[PPT] - The sovereign debt crisis: a catalyst for further European PowerPoint Presentation

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The sovereign debt crisis: a catalyst for further European integration?

Gabriel Glöckler *

Deputy Head of the EU Institutions Division European Central Bank Poros, 9 July, 2011

* The views expressed are those of the author and do not necessarily reflect the position of the ECB.

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Getting out of a systemic crisis

Kindleberger: 5 functions essential to stabilise (international) economic system

1. Maintaining open market for distressed goods 2. Stabilising exchange rates 3. Acting as lender of last resort 4. Providing countercyclical long-term lending 5. Ensuring coordination of macroeconomic policies

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EMU has done well overall

Delivered all 5 functions during the crisis

1. Open market maintained through internal

market rules

2. Exchange rates stabilised through euro
3. Eurosystem as lender of last resort
4. Countercyclical long-term lending though Greek

Loan Facility, EFSF, ESM

5. Coordination of macroeconomic policies

through SGP, Euro Plus Pact, governance reforms

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But results uneven

Kindleberger: 5 functions have to be performed

by single authority (‘benign hegemon’)

Where EMU has de facto ‘hegemony’ through

EU/euro area governance/institutions, response has been very effective (1-3)

But where authority is decentralised at national

level, results has been less conclusive (4-5)

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5

Problems with decentralisation (I) …

Influence of domestic politics Resurgence of nationalism Lack of capacity to enforce common rules

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Problems with decentralisation (II) …

0.0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0 01/01/10 01/02/10 01/03/10 01/04/10 01/05/10 01/06/10 01/07/10 01/08/10 01/09/10 01/10/10 01/11/10

Weak implementation Uncertainty over outcomes, making final costs higher

IE 10y bond spreads over DE 10y, Jan-Nov 2011

8
7
6
5
4
3
2
1

2000 2001 2002 2003 2004 2005 2006 2007 2000 2001 2002 2003 2004 2005 2006 2007 % GDP

EL PT

Govt balance in EL and PT, 2000-2007

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7

Table 1: Compliance with the preventive arm of the Stability and Growth Pact

(as a percentage of GDP)

indicates budgetary position close to balance or in surplus prior to 2005 and compliance with medium-term objective thereafter indicates compliance with minimum benchmark only indicates non-compliance with minimum benchmark

General government structural net lending (+)/borrowing (-)

MB MTO 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Belgium

1.3

0.5

0.6
0.8
0.9

0.1

0.1
1.1
0.9
0.2
0.6
0.3

Germany

1.6

BB

1.9
1.3
1.9
3.4
3.6
3.3
3.0
2.4
1.4
0.3

Ireland

1.5

CTBOIS 2.0 1.5 3.0

0.2
1.7
0.1

2.1 1.3 2.9 0.2 Greece

1.4

BB

3.3
2.6
3.3
4.9
4.7
5.9
8.0
5.7
3.7
3.5

Spain

1.2

BB

3.1
1.7
1.9
1.4
0.9
0.3
0.2

1.2 2.0 2.4 France

1.6

BB

2.4
2.1
2.6
2.5
3.5
4.0
3.8
3.6
2.7
2.7

Italy

1.4

BB

2.5
1.6
2.9
4.1
3.4
5.1
4.7
4.5
2.8
1.5

Cyprus

1.8

BB

3.7
4.5
3.1
3.4
5.1
8.1
5.2
2.8
0.7

3.5 Luxembourg

1.0
0.8

4.3 3.0 4.0 5.3 1.6 1.2

0.9

0.4 1.4 2.8 Malta

1.7

BB

10.3
8.5
7.8
6.5
5.8
6.5
4.2
4.1
2.9
2.4

Netherlands

1.1
1 to -0.5
1.3
0.8
0.4
1.3
1.9
2.0
1.1

0.8 1.1 0.3 Austria

1.6

BB

2.5
2.8
3.0
0.3
0.3
0.6
3.1
0.8
1.4
1.0

Portugal

1.5
0.5
3.8
3.5
4.5
5.4
3.4
4.7
4.9
5.2
3.2
2.2

Slovenia

1.6
1.0
2.5
2.4
4.1
4.5
2.2
1.9
1.6
0.9
1.3
0.7

Finland

1.2

2.0 0.6 0.6 5.2 4.0 4.1 3.3 2.9 3.7 4.2 4.9 Euro area

2.1
1.6
2.0
2.6
2.7
3.1
2.9
2.2
1.2
0.7

Poor compliance with SGP targets

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8 Unit labour costs in selected euro area countries, nominal

(index 2000Q4 = 100, relative to Germany, based on sa data) Source: Eurostat. Quarterly data up to 2010 Q1 for EA, GR, IT, ES, FI, BE, FR; 2009Q4 for NL and AT; 2009Q3 for IE; PT is based on annual data (up to 2009). Note: The ULC indices are set to 100 in the last quarter before the euro area accession of Greece. The ULC developments presented for Greece and Portugal might differ from the calculations made by the National Central Banks. The quarterly pattern in Greek ULC is affected by substantial volatility in quarterly compensation of employees figures. 95 100 105 110 115 120 125 130 135 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 95 100 105 110 115 120 125 130 135

Germany France Italy Spain Netherlands Belgium Austria Greece Ireland Finland Euro area Portugal

Table 2: Compliance with the corrective arm of the Stability and Growth Pact

(as a percentage of GDP) indicates a deficit ratio below the 3% reference value (a debt ratio below the 60% reference value) indicates a deficit ratio above the 3% reference value which was not recognised as excessive in the following year (usually because the deficit was revised upwards ex post) indicates a deficit ratio above 3% of GDP which was recognised as excessive in the following year (a debt ratio above 60%)

General government: Net lending (+)/borrowing (-) Gross debt

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1998 2007 Belgium

0.9
0.5

0.1 0.4 0.0 0.0 0.0

2.3

0.3

0.2

117.1 84.8 Germany

2.2
1.5
1.1
2.8
3.7
4.0
3.8
3.4
1.6

0.0 60.3 65.0 Ireland 2.4 2.7 4.7 0.9

0.6

0.4 1.4 1.6 3.0 0.3 54.0 25.5 Greece

3.9
3.1
3.7
5.0
4.7
5.6
7.4
5.1
2.6
2.8

105.8 94.5 Spain

3.2
1.4
1.1
0.6
0.5
0.2
0.3

1.0 1.8 2.2 64.1 36.2 France

2.6
1.8
1.5
1.6
3.2
4.1
3.6
2.9
2.4
2.7

59.4 63.9 Italy

2.8
1.7
2.0
3.1
2.9
3.5
3.5
4.2
3.4
1.9

114.9 104.0 Cyprus

4.1
4.3
2.3
2.2
4.4
6.5
4.4
2.4
1.2

3.3 58.4 59.8 Luxembourg 3.4 3.4 6.0 6.1 2.1 0.5

1.2
0.1

1.3 2.9 7.4 6.9 Malta

9.9
7.7
6.2
6.4
5.5
9.8
4.6
3.2
2.5
1.8

53.4 62.6 Netherlands

0.9

0.4 1.3

0.2
2.1
3.1
1.7
0.3

0.5 0.4 65.7 45.4 Austria

2.3
2.2
2.1

0.0

0.6
1.4
3.7
1.5
1.5
0.5

64.3 59.1 Portugal

3.4
2.8
3.2
4.3
2.9
2.9
3.4
6.1
3.9
2.6

52.1 63.6 Slovenia

2.4
2.0
3.8
4.6
2.5
2.7
2.3
1.5
1.2
0.1

23.1 24.1 Finland 1.7 1.6 6.9 5.0 4.1 2.6 2.4 2.9 4.1 5.3 48.2 35.4 Euro area

2.3
1.4
1.0
1.9
2.5
3.1
2.9
2.5
1.3
0.6

72.8. 66.3.

Slow correction of excessive deficits

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Cacophonous communication

25/01/11: EFSF first bond issue. 16-17/12/10 : European Council confirms private creditors’ involvement in the ESM 18/10/10: Deauville Summit declaration: private creditors to be involved in the crisis resolution mechanism 28-29/10/10 : European Council endorses the Van Rompuy report but divided on sanctions. 23/11/10: Merkel: “We are facing an exceptionally serious situation.” 28/11/10 : ECOFIN approves €85 bn Irish package

Government bond spreads against German Bund in basis points (10 yr)

12/11/10: G-20 Joint F/D/IT/ES/UK statement “Any new [bail-out] mechanism

nly after mid-2013;

no impact on current arrangements.’’ 10/01/11: After China, Japan announces bond buys to boost confidence in EFSF.

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… lead to obvious conclusion?

Kindleberger was right
Either:

– continuation of myopic crisis management; – accept de facto German hegemony (veto power and essential financier); – overburdening of ECB

Or: create supranational ‘hegemony’ at euro

area level (for 4-5)

This is what most current reform proposals in

fact imply

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3 popular ideas of how to overcome crisis

Adjustment hegemony via technocracy Market hegemony via “perpetual

pinion poll”

EU hegemony via financing of government borrowing Proposal Threat of default Market financing

II. ‘Orderly’

default EU-IMF programmes Common bonds Countercyclical lending (4) Pre-condition for participation

I. Eurobonds

Conditionality Coordination of macroeconomic policies (5)

III. Loss of

sovereignty

But problems with all three

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I. Eurobonds

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‘Transfer union’ politically not acceptable

Domestic communication ‘challenging’

In addition: moral hazard problems, costs/incentives for AAA countries, operational and legal questions

Source: Financial Times

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Strong resistance to implicit transfers

Greek sovereign liabilities (in bn €, assuming gross financing need is met by official loans)

50 100 150 200 250 300 350 2009 2010 2011 2012 2013 2014 2015

Source: JP Morgan Chase Global Data Watch, June 2011 Market debt Official liabilities (incl. ECB holdings)

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Not yet serious about stronger governance

ECB Opinion on “economic governance” package

1. Greater automaticity
Non-compliance must have predictable consequences;

Council to have less room for manoeuvre to halt or suspend procedures

2. Strict deadlines
to avoid lengthy procedures; delete “escape clauses”
3. Focus – asymmetrically – on problem countries
i.e. those with current account deficits, competitiveness

losses, high levels of public and private debt. Current text Partly No Partly

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Not yet serious about stronger governance (II)

4. Political and reputational incentives
Increased reporting; escalation to European Council;

Commission/ECB surveillance missions.

5. Earlier and graduated sanctions (in macro-

surveillance)

interest-bearing deposit after the first instance of

non-compliance in EIP, fine after repeated non-compliance

6. Ambitious benchmarks for excessive deficit
Reduce scope of “relevant factors”

Current text Mostly Yes No

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Not yet serious about stronger governance (III)

7. Ambitious medium-term budgetary objective
Improvement of structural balance to be significantly

higher than 0.5% of GDP for high debt countries.

8. Quality and independence of economic analysis
Body of wise (wo)men to perform ex post

assessment of surveillance

9. Strong national fiscal frameworks
Swift and uniform implementation of directive
10. Improved statistics

Current text Partly No No Yes

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II. ‘Orderly’ default

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Market record on governance not very impressive (I)

200 400 600 800 1000 1200 1400 1600 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 50 100 150 200

gov. bond spread
gov. gross debt (rhs)

Reaction of Greek government bond spreads to debt developments in Greece (over German 10 year Bund)

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Market record on governance not very impressive (II)

200 400 600 800 1000 1200 1400 1600 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 5 10 15 20

gov. bond spread
gov. budget deficit (rhs)

Reaction of Greek government bond spreads to deficit developments in Greece (over German 10 year German Bund)

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500 1000 1500 2000 2500 3000 Jan '10 Feb '10 Mar '10 Apr '10 May '10 Jun '10 Jul '10 Aug '10

Trading volumes in Greek government bonds

(1 Jan - 23 Aug 2010; EUR mil, daily data)

Sources: Bank of Greece. Notes: Volumes traded on Secondary Market Platform run by the Bank of Greece (HDAT).

Sudden stops in certain bond markets…

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Daily changes in bond prices, in percentages

… leading to widespread market dysfunction

Daily price changes in government bonds, in percent

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Excessive power to ratings agencies

Embedded pro-cyclicality, questionable judgements

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Under/overshooting, contagion

Spread over 10-year German government bond yield, in basis points

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Contagion (II)

Strong correlation between sovereign and banks’ CDS

Sources: CMA DataVisiosn via Datastream

250 500 750 1000 1250 Jan.09 Jul.09 Jan.10 Jul.10 Jan.11 Germany France Italy Spain Greece Ireland Portugal Netherlands

Banks Sovereigns

250 500 750 1000 1250 Jan.09 Jul.09 Jan.10 Jul.10 Jan.11 Deutsche BNP Paribas Unicredito Santander

Nat. Bk of Gr.
Bk. Of Ireland

Banco Com. Port. ING

Latest observation: 25 Jan. 11. Note: Five-year CDS; basis points.

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III. Loss of sovereignty

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Not how the EU usually does business

Economic sovereignty Financial support

From partners to wards?

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Difficult to enforce without supportive domestic consensus

For Against

Support for Medium-Term Fiscal Strategy implementing legislation in Greek parliament

5 10 15 20 25 30 35 40 45 PASOK ND Others

Support for main Greek political parties, June 2011

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Which way ahead?

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Way ahead

Need to take a broader perspective
EMU is following a path-dependent process of

incremental change based on – existing logic of institutional development, same as in first 8 years (layering, redirection) – Existing preferences of euro area Member States (subsidiarity, consensus) – Will a new “Churchillian moment” lead to “branching point” and a new development path?

Don’t expect “clean slate”/redesign EMU approach!

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FISCAL GOVERNANCE

1997: SGP and Eurogroup added to Maastricht setup (layering) 2005: SGP reformed, focus on “sustainability” (redirection) 2011: ‘new’ SGP + national fiscal frameworks (layering) 2011 : Euro Plus Pact, regular Euro Area Summits; technical assistance (layering)

Macroeconomic coordination

MACRO SURVEILLANCE

1997-1999: Luxembourg, Cologne, Cardiff processes added to BEPGs (layering) 2000: Lisbon Strategy created to streamline processes (layering) 2010: Europe 2020 Strategy refines priorities (redirection) 2011: Macroeconomic imbalances surveillance formalised (redirection)

“Enforcement officer”? (ECB); “Binding debt ceiling/European Debt Management Agency”? (Bini Smaghi) “European Finance Minister”? (Trichet)

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Countercyclical lending

“No bail out clause” Greek Loan Facility ad hoc

EFSF layering on Eurogroup, EIB, ECB, … EFSM layering on MTFA ESM Secondary market purchases? redirection Precautionary facilities? redirection Use for recapitalisations? redirection Other uses – genuine EMF? redirection

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Conclusion

Despite crisis, EMU continues to reform in same manner as in past 8 years (and past 60)

Incremental, though in all likelihood accelerated
Path-dependent
Reflecting national preferences – mitigating

legitimacy/accountability concerns

Neither pretty nor particularly fast

But ultimately delivering…

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The euro area is ahead of others

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