Straining the Bond: Europe in Crisis Evening at the Fed December 2012 Mark A. Wynne Vice President...
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Transcript of Straining the Bond: Europe in Crisis Evening at the Fed December 2012 Mark A. Wynne Vice President...
Straining the Bond: Europe in Crisis Evening at the Fed
December 2012Mark A. Wynne
Vice President FRB DallasDirector Globalization & Monetary Policy Institute
Overview
• The story so far…• The (increasingly global) fallout
– Contagion from periphery to core– Contagion to the rest of the world
• The fundamental challenges– Burned ships (the Cortes strategy)– The world’s greatest game of chicken
• Lessons from history• End game
– Move to a political union?– Or lost decade(s) à la Japan?
The euro crisis: a chronology
• May 2010: Greek bailout €110 bn• November 2010: Irish bailout €85 bn• April 2011: Portuguese bailout €78 bn• July 2011: Second Greek bailout €130 bn• December 2011: Fiscal compact agreed; ECB LTROs• April 2012: Greek default• Summer 2012
– Yields on Spanish government debt reach record highs– €100 bn bailout of Spanish banks– Yields on stronger sovereigns go negative on safe-haven flows– ECB cuts deposit rates to zero
• July 26: “…the euro is irreversible…. Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” – ECB President Mario Draghi
Major developments August-December 2012
• September – ECB announces plans to conduct Outright Monetary Transactions (OMTs) “…to safeguard
the monetary policy transmission mechanism in all countries of the euro area” and “…address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro”• One dissenting vote: Bundesbank President Weidmann
– German constitutional court rules that Germany can contribute to the European Stability Mechanism
– European Commission publishes proposals for a European banking union• Focus on bank supervision; issues of deposit insurance and bank resolution unaddressed
• October– S&P downgrades Spain to BBB-– European Union wins Nobel Peace Prize
• November– Third Greek “bailout”
• Lower interest rates & extended terms on loans; recycling of SMP profits back to Greece
The story so far(10-year government interest rates)
1990 1995 2000 2005 20100
5
10
15
20
25
30 Greece
Portugal
Spain
Ireland
Italy
Belgium
France
Austria
Netherlands
Finland
Germany
Percent
Jan 1, 1999Euro launched
Jan 1, 2001Greece joins
Greece: in depression
1999 2001 2003 2005 2007 2009 2011 20133400.0
3600.0
3800.0
4000.0
4200.0
4400.0
4600.0
100000
120000
140000
160000
180000
200000
220000Peak-to-trough decline through 2011: 10.2%
Peak-to-trough decline through 2011: 14.6%
Employment GDP
Millions Bil. Ch. 2005 euros
Aug 2012 UR: 25.4%Aug 2012 youth UR: 57.0%
Note: Diamonds indicate OECD November 2012 forecasts. Dashed lines indicate OECD forecasts in June 2012.
Gross government debt as a percentage of GDP
2009 2010 2011 2012 2013 2014 2015 2016100
120
140
160
180
200Greek budget report Oct. 31, 2012
IMF's World Economic Outlook October 2012
Review of bailout program March 2012 (Estimates overlap with 2012 IMF data for 2009-2011)
Original bailout program May 2010
Estimates Projections
Percent
Ireland: life after austerity?
1999 2001 2003 2005 2007 2009 2011 20131600.0
1800.0
2000.0
2200.0
100000
120000
140000
160000
180000Millions Bil. Ch. 2009 euros
Sep 2012 UR: 15.1%Sep 2012 youth UR: 34.5%
Peak-to-trough decline through 2011: 14.5%
Peak-to-trough decline through 2011: 6.9%
Note: Diamonds indicate OECD November 2012 forecasts. Dashed lines indicate OECD forecasts in June 2012.
July 26, 2012: Ireland returns to financial markets for first time since September 2010
Employment GDP
Portugal: further contraction expected
1999 2001 2003 2005 2007 2009 2011 20134400.0
4600.0
4800.0
5000.0
5200.0
145000
150000
155000
160000
165000
Sep 2012 UR: 15.7%Sep 2012 youth UR: 35.1%
Millions Bil. Ch. 2006 euros
Peak-to-trough decline through 2011: 7.0%
Peak-to-trough decline through 2011: 3.2%
Note: Diamonds indicate OECD November 2012 forecasts. Dashed lines indicate OECD forecasts in June 2012.
Employment GDP
Spain: latest bailout request
1999 2001 2003 2005 2007 2009 2011 201314000
15000
16000
17000
18000
19000
20000
21000
750000
825000
900000
975000
1050000
1125000Millions Bil. Ch. 2008 euros
Sep 2012 UR: 25.8%Sep 2012 youth UR: 54.2%
Peak-to-trough decline through 2011: 11.1%
Peak-to-trough decline through 2011: 3.7%
Note: Diamonds indicate OECD November 2012 forecasts. Dashed lines indicate OECD forecasts in June 2012.
Employment GDP
OECD NEET Ratios, 15 to 24 Years
Netherla
nds
Denmark
Iceland
Switzerla
nd
Sweden
Austria
Slovenia
Luxe
mbourg
Finland
Norway
Germany
Japan
Canada
Czech
Republic
Estonia
Poland
Australia
France
Portugal
Euro are
a 17EU27
Britain
Hungary
New ZealandUSA
Slovakia
BelgiumOECD
Ireland
Spain
Greece
Italy
Mexic
o
Turkey
-10-505
10152025303540
0.31.4 1.1 0.6
-0.1 -0.3
0.4 2.1 0.8 1.4 0.3 1.0
-4.1
1.0 0.4 1.7 1.9
-0.9
2.1 1.8 1.7 2.0 2.7 2.7 1.2 3.5 1.07.4 5.9 2.5
3.4
1.0
-8.1
Change Q1 2007 to Q1 2011Q1 2007Q1 2011
OECD = Organization for Economic Cooperation and DevelopmentNEET = not in education, employment, or trainingSource: OECD Employment Outlook 2012
Percent
Housing booms and bustsResidential investment as a share of GDP
1980 1985 1990 1995 2000 2005 20102
4
6
8
10
12
14Percent
U.S.
Housing booms and bustsResidential investment as a share of GDP
1980 1985 1990 1995 2000 2005 20102
4
6
8
10
12
14Percent
Arizona
U.S.
Florida
Nevada
Housing booms and bustsResidential investment as a share of GDP
1980 1985 1990 1995 2000 2005 20102
4
6
8
10
12
14Percent
ArizonaSpain
U.S.
Florida
Nevada
Ireland
Germany PMI in contraction phase
2005 2006 2007 2008 2009 2010 2011 201230
35
40
45
50
55
60
65
Expansion
Contraction
Index
ServicesComposite
Manufacturing
Broader euro-area PMI also in negative territory
2005 2006 2007 2008 2009 2010 2011 201230
35
40
45
50
55
60
65
Expansion
Contraction
Index
ServicesComposite
Manufacturing
Global falloutExports to the U.S. and euro area: share of world total
1980 1985 1990 1995 2000 2005 20106
8
10
12
14
16
18Percent
U.S.
Euro area
Global fallout
• United Kingdom– 50 percent of exports to euro area– “The greatest threat to the recovery stems from the risk that an
effective policy response is not implemented sufficiently promptly in the euro area” (Bank of England)
• China– EU is China’s largest export market, overtaking U.S. in 2007– “capricious development of the European debt crisis” as drag on
growth (People’s Bank of China)• United States
– 20 percent of exports to Europe– “…strains in global financial markets continue to pose significant
downside risks to the economic outlook” (FOMC)
German cross-border lendingNet Balance
1999 2001 2003 2005 2007 2009 20110
50
100
150
200
250
300
350
400
450
500
IrelandPortugalGreeceItalySpain
Bil. euros
The story so far(10-year government interest rates)
1990 1995 2000 2005 20100
5
10
15
20
25
30 Greece
Portugal
Spain
Ireland
Italy
Belgium
France
Austria
Netherlands
Finland
Germany
Percent
Jan 1, 1999Euro launched
Jan 1, 2001Greece joins
One-size-fits-all monetary policy:Euro & U.S.
1999 2001 2003 2005 2007 2009 2011-15
-10
-5
0
5
10
15
20
Euro area Taylor rate range
U.S. regions Taylor rate range
ECB policy rate
Federal funds rate
Percent
Euro area average range (1999-2011) = 10.6U.S. regions average range (1987-2011) = 5.2
(Taylor rate range)
Labor mobility a hindrance toa common monetary policy
1999 2001 2003 2005 2007 2009 20110
5
10
15
20
25
30
Euro area unemployment rangeU.S. regions unemployment range
Percent
Euro area average range (1999-2012) = 10.0U.S. regions average range (1999-2012) = 2.6
(Regional variation in unemployment rates)
Fixes
• Monetary union can exist without a fiscal union– But need rules to make it work– Tried and failed in Europe
• Fiscal & political union along U.S. lines– Tighter constraints on ability of member states to
run deficits– Pooling of regional risks, especially of banking
system risks
Lessons from history
• The United States in 1780s– Fiscal crisis associated with servicing debt incurred
during Revolutionary War• Solution: strengthen powers of federal
government (replace Articles of Confederation with U.S. Constitution)– Federal government assumed debts of states– One-time bailout: states allowed to default in 1840s– States adopted balanced budget rules thereafter
Deficits in peripheral European countries comparable to U.S. deficits
1999 2001 2003 2005 2007 2009 2011-14
-12
-10
-8
-6
-4
-2
0
2
4
Peripheral Europe: GDP-weighted fiscal balance
U.S.
PercentBudget deficits as a share of GDP
Fiscal situation of Europe as a whole relatively sound
1999 2001 2003 2005 2007 2009 2011 201330
40
50
60
70
80
90
100Percent
Note: Diamonds indicate OECD forecasts.
U.S.
Euro area
Government debt as a share of GDP
Disunion
• Declining trust in European institutions– Just 31 percent compared to 57 percent before
crisis• Less favorable image of the EU• Majority (52 percent) still support the single
currency– Down from 61 percent before crisis
Conclusions
• Euro crisis is spreading from the periphery to the core, and increasingly weighing on global economic activity
• LTROs of December 2011 and February 2012 have bought time– ECB rate reduction and possible revival of securities market program can ease strains– ECB is involved in a game of chicken with national governments
• OMTs will also buy time when implemented• New “fiscal compact”
– A significant improvement over earlier Stability and Growth Pact?– EMU 2.0 workable?
• Challenges– Achieving consensus on new rules: loss of sovereignty– Market rigidities – Austerity programs– Potential for social unrest
• Europe 1914