The Euro Zone Crisis through Economic Glasses: Origins, Responses and Challenges Ahead

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28 Οκτ 2013 (πριν από 3 χρόνια και 9 μήνες)

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May 2013

The Euro Zone Crisis through
Economic Glasses:
Origins,
Responses and Challenges
Ahead


Anita Angelovska
-
Bezoska

National Bank of the Republic of Macedonia

Content


What are the origins and implications of
the Euro zone crisis?



How are European policymakers dealing
with it?



What are the main challenges ahead?



Direct effects


strong negative
effects on the European financial
institutions that held many
“toxic”
assets
originating from the United
States.



Preexisting conditions
contributed as well


high credit
growth accompanied with high
leverage and low equity ratios
implied high vulnerability

US financial crisis as a trigger of the EU
banking system disruptions

European banks were heavily affected by
the global financial crisis...




The financial turmoil brought to the fore the
intrinsic deficiencies of the Euro zone


The process of intra EU financial integration turned into
process of financial
fragmentation
(sharp reversal of capital flows from periphery to the core)


The risk premium of the periphery increased...the growth
-
interest rate differential turned
sharply

the risk of insolvency become a reality


The banking system faced with funding pressures


the deleveraging, as well as the
renationalization of banks


Banking crisis paralyzed the economic
activity


Resulting halt in the credit flows, as a key source for financing the
corporate sector, contributed to...

...and rise in unemployment

contraction of economic activity...

Financial and

economic crisis emerged into
sovereign debt crisis

Financial assistance to the banking system, automatic stabilizers and discretionary
countercyclical policies lead to an
increase in the government deficits and
the level of public debt across the Euro zone
...

...in some countries even to unsustainable levels....

...questioning the solvency of the public finances

Pre
-
crisis fundamentals shaping the severity of
impact

Peripheral EU countries with higher macro
-
economic imbalances in
the pre
-
crisis period suffered more...

The build
-
up of imbalances
was supported
by the
easy access to finance
and convergence of
nominal interest rates

as a result of the
interest
rate convergence across
the Euro zone in the early
90s, despite different
fundamentals of different
countries

Pre
-
crisis fundamentals shaping the severity
of impact


Some of the countries enjoyed consumption
-
driven growth,
fueled by
abundant inflows in non
-
tradable sector, which lead to rising unit labor costs,
current account deficits and indebtedness of the economy.


The crisis brought to the fore the old debates about the main
ingredients of the “monetary union”

The crisis brought to the fore the old debates about
the main ingredients of the “monetary union”


Many OCA criteria
remain unfulfilled
implying still diverse economies.


The crisis showed that a combination of diverse economies with single
currency in not sustainable.


In addition, it confirmed the view of
German “economists”
(50 years
ago) that monetary union should come after economic and political
union is reached (as opposed to
French “monetarists”
view that
monetary union should lead to economic and political union).


Current policy set
-
up: centralized monetary policy and
decentralized other policies can lead to build up of
macroeconomic imbalances endangering the financial stability of the EA.


In particular when the mechanisms aimed at ensuring consistent
macroeconomic policies do not work
(SGP
)

(Non)Compliance with the fiscal Maastricht
criteria by Euro zone members)

Policy Responses to Contain the Euro Zone Crisis


Lowering policy rate and RR
requirement


Liquidity provision to banks at longer
tenures


Expansion of the collateral framework



Covered bond purchase program


Securities market program: purchase of
state securities


Outright monetary transactions:
unlimited government bond purchases
with conditionality to apply to ESM

ECB


The ECB played an important role in containing the
crisis...


The undertaken measures addressed the “acute” issues of liquidity and
calming market expectations ...



While additional measures introduced to tackle “design failures” of the
monetary union


Policy Responses to Contain the Euro Zone
Crisis



“too much
monetary
union and ...

...too little fiscal
union” in the
Euro zone

The sovereign debt crisis exposed fundamental weaknesses in the EU’s
economic governance framework...


...filling the gaps by moving towards the fiscal and financial union


Policy responses to address “design failures”

The

reforms

of

the

European

legislation

aimed

at

addressing

the

“design

failures”
:



Strengthening

economic

policy

coordination,

through
:


prevention

and

correction

macroeconomic

imbalances

(MIP)
;


policy

reform

plans

to

be

discussed

ex
-
ante

with

special

focus

on

convergence

and

competitiveness
.




Fostering

fiscal

discipline,

through
:


stricter

budget

rules
;


automatic

application

of

corrective

mechanism
;


emphasis

on

the

preventive

stage
;


more

strict

application

of

the

correction

of

excessive

debt

ratios

in

MS
.



Fostering greater banking
integration, through:


enhanced supervisory coordination; and


uniform supervisory
-
regulatory framework


SIX
-
PACK

(December 2011)

The

six
-
pack

reinforces

the

SGP

both

in

the

preventive

and

in

the

corrective

arm

of

the

Pact,

i
.
e
.

the

Excessive

Deficit

Procedure

(EDP)
,

which

applies

to

Member

States

that

have

breached

either

the

deficit

of

the

debt

criterion
.


Treaty

on

Stability,

Coordination,

and

Governance

(

March,

2012
)



FISCAL

COMPACT


(March,

2012
)

The

Fiscal

Compact,

which

is

the

fiscal

part

of

the

Treaty

on

Stability,

Coordination

and

Governance

(TSCG)
-

runs

in

parallel

with

the

six
-
pack
.


TWO
-
PACK
(
expected by the summer 2013)

The

proposed

regulation

for

”monitoring

and

assessing

draft

budgetary

plans

and

ensuring

the

correction

of

excessive

deficit

of

the

Member

States

in

the

Euro

area”

aims

at

further

strengthening

the

budgetary

and

economic

surveillance

of

the

Euro

area

countries

and

restoring

confidence

in

financial

markets
.


The Six Pack


Stricter fiscal surveillance and application of fiscal rules by:



defining quantitatively “significant deviation from the MTO”;



making SGP debt criterion more operational, i.e., allowing
EDP

procedure,
even if the deficit is below 3%, when debt is above 60%;



Imposing financial sanctions in a gradual way throughout the EDP (0,5% of
GDP);



introducing reverse qualified majority voting for most of the sanctions.




Stricter macroeconomic surveillance through MIP.



In 2012, 23 of 27 member states were in EDP (except for Estonia,
Finland, Luxembourg and Sweden)

The Fiscal Compact: Treaty on Stability,
Coordination and Governance (TSCG)


Treaty applicable to euro zone
member states only (UK and
Czech republic will not adopt it)



Common budgetary rules at the
national level
-

balanced budget
rule

Structural deficit not to exceed
0.5% of GDP

If MS deviates, automatic
correction mechanism will be
triggered

“Balanced budget rule”
enshrined in the national law,
preferable at constitutional level

Compliance also monitored by
independent national
institutions

European Stability Mechanism





From

temporary

EFSM

and

EFSF

to

a

permanent

resolution

mechanism



“a

firewall

against

debt

crisis”



Provide loans to a euro zone member state in financial difficulties;


Intervene in the primary and secondary debt markets;


Precautionary credit lines;


Provide loans to governments for the purpose of recapitalization of financial
institutions.

Permanent facility, providing
conditional
financing,
defending the sovereign and financial stability

European banking union


SSM is a first steps on a
long march


Motivation:
Integrated banking system requires integrated
prudential oversight.

EMU system of unity in monetary policy, but
national plurality in financial policies showed to be unsustainable.



Goal:

safeguard of financial stability through:


reducing fragmentation of financial markets;


weaken the loop of sovereign and bank borrowing costs; and


thus, enhance the monetary policy transmission mechanism
.












Financial Fragmentation

Diverging funding costs deviating
from the policy rate path

Sovereign creditworthiness affecting
that of banks

...and acknowledging the doom loop

Source: IMF Staff Discussion Note 13/01.

European banking union
-

first steps on a long
march

EUROPEAN BANKING UNION

1. Single Supervisory
Mechanism (SSM)



-

Supervisory tasks and powers to
ECB


-
Separation from monetary policy


-
Applies to all EA MSs, open for
non
-
EA MSs


-
Most of the banking system under
direct EU authority (80
-
85% of the
system)


Status:

established in March 2013

Operational


mid 2014


















2. Single Resolution
Mechanism (SRM) and
Backstops


-
For individual bank failures


-
Financed by industry on a risk
-
based approach


-

Appropriate and effective
backstop arrangements for
systemic cases



Status:
pending


Adoption targeted


Q2 2013

Establishment targeted

mid
2014

























3. European Deposit Insurance
Scheme


-
Intended to tackle the problem of
capital flight



Status: pending

Adoption targeted


Q2 2013















The Euro crisis led to profound governance
reforms...but are we there yet?


The creation of the ESM
supports the overall structure of EMU


but the risks of
moral
hazard
requires stringent observance of macro
-
conditionality for acquiring financial
assistance



The
ESM limited financial capacity
implies that it cannot be treated as a lender of last
resort and prevent panic and self
-

fulfilling liquidity crisis.


Reforms on fiscal governance
comprehensive and profound, but...


Room for national
administrative and political discretion


Higher complexity
in monitoring and implementation of rules


Strict observance,

implementation and ownership


key for not replicating the same flaws
of the former fiscal set
-
up


Fully fledged fiscal union?


a lively debate with lots of pros and cons coming to the fore


Strengthening economic policy coordination
-
prerequisite

for preventing
macroeconomic imbalances and higher convergence, but TSCG seems
“vague” on the
implementation instruments
.


Banking union


indispensable for breaking the banking


sovereign vicious circle. However
if left alone
, without unified crisis resolution mechanisms and appropriate backstop, the full
benefits will not be reaped.

Future of the Euro zone

The bold response of policy makers clearly removed the tail risk of Euro zone break
up...

...but the Euro zone must continue fixing structural and institutional deficiencies,
which exacerbated the crisis


increase
wage and labor flexibility



move towards more sustainable growth through increasing the overall
competiveness

of
the Euro zone


continue with the efforts in
enhancing the fiscal, macroeconomic and financial
governance


enabling better fiscal discipline and flexibility


providing financial backstops


creating more robust banks and hence lesser risk and less contagion



The crisis proved that the smooth functioning of a monetary union requires
economic competiveness, fiscal sustainability and stability of the financial system