European Macroeconomic Policies Martin Neil Baily The Brookings - - PowerPoint PPT Presentation

European Macroeconomic Policies

Martin Neil Baily The Brookings Institution McKinsey Global Institute Center for Transatlantic Relations at the Nitze School and Centre Cournot Conference, October 19, 2010.

All data slides prepared by the McKinsey Global Institute. Opinions solely those of All data slides prepared by the McKinsey Global Institute. Opinions solely those of the author

Aggregate Dem and Policies in the United States the United States

• In the United States, the TARP was used to recapitalize the
• banks. The Federal Reserve has dropped interest rates to

zero, provided credit guaranties and quantitative easing. The $800 billion stimulus package was used to supplement declining private demand. These were the right policies even if they were not executed perfectly.

• The US economy is recovering slowly. This has been a

The US economy is recovering slowly. This has been a serious illness not a mild cold and it will take several years to

• recover. Taxes were cut too much after 2001, while spending

continued to rise generating chronic deficits These bad continued to rise, generating chronic deficits. These bad policies are constraining our ability to provide further fiscal stimulus now.

• Policy should follow a ‘wait and see’ approach

No new large

• Policy should follow a wait and see approach. No new large

fiscal stimulus now. Re-think if there is a double dip.

Aggregate Dem and Policies in Europe Europe

• Most European economies have safety nets that are more

generous than those in the United States. The automatic stabilizers are more effective.

• Many countries discourage rapid large layoffs, which means

y g p g y , that the drop in employment in Europe was less severe than in the United States.

• The ECB was quicker than the FED to recognize the severity
• The ECB was quicker than the FED to recognize the severity
• f the crisis. It has followed broadly similar policies of low

interest rates and quantitative easing but has been somewhat less aggressive than the FED less aggressive than the FED.

• Fiscal stimulus has been smaller and is now giving way to the

pressure to reduce deficits and undertake fiscal consolidation.

• Germany and France appear to be recovering, especially in

Germany where there has been export-driven growth.

Fiscal Consolidation in Europe

• Germany and France have fairly modest programs of consolidation.

I G th b t f t l b l d d h ld b h In Germany, the boost from strong global demand should be enough to sustain growth. France is adjusting its pensions, which will not have a big impact on current demand and growth. It l i l i i it ti t b t it ill ti

• Italy is also raising its retirement age, but its economy will continue

to struggle with a lack of competitiveness. Spain is being forced to make larger fiscal adjustments as a result of spillover from Greece, and this will slow Spanish growth Spain also has a cost and this will slow Spanish growth. Spain also has a cost competitiveness issue.

• It is hard to see how Greece can pay off its debts without

restructuring at some point Ireland has moved aggressively to deal restructuring at some point. Ireland has moved aggressively to deal with its budget deficit and its growth has suffered as a result.

• The new coalition government in the UK inherited a very bad fiscal

situation and has moved to reduce spending This is likely to curtail situation and has moved to reduce spending. This is likely to curtail its growth, although unlike euro area countries, the pound is free to

• adjust. The Bank of England has eased monetary policy

Fiscal Consolidation, Continued

• At the past G-20 meeting, the United States pressed Europe to

t i fi l i d t t d t k lid ti sustain fiscal expansion and not to undertake consolidation. European leaders resisted and argued that fiscal consolidation would be expansionary. T i dit t ill t k t f th

• Tax increases or expenditure cuts will take money out of the

economy and cause a reduction of aggregate demand. There is no need to turn Keynes on his head. H if th i i ifi t i k f i d bt d f lt thi

• However, if there is a significant risk of sovereign debt default, this

has the potential to be very damaging to economic growth. Policymakers must weigh the costs and risks and choose among unpleasant alternatives unpleasant alternatives.

• In principle, sustaining fiscal expansion now while pledging to

reduce deficits in the future is a way around the problem, but it depends upon the believability of the promise depends upon the believability of the promise.

In most European countries, public debt has soared way above 60 per cent of GDP

% of GDP 2010 projection

2007 level 2007 level

Gross public debt, Maastricht criterion 103 Greece 125 96 Italy 119

• 5 2
• 8.1

Government net lending1

% of GDP, 2010 projection

103 Portugal 85 64 France 85 64 Belgium 100 84 Italy 119

• 7.4
• 7.8
• 4.9
• 5.2

Ireland 76 25 Germany 78 65 United Kingdom 78 45 g

• 11.7
• 5.4
• 11.5

70 60 Fi l d 52 35 Spain 63 36 Netherlands 67 45 Austria 3 8

• 9.4
• 6.4
• 4.7

Luxembourg 20 7 Sweden 44 40 Denmark 45 27 Finland 52 35

• 3 8
• 2.9
• 5.5
• 3.8

60

1 Differs from the Maastricht definition in that it does not include streams of payments and receipts from swap agreements and forward rate agreements. SOURCE: OECD Economic Outlook Database, 2010

Luxembourg 20 7

• 3.8

60

Restoring government debt to 60 percent of GDP by 2030 will require painful fiscal adjustment in many countries

Required adjustment for advanced G20 countries Assumed 2010 adjustment in Greece primary balance

Change in fiscal balance3 required to achieve sustainable government debt1 by 2030 Percent of GDP 13.1 Japan1 Cyclically adjusted primary balance, % of GDP 2010 2020

• 6.5

6.7 9.4 9.8 12.0 Spain Ireland United States p

• 7.6
• 5.8
• 6.0

4.4 3.6 3.8 9.2 8.3 9.0 7.6 France United Kingdom Greece2 16.8

• 2.4
• 5.4
• 4.6

6.8 3.6 3.7 4.4 5.2 7.8 Canada Australia Portugal

• 4.1
• 4.6
• 2.2

3.7 0.6 2.2 4.0 4.1 Germany Italy

1 All countries are assumed to target a 60% gross debt to GDP ratio except Japan whose target is set at 80 percent of net debt to GDP which corresponds

0.9 5.0

• 1.6

2.4

SOURCE: International Monetary Fund Fiscal Monitor May 14; McKinsey Global Institute 1 All countries are assumed to target a 60% gross debt to GDP ratio except Japan whose target is set at 80 percent of net debt to GDP which corresponds to a gross debt level of 200 percent of GDP. The transition is assumed to occur gradually in a straight-line fashion between 2010 and 2020. 2 Assuming Greece implements a 7.6 percent of GDP adjustment in their primary balance in 2010. 3 Fiscal balance here is the cyclically adjusted primary balance which is equal to the fiscal revenue less net interest expenditure.

Structural Em ploym ent and Productivity Productivity

• Employment growth in the EU-15 1995-2008 exceeded

the United States, especially in relation to population growth.

• Unemployment has dropped especially in Ireland UK
• Unemployment has dropped, especially in Ireland, UK,

Netherlands and Denmark.

• Diverging paths of unit labor costs have created

imbalances within the EU.

• The number of hours worked per year per employee is

low in the EU and declining low in the EU and declining.

• Productivity growth has been very slow.

Europe has already successfully created many new jobs above population growth in the last decade

Additional jobs 1995 2008 EU-15 EU-15 23.9 Additional jobs, 1995–2008 Million 8.7 2 1 12.1 5.3 2.1 18.8 20.5 3.3 1.4 0.3 United States United States Related to l ti Shifts in age t t Increased ti i ti Unemploy- t Total job th

SOURCE: The Conference Board; International Monetary Fund; Eurostat; McKinsey Global Institute analysis

population growth structure participation rates ment reduction growth

Note: Numbers may not sum due to rounding.

Successes in reducing unemployment include Ireland, the United Kingdom, the Netherlands, and Denmark

Unemployment rate 4 9 16.4

• 11.5

Unemployment rate % 4.9 5.2 10.4

• 5.2

3.8 7.9

• 4.1

4.3 6.1

• 1.8

7.6 10.3

• 2.7

SOURCE: Eurostat; OECD

Average 2004–08 Average 1984–88

Different trends in unit labour costs contributed to eurozone imbalances

Unit cost of labour

Northern Europe Continental Europe Southern Europe Northern Europe Northern Europe Continental Europe Continental Europe Southern Europe Southern Europe

Spain2 Greece 1.40 Unit cost of labour Index: 1.00 = 19991

Southern Europe Southern Europe Southern Europe

1.35 1.30 1 25 Netherlands Italy Ireland Greece 1.25 1.20 1.15 Belgium Portugal2

2

Finland 5 1.10 1.05 Germany France2 Austria 1.00 2009 2008 2007 2006 2005 2004 2003 2002 2000 1999 2001

SOURCE: OECD 1 Instead of 1999 = 1.00, Greece is indexed to 2000 = 1.00. This is because the exchange rate between the Greek drachma and the euro was fixed in June 2000 2 2009 data not available

EU-15 working time has fallen substantially, widening the gap with the United States

Annual hours worked per employee 2,100 Annual hours worked per employee 1,900 2,000 1,700 1,800 1,600 1,500 1970 1975 1980 1985 1990 1995 2000 2005 1,400 1,300 2009

SOURCE: The Conference Board; national statistical institutes

2009

Europe’s labour productivity stopped catching up with the United States in the mid-1990s

L b d ti it

1 i d

d t th U it d St t

EU-15 Northern Europe United States

110 Labor productivity,1 indexed to the United States

Southern Europe Northern Europe Continental Europe

95 100 105 80 85 90 65 70 75 80 55 60 65 1970 1975 1980 1985 1990 1995 2000 2005 2010 1970 1975 1980 1985 1990 1995 2000 2005 2010

1 Expressed in $ at 2009 EKS PPPs. SOURCE: The Conference Board

Structural Policies to I m prove Grow th Can be Draw n from w ithin the EU

• The US generally does not define best practice along a

range of economic indicators. S d d t k i f d it id ff

• Sweden undertook economic reform and it paid off.

For most indicators, EU member countries define the best practice

Best practice indicator values and top three performers

EU-15 average EU-15 range United States Best practice x

Labor market indicators Best practice indicator values and top three performers

Senior participation 2050 workers per retiree 74% 2.2

indicators

Adult unemployment Youth unemployment Women participation F l % f f ll ti 3% 7% 78% 68%

Service sector1

Female % of full-time Value added per capita Value added per capita growth 68% 31.6 6.3%

performance indicators

Value added per capita growth Productivity Productivity growth Hours per capita 6.3% 58.6 3.9% 539 Hours per capita growth Product market regulation indicator 3.2% 0.84

SOURCE: Conference Board; OECD; Eurostat; EU-KLEMS; WEF; Newsweek; CIA; UNODC; IMF; European Commission; McKinsey Global Institute analysis 1 Local, business, and professional and financial services. Range and values indicated exclude Luxembourg due the small economy strongly skewed to financial services

For most indicators, EU member countries define the best practice (CONTINUED)

Best practice indicator values and top three performers

EU-15 average EU-15 range United States Best practice x

Best practice indicator values and top three performers Growth and renewal indicators

Patents per capita R&D expenditure 296 3.8%

indicators

WEF innovation index OHI1 entrepreneurial index Science & Engineering graduates 100 46% 2.3

Public finance indicators

Debt level Deficit Cost of aging 15

• 0.5

1.1

Other non- GDP related indicators

Quality of life Gini index Crime rate 93 23 0 6 Crime rate Healthy life expectancy Gender gap index 0.6 74 83

SOURCE: Conference Board; OECD; Eurostat; EU-KLEMS; WEF; Newsweek; CIA; UNODC; IMF; European Commission; McKinsey Global Institute analysis 1 Organizational Health Index.

Under the pressure of the crisis, Sweden launched several successful reforms

S d GDP it P d ti it L b i t i d d t EU Sweden GDP per capita, Productivity, Labor input, indexed to EU

1.15 Reform period

▪ Under the pressure of fiscal and

economic crisis in early 90s, Sweden reduced government L b GDP per capita 1.10 g spending, eliminated the budget deficit, went to flexible exchange rate and inflation targeting

▪ The tax reform included the

li i i f di i (lik Labor Productivity 1.05 elimination of many distortions (like incentives for second earners), the pension reforms ensured a quasi- funded forward looking system (from the previous pay-as-you-go model) 1.00 model)

▪ Deregulation of network

industries and other traditional monopolies were realized to increase competition 1980 1985 1990 1995 2000 2005 2010 p

▪ Replacement rates in

Unemployment Insurance for above-median earners were substantially reduced

According to the Swedish Ministry of Finance these policy SOURCE: Conference Board; IMF; Reforming the welfare state: recovery and beyond in Sweden; How regulatory reforms in Sweden have boosted productivity, OECD; McKinsey Global Institute According to the Swedish Ministry of Finance, these policy measures were only possible to undertake as there was a “crisis mood” among the Swedish population