Download The Restructuring and Resolution of External

Economic Experience and Crisis
in the Euro Zone
Carlos Hurtado*
The Restructuring and Resolution of External Sovereign Debt
World Bank. Annual Law, Justice and Development Week
*Economic consultant, LCSPR, World Bank. The views are personal and do not reflect
necessarily those of the World Bank
Background. History of the EEC and Path to the
Monetary Union in 1999
 1975: European Economic Community, EEC
Custom union, common market
 1985: Schengen Rules
Free migration
 1992: Maastricht Treaty. Three pillars: Foreign Policy and Security,
Justice and Home Affairs, and European Community
…leading eventually to Economic and Monetary Union (EMU)
 1999: Beginning of the Euro zone, Euro as a common currency, with
11 countries (of the 15 members of the EC)
Austria, Belgium, Finland, France, Germany, Ireland, Italy,
Luxembourg, The Netherlands, Portugal, and Spain
 Further accession: Greece (2001), Slovenia (07), Cyprus and Malta
(08), Slovakia (09), Estonia (11)
“The Law”: The Treaty of the European
Community. Convergence Criteria
 The Maastricht or Convergence Criteria (1992), defined in
art. 121 of the Treaty Establishing the European Community
(EC) and its protocols, in order to maintain stability of the
EC
 Inflation: no more than 1.5 %pts., above the average of the 3
lowest inflation countries (“reference value”)
 Public Deficit: equal or below 3% of GDP
 Public Debt: equal or below 60% of GDP
 Interest Rates: no more than 2 %pts., above the average of the 3
lowest inflation countries (ref. value)
 (2 Years under the exchange rate mechanism ERM II)
Note: The idea is either to comply or to be on the compliance track
1998: Compliance with the Maastricht Criteria
Complying.
Germany,
Spain and
Austria just
exceeded
the Debt
target
Not complying.
Most entered
the Euro Zone
in 1999.
Greece in 2001
Country Risk and the Common Currency
Ten-Year Bond Yields before and after Adoption of the Euro
Source: Bergsten and Funk (2012).
Country risk suddenly disappeared with the adoption of the common currency, while
the Treaty did not consider bailout provisions or any form of debt “mutualization”
Countries and markets behaved as if sovereign debt had an implicit guarantee from the
Union
To no surprise, capital inflows poured into relatively capital-scarce countries: Greece,
Ireland, Portugal and Spain
The Euro Experience 1999-2007
In general, according to expectations: significant resource absorption and investment,
higher current account deficits and growth, and declining unemployment*
Convergence towards the German economy
Greece and Portugal: increased public deficit and debt
Ireland and Spain: public finances actually improved but absorbed financial flows in a
typical “bubble” fashion
The EU lost competitiveness significantly. Unit labor costs increased steeply
everywhere, except Germany, and the real exchange rate appreciated
* Exceptions: Growth was modest in Portugal and Italy; unemployment actually increased
in Portugal; and investment declined in Portugal and Greece
Unit Labor Costs in Troubled European
Economies v.s. Germany
2007: Compliance with the Maastricht Criteria
Not complying:
Still Greece,
Portugal, Belgium
and Italy*, plus
Germany* and
France*
Complying:
Notably Spain
and Ireland, plus
all the newer
membership
*Italy, Germany and France showed
“excessive” fiscal deficits in the first half
of the years2000
Why is adjustment so difficult
After 2007, stagnation and high unemployment in the UE, especially in the most
troubled: Greece, Ireland, Portugal and Spain*
Inherent problems:
 Impossibility of nominal depreciation forces “fiscal” depreciation: nominal
reductions of wages, public expenditure, debt…
 Imperfect migration: e.g. contrasting unemployment rates in Germany and Spain
 No fiscal union: lack of solidary system
 No banking union
 Uncertainty about backstop mechanism. Implicit belief that the EU would be
LOLR, although the ECB legislation explicitly prohibits it
 Lack of full recognition of the necessity to reduce debt significantly in insolvency
cases (e.g. LA in the 80-90s)
 Use of politically costly mechanisms to provide help to Greece
*The first three, under programs with conditionality –very difficult to comply
END
Outline for Presentation
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Background. History of the EEC and path to the monetary union in
1999
The Law: The Treaty of the European Community. Convergence
criteria and limits on intervention
How the 11 countries looked vs the convergence criteria before
accession (incl. Greece)
How the country risk disappeared after 1999 and $ poured into
the relatively LDC’s
Bonanza between 1999 and 2007, and deterioration of imbalances
How the 17 countries looked vs the convergence criteria in 2007
Why is adjustment so difficult
– Lack of stronger federation-like union (fiscal, solidarity, banking reg.,
migration…)
– Limits to bailouts. ECB limitations (treaty), political constraints