EIN seminar on

'Clues for a more competitive EU both internally and externally; a true

internal market source of mobility and employment‘

Carlo ALTOMONTE

(Bocconi U. & Bruegel)

Brussels, 19June 2012

The European crisis visualized

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EMU start (1 January 1999)

Start of Greek crisis (Feb - May 2010)

Lehman Brothers

(Sept. 2008)

Greece in EMU (1 January 2001)

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+81%+34%+53%

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A fiscal crisis? Not only that …

What is this crisis about ?

The bank-sovereign negative feedback loop

Rescuing banks increases deficits, worsening the sustainability of debt.

• Banks already have sovereign assets in their portfolio: due to the worsening of

their RWA ratios, banks find it difficult to access the inter-banking market

• The latter generates bank deleveraging leading to less credit to the economy and

lower growth

• Lower growth worsens the sustainability of debt…

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Avoid the “fairy tales” of the crisis• Solving the negative bank-sovereign fiscal loop requires also changing the public

narrative of the crisis, overcoming two general misconceptions:

• The fiscal fairy tale: “the crisis is due to an unsustainable fiscal stance of

Southern European countries; once deficit spending is curbed and profligacy is

eliminated, the crisis is over” Not true: this is a balance of payments crisis, not a fiscal crisis; an austerity

– only solution actually risks of worsening the crisis via the worsening of

the bank-sovereign negative feedback loop

• The inflation fairy tale: “the ECB cannot act as lender of last resort for the

Euro (funding both banks and Governments) as otherwise it will generate

inflation” Not true: the current value of the money multiplier is at its historical lows

=> there is time to reabsorb liquidity before inflation kicks in. The real

reason the ECB cannot act is because there is no federal debt (Eurobond) to

purchase => intervention = fiscal redistribution, banned by current

Constitutional rules

What to do: eliminate the negative feedback loop in EU

Common bank resolution frameworkPan-European deposit guarantee scheme

EU-level supervision

Fiscal compact & ‘6+2 pack’Euro-bond scheme (various

proposals)

Revamp of Single MarketProject-bond & infrastructureRole of EIB and EU Budget

The above is necessarily a medium-term roadmap (due to the needed institutional changes,

including the required transfer of sovereignty from national Governments to EU Institutions).

In the short term the ECB should keep on acting as a provider of liquidity (SMP and LTRO),

until European banks and peripheral countries regain access to international capital markets

Not much time left

How an inter-banking market should

work: bank lend among themselves

while the ECB act as a marginal lender,

regulating the system. Total size of

inter-banking market: €4.000Bln / year

How it is working: ECB is the hub.

Total size of outstanding ECB liquidity after

LTRO is around €2700Bln (30% of Euro area

GDP) with a paid-in capital of €80Bln. Given

the yearly needs of liquidity, there is not much

additional room of manoeuvre left...

Northern EU

Southern EU

LTRO

Where the debate is: kicking again the can down the

road ?

Where the debate should be: this is the last exit for everyone…

The long run for the EU: overcome the impossible trinity

In a monetary union characterized by competitiveness differentials, liquidity-constrained current account imbalances are deadly within a system where: 1) there is no monetary financing by the ECB; 2) there are no fiscal transfers across States (no co-responsibility of debt), and in which 3) the bank-sovereign loop is active.

In the short to medium-run the EU has to decide which corner of the triangle it wants to cut first, just to survive.

In the long run it might decide to cut all corners and become the economic and political power it deserves to be

=> Political Union

La situazione italiana: il rischio default a novembre

Debito / PIL in Italia 2011 - 2020 con differenti scenari

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2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Recession Baseline Reforms

Recession: real growth -1.5% & -0.5% in 2012 and 2013 with 2% and 1.5% inflation, then nominal growth at 3%; average cost of debt at 4.9% in 2012 & 2013 (BTP 10y > 7%); 4.5% from 2014 onwards

Reforms: real growth -1.5% & -0.5% in 2012 and 2013 with 2% and 1.5% inflation, 1% in 2014 and 1.5% from 2015 onwards, with 2% inflation; average cost of debt at 4.7% in 2012, 4.5% in 2013, 4.2% in 2014 and 3.5% from 2015 onwards; primary balance at 5% already from 2012

Baseline 2011 2012 2013 2014 2015 →Real Growth 0.8 0.6 0.8 1.1 1 →Inflation (prod. prices) 1.4 1.9 1.8 1.8 2 →Nominal Growth 2.2 2.5 2.6 2.9 3 →Average cost of debt 4.2 4.2 4.2 4.2 4.2 →Primary balance surplus (%GDP) 0.9 3.7 5.4 5.7 3 →

La manovra di stabilizzazione del debito pubblico