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ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
The euro crisis: ways out for the euro zone and its member states
Vesa Vihriälä
28 November 2012
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Contents
• Where do we stand?
• Why is the euro crisis so stubborn?
• Way(s) out
• Three crises: a comparison
The phases of the crisis and policy reactions
2007Sub-primecrisis
2008Systemiccrisis
2009Greatrecession
2010Sovereigndebt crisis
2011Euro areaconfidence…
2012
…crisis
2013 ???
Policycoordination
Financialmarkets
Financialassistance
Bank support
Fiscal policy
Monetary policy
Liquidityprovision
Consolidation, structural reformsStimulus
Bilateral Greek loansEFSM, EFSF
SMP LTRO OMT
ESM
Regulatory andsupervision reforms
European semester, Six-pack, Two-pack, Fiscal compact
Banking union?
Recapitalization and guarantee schemes
Cutting policy rates
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Where do we stand now?
• Eurozone is in a double dip recession• Increasing divergence among the MS• Adjustment has started but mostly slow• Also growth potential has been affected
• ECB’s OMT promise has eased pressures
• But the short-term outlook remains weak, and the crisis still unresolved
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Great divergence in the euro zone
GDP at 2005 market prices Unemployment rate, %
Source: EU Commission projection, autumn 2012
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Great divergence: Baltic recovery vs. Greek stagnation (at best)GDP at 2005 market prices Unemployment rate, %
Source: EU Commission projection, autumn 2012
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Competitiveness has started to improve
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Strong variations of competitiveness in the Baltics
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Current accounts adjust, but slowly
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Significant fiscal consolidation
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
…which shows up in a gradual reduction of the headline deficits
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
…, including in the Baltics
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Why is the crisis so stubborn?
• The recessions associated with a financial crisis always deep and protracted
• Eurozone suffers from a coordination failure– No automatic stabilisation across MS– No automatic backing of sovereign debt by the
central bank– A vicious circle between banking problems and
sovereign debt problems at the MS level– Decision making on financial assistance difficult
among 17 sovereign nations
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Debt levels high, but not exceptional in the euro area on average
Sources: Bank of Finland, EKP, Eurostat, OECD, FED, BEA.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Non-solutions
• Massive fiscal easing across the board– Several MS have too tight borrowing constraints
• Transforming the euro zone into a genuine federal construct– Not enough political cohesion; would require a Treaty
change, which time consuming and uncertain
• Dissolution of the euro zone– Potentially catastrophic macroeconomic
consequences, would wreck the European project
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Way(s) out• Strengthening the current policies
– Bigger, more flexible ESM
– Expanded ECB action (OMT; QE)
– Ambitious reforms and fiscal consolidation in the problem countries, slowing down consolidation in fiscally stronger MS
– Most realistic
• A banking union– Euro level supervision
– Euro level deposit insurance and resolution mechanism
– Very likely too slow to impact on the current crisis
• A broader fiscal union, yet short of a federal state– Eurobonds, significant euro area budget
– More centralised fiscal policy making
– Not likely (a last resort response if dissolution threat imminent)
• Debt restructurings: Greece for sure, others = ?
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Light at the end of the tunnel?
• In the best case financial conditions could improve by early 2013, following by a gradual real recovery starting by mid-2013
• Even then, growth will be slow and uneven across MS
• Experience => major set backs cannot be excluded
• But: EU has proved to be rather resilient in crises
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
A comparison of three crises
• Finland 91-94
• Greece 2009 -
• Latvia 2008 -
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Finland in the early 1990s
• Credit boom/bust as in Spain and Ireland• Key policy measures
– Improved price competitiveness through depreciation and wage moderation
– Relatively strong fiscal consolidation, despite a low debt level– Growth-enhancing tax reform– Strong restructuring of the banking sector– Emphasis on education and R&D; Nokia– EU membership
• Relatively rapid recovery (GDP), improvement of public finances, slow but steady improvement of employment
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Greece
• Significant convergence towards EA average based on domestic demand
• Badly-run public sector, high public debt• Small export sector, weak competitiveness• Adjustment has centred on fiscal consolidation, which
largely self-defeating given the high debt level and slow adjustment of competitiveness
• Difficult to see a sustained recovery without a further debt restructuring (PSI and OSI)
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Latvia
• A strong credit-financed domestic demand boom prior to the global crisis; a very high CA deficit
• Strong fiscal consolidation and low debt level helped in regaining market confidence in the exchange rate and public finances
• Wage flexibility improved competitiveness quite fast despite the exchange rate regime
• Political resistance to adjustment policies moderate compared to Greece, despite (because of?) substantially lower GDP/capita level
• GDP, CA recovery rapid
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
GDP adjustment fastest in Latvia
GDP index: Finland (1990/Q1=100), Greece (2008/Q1=100), Latvia (2008/Q1=100)
2006Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1Finland:
Greece, Latvia:1998Q1 89Q1 90Q1 91Q1 92Q1 93Q1 94Q1 95Q1 96Q1
Source: Eurostat.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
2006Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1Finland:
Greece, Latvia:1998Q1 89Q1 90Q1 91Q1 92Q1 93Q1 94Q1 95Q1 96Q1
Also the UNR adjustment fastest in Latvia
Unemployment rate, %: Finland, Greece, Latvia
Source: Eurostat.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
2006Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1Finland:
Greece, Latvia:1998Q1 89Q1 90Q1 91Q1 92Q1 93Q1 94Q1 95Q1 96Q1
Depreciation helpful for restoring competitiveness but not necessaryRelative unit labour costs (total economy), indexFinland (1990/Q1=100), Greece (2008/Q1=100), Latvia (2008/Q1=100)
Source: Eurostat.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
2006Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1Finland:
Greece, Latvia:1998Q1 89Q1 90Q1 91Q1 92Q1 93Q1 94Q1 95Q1 96Q1
CA improves slowly, except in Latvia
Current account, % of GDP: Finland, Greece, Latvia
Source: Eurostat.
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Source: Eurostat. * = EU Commission forecast.2006 07 08 09 10 11 12*
Finland:Greece, Latvia:
1988 89 90 91 92 93 94 95 9613* 14*
Finland slowest to reduce public deficit, thanks to the low level of debt at the outset
General government deficit, % of GDP: Finland, Greece, Latvia
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
2006 07 08 09 10 11 12*Finland:
Greece, Latvia:1988 89 90 91 92 93 94 95 96
13* 14*Source: Eurostat. * = EU Commission forecast.
Debt dynamics works against Greece
General government debt, % of GDP: Finland, Greece, Latvia
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
07 08 09 10 11 12*2006Finland:
Greece, Latvia:1988 90 91 92 93 94 95 96
13* 14*89
Source: Eurostat. * = EU Commission forecast.
Greece relatively rich at start of the crisis
GDP per capita, PPP (constant 2005 international USD)Finland, Greece, Latvia
ELINKEINOELÄMÄN TUTKIMUSLAITOS, ETLATHE RESEARCH INSTITUTE OF THE FINNISH ECONOMY
Some lessons• Low public debt an essential cushion to limit market
reactions to deficits and to allow time for policies to work • Significant adjustment of competitiveness possible even
without exchange rate changes, but requires very flexible labour markets and social acceptance of harsh policies
• Sustained recovery requires also healthy real competitiveness; while the benefits of policies to this effect take time to materialize, also positive confidence effects possible => important not to delay action.
• A diversified supply of financial services probably better than relying purely on domestic institutions or purely on foreign institutions.
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