Download real interest rate

Prepared for the Chinese - Hungarian
International Conference on
Economics of Crisis, Education and Labour
30th June -1st July 2011, Budapest
The crisis in the Euro-zone and
lessons for Euro-adoption in
Hungary
Gábor Oblath
IEHAS
1
Two questions
•
What are the possible links between
a)
b)
•
•
the present crisis („macro-economic strains”) in four membercountries (the „GIPS”*/) of the Euro-area (EA) and
the design of the EA?
What are the lessons of experiences of the GIPS for
the CEE-NMS (e.g., Hungary) that hope to (in due
time: have to) join the EA?
(Assumption: the EA survives the present crisis)
*/Geece, Ireland, Portugal, Spain
2
Outline
1. Earlier notions regarding EA-accession
in HU
2. Confronting these notions with
experiences of the GIPS
3. Some lessons: internal conditions of
successful EA-adoption
3
1. Earlier (pre-crisis) notions regarding EAaccession in HU
• Join ASAP
– Costs/dangers of own exchange rate in a small open
economy: a major source of exogenous shocks – without
evident benefits
– While: significant benefits from joining the EA
• No exchange rate volatility
• Transaction costs decrease
• Interest rates decrease
• BOP-constraint removed, etc.
 all in all: boost to economic growth
• Main task: fulfil the Maastricht criteria ASAP
Earlier assumptions – what happens after
joining the EA?
• Inflation differentials may persist, but only due to
„equilibrium” (catch-up) inflation (BalassaSamuelson effect) cannot be a problem;
• Wage-increases will have to be in line with increases
in productivity (no resort to devaluation)
• The removal of the BOP-constraint can only have
beneficial effects
Some (earlier) overlooked issues
• Inflation differentials may reflect „catching up” (or
„overheating”), but whatever the cause, the common nominal
interest rate may result in too low (or even negative) real
interest rates in high-inflation countries
• Nominal wage increases can persistently exceed increases in
productivity
• The BOP-constraint is not removed; it only becomes „softer”,
with potentially adverse affects:
The signals regarding unsustainable developments either do not exist, or
arrive with excessive lags
• The exchange rate cannot signal
• Yields on government bonds signal with a huge lag, but then brutally
Yields on 10-year government bonds
Greece
Ireland
Portugal
Spain
Italy
7
5 year sovereign CDS spreads in the
GIPS (and IT+WE)
25 May
27 Apr.
30 Mar.
2 Mar.
2 Feb.
5 Jan. 2011
8 Dec.
10 Nov.
13 Oct.
15 Sep.
18 Aug.
21 July
23 June
26 May
28 Apr.
31 Mar. 2010
Basis points
1600
1400
1200
1000
800
600
400
200
0
Greece
Portugal
Spain
Italy
Ireland
Western Europe composite
8
2. Confronting earlier expectations with
experiences of the GIPS
• Is the current fiscal/financing crisis in the GIPS-group due to
– membership in the EA
– factors unrelated to EA-membership (domestic economic policy)
– some combination of the two?
• How to disengage the first two? A possible approach:
– EA-membership: developments in real interest rates and real
exchange rates
– Domestic economic policy: fiscal developments
• Government balance
• Public debt
• Interactions between domestically created problems and EAmembership:
– Unsustainable developments, supported by the lack of „early warning”
by financial markets
Types of problems
• Different stories
• Problems related to the EM-membership
– Accession at a misaligned exchange rate and „getting stuck”
– Own inflation + common interest rate  problem with the real
interest rate (bubbles)
– Own wage and productivity developments + common exchange rate
 real-exchange rate (competitiveness) problems
• Domestically generated problems
– Fiscal irresponsibility
– Loose handling of macro-stability risks of the financial sector (bubbles)
– Considering public revenues from bubbles as permanent
Accession at an overvalued exchange rate:
Portugal’s example
• Portugal during the 2000s: a decade of stagnation –
after rapid catch-up in per capita income to the EU15
(between 1985 –1990: from 55 to 70%)
• After EA-accession: no opportunity for devaluation
(only „internal devaluation”  recession/depression)
• No unambiguous indicator of overvaluation exists,
but a rule of thumb:
– if the comparative price level (PPP/exchange rate) >> per
capita relative real GDP: suspect of overvaluation
11
A concern justified: EA-accession at an overvalued exchange rate may result
in lasting stagnation - Portugal’s experiences in comparative perspective
(1999-2008)
Real per capita income (PPP) and comparative price levels (ER/PPP); EU15=100
gr
es
de
112
96
90
108
92
85
104
88
80
100
84
75
96
80
70
65
76
92
99
00
01
02
04
03
05
06
07
99
08
00
01
04
03
05
06
07
08
99
00
01
02
03
V_GDP
P_GDP
P_GOOD
P_SERV
V_GDP
P_GDP
P_GOOD
P_SE RV
V_GDP
P_GDP
02
04
05
06
07
08
P_GOOD
P_SERV
pt
ie
85
135
Price level: goods
130
80
125
Price level: GDP
Price level: services
120
75
115
110
GDP/capita (PPP)
70
105
65
100
99
00
01
02
03
V_GDP
P_GDP
04
05
06
P_GOOD
P_SE RV
07
08
99
00
01
02
03
V_GDP
P_GDP
04
05
06
07
08
P_GOOD
P_SERV
12
GIPS: Macroeconomic and competitiveness
indicators*/
•
•
•
•
•
•
•
Inflation
Real interest rate
Domestic credit growth
Real exchange rate
Foreign market share
Net foreign debt
Public deficit and debt
*/sources: AMECO, Eurostat
13
Inflation in the EA and the inflation target
of the ECB (2000=100)
135
South_EU3
130
Ireland
125
Germany
EA
120
115
SEU3
IE
EA
ECB inflation target
DE
110
105
100
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
14
Real interest rates GIPS vs. Germany (DE)
and the EA
10
EA-12
8,0
EA-12
DE
7,0
IE
DE
8
6,0
IE
EL
6
ES
PT
4
EL
5,0
ES
4,0
PT
3,0
2,0
2
1,0
0,0
0
-1,0
-2
-2,0
-3,0
-4
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Long-term real interest rates
2008
2009
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Short-term real interest rates
In the EA (and Germany) real interest rates never became negative; in the GIPS they did
Growth of domestic credit
(1999=100)
400
350
300
Ireland
Greece
Spain
Portugal
EA
250
200
150
100
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
16
Real exchange rates based on GDP deflator
(1999=100)
(: deterioration in competitiveness : improvement)
130
125
DE
EL
120
115
ES
IE
PT
110
105
100
95
90
85
80
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
17
Real exchange rates based on unit labour cost,
total economy (1999=100)
140
DE
130
EL
ES
IE
120
PT
110
100
90
80
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Changes in foreign market shares
(2000=100)
Germany
Ireland
Greece
Spain
Portugal
120
115
110
105
100
95
90
85
80
2000
2001
2002
2003
2004
2005
2006
2007
2008
Downward trends indicate competitiveness problems: GIPS vs. DE
19
Net foreign debt in the GIPS and Italy
(in % of GDP)
100%
90%
80%
70%
60%
50%
150%
Greece
Spain
100%
Italy
Portugal
50%
Ireland (rhs)
40%
0%
30%
20%
-50%
10%
0%
-100%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Italy
General government balance and public debt
(in % of GDP)
Balance
Debt
4
10
160
2
5
140
0
120
0
-2
-5
-4
-6
-8
-10
Greece
-10
Spain
-12
Portugal
-14
Ireland
-15
-20
Spain
Portugal
80
60
40
-16
-30
20
-18
-35
0
Ireland, Spain: seemingly sound
Greece
100
-25
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Ireland
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
In hindsight: unsound
21
3. Some lessons
• Once inside the EA, unsustainable macroeconomic
developments, e.g.:
• excessive domestic credit-growth
• deterioration in international competitiveness,
• increasing foreign indebtedness
could be sustained much longer (imbalances could become
much larger) than outside, because
• the exchange rate cannot depreciate (no signal + no corrective
changes)
• Interest rates/yields react too late (but then, drastically)
• Therefore, countries
• prone to fiscal irresponsibility and/or
• lacking the culture (tradition) of economic stability
may eventually be worse off by joining the EA
22
Some lessons (cont.)
• Fulfilling the Maastricht criteria is a necessary, but not a sufficient condition
for EU-accession (domestic conditions also have to be elaborated and met)
• After accession : fiscal responsibility is necessary, but insufficient for
avoiding unsustainable developments in the private sector
• Giving up monetary autonomy (i.e., disposing of the exchange rate ) is a
fundamental decision, to be considered very carefully; two points:
• the accession-exchange rate may have lasting effects (see Portugal);
• Until the exchange rate exists, depreciation may be a useful aid in correcting
macroeconomic imbalances: depreciation can solve coordination problems;
analogy: daylight savings time (©M. Friedman)
• The alternative of depreciation (wage-price deflation) may lead to
recessionary spirals (e.g. by increasing the real value of nominal debt)
• Giving up the exchange rate: only if institutions are established
– to prevent the need for the exchange rate (macroeconomic stability);
– in case of need, can solve the coordination problems
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