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Recent Reforms to Deal with Recurrent Sovereign Debt
Crisis in the Euro AreaWaltraud Schelkle
LSBU Centre for International Business
22 February, 2011
Overview
What is this a crisis of? Competitiveness Private Debt Sovereign Debt
How promising are reforms and proposals? ‘Strengthening economic governance’ The proposed Pact for Competitiveness The proposed Eurobond Ideas for debt reduction
Conclusion
Competitiveness (1): How bad are divergences?
Nominal Unit Labour Costs (2000=100)
80859095
100105110115
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Belgium France Germany Greece Ireland
Italy Portugal Spain
..but who paid for rising NULC – firms or workers?
Real compensation per employee (2000=100)
80
90
100
110
120
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Belgium France Germany Greece Ireland
Italy Portugal Spain
In SP, PT and IT, the worsening performance was ‘paid for’ by workers, ie lower real wages.
Competitiveness: Growth
Annual Real Growth Rates
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Belgium France Germany Greece Ireland
Italy Portugal Spain
IR, GR and SP grew fastest, IT and GE grew least..
Private Debt (1): Asset bubblesGraph I.1.6: Real house prices, 2000-09
90100110120130140150160170180190
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Inde
x, 2
000
= 10
0
United States euro area
United Kingdom euro area excl. Germany
Source: OECD
..driven by high lending to households Graph I.1.4: Bank lending to private economy in
the euro area, 2000-09
02468
10121416
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
y-o
-y p
erc
en
tag
e c
ha
ng
e house purchases
households
Non-financial corporations
Source: European Central Bank
..while current account deficits were high only in some.
Current Account Balances
-15.0
-10.0
-5.0
0.0
5.0
10.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
% o
f G
DP
Belgium France Germany Greece Ireland
Italy Portugal Spain
GR and PT had high current account deficits, SP only more recently and IR had sustainable ones; BE had a higher surplus on average than GE
Private Debt (2): When the bubble burst, central banks became the lender of last resort..
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
20.00
ECB credit as share of GDP Reserve Bank credit as share of GDP
Aug-07
Dec-07
Jun/Jul-08
Sept/Oct-08
Dec-08
Jun-09
0.00
5.00
10.00
15.00
20.00
25.00
ECB credit as share of euro areabank credit
Reserve Bank credit as share ofcommercial bank credit
Aug-07
Dec-07
Jun/Jul-08
Sept/Oct-08
Dec-08
Jun-09
Private Debt Public Debt: Fiscal authorities had to step in where the bursting bubble became a solvency problem for banks.
Acknowledgement: Some of the following graphs are taken from a presentation by Lorenzo Bini-Smaghi (ECB), February 2011.
Public Debt (1): After 2009, the banking crisis became a sovereign debt crisis
..for some in the Euro area more so than others.
But a virtual banking crisis it still is.
Exposure of banks by nationality (bn US-$, 6/2010)
Ger-man
Spa-nish
Fren-ch
OtherEuro
British All banks
GRE 65.4 1.3 83.1 38.4 17.0 252.1
IRL 186.4 17.7 77.3 88.9 187.5 746.8
POR 44.3 98.3 48.5 28.9 29.0 292.6
SPA 216.6 n.a. 201.3 300.6 136.5 989.8
Source: BIS Quarterly Review December 2010
Public Debt (2): How about growing out of your difficulties?
A bit difficult at these interest rates..
..and these growth rates, in normal times.
Summary on the first question: What is this a crisis of? No simple answer: the four or six at risk have
very different growth-debt-competitiveness patterns.
For the Euro area as a whole, it is a banking crisis in disguise, turned into and dealt with as a sovereign debt crisis.
Debt levels in GR and IR are now clearly unsustainable and only some relief will help to get them – and the Euro area – back on track.
Reforms already decided (Dec 2011): ‘Strengthening economic governance’ A European Stability Mechanism, replacing the
present EFSF, from 2013 onwards Bailing in of private creditors on a case by case
basis (Collective Action Clauses in bond issues) Strict conditionality of the loan
An excessive debt and an excessive imbalances procedure (asymmetric)
A ‘European Semester’: scrutiny of draft budgets before they go to national parliaments
Sealed with a kiss: The proposed ‘Pact for Competitiveness’
Franco-German 'Pact for Competitiveness' hits immediate opposition4 Feb 2011 (Photo: consilium.europa.eu)
..to be decided at a special summit in March 2011
Six points that will do exactly nothing to deal with a Euro crisis.. Abolishing indexation of wages to inflation A recognition agreement for educational
diplomas and vocational certifications Raising retirement ages Harmonizing the corporate tax base Implementation of legal “debt-brakes” Establishment of a national crisis regime for
banks
A Eurobond (proposed by Juncker and Tremonti in Dec 2010)A bond issue that is collectively guaranteed by
all Euro area member states To ensure market access, albeit served at
the national interest rate (De Grauwe and Moesen 2009)
To ensure fiscal coordination for the Euro area as a whole, rewarded by a low common interest rate (Mabbett and Schelkle 2010)
Proposals for reducing existing debt (Gros and Meyer 2011) Force banks to mark to market their bond holdings Exchange of country bonds against bonds by EFSF
(European Financial Stabilisation Facility) at market prices before country came under the umbrella of
the EFSF EFSF then negotiates with the country a reduction in
the nominal value of its debt and a fiscal adjustment programme
No financial commitment of other member states to the extent that the debt reduction does not exceed the discount in the banks-EFSF exchange
Summary on the second question: How promising are reform proposals? The ESM is a way forward, although possibly
destabilising until bondholders know how it will work in a default.
The entire Pact for Competitiveness is useless, addressing an overrated problem in a counter-productive way.
Relevant problems are: liquidity and solvency of banks and countries, coordinated counter-cyclical fiscal policy for the Euro area as a whole.
A Eurobond plus an orderly debt reduction mechanism would go a long way to alleviate all three of these problems.
