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H.-W. Sinn Austerity in Europe Hans-Werner Sinn January 2014 H.-W. Sinn Summary of the argument H.-W. Sinn Austerity of a currency union as a whole versus Austerity of a sub-region within a currency union H.-W. Sinn • The Eurozone needs austerity in the south to realign relative prices • Austerity comes from markets; policy softens the budget constraints • Exits may be better than austerity H.-W. Sinn Hans-Werner Sinn CESifo Munich The Euro Trap On Bursting Bubbles, Budgets and Beliefs H.-W. Sinn, „Austerity, Growth and Inflation: Remarks on the Eurozone’s Unresolved Competitiveness Problem,“ The World Economy 36, 2013 2014 Oxford University Press H.-W. Sinn The bubble H.-W. Sinn Net yields for 10-year government bonds 40 % Irrevocably fixed conversion rates 35 Summit of EU governments in Madrid 30 25 20 15 10 5 Germany 0 1985 1990 Source: Thomson Reuters Datastream. 1995 2000 2005 2010 Greece Portugal Spain Italy Ireland Belgium France 2013 December 2013 H.-W. Sinn Net yields for 10-year government bonds 40 % Irrevocably fixed conversion rates 35 Summit of EU governments in Madrid 30 25 20 15 10 5 Germany 0 1985 1990 Source: Thomson Reuters Datastream. 1995 2000 2005 2010 Greece Portugal Spain Italy Ireland Belgium France 2013 December 2013 H.-W. Sinn Unemployment rates in Europe % 30 Greece Spain 23 Portugal Cyprus 16 Ireland Italy 9 2 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Eurostat; December 2013. H.-W. Sinn Youth unemployment 70 % (< 25 years) 60 Spain Greece 50 Italy Portugal 40 30 Ireland 20 Cyprus 10 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Eurostat, December 2013. H.-W. Sinn Industrial production 130 2008Q1=100 Emerging and developing economies 120 110 Ireland 100 Advanced economies 90 Portugal 80 Italy Spain Greece 70 60 00 01 02 03 04 05 06 07 08 09 10 11 12 Source: Eurostat; OECD; CPB Netherlands Bureau for Economic Policy Analysis, World Trade Monitor. 13 H.-W. Sinn The realignment problem H.-W. Sinn Real exchange rates (GDP deflator relative to rest of euro area) & necessary realignment according to Goldman Sachs Q3/2008=100 140 120 Germany Lehman France 100 Portugal Greece Ireland Spain 80 Italy Italy 60 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Long run target H.-W. Sinn Four dismal options 1. Transfer union H.-W. Sinn Four dismal options 1. Transfer union 2. Deflation in the periphery (austerity) H.-W. Sinn Four dismal options 1. Transfer union 2. Deflation in the periphery (austerity) 3. Inflation in the core H.-W. Sinn Four dismal options 1. Transfer union 2. Deflation in the periphery (austerity) 3. Inflation in the core 4. Exits H.-W. Sinn Austerity or soft budget constraints? H.-W. Sinn Bail out with the printing press: Non-investment grade collateral for ECB refinancing credit H.-W. Sinn Inside money and outside money Monetary base Eurozone % 100 90 80 Inside money non-GIPSIC Monetary base non-GIPSIC 81% 70 Base money originating in GIPSIC 60 50 Outside money ( GIPSIC Target balance) 55% 40 30 26% Monetary base GIPSIC 20 10 0 2007 2008 2009 2010 2011 2012 2013 H.-W. Sinn Lending funds to euro countries (Billion euros) Paid-out to date Cyprus (ESM) Spain (ESM) Portugal (EFSM, EFSF, IMF) Ireland (EFSM, EFSF, IMF) 5 41 72 61 Greece (euro countries, EFSF, IMF) 213 Purchases of GIPSIC government bonds by the central banks of the other euro countries* 116 Target liabilities* (GIPSIC) 639 Claims related to the under-proportionate issuance of banknotes ) 392 698 (36%) Parliaments (64%) ECB 56 1090 * Updated 13 December 2013 H.-W. Sinn Soft budget constraints = abolishment of risk premia ex ante = credit bubbles and overheating = lack of reforms and realignment efforts ex post H.-W. Sinn Soft budget constraints are dangerous Harold James, Princeton: The Hamiltonian scheme of federal finance did not guarantee a peaceful commonwealth. “In fact the fiscal union proved to be explosive rather than cement.” H.-W. Sinn Unsustainable debt H.-W. Sinn Debt sustainability requires real devaluations, but real devaluations increase the debt-to-GDP ratios. H.-W. Sinn Actual and hypothetical public debt-to-GDP ratios ( 2012, % ) Official Official public public debt at debt competitive GDP prices 157 197 211 294 Ireland 118 114 Portugal Spain 124 84 173 118 Italy 127 141 Greece NB: without haircut H.-W. Sinn The way out H.-W. Sinn Three basic measures to rescue the EU and the euro 1. Debt conference to forgive part of the public debt, the bank debt and the Target debt 2. Temporary exits of severely uncompetitive countries 3. Harder local budget constraints for central banks (settlement of new Target balances, internal gold standard like US until 1975) H.-W. Sinn A “breathing currency union” placed between Bretton Woods and the dollar until the United States of Europe is founded H.-W. Sinn H.-W. Sinn