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Fiscal Policy and National Accounting in the Euro-zone Dimitrios Syrrakos Department of A,F&E 18 th October 2012 RIBM Research Seminars. 1. General. Special thanks to John Simister for his help. 1. Introduction. 1. Introduction 2. Exchange Rate Theory
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Fiscal Policy and National Accounting in the Euro-zone Dimitrios Syrrakos Department of A,F&E 18th October 2012 RIBM Research Seminars 1
General • Special thanks to John Simister for his help
1. Introduction • 1. Introduction • 2. Exchange Rate Theory • 3. National Accounting in EMU • 4. Policy Implications • 5. Conclusions
1. Introduction • EMU debt crisis in a broader historical and international framework • Lessons for today • Implications • Consideration
1. Introduction • 1st January 1999: The European Monetary Union – EMU (introduction of the Euro currency) and the creation of the European Central Bank ( ECB). • Initially 11 countries joined in 1999. • The UK, Sweden and Denmark could join but decided not to. • Currently there are 17 member countries.
1. Introduction • The European Monetary Union performed very well from 1999-2008. • Average inflation rates for the Euro-zone < 2 per cent benchmark of the ECB. • Average inflation rates for Germany from 1999-2008 < than German inflation from 1988-1998. • Massive increase in intra-Eurozone trade.
1. Introduction • Business cycle convergence. Graph-1 presents the evolution of business cycles for Belgium, Denmark, France, Germany, Ireland, Italy, Netherlands and Portugal by measuring the output gap as a percentage of GDP. This contrasts the prediction and findings of many authors (e. g. Artis & Zhang) concerning the longevity of EMU based on business cycles divergence.
1. Introduction • Artis, for example, advocated that: 'we find that the European business cycle is a more elusive phenomenon than we might have expected; whilst some European countries seem to “stick together”, there are many which do not.' (p. 2) • According to graph-1, Belgium, France, Germany, Ireland, Italy, Netherlands and Portugal are sticking together from the mid-1990s.
1. Introduction • International crisis in 2008 • Debt crisis in EMU • Countries: Greece, Ireland, Portugal • Countries: Italy, Spain, Belgium, France (?) • Why? • EMU – European Central Bank (ECB) • EMU – European Central Fiscal Authority?
2. Exchange Rate Theory • Assume a monetary union with no fiscal framework: • Two main problems: • i) Free Rider Problem: It occurs when one country loosens its fiscal policy expecting other member countries to offset this by tightening their policies.
2. Exchange Rate Theory • ii) Spill-over Effects: It occurs when countries formulate their own fiscal policies failing to take into account the impact on other member states’ fiscal policies.
2. Exchange Rate Theory • The creation of a monetary union may stimulate national governments to pursue expansionary fiscal policies. • Why? • A country in a monetary union can borrow money from other countries/institutions in the same currency.
2. Exchange Rate Theory • However, the creditworthiness of heavy borrowers determines the interest rate they pay on their debts. • However, financial markets may believe (as they did) that EMU provides an implicit guarantee of its members’ debts, so that any default risk premium on the debt of the heavy borrowers will disappear.
2. Exchange Rate Theory • When a country faces problems with servicing its national debt, it seeks help from its central bank. • How? (monetarise debt). • As a result the value of the domestic currency decreases, which helps restore competitiveness losses • Problems?
2. Exchange Rate Theory • When a country is in a monetary union, like Greece, Ireland and Portugal, cannot engage in the previous process. • Thus, they need the Union’s help. This should involve the transfer of resources from rich parts to poor parts of the Union (Mundell, R.) • What kind of help?
2. Exchange Rate Theory • Therefore, excessive borrowing by EMU member countries will harm the union as a whole. Because of these externalities it would be in the interest of the fiscally prudent countries that a control mechanism be in place restricting the size of budget deficits. • What if there is no such mechanism?
2. Exchange Rate Theory A fiscal framework refers to the sustainability of public finances ofall member states. A country unable to finance its debt: • Default on its debts (debts). • Receive direct transfers from other countries • Central Bank to reduce interest rates to reduce the cost of debt financing. • “Create Euro-zone bonds”?.
2. Exchange Rate Theory • Debt crises more likely in the euro area as 17 countries and only one Central Bank AND • In the case of EMU, the Treaty explicitly rules out bail outs of one Member State by another or by the ECB (Articles 101 and 103). • Solutions?
3. National Accounting • Maastricht Treaty (1992) the deficit of every country in the EMU should not exceed 3 per cent of GDP. However, this 3 per cent deficit criterion does not take into account each country’s position in the business cycle (e. g. structural and cyclical component of the overall deficit). • Given the convergence of EMU countries’ business cycles this should not be a problem.
3. National Accounting Most EMU countries (including EMU peripheral countries) satisfied that criterion from 1996 – 2007.* However, this does not imply that the competitiveness of EMU peripheral countries was converging to the one of the ‘core’ or ‘northern’ EMU countries. Graphs 2-7 depict the evolution of countries’ exchange rates, current accounts and capital accounts.
3. National Accounting • As it can be observed in the graphs all countries capital accounts were balanced for most of time under consideration. • A continuous gradual deterioration in the current account is taking place from 1999 onwards in the case of France moving from a surplus of 3 per cent in 1999 to a deficit of 2 per cent in 2011.
3. National Accounting • In the cases of Italy and Spain the deterioration in the current account coincides with the creation of EMU in 1999. In the case of Portugal, the deterioration commences earlier in the mid-1990s but becomes much more severe after 1999.
3. National Accounting • The Irish current account also starts deteriorating after the creation of the EMU and in particular after 2004. However, there is a remarkable elimination in the current account deficit from 2009 to present, reflecting the impact of fiscal consolidation.
3. National Accounting • Causes of competitiveness gap in the case of Greece: • 1. Huge public sector accounting for 44% of the economic activity prior to the crisis • 2. Military expenditure, exceeding 1.1% that of EU average every year since 1974 • 3 Geography: e.g. there are around 2,000 islands out of which 197 are inhabited.
3. National Accounting • 4. Emphasis on Consumption to boost growth • 5. Lack of industrial base-capacity • 6. Energy-oil dependent
4. Policy Implications • Clearly, a number of EMU countries, including Greece, Portugal, Spain, Ireland and France were meeting the 3 per cent deficit criterion of the Maastricht Treaty from 1999 to 2008. • The 3 per cent deficit criterion [as perhaps the 60 per cent] debt criterion proved inadequate in preserving countries from growing imbalances in their national accounting.
4. Policy Implications • Lack of emphasis in boosting/maintaining demand after 2009. • The case of Spain reflects that even balancing the overall budget (prior to 2007) does not guarantee economic stability in a recession. • Each country is a different case.
5. Conclusions • The notion of bail-out with regards to EMU debt crisis and management. • The notion of South-North EMU. • Is the debt crisis spreading: Belgium, Netherlands? • Is there an end to it? • What is the solution enforced by Germany?
5. Conclusions • USA: consumer confidence versus restoring competitiveness • Germany’s commitment to the Euro in the light of a ‘complete’ German reunification • Are we experiencing Euro’s disintegration? • This is no longer an ‘economic issue’
Conclusions • Thank you
