The euro crisis:
What did we know?
What have we learnt?
Oxonia,
22 February 2012
Jean Pisani-Ferry (Bruegel)
•
•
•
•
Extensive research on EMU in the
1990s
Many advance warnings from
academia about euro risks
In many respects the crisis was
foretold
However not in all
Goal:
 Find out what could be expected and
what have been genuine surprises
 Discuss policy lessons
Jonung and Drea’s count of US
academic papers on the euro
Outline
1. Non-surprises
2. Surprises
3. Implications
1. Non-surprises
1. Eurozone not an OCA
–
Bayoumi-Eichengreen
2. Not an endogeneous OCA
–
Krugman’s lessons of Massachussets for EMU
3. One-size-fits-all monetary policy destabilising
–
Walters critique
4. Long-lasting real exchange rate cycles
-
Blanchard-Muet
5. Sovereign solvency crises more likely in EMU
–
De Grauwe
6. Inadequate pricing of sovereign risk
–
Buiter-Sibert
7. Incentives to fiscal indiscipline
–
Beetsma, Uhlig
8. Design/enforcement problems of SGP
–
Eichengreen-Wyplosz
9. Weak provisions for coordination of bank supervision/crisis resolution
–
Lamfalussy, Goodhart
What did policymakers do to address these risks?
Some:
• SGP
• Surveillance framework
But not much...
• Nominal rather than real entry criteria
• No real efforts to foster single market integration
• Only a few states gave thoughts to ways of controlling divergence,
weak implementation of surveillance provisions
• Limited efforts to ensure wage/price flexibility
• No appetite for integration of supervisory policies
• No crisis management mechanisms
Not only the EU failed to anticipate problems
... also the IMF
• Country-by-country approach
• “Europe is different” mindset
• Institutional mimicry
Why were warnings ignored?
•
Predominance of (high) politics
•
•
•
Implementation problems
•
•
Euro choice
Entry highly politicised choice
Hard to define undisputable entry criteria based on OCA
Adjustment and integration fatigue
•
•
•
•
No appetite for further reforms
No appetite for surveillance
No appetite for further transfer of competence
Not even for single market enforcement
Hence, complacent reading of the literature
•
•
•
Endogenous price flexibility assumed
Endogenous OCAs taken for likely
Solvency crises not considered a real risk
 In the end, incoherence between euro and other dimensions of integration
2. Surprises
1. Current-account crises
2. Correlation of banking crises and sovereign crises and the
consequences of not having a LLR for sovereigns
A. Current-account crises
Target balances : North vs. South, €bn
•
Evidence of currentaccount crises within euro
area:
•
Indirect: sovereign spreads
correlated to NFA position
•
Direct: Target 2 data
Source: Bruegel
Evidence of Sudden Stops
(Merler and Pisani-Ferry, work in progress)
•
Calvo methodology to identify sudden stops episodes
•
•
•
One observation at least with yoy capital inflows 2 standard deviations below mean
Starts: first observation with delta (yoy capital inflows) 1 SD below mean
Ends: first observation with delta (yoy capital inflows) exceeds 1 SD below mean
(reversion)
•
Applied to monthly BOP data
•
Preliminary results:
•
•
•
Evidence of SS episodes in Southern Europe
First major episode Spring 2010 (before and around first Greek programme)
Second major episode Summer-Autumn 2011
How can current accounts matter?
•
•
Old research: current accounts don’t matter within a country, hence they don’t
matter in a MU. See Ingram (1973): “The traditional concept of a deficit or a
surplus in a member nation’s balance-of-payments becomes blurred.. With a
common currency, no individual country can be exposed to speculative attacks”
Not seriously challenged by later research. Questions about reasons for CA
imbalances (Blanchard-Giavazzi) but general belief that euro was eliminating
Feldstein-Horioka
Practical consequences:
• EU BOP assistance (Art. 143) reserved to countries outside the euro
• No serious attempt to exercise BOP surveillance in the 2000s
Why do they matter?
• Mobility?
• Banks!
B. Correlation of banking crises and sovereign crises
•
•
Known stylised fact: banking crises and BOP crises are correlated
In the euro area also..
•
•
Was foreseen (Eichengreen Wyplosz 1998)
But was not seen that would be magnified by the absence of a lender of
last resort for sovereigns
•
•
Governments treated financial specialisation like any other
specialisation
State debt was assumed safe
•
Results is unexpected “fragility” (De Grauwe 2011)
200 200 100 100 0 0 14.12.11 14.10.11 14.08.11 14.06.11 14.04.11 14.02.11 14.12.10 14.10.10 14.08.10 14.06.10 14.04.10 Spain
14.02.10 14.12.09 14.10.09 sovereign 14.08.09 300 14.06.09 400 14.04.09 400 14.02.09 500 14.12.08 SPAIN 5years CDS premia on sovereign and banks (daily data) 14.10.08 500 14.08.08 600 14.06.08 600 14.04.08 700 14.02.08 700 14.12.07 14.12.11 14.10.11 14.08.11 14.06.11 14.04.11 14.02.11 14.12.10 14.10.10 14.08.10 14.06.10 14.04.10 14.02.10 14.12.09 14.10.09 14.08.09 14.06.09 14.04.09 14.02.09 14.12.08 14.10.08 14.08.08 14.06.08 14.04.08 14.02.08 14.12.07 Correlation of sovereign and banking spreads
Italy
ITALY 5years CDS premia on sovereign and banks (daily data) banks 300 sovereign banks Why? Sovereign exposure to banks is considerable...
Total bank assets to government tax receipts ratio, 2010
50.00
45.00
40.00
35.00
30.00
25.00
20.00
15.00
10.00
5.00
0.00
Source: Eurostat, ECB, Bruegel calculations
..and banks exhibit strong home bias in holding of govt bonds
Share of own sovereign’s bonds
in EA government bonds held by banks, 2010
Home Bias (Gross Exposure) 100 90 80 70 60 50 40 30 20 10 0 GR MT ES PT IE IT DE AT SI LU FI BE NL FR CY Share domes c exp. in overall EA sovereign exp. Share of country in total EA General Gov. debt Share of country in total EA Central Gov. debt Source: EBA, EUROSTAT, Bruegel calculations
Correlation of sovereign and bank CDSs
Sovereign CDSs and bank CDSs, 1/2008 to 1/2012
US
US ‐ 5y banks and sovereign CDS Index 120 80 R² = 0.05421 60 40 20 SPAIN 450 0 0 100 200 300 400 500 R² = 0.88499 600 400 Banks CDS Index 5y 350 jan10‐dec10 jan11‐jan12 jan08‐dec09 5y Sovereign CDS Sovereign CDS 5y 100 300 250 200 150 R² = 0.85021 100 50 0 0 100 200 300 avg. 5y banks' CDS Source: Bruegel based on Thomson Reuters data
jan08‐dec10 jan11‐jan12 400 500 600 50 40 0 GREECE 70 Eurostat reveals GR false sta s cs na onal banks 30 non‐residents 20 20 10 10 0 1997_4 1998_2 1998_4 1999_2 1999_4 2000_2 2000_4 2001_2 2001_4 2002_2 2002_4 2003_2 2003_4 2004_2 2004_4 2005_2 2005_4 2006_2 2006_4 2007_2 2007_4 2008_2 2008_4 2009_2 2009_4 2010_2 2010_4 2011_2 80 0 1997_4 1998_2 1998_4 1999_2 1999_4 2000_2 2000_4 2001_2 2001_4 2002_2 2002_4 2003_2 2003_4 2004_2 2004_4 2005_2 2005_4 2006_2 2006_4 2007_2 2007_4 2008_2 2008_4 2009_2 2009_4 2010_2 2010_4 2011_2 60 1997_4 1998_2 1998_4 1999_2 1999_4 2000_2 2000_4 2001_2 2001_4 2002_2 2002_4 2003_2 2003_4 2004_2 2004_4 2005_2 2005_4 2006_2 2006_4 2007_2 2007_4 2008_2 2008_4 2009_2 2009_4 2010_2 2010_4 2011_2 Furthermore banks home bias has increased (even before 3-y LTRO)
Shares of domestic banks and non-residents in holding of govt bonds, 1998-2011
80 70 SPAIN 60 Lehmann Euro 50 40 na onal banks 30 non‐residents 80 70 GERMANY 60 Greek Programme 50 40 na onal banks 30 non‐residents 20 10 Source: Bruegel based on national data
Source: Merler and Pisani-Ferry (2012)
C. The new impossible trinity
National banking systems
Strict no-monetary
financing
Financial union
No co-responsibility
over public debt
The no-coresponsibility principle
•
Government in the EA are individually responsible for the debt they have issued
(No bail-out rule)
Art. 125: “The Union shall not be liable for or assume the commitments of
central governments, regional, local or other public authorities, other bodies
governed by public law, or public undertakings of any Member State, without
prejudice to mutual financial guarantees for the joint execution of a specific
project. A Member State shall not be liable for or assume the commitments
of central governments, regional, local or other public authorities, other bodies
governed by public law, or public undertakings of another Member State, without
prejudice to mutual financial guarantees for the joint execution of a specific
project”
•
Markets did not believe it would be enforced. In 2001 Greece was upgraded after
joining the euro ”on the belief that Greece was now part of the euro zone and that
nobody was ever going to default”
Strict no-monetary financing
Art. 123: Overdraft facilities or any other type of credit facility with the
European Central Bank or with the central banks of the Member States
(hereinafter referred to as ‘national central banks’) in favour of Union institutions,
bodies, offices or agencies, central governments, regional, local or other public
authorities, other bodies governed by public law, or public undertakings of
Member States shall be prohibited, as shall the purchase directly from
them by the European Central Bank or national central banks of debt
instruments.
Art. 123 prohibits institutionalised fiscal dominance, i.e. explicit agreements between
government(s) and central bank(s) similar to the Fed-Treasury accord of 1951…
Where are the problems?
1. ECB has no financial stability mandate
• Art. 127-5 very weak
The ESCB shall contribute to the smooth conduct of policies pursued by the
competent authorities relating to the prudential supervision of credit institutions
and the stability of the financial system
• Justification of SMP is to help ensure the proper transmission of monetary policy
decisions
2. ECB does not have the proper governance structure
• One governor-one vote not appropriate for decisions with potential distributive
consequences
3. ECB not made to exercise broad policy conditionality
• Legitimacy issue
Result: hesitant behaviour
Purchases on secondary market are limited and lack consistency
3. Implications
The strategy:
 Force RER adjustment in the periphery by enforcing fiscal discipline
 Eliminate insolvency risk by making states super-safe
The alternative solutions:
• Make sovereign risk manageable
• Restore the LLR function
• Revise the no-coresponsibility principle
A. Super-safe sovereigns
•
•
•
•
Safe public debt levels lower than thought
Need to move away from deterministic approach to budgetary
surveillance, take into account implicit liabilities and tail risks
Stress test the sovereigns
But:
• Evaluation of safe debt levels elusive
• Goal VERY distant
The (long) way to go…
Required adjustment to reach 60 per cent debt ratio in 2030
Illustrative Fiscal Adjustm ent Strategy to Achieve Debt Target in 2030
2010
Gross debt
Austria
Belgium
Estonia
Finland
France
Germany
Greece
Ireland
Italy
Netherlands
Portugal
Slovak Republic
Slovenia
Spain
72.2
96.7
6.6
48.4
82.4
84.0
142.8
94.9
119.0
63.7
92.9
41.8
37.3
60.1
Prim ary balance
-2.5
-0.9
0.4
-3.2
-4.9
-1.2
-4.9
-28.9
-0.3
-3.9
-6.3
-6.8
-4.1
-7.8
CAPB
-1.6
0.3
4.3
-0.7
-3.1
-0.4
-5.7
-6.4
1.2
-3.1
-5.3
-5.8
-2.8
-6.3
CAPB in 2020–30
1.8
3.1
0.4
0.4
3.1
2.0
9.8
5.6
4.3
1.3
4.3
0.9
1.1
2.0
Required adjustm ent
betw een 2010 and 2020
3.4
2.8
-3.9
1.1
6.3
2.3
15.5
12.0
3.1
4.4
9.6
6.6
4.0
8.3
Required adjustm ent and
age-related spending,
2010–30
7.7
8.4
-3.5
6.8
7.9
4.6
19.0
13.5
4.1
9.7
13.8
8.5
7.9
10.4
Source: IMF
…and the risk of rushing
• Current adjustments tend to
be biased towards
immediate revenue-raising
measures
• Trade-off speed-quality
B. Make sovereign risk manageable
Much to do in this area
•
•
Limit exposure of banks to their sovereign (prudential policy)
Steps towards banking federation
• Long term: European FDIC
• Short term: EFSF backstop to national guarantees (or EFSF direct
recapitalisation of banks – see Greece)
Euro area features not universal
Share of domestic banks in total holdings of
government securities, 2011
30
25
20
15
10
5
0
Note: for Germany and Portugal the measure is measure is general
government debt
Source: Bruegel calculations
Two limitations
•
Political economy à la Carmen Reinhart: to limit sovereign access to
their own financial institutions in times of fiscal stress is an uphill
struggle
•
Even with a safer financial system, the default of a medium-sized
European state would be a major financial shock.
Qualitatively the same as in the US..
but not quantitatively
Central Government Debt as % of EA GDP versus State Government Debt as % of US GDP
IT
18
16
FR
14
DE
% US or EA GDP
12
10
EA
8
US
ES
6
GR
4
NL
BE
AT
2
CA
NY
MASS
ILLI
3
4
NJ
PT
IE
PENN
FLO
TEX
MICH
CONN
6
7
8
9
10
0
1
2
5
ranking
Source: Eurostat, US Census, Bruegel calculations
C. Restore LLR role for the ECB
•
EFSF leverage proposed by Gros-Mayer (2011)
•
Advantages
• With appropriate haircut, most of the risk remains with EFSF
• EFSF has proper shareholding structure
• Distinction fiscal / monetary roles
•
But difficulties
• EFSF borrowing conditions
•
In the end was rejected
D. Fiscal union
•
•
•
•
Old discussion on economic pillar of Economic and Monetary Union
Choice was made not to create a federal budget
Now issue back in new clothes
Eurobonds:
•
•
•
Joint and several liability (so co-responsibility)
Possibly partial (Red /Blue bonds)
Several proposals
•
•
•
•
Delpla-Weizsäcker
German Economic Experts
ESBIEs
Hellwig-Philippon
Blue/red bonds: basic mechanism
Principles
• Senior blue debt tranche issued
up to [60] per cent of GDP,
junior red debt above
• Joint and several responsibility
on blue debt
• Red debt not eligible to ECB
repo, subject to higher capital
requirements
Expected effects
• Higher marginal cost of debt,
hence incentive properties
• Average cost of debt unaffected
ex ante (abstracting from
liquidity premium, incentives)
Policy issues
•
Two key issues
• Which underlying guarantee structure?
• Joint and several
• Guarantee by EU budget – with taxing power
•
•
•
Responsibility for ex ante control
• Parliamentary (implies new body made up of NPs and EP)
• Judicial (ECJ)
Can Germany accept?
• No direct benefits
• Only with strict conditions
Can France accept (politically)?
• Surrender of budgetary sovereignty
• Political integration
Conclusions for research
•
•
•
Research correctly anticipated many of the problems that developed
within euro area
Key limitations were failure to imagine that BOP crises could occur,
failure to anticipate the full consequences of absence of LLR for
sovereigns
Other issue has been selective use of research in policy discussion,
bordering to instrumentalisation