Euro@20

Banca d'Italia, Roma – 10 Dicembre 2018

Marco Buti

Direttore Generale

Direzione per gli Affari economici e finanziari

Commissione europea

1

Content

1. EMU@20 = EMU@10 + 10

2. Did EMU change policy behaviours?

3. Euro area throughout the crisis

4. Reforms during the crisis and way forward

2

• Efficiency ++

(but certain aspects, like productivity/reforms fully decentralised)

• Stabilisation +

(only based on monetary policy and automatic stabilisers)

• Equity 0

(interpersonal fully in the hands of Member States; cohesion between countries inEU budget)

• Sustainability/Stability +++

(necessity of supranational fiscal rules to secure sustainability and protectmonetary policy from deficit bias and debt spillovers/ ECB as the most independentCB in the world)

3

MUSGRAVE + and the MAASTRICHT ASSIGNMENT

MAASTRICHT ASSIGNMENT

Institutional setting in EMU (strong version of the“consensus” on policy making of the 80s' – see Buti Sapir1998)

i) Monetary Policy (centralised) by independent central bank instrumental tocredibly bring down inflation <= conservative, independent central bank tobring down inflation, Barro-Gordon (1983), Rogoff (1985)

ii) Fiscal Policy (decentralised) action limited to automatic stabilization (normalcycles) <= Barro (1979)

iii) Ban on excessive government deficits & on monetary financing of governmentdeficits <= avoid fiscal dominance and no government bailout, Sargent &Wallace (1981)

iv) Financial markets allocate resources efficiently within and across memberstates <= markets are efficient, Fama (1970) – financial markets smoothefficiently, Obstfeld (1986) & Eichengreen (1992)

v) Competition (trade and internal market) increases efficiency, OCA criteria areendogenous <= Cecchini Report (1988), Frankel & Rose (1998) 4

EMU@0: our beliefs EMU@10 EMU@20

Efficiency -Financial markets as shock absorbers

- Improve resource allocation

-Uptake of structural reforms

-Anaesthetic effect of EMU on structural reforms

-Destabilising role of financial markets

-Shock propagated in the crisis

-Capital allocation not always efficient

Stabilization -House in order allows automatic stabilisers to address country-specific shocks

-Lack of fiscal buffers-Aggregation of national fiscal stances do not necessarily give an adequate EA stance

-Need of a central stabilization function

Equity -Limited / restricted to real convergence

-Redistribution done by MS

-Too optimistic on real convergence (endogenous OCA)

-Limited convergence-Adjustment born by crisis countries

Sustainability/Stability

-Credibility of the central bank

-Expectations that MS would maintain sustainable public finances

-No consideration of internal imbalances

-Established credibility of the ECB

-Unsustainability of internal imbalances

-Fiscal benefits of euro accession largely spent

Our early beliefs… and what happened in the first 10 and then 20 years

5

Content

1. EMU@20 = EMU@10 + 10

2. Did EMU change policy behaviours?

3. Euro area throughout the crisis

4. Reforms during the crisis and way forward

6

Improvement in prosperity broadly at par with the US, but convergence with the US stalled

GDP per capita

(in pps, US=100)

Source: Ameco

7

• GDP per capita growth

• (%)

Source: Ameco

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

European

Union

Euro area

(EU-19)

US

50.0

60.0

70.0

80.0

90.0

100.0

110.0

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

EuropeanUnion

Euro area (EU-19)

US

Credibility of the Central Bank

Dispersion of HICP inflation

Notes:

Dispersion measured as an unweighted standard deviation.

2018/19 projected values according to Autumn 2018 forecast.

EA changing composition: according to entry date in EA

Source: Ameco

0

1

2

3

4

5

6

7

8

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

EA-11 Current EA-19 EA changing composition

8

Not all MS improved sufficiently public finance sustainability

Data source: AMECO

Government debt/GDP10-year government bond yields (%)

9

Real convergence mostly driven by 'new' euro area Member States

AT

BE

EE

FI

FRDE

ELIE

IT

LU

NLPT

SK

SI

ESCY

LV

LT

MT

0

2

4

6

8

10

12

0 10 20 30 40 50

GD

P p

er

capita in P

PS

(avera

ge g

row

th 1

999-2

007)

GDP per capita in thousands PPS (1999)

excl. 'new' EA MS

all countries

ATBE

EE

FI

FR

DE

EL

IE

IT LUNLPT

SK

SIESCY

LVLT

MT

-4

-3

-2

-1

0

1

2

3

4

5

0 20 40 60 80

GD

P p

er

capita in P

PS

(avera

ge g

row

th 2

008-1

3)

GDP per capita in thousands PPS (2008)

excl. 'new' EA MS

all countries

Note: Countries which were in 1999 (left chart) and in 2008 (right chart) not members of the euro area are highlighted in red.

The black regression line is based on the full sample of countries, the blue one excludes the 'new' euro area Member States, which are highlighted in red.

Source: Eurostat.

GDP per capita (in PPS) before and after the start of the financial crisis

10

Imbalances and resource allocation

11

Increasing imbalances

-60

-40

-20

0

20

40

60

-6

-4

-2

0

2

4

6

8

99 00 01 02 0304 05 06 07 08 09 10 1112 1314 15 16 17 18

NII

P,

% o

f countr

y g

roup G

DP

CA,

% o

f countr

y g

roup

CA - Creditors CA - Debtors

NIIP - Creditors NIIP - Debtors

Cumulative growth rate of non-tradable/tradable value added

-5

0

5

10

15

20

25

EA center EA periphery

1995-98 1999-2007 2008-2013

Source: Commission calculations based on AMECO and Eurostat

Center

Center

Periphery

Periphery

Content

1. EMU@20 = EMU@10 + 10

2. Did EMU change policy behaviours?

3. Euro area throughout the crisis

4. Reforms during the crisis and way forward

12

Origin of the EA crisis: my preferred reading

• A "sudden stop" crisis following capital misallocation in pre-crisis years

• A banking crisis triggered a feedback loop: bank solvency concerns higher bond yields and debt service default worries deeper

recession

• The euro-area crisis was not a fiscal crisis (apart from Greece), but lack of fiscal space hindered the policy response during the crisis

• Heterogeneity in the euro area much larger than assumed before the crisis: different growth models and agglomeration effects

• Structural divergences during the first 10 years of EMU led to divergent social and political preferences "ultima ratio" mode

13

Upon sudden stops, short-term flows were replaced by central bank lending

* start in 2002 , ** start in 2004Source: Eurostat

Central bank lending to EA credit institutions

14

ECB intervention: rates and balance sheet

15

0

50

100

150

200

250

300

350

400

450

-1

0

1

2

3

4

5

6

janv-05 janv-07 janv-09 janv-11 janv-13 janv-15 janv-17 janv-19

ECB policy and euro overnight rates, Eurosystem BS size

ECB deposit facility rate EONIA BS total (Jan-07 = 100), rhs

%

Source: Macrobond, ECB

indexLehmanBrothersdefault

Start of EASovereignDebt Crisis

ECB negativepolicyrate

QE announcement

OMT

Fiscal policy tend to be pro-cyclical

Source: Commission calculations based on spring 2018 Commission forecast 16

Broadly neutral fiscal stance

Contra-cyclical loosening

Pro-cyclical loosening

Pro-cyclical restriction

Contra-cyclical restriction

Fiscal stance over the economic cycle, EA 2011-2018e

2011

2012

2013

2014

20152016

2017

2018e

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0

Ch

an

ge

in S

tru

ctu

ral

Ba

lan

ce (

pp

s. o

f G

DP

)

Output Gap (% of GDP)

Structural reform uptake

17

Source: OECD (PMR)

Programs: the euro-area crisis was not a fiscal crisis (apart from Greece)

Ireland: €85bn, exit

in 2013

Five financial assistance

programmes

Portugal: €78bn, exit

in 2014

Spain: financial sector

support; €40bn, exit in

2014

18Greece: 1st €110bn in 2010,

2nd €172.6bn in 2012 and

€86bn in 2015 €, exit in 2018 Cyprus: €10bn, exit in 2016;

Content

1. EMU@20 = EMU@10 + 10

2. Did EMU change policy behaviours?

3. Euro area throughout the crisis

4. Reforms during the crisis and way forward

19

20

Structural reform

strategy

(Europe 2020)

Crisis resolution

instruments

- EFSM/EFSF: temporary

- ESM: permanent

- ECB: OMT

Growth Compact (EIB, Structural funds,

Projects bonds)

More effective

supervision and

regulation of the

financial systemESAs - ESRB - CRD IV

Banking Union: SSM; direct recaps

by ESM

Prevention and

correction of macro

imbalances

Procedure and

sanctions

European Semester

for economic policy

coordination

Balanced

growth

Better enforcement

of SGP rules

-Sanctions

- Two Pack: ex ante submission of

draft budgets, closer monitoring

- National layer: Directive on fiscal

frameworks, Fiscal Compact

Focus on debt

developments

Debt reduction benchmark

More effective

prevention of gross

policy errors

- Focus on structural balances

- Expenditure benchmark

Sound fiscal

policy

EMU reform during the crisis: an overview

Two competing models for EMU

"Back-to-Maastricht" Fast forward to federalist EMU

Stronger enforcement of EU fiscal rules to rein debt and deficits

Distribution of fiscal efforts to achieve an appropriate aggregate fiscal stance

Mechanism of imbalances procedures (MIP) focused on competitiveness of lagging countries

Symmetric adjustment to help weak countries and reduce Euro area current account surplus

Banking Union does not need common deposit insurance

Full Banking Union to ensure financial stability and private risk sharing

End to the risk-free status for sovereign debt and establish sovereign debt restructuring mechanism

Fiscal capacity for public risk sharing and eventually sovereign debt mutualisation

More market discipline Euro area Treasury

21

In their « pure » form, both are economically and/or politicallyunfeasible

To enter into the adult age of the Euro, the institutional framework is to be profoundly reinforced

22

Complete Banking Union

and Capital Markets Union

Common fiscal

stabilisation function

Accountable institutions and

effective governance

Economic and social

convergence

1. Financial Union

2. Economic and

Fiscal Union

3. Institutions and

Governance

European safe asset,

Not €bonds

Diversified banks'

sovereign exposures

Completing the Financial Union

23

Private risksharing

Reallocationof excess

savings via equity

Banking Union Capital Market Union

SSM,SRM

EDIS,SRF backstop

Action plan17 proposals

14 still on-going

Economic objectives

EU initiative

InstrumentsDelivered Pending Delivered Pending

The evolving EA fiscal frameworkIncreased adaptability at the expense of simplicity…

CLARITY

(simplicity)

ADEQUACY (adaptability)

PREDICTABILITY

24

Impact of a central stabilisation capacity in bad times

Source: Commission calculations based on spring 2018 Commission forecast 25

Contra-cyclical loosening

Pro-cyclical loosening

Pro-cyclical restriction

Contra-cyclical restriction

Fiscal stance over the economic cycle, EA 2011-2018

(2013) (2012)

Very bad economic times

Very good economic times

2011

2012

2013

2014

20152016

2017

2018e

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0

Ch

an

ge

in S

tru

ctu

ral

Ba

lan

ce (

pp

s. o

f G

DP

)

Output Gap (% of GDP)

Possible forms for a European safe asset

26Source: Buti, Deroose, Leandro and Giudice (2017)

Deliverables of the EA summit in December

Deliverables Key issues for decision

Single Resolution Fund (SRF) backstop

• Decision-making process• Conditions for early introduction• Maturity of the loans and pricing

ESM reform • Eligibility criteria for precautionary credit line• Financing terms for the instruments• Cooperation between the ESM and COM within

and without programmes

Banking Union • Progress in reducing legacy asset risks• Actions to increase prudential and anti-money

laundering frameworks• Consensus on the need for EDIS but strong

disagreement on the pre-conditions• Solution framework for liquidity in resolution

EA budget • Objectives include competitiveness, convergence and stabilisation

• Discussions on the design and characteristics of possible instruments and limited consensus so far

27

Conclusion

28

• Crisis is over, but the job is not yet done

• EMU deepening is an unfinished business

• Overcome creditors/debtors divide

• Additional difficulties in a multi-layer

governance. Discount rate of COM < than

that of Member States

• Key ingredient: trust to be rebuilt

(Habermas’ definition of solidarity)

Thank you for your attention

29