“Debt and Credit, Growth and Crises” Bank of Spain and the World Bank Madrid, Spain

1. Can Europe Get its Act Together?Three Scenarios for the Euro ZonePresentation by William R White “Debt and Credit, Growth and Crises” Bank of Spain and the World Bank Madrid, Spain 19 June, 2012

2. What is the nature of the euro zone problem? • Greece, Ireland and Portugal likely have “unsustainable” sovereign debt levels • But not themselves of systemic importance • Conversely, large peripheral countries (debtors) and core banking systems (creditors) are systemic • And the two are “joined at the hip” • Implying possible non linear outcomes • And even the breakup of the euro zone

3. Where did these problems come from? • In spite of German rhetoric, fiscal excess in small peripherals only a small part of the problem • But general fiscal indiscipline has increased exposure elsewhere and hinders a policy response • Private sector excesses, in response to financial convergence across the zone, were of critical importance • Leading to real divergences in an already “sub optimal” currency area

4. Finding solutions: the “should, could and would” problems • Strongly held economic beliefs, some likely wrong, but already hard wired into European institutions • Different visions of Europe • Many different countries with no effective mechanism for resolving disputes • No ex ante mechanisms for either bailouts or exit • A “democratic deficit” that hinders leadership and promotes division • Leaving the impression that policy is always “behind the curve”

5. Steps needed to solve the euro zone crisis • Short term challenges: meeting contagion • Ring fence large peripheral sovereigns and core banks • Avoid “triggering events” until ring fencing is adequate • Long term challenges: reducing contagion • Fiscal and financial oversight must move to the centre • Structural reforms affecting growth and “competitiveness”

6. Short term challenges: ring fencing large peripherals and core banks • ECB could buy sovereign paper in required quantities, but conflicts with perceived mandate • EFSF and ESM could also buy sovereign paper and/or recapitalize banks, but too small • Initially many schemes for leveraging the EFSF, but non-starter • G 20 could help but many constraints

7. Short term challenges: avoiding “trigger” events until ring fencing is adequate • Work with G20 to minimize global shocks • Having mismanaged Greece, need to convince markets that • Greece is unique among small peripheral countries • Debt restructuring does not imply leaving the euro zone • Measures to ring fence are adequate • But restoring confidence remains a “horse race”

8. Long term challenges: fiscal and financial oversight must move to the centre • A permanent “transfer union” is not politically possible • Going back to the original framework is also not possible; fundamentally flawed • Must build stronger European institutions • To allow euro zone bond issues • To curb excesses which threaten banking systems • To better manage future crises But confront “should, could and would” problems

9. Long term challenges: structural reforms • All countries would benefit from structural reforms to promote growth and deal with assymetric shocks • Debtor countries must focus on tradables • Creditor countries must focus on non tradables • All members must embrace the full implications of being in a monetary union • But again confront “should, could and would problems”

10. Three scenarios about the “horse race” • An orderly outcome as confidence comes back on the basis of measures announced end June • A disorderly outcome with a widening crisis eventually prompting required policy action • A very disorderly outcome as the crisis widens without an adequate policy response • With serious implications for the future of the euro zone and the broader global economy