the euros three crises
DESCRIPTION
Overview of the three crises in the Euro zoneTRANSCRIPT
The Euro’s Three CrisesSub regional meeting May 2 2013
• A banking crisis• A sovereign debt crisis• A growth crisisInterdependence!
The banking crisisInitial problems
• The size of euro zone banks– 300% of GDP vs. 100% in the US, ING
• Corporate reliance on banks• Cross-border banking• No supervision at euro zone level• No statutory lender of last resort• No euro zone bank rescue facility
The banking crisisUS subprime contagion
The banking crisisHesitant ECB reaction (39% vs. 210%)
The banking crisis
How the two other euro zone crises worsen it:
• The growth crisis– Weak economy and falling asset prices damage
banks’ balance sheets
• The sovereign debt crisis– Sovereign defaults bankrupt banks with sizable
sovereign debt holdings
The sovereign debt crisisMixed initial conditions
The sovereign debt crisisLoss of confidence in 2010
The sovereign debt crisisMarkets punishing fiscal profligacy?
The sovereign debt crisisMarkets fearing unsustainability?
The sovereign debt crisisMarkets punishing public and private indebtedness
The sovereign debt crisisThe problem of dual equlibria
• ”Good” equilibrium: A virtuous circleTrust → Low interest rates → Small budget deficit → Sustainable public debt → Trust…
• ”Bad” equilibrium: A vicious circleLack of trust → High interest rates → Large budget deficit → Unsustainable public debt → Lack of trust…
The sovereign debt crisis
How the two other euro zone crises worsen it
• The banking crisis– Risk of bank failures leads to higher expected
public debt as a result of bank support
• The growth crisis– Weak growth raises debt/GDP ratios via higher
budget deficits and lower GDP
The growth and competitiveness crisis
The competitiveness crisisHard to compete on foreign markets
The competitiveness crisisHard to compete on domestic markets
The growth crisisFiscal austerity leads to lower growth
The growth crisisWeak banks are reluctant to lend
The growth and competitiveness crisis
How the two other euro zone crises worsen it
• The banking crisis– Weak banks with higher capital requirements slow
growth through reduced lending
• The sovereign debt crisis– Austerity measures imposed to reduce budget
deficits weaken aggregate demand via lower public spending and lower disposable income
The euro zone’s three crises:Many vicious circles
Solving the euro crisisShambaugh’s suggestions
• Fiscal devaluation plus fiscal revaluation• Monetary policy: Quantitative easing• Recapitalization of banks• Fiscal expansion in solid countries• Banking union– Supervisory agency– Deposit insurance– Bank resolution agency
Solving the euro crisisOther suggestions
The dream solution: Economic growthThe Baltic solution: All at onceThe dissolution solution: Back to square 1The Soros (1) solution: Germany leavesThe default solution: Sovereign defaultThe Soros (2) solution: EurobondsThe realistic ”solution”: Muddling through
The dream solution: Growth
Higher GDP growth leads to:• Less need for public spending + higher tax
revenues = Lower budget deficits• Lower debt/GDP ratios• Less private defaults = stronger banksBut unachievable because:• Low competitiveness = low foreign demand• Austerity measures = low domestic demand
The Baltic solution: All at once
• Nominal wage cuts• Public spending cuts• Migration• Political consensus
Too late for euro zone
The Baltic solution25% public wage cuts
The Baltic solution:Rapid gain in competitiveness
The Baltic solution: Migration
The Baltic solution:Steady growth from a lower level
The dissolution solutionHow it works
• Exchange rate depreciation leads to rapid gain in competitiveness
• Increased competitiveness leads to export led growth• Export led growth leads to higher employment• Higher employment leads to reduced deficits• Lower interest rates lead to stabilized asset prices• Stable asset prices lead to financial stabilityThis was Sweden’s and Finland’s way out of the crisis
The dissolution solutionIs it so unrealistic?
The Soros (1) solutionHow it works
• Germany leaves the euro• The D-mark appreciates• The euro depreciates• Remaining euro zone rapidly gains
competitiveness and goes for the growth solution via export led growth
Economically interesting - politically unrealistic
The sovereign default solution
• Countries with unsustainable public debt enter orderly default proceedings
• Partial debt cancellation, debt restructuring, moratorium
• Defaulted creditors (too big to fail) saved via nationalization
• End of austerity measures – resumed economic growth
Economically interesting - politically possible?
The sovereign default solutionWhich countries?
The Soros (2) solution: EurobondsHow it works
• Pooling of all existing euro zone public debt• = Pooling of all national sovereign risk• = Lower borrowing costs• = Lower budget deficits• = Existing debt sustainable• Conditions on further Eurobond borrowing
The realistic solutionMuddling through
• Continued austerity measures to reduce budget deficits
• Structural policies to raise aggregate supply• Reduced demand and increased supply lead to– Stagnating GDP– Rising debt/GDP ratios– Higher unemployment– Financial instability
Realistic – but politically dangerous
Thank you for your attention!