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Professor Stefan Collignon Rapporto Europa Adjusting to the crisis 1 Professor Stefan Collignon 1. 2. 3. 4. 5. 6. Table of Content Europe's adjustment to the crisis Exit strategies for what? Public deficits and the sustainability of debt Private union bonds as an exit from the Greek drama Global imbalances: Europe’s role European economic governance. The Lisbon Treaty, the crisis and possible outlooks 2 Professor Stefan Collignon Rapporto Europa 2010 The world is coming out of its deepest economic crisis in 70 years, but the danger is not over. Although economic growth has returned, it is weak. The European economy risks falling back into a «double-dip» recession, unless the restocking of inventory translates into sustained investment and job creation. 3 Professor Stefan Collignon Rapporto Europa 2010 Lessons from the Great Depression teach that an early recovery can revert back into recession, when bankruptcies, defaults, currency depreciations, and low assets prices undermine the creditworthiness of borrowers. The Greek crisis risks to be precisely such an event Falling bond and stock prices Fiscal restraint Weak euro 4 Professor Stefan Collignon 1. Europe's adjustment to the crisis 5 Professor Stefan Collignon The crisis has not only lowered growth, but also affected long term growth potential negatively Investment Employment Euro Area is less affected than non-euro Rapporto Europa 2010 Exception: Poland Asia is least affected 6 Professor Stefan Collignon Rapporto Europa 2010 7 Professor Stefan Collignon Rapporto Europa 2010 8 Professor Stefan Collignon Table 2. Employment Adjustment Column 1 2 3 4 jobs created 199-2008 job growth job losses 2008-10 job losses in thousands in % of 1999 in thousands in % of 2008 Euro area16 15,181.8 11.4% -4866.0 -3.3% Euro area12 14,803.2 11.5% -4772.6 -3.3% Ireland 476.7 29.4% -238.4 -11.4% Spain 4,884.7 31.3% -1806.2 -8.8% Finland 286.3 12.7% -133.2 -5.3% Slovenia 97.1 10.9% -45.4 -4.6% Portugal 220.1 4.5% -139.3 -2.7% France 2,144.6 9.1% -674.0 -2.6% Netherlands 797.3 10.0% -193.3 -2.2% Belgium 433.4 10.8% -97.9 -2.2% Austria 364.4 9.7% -90.0 -2.2% Germany 1,855.0 4.8% -838.3 -2.1% Slovakia 175.9 8.5% -45.7 -2.0% Italy 2,769.0 12.3% -480.6 -1.9% Greece 472.8 11.2% -80.7 -1.7% Cyprus 85.3 27.6% -1.9 -0.5% Malta 20.3 14.2% -0.5 -0.3% Luxembourg 98.9 39.6% -0.6 -0.2% 9 5 (3)/(1) loss/gain -32.1% -32.2% -50.0% -37.0% -46.5% -46.7% -63.3% -31.4% -24.2% -22.6% -24.7% -45.2% -26.0% -17.4% -17.1% -2.2% -2.5% -0.6% Professor Stefan Collignon Rapporto Europa 2010 Okun’s Law claimed a dependable relation between employment and output. Our estimate (table 3) shows Okun’s law for Europe Given that the unemployment rate has risen from 6 to 9.5 percent in the crisis: the European economy would have to grow 8.2 % in one year to return to the status quo ante or 5.2 % over two years. If it grows at the rate of 3 percent, it will take over 7 year to return to Unemployment rates of 2008 10 Professor Stefan Collignon Rapporto Europa 2010 Competitiveness distortions The PIIG problem? Current account balances vs unit labour cost levels? Unit labour cost levels determine relative growth Nominal wages relative to productivity Degree of distortions measured by Variance 11 Professor Stefan Collignon Rapporto Europa 2010 Unit Labour Cost Levels in the Euro Area Levels of ULC 1999Q1: nominal = real ULC 1.0 0.9 0.8 0.7 0.6 0.5 Variance Coefficient of Variation: ULC in Euro Area .12 0.4 99 00 01 02 03 04 05 06 07 08 .11 ULCEU ULCFI ULCGR ULCLUX ULCSP .10 .09 .08 .07 ULCAU ULCFR ULCIR ULCNL ULCBE ULCGE ULCIT ULCSLOVAK 12 Source: OECD, own calculations .06 99 00 01 02 03 04 05 06 07 08 Professor Stefan Collignon Rapporto Europa 2010 How did member states adjust? 13 Professor Stefan Collignon Rapporto Europa 2010 14 Professor Stefan Collignon 2. Exit strategies for what? 15 Professor Stefan Collignon Policy response to the crisis Low interest rates and monetary easing Fiscal stimulus packages But when is it time to return to less accommodating policies? Who should tighten first? Rapporto Europa 2010 Monetary or fiscal policy? Is there a danger of inflation? 16 Professor Stefan Collignon Rapporto Europa 2010 17 Professor Stefan Collignon Rapporto Europa 2010 Euro Monetary Aggregates 12 10 8 bn euros 6 4 2 0 18 Professor Stefan Collignon Rapporto Europa 2010 Despite ample liquidity supply, money supply is not growing No danger of inflation Credit is not growing But also: no growth Danger of deflationary spiral? 19 Professor Stefan Collignon Rapporto Europa 2010 The interaction of monetary and fiscal policy New issue after Greek bail-out and ECB buying government debt Keynesian economics: stimulate demand Ricardian economics: Not possible Savings will increase to cover future tax liabilities Government bonds are not net wealth 20 Professor Stefan Collignon Rapporto Europa 2010 If Central bank buys government debt, the tax liability of citizens is reduced Seignorage Government bonds are then net wealth because government spending increases income Whether the economy is Keynesian or Ricardian depends on open market operations of Central bank 21 Professor Stefan Collignon Rapporto Europa 2010 22 Professor Stefan Collignon Rapporto Europa 2010 23 Professor Stefan Collignon Rapporto Europa 2010 The optimal exit strategy ECB buys government bonds ECB controls price stability and money supply, possibly rising interest rates Increases seignorage effects Governments maintain fiscal stimulus Until corporate sector is borrowing again Like Obama 24 Professor Stefan Collignon 3. Public deficits and the sustain 25 Professor Stefan Collignon Rapporto Europa 2010 Is fiscal policy out of control? The Greek crisis Excessive spending Or reduced income due to crisis? 26 Professor Stefan Collignon Rapporto Europa 2010 Euro Area 12 countries Germany 4,800 France 1,200 1,200 1,100 4,400 1,000 1,000 4,000 900 800 800 3,600 600 700 3,200 600 400 500 2,800 200 400 2,400 1980 1985 1990 1995 2000 EURO Expenditure 2005 2010 300 1980 1985 1990 Euro Revenue 1995 2000 2005 2010 0 1980 1985 1990 GERMANY Expenditure GERMANY Revenue Greece 2000 2005 2010 2005 2010 FRANCE Expenditure FRANCE Revenue Ireland Italy 140 90 900 120 80 800 700 70 100 1995 600 60 80 500 50 400 60 40 40 20 0 1980 300 30 200 20 1985 1990 1995 2000 GREECE Expenditure 2005 2010 10 1980 100 1985 1990 GREEC Revenue 1995 2000 2005 2010 0 1980 1985 IRELAND Expenditure IRELAND Revenue Portugal Spain 90 80 1990 1995 ITALY Expenditure 2000 ITALY Revenue United Kingdom 500 800 450 700 70 600 400 60 500 50 350 40 300 400 300 30 250 200 20 200 10 0 1980 1985 1990 1995 2000 PORTUGAL Expenditure PORTUGAL Revenue 2005 2010 150 1980 100 1985 1990 1995 SPAIN Expenditure 2000 2005 SPAIN Revenue 2010 27 0 1980 1985 1990 1995 UK Expenditure 2000 2005 UK Revenue 2010 Professor Stefan Collignon Rapporto Europa 2010 Greece budget trends in euro 130 Geece joins euro 120 110 Bn euro 100 90 80 Lehman crisis 70 60 50 99 00 01 02 03 04 05 06 07 08 GREECE Expenditure GREECE Expenditure forecast GREECE Revenue GREECE Revenue forecast 28 09 10 11 Professor Stefan Collignon Rapporto Europa 2010 Greece Budget Deficits 12 8 George Papandreou 4 billion euros 0 -4 -8 -12 Andreas Papandreou -16 Kostas Karamanlis Kostas Simitis Konstantinos -20 Mitsotakis -24 90 92 94 96 98 00 02 04 06 GREECE SURPRISE DEFICIT 29 GREECE TREND DEFICIT 08 10 Professor Stefan Collignon Rapporto Europa 2010 Italian Deficits 60 euro Amato Ciampi Berlusconi 40 20 0 -20 Prodi D'Alema Amato -40 Berlusconi Prodi -60 -80 90 92 94 96 98 00 02 04 ITALY SURPRISE DEFICIT 30 ITALY TREND DEFICIT 06 08 10 Professor Stefan Collignon Rapporto Europa 2010 Is public debt in Europe sustainable? Rising debt/GDP ratios The concept of sustainability A long term „steady state“ Depends on fiscal policy objectives and growth rate Convergence to the steady state Fast or slow? Depends on policy reaction function relative to growth adjusted real interest rate (r-y)>α 31 Professor Stefan Collignon Rapporto Europa 2010 32 Professor Stefan Collignon Rapporto Europa 2010 33 Professor Stefan Collignon Rapporto Europa 2010 Our estimates of the policy parameter Growth adjusted interest rate (r-y) hardly ever exceeded 10% Policy reaction to excessive deficit is well above these values: α Italy: 20-24 % Greece: 35 % Spain: 28 % Germany: 70-74 % Denmark: 8-13 % 34 Professor Stefan Collignon Hence: public debt is sustainable in Europe but the steady state rises significantly because of low growth Rapporto Europa 2010 Need to accelerate growth is more urgent than cutting deficits However, if debt is growing fast and there is need for refinancing, this could lead to illiquidity and default 35 Professor Stefan Collignon 4. Private Union Bonds as an ex 36 Professor Stefan Collignon On 9 May, Euro Area member states have set up a European Stabilisation Mechanism of € 750 bn Rapporto Europa 2010 Subject to radical austerity packages Is it sufficient? Will it generate non-Keynesian growth effects? Danger: overly hasty fiscal exit will push the European economy back into recession What will happen to bail-out loans? 37 Professor Stefan Collignon The constitutional problem Defaulting on bail-out loans is equivalent to “assuming a member state’s debt” Rapporto Europa 2010 Forbidden by Lisbon Treaty § 123 German constitutional court The Transfer Union and moral hazard A way to circumvent the problem: synthetic Union Bonds 38 Professor Stefan Collignon Rapporto Europa 2010 Private Union Bonds Different from Tremonti’s proposal A Fund or Trust buys government bonds of all Euro member states in proportion of ECB share capital Issues Union Bonds in exchange A portfolio of government debt Les risk and volatility Higher return 39 Professor Stefan Collignon Rapporto Europa 2010 40 Professor Stefan Collignon Rapporto Europa 2010 41 Professor Stefan Collignon Rapporto Europa 2010 42 Professor Stefan Collignon Rapporto Europa 2010 Private Union Bonds Acceptable as paper for central bank operation AAA Ensures liquidity for banking system in case of default Possibility to structure this product to give greater security to sovereign lenders and higher returns to risk taking private lenders Overcomes the constitutional problem 43 Professor Stefan Collignon 5. Global imbalances: Europe’s role 44 Professor Stefan Collignon Rapporto Europa 2010 The Greek crisis has accelerated the fall of the euro Short term speculation? Long term equilibrium: parity? Economic stagnation in Europe Accelerating growth in USA High growth in Asia This poses new difficulties and threats to the global economy 45 Professor Stefan Collignon Rapporto Europa 2010 Global imbalances were a major cause of the financial crisis Low savings in USA High current account surpluses in Asia Consequence of bubble Bernanke: Global savings glut Europe in balance 46 Professor Stefan Collignon Rapporto Europa 2010 Current Account Balance as Percent of GDP 12 8 4 0 -4 -8 1980 1985 1990 1995 United States JAPAN CHINA Euro area 2000 2005 2010 USA TREND JAPAN TREND CHINA TREND 47 Professor Stefan Collignon Rapporto Europa 2010 Global imbalances reveal Excessive US deficits of the Bush years are getting corrected by financial crisis But structural US deficit remains Euro Area is in balance China will increase its surpluses Who will absorb them? Symbiotic relationship: USA-Asia 48 Professor Stefan Collignon The three objectives for global adjustment Reduce the American current account deficit Prevent the crash of the Asian growth model Avoid putting the burden of adjustment exclusively on the euro 49 Professor Stefan Collignon Rapporto Europa 2010 The transformation of the world economy Elastic world labour supply due to globalisation China`s labour force: 25% of world and still growing But slowing down and will stop in 2015 Anchor for wage and price stability Unlimited supply of labour (Arthur Lewis) Great Moderation The new global growth pole is Asia 50 Professor Stefan Collignon Rapporto Europa 2010 The Asian development model Based on stable and competitive exchange rates Competitive level generates attractive profits Low volatility generates certainty for investment planning Focus on the USD zone Similar Europe and Japan under Bretton Woods 51 Professor Stefan Collignon Rapporto Europa 2010 CHINA 12 11 10 9 8 7 6 99 00 01 02 03 04 05 06 52 YUAN YUANUSD 07 08 09 Professor Stefan Collignon Rapporto Europa 2010 Asia’s Dollar Standard Volatility between Asian currencies and euro is higher than with USD Deters trade and investment between Europe and Asia Chinese FDI benefits from exchange rate stability to the United States and Japan with respect to Europe the undervaluation of the exchange rate compensates for the increased volatility-induced uncertainty 53 Professor Stefan Collignon Economic growth dominates exchange rate effects Import and Export Elasticities for China and Europe c trend GDP growth E GDP growth China Yuan/euro R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Imports Coeff t-Stat 0.079 1.476 -0.001 -0.500 6.604 12.172 0.649 0.800 0.774 0.077 0.228 53.327 5.683 Exports Coeff t-Stat 0.061 0.693 -0.005 -4.202 2.885 -0.676 0.514 0.455 0.088 0.316 50.868 54 2.381 -5.380 Professor Stefan Collignon Import and export shares for Asian countries (2008) Export destination Exporter China Japan China 8.1 Japan 16.0 Korea 21.7 6.7 India 5.6 2.0 ASEAN 12.4 10.3 ASEAN+4 9.1 6.5 Usa 5.5 5.1 EU12 2.5 1.3 EU12 external trade 6.9 3.5 Importer China Japan Korea India ASEAN ASEAN+4 Usa EU12 EU12 external trade Import source China Japan 18.8 17.7 10.1 11.3 10.0 16.5 4.8 12.2 14.0 2.5 11.3 9.0 6.6 1.8 4.7 Korea 5.2 7.6 2.1 4.1 4.7 2.7 0.7 2.1 Korea 9.9 3.9 2.6 4.8 5.5 2.3 0.8 2.1 India 2.2 1.0 2.1 2.8 2.0 1.4 0.7 2.1 India 1.8 0.7 1.5 2.0 1.4 1.2 0.7 1.7 ASEANASEAN+4 6.7 22.2 12.2 36.8 9.7 40.1 9.5 19.1 22.9 52.6 12.2 34.5 5.0 19.7 1.6 6.8 4.3 18.9 USA 17.7 17.8 11.0 11.8 10.9 15.0 ASEANASEAN+4 9.9 34.9 12.2 35.5 8.5 41.7 7.9 23.1 21.6 51.1 12.9 38.7 4.5 31.2 1.8 10.0 4.6 25.3 Usa 7.2 10.4 8.9 7.8 7.7 8.3 6.5 17.9 4.6 55 11.7 EU12 14.7 10.3 8.5 16.2 8.8 11.7 15.5 63.9 RoW 45.4 35.2 40.3 52.9 27.7 38.7 64.8 22.8 63.2 World 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 EU12 9.6 7.3 7.5 10.4 8.1 8.6 13.1 60.6 RoW 48.3 46.8 42.0 58.7 33.1 44.4 55.8 24.8 63.0 World 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Professor Stefan Collignon The need to defuse excessive appreciation pressure for the euro China bashing China manipulates its currency to gain unfair trade advantages China should revalue US need more exchange rate flexibility, not Asia Appreciating RMB would kill growth in Asia Demand from China for European exports is 3 times as important as the exchange rate 56 Professor Stefan Collignon An alternative proposal Burden sharing for global adjustment. Asia switches its peg from the dollar to a basket of euros and Japanese yen Maintain competitive exchange rate to keep growth going The two main economies 25 % of Chinese exports against 18% of USA 23.% of Chinese imports against 7% of USA A collective switch would maintain the stability of Asian monetary system See Europe’s experience 57 Professor Stefan Collignon An alternative proposal The Euro Area and Japan cooperate to minimize exchange rate volatility Create a stable environment for investment Japan as leading FDI provider for Asia Stronger trade and investment relations between Europe and Japan would foster growth 58 Professor Stefan Collignon Reserve management Asian surplus countries place an increasing share of their reserves in European and Japanese bonds A gradual shift: old stock remain in USD, new reserves are placed in euro and yen thereby stimulating financial markets in Europe and Asia Kickstart for higher domestic demand in these two economies due to wealth effects Supporting exports from China and other emerging Asian economies 59 Professor Stefan Collignon Reserve management The basket could become a vehicle for a future international reserve currency The basket composition could change over time Moving away from the Triffin dilemma The basket is managed by more than 1 country Learning from the ECU experience? PBC governor Zhou Xiaohuan : a new definition of SDRs? 60 Professor Stefan Collignon Policy implementation a unilateral re-peg? Need for exchange rate stability within the basket Coordination should be discussed in the G20 but the initiative would best be taken by a reduced G4 and ASEM. The sleeping beauty Europe could be kissed awake by Asia The Treaty foresees the possibility of coordinated exchange rate management. But is Europe capable to govern itself? 61 Professor Stefan Collignon 6. European economic governance. Th 62 Professor Stefan Collignon Rapporto Europa 2010 1st December 2009, the Lisbon Treaty entered into force. The economic governance innovations contained in it are only of marginal impact and appear far from providing the answers that are required to overcome the economic crisis quickly. Recognition of Euro-group (art. 136) weak in terms of contents and procedures relating to the Broad Economic Policy Guidelines (BEPG) (art. 121 TEU) 63 Professor Stefan Collignon Rapporto Europa 2010 First application: European Stabilisation Mechanism (9. May 2010) Commission now wishes to keep tighter control over member state finances European semester Submit financial programs in advance 64 Professor Stefan Collignon Rapporto Europa 2010 Conclusion: What Europe needs Better governance No diktat Efficiency in administrating our common goods Freedom from domination Democratic legitimacy Equality among European citizens 65 Professor Stefan Collignon Rapporto Europa 2010 Grazie! Viva la Repubblica europea! 66