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Transcript
The (never-ending) Eurozone
Crisis
J. Lawrence Broz
Associate Professor of Political Science
UCSD
1
Europe’s Bleak Outlook (est. 2015)
2
Scariest Graph in the World
3
When young people lose faith in the
economy, political chaos usually
follows
4
Consider The Great Depression
• The Great Depression of the 1930s bred
support for extremist ideologies that
advocated the overthrow of the political
system
– e.g. National Socialists in Germany, Iron Cross in
Hungary, the Iron Guard in Romania, communist
parties in many countries
• Recent research shows that the share of votes
for extremist parties in elections in 1930s
correlates strongly with economic hard times
Source: Alan de Bromhead, et al. “Political Extremism in the 1920s and 1930s:
Do the German Lessons Generalize?” Journal of Economic History (July 2013).
5
Lecture Outline
• Origins of the Euro Project
– Political motivations for European economic
integration
– Path toward monetary union
• Weaknesses that lead to the crisis
– EU not an “optimal currency area”
– Eurozone banks viewed the creation of the
euro as an implicit bailout guarantee
• The Greek Debt Crisis
– Bargaining and Bailouts
6
Origins of the Euro Project
• Creation of the euro—or “Economic and
Monetary Union” (EMU)—is the latest step
in a long process of politically motivated
economic integration
• After World War II, the U.S. and the political
leaders of France and Germany sought to
bind the former antagonists economically, so
as to ease Franco-German tensions and build
a bulwark against Soviet expansion
7
European Coal and Steel Community
• Coal and steel had been the source of conflict
between Germany and France for a century
– they had battled over the coal of the Ruhr, iron
the Lorraine, and steel mills of the Saar since 1870
• With the backing of the U.S. and in the
shadow of the Cold War, the French came up
with the “Shuman Plan” for inducing FrancoGerman cooperation in this area
• French foreign minister Robert Schuman said
the aim was to "make war not only
unthinkable but materially impossible.“
8
European Coal and Steel Community
• ECSC (1951) marked the birth of Europe--its first
supranational institution
• It’s members—France, Germany, Belgium, the
Netherlands, and Luxembourg—were bound under a
joint authority, with a common market and common
regulations
• ECSC was a remarkable accomplishment given that
France and Germany were at war a few years earlier
• It also provided the model for further integration and
was followed in 1956 by the European Economic
Community (EEC) which extended the common market
and built a customs union within Europe
9
History of the Euro
• To promote greater cooperation and further
integrate their economies and, Europeans
sought to minimize the variability of their
exchange rates
• In 1979, the European Monetary System (EMS)
linked EU member currencies to the
Deutschemark in a fixed-rate regime
• In 1992 Maastricht Treaty, EU members agreed
to create a common currency (the euro)
managed by a single authority, the European
Central Bank (ECB)
10
Transition to the Euro took 8 years
• Maastricht Treaty (1992) committed countries
to fiscal discipline prior to the rollout
– Reduce national budget deficits to within 3% of
GDP, and government debt could not exceed 60%
of GDP
• Most countries failed to heed these rules
– Even Germany and France breeched rules 3 years
in a row
• Nevertheless, the Eurozone was created in
1999 and the physical currency was rolled out
in 2001
11
Economic Benefits of Currency Union
• Having many currencies is costly because it
impedes the flow of goods and capital across
borders
• Thus, a key benefit of currency union is that it
encourages trade and financial integration
– Europe was to be like the United States, with its
single currency and its single central bank
• In the context of Europe’s continuing quest for
greater economic integration, a currency
union seemed the next logical step
12
Economic Costs of Currency Union
• The main cost is that a nation gives up one of the
most powerful tools of macroeconomic
management: a flexible exchange rate
• A flexible exchange rate is a kind of
macroeconomic “shock absorber” that allows
governments to adjust policy to changes in
economic conditions
– e.g., if demand for U.S. goods decreases, a weakening
of the U.S. dollar (which makes U.S. goods cheaper
for foreigners) can help offset the negative impact on
the economy
• Adopting the euro meant that EU nations gave up
this shock absorber
13
When do the benefits of currency
union outweigh the costs ?
• “Optimal Currency Area” (OCA) criteria:
– When members have sufficiently similar
economies such that a “one size fits all” policy is
appropriate
– When labor mobility among members is high
• e.g., in the U.S. people move from where
unemployment is high to where it is low
– When members are part of a fiscal union
• e.g., in the U.S. , unemployment insurance flows to
areas that face region-specific shocks
• Europe did NOT meet any of these criteria…
14
So why did the project proceed?
• Currency union was desirable because it
furthered political integration within
Europe, which was the point all along
– Members also thought they could approximate
OCA criteria with a steady flow of EU edicts aimed
at increasing cross-country labor mobility
• Powerful business and banking interests
with major cross-border economic ties
supported the project
15
Underlying Weaknesses
1. EU was NOT an Optimal Currency Area. It is
composed of two different types of economies:
– “Core” (Germany, France, the Benelux countries,
Austria, Finland)
– Periphery” (Greece, Ireland, Portugal, Spain, Italy,
Cyprus)
2. An implicit “bail out” guarantee that loosened
borrowing constraints for the periphery
– Core banks made risky loans to the periphery
because they believed a bailout would be
forthcoming if a member state got into trouble
16
Calm before the storm
• From 1999 to 2007, the Eurozone faced a
benign economic environment
– The nation-specific economic problems that
occurred were not so serious as to call into
question the integrity of the Eurozone
• But underlying problems grew…
– Lending from Core to Periphery fueled
housing bubbles in Spain and Ireland, and a
massive public debt buildup in Greece
17
10 year yield on Government Debt
Implicit bailout guarantee and the
“disappearance of risk”
18
Variety of crises, but a Common Cause
• Foreign borrowing was the common cause but
there were a variety of failures
• Greece’s problem was fiscal policy and a large
government debt
– Foreign borrowing financed generous public sector
pay, welfare, and retirement benefits
• Ireland and Spain were fiscally responsible but
their banks lent the foreign money to property
developers, generating massive housing bubbles
– When the housing bubbles burst, governments
assumed the debts via bank bailouts (sound familiar?)
19
Onset of the Crisis
• Benign environment gave way to the Great
Recession in 2008 which shook confidence in
lending to the periphery
• As their debts mounted, foreign banks
became doubtful that peripheral countries
could repay, which forced interest rates
higher—a vicious circle
• With news in 2010 that Greece had hidden
the truth about its problems, lending to the
periphery stopped altogether—a “sudden
stop” that marked the onset of the crisis
20
Risks beyond Greece
• If peripheral countries like Greece can’t
borrow to rollover their debts, they will
be forced to default
• If Greece defaults, it could trigger other
defaults
• If a defaults occur, it could bring down the
entire European banking system since
banks in the Core are heavily exposed
– If a nation defaults on its foreign debt, the
banking systems of creditor nations face
large, perhaps fatal, loses
21
The Core’s Banks are on the Hook
Foreign banks combined consolidated claims on Greece,
Ireland, Italy, Portugal, Spain (% GDP)
40
% GDP
30
20
10
0
22
Greek Debt Crisis
• In 2010, the EU faced the choice between
Greek default or a bailout
• The EU (and IMF) chose a bailout - €146 billion
to Greece over 3 years in installments
• In 2012, the “Troika” (EU, IMF, ECB) provided a
second bailout worth €130 billion. The terms:
– Greece has to impose austerity: hike taxes,
cut public sector salaries, pensions, etc
– But there was debt restructuring too: banks
in the core agreed to debt reduction of 53%
23
Debt Crisis Bargaining
• Countries in the core square off with debtor
countries in the periphery to see who will
bear the burden of adjustment
• A “morality play” over who is responsible:
– Creditors blame debtors for and “living
beyond their means.” Derisively “PIIGS.”
Creditors demand debtor austerity to maintain
debt service
– Debtors blame core banks for making huge
profits on risky loans and they demand debt
restructuring to make their debt burdens more
manageable
24
Outcomes Depend on Relative
Bargaining Power
• Core’s leverage: Since private loans are not
available, official creditors (EC, IMF, ECB) have
leverage over debtors
– Without their loans, a debtor government can’t
pay its bills, leading to economic and financial
collapse and an existential socio-political crisis
• Periphery’s leverage: since core banks hold so
much of the periphery’s debt, defaults pose
an existential threat to the core’s banking
systems
– This give the periphery substantial leverage
25
Muddling Through
• The EU has muddled through each new
crisis—Cyprus being the most recent—with
outcomes reflecting a mixture of austerity
and debt restructuring (creditor “haircuts”)
• Despite their differences, the core and
periphery are mutually dependent, which
explains why they have found compromises
and avoided disaster
• No one wants to see the Eurozone collapse
26
Reasons for Optimism
• They EU has fixed some of the underlying
problems by way of new treaties
– “European Stability Mechanism” (2012) can
provide instant financial assistance . It has €500
billion in resources
– “European Fiscal Compact” (2013) creates
stronger fiscal discipline
• Public opinion throughout the EU remains
strongly committed to the Euro
27
Public opinion is surprising resilient
Pew Research Survey conducted in March 2013
28
Towards Political Union
• “Political union” is often presented as the
culminating and final stage of European Union
• The irony is that the crisis has fostered a lot of
political union— the decisions made recently
to reinforce fiscal, economic, and financial
governance are significantly fostering political
union
• Recall Shuman: “Europe will not be made all
at once, nor according to a single plan.”
29
End
30
What happens when a country defaults
31