Transcript The Eurozone Crisis? Will the Euro Survive?

The Eurozone Crisis? Will the
Euro Survive?
Michael Bordo
Rutgers University, Hoover Institution
and NBER
Introduction
• EMU and ECB were a culmination of a long process of
economic integration going back to the end of WWII
• The negotiations leading to EMU began in the 1970s
after the breakdown of the BWS
• Opposition to floating exchange rates and fear of US
international monetary dominance drove the project
forward
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Introduction
• The Great Inflation and weak dollar of the 1970s and
strong dollar in the 1980s put considerable stress on
the weaker European currencies relative to the DM
• This led to instability in the “snake in the tunnel” and
the EMS
• This contributed to the case for perfectly rigid
exchange rates combined with a DBB style ECB to
provide sound money
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Introduction
• EMU went forward despite skepticism that it did not
satisfy the OCA criteria of labor mobility and a fiscal
union
• Maastricht 1992 left out a fiscal union despite
misgivings by key players
• Proponents argued that financial integration would
lead to private insurance mechanisms as a substitute
for a fiscal union
• They also expected labor market reform
• The Maastricht ‘no bail out’ clause and the SGP fiscal
limits would make up for the absence of a fiscal union
• Finally Maastricht did not include a banking union
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From Early Success to Crisis
• Bordo and Jonung (2003) distinguished between
national and international MUS
• National MUs predicated on political unification and
fiscal union were more successful than international
MUs
• The key determinant of success was the common belief
by the founding member states in the creation of an
overarching national (federal ) state
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From Early Success to Crisis
• We argued that EMU seemed closer to a national than
an international MU
• But its success would ultimately depend on political
will
• The question arises over a decade later:
• How has the EMU fared? And will it survive going
forward?
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From Early Success to Crisis
• For its first 8 years the EZ seemed to be thriving
without a fiscal union or a banking union
• There was significant integration in goods and capital
markets but labor mobility languished
• The integration of capital markets led to the
convergence of sovereign bond yields across the EZ
• See figure 1
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Figure 1. Bond Yields in the Eurozone
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From Early Success to Crisis
• Many argued that this reflected successful integration
• Others believed that convergence reflected a cynical
belief that the ‘no bail out’ clause would not hold in
the event of a debt crisis in a peripheral country
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From Early Success to Crisis
• The 2007-2008 subprime mortgage crisis created the
conditions for the existential shock that the euro
skeptics prophesied
• The crisis and Great Recession led to large fiscal deficits
and run ups in national debt as member states
increased G to offset recession and tax receipts
declined
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From Early Success to Crisis
• The incidence of the crisis/recession fell more on the
peripheral countries which had slower growth and
were less competitive.
• The fiscal imbalances were in part tempered by the
operation of TARGET 2, which accommodated the
member NCBs demands for liquidity
• See figure 2
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Figure 2. Net claims of
the NCBs resulting
from transactions
within the Eurosystem
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From Early Success to Crisis
• Matters took a turn for the worse in 2010 when it was
revealed that Greece’s fiscal position was much more dire
than originally believed
• The Greek debt crisis and the initial reluctance by the EZ
not to bail out Greece led to a wide divergence in
sovereign spreads seen in figure 1
• It also led to contagion to other peripheral countries that
had weak fundamentals
• Banks in the fiscally challenged countries were exposed
because of their large holdings of domestic sovereign debt
• Banks in other advanced EZ countries were also exposed
to peripheral sovereign debt
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From Early Success to Crisis
• The EZ authorities were initially opposed to a Greek
restructuring for fear that it would force Greece to
leave the EZ
• Greece was forced into painful fiscal consolidation and
contraction
• In 2011 when it became clear that Greek fundamentals
were unsustainable the Troika worked out a
restructuring
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From Early Success to Crisis
• This action exposed the IMF to credit risk and violated
principles established after the 1990s EM crisis
• Had the EZ authorities and IMF initially treated the
Greek crisis like an EM crisis and restructured the debt
when the crisis broke out the deterioration in debt
markets that followed could have been avoided
• The Greek rescue and others for Portugal and Ireland
reduced sovereign spreads somewhat but did not end
the crisis
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From Early Success to Crisis
• The 2010-2012 EZ debt crisis more than the 2007-2008
global financial crisis revealed the fundamental
mistakes of omitting fiscal and banking unions from the
original deal
• Had they been in place, much of the fiscal, financial
and real dislocation could have been avoided
• A euro bond like Alexander Hamilton’s 1790 national
bond and a euro wide resolution mechanism like FDIC
would have made a big difference
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From Early Success to Crisis
• Had the peripheral EZ countries been on floating
exchange rates they could have avoided most of the
deflation and adjustment would have been faster eg
Iceland
• In the absence of a fiscal union the ECB was pressed
into service to resolve the crisis
• In Spring 2010 Trichet pledged to support peripheral
sovereign debt markets
• In July 2012 OMT promised unlimited liquidity support
for the sovereign debt markets of the EZ
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From Early Success to Crisis
• OMT was successful in reducing sovereign debt spreads
• OMT was sold as a liquidity/LLR policy to be consistent
with the ECBs mandate
• In actual fact the jump in spreads between 2010-2012
reflected the deep seated structural flaws behind the
fiscal imbalances
• They reflected insolvency rather than illiquidity
• The ECB has been engaging in fiscal policy which
violates both its independence and its mandate
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Conclusion: Will the Euro survive?
• The EZ crisis has been (temporarily) allayed by ECB
actions
• The deeper real problems of slow labor mobility,
divergent productivity and competitive trends,
excessive regulation and slow economic growth are still
there
• There has been limited progress towards a banking
union but no progress towards a fiscal union
• It has been opposed by member states fearing losing
sovereignty
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Conclusion: Will the Euro survive?
• The collapse of the EZ has been avoided by the
exertion of political will
• This has compromised the independence of the ECB
• As long as political will for EMU prevails (regardless of
the costs to the EUs fundamental institutions) the EZ
will limp forward
• Unless the flaws of EMU are really corrected the
prospects for a crisis free future are limited
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