Euro@20

Harvard University, Centre for European studies – 30 October 2018

Marco Buti

Director General - DG ECFIN

European Commission

Content

1. Introduction

2. Did EMU change policy behaviours?

3. Euro area throughout the crisis

4. Reforms during the crisis but job still not done

2

• Efficiency ++

(but certain aspects, like productivity/reforms fully decentralised)

• Stabilisation +

(only based on monetary policy and automatic stabilisers)

• Equity 0

(interpersonal fully in the hands of Member States; cohesion between countries in EU budget)

• Sustainability/Stability +++

(necessity of supranational fiscal rules to secure sustainability and protect monetary policy from deficit bias and debt spillovers/ ECB as the most independent CB in the world)

3

MUSGRAVE + and the MAASTRICHT ASSIGNMENT

MAASTRICHT ASSIGNMENT

Institutional setting in EMU (strong version of the “consensus” on policy making of the 80s' – see Buti Sapir 1998) i) Monetary Policy (centralised) by independent central bank instrumental to

credibly bring down inflation <= conservative, independent central bank to bring down inflation, Barro-Gordon (1983), Rogoff (1985)

ii) Fiscal Policy (decentralised) action limited to automatic stabilization (normal cycles) <= Barro (1979)

iii) Ban on excessive government deficits & on monetary financing of government deficits <= avoid fiscal dominance and no government bailout, Sargent & Wallace (1981)

iv) Financial markets allocate resources efficiently within and across member states <= markets are efficient, Fama (1970) – financial markets smooth efficiently, Obstfeld (1986) & Eichengreen (1992)

v) Competition (trade and internal market) increases efficiency, and synchronization of business cycles <= Cecchini Report (1988), Frankel and Rose (1996)

4

5

What was expected What happened

Efficiency - Financial markets as shock absorbers - Improve resource allocation - Uptake of structural reforms

Efficiency - Shock propagated in the crisis - Capital allocation not always efficient - Limited, anaesthetic effect

Stabilization - House in order allows "negative

coordination" and facing country-specific shocks

Stabilization - Adequate EA fiscal stance not

necessarily resulting from bottom-up national fiscal stances

Equity - Real convergence - Equity/redistribution

Equity - Limited - Limited, no redistribution

Sustainability/Stability - Credibility of the central bank - Expectations that MS would maintain

sustainable public finances

Sustainability/Stability - Established - Fiscal benefits of euro accession largely

spent

Our early beliefs… …and what happened

Content

1. Introduction

2. Did EMU change policy behaviours?

3. Euro area throughout the crisis

4. Reforms during the crisis but job still not done

6

Improvement in prosperity broadly at par with the US, but convergence with the US stalled

GDP per capita

(in pps, US=100)

Source: Ameco

7

• GDP per capita growth

• (%)

Source: Ameco

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

EuropeanUnion

Euro area(EU-19)

US

50,0

60,0

70,0

80,0

90,0

100,0

110,0

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

EuropeanUnion

Euro area (EU-19)

US

Credibility of the Central Bank

Dispersion of HICP inflation

Notes:

Dispersion measured as an unweighted standard deviation.

2018/19 projected values according to Autumn 2018 forecast.

EA changing composition: according to entry date in EA

Source: Ameco

0

1

2

3

4

5

6

7

8

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

EA-11 Current EA-19 EA changing composition

8

Not all MS improved sufficiently public finance sustainability

Data source: AMECO

Government debt/GDP

10-year government bond yields (%)

9

Real convergence mostly driven by 'new' euro area Member States

AT

BE

EE

FI

FR DE

EL IE

IT

LU

NL PT

SK

SI

ES CY

LV

LT

MT

0

2

4

6

8

10

12

0 10 20 30 40 50

GD

P p

er

capita in P

PS

(avera

ge g

row

th 1

999-2

007)

GDP per capita in thousands PPS (1999)

excl. 'new' EA MS

all countries

AT BE

EE

FI

FR

DE

EL

IE

IT LU NL PT

SK

SI ES CY

LV LT

MT

-4

-3

-2

-1

0

1

2

3

4

5

0 20 40 60 80

GD

P p

er

capita in P

PS

(avera

ge g

row

th 2

008-1

3)

GDP per capita in thousands PPS (2008)

excl. 'new' EA MS

all countries

Note: Countries which were in 1999 (left chart) and in 2008 (right chart) not members of the euro area are highlighted in red.

The black regression line is based on the full sample of countries, the blue one excludes the 'new' euro area Member States, which are highlighted in red.

Source: Eurostat.

GDP per capita (in PPS) before and after the start of the financial crisis

10

Imbalances and resource allocation

11

Increasing imbalances

-60

-40

-20

0

20

40

60

-6

-4

-2

0

2

4

6

8

99 00 01 02 03 04 05 0607 08 09 10 1112 13 14 15 1617 18

NII

P,

% o

f countr

y g

roup G

DP

CA,

% o

f countr

y g

roup

CA - Creditors CA - Debtors

NIIP - Creditors NIIP - Debtors

Cumulative growth rate of non-tradable/tradable value added

-5

0

5

10

15

20

25

EA center EA periphery

1995-98 1999-2007 2008-2013

Source: Commission calculations based on AMECO

Center

Center

Periphery

Periphery

Content

1. Introduction

2. Did EMU change policy behaviours?

3. Euro area throughout the crisis

4. Reforms during the crisis but job still not done

12

Origin of the EA crisis: my preferred reading

• A "sudden stop" crisis following capital misallocation in pre-crisis years

• A banking crisis triggered a feedback loop: bank solvency concerns higher bond yields and debt service default worries deeper

recession

• The euro-area crisis was not a fiscal crisis (apart from Greece), but lack of fiscal space hindered the policy response during the crisis

• Heterogeneity in the euro area much larger than assumed before the crisis: different growth models and agglomeration effects

• Structural divergences during the first 10 years of EMU led to divergent social and political preferences "ultima ratio" mode

16

Upon sudden stops, short-term flows were replaced by central bank lending

* start in 2002 , ** start in 2004 Source: Eurostat

Central bank lending to EA credit institutions

17

ECB intervention: rates and balance sheet

15

0

50

100

150

200

250

300

350

400

450

-1

0

1

2

3

4

5

6

janv.-05 janv.-07 janv.-09 janv.-11 janv.-13 janv.-15 janv.-17 janv.-19

ECB policy and euro overnight rates, Eurosystem BS size

ECB deposit facility rate EONIA BS total (Jan-07 = 100), rhs

%

Source: Macrobond, ECB

index Lehman Brothers default

Start of EA Sovereign Debt Crisis

ECB negative policy rate

QE announcement

OMT

Fiscal policy tended to be pro-cyclical

Source: Commission calculations based on spring 2018 Commission forecast 16

Broadly neutral fiscal stance

Contra-cyclical loosening

Pro-cyclical loosening

Pro-cyclical restriction

Contra-cyclical restriction

Fiscal stance over the economic cycle, EA 2011-2018e

2011

2012

2013

2014

2015 2016

2017

2018e

-1,5

-1,0

-0,5

0,0

0,5

1,0

1,5

-4,0 -3,0 -2,0 -1,0 0,0 1,0 2,0

Ch

an

ge

in S

tru

ctu

ral

Ba

lan

ce (

pp

s. o

f G

DP

)

Output Gap (% of GDP)

Structural reform uptake

17

Source: OECD (PMR)

Programs: the euro-area crisis was not a fiscal crisis (apart from Greece)

Ireland: €85bn, exit

in 2013

Five financial assistance

programmes

Portugal: €78bn, exit

in 2014

Spain: financial sector

support; €40bn, exit in

2014

18 Greece: 1st €110bn in 2010,

2nd €172.6bn in 2012 and

€86bn in 2015 €, exit in 2018 Cyprus: €10bn, exit in 2016;

Content

1. Introduction

2. Did EMU change policy behaviours?

3. Euro area throughout the crisis

4. Reforms during the crisis but job still not done

19

20

Structural reform

strategy

(Europe 2020)

Crisis resolution

instruments

- EFSM/EFSF: temporary

- ESM: permanent

- ECB: OMT

Growth Compact (EIB, Structural funds,

Projects bonds)

More effective

supervision and

regulation of the

financial system ESAs - ESRB - CRD IV

Banking Union: SSM; direct recaps

by ESM

Prevention and

correction of macro

imbalances

Procedure and

sanctions

European Semester

for economic policy

coordination

Balanced

growth

Better enforcement

of SGP rules

-Sanctions

- Two Pack: ex ante submission of

draft budgets, closer monitoring

- National layer: Directive on fiscal

frameworks, Fiscal Compact

Focus on debt

developments

Debt reduction benchmark

More effective

prevention of gross

policy errors

- Focus on structural balances

- Expenditure benchmark

Sound fiscal

policy

EMU reform during the crisis: an overview

Two competing models for EMU

"Back-to-Maastricht" Fast forward to federalist EMU

Stronger enforcement of EU fiscal rules to rein debt and deficits

Distribution of fiscal efforts to achieve an appropriate aggregate fiscal stance

Mechanism of imbalances procedures (MIP) focused on competitiveness of lagging countries

Symmetric adjustment to help weak countries and reduce Euro area current account surplus

Banking Union does not need common deposit insurance

Full Banking Union to ensure financial stability and private risk sharing

End to the risk-free status for sovereign debt and establish sovereign debt restructuring mechanism

Fiscal capacity for public risk sharing and eventually sovereign debt mutualisation

More market discipline Euro area Treasury

21

In their « pure » form, both are economically and/or politically unfeasible

To enter into the adult age of the Euro, the institutional framework is to be profoundly reinforced

22

Complete Banking Union

and Capital Markets Union

Common fiscal

stabilisation function

Accountable institutions and

effective governance

Economic and social

convergence

1. Financial Union

2. Economic and

Fiscal Union

3. Institutions and

Governance

European safe asset,

Not €bonds

Diversified banks'

sovereign exposures

Banking & Capital Market Union

23

CAPITAL MARKET UNION

33 action in 6 areas

Possible forms for a European safe asset

24 Source: Buti, Deroose, Leandro and Giudice (2017)

The evolving EA fiscal framework

Increased adaptability at the expense of simplicity…

CLARITY

(simplicity)

ADEQUACY (adaptability)

PREDICTABILITY

25

Impact of a central stabilisation capacity in bad times

Source: Commission calculations based on spring 2018 Commission forecast 26

Contra-cyclical loosening

Pro-cyclical loosening

Pro-cyclical restriction

Contra-cyclical restriction

Fiscal stance over the economic cycle, EA 2011-2018

(2013) (2012)

Very bad economic times

Very good economic times

2011

2012

2013

2014

2015 2016

2017

2018e

-1,5

-1,0

-0,5

0,0

0,5

1,0

1,5

-4,0 -3,0 -2,0 -1,0 0,0 1,0 2,0

Ch

an

ge

in S

tru

ctu

ral

Ba

lan

ce (

pp

s. o

f G

DP

)

Output Gap (% of GDP)

Conclusion, quasi

27

• Crisis is over, but the job is not yet done

• EMU deepening is an unfinished business

• Key ingredient: trust to be rebuilt

(Habermas helps).

• Overcome creditors/debtors divide

• Additional difficulties in a multi-layer

governance. Discount rate of COM < than

that of Member States

• …and Italy

28

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1792

1798

1804

1810

1816

1822

1828

1834

1840

1846

1852

1858

1864

1870

1876

1882

1888

1894

1900

1906

1912

1918

1924

1930

1936

1942

1948

1954

1960

1966

1972

1978

1984

1990

1996

2002

2008

2014

2020p

Total Federal Government Expenditure 1792-2020p

Total Federal Government Expenditure, Excl. War Department,Naval Department and Interest on the National Debt 1792-1945

EU Budget in 2014 = ~1.17% of EU GDP

War of 1812: 1812-1815

Mexican-American War:

1846-1848

U.S. Civil War: 1861-1865

Spanish-American War:

1898

World War I: 1917-1918

World War II: 1941-1945

LESSON FROM THE US: completing monetary unions take a long time

Source: Kirkegaard (2018), Williamson (2014). Expenditure data from 1792-1945 , US Census (1949); 1945-2020p OMB (2015).

Thank you for your attention

29