The euro crisis and the ECB Jakob de Haan Head of Research, De Nederlandsche Bank Professor of Political Economy University of Groningen
Debt crisis: causes
In analysing and solving the sovereign debt crisis, the focus was on fiscal and monetary factors rather than on the macroeconomic causes of the crisis. Prior to the crisis, mainly Ireland, and to a lesser extent also Greece and Spain, showed signs of real convergence. However, Italy and Portugal hardly experienced any real convergence towards the German welfare level, even before the crisis.
Debt crisis: causes
Unfortunately, the catching-up process largely took place through debt, either public or private. As a result, debt with the rest of the world ran up tremendously. This was most dramatically the case in Ireland, which moved from a net creditor position of 52% of GDP in 1999 to a net debtor position of 71% of GDP in 2008.
Debt crisis: causes
The next slide shows the cumulative growth of unit labour costs relative to the euro area average from the start of EMU. Unit labour costs in Southern European countries went up, undermining their competitiveness. The countries that found themselves in the top of the chart when the sovereign debt tensions started in 2009 – that is Greece, Spain, Ireland, Portugal and Italy – all ran into trouble one after the other. This is no coincidence.
Credit growth Average annual growth rate of credit to private sector: 2000-2011 16 14 12 10 8 6 4 2 0 DE
Debt crisis: causes
Besides being largely based on credit, real convergence was accompanied by high inflation (next slide). Whereas Germany experienced lower inflation compared to the euro area average, the inflation rates in Greece, Ireland, Spain and Portugal were much higher than the EMU average. This substantial deterioration of competitiveness mainly reflects the development of unit labour costs.
Inflation differentials Cumulative differentials compared to EMU total : 2000-2007 12 10 8 6 4 2 0 -2 -4 -6 DE
Debt crisis: causes
Before EMU, the current euro area countries followed different economic strategies. Between 1970 and 1999, unit labour costs in Germany, the Netherlands en Austria grew by a factor of 2.5 to 3, while unit labour costs grew by a factor of 12 in Italy, 14 in Spain, 35 in Portugal and 55 in Greece. By regularly devaluing their currencies, these countries were able to restore competitiveness. But after the launch of EMU, this policy option was no longer available, of course.
Growth of unit labour costs relative to euro area, 1998=100 120 115 110 105 100 95 90
Austria France Ireland Portugal
Belgium Germany Italy Spain
Finland Greece Netherlands
Composition of exports: Destination and high-tech (blue) as % GDP
Debt crisis: causes
The divergences in unit labour cost developments and competitiveness within the euro area are reflected in the current account balances of the individual countries. For many years it was thought that in a monetary union, the current account balances of individual countries were no longer relevant. It was thought that only the balance of payment of the euro area as a whole mattered. We know better now.
Current account balance percent of GDP 10 5 0 -5 -10 -15 Netherlands
Debt crisis: causes
Of course, besides competitiveness problems, the crisis also had fiscal causes. The SGP didn’t prevent some governments from taking up old habits once they had fulfilled the convergence criteria that enabled them to join EMU, facilitated by some of the core countries of EMU. Let’s zoom in on the SGP: why do we need it and why did it fail?
Monetary union Monetary union requires restrictions on the fiscal policies of its Member States. Unsustainable fiscal policies of individual countries in EMU may undermine financial stability in the euro area and affect the policies of the ECB. The high levels of exposure to both the government and the private (financial) sectors of other euro area Member States considerably increase these risks. 14
Monetary union So for good reasons, the Maastricht Treaty and the Stability and Growth Pact (SGP) as adopted in 1997 stipulate that euro area Member States have the obligation to avoid excessive government deficits (based on a deficit criterion and a debt criterion, which are assessed against the reference values of 3% and 60% of GDP, respectively).
SGP • The SGP contains a preventive and a corrective arm. • The preventive arm prescribes the path for sound fiscal policies. • The corrective arm (the Excessive Deficit Procedure, or EDP) is intended to ensure the correction of excessive deficits in case they do occur. In the original SGP, only the latter ultimately provided for financial sanctions in case of non-compliance with Council recommendations. 16
Budgetary discipline in EMU was supposed to be exacted not only by the SGP, but also by market discipline. But market discipline was largely absent during the first ten years of EMU, allowing governments to pursue unsustainable policies. And when markets finally started to differentiate between governments, they did so with a vengeance. A stable monetary union cannot be based on this mechanism.
“On/off”market discipline 20
Germany Italy Netherlands
14 12 10 8 6 4 2 0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Why the Stability and Growth Pact failed? (1)
Under the original SGP, Member States were required to pursue the medium-term objective of budgetary positions that were “close to balance or in surplus”. There was, however, no possibility to impose sanctions on Member States violating Commission recommendations. Under the corrective arms, sanctions may be imposed. Sanctions include the requirement for the Member State concerned to make a non-interest bearing deposit, which, if noncompliance persists, is eventually turned into a fine.
Why the Stability and Growth Pact failed? (2)
The ECOFIN will not automatically impose sanctions, as each step requires a discretionary decision by the Council. Ministers who are responsible for drafting national budgets and who may therefore be accused of breaking the rules also have to decide whether one of their colleagues breaches the same rules. Credible rules need an impartial, consistent and competent enforcement mechanism. The ECOFIN “manifestly does not have the collective capacity to commit itself to an impartial, consistent enforcement of the rules” (Buiter 2003, p. 15). 20
Why the Stability and Growth Pact failed? (3)
The amendments of the SGP as introduced in 2005 brought even more discretion and flexibility into the corrective arm, although the preventive arm became slightly more stringent. As to the latter: Each Member State will present its own country-specific medium-term objective (MTO). The adjustment effort should be greater in good times and could be more limited in bad times. As a benchmark, Member States should pursue an annual adjustment in cyclically adjusted terms, net of one-off and temporary measures, of 0.5 per cent of GDP. 21
Why the Stability and Growth Pact failed? (4)
In periods with above-trend growth fiscal policies were not sufficiently adjusted to achieve sustainable budgetary positions. Violations of the deficit criterion were not sufficiently corrected. In addition, the debt criterion was largely ignored. This is problematic as the euro crisis stemmed principally from doubt regarding serviceability of government debts. Financial crisis caused a budgetary deterioration that was much larger than what was foreseen when the existing budgetary rules in EMU were designed. 22
Six-pack and Fiscal Compact (1)
The so-called six-pack, consisting of five Regulations and one Directive, entered into force on 13 December 2011. It does not only cover fiscal policy surveillance, but also macroeconomic surveillance under the new Macroeconomic Imbalance Procedure. In the fiscal field, the six-pack reinforces both the preventive and the corrective arm of the SGP. Most important: the six-pack introduces reverse qualified majority voting (RQMV) for decisions on most sanctions.
Six-pack and Fiscal Compact (2)
ECB (2012) identifies several weaknesses of the reinforced SGP: Still too many exceptional situations that can be taken into account so that non-compliance with the deficit or debt criterion will not necessarily result in the launch of EDP. Reinforced SGP still lacks sufficient automaticity in case of non-compliance. As decisions have to be taken on the basis of a proposal of Commission, the effectiveness of reinforced SGP still depends heavily on a strict and rigorous application of rules by the Commission.
Six-pack and Fiscal Compact (3)
Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (TSCG), which will enter into force after twelve euro area countries have ratified it. The articles in Title III of the Treaty referring to fiscal policy are referred to as Fiscal Compact. The two most important elements are a balanced budget rule, including an automatic correction mechanism, and a strengthening of the excessive deficit procedure.
Six-pack and Fiscal Compact (4)
As to Excessive Deficit Procedure of the SGP: at each stage of the Excessive Deficit Procedure euro area Member States will support the Commission’s proposals or recommendations in the Council if a euro area Member State is in breach of the deficit criterion, unless a qualified majority of them is against it. In practice this means that if a euro area Member State breaches the deficit criterion, reverse qualified majority voting applies to all stages of the EDP.
Six-pack and Fiscal Compact (5)
Fiscal rule, which requires the general government budget to be in balance or in surplus, with a lower limit of a structural deficit of 0.5% of GDP (1% if the government debt-toGDP ratio is significantly below 60%). New rule will not be more ambitious than the EU regulation already demands: all euro area Member States have an MTO that equals a structural deficit of 0.5% of GDP or less. Rule must include a correction mechanism, which is automatically triggered if significant observed deviations from MTO or the adjustment path towards it occur.
Six-pack and Fiscal Compact (6)
The balanced budget rule must be introduced in the national law of the countries concerned within one year after the TSCG enters into force. This must be done in a binding and permanent way, preferably at the constitutional level. The European Court of Justice (CoJ) may impose a financial sanction (0.1% of GDP) if a country does not properly implement the new budget rules in national law and fails to comply with a CoJ ruling that requires it to do so.
Further steps needed • Even though we consider the Fiscal Compact a step in the right direction, it does not sufficiently redress all the shortcomings of the SGP identified earlier. Furthermore, “its effectiveness and credibility remains subject to a strict implementation of fiscal policy surveillance by the Commission and a limited use of political discretion by the Council” (ECB, 2012, p. 93). That is why we argue in favor of further steps curtailing national fiscal sovereignty. 30
Role of the ECB
The ECB took measures to avoid the credit crisis from severely dragging down the real economy. It did so by introducing a refinancing operation with a maturity of three years. This operation attracted a lot of interest (see next graph). This provides banks with the liquidity security they need in light of the market tensions and, thus, helps prevent a sharp reduction in credit supply to the economy.
LTRO Long-term refinancing operations
4. Exceptional circumstances called for exceptional ECB measures Gross allocations by maturity, € bln
LTRO allotment Gross allocaton by maturity, €bn 900 800 1-month
300 200 100 06 32
Recently the European Central Bank (ECB) announced a new program of outright monetary transactions (OMTs). The program involves discretionary sterilized purchases of short-term sovereign bonds under certain conditions and is subject to a prior request by the respective country’s government for international assistance via the European Financial Stability Facility/European Stability Mechanism (EFSF/ESM).
Crisis not the same eveywhere
Debt crisis: what to do
The ECB cannot solve the crisis The ECB cannot solve the crisis overnight (in fact nobody can) Further steps are needed and they have to be taken by politicians (fast) Including: More budget discipline by delegating some fiscal sovereignty to European level Move towards banking union Structural reforms 35
Thank you for your attention