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Theorie und Politik der Europäischen Integration

Theorie und Politik der Europäischen Integration . Theory and Politics of European Integration . Lecture 8 The EURO Crisis. Prof. Dr. Herbert Brücker. The Last Lecture (I/II). Optimum Currency Area (OCA) Theory What are the trade-offs ?

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Theorie und Politik der Europäischen Integration

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  1. Theorie und Politik der Europäischen Integration Theory and Politics of European Integration Lecture 8 The EURO Crisis Prof. Dr. Herbert Brücker

  2. The Last Lecture (I/II) Theory and Politics of European Integration Fiscal Policy and Stability Pact Optimum Currency Area (OCA) Theory • Whatarethetrade-offs? • Asymmetricshocksandcurrencyareas • Criteriafor an optimal currencyarea • Labour Mobility • Trade Openness • DiversityofProduction • Transfers • Common Values • Common Destiny • Is the EMU an optimal Currency Area?

  3. The last lecture II/II Theory and Politics of European Integration Fiscal Policy and Stability Pact • Fiscal Policy and the Stability Pact • Fiscal policy in the monetary union • More and more important? • Borrowing instead of transfers • Automatic stabilizers and discretionary policy actions • Fiscal policy externalities • Spillovers and coordination • Cyclical income spillovers • Borrowing cost spillovers • Excessive deficit and the no-bailout clause • Collective discipline

  4. This Lecture Theory and Politics of European Integration Fiscal Policy and Stability Pact Diagnosis • Whatisthe EURO crisis? Whatarethequestions? • Monetarypolicies, assymmetricshocksandinternalimbalances • Public vs. private debts • Hasthe ECB monetarypolicytriggeredthe real estatebubble? • Whyarepublicdebts in a currencyunionmoreseriousthanwith national currencies? • Debtfinancing via the TARGET2 facilityofthe EURO System Therapy • Banking regulation • ECB: Buying governmental bonds • Creating a Transfer Union • State Bankruptcy within Eurozone • Leaving the Eurozone

  5. The EURO crisis: whatarewetalkingabout? (I/II) Theory and Politics of European Integration Fiscal Policy and Stability Pact • The EURO crisisis no currencycrisis in traditionalsense • No (dramatic) depreciation of EURO • No capital flight out of EURO zone • No balance of paymentscrisis of EURO zone • No inflation

  6. Exchange rate USD/EURO Theory and Politics of European Integration Fiscal Policy and Stability Pact Source: OECD STAT database, owncalculations.

  7. Inflation (Consumer priceindex, change p.a. in %) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  8. Inflation (Consumer priceindex, change p.a. in %) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  9. The EURO crisis: whatarewetalkingabout? (II/II) Theory and Politics of European Integration Fiscal Policy and Stability Pact • But: • Burst of real estatebubbles in manyMember States • High risks of bankfailures in privatesector • Sovereigndebtcrisis of somemembers of EURO zone (Greece, Ireland, Portugal, Spain, Italy?, others?) • High spread of interest rates within EURO zone • Zerogrowth in the Eurozone and seriousrecessions in someMember States withhighunemployment

  10. General GovernmentDebt in % of GDP, 2007-2013 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  11. General GovernmentDebt in % of GDP, 2007-2013 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  12. Net GovernmentLending in % of GDP, 2007-2013 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  13. Net GovernmentLending in % of GDP, 2007-2013 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  14. Central Bank Interest Rate (3 month rate) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  15. Long-terminterestrates (10 yearsgovernmentbonds) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  16. Long-terminterestrates (10 yearsgovernmentbonds) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  17. Real GDP growth rate in %, 2007-2012 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  18. Real GDP growth rate in %, 2007-2014 (forecast 13-14) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  19. Unemployment rate in %, 2007-2012 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  20. Unemployment rate in %, 2007-2014 (forecast 13-14) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  21. Whatarethequestions? (I/II) Theory and Politics of European Integration Fiscal Policy and Stability Pact • Is the ‘one-fits-all’ monetarypolicy in the Eurozone the cause of the crisis? What about asymmetricshocks? • Have soft monetarypolicies of the ECB triggered the financialcrisis, e.g. the real estatebubble? • Or isbankingregulation the problem, i.e. the Eurozone in the samewayaffectd as, e.g., the US? • Has the Eurozonecreatedincentives for moral hazard in fiscal policies? Has the Stability and GrowthPactfailed?

  22. Whatarethequestions? (II/II) Theory and Politics of European Integration Fiscal Policy and Stability Pact • Is the risk of a sovereigndebtcrisis and capital flight higher in a Currency Union ratherthan in the case of national currencies? • Creates the EURO System additionalopportunities to raiseunsustainabledebts? TARGET2 debt stocks? • Is state bankruptcy possible in the Eurozone? • Is itbetter to move to a transfer union? How? • Wouldit help countries to leave the Eurozone?

  23. Monetarypoliciesandasymmetricshocks Theory and Politics of European Integration Fiscal Policy and Stability Pact • Recall: Optimal currency area theoryfocuses on asymmetricshocks • Economic structures between the North and the South mightbe diverse (manufacturing vs. tourism), but are affected by business cycle shocks in similarway • The ‘Great Recession’ 2008-09 affectedtherefore countries withstrongmanufacturingsectors(export demandshock) as least as much as countries withstrongtourism

  24. Wagesandcurrentaccountimbalances in the Eurozone Theory and Politics of European Integration Fiscal Policy and Stability Pact • If prices and wages are not flexible, different (productivityadjusted) wagedevelopmentscancreateimbalances in currentaccount, which have to bematched by capital inflows • In theory, Hume’smechanismwouldguarantee a balance of paymentsequilibrium and in long-termalsoequilibrium in currentaccount • In practice, thisneed not necessarilybe the case, sincecurrentaccountimbalances are financed by public transfers in one way or another (seebelow)

  25. Real Earnings (change in %: 2008 vs. 2000) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  26. Real wage index (1995 = 100), 1995-2010 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  27. Relative unitlabourcosts (index: 2000 = 100) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  28. Currentaccountbalance in % of GDP, 2004-2011 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  29. Currentaccountbalance in % of GDP, 2004-2011 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  30. The bottomline Theory and Politics of European Integration Fiscal Policy and Stability Pact • Wagegrowth has been unbalanced in Eurozone, but (productivityadjusted) real unit labour costshave been muchlessunbalanced. This suggeststhatdifferent rates of wagegrowthreflectdifferentproductivitygrowth patterns • But: currentaccount surplus of Germany tended to increasepersistantly and substantially, whilecurrentaccount of Greece, Portugal and Spain deterioratedpersistantly. This is a first hint for imbalances in the Eurozone

  31. Public vs. private debt Theory and Politics of European Integration Fiscal Policy and Stability Pact • Conventionalwisdomexplains EURO crisis by moral hazard of governments in Eurozone • But:With the notable exception of Greece, (i) public debt has fallen and not increased in Eurozonebefore the crisis, and (ii) privatedebt has increaseddramaticallybefore the crisis • Bank debt has increased more thancorporatedebt • Thus, bankingregulation and moral hazard in privatesectormightbe more underrated in the debate (DeGrauwe 2010)

  32. Governmentand private debt in the Eurozone, 1999-2008 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  33. Governmentdebt in % of GDP, 1995-2011 Theory and Politics of European Integration Fiscal Policy and Stability Pact post –crisisdevelopment pre –crisisdevelopment

  34. Bank liabilitiesandcorporatedebt, 1999-2008 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  35. Growth ofbankloans in the Eurozone, 2003-2009 Theory and Politics of European Integration Fiscal Policy and Stability Pact

  36. The bottomline II Theory and Politics of European Integration Fiscal Policy and Stability Pact • With exception of Greece, the dramaticincrease of privatedebts (real estateloans) are the first cause of financialcrisis • The crisis of the bankingsectorforcedgovern-ments to take-over privatedebts to avoidsystemicfailure of financialsector • This increaseddramatically public debts in some countries whichhadlow public debtsbefore • ‘Great Recession’ increased public debtfurtherthroughautomaticstabilizers and fiscal packages

  37. Has ECB monetarypoliciestriggeredthefinancialcrisis? Theory and Politics of European Integration Fiscal Policy and Stability Pact • Hypothesis: low and ‘one-fits-all’ interest rate policies have triggeredfinancialcrisis, i.e. real estatebubble • Interest rates indeedsubstantiallydeclined in some countries (e.g. Greece, Italy) • But: A deeperanalysissuggeststhat the ECB interest rate policiesfollowedcloselywhatweexpect in case of a strict application of ‘Taylor’srule’

  38. Long-terminterestrates (10 yeargovernmentbonds) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  39. Long-terminterestrates (10 yeargovernmentbonds) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  40. Long-terminterestrates (10-year governmentbonds) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  41. Didthe ECB violateTaylor‘srule? (I/III) Theory and Politics of European Integration Fiscal Policy and Stability Pact • Taylor’sRule: Central Banks policiescanbeexplained by the following simple formula: • it = 2 + pt + a(pt – p*) + b(yt –yt*) (1) • whereiis the interest rate, pt the current inflation, p* the inflation target (2%), and yt the output gap as a percentage of potential output yt*. • ais the weightassigned by Central bank to pricestability, b the weightassigned to economicstability and growth.

  42. Didthe ECB violateTaylor‘srule? (II/III) Theory and Politics of European Integration Fiscal Policy and Stability Pact • Taylor’srulehelps to stabilize expectations of market participants. • It explainsusually Central Banks monetarypoliciesprettywell.

  43. Didthe ECB violateTaylor‘srule? (III/III) Theory and Politics of European Integration Fiscal Policy and Stability Pact • To check whether a Central Bank followsTaylor’sruleistherefore a good indicatorwhethermonetarypolicies has deviatedfrom standard pathundergiveneconomic conditions • The answeris, the ECB has not. The interest rate wasonlyslightlybelow the rate predicted by Taylor’srule. And lessbelowthan the US rate (Dokko et al., 2011)

  44. Do lowinterestratesexplain real estatebubble? Theory and Politics of European Integration Fiscal Policy and Stability Pact • More importantly, wecannotexplain the boost in housingprices by national interest rates in most Euro countries empirically(Dokko et al., 2011) • But wecanexplain the boost by inprudentbankingregulationand the subsequentfinancial packages likesubprimemortages. • Thus, the right policyresponseis to reformbankingregulation not monetarypolicies. • Bottomline: Housingpricebubbleis a keyreason for public debtproblem in Eurozonetoday.

  45. Spain: Real estateprices (EURO per qm) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  46. Ireland: Real estateprices (Index: 2003 = 100) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  47. Constructionproduction (Index: 2000 = 100) Theory and Politics of European Integration Fiscal Policy and Stability Pact

  48. Are governmentaldebts different in a currencyunion? Theory and Politics of European Integration Fiscal Policy and Stability Pact • So far we know that (i) public debts of EURO countries have substantiallyincreased in course of crisis, and (ii) this has started as a debtcrisis in the private (financialsector) –- with the notable exception of Greece. • Ok, thathappens to other countries as well, e.g. Japan, the US and UK. But these countries are so far not affected by a currencycrisis. Why? • And why are the US, UK and Japanwith a higherdebt-to-GDP ratio thanmanycrisis countries in Eurozonenotaffected?

  49. Theory and Politics of European Integration Fiscal Policy and Stability Pact General GovernmentDebt in % of GDP, 2007-2012

  50. Theory and Politics of European Integration Fiscal Policy and Stability Pact Net lending in % of GDP, 2007-2012

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