After the Crisis, Much Still at Stake for Eurozone
IMF Blog, January 21, 2010
Source details
- Canonical URL
- After the Crisis, Much Still at Stake for Eurozone
Other formats
Bibliographic details
- Authors: Marek Belka
- Published: January 21, 2010
Context and immediate impact of the crisis
- January 2009 marked 10 years since the introduction of the euro; that anniversary fell in the midst of the worst global financial crisis in the past half century.
- The euro—and the European Central Bank—proved important safeguards against the spread of the crisis:
- Countries that would likely have faced severe market gyrations without the euro “held their ground.”
- The ECB, along with central banks around the world, used innovative approaches to help provide liquidity and calm markets.
- By January 2010 (as the euro turns 11) the crisis was receding and an economic recovery was underway, yet strains within the eurozone remained and “will need serious attention” (commentators cited include Martin Wolf and Paul Krugman).
Divergences within the eurozone
- Pre-crisis expansion featured widely different growth and inflation rates across eurozone countries.
- OECD-based calculations applying the Taylor Rule to individual countries would have implied very different interest rates across countries.
- Underlying drivers of divergence included:
- Rapid growth in property prices.
- Insufficient supervision of financial sectors.
- Long-standing structural weaknesses.
- Markets largely ignored these differences before the crisis; risk premia on sovereign bonds were small and stable through to the start of the crisis in July 2007.
- Once the crisis hit, differences in projected public debt levels, the state of financial sectors, and overall competitiveness undermined the presumption of self-correction.
- Market differentiation increased (though spreads were off their peak levels), and this differentiation is “likely to stay,” as noted by colleagues Ashoka Mody, and separately Silvia Sgherri and Edda Zoli.
Tackling regional imbalances — limits of monetary policy and needed structural measures
- Scope for changes in monetary policy is limited; the monetary policy framework has worked well and is regarded as credible.
- Major underlying problems stem from differences in country policies and structures rather than monetary policy settings.
- Emerging global consensus on how best to regulate and supervise financial systems is a positive development; the European Union is committed to instituting more stringent financial policies across member countries.
- Within the EU’s single financial market, a system of cross-border arrangements is needed to assess and manage systemic risks; an EU Financial Stability framework is “emerging” and is characterized as a key initiative.
- Two U.S. features that help mitigate regional imbalances (and are less available in Europe):
- Movement of people from weaker to stronger regions promotes medium-term adjustment.
- Federal fiscal transfers reduce the distress of depressed regions.
- In Europe:
- Labor mobility has increased over time and has been important in countries such as Ireland and Spain, but remains limited overall.
- Structural policy measures that could encourage labor mobility include portability of pensions and healthcare.
- Federal fiscal transfers do not really exist; instead, large automatic stabilizers combined with borrowing in a single currency should mimic transfers to some extent, provided overall fiscal discipline is preserved.
- The Stability and Growth Pact (SGP) embodies the central European policy premise that national fiscal discipline will discourage imbalances from emerging.
Fiscal challenges and the need for broader fiscal governance
- The crisis increased deficits and public debt as eurozone economies shrank in 2009 and fiscal stimulus was injected; public debt was “headed higher for a number of years.”
- The SGP benchmarks to which countries must return:
- A deficit less than 3 percent of GDP.
- A public debt-to-GDP ratio less than 60 percent.
- The SGP’s underlying goal is a close-to-structural balance in each country; meeting these targets will be a “huge challenge.”
- Risks and trade-offs:
- An unreasonable pace of consolidation may do more harm than good.
- Flexibility in the SGP that becomes necessary may call its credibility into question.
- The SGP was not designed to handle:
- Fiscal challenges from a large common shock in the context of constrained monetary policy effectiveness.
- Individual euro area members running into financing difficulties.
- Policy options to strengthen fiscal governance:
- Encourage individual countries to credibly commit to fiscal self-discipline via fiscal targets and supporting institutions that create momentum for restraint.
- Strengthen European-level monitoring of fiscal numbers in a consistent and preemptive manner (made more feasible with the Lisbon treaty in effect).
- Explore access to central resources—either from common bond issuance or increased federal transfers—conditioned on good behavior.
Stakes and outlook
- The ECB has established a sound monetary framework and has proven responsive to recent challenges.
- The relatively benign global conditions of the euro’s first decade masked divergent performance; that reprieve no longer exists.
- The ECB and the European Union are in the process of establishing new institutions and rules to create a stronger Europe.
- The success of these efforts will determine Europe’s course and the role of the euro in its next decade and beyond: “Much is at stake.”
Source: Marek Belka, January 21, 2010 — After the Crisis, Much Still at Stake for Eurozone (IMF blog).
Content in this bundle
- Μετά την κρίση, διακυβεύονται ακόμη πολλά στην ευρωζώνη
- Country Report