HOW STABLE IS THE EURO? G. Malliaris Loyola University Chicago Society for Policy Modeling at the ASSA Annual Meetings Chicago, Illinois, January 6 - 8, 2012
KEY QUESTIONS FOR DISCUSSION • Will the Euro Survive the Recent Crisis? • Is the Euro Still a Good Idea for the EU? • Is there a Sufficient Political Commitment to Preserve the Euro? • What Are the Choices of the Weak EMU Countries?
BROADER QUESTIONS • What is the Role of the Euro in the Global Monetary System? • How is the U.S. Impacted from the Euro? Other Countries such as China? • What is the Role of the Euro in Terms of Global Imbalances? • What Are the Most likely Scenarios About the Euro and the Global Economy?
HOW TO APPROACH THESE QUESTIONS? • Few Methodological Choices • Review Recent History • Economics of Optimum Currency Area • Global Financial Crisis of 2007-09 • Persistent Global Financial Imbalances • Use the Concept of STABILITY
How to Proceed? • How Stable is the Euro? • Stability as a Unifying Theme • But “What is Stability?” • An Economic System is Stable if it Recovers After an Internal or External Shock. • Recovers Means Return to Potential GDP • Claim: The Euro is Stable • Challenge: How Stable??
Proposed Methodology • Examine and Evaluate the Shock • Assess the Impact of the Shock on the Stability of the Euro
Examine the Shock • The Global Financial Crisis of 2007-09 • Declines in Real GDP • Increases in Government Expenditures • Greece, Ireland, Portugal, Spain, Italy Experience Large Public Deficits and Debts • Banks Face Significant Risks from Holding Sovereign Debt
Evaluating the Shock • Impact on the Euro: Remains Stable • Impact on EU Growth: Weak but not Dismal • Banks Remain Stable • Most Pain Experienced by Greece, Ireland, Portugal
First Arguments for Stability • The Euro as a Currency Remains Stable; No Evidence of Imminent Collapse
Second Argument for Stability • The EMU Economy Remains Stable • EMU GDP is about 20% of Global Economy • 2012 EMU GDP to Grow at about 0.5% to -0.2% • 2013 EMU GDP Expected to Resume 1% to 2% Growth
Third Argument for Stability • Robust Global Growth of 3.5% Will Help the EU • A Weak Euro Will Help Also Exports • Additional Easing Expected by the ECB
Fourth Argument for Stability • Additional Easing Expected by the ECB • Bank Deleveraging is Going Well and May End by 2012 • Excellent Corporate Balance Sheets
Fifth Argument for Stability • Solid Past Record on Growth • Solid Record on Low Inflation • Low Interest Rates • PARADOX: Past Success May Have Contributed to Excessive Sovereign Borrowing
Sixth Argument for Stability • Despite Political Complexities There Is Sufficient Political Will to Stabilize the Euro • Dramatic Success of Political Developments in Greece and Italy (Papademos and Monti Governments of Technocrats) • Long History of Political Initiatives for Over 50 Years Towards Establishing the EMU
Seventh Argument for Stability • Core Germany and France are Stable • Serious Imbalances for Greece, Ireland, Portugal • Options to Leave the Euro Are not Attractive • The Euro Commands a 25% Share of Global Reserves; Second to US Dollar with 60% • British Pound is 4% and Japanese Yen is also about 4%
Counter-Arguments • Long History of Financial Crises • Financial Markets Often Fail to Estimate Correctly Risks • Financial Institutions Often Fail to Manage Risks Effectively • The Euro Compounded Both by Promoting Fixed Interest Rates and Exchange Rates • ECB Should Re-Address Financial Stability
Possible Future Scenarios • Have Argued In Support of Stability of the Euro with Gradual Return to Normality in 2-3 Years • If Rescue Plans Fail, Uncertainty May Contribute to Further Instability • What If Some Countries Choose to Default and Leave the EMU? • Total Collapse of the Euro?
ANSWERS TO QUESTIONS • Is the Euro Still a Good Idea for the EU? YES. • Will the Euro Survive the Recent Crisis? MOST LIKELY; CLOSER FISCAL COOPERATION IS NEEDED. • What Has Caused the Recent Euro Crisis? THE GLOBAL CRISIS AND SUCCESS OF THE EURO. • Is there a Sufficient Political Commitment to Preserve the Euro? MOST LIKELY; AREA OF UNCERTAINTY DUE TO COMPLEX INSTITUTIONS • What Are the Choices of the Weak EMU Countries? VERY DIFFICULT
FURTHER ANSWERS • What is the Role of the Euro in the Global Monetary System? USEFUL DIVERSIFICATION TOOL. • How is the U.S. Impacted from the Euro? Other Countries such as China? MOSTLY POSITIVELY. • What is the Role of the Euro in terms of Global Imbalances? THE EURO HAS BEEN MORE FLEXIBLE THAN THE YEN OR YUAN AND CONTRIBUTED TO A MODERATION OF GLOBAL IMBALANCES. • What Are the Most likely Scenarios about the Euro and the Global Economy? EURO SURVIVES (95%); IF NOT, THE WORLD WILL EXPERIENCE A GLOBAL FINANCIAL CHAOS AND A SERIOUS ECONOMIC DOWNTURN.