The Euro Zone Crisis through
Economic Glasses: Origins,
Responses and Challenges
Ahead
Anita Angelovska-Bezoska
National Bank of the Republic of Macedonia
May 2013
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Content
 What are the origins and implications of
the Euro zone crisis?
 How are European policymakers dealing
with it?
 What are the main challenges ahead?
NBRMNBRMNBRMNational Bank of the Republic of MacedoniaNBRMNBRMNBRM
US financial crisis as a trigger of the EU
banking system disruptions
European banks were heavily affected by
the global financial crisis...

Direct effects – strong negative
effects on the European financial
institutions that held many “toxic”
assets originating from the United
States.

Preexisting conditions
contributed as well – high credit
growth accompanied with high
leverage and low equity ratios
implied high vulnerability
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The financial turmoil brought to the fore the
intrinsic deficiencies of the Euro zone

The process of intra EU financial integration turned into process of financial
fragmentation (sharp reversal of capital flows from periphery to the core)

The risk premium of the periphery increased...the growth-interest rate differential turned
sharply –the risk of insolvency become a reality

The banking system faced with funding pressures – the deleveraging, as well as the
renationalization of banks
BIS cross-border bank claims (in percent of reporting country’s GDP)
Source: IMF Staff Discussion Note 13/01.
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Banking crisis paralyzed the economic
activity
Resulting halt in the credit flows, as a key source for financing the
corporate sector, contributed to...
contraction of economic activity...
...and rise in unemployment
GDP growth rate
(in %)
8.0
25
6.0
20
4.0
2.0
UNEMPLOYMENT RATE
(3 year backward moving average)
Germany
Ireland
Spain
Portugal
France
Greece
Italy
15
0.0
10
-2.0
-4.0
-6.0
EA 17
Ireland
Portugal
Greece
Italy
Spain
5
0
-8.0
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source: Eurostat, Macroeconomic Imbalance Procedure.
NBRMNBRMNBRMNational Bank of the Republic of MacedoniaNBRMNBRMNBRM
Financial and economic crisis emerged into
sovereign debt crisis
Financial assistance to the banking system, automatic stabilizers and discretionary
countercyclical policies lead to an increase in the government deficits and
the level of public debt across the Euro zone...
...in some countries even to unsustainable levels....
...questioning the solvency of the public finances
Government deficit
(% of GDP)
5.0
180
160
0.0
140
-5.0
GENERAL GOVERNMENT DEBT
(in % of GDP)
Germany
Ireland
Spain
Portugal
France
Greece
Italy
120
-10.0
100
-15.0
80
-20.0
60
-25.0
-30.0
EA 17
Ireland
Portugal
Greece
Italy
Spain
40
20
0
-35.0
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source: Eurostat, Macroeconomic Imbalance Procedure.
NBRMNBRMNBRMNational Bank of the Republic of MacedoniaNBRMNBRMNBRM
Pre-crisis fundamentals shaping the severity of
impact
Peripheral EU countries with higher macro-economic imbalances in
the pre-crisis period suffered more...
The build-up of imbalances
was supported by the
easy access to finance
and convergence of
nominal interest rates
as a result of the interest
rate convergence across
the Euro zone in the early
90s, despite different
fundamentals of different
countries
NBRMNBRMNBRMNational Bank of the Republic of MacedoniaNBRMNBRMNBRM
Pre-crisis fundamentals shaping the severity
of impact
 Some of the countries enjoyed consumption-driven growth, fueled by
abundant inflows in non-tradable sector, which lead to rising unit labor costs,
current account deficits and indebtedness of the economy.
CURRENT ACCOUNT BALANCE
(as % of GDP, 3 year backward moving average)
NOMINAL UNIT LABOUR COST
(3 years percentage change)
20
15
10
10
5
Germany
Ireland
Spain
Portugal
France
Greece
Italy
France
Greece
Italy
150
-5
-15
250
Germany
Ireland
Spain
Portugal
0
0
-10
300
200
5
-5
350
PRIVATE SECTOR DEBT
(in % of GDP)
Germany
Ireland
Spain
Portugal
France
Greece
Italy
Source: Eurostat, Macroeconomic Imbalance Procedure.
100
-10
50
-15
0
Source: Eurostat, Macroeconomic Imbalance Procedure.
Source: Eurostat, Macroeconomic Imbalance Procedure.
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The crisis brought to the fore the old debates about the main
ingredients of the “monetary union”
GENERAL OCA CRITERIA
Mobility of
factors of
production
Financial
integration
Convergence of
inflation rates
Diversification
of production
Symmetry of
external shocks
Openness of
the economy
How close was EUROZONE to OCA before crisis?
    
Capital mobility
Labour mobility
Financial
integration
Convergence of
inflation rates
Fiscal
integration
Many OCA criteria remain unfulfilled implying still diverse
economies.
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The crisis brought to the fore the old debates about
the main ingredients of the “monetary union”

Many OCA criteria remain unfulfilled implying still diverse economies.

The crisis showed that a combination of diverse economies with single
currency in not sustainable.

In addition, it confirmed the view of German “economists” (50 years
ago) that monetary union should come after economic and political
union is reached (as opposed to French “monetarists” view that
monetary union should lead to economic and political union).

Current policy set-up: centralized monetary policy and
decentralized other policies can lead to build up of
macroeconomic imbalances endangering the financial stability of the EA.

In particular when the mechanisms aimed at ensuring consistent
macroeconomic policies do not work (SGP)
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(Non)Compliance with the fiscal Maastricht
criteria by Euro zone members)
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Policy Responses to Contain the Euro Zone Crisis
• The ECB played an important role in containing the
crisis...
ECB
• Lowering policy rate and RR
requirement
• Liquidity provision to banks at longer
tenures
• Expansion of the collateral framework
• Covered bond purchase program
• Securities market program: purchase of
state securities
• Outright monetary transactions:
unlimited government bond purchases
with conditionality to apply to ESM
•The undertaken measures addressed the “acute” issues of liquidity and
calming market expectations ...
• While additional measures introduced to tackle “design failures” of the
monetary union
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Policy Responses to Contain the Euro Zone
Crisis
The sovereign debt crisis exposed fundamental weaknesses in the EU’s
economic governance framework...
...filling the gaps by moving towards the fiscal and financial union
“too much
monetary
union and ...
...too little fiscal
union” in the
Euro zone
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Policy responses to address “design failures”
The reforms of the European legislation aimed at
addressing the “design failures”:

Strengthening
economic
coordination, through:



policy
prevention
and
correction
macroeconomic
imbalances (MIP);
policy reform plans to be discussed ex-ante with
special
focus
on
convergence
and
competitiveness.
Fostering fiscal discipline, through:





stricter budget rules;
automatic application of corrective mechanism;
emphasis on the preventive stage;
more strict application of the correction of
excessive debt ratios in MS.
SIX-PACK (December 2011)
The six-pack reinforces the SGP both in the preventive and in the
corrective arm of the Pact, i.e. the Excessive Deficit Procedure
(EDP), which applies to Member States that have breached either
the deficit of the debt criterion.
Treaty on Stability, Coordination,
and Governance ( March, 2012)
FISCAL COMPACT (March, 2012)
The Fiscal Compact, which is the fiscal part of the Treaty on
Stability, Coordination and Governance (TSCG)- runs in parallel with
the six-pack.
TWO-PACK
(expected by the summer 2013)
The proposed regulation for ”monitoring and assessing draft
budgetary plans and ensuring the correction of excessive deficit of
the Member States in the Euro area” aims at further strengthening
the budgetary and economic surveillance of the Euro area countries
and restoring confidence in financial markets.
Fostering greater banking
integration, through:


enhanced supervisory coordination; and
uniform supervisory-regulatory framework
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The Six Pack

Stricter fiscal surveillance and application of fiscal rules by:

defining quantitatively “significant deviation from the MTO”;

making SGP debt criterion more operational, i.e., allowing EDP procedure,
even if the deficit is below 3%, when debt is above 60%;

Imposing financial sanctions in a gradual way throughout the EDP (0,5% of
GDP);

introducing reverse qualified majority voting for most of the sanctions.

Stricter macroeconomic surveillance through MIP.

In 2012, 23 of 27 member states were in EDP (except for Estonia,
Finland, Luxembourg and Sweden)
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The Fiscal Compact: Treaty on Stability,
Coordination and Governance (TSCG)
 Treaty applicable to euro zone
member states only (UK and
Czech republic will not adopt it)
 Common budgetary rules at the
national level- balanced budget
rule
Structural deficit not to exceed
0.5% of GDP
If MS deviates, automatic
correction mechanism will be
triggered
“Balanced budget rule”
enshrined in the national law,
preferable at constitutional level
Compliance also monitored by
independent national
institutions
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European Stability Mechanism
 From temporary EFSM and EFSF to a permanent resolution
mechanism – “a firewall against debt crisis”

Provide loans to a euro zone member state in financial difficulties;

Intervene in the primary and secondary debt markets;

Precautionary credit lines;

Provide loans to governments for the purpose of recapitalization of financial
institutions.
Permanent facility, providing conditional financing,
defending the sovereign and financial stability
NBRMNBRMNBRMNational Bank of the Republic of MacedoniaNBRMNBRMNBRM
European banking union – SSM is a first steps on a
long march

Motivation: Integrated banking system requires integrated
prudential oversight. EMU system of unity in monetary policy, but
national plurality in financial policies showed to be unsustainable.

Goal: safeguard of financial stability through:

reducing fragmentation of financial markets;

weaken the loop of sovereign and bank borrowing costs; and

thus, enhance the monetary policy transmission mechanism.
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Financial Fragmentation
Diverging funding costs deviating
from the policy rate path
Sovereign creditworthiness affecting
that of banks
Source: IMF Staff Discussion Note 13/01.
...and acknowledging the doom loop
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European banking union - first steps on a long
march
EUROPEAN BANKING UNION
1. Single Supervisory
Mechanism (SSM)
- Supervisory tasks and powers to
ECB
-Separation from monetary policy
-Applies to all EA MSs, open for
non-EA MSs
2. Single Resolution
Mechanism (SRM) and
Backstops
-For individual bank failures
3. European Deposit Insurance
Scheme
-Intended to tackle the problem of
capital flight
-Financed by industry on a riskbased approach
- Appropriate and effective
backstop arrangements for
systemic cases
Status: pending
Adoption targeted – Q2 2013
-Most of the banking system under
direct EU authority (80-85% of the
Status: pending
system)
Status: established in March 2013 Adoption targeted – Q2 2013
Establishment targeted –mid
Operational – mid 2014
2014
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The Euro crisis led to profound governance
reforms...but are we there yet?

The creation of the ESM supports the overall structure of EMU – but the risks of moral
hazard requires stringent observance of macro-conditionality for acquiring financial
assistance
•
The ESM limited financial capacity implies that it cannot be treated as a lender of last
resort and prevent panic and self- fulfilling liquidity crisis.

Reforms on fiscal governance comprehensive and profound, but...
•
Room for national administrative and political discretion
•
Higher complexity in monitoring and implementation of rules
•
Strict observance, implementation and ownership – key for not replicating the same flaws
of the former fiscal set-up
•
Fully fledged fiscal union? – a lively debate with lots of pros and cons coming to the fore
•
Strengthening economic policy coordination-prerequisite for preventing
macroeconomic imbalances and higher convergence, but TSCG seems “vague” on the
implementation instruments.

Banking union – indispensable for breaking the banking – sovereign vicious circle. However
if left alone, without unified crisis resolution mechanisms and appropriate backstop, the full
benefits will not be reaped.
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Future of the Euro zone
The bold response of policy makers clearly removed the tail risk of Euro zone break
up...
...but the Euro zone must continue fixing structural and institutional deficiencies,
which exacerbated the crisis

increase wage and labor flexibility

move towards more sustainable growth through increasing the overall competiveness of
the Euro zone

continue with the efforts in enhancing the fiscal, macroeconomic and financial
governance
•
enabling better fiscal discipline and flexibility
•
providing financial backstops
•
creating more robust banks and hence lesser risk and less contagion
The crisis proved that the smooth functioning of a monetary union requires
economic competiveness, fiscal sustainability and stability of the financial system
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