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6. EMU: the first decade ( when all went well – or at least seemed to do so ). 6.1 Heterogeneity 6.2 Effects of low interest rates 6.3 Changes in competitiveness : causes and consequences 6.4 Monetary policy

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6. EMU: the first decade ( when all went well – or at least seemed to do so )

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6 emu the first decade when all went well or at least seemed to do so

6. EMU: the firstdecade(whenallwentwell – or at leastseemed to doso)

6.1 Heterogeneity

6.2 Effects of lowinterestrates

6.3 Changes in competitiveness: causes

and consequences

6.4 Monetarypolicy

6.5 Public finances and fiscalpolicy

6.6 Output and employment


6 1 structural characteristics of eu some countriesm ranks in brackets

6.1 Structuralcharacteristics of EU somecountriesm (ranks in brackets)

The Nordicsgethighscores for the rule of law, the school, economicfreedom and creativity; Southern Europe scoreslesswell

Rule of law1

School 2

Economicfreedom3

Creativityindex4

GDP per capita5

Employmentrate6

AUT

BEL

DEN

FIN

FRA

GER

GRE

IREITA

NET

POR

SPA

UKM

SWE

1.80

1.40

1.88

1.97

1.52

1.63

0.62

1.76

0.38

1.81

1.04

1.19

1.77

1.95

(5)

(10)

(3)

(1)

(9)

(8)

(13)

(7)

(14)

(4)

(12)

(11)

(6)

(2)

496

515

503

511

497

513

466

487

483

526

487

483

492

494

(7)

(3)

(5)

(1)

(6)

(4)

(14)

(10)

(12)

(2)

(10)

(12)

(9)

(8)

70.3

69.0

76.2

72.3

63.2

71.0

55.4

76.9

58.8

73.3

63.0

69.1

74.1

71.7

(8)

(10)

(2)

(5)

(11)

(7)

(14)

(1)

(13)

(4)

(12)

(9)

(3)

(6)

0.663

0.813

0.878

0.894

0.764

0.764

0.638

0.805

0.707

0.854

-

0.744

0.789

0.923

(12)

(5)

(3)

(1)

(8)

(8)

(13)

(6)

(11)

(4)

(10)

(7)

(1)

126

119

127

115

108

118

90

128

101

133

80

100

112

123

(4)

(6)

(3)

(8)

(10)

(7)

(13)

(2)

(11)

(1)

(14)

(12)

(9)

(5)

72.1

61.9

73.1

69.0

63.8

72.5

55.6

59.2

56.9

74.9

64.2

57.7

69.5

74.1

(5)

(10)

(3)

(7)

(9)

(4)

(14)

(11)

(13)

(1)

(8)

(12)

(6)

(2)

1 Oikeusvaltioindeksi (Rule of Law). Lähde: Maailmanpankki .

2PISA-tutkimus, matemaattinen osaaminen. Lähde: OECD.

3 Index of EconomicFreedom. Lähde: Heritage-säätiö.

4 Richard Florida, University of Toronto, the Martin Prosperity Institute.

5 BKT henkeä kohti ostovoimapariteetilla arvioituna. Lähde: Euroopan komissio.

6 Työllisyysaste 15–64 -vuotiaat. Lähde: Eurostat.


Structural characteristics of some eu countries cont

Structuralcharacteristics of someEU-countries (cont.)

Incomedistribution1

Child poverty2

Trust3

Happiness4

Excessivefatness5

Drinking of the young6

Itävalta

Belgia

Tanska

Suomi

Ranska

Saksa

Kreikka

IrlantiItalia

Hollanti

Portugali

Espanja

Englanti

Ruotsi

0.265

0.269

0.248

0.263

0.293

0.295

0.321

0.299

0.337

0.294

0.361

0.309

0.341

0.259

(4)

(5)

(1)

(3)

(6)

(8)

(11)

(9)

(12)

(7)

(14)

(10)

(13)

(2)

14.3

18.3

10.9

11.4

18.4

17.5

23.0

19.7

24.7

13.7

22.4

26.2

20.3

13.1

(5)

(7)

(1)

(2)

(8)

(6)

(12)

(9)

(13)

(4)

(11)

(14)

(10)

(3)

70.2

63.0

131.9

117.5

37.9

75.8

54.6

72.1

60.8

90.6

21.9

40.9

61.7

134.5

(7)

(8)

(2)

(3)

(13)

(5)

(11)

(6)

(10)

(4)

(14)

(12)

(9)

(1)

7.7

7.3

7.9

7.8

7.0

7.4

7.0

7.5

7.1

7.7

7.1

7.0

7.4

7.9

(3)

(8)

(1)

(2)

(12)

(6)

(12)

(5)

(9)

(3)

(9)

(11)

(6)

(1)

12.4

12.7

11.4

14.3

10.5

13.6

21.9

13.0

10.2

11.3

12.8

14.9

24.0

10.7

(6)

(7)

(5)

(11)

(2)

(10)

(13)

(9)

(1)

(4)

(8)

(12)

(14)

(3)

23.0

17.5

31.5

28.0

14.3

18.0

13.0

21.0

12.5

15.0

15.0

18.5

32.5

16.0

(11)

(7)

(13)

(12)

(3)

(8)

(2)

(10)

(1)

(4)

(4)

(9)

(14)

(6)

The Nordicsscorewell in terms of equality, trust and happiness – butFinnsarefat and drinktoomuch

1 Gini-kerroin, joka saa arvon 0, jos tulonjako on täysin tasainen ja arvon 1, jos täysin epätasainen. Lähde: OECD.

2 Osuus alle 18-vuotiaista, joiden perheiden tulot ovat alle 60 % mediaanituloista. Lähde: Eurostat.

3 Osuus vastaajista, jotka katsovat voivansa luottaa kanssaihmisiin. Lähde: World ValuesSurvey.

4 Tyytyväisyys omaan elämäänsä. Lähde: World Poll Gallup.

5 Osuus joiden BMI > 30, jossa BMI = paino/pituuden neliö. Lähde: OECD.

6 Toistuvasti itsensä humalaan juovien nuorten osuus. Lähde: OECD.


6 emu the first decade when all went well or at least seemed to do so

6.1 Structuralindicators: Anglo-Saxons and Nordicsare ”liberal”, Central and South Europeansarenot – but the situation is changingbecause the crisishastriggered a lot of reforms in the countriesconcerned!

PMR

KOF

UK

NL

SE

FI

GR

BE

IE

DK

FR

AT

FR

BE

IT

PT

SE

PT

IT

AT

DE

FI

DE

ES

DK

IE

NL

UK

GR

ES

EPL

FRA

PMR = Product market regulation

EPL = Employment protection legislation

KOF = Globalisation index (trade and capital)

FRA = Fraser economic freedom index


6 2 effects of low interest rates credit expansion house prices domestic demand

6.2 Effects of lowinterestrates: creditexpansion, houseprices, domesticdemand

  • Joining the EMU brought with itsignificantlylowerinterestrates for a number of memberstates (GRE, POR, IRE, SPA, ITA, also FIN)

  • The rapidconvergence of nominalinterestrates, includingbondyields on long-termgovernmentbonds, had the consequencethatrealinterestrateswerelower the higher the rate of inflation (cf. the ”Walter’scritique”)

  • Lowrealinterestrateshavebeenassociated with rapidcreditexpansion

  • Rapidcreditexpansionhasbeenassociated with big increases in houseprices (implying a risk of a bubble)

  • Lowrealinterestrates and rapidcreditexpansionhavealsobeenassociated with a largecumulativeincrease in realgrowth of domesticdemand


10 year government bond yields

10 yeargovernmentbondyields

Interestratespreads (differences) used to berather big because of inflationdifferentials and exchangerateexpectations. EMU largelyeliminatedsuchexpectations. Recentlyspreadshavebeencausedby the risk of default of governments.

Greece

Italy

Spain

Irland

Finland

Germany

1995

2000

2005

2010


6 emu the first decade when all went well or at least seemed to do so

Real rate of interest and inflation 1999-2008Inflation = averageconsumerpriceinflationReal interestrate = 10 yeargovernmentbondyieldlessinflation as definedabove

Real interestrateswerehigher the lower the rate of inflation and viceversa – presumably the opposite to whatwouldhavebeencalled for!

Finland

Austria

Germany

Denmark

France

Belgium

Italy

Netherlands

Real interestrate

Greece

Portugal

Spain

Irland

Inflation


6 emu the first decade when all went well or at least seemed to do so

Real rate of interest and creditexpansion 1999-2008realrate of interest = 10 yeargovernmentbondyieldlessconsumerpriceinflationcreditexpansion = averageincrease in stock of outstandingbankloans

Lowrealinterestratesgohand in hand with rapidcreditexpansion

Greece

Irland

Spain

Finland

Italy

Credit expansion

Belgium

Portugal

France

Netherlands

Austria

germany

Real rate of interest


6 emu the first decade when all went well or at least seemed to do so

Credit expansion and housingprices 1999-2008creditexpansion = averageincrease in stock of banklendinghousingprices = cumulativeincrease in housingprices

Rapidcreditexpansiontends to gohand in hand with rapidlyrisinghouseprices.

Spain

Irland

France

Belgium

Netherlands

Greece

Housingprices

Finland

Italy

Portugal

Austria

Germany

Credit expansion


6 emu the first decade when all went well or at least seemed to do so

Credit expansion and domesticdemand 1999-2008creditexpansion = avergaeincrease in stock of bankloansdomesticdemand = averageannualgrowth of domesticdemand

Rapidcreditexpansionalsofuelles a rapidrate of growth of domesticdemand (privateconsumption plus investment).

Irland

Spain

Greece

Finland

Domesticdemand

France

Netherlands

Portugal

Belgium

Austria

Germany

Italy

Credit expansion


Unit labor cost 1998 2008 unit labor cost of the whole economy index 1998 100

Unitlaborcost 1998-2008unitlaborcost of the wholeeconomy, index, 1998 = 100

Rapidgrowthwasassociated with rapidlyrisingunitlaborcosts

Irland

Spain

Italy

Portugal

Greece

France

Finland

Germany


Housing prices 1999 2013 index 1999 1 100

Housingprices 1999-2013’index, 1999/1 = 100

Whatgoesupmayalsocomedown

Irland

Finland

Spain

Italy

Greece

Portugal

germany

1999

2002

2005

2008

2011


6 3 changes in competitiveness causes and consequences

6.3 Changes in competitiveness: causes and consequences

  • stronggrowth in domesticdemandtends to raisecostdevelopmentsweakeningcompetitiveness (measured as relativeunit labour costs in a common currency, relative to a weightedaverage of competitorcountries)

  • Weakeningcompetitivenessriskslead to slowergrowth in exports

  • Also, itmay show up as a deterioration of externalbalance, that is a decrease in the currentaccountsurplus (or an increase in the deficit)

  • Such a weakening of externalbalance (decrease in exportsand/orincrease in imports) is bad for economicgrowth

  • Itmayalsobeindicatingthat the privatesector is gettingexcessivelyindebted

  • Whileitmaybeeasilyfinanced as long as bankscanfreelyincreasetheirnetdebt to the ECB, itmaycausefinancingproblemsifbankshave a lack of high-qualitycollateral to backtheirborrowingfrom the ECB


Competitiveness and the current account of gdp changes from 1998 to 2008

Competitiveness and the currentaccount (% of GDP),changesfrom 1998 to 2008

There is a reasonablyclear association of externalbalance (the currentaccount) and competitiveness (relativeunit labour costs in a common currency)


Summary of the preceding

Summary of the preceding

  • Nominalinterestratesdeclinedsignificantly in Southern Europe uponjoining the EMU, butinflationremainedhigherthanelsewhere, sorealinterestrateswerecomparativelylow

  • Lowrealinterestrateswereassociated with rapidcreditexpansion, rapidincreases in houseprices and rapidgrowth of domesticdemand

  • Rapidgrowth of domesticdemandwasassoicated with relativelyhighwage and costincreasesleading to increases in relativeunit labour costs

  • Loss of competitivenessshowedup in weakerexports and notably in a negativedevelopment of the currentaccount; the deficit on the currentaccountincreasedsignificantly in allthosecountriesthatlaterhavecome to beidentified as the crisiscountries


6 4 monetary policy of the ecb measured by the short term interest rate and the cycle output cycle

6.4 Monetarypolicy of the ECB (measuredby the short-terminterestrate) and the cycle (output cycle)

1

2

Pricestabilityhasprevailed (with inflationmostlysightlyabove 2 %) and the ECB hassystematicallypursued a countercyclicalmonetarypolicy.

1Lyhyt korkotaso.

2 Tuotannon poikkeama potentiaalisesta tasostaan, %.

Lähde: Euroopan komissio.


Monetary policy and the cycle us fed

Monetarypolicy and the cycle: US Fed)

1

2

The US Fedhasalsopursued a countercyclicalmonetarypolicy, and ithastypicallytakenstronger action than the ECB.

1Short-terminterestrate.

2Deviation of GDP fromitspotentiallevel, %.

EuropeanComission.


6 5 public finances and fiscal policy

6.5 Public finances and fiscalpolicy

  • Almostallmemberstateshavequiteoftenrunbudgetdeficits (general governmentfinancialdeficits) above 3 per cent of GDP and hadgrosspublicdebtsabove 60 per cent of GDP, whichnormallyamounts to a violation of the Stability and GrowthPact and the ExcessiveDeficitProcedure

  • Manymemberstateshavealsobeenrunningprocyclicalfiscalpolicies, that is, policieshavebeenexpansionary in booms and contractionary in recessions, therebyadding to economicinstability

  • One reason for procyclicalpolicies is that a favourablecyclicalsituationincreasestaxrevenues (and reducesspending on unemployment), and politiciansareeager to spend the extrarevenues, makingitmoredifficult to allow the budget to weaken in the nextrecessioin.

  • Anotherreason for procyclicality is that the debt and deficitmaybetoo big to allow for countercyclicalexpansionarypolicies in a recession (due to lack of confidence in the financialmarket); thus, the governmentmayhave no choicebut to tightenfiscalpolicy in the recessionbecause of the fall in taxrevenues (and the increase in spending on unemployment).

  • Notabenethat big deficitsmaybe a source of problems (notleastbyreducingconfidence in policies), butarealso a consequence of economicdevelopments, i.e. a deeprecessionalmostinevitablyincreases the budgetdeficit (byreducingtaxreveneus and adding to cyclicalexpenditureitems)


General government financial balances of gdp

General governmentfinancialbalances, % of GDP


Gen gov gross financial debt of gdp

Gen. gov. grossfinancialdebt, % of GDP


Fiscal policy and the cycle the euro area

Fiscalpolicy and the cycle: the euro area

The fipo-indicator (the change in the cyclicallyadjustedbudgetbalance) and the output gaptypicallygo in oppositedirections, whichillustratesprocyclicalfiscalpolicy, that is, policythat is expansionaryduringgoodtimes and contractionaryduringbad. However, policyhasbeencountercyclicalsince 2007.


Fiscal policy and the cycle finland output gap and change in cyclically adjusted gen gov balance

Fiscalpolicy and the cycle: Finland (output gap and change in cyclicallyadjusted gen. gov. Balance)

Fiscalpolicyhasbeenrathersystematicallycountercyclical in Finland, butchanges in policyhavetypicallybeenrathermodest.


Fiscal policy and the cycle greece

Fiscalpolicy and the cycle: Greece

Fiscalpolicyhasbeensystematicallyprocyclical in Greece. Someslighteasing in 2008-2009 constitute an exception, thathad to bereversed with significanttightening as from 2010 because of the unsustainablepublicfinances


Fiscal policy and consolidation 1999 2008

Fiscal policy and consolidation 1999-2008

aCorrelation coefficient of output gap and fiscal impulse measured by change

in cyclically-adjusted budget balance, % of GDP

b General Government financial balance on average in 1999-2008, % of GDP

Source: OECD Economic Outlook No. 86, November 2009


Emu the first decade

EMU: the firstdecade

Commissionar of Economic and MonetaryAffairsJoaquinAlmunia:

”A fulldecadeafterEurope’sleaderstook the decision to launch the euro, wehavegoodreason to beproud of the single currency. The Economic and Monetary Union and the euro are a majorsuccess. For itsmembers, EMU hasanchoredmacroeconomicstability, and increasedcrossbordertrade, financialintegration and investment. For the EU as a whole, the euro is a keystone of furthereconomicintegration and a potentsymbol of ourgrowingpoliticalunity. And for the world, the euro is a major new pillar of the international monetarysystem and a pole of stability for the globaleconomy.”

([email protected] – Successes and challenges of Economic and Monetary Union, EuropeanEconomy, 2/2008)

With the benefit of hindsight, thischaracterizationdoesnotquitehit the nail. In fact, a housingbubblewasbuilding, publicfinanceswerestructurallygettingweaker, seriousreformswerenotundertaken, competitivenesswaseroded in weakcountries, vulnerability to anyshockwasbecomingevermoreserious – and all of thiswasneglected in an atmosphere of complacencyoreveneuphoria!


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