Overcoming the euro crisis

Athanasios OrphanidesMIT

The Euro Area After the CrisisGreece and the Euro: From Crisis to Recovery

Tufts University, April 12, 2019

1

Real GDP per person: G7 advanced economies

Non-EU Euro Area

80

85

90

95

100

105

110

115

80

85

90

95

100

105

110

115

Inde

x 20

07=1

00

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

United States Canada Japan

80

85

90

95

100

105

110

115

80

85

90

95

100

105

110

115

Inde

x 20

07=1

00

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

France Germany Italy

IMF WEO, April 2019. Index, 2007=100.What is the cause of divergence in the euro area?

2

Overcoming the euro crisis

I Three stages of treatment of a systemic failure

I Analysis of failure

I Identification of the cause of the problem

I Correction

I Three obstacles hindering progress

I Denial

I Misdiagnosis of failure (blame game)

I Politics

3

Politics over economics: Federation vs confederation

I Federation

I Common government protecting common interest.

I Common government accountable to all citizens of all states.

I Confederation

I Competing interests among member states.

I Leaders in each state accountable only to citizens in their state.

4

The fragility of confederations

I United States (under the Articles of Confederation, until 1789).

I Delian League.

5

The role of independent institutions

I How are common policies decided when the interests of individual MemberStates diverge?

I The success of the Union rests on the ability of Europe’s independentinstitutions to protect the common good over the interests of any individualMember State.

I Individual Member States that manage to exert undue influence on theseinstitutions can distort policy to benefit their own citizens at the expense ofothers and the euro area overall.

6

A closer look at the ECB

I Europe’s unique central bank—the most independent and least accountablecentral bank ever created in history.

I The most appropriate monetary policy for the euro area as a whole is notbest for all Member States.

I Success in influencing ECB policy can disproportionately benefit a MemberState at the expense of the common good.

7

A closer look at the ECB

I Has the overall stance of monetary policy been properly calibrated?

I Interest rate policy

I Balance sheet policy.

I Has the implementation of monetary policy been well managed?

I Deviation from profit/loss sharing in asset purchases.

I Delegation of collateral policy to rating agencies.

8

The unemployment rate in Germany and Italy

3

4

5

6

7

8

9

10

11

12

13

3

4

5

6

7

8

9

10

11

12

13

Per

cent

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Germany Italy

ECB policy: Too loose or too tight?9

Core inflation in Germany and Italy

0

1

2

3

0

1

2

3

Per

cent

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Germany Italy

ECB policy: Too loose or too tight?10

ECB policy outcomes: Core inflation in euro area

0

1

2

3

0

1

2

3

Per

cent

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Notably below and not close to 2% for several years.11

Evaluating ECB policy: Long-term inflation expectations

1.6

1.7

1.8

1.9

2

2.1

1.6

1.7

1.8

1.9

2

2.1

Per

cent

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

Mean Median Density Mean

ECP SPF. Surveys after May 2003 clarification of ECB inflation objective.An unhelpful disanchoring of inflation expectations.

12

Evaluating ECB policy: Inflation swaps

0

1

2

3

0

1

2

3

Per

cent

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

5-year 10-year

An unhelpful disanchoring of market-based readings of long-term inflation expectations.13

What is the source of the continuing fragility?

-1

0

1

2

3

-1

0

1

2

3

Per

cent

2013 2014 2015 2016 2017 2018 2019 2020

Germany Italy

Two-year government bond yields.

14

Adverse expectational equilibria in sovereign debt markets

“In 2011, after the Deauville episode and the early talk about the Greek debtprivate sector involvement, financial markets attacked Italian and Spanishsovereign bonds without any change in their fundamentals . . .”(Vitor Constancio, 17 May 2018)

15

Interactions with fiscal policy?

“Turning to fiscal policy, since 2010 the euro area has suffered from fiscal policybeing less available and effective, especially compared with other large advancedeconomies. This is not so much a consequence of high initial debt ratios-publicdebt is in aggregate not higher in the euro area than in the U.S. or Japan. Itreflects the fact that the central bank in those countries could act and has actedas a backstop for government funding. This is an important reason why marketsspared their fiscal authorities the loss of confidence that constrained many euroarea governments’ market access.” (Draghi, 2014.)

16

“Sub-optimal”∗ fiscal policy

-6

-4

-2

0

2

4

-6

-4

-2

0

2

4

Per

cent

of G

DP

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Germany Italy

IMF WEO, April 2019. Primary balance as a percent of GDP.∗European Commission (2016).

17

Distributional consequences of ECB policy

-1

0

1

2

3

4

5

6

7

8

-1

0

1

2

3

4

5

6

7

8

Per

cent

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Germany Italy Eonia OIS

Two-year government bond yields and euro OIS rate

18

Distributional consequences for fiscal policy

Primary balance Total balance

-6

-4

-2

0

2

4

-6

-4

-2

0

2

4

Per

cent

of G

DP

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Germany Italy

-6

-4

-2

0

2

4

-6

-4

-2

0

2

4

Per

cent

of G

DP

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Germany Italy

IMF WEO, April 2019.

19

The ongoing euro crisis: Winners and losers

80

85

90

95

100

105

110

115

80

85

90

95

100

105

110

115

Inde

x 20

07=1

00

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Germany Italy

Real GDP per person. IMF WEO, April 2019. Index 2007=10020

Shared prosperity: The key to overcoming the euro crisis

I At present, the euro is a threat to Europe.

I To overcome the crisis, Europe’s common independent institutions mustassert their independence and act in accordance to the Treaties.

I In accordance to the Treaties, common institutions must use theirindependence to effectively counterbalance narrow national interests.

I Policy must protect and promote the common good.

I The key to overcoming the euro crisis is shared prosperity.

21