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______________________________________________________________________ The ECB and its Watchers Frankfurt, 9 July 2010 Imbalances and Sustainability in the euro area Lorenzo Bini Smaghi European Central Bank ______________________________________________________________________ EUROPEAN CENTRAL BANK Up until 6 months ago ______________________________________________________________________ The euro was celebrated for its successes ______________________________________________________________________ 2 EUROPEAN CENTRAL BANK In particular, over its first 11 years and a half ______________________________________________________________________ The euro delivered price stability The average inflation rate has been 1.98% ______________________________________________________________________ 3 EUROPEAN CENTRAL BANK Euro area growth ______________________________________________________________________ Has been slightly slower than in the US 125 US 120 EA 115 110 105 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 100 Real GDP (1999=100). Source: IMF and IMF projections (WEO, April 2010) ______________________________________________________________________ 4 EUROPEAN CENTRAL BANK But in per capita term ______________________________________________________________________ Growth has been similar to the US 114 112 US 110 EA 108 106 104 102 100 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Per capita GDP (1999=100). Source: IMF and IMF projections (WEO, April 2010) ______________________________________________________________________ 5 EUROPEAN CENTRAL BANK Strong convergence ______________________________________________________________________ Of most lower income euro area countries 100 ES 90 GR CY 80 SI MT 70 PT SK 60 50 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Per capita GDP in PPS (euro area = 100) Source: EC. ______________________________________________________________________ 6 EUROPEAN CENTRAL BANK But there have been divergences ______________________________________________________________________ In the performance of euro area countries These divergences have been pointed out on various occasions by the ECB e.g.: Monthly Bulletin, April 2007, “Output growth differentials in the euro area: sources and implications”, pages 73 - 86 Monthly Bulletin, November 2008, “Monitoring labour cost developments in the euro area countries”, pages 76-86 ______________________________________________________________________ 7 EUROPEAN CENTRAL BANK Divergences ______________________________________________________________________ In the rate of growth of GDP 160 IE GR 150 ES 140 FI FR 130 DE 120 PT IT 110 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 100 Real GDP Developments (1999=100) Source: IMF and IMF projections (WEO, May 2010) for real GDP. ______________________________________________________________________ 8 EUROPEAN CENTRAL BANK Which were not aligned with ______________________________________________________________________ The rate of growth of domestic demand Net trade Domestic demand Stocks GDP FI ES 6 5 4 3 2 1 0 -1 -2 IT DE PT EA FR BE AT NL GR LU IE Real GDP and demand composition (average 1999-2008) Source: EC Notes: countries ranked in ascending order according to real GDP growth. ______________________________________________________________________ 9 EUROPEAN CENTRAL BANK Fuelled by ______________________________________________________________________ Excessive credit growth in some countries…and very slow in others 19 17 15 13 11 9 7 5 3 1 DE BE AT EA FR IT NL LU FI PT ES GR IE Loans to the private sector (average 1999-2008) Source: ECB ______________________________________________________________________ 10 EUROPEAN CENTRAL BANK In particular in the housing market ______________________________________________________________________ Of some countries Construction investment in % of GDP Cumulated changes in real house prices 100 21 90 Ireland 19 80 17 70 Spain 60 Spain 15 Ire land 50 40 13 30 11 2008 2006 2004 2002 2000 2008 2002 2004 2006 2000 1994 1996 1998 1992 0 1988 1990 7 1982 1984 1986 10 1980 9 1998 20 Source: Own computation on EC, ECB. Real house prices deflated with HICP ______________________________________________________________________ 11 EUROPEAN CENTRAL BANK And divergences in cost competitiveness ______________________________________________________________________ Driven by excess growth of wages with respect to productivity 135 GR 130 IT 125 ES IE PT 120 115 EA 110 105 DE 100 95 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Competitiveness calculated on the basis of Unit Labour Costs, relative to Germany. 2000Q4= 100 Source: Eurostat. Note: Quarterly data up to 2010 Q1 for Germany and Spain, 2009Q3 for Ireland and 2009Q4 for the other countries, except for Portugal which is based on annual data (up to 2009). Note: The ULC indices are set to 100 in the last quarter before the euro area accession of Greece. The ULC developments presented for Greece and Portugal might differ from the calculations made by the National Central Banks. The quarterly pattern in Greek ULC is affected by substantial volatility in quarterly compensation of employees figures. ______________________________________________________________________ 12 EUROPEAN CENTRAL BANK Producing deficits ______________________________________________________________________ In the current account positions of some countries 5 0 IE ES -5 PT -10 GR -15 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Current account in % of GDP. Source: EC. Note: 2010 is forecast (EC May 2010) ______________________________________________________________________ 13 EUROPEAN CENTRAL BANK And surpluses ______________________________________________________________________ In the current account position of other countries 10 NL DE 5 AT FI 0 -5 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 -10 Current account in % of GDP. Source: EC. Note: 2010 is forecast (EC May 2010) ______________________________________________________________________ 14 EUROPEAN CENTRAL BANK Producing divergent net asset positions ______________________________________________________________________ And significant external indebtedness in persistent deficit countries 40 20 0 -20 -40 -60 -80 -100 BE NL DE FI FR AT EA IT SI SK IE ES GR PT Net foreign assets / liabilities in % of GDP (2008). Source: EC. ______________________________________________________________________ 15 EUROPEAN CENTRAL BANK As a result of the global crisis ______________________________________________________________________ The imbalances accumulated within the euro area have given rise to broader divergences, affecting the relative price of various risks prevailing in the member states, in particular sovereign risk but also bank solvency ______________________________________________________________________ 16 EUROPEAN CENTRAL BANK The challenge going forward ______________________________________________________________________ For all euro area countries is to: • Regain control over budgetary policy • Achieve stronger and more balanced growth For the euro area as a whole: • Achieve a better institutional framework that ensures a better prevention and crisis management for the future ______________________________________________________________________ 17 EUROPEAN CENTRAL BANK The fiscal adjustment has started ______________________________________________________________________ In all euro area countries 160 GR 140 IT 120 PT 100 FR IE 80 DE 60 ES 40 FI 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 20 Public Debt in % of GDP Source: EC and 2010 Stability Programmes targets for Government debt. For IT available up to 2012, for IE up to 2014 and for the remaining countries up to 2013. For GR EC/ECB/IMF programme ______________________________________________________________________ 18 EUROPEAN CENTRAL BANK The task will be daunting ______________________________________________________________________ not only in the euro area…. Over 5 years Adjustment 25 20 15 10 5 0 IT DE AT NL PT GR FR ES US JP UK IE Adjustment of the primary balance required to stabilise the public debt/GDP ratio at the 2007 level Source: Cecchetti, Mohanty and Zampolli (2010), “The future of public debt: prospects and implications” BIS working paper n.300. Notes: The purple bars indicate the average primary balance required to stabilise the public debt/GDP ratio at the 2007 level over 5 years. The yellow bars indicate the adjustment from primary balance in 2011 to the target average primary balance. Starting point: 2011; consolidation from 2012. _____________________________________________________________________ 19 EUROPEAN CENTRAL BANK And can hardly be achieved ______________________________________________________________________ Unless euro area (and other) countries implement strategies aimed at stronger and more balanced growth ______________________________________________________________________ 20 EUROPEAN CENTRAL BANK Given the existing imbalances ______________________________________________________________________ The recipe differs across countries Low growth CA Surplus CA Deficit High growth DE FI, LU, NL, BE, AT IT, PT ES, GR, IE (SL,SK,CY) ______________________________________________________________________ 21 EUROPEAN CENTRAL BANK Countries with CA deficits ______________________________________________________________________ Countries with persistent and deteriorating external deficits should adopt measures to: 1. Become more competitive 2. Increase net private savings 3. Rebalance sources of growth towards tradable ______________________________________________________________________ 22 EUROPEAN CENTRAL BANK Countries with CA deficits ______________________________________________________________________ The strategy requires: - Wages increasing less than productivity - Labour market reforms (contracts at firm level) - Strengthening of the financial sector (to allow for de-leveraging) - Reallocation of resources to the high productivity growth sectors leading to a change of the structure of the export sector ______________________________________________________________________ 23 EUROPEAN CENTRAL BANK Countries with CA deficit ______________________________________________________________________ Need to upgrade the technological content of exports 50% 45% 40% 35% 30% 25% 20% 15% PT ES IT GR AT EA FI DE IE BE NL FR Trade structure - Degree of overlap in export specialisation between selected economies and China (average overlap over 2005-2008). Source: CHELEM and ECB calculations. Note: The degree of overlap in export specialisation is determined by comparing Balassa Indices for 72 industries. ______________________________________________________________________ 24 EUROPEAN CENTRAL BANK Countries with CA surplus ______________________________________________________________________ For countries with persistent and external surplus, the recipe cannot be doing the opposite of what the countries with CA deficit are expected to do i.e.: - Become less competitive - Reduce domestic savings ______________________________________________________________________ 25 EUROPEAN CENTRAL BANK Impact of other countries’ adjustment ______________________________________________________________________ As countries with CA deficit are expected to grow less over the next few years and will aim at regaining competitiveness, there is a risk that demand for net exports for countries with a CA surplus will decrease: “Germany will be less German if the other euro area countries start behaving like Germany” However, markets outside the euro area are likely to grow more than within the euro area. Competitiveness with the rest of the world is essential ______________________________________________________________________ 26 EUROPEAN CENTRAL BANK Germany Directions of trade ______________________________________________________________________ Growing trade with Emerging economies 12.0 Intra 10.0 Extra 8.0 6.0 4.0 Russia China DK/SE CH US EU-8 Emerg. countries IE GR PT ES BE AT IT NL FR 0.0 UK 2.0 German exports towards larger trading partners in % of total exports in 2008. Source: IMF. Emerging and developing countries excludes EU8, China and Russia. It includes other Eastern Europe, other CIS, other developing Asia, Middle East and North Africa, Western Hemisphere. ______________________________________________________________________ 27 EUROPEAN CENTRAL BANK Countries with CA surplus ______________________________________________________________________ On the other hand, having a successful export sector and a trade surplus is not necessarily a guarantee of high growth of GDP, employment and income Why? • The tradable sector might not be sufficiently large to pull the rest of the economy • The tradable sector absorbs a relatively minor share of employment • Limited spillovers to the non tradable sector due to excessive regulation/protection in the domestic market • Lack of incentives for private domestic investment ______________________________________________________________________ 28 EUROPEAN CENTRAL BANK Strong export growth ______________________________________________________________________ Does not necessarily imply strong GDP growth Exports growth 8 GDP growth 7 6 5 4 3 2 1 0 IE DE FI AT GR NL EA ES BE PT FR IT Export and GDP growth (average growth 1999-2008). Source: EC Notes: countries ranked in ascending order according to exports growth. ______________________________________________________________________ 29 EUROPEAN CENTRAL BANK Strong export growth ______________________________________________________________________ Does not necessarily imply strong investment growth Exports growth 8 Investment growth 7 6 5 4 3 2 1 0 IE DE FI AT GR NL EA ES BE PT FR IT Export and investment growth (average growth 1999-2008). Source: EC Notes: countries ranked in ascending order according to exports growth. ______________________________________________________________________ 30 EUROPEAN CENTRAL BANK Strong export growth ______________________________________________________________________ Does not necessarily imply strong employment growth Exports growth Employment growth 8 7 6 5 4 3 2 1 0 IE DE FI AT GR NL EA ES BE PT FR IT Export and employment growth (average growth 1999-2008). Source: EC Notes: countries ranked in ascending order according to exports growth. ______________________________________________________________________ 31 EUROPEAN CENTRAL BANK Strong export growth ______________________________________________________________________ Does not necessarily imply strong income growth Exports growth Real compensation growth in manufacturing 8 7 6 5 4 3 2 1 0 IE DE FI AT GR NL EA ES BE PT FR IT Export and investment growth (average growth 1999-2008). Source: EC Notes: countries ranked in ascending order according to exports growth. Real compensation deflated with HICP. For PT and EA, 1999-2006 average is shown for real compensation growth ______________________________________________________________________ 32 EUROPEAN CENTRAL BANK Strong export growth ______________________________________________________________________ Is achieved through high productivity growth, but is not sufficient to deliver employment growth Employment Productivity GDP 6 5 4 3 2 1 0 -1 -2 IT DE PT EA FR BE AT NL FI ES GR LU IE Real GDP and supply composition (average growth 1999-2008). Source: EC Notes: countries ranked in ascending order according to real GDP growth. ______________________________________________________________________ 33 EUROPEAN CENTRAL BANK Employment ______________________________________________________________________ Is bound to grow mainly in the services sector Germany: Sector shares in total employment (in percent) Manufacturing Services 21 Construction 74 8 73 20 7 72 71 19 6 70 5 69 18 68 4 67 17 66 2000 2007 2009 3 2000 2007 2009 2000 2007 2009 ______________________________________________________________________ Source: Eurostat. 34 EUROPEAN CENTRAL BANK But the Service sector ______________________________________________________________________ Is highly regulated (professional services) 3.5 3 2.5 2 1.5 1 0.5 0 IT DE GR AT PT EA BE FR ES NL US FI IE UK Product Market Regulation (PMR) index in professional services (the professional services indicators cover entry and conduct regulations in the legal, accounting, engineering, and architecture professions, 2008). Source: OECD . Note: A higher figure means higher regulation. PMR index ranges from 0 to 6. ______________________________________________________________________ 35 EUROPEAN CENTRAL BANK Countries with CA surplus ______________________________________________________________________ Stronger and sustainable growth cannot be achieved only through continuous improvements in the competitiveness of the tradable sector but requires increasing growth potential in the non tradable sector, in particular services ______________________________________________________________________ 36 EUROPEAN CENTRAL BANK The above tasks ______________________________________________________________________ Are mainly the responsibility of the member states, because they involve competences which are still national (taxation policy, labour markets, product markets, education, research and development…) We should avoid repeating the mistakes of the Lisbon Agenda, which creates EU objectives without providing the EU the instruments to achieve these objectives But the EU/EA institutional framework needs to be strengthen because problems in some member states may affect the other member states ______________________________________________________________________ 37 EUROPEAN CENTRAL BANK Principles for reform: “three don’t” ______________________________________________________________________ 1. Don’t assume that all (agents/governments/markets) have learned the lesson from this crisis: Stronger surveillance and crisis prevention 2. Don’t assume that there will be no more crises: Crisis management 3. Don’t assume that there are “easy solutions” to complex problems (“orderly debt restructuring”; “expulsion”…) ______________________________________________________________________ 38 EUROPEAN CENTRAL BANK ECB contribution to the Van Rompuy TF: ______________________________________________________________________ 1. strengthening surveillance over budgetary policies and more effective prevention/correction of excessive deficits and debts 2. improving framework for competitiveness surveillance and the correction of economic imbalances via a traffic light system 3. designing an appropriate euro area framework for crisis management ______________________________________________________________________ 39 EUROPEAN CENTRAL BANK Differences with Commission proposals ______________________________________________________________________ ECB thinks the Commission should go further: Clear and agreed triggers to detect vulnerabilities and define surveillance needs Surveillance missions by COM, ECB Adoption of a “corrective policy programme” Strengthening fiscal surveillance Quasi-automatic initiation of EDP procedure Independent national fiscal institutions Relying more on incentives and sanctions Reversal of voting majorities in EDP Introduce sanctions for persistent imbalances ______________________________________________________________________ 40 EUROPEAN CENTRAL BANK Strengthen the E of EMU ______________________________________________________________________ Complete the Single Market (Monti report): • Removing barriers to trade and to cross-border activities, especially in the service sector (full implementation of the service directive) • Accelerating the uptake of new technologies – foster a Digital single market • Promoting a common energy market green growth) (competition, • Fostering a single market for capital and financial services • Eliminating business investment restrictions ______________________________________________________________________ 41 EUROPEAN CENTRAL BANK A priority: the service directive ______________________________________________________________________ The service provisions in the EU is badly fragmented (only 20% of services provided in the EU have a cross-border dimension) A full implementation of the services directive would result in an increase in growth potential of 0.6-1.5% of EU GDP ______________________________________________________________________ 42 EUROPEAN CENTRAL BANK Conclusions ______________________________________________________________________ Will it work? The crisis has triggered a mood for change. Many governments are now embarking on fiscal consolidation strategies There is awareness that fiscal discipline has to be supported by ambitious programmes of structural reforms to strengthen growth potential ______________________________________________________________________ 43 EUROPEAN CENTRAL BANK Example (I): labour market reform in Spain ______________________________________________________________________ In June 2010, the Spanish government has approved a reform of the labour market: - Two main objectives: reduce the large proportion of temporary contracts (so called duality of the labour market) and improve the flexibility of firms’ labour conditions to economic circumstances ______________________________________________________________________ 44 EUROPEAN CENTRAL BANK Example (II): structural reforms in Greece ______________________________________________________________________ • The law on the Financial Stability Fund (FSF) was submitted to Parliament in June. The FSF will contribute to safeguarding financial sector stability by providing equity support to Greek banks should they face solvency problems. • Newly-created independent Hellenic Authority (strengthening data reliability) Statistics • Labour market reforms include changes to the framework for wage bargaining, new legislation on minimum wages, reduced severance payments and legislation to increase the flexibility of working hours and part-time work ______________________________________________________________________ 45 EUROPEAN CENTRAL BANK The experience of the last few months ______________________________________________________________________ Shows that Countries reacted late, and under the pressure of markets But they reacted Showing the willingness to do what is needed to overcome the crisis, being full members of the euro area ______________________________________________________________________ 46 EUROPEAN CENTRAL BANK Indeed ______________________________________________________________________ This is not a crisis of the euro, it’s a crisis of advanced countries’ ability to adapt to a changing global economy Membership of the euro has for long delayed the recognition of the problem But the euro exposed countries earlier to the need to adjust ______________________________________________________________________ 47 EUROPEAN CENTRAL BANK Ultimately ______________________________________________________________________ The challenges for advanced countries can be addressed only through: - budgetary policies - structural policies The earlier countries recognize this, the sooner they will implement the right policies And the stronger they will get out of the crisis ______________________________________________________________________ 48 EUROPEAN CENTRAL BANK ______________________________________________________________________ Thank you for your attention ______________________________________________________________________ 49 EUROPEAN CENTRAL BANK ______________________________________________________________________ Background slides ______________________________________________________________________ 50 EUROPEAN CENTRAL BANK Competitiveness surveillance ______________________________________________________________________ Traffic light system Focus: Differentiate intensity of problems competitiveness surveillance and Elements: Small number of indicators in order to assess which Member States would require no specific surveillance (green), standard surveillance (yellow) or intense surveillance (red) ______________________________________________________________________ 51 EUROPEAN CENTRAL BANK Fiscal framework (I): Euro area dimension ______________________________________________________________________ Enhancing the euro area dimension of fiscal policy surveillance by: strengthening ex ante discussions in the Eurogroup (early review of national budgetary plans by Eurogroup; issuance of precise fiscal policy guidelines) making the Eurogroup the guardian of fiscal sustainability (Eurogroup to review how common guidelines have been incorporated into national budgets; deviations from guidelines to engender warnings from Commission, triggering comply-or-explain approach) 52 Fiscal framework (II): Better implementation ______________________________________________________________________ Strengthening the implementation of rules and procedures by: increasing the quasi-automaticity of the EDP procedures and steps (initiation of EDP quasi-automatically once the 3% deficit or the 60% debt criterion are breached: reverses ‘burden of proof’ - Council needs to decide explicitly to stop escalation of procedure) the quasi-automatic initiation of sanctions (sanctions/means to encourage compliance to be applied earlier, or if country fails to correct excessive deficit by the given deadline) 53 Fiscal framework (III): Make use of sanctions ______________________________________________________________________ Strengthening the implementation of sanctions in case of non-compliance by: earlier application of sanctions, already under the preventive arm, and in any case for excessive deficits (already under the preventive arm, and in any case for excessive deficits; with increasing severity and duration of fiscal imbalance, scale of sanctions to be increased) broadening the scope of application of sanctions (including for excessive debt ratios and in cases where progress towards the medium-term budgetary objective is insufficient) 54 Fiscal framework (IV): Broader set of sanctions ______________________________________________________________________ A wider spectrum of sanctions and creation of new types of means to encourage compliance: financial sanctions (e.g. reduced access to EU funds and transfers) non-financial sanctions (limitation or suspension of voting rights) procedural sanctions (detailed specific adjustment programmes; more stringent reporting requirements; on-site monitoring via special missions by Commission, in liaison with the ECB; requirement to seek prior Council consent for national budgetary measures or borrowing) 55 Fiscal framework (V): Leaner surveillance ______________________________________________________________________ Leaner and more effective fiscal surveillance by: differentiating the surveillance processes applied to Member States according to their fiscal performance (focus on most critical cases; lighter surveillance for well-performers) assigning greater responsibilities to the Commission in making recommendations/proposals (reversal of voting majorities in the Council (e.g. sanction deemed adopted unless opposed by the qualified majority); Commission to make proposals rather than recommendations; strengthening Economics Commissioner inside the collège; Commission to assess individual fiscal policy measures and possibly publish assessment) measures to enhance the quality of statistics (enhance powers of Eurostat, e.g. to conduct audits) 56 Fiscal framework (VI): national link ______________________________________________________________________ Enhancing national fiscal frameworks by: a strengthening of national legislation related to national fiscal rules and institutions (consistent with the provisions of the EU fiscal framework, to anchor SGP rules in national law) establishment in all Member States of independent budget offices or fiscal monitoring institutions (with the task of monitoring that objectives of SGP and national rules are fully respected) 57 The euro area has started the adjustment ______________________________________________________________________ On the fiscal side 100 US 90 EA 80 70 60 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 50 Public debt in % of GDP Sources: IMF and IMF projections (WEO, April 2010) for US and aggregation of Stability Programmes for EA. The US projections are based on the 2010 administration’s budget and the U.S. Congressional Budget Office’s budget outlook for 2010–19. These projections include the $787 billion stimulus package under the American Recovery and Reinvestment Act of 2009. They are adjusted for differences in forecasts of (1) macroeconomic and financial variables, (2) the timing of stimulus disbursements, (3) additional costs to support financial institutions and government-sponsored enterprises, and (4) the effect of financial sector support on government-owned financial assets. ______________________________________________________________________ 58 EUROPEAN CENTRAL BANK