The Euro Crisis: a View from the North€¦ · 22.5.2013 Seppo Honkapohja 10 80 90 100 110 120 130...

SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND

The Euro Crisis: a View from the North

Seppo HonkapohjaBank of Finland

1Seppo Honkapohja22.5.2013

Views expressed are my own and do not necessarily reflectthose of the Bank of Finland.


Outline

♦ Build-up of the crisis

♦ Some design faults

♦ Adjustment and policies in the crisis

♦ The austerity debate: comments

♦ Going forward

222.5.2013 Seppo Honkapohja


1. Build-up of the crisis



Fig. 1: Disappearance of interest ratedifferentials (before 2008)

22.5.2013 4Seppo Honkapohja

0

4

8

12

16

20

24

28

32

0

4

8

12

16

20

1995 2000 2005 2010

Ireland Italy Portugal Spain Greece (right scale)

%

10 years government bond interest rate differential to Germany.Source: Bloomberg.24297@Korkoerot(m)_SH_0513

Interest rate differentials


Figure 2A: Public deficits


-35

-30

-25

-20

-15

-10

-5

0

5

10

1998 2000 2002 2004 2006 2008 2010 2012

Greece Ireland Italy Portugal Spain Euro area

% of GDP

Source: European Comission.24297@Alijäämät_SH_0513

Public deficits: GIIPS


Figure 2B: Public debt


0

20

40

60

80

100

120

140

160

180

1998 2000 2002 2004 2006 2008 2010 2012

Greece Ireland Italy Portugal Spain Euro area

% of GDP

Source: European Comission.24297@Velat_SH_0513

Public debt: GIIPS


Figure 3: Current account and public debtdynamics, GIIPS countries


Spain

Ireland

ItalyGreece

Portugal

‐35

‐30

‐25

‐20

‐15

‐10

‐5

0

5

10

‐20 ‐10 0 10 20

Public deficit

Current account

Imbalances: GIIPS 2002‐2012

Spain

Ireland

Italy

Greece

Portugal


Figure 4: Current account and public debtdynamics, high-rated countries


Finland

AustriaBelgium

Netherlands

France

Germany

‐10

‐5

0

5

10

‐10 ‐5 0 5 10

Public deficit

Current Account

Imbalances: High‐rated countries 2002‐2012

Finland

Austria

Belgium

Netherlands

France

Germany


Figure 6: Unit labor costs for selected high-rated countries

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95

100

105

110

115

120

125

130

135

2000 2002 2004 2006 2008 2010 2012

Belgium Finland France Germany Netherlands

2000 = 100

Source: European Comission.25200@ULC_SH_0513

Unit labor costs: high-rated countries


Figure 7: Unit labor costs for GIIPS countries


80

90

100

110

120

130

140

150

2000 2002 2004 2006 2008 2010 2012

Greece Ireland Italy Portugal Spain

2000 = 100

Source: European Comission.25200@ULC_GIIPS_SH_0513

Unit labor costs: GIIPS


2. Some design faults



♦ Currency union is no shield from BOP crises - on the contrary!– BOP crisis took the form of a run on weak sovereigns .– ”Original sin”: sovereign debts in currency outside control by the

country.

♦ SGP problems:− No monitoring of external imbalances.− Lax implementation of SGP.

♦ Downgrading of the no bail-out clause.

♦ Insufficient completion of the EU single financial marketprogramme.



3. Adjustment and policies in the crisis



♦ Only hard choices remain once the crisis has erupted.– Necessary to adjust GDP downward.

♦ Making policy choices about downward adjustment arecomplex in the euro system.



Fig. 8: GDP declining, except for Ireland


60

70

80

90

100

110

120

130

2000 2002 2004 2006 2008 2010 2012


2005 = 100

Source: European Comission.26750@Chart8

GDP: GIIPS


Fig. 9: Current accounts in still deficit, exceptIreland


-20

-15

-10

-5

0

5

10

2000 2002 2004 2006 2008 2010 2012


% of GDP

Source: European Commission.26813@Chart4(en)

Current account: GIIPS


Fig. 10: Primary balances improving


-30

-25

-20

-15

-10

-5

0

5

10

2005 2006 2007 2008 2009 2010 2011 2012


% of GDP

Source: European Commission.26037@Perusjäämät_SH_0513

Primary deficit to GDP: GIIPS


Fig. 11: Rising unemployment


0

5

10

15

20

25

30

2005 2007 2009 2011 2013


%

Source: Eurostat.26295@Työt_GIIPS_SH_0513

Unemployment: GIIPS


4. The austerity debate: comments


SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND 2022.5.2013 Seppo Honkapohja

Constant 0.97* (0.54)

Forecast of fiscal stance ‐0.28 (0.39)

Fitted value of change in sovereign bond yields ‐0.56** (0.21)

R2 0.67

Growth forecast error = α + β forecast of fiscal stance + γ fitted value of change in sov. yields + ε

Change in sov. bond yields = γ0 + γ1 sov. rating + γ2 sov. CDS spread + γ3 headline fiscal deficit + ε

Table1:GDPgrowthforecasterrorsandforecastoffiscalstance,estimation with instrument variables


♦ Alternatives to present policies:(1) Slower speed in adjustment:

Finance for countries in EU-IMF programmes?Other countries: risk of increasing rates with major slow-down or reversal in adjustment.

(2) More expansionary FP in high-rated countries:Limited impact?Public finances of Northern countries are not that strong. Political willingness in Northern countries?

(3) Defaulting on existing debt (and possibly exit from euro). Quick balancing of public deficit and CA => additional austerity, capital controls, possibly fragile new currency.



5. Going forward

♦ Two principal parts in the policy response.

(1) Crisis management. – Policies in the crisis countries. – Provision of bridge finance by IMF and EU (ESM). – Accommodative monetary policy by ECB.

(2) Improvements in economic and fiscal institutions and governance.



♦ Banking union: SSM, bank resolution, deposit insurance.

♦ Improved governance for more resilient EU/euro area.− European Semester, Six-pack, Two-pack, Fiscal compact…

♦ Implementation of the new rules is crucial.

♦ ”Legacy” problem: what to do with the existing highlevels of private and public debts? (see figure)



Figure 12: Greek and Irish public debt ration1970-2011

20.12.2010

0

40

80

120

160

200

240

1970 1975 1980 1985 1990 1995 2000 2005 2010

Ireland Greece Euro area

% of GDP

Sources: Eurostat ja European Commission. Forecast autumn 2011.23162@EA J-velka(pitkä)


♦ Numerous proposals (Euro bonds, EMF, Specialfund,…)

− Involve complicated and possibly drastic redistributions of liabilities among countries.

− Moral hazard problems in many of them.


The Euro Crisis: a View from the North€¦ · 22.5.2013 Seppo Honkapohja 10 80 90 100 110 120 130...

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