the World
2
0
-2
Shift from
3Q 2008 in
public sector:
3.12% of GDP
-4
General
Government
Corporate Sector
-6
(Non-Financial Sector + Financial Sector)
(Financial Deficit)
-8
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.
Source: ECB
Source: Koo (2012)
http://ineteconomics.org/conference/berlin/world-balance-sheet-recession-whatpost-2008-west-can-learn-japan-1990-2005
Money Growth (M3) in the € Zone
More QE
please?
Source: ECB Statistical Data Warehouse
http://sdw.ecb.europa.eu/home.do?chart=t1.2
Lessons from Canada?
• # 1: fiscal & monetary policies must work together
• # 2: Monetary objectives/strategies need to be
reviewed/renewed regularly
– To ensure democratic accountability
– In recognition that the world is dynamic not static as
Treaties tend to assume
Conclusions I
• “It can’t Happen, It’s a Bad Idea, It Won’t Work”
– Another ‘black swan’?
– “…the standard scenario for an EMU collapse has been discussed so many
times that it sometimes seems to long term eurobuffs like myself as it had
already happened” (Krugman 1998)
– “… there is a very wide gap between what the euro needs to survive and what
European leaders are willing to do, or even talk about doing. And given that
gap, it’s hard to find reasons for optimism.” (Krugman, 26 Sept 2011)
• They were wrong then, could they be wrong again?
– “... this colossal error of a single currency.” JOHNSON & BOONE, May 27, 2012
Conclusions II
• The euro will survive
– If politics come first: the Southern & Eastern flanks
needs thinking about in political terms
– If some of the economics are met: some
mutualization of euro area debt, ECB’s role, some
fiscal coordination