Financial Integration in Europe in Light of the Euro Area Crisis Max Watson Director, Political...
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Transcript of Financial Integration in Europe in Light of the Euro Area Crisis Max Watson Director, Political...
Financial Integration in Europein Light of the Euro Area Crisis
Max Watson
Director, Political Economy of Financial Markets (PEFM)Co-ordinator, Political Economy of Southeast Europe
European Studies Centre, Oxford
Reflecting PEFM Working Group discussions with, and inputs from, Gillian Edgeworth, Gene Frieda, Valerie Herzberg and Russell Kincaid
University of Sarajevo
Motivation (1)
Expectations that financial integration would:
• revitalise economies of EU core• boost catching-up in all of periphery• achieve ‘risk-sharing’ in euro area...
Motivation (1)
Expectations that financial integration would:
• revitalise economies of EU core• boost catching-up in all of periphery• achieve ‘risk-sharing’ in euro area...
Rapid financial integration from late 1990s
End of ‘Feldstein-Horioka Puzzle’
Motivation (2)
But from 2008 integration stalls, reverses
Experience of boom-bust cycles in euro area periphery, Baltic States, Balkans
Contagion, and sudden stops in capital flows
Motivation (2)
But from 2008 integration stalls, reverses
Experience of boom-bust cycles in euro area periphery, Baltic States, Balkans
Contagion, and sudden stops in capital flows
Did integration promote risk-sharing and healthy growth - or what went wrong...?
Narrative – Main Points
• Flows driven by ‘perfect storm’ of factors• In boom economies, mutually-reinforcing• National policies able to avoid meltdown• Under EMU, some key factors will recur• Implies change in how to manage policy• Key for euro area and linked economies • But political-economy threatens success
Macrofinancial Drivers
Six mutually-reinforcing framework factors:
• Global financial ‘push’ factors
Long-term interest rates in percent* Broad money and GDP*
Source: OECD *Long-term government bond yields (10 years). *Nominal GDP converted at constant PPP and broad Weighted average of the US, Japan and Euro Area. money (M3) in the US, Japan and Euro Area.
Global Conditions
Macrofinancial Drivers
Six mutually-reinforcing framework factors:
• Global financial ‘push’ factors• Global trade shocks• Real convergence play• Currency convergence• € area monetary conditions
Real short-term interest rates*
Source: OECD*3-month interbank interest rates deflated by the harmonised index of consumer prices.
Euro Area Conditions
Macrofinancial Drivers
Six mutually-reinforcing framework factors:
• Global financial ‘push’ factors• Global trade shocks• Real convergence play• Currency convergence• € area monetary conditions• National fiscal, prudential policy
Source: IMF
Struct. Budget Balancein % of GDP
2006Seen then Seen now
2007Seen then Seen now
Ireland
Budget 2.7 0.7
Spain
Budget 1.8 1.2
Source: IMF
Struct. Budget Balancein % of GDP
2006Seen then Seen now
2007Seen then Seen now
Ireland
Budget 2.7 -4.0 0.7 -7.2
Spain
Budget 1.8 -1.2 1.2 -1.1
Political-Economic Roots
These financial factors had deep roots...
• ideological capture: US (efficient markets) but also euro area (‘BoP abolished’)
• political factors: China (surplus); US (housing); EU (bank supervision and resolution); national (budget, banking)
Note: Canada, Sweden, Turkey had ‘coalitions for sound finance’ after earlier crises
Integration & Imbalances
Integration analysis featured spreads, assets, bank groups, not current account imbalances:
• Composition: equity or debt?• Sector: traded or nontraded goods?• Obligors: firms or banks & govt’s?
*This chart was prepared by Gillian Edgeworth, a member of the Oxford financial markets working group on financial integration
Capital Flows: EU Periphery
*This chart was prepared by Gillian Edgeworth, a member of the Oxford financial markets working group on financial integration
Capital Flows: CEE
*This chart was prepared by Gillian Edgeworth, a member of the Oxford financial markets working group on financial integration
Capital Flows: CZ, PL, SK
*This chart was prepared by Gillian Edgeworth, a member of the Oxford financial markets working group on financial integration
Capital Flows: Baltics
*This chart was prepared by Gillian Edgeworth, a member of the Oxford financial markets working group on financial integration
Capital Flows: Balkans
Integration & Imbalances
Integration analysis featured spreads, assets, bank groups, not current account imbalances:
• Composition: equity or debt?• Sector: traded or nontraded goods?• Obligors: firms or banks & govt’s?
€ area: not + for risk-sharing/debt capacity. Eastern Europe: higher % of FDI... esp. CZ, PL, SK (with lower levels of imbalances).
Policies in a Stable State
Interim steady state in € area will probably feature limited, conditional fiscal back-stops
So national fiscal and prudential policies still key to dampen private sector imbalances in euro area as well as euro-linked economies
But preventative policies prone to ‘capture’ – so need clear goal & triggers
Prevention (1)
Goal in real time is macrofinancial risk (not misallocation or competitiveness loss per se)
• external deficit driven by credit growth, financed by short-term/portfolio inflows
External Balance: Ireland
0%
5%
10%
15%
20%
25%
30%
35%
2003 2004 2005 2006 2007 2008
Source: Central Bank of IrelandIncludes subsidiaries of foreign banks in IrelandIncludes securitised residential mortgages
Private Sector Credit: Ireland
0%
50%
100%
150%
200%
250%
Ireland Portugal Spain
2004
2005
2006
2007
2008
Source: IMF
Loan-to-Deposit Ratios: Ireland
Prevention (1)
Goal in real time is macrofinancial risk (not misallocation or competitiveness loss per se)
• external deficit driven by credit growth, financed by short-term/portfolio inflows
• accompanied by competitiveness loss with rigid wages
Source: OECD * Unit labour costs compared to Euro Area, total economy, double export weights
Relative Unit Labour Costs*
Prevention (1)
Goal in real time is macrofinancial risk (not misallocation or competitiveness loss per se)
• external deficit driven by credit growth, financed by short-term/portfolio inflows
• accompanied by competitiveness loss with rigid wages, and
• domestic and external balance sheet risks
3.5 3.0
12.57.4
0
10
20
30
40
50
60
70
80
90
Allied Irish Banks Bank of Ireland Anglo Irish Bank Irish Nationwide Building
Society
Construction and property (% of total loans, 2006) Construction and property (as a multiple of capital base, 2006)
*Data exclude residential mortgages and can thus be taken as representing the exposure of banks to commercial property in a broad sense.Source: Annual Reports 2006 Specifically the data are for: Allied Irish Banks and Irish Nationwide December 2006; Bank of Ireland March 2007; Anglo Irish Bank September 2007, estimated based on data in the 2008 annual report.
Commercial Property Loansand Capital: Ireland
Prevention (2)
How overcome political-economic resistance to pre-emption, risks of policy ‘capture’?...
• clear triggers, incl. C/A/C norms; output risks; mismatched monetary conditions
• which EU body avoids capture (IMF 2006)? ‘MIP’ and ESRB not encouraging so far
• can co-ordination work, esp outside euro?
Conclusions
A new stable state will involve limited and conditional fiscal backstops in/out of € area
Financial integration will work only if national fiscal, prudential policies are pre-emptive
Serious concern pre-emptive policies may be subject to ‘capture’ – and not just in EU
Major question: macroprudential coordination