Economic Drivers of the European Future-–

– 15 Propositions – (one proposition every four minutes)

Wolfgang Wiegard

University of Regensburgand

German Council of Economic Experts

Oberbank Day Linz, May 28 2010

Table of contents

Economic Drivers of the European Future

II. Looking forward: Euro at risk?

III. Final remarks

I. Looking back: European policy reactions during the financial crisis

II.1. Sovereign debt problems in the euro areaII.2. How to reduce public debt burdensII.3. A brief evaluation of current policy reactions to the euro crisis II.4. Still lacking: Reform of the Stability and Growth PactII.5. Monetary policy and inflationII.6. Will the euro survive? II.7. Taxing financial transactions or activities?

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.

I. Deep recession in 2009

-7.8

-7.3-7.1

-5 -4.9-4.7

-4.2 -4.1 -4.0

-3.6 -3.6

-3.0

-2.7

-2.2-2.0 -1.9

-1.7

-8.0

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

Finl

and

Slov

enia

Irela

nd

Italy

Ger

man

y

Slov

ak R

epub

lic

Luxe

mbo

urg

Euro

Are

a

Net

herla

nds

Spai

n

Aust

ria

Belg

ium

Port

ugal

Fran

ce

Gre

ece

Mal

ta

Cypr

us

Source: IMF, World Economic Outlook, April 2010

Annual percentage change in real GDP (2009)

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

-2.4

-2.6

-5.2

-7.9

-4.4

-4.9

-4.1

United States

Canada

Japan

Russia

Sweden

United Kingdom

Euro Area

8.7

5.7

2.4

2.1

1.7ASEAN 5

Sub-Saharan Africa

Middle East/North Africa

India

ChinaSource: IMF, WEO, April 2010

Annual percentage change in real GDP (2009)

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.

I. Economic policy reactions during the financial crisis

0

1

2

3

4

5

6

7

%

0

1

2

3

4

5

6

7%

United States

United Kingdom

1999 2000 2001 2002April 20 2010 Source: Thomson Financial Datastream

2003 2004 2005

Euro-Area

Japan

2006 2007 2008 2009 2010

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

2009 2010 2009 2010 2009 2010 2009 2010

Belgium ............................... 1.3 1.2 0.9 0.8 0.36 0.33 0.27 0.24 Germany ................................................ 35.9 48.4 18.0 13.6 1.44 1.93 0.72 0.54 Finland ................................ 2.4 2.4 0.4 0.4 1.25 1.25 0.23 0.23 France ................................ 17.0 4.0 16.3 4.0 0.87 0.20 0.83 0.20 Greece ................................ 0.0 0.0 0.0 0.0 0.00 0.00 0.00 0.00 Ireland ................................. 0.0 0.0 0.0 0.0 0.00 0.00 0.00 0.00 Italy ..................................... – 0.3 – 0.8 3.1 0.2 – 0.02 – 0.05 0.19 0.01 Netherlands ........................ 3.1 2.9 0.2 0.0 0.53 0.49 0.03 0.00 Austria .............................. 4.9 4.6 1.4 1.0 1.71 1.63 0.48 0.36 Portugal ............................... 1.0 0.3 0.9 0.3 0.60 0.18 0.54 0.18 Spain ................................... 26.8 14.7 12.1 0.0 2.44 1.34 1.10 0.00 Total ..................................... 92.0 77.6 53.2 20.4 1.01 0.85 0.58 0.22

1)Source: GCEE, Annual Report 2009/10

Countrybillion Euro percent of GDP

Total Fiscal PackageIncluding:

ExpendituresTotal Fiscal Package

Including:Expenditures

I. Fiscal stimulus packages in the euro area

I. Expenditure multipliers in the euro area

©German Council of Economic Experts

Expenditures:

-0.4

-0.2

0.2

0.4

0.6

0.8

1.0

1.2

0

%

-0.4

-0.2

0.2

0.4

0.6

0.8

1.0

1.2

0

%

I II III IV I II III IV I II III IV I II III IV I II III IV2009 2010 2011 2012 2013

Taylor (1993)

Impact of Expenditure Programs on Euro Area GDP Percentage Changes Against Reference Path

LaxtonandPesenti (2003)

Fagan et al. (2005)

Smets and Wouters (2003) Ratto et al. (2009)Real GDP:

NiGEM

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.

II.1. Sovereign debt problems in Europe

II.1. Long-term debt projections under no-policy-change assumption

Debt to GDP Ratios

0

50

100

150

200

250

300

Germany Italy Austria France Spain Ireland United Kingdom EU 27

vH

0

50

100

150

200

250

300

vH2009 2010 2030

Source: European Commission, Sustainability Report 2009, p. 40

155.6

8,7

64.0

271.3

70.6 60.0

260.8

48.1

188.2

78.5

177.4

69.3

116.7 113.3 112.2

72.4

102.5

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

II.1. Economic effects of government debt

increase long-term interest rates and reduce economic growth

narrow the room for growth-enhancing public investment expenditure

burden future generations.

Proposition 5

In principle, there are five ways of achieving a reduction in public debt burden :

1. strict consolidation efforts by reducing (structural) primary deficits (i.e. cutting public expenditures or increasing taxes)

2. a higher growth rate of GDP3. a “bailout” or capital transfer from abroad4. a default (repudiation; restructuring of sovereign

debt)5. higher inflation.

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.

II.2. How to reduce public debt burdens

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.

ZERO

For example: The growth rate effects of the German “Growth

Acceleration Law”, implemented in 2010, are

-0.01

0.01

0.02

0.03

0.04

0.05

0.06

0

- 0.01

0.01

0.02

0.03

0.04

0.05

0.06

0

I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV2010 2011 2012 2013 2014 2015 2016

Growth Rate Effects of the German "Growth Acceleration Law" (2010)Percentage Changes Against Refernce Path

© German Council of Economic Experts

1) Own calculations with NiGem.

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

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.

II.2. How to reduce public debt burdens

Unfortunately, so far almost nothing has been done in DE, AT, FR.

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.

II.3. Evaluation of the Greek “rescue package”

3.58

27.92

1.64

12.24

20.97

18.42

0.2

0.26

0.09

5.88

2.86

2.58

0.48

1.85

1.85

“rescue shield”for Greece

110 bn euro

€ 80 bnbilateral loans

€ 30 bnIMF SK

BE

DE

IE

EL

ES

FR

IT

CY

LU

MT

NL

AT

PT

SI

FI

Relative Shares in ECB‘s capital

(excl. Greece share)

II.3. Some details of the Greek “rescue package”

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

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.

II.3. European Stabilization Mechanism

European Stabilization Mechanism:an even larger rescue shield

750 bn euro

€ 60 bnloans and credit lines from EU Commission

€ 250 bnIMF

II.3. Details of the “European Stabilization Mechanism”

€ 440 bnby euro area

members via SPV

II.3. Risk spreads before and after the ESM

-100

0

100

200

300

400

500

600

700

800

900

1000

1100

-100

0

100

200

300

400

500

600

700

800

900

1000

1100

France

United Kingdom

Greece

Irland

Italy

Portugal

Spain

Spreads for 10-year government bonds

Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec2008 2009

Source: Thomson Financial Datastream

basis points basis points

Jan Feb2010

Mar

May 25 2010

Apr May Jun Jul Aug Sep

EU-IMF-Stabilization Mechanism

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

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.

II.4. Reforming the Stability and Growth Pact

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).

II.5. ECB has lost its reputation

II.5. The legal basis for ECB bailout

Bilateral exchange rates

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

USD or GBP

60

70

80

90

100

110

120

130

140

150

160

170

180JPY

daily values

2004 2005 2006 2007May 25 2010 source: Datastream

GBP/Euro

Dollar/ Euro

Yen/ Euro

2008 2009 2010

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

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.

II.5. Inflation will remain low in the euro area

-2

0

2

4

6

8

10

12

14

2004 2005 2006 2007 2008 2009 2010

Saisonally adjusted%

-2

0

2

4

6

8

10

12

14%

Loans to private sector

Monetary aggregate M1

Date: May 26 2010 Source: ECB

3-month moving average (centred)

Monetary aggregate M3

Reference value M3

II.5. M3 growth is negative

II.5. Long-term inflation expectations remain low

Source: ECB, Monthly Bulletin, May 2010

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!

II.6. Will the euro survive ?

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.

II.7. Taxing financial transactions or activities ?

Proposition 15(a somewhat optimistic outlook)

Economic recovery is underway in the euro area, even if only gradually and only for the “core” countries.

III. Final remarks

1.41.1

-0.9

0.8

1.2

2.7

2.0

0.9

1.3

-0.4

1.3 1.3

0.5

1.3

-3.0

1.1

-0.4

2.11.8

3.0

1.41.6

3.7

2.4

1.51.8

0.8

1.6 1.6

0.7

1.5

-0.5

1.7

1.3

Finland Slovenia Ireland Italy Germany SlovakRepublic

Luxembourg Euro Area Netherlands Spain Austria Belgium Portugal France Greece Malta Cyprus

2010 2011

Source: European Comission, Spring Forecast, April 2010

Annual percentage change in real GDP (2010 and 2011)

European Commission Spring Forecast

1.7

-0.7

1.1

1.9

3.6

2.7

1.2 1.2

-0.2

1.4 1.41.0

1.7

-3.7

2.5

3.0

1.5

2.1

3.9

3.1

1.82.0

0.9

2.31.9

0.8

2.1

-2.5

Finland Ireland Italy Germany SlovakRepublic

Luxembourg Euro Area Netherlands Spain Austria Belgium Portugal France Greece

2010 2011More optimistic: OECD Spring Forecast

Source: OECD, Economic Outlook, May 2010

Thanks for listening ..

and have a nice evening

III. Final remarks