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Economic Drivers of the European Future – – 15 Propositions –

Oberbank Day Linz, May 28 2010. Economic Drivers of the European Future – – 15 Propositions – (one proposition every four minutes) Wolfgang Wiegard University of Regensburg and German Council of Economic Experts. Economic Drivers of the European Future. Table of contents.

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Economic Drivers of the European Future – – 15 Propositions –

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  1. Oberbank Day Linz,May 282010 • Economic Drivers of the European Future • – • – 15 Propositions – • (one proposition every four minutes) • Wolfgang Wiegard • University of Regensburg • and • German Council of Economic Experts

  2. Economic Drivers of the European Future Table of contents I. Looking back: European policy reactions during the financial crisis II. Looking forward: Euro at risk? II.1. Sovereign debt problems in the euro area II.2. How to reduce public debt burdens II.3. A brief evaluation of current policy reactions to the euro crisis II.4. Still lacking: Reform of the Stability and Growth Pact II.5. Monetary policy and inflation II.6. Will the euro survive? II.7. Taxing financial transactions or activities? III. Final remarks

  3. I. Deep recession in 2009 Proposition 1 In 2009, European economies as well as other industri-alized countries have been hit by the deepest recession since the Great Depression. Only in the emerging and developing economies did the GDP increase during the crisis.

  4. Annual percentage change in real GDP (2009) Source: IMF, World Economic Outlook, April 2010

  5. -4.1 Euro Area -4.9 United Kingdom Sweden -4.4 Russia -7.9 Japan -5.2 -2.6 Canada United States -2.4 ASEAN 5 1.7 Sub-Saharan Africa 2.1 2.4 Middle East/North Africa 5.7 India China 8.7 Annual percentage change in real GDP (2009) Source: IMF, WEO, April 2010 Source: IMF, WEO, April 2010 -10.0 -9.0 -8.0 -7.0 -6.0 -5.0 -4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0

  6. I. Economic policy reactions during the financial crisis Proposition 2 Fiscal and monetary policy interventions on an unpre- cedented scale prevented an even worse slump in economic activity. Massive fiscal stimulus packages in the euro area helped to stabilize aggregate demand.

  7. I. Monetary policy reactions: central banks’ key interest rates

  8. I. Fiscal stimulus packages in the euro area

  9. I. Expenditure multipliers in the euro area

  10. II.1. Sovereign debt problems in Europe Proposition 3 Due to fiscal policy interventions, public debt in- creased considerably during the crisis, and will con-tinue to increase dramatically if fiscal policy does not change.

  11. II.1. Long-term debt projections under no-policy-change assumption 8,7 271.3 260.8 188.2 177.4 155.6 116.7 113.3 112.2 102.5 78.5 72.4 64.0 70.6 69.3 60.0 48.1 Source: European Commission, Sustainability Report 2009, p. 40

  12. II.1. Economic effects of government debt Proposition 4 In the short run, higher deficit-spending stabilizes aggregate demand and dampens economic fluctu-ations. In the long run, higher debt-to-GDP ratios will  increase long-term interest rates and reduce economic growth narrow the room for growth-enhancing public investment expenditure burden future generations.

  13. II.2. How to reduce public debt burdens • Proposition 5 • In principle, there are five ways of achieving a reduction in public debt burden : • strict consolidation efforts by reducing (structural) primary deficits (i.e. cutting public expenditures or increasing taxes) • a higher growth rate of GDP • 3. a “bailout” or capital transfer from abroad • 4. a default (repudiation; restructuring of sovereign debt) • 5. higher inflation.

  14. II.2. How to reduce public debt burdens Proposition 6 A higher growth rate could help to solve the debt problem, but will not suffice to consolidate public budgets. GDP growth rate is endogenous and not a policy instrument; it is hard to boost growth rates in a lasting manner by tax or expenditure policies. For example: The growth rate effects of the German “Growth Acceleration Law”, implemented in 2010, are ZERO

  15. II.2. Growth rate effects of recent tax policies in Germany

  16. II.2. How to reduce public debt burdens Proposition 7 In northern “core” countries of the euro area (DE, FR, AT, NL, BE, LU) fiscal sustainability has to be restored by a long-term fiscal tightening. Public expenditures have to be cut and/or taxes increased in order to achieve (structural) primary surpluses in public budgets. Unfortunately, so far almost nothing has been done in DE, AT, FR.

  17. II.3. Evaluation of the Greek “rescue package” Proposition 8 With the “rescue package” of May 2 2010, euro area member states and the IMF agreed to bail out Greece, conditional on Greece meeting strict consolidation requirements. The alternative – a Greek default or “haircut” – could have been even more expensive for euro area countries. Even after the three-year financial support program, Greece will not be able to manage its debt crisis alone and will need additional help or have to restructure its debt.

  18. II.3. Some details of the Greek “rescue package” “rescue shield” for Greece BE DE IE EL ES FR IT CY LU MT 110 bn euro NL AT PT Relative Shares in ECB‘s capital (excl. Greece share) SI € 80 bn bilateral loans € 30 bn IMF SK FI

  19. II.3. Is there a conflict between the rescue package and the no-bail-out clause of the TFEU? ?

  20. II.3. European Stabilization Mechanism Proposition 9 In addition to the Greek rescue package, on May 10 2010, EU finance ministers established a European Stabilization Mechanism (ESM) with a total volume of 500 billion euros. The IMF will participate and provide a further 250 billion euros. The package provides financial support to member states in financial difficulties and is subject to strong conditiona-lity. Even if the legal basis for the program is weak, it will help to stabilize financial markets.

  21. II.3. Details of the “European Stabilization Mechanism” European Stabilization Mechanism: an even larger rescue shield 750 bn euro € 60 bn loans and credit lines from EU Commission € 440 bn by euro area members via SPV € 250 bn IMF

  22. II.3. Risk spreads before and after the ESM

  23. II.3. The legal basis for the ESM is weak

  24. II.4. Reforming the Stability and Growth Pact Proposition 10 The rules of the Stability and Growth Pact (SGP) were neither strict enough nor enforced strictly enough to prevent the European debt crisis. Hence, it is essential for the Greek rescue package and the European Stabilization Mechanism to be complemented by a strengthening of the SGP. A recent proposal by the European Commission is a first step; the proposal of a “European Consolidation Pact” launched by the German Council of Economic Experts is even better.

  25. II.5. ECB has lost its reputation • Proposition 11 • The role of the ECB in the current euro crisis is not at all convincing. • By first explicitly excluding far-reaching measures, only to take a number of them a few days later, the reputation of the ECB has been diminished. • The critical measures are: • purchasing sovereign debt in secondary markets as part of the “Securities Markets Program” (May 10 2010); • suspending the application of any minimum credit rating for collateral requirements in the case of Greek sovereign debt (May 3 2010).

  26. II.5. The legal basis for ECB bailout

  27. II.5. ECB reputation loss translates into a weaker euro

  28. II.5. Inflation will remain low in the euro area Proposition 12 Despite the purchase of sovereign debt by the ECB there will be no inflation in the euro area during the next few years. The probability of inflating away the real burden of public debt is higher in the United States and, to a lesser degree, in the United Kingdom.

  29. II.5. M3 growth is negative

  30. II.5. Long-term inflation expectations remain low Source: ECB, Monthly Bulletin, May 2010

  31. II.6. Will the euro survive ? Proposition 13 The euro area will not break up, nor will the euro collapse. A country cannot simply leave the euro area. It could, however, leave the EU and then re-apply for EU membership. Incentives are weak, even if a country could depreciate its currency in the meantime. A country cannot be expelled from the euro area, or from the EU. The only real threat to the euro area is that Germany or France will leave the EU, because of the fear of becoming the principal bail-outers. But this will not happen!

  32. II.7. Taxing financial transactions or activities ? • Proposition 14 • In June 2010, the G-20 leaders will decide on how the financial sector can contribute to paying for any burden associated with government interventions to repair the banking system. • The options are: • a financial transaction tax • a financial activity tax • a levy on financial institutions. 

  33. III. Final remarks Proposition 15 (a somewhat optimistic outlook) Economic recovery is underway in the euro area, even if only gradually and only for the “core” countries.

  34. Annual percentage change in real GDP (2010 and 2011) European Commission Spring Forecast Source: European Comission, Spring Forecast, April 2010

  35. More optimistic: OECD Spring Forecast Source: OECD, Economic Outlook, May 2010

  36. III. Final remarks Thanks for listening .. and have a nice evening

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