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The future of the Euro Area and Its Enlargement
André Sapir
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Outline
• EMU: lessons from the crisis
• When should Romania join EMU?
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Lessons from the crisis: What was wrong with EMU 1.0?
3
• Impact of EMU on financial integration underestimated & consequences for financial stability ignored: EMU 1.0 was liable to financial crises
• Nature of EMU sovereign debt ignored: EMU 1.0 was liable to sovereign debt crises
• Loss of the ER instrument not compensated: EMU 1.0 was liable to adjustment problems
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The EMU 1.0 system failed
4
• Prior to the crisis, surveillance was inadequate
• It did not understand well the nature of the risks, including for BOP • Fiscal surveillance: SGP focus on deficit rather than debt sustainability • No EZ financial surveillance, inadequate national surveillance
• Prior to the crisis, adjustment mechanisms were inadequate
• The REER channel did not work well: divergences in competitiveness
were not corrected automatically or otherwise
• When the crisis occurred, the system lacked adequate tools to respond
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The system allowed huge imbalances
5
• Very large current deficits
• Huge build up of private and public debts, and external debts
• Loss of competitiveness
• The music stopped when the financial crisis started
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6
Effect of EMU on external imbalances: Current account
Data source: AMECO May 2012
Correlation (GIIPS,DM) 1960-1998: +0.28
-8
-6
-4
-2
0
2
4
6
19
60
19
62
19
64
19
66
19
68
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
20
10
20
12
DM
GIIPS
Correlation (GIIPS,DM) 1999-2012: -0.73
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7
Same for Germany and Greece
Data source: AMECO May 2012
Averages 1960-1998 DE = 0.9 GR = -0.9
Averages 1999-2012 DE = 3.7
GR = -12.1
-20
-15
-10
-5
0
5
10
19
60
19
62
19
64
19
66
19
68
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
20
10
20
12
D
GR
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8
Risk of sudden stop not understood before Lehmann
AUSTRIABELGIUM
DENMARK
FINLAND
FRANCE GERMANY
GREECE
IRELANDITALY
NETHERLANDS
PORTUGAL
SPAIN
SWEDEN
UNITED KINGDOM
AUSTRIA
BELGIUM
DENMARK
FINLAND
FRANCE
GERMANY
GREECEIRELAND
ITALY
NETHERLANDS
PORTUGALSPAIN
SWEDEN
UNITED KINGDOM
AUSTRIABELGIUM
DENMARK
FINLAND
FRANCE
GERMANY
GREECE
IRELAND
ITALY
NETHERLANDS
PORTUGALSPAIN
SWEDEN
UNITED KINGDOM
020
40
60
80
100
5 Y
ear
Cre
dit D
efa
ult S
wap o
n G
ov B
ond
-15 -10 -5 0 5 10Current Account over GDP
31/12/2006 29/12/2007 20/10/2008
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How can EMU avoid or deal with financial crises?
9
• EMU needs a common mechanism for supervision, resolution and deposit insurance guarantee for banks
• EMU 2.0 provides a partial answer
• EMU 3.0 needs to
• Improve SRM, create a common deposit insurance guarantee
scheme
• Eventually merge SSM, SRM and DIGM into one institution
• Reduce bank dependence: Capital Markets Union
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How can EMU avoid or deal with sovereign debt crises?
10
• EMU needs common mechanisms to lower national sovereign debt and to reduce the exposure of banks to sovereign debt
• EMU 2.0 provides a partial answer
• EMU 3.0 needs to
• Better enforce fiscal rules to reduce debt levels
• Envisage Eurobonds/Eurobills
• Replace ESM by EMF and include a European SDRM
• Limit the exposure of banks to sovereign debt
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How can EMU avoid or deal with adjustment problems?
11
• EMU needs national and common mechanisms to reduce or handle adjustment problems
• EMU 2.0 provides a partial answer
• EMU 3.0 needs to
• Improve market mechanisms at national and EU levels
• Improve fiscal mechanisms at national and EU/EA levels
• Reduce heterogeneity among MS
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When should Romania join EMU?
• “The euro is meant to be the single currency of the EU as a whole...Member States that want to join the euro must be able to do so.” (JC Juncker)
• When should Romania adopt the euro?
• Should Romania join the BU before adopting the euro?
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The EU 2016 Convergence Report: Results for Romania
• Legal compatibility? NO
• Maastricht convergence criteria fulfilment?
• Price stability: YES (but NOT in 2018 according to COM)
• Public finances: YES (but NOT in 2017 & 18 according to COM)
• LT interest rate: YES
• Exchange rate (ERM2): NO
• Other relevant factors
• Macro (MIP): OK
• Micro (markets, business environment): still problematic
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Nominal vs. real convergence
• The nominal convergence criteria are basically meant to ensure that countries can live with price stability
• They don’t ensure against macroeconomic imbalances (the MIP was introduced for that, during the crisis)
• Insufficient real convergence is a better indicator of the risk of macroeconomic imbalance
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Convergence in the 11 CEECs that joined the EU in/after 2004 (GDP per capita at PPP, EU15 =100)
15
20
30
40
50
60
70
80
90
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Bulgaria Czech Republic Estonia Croatia Latvia Lithuania
Hungary Poland Romania Slovenia Slovakia
40 41 49 64
Simple average for the 11 countries
Start of negotiations
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Nominal vs. real convergence
• The nominal convergence criteria are basically meant to ensure that countries can live with price stability
• They don’t ensure against macroeconomic imbalances (the MIP was introduced for that, during the crisis)
• Insufficient real convergence is a better indicator of the risk of macroeconomic imbalance
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Rule of thumb
• A good rule of thumb should that countries with relatively low GDP per capita
• Should not abandon the ER instrument
• If they do, they should be especially mindful of the risk of macroeconomic imbalances
• And have very flexible product and labour markets
• With the second lowest GDP per capita country in the EU, Romania should be especially mindful
• Yet it is true that some CEECs have successfully adopted the euro when they had low pc GDP (Slovakia)
• No simple correlation between ER regime and growth
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Exchange rate regimes, 1996-2009 and 2017
18 Source: Becker et al. (2010)
2017
Currency board
Floating
Euro
Floating
Euro
Euro
Floating
Floating
Euro
Euro
Managed peg
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Exchange rates: national currencies against the euro 2008=100
19 Data source: WEO, IMF
90
95
100
105
110
115
120
125
130
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Bulgaria Czech Republic Estonia Croatia Latvia Lithuania
Hungary Poland Romania Slovenia Slovakia
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GDP growth rates, 2004-2016: All CEECs
20 Data source: WEO, IMF
-20
-15
-10
-5
0
5
10
15
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Bulgaria Croatia Czech Republic Estonia
Hungary Latvia Lithuania Poland
Romania Slovak Republic Slovenia
SK 4.01 EE 2.70
PL 3.87 CZ 2.64
RO 3.47 SL 1.73
LT 3.32 HU 1.54
BG 3.29 HR 0.90
LV 3.00
AAGR
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Adopting the euro: Economic pros and cons
• Joining EMU 2.0 is better than EMU 1.0, but EMU 3.0 would even be better though the waiting may be long
• Pros • Anchoring the fiscal framework
• Less transaction costs => trade, investment
• More financial integration
• Financial stability: ECB access, banking union
• ESM access
• Cons • Risk of macroeconomic imbalances during convergence process
• Loss of ER instrument for stabilization
• ESM cost
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Joining the banking union: Economic pros and cons
• Pros
• Financial stability, though without ECB access
• Improved home-host coordination of supervision
• Improved resolution of cross-border institutions
• Cons
• ?
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Conclusion
• Only one CEEC with floating rates has adopted the euro
• Will Romania be the next one? When?
• Romania was on-track to meet Maastricht criteria
• But the crisis has reminded us that real convergence matters at least as much as nominal convergence
• EMU 2.0 is a significant improvement over EMU 1.0
• Still, Romania should take its time. In the meantime it should consider joining the banking union
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Thank you!