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<strong>EZ</strong> <strong>Crisis</strong>: A <strong>Consensus</strong> <strong>Narrative</strong><br />
These slides are taken from “Rebooting the Eurozone:<br />
Step 1 – agreeing a crisis narrative”, CEPR Policy Insight<br />
No.85<br />
by Richard Baldwin, Thorsten Beck, Agnès Bénassy-Quéré, Olivier<br />
Blanchard, Giancarlo Corsetti, Paul de Grauwe, Wouter den Haan,<br />
Francesco Giavazzi, Daniel Gros, Sebnem Kalemli-Ozcan, Stefano<br />
Micossi, Elias Papaioannou, Paolo Pesenti, Christopher Pissarides,<br />
Guido Tabellini and Beatrice Weder di Mauro<br />
Feel free to use, change, and distribute these slides, but please cite CEPR Policy Insight No.85 as the source
Today’s situation:<br />
<strong>EZ</strong> <strong>Crisis</strong>: a long way from recovery<br />
The Eurozone <strong>Crisis</strong> is far from finished…<br />
• Lacklustre growth and bleak economic prospects<br />
• “Jobless Europe” for the youth<br />
• Extremist views and nationalistic tendencies<br />
…fragilities and imbalances are still present.<br />
• Non-performing banking loans<br />
• Feedback loops between banks and the sovereign via debt holdings<br />
• Risky interest rate normalization
The causes of the <strong>EZ</strong> crisis<br />
The core reality<br />
<strong>EZ</strong> crisis as a ‘sudden stop’ crisis<br />
• Abrupt end of capital flows slow growth increased public debt<br />
and deficit public debt crisis<br />
<strong>EZ</strong> <strong>Crisis</strong> amplifiers<br />
• No lender of last resort<br />
• No devaluation possibilities<br />
• Vicious feedback cycle between banks and government<br />
• Predominance of banking financing<br />
• Rigid labor and product market
<strong>EZ</strong> crisis: a consensus narrative<br />
Plan of lecture<br />
• Building up problems<br />
• Triggers of the crisis<br />
• Phase one: failed bailouts and contagion<br />
• Phase two: contagion spreads to the core<br />
• Denouement
Building up problems<br />
• Sharp drop in borrowing costs and the disappeared spreads<br />
• Critical intra-<strong>EZ</strong> imbalance<br />
• Current account deficits<br />
• Investment versus saving<br />
• Competitive imbalance<br />
• Public debt build up (not the driving force!)<br />
• Private debt build up<br />
• <strong>EZ</strong> banks’ cross-border lending<br />
• <strong>Crisis</strong> prelude
Jan-1990<br />
Apr-1991<br />
Jul-1992<br />
Oct-1993<br />
Jan-1995<br />
Apr-1996<br />
Jul-1997<br />
Oct-1998<br />
Jan-2000<br />
Apr-2001<br />
Jul-2002<br />
Oct-2003<br />
Jan-2005<br />
Apr-2006<br />
Jul-2007<br />
Jan-1990<br />
Jan-1991<br />
Jan-1992<br />
Jan-1993<br />
Jan-1994<br />
Jan-1995<br />
Jan-1996<br />
Jan-1997<br />
Jan-1998<br />
Jan-1999<br />
Jan-2000<br />
Jan-2001<br />
Jan-2002<br />
Jan-2003<br />
Jan-2004<br />
Jan-2005<br />
Jan-2006<br />
Jan-2007<br />
Sharp drop in borrowing costs and the disappeared spreads<br />
10 yr gov't bond yields (%)<br />
10 yr gov't bond yields (%)<br />
16<br />
14<br />
12<br />
Greece<br />
Ireland<br />
Italy<br />
Spain<br />
16<br />
14<br />
12<br />
France<br />
Germany<br />
10<br />
8<br />
6<br />
4<br />
Portugal<br />
Austria<br />
Belgium<br />
France<br />
Germany<br />
Lux'g<br />
10<br />
8<br />
6<br />
4<br />
Italy<br />
Japan<br />
UK<br />
2<br />
0<br />
NL<br />
Finland<br />
2<br />
0<br />
US<br />
Source: OECD online database with author’s elaboration.
Jan-1990<br />
Oct-1990<br />
Jul-1991<br />
Apr-1992<br />
Jan-1993<br />
Oct-1993<br />
Jul-1994<br />
Apr-1995<br />
Jan-1996<br />
Oct-1996<br />
Jul-1997<br />
Apr-1998<br />
Jan-1999<br />
Oct-1999<br />
Jul-2000<br />
Apr-2001<br />
Jan-2002<br />
Oct-2002<br />
Jul-2003<br />
Apr-2004<br />
Jan-2005<br />
Oct-2005<br />
Jul-2006<br />
Apr-2007<br />
Jan-2008<br />
Oct-2008<br />
Jul-2009<br />
Apr-2010<br />
Jan-2011<br />
Oct-2011<br />
Jul-2012<br />
Apr-2013<br />
Jan-2014<br />
Oct-2014<br />
Jul-2015<br />
German long-run interest rates fell in line with global trends<br />
% per annum<br />
14<br />
12<br />
Germany<br />
10<br />
Japan<br />
8<br />
UK<br />
6<br />
US<br />
4<br />
2<br />
0<br />
Source: OECD online database with author’s elaboration.
1995<br />
1996<br />
1997<br />
1998<br />
1999<br />
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
2007<br />
1995<br />
1996<br />
1997<br />
1998<br />
1999<br />
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
2007<br />
Critical intra-<strong>EZ</strong> imbalance<br />
current account imbalances<br />
% of own GDP<br />
% of own GDP<br />
6<br />
10<br />
4<br />
2<br />
8<br />
Germany<br />
0<br />
-2<br />
-4<br />
-6<br />
-8<br />
-10<br />
-12<br />
-14<br />
Italy<br />
Ireland<br />
Spain<br />
Portugal<br />
Greece<br />
6<br />
4<br />
2<br />
0<br />
-2<br />
NL<br />
Finland<br />
Belgium<br />
France<br />
-16<br />
-4<br />
Peripheral <strong>EZ</strong> members generally ran current deficits while Core members general<br />
ran current account surpluses
1995<br />
1996<br />
1997<br />
1998<br />
1999<br />
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
2007<br />
1995<br />
1996<br />
1997<br />
1998<br />
1999<br />
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
2007<br />
1995<br />
1996<br />
1997<br />
1998<br />
1999<br />
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
2007<br />
Critical intra-<strong>EZ</strong> imbalance<br />
Saving and investment imbalances<br />
Savings (% of GDP)<br />
31<br />
31<br />
Savings (% of GDP)<br />
28<br />
25<br />
22<br />
19<br />
16<br />
13<br />
10<br />
Greece<br />
Ireland<br />
Italy<br />
Portugal<br />
Spain<br />
<strong>EZ</strong><br />
28<br />
25<br />
22<br />
19<br />
16<br />
13<br />
10<br />
Germany<br />
NL<br />
Belgium<br />
France<br />
<strong>EZ</strong><br />
Investment (% of GDP)<br />
Investment (% of GDP)<br />
31<br />
Greece<br />
31<br />
Germany<br />
28<br />
25<br />
22<br />
19<br />
Ireland<br />
Italy<br />
Portugal<br />
Spain<br />
<strong>EZ</strong><br />
28<br />
25<br />
22<br />
19<br />
16<br />
NL<br />
Belgium<br />
France<br />
<strong>EZ</strong><br />
16<br />
GIIPS generally saved less and invested more than average while Core <strong>EZ</strong> nations<br />
generally saved more and invest less the average
1997<br />
1998<br />
1999<br />
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
2007<br />
1997<br />
1998<br />
1999<br />
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
2007<br />
Critical intra-<strong>EZ</strong> imbalance<br />
Public debt fell in most <strong>EZ</strong> nations<br />
Debt-to-GDP ratio(1990=100)<br />
160<br />
160<br />
140<br />
Portugal<br />
140<br />
120<br />
Greece<br />
120<br />
France<br />
Germany<br />
100<br />
80<br />
<strong>EZ</strong><br />
Italy<br />
100<br />
80<br />
Austria<br />
<strong>EZ</strong><br />
Finland<br />
Belgium<br />
NL<br />
60<br />
Spain<br />
60<br />
Ireland<br />
40<br />
40<br />
Government debt ratios improved for most <strong>EZ</strong> nations (especially Ireland and Spain)<br />
but Portuguese and Greek debt burdens soared
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
2007<br />
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
2007<br />
Critical intra-<strong>EZ</strong> imbalance<br />
Bank debt rose rapidly in some <strong>EZ</strong> nations<br />
Total bank assets to GDP<br />
210<br />
Total bank assets to GDP<br />
210<br />
190<br />
170<br />
150<br />
130<br />
110<br />
90<br />
70<br />
Ireland<br />
Spain<br />
Italy<br />
Greece<br />
Portugal<br />
190<br />
170<br />
150<br />
130<br />
110<br />
90<br />
70<br />
France<br />
Finland<br />
Belgium<br />
Austria<br />
Germany<br />
NL<br />
Rapid accumulation of bank debt was a problem especially in Ireland, Spain, Italy and<br />
France
House prices rose in the GIIPS more than in the US<br />
while Germany’s fell<br />
Note: 1999 Q1=100.<br />
Source: OECD online database. House price indices in real terms.
Total landing from core countries’ bank to the periphery<br />
(billion euros)
Sep-2008<br />
Oct-2008<br />
Nov-2008<br />
Dec-2008<br />
Jan-2009<br />
Feb-2009<br />
Mar-2009<br />
Apr-2009<br />
May-2009<br />
Jun-2009<br />
Jul-2009<br />
Aug-2009<br />
Sep-2009<br />
Oct-2009<br />
Nov-2009<br />
Dec-2009<br />
Jan-2010<br />
Feb-2010<br />
Mar-2010<br />
Apr-2010<br />
May-2010<br />
Jun-2010<br />
Jul-2010<br />
Aug-2010<br />
Sep-2010<br />
Oct-2010<br />
Nov-2010<br />
Dec-2010<br />
Jan-2011<br />
Feb-2011<br />
Mar-2011<br />
Apr-2011<br />
May-2011<br />
Jun-2011<br />
Jul-2011<br />
Aug-2011<br />
Sep-2011<br />
Oct-2011<br />
Nov-2011<br />
Prelude and Phase One of the <strong>Crisis</strong> in <strong>EZ</strong> Periphery<br />
Spreads<br />
18<br />
16<br />
Greek deficit deceit Greek bailout Irish bailout Portuguese bailout Greece<br />
14<br />
12<br />
10<br />
8<br />
6<br />
Portugal<br />
Ireland<br />
4<br />
2<br />
0<br />
Prelude<br />
Phase One<br />
Note: The spreads are the difference between national 10-year government bound yields and those of Germany, in<br />
percentage points.<br />
Source: OECD online database with author’s elaboration.
Summary of pre-crisis imbalances<br />
1999 to 2007 (% of own<br />
GDP) Bank assets (% of GDP) %<br />
Cumulative<br />
current<br />
account<br />
balance<br />
2000 to 2008<br />
increase<br />
(p.p.)<br />
Excess<br />
inflation<br />
(1999-2007)<br />
Cumulative<br />
budget deficit<br />
Bank assets,<br />
2008<br />
Debt-GDP<br />
ratio, 2008<br />
Portugal -96 -36 44% 262% 72 7.5<br />
Greece -84 -47 36% 173% 109 9.9<br />
Spain -60 2 121% 296% 39 9.2<br />
Ireland -21 14 464% 783% 43 11.6<br />
Italy -8 -26 85% 235% 102 1.8<br />
<strong>EZ</strong> -2 -17 94% 335% 69 0.0<br />
France 6 -23 180% 395% 68 -2.9<br />
Austria 16 -19 305% 379% 69 -3.2<br />
Germany 27 -19 18% 316% 65 -4.8<br />
Belgium 47 -5 83% 392% 92 -1.1<br />
NL 48 -5 -9% 375% 55 2.8<br />
Finland 61 33 101% 197% 33 -4.9<br />
Lux'g 98 23 -577% 2367% 14 5.5<br />
Note: ‘Excess’ inflation is the nation’s cumulative inflation rate minus that of the <strong>EZ</strong> average.<br />
Source: OECD online database with author’s elaboration.
Triggers of the crisis<br />
• October 2009: Greece budget<br />
deficit unmasked<br />
• Six-moth attempt of ‘self rescue’<br />
– failed<br />
• Greece trapped into a public debt<br />
vortex<br />
• Debt loop<br />
• Austerity loop
Sep-2008<br />
Oct-2008<br />
Nov-2008<br />
Dec-2008<br />
Jan-2009<br />
Feb-2009<br />
Mar-2009<br />
Apr-2009<br />
May-2009<br />
Jun-2009<br />
Jul-2009<br />
Aug-2009<br />
Sep-2009<br />
Oct-2009<br />
Nov-2009<br />
Dec-2009<br />
Jan-2010<br />
Feb-2010<br />
Mar-2010<br />
Apr-2010<br />
May-2010<br />
Jun-2010<br />
Jul-2010<br />
Aug-2010<br />
Sep-2010<br />
Oct-2010<br />
Nov-2010<br />
Dec-2010<br />
Jan-2011<br />
Feb-2011<br />
Mar-2011<br />
Apr-2011<br />
May-2011<br />
Jun-2011<br />
Jul-2011<br />
Aug-2011<br />
Sep-2011<br />
Oct-2011<br />
Nov-2011<br />
Phase One: failed bailouts and contagion<br />
• Failed bailouts - Greece’s borrowing cost continued to soar<br />
• Contagion in the periphery<br />
Spreads<br />
• Public debt vortexes: Portugal<br />
• Bank debt vortexes public debt vortexes: Ireland<br />
18<br />
16<br />
Greek deficit deceit Greek bailout Irish bailout Portuguese bailout Greece<br />
14<br />
12<br />
10<br />
8<br />
6<br />
Portugal<br />
Ireland<br />
4<br />
2<br />
0<br />
Prelude<br />
Phase One<br />
Figure : Prelude and Phase One of the <strong>Crisis</strong> in <strong>EZ</strong> Periphery
Phase Two: contagion spreads to the core<br />
• Mismanagement of the bailouts give rise to a general fear<br />
• Pro-cyclical fiscal tightening further stoking contagion<br />
• Self-feeding panic: Good equilibrium, bad equilibrium
Fiscal policy turned pro-cyclical from 2010<br />
Note: Inspired by Carrot and de Castro (2015) with author’s elaborating using IMF WEO data.
Pro-cyclical fiscal policy, 2010 to 2014<br />
% of own potential<br />
GDP<br />
bill EUR % %<br />
2010 to 2014 swing 2010 to 2014 swing Share of <strong>EZ</strong> swing Share <strong>EZ</strong> 2014 GDP<br />
Greece 7% 14 4% 2%<br />
Ireland 28% 49 14% 2%<br />
Italy 2% 28 8% 16%<br />
Portugal 9% 17 5% 2%<br />
Spain 5% 53 16% 11%<br />
<strong>EZ</strong> 4% 340 100% 100%<br />
Austria 1% 2 1% 3%<br />
Belgium 0% 2 0% 4%<br />
Finland 0% 0 0% 2%<br />
France 2% 46 13% 21%<br />
Germany 4% 108 32% 29%<br />
Luxembourg 1% 1 0% 0%<br />
Netherlands 2% 15 5% 6%
May-2010<br />
Jun-2010<br />
Jul-2010<br />
Aug-2010<br />
Sep-2010<br />
Oct-2010<br />
Nov-2010<br />
Dec-2010<br />
Jan-2011<br />
Feb-2011<br />
Mar-2011<br />
Apr-2011<br />
May-2011<br />
Jun-2011<br />
Jul-2011<br />
Aug-2011<br />
Sep-2011<br />
Oct-2011<br />
Nov-2011<br />
Dec-2011<br />
Jan-2012<br />
Feb-2012<br />
Mar-2012<br />
Apr-2012<br />
May-2012<br />
Jun-2012<br />
Jul-2012<br />
Aug-2012<br />
Sep-2012<br />
Oct-2012<br />
Nov-2012<br />
Dec-2012<br />
Jan-2013<br />
Feb-2013<br />
Phase Two: contagion spreads to the core<br />
Spreads started to rise for Belgium, France and Austria – as well as<br />
Italy and Spain<br />
Spreads<br />
7<br />
6<br />
5<br />
Greek bailout Irish bailout Portuguese bailout 2nd Greek bailout<br />
Italy<br />
Spain<br />
4<br />
3<br />
2<br />
Belgium<br />
France & Austria<br />
1<br />
0<br />
Phase One<br />
Phase Two
Jan-…<br />
Oct-…<br />
Jul-…<br />
Apr…<br />
Jan-…<br />
Oct-…<br />
Jul-…<br />
Apr…<br />
Jan-…<br />
Oct-…<br />
Jul-…<br />
Apr…<br />
Jan-…<br />
Oct-…<br />
Jul-…<br />
Apr…<br />
Jan-…<br />
Oct-…<br />
Jul-…<br />
Apr…<br />
Jan-…<br />
Oct-…<br />
Jul-…<br />
Apr…<br />
Jan-…<br />
Oct-…<br />
Jul-…<br />
Apr…<br />
Jan-…<br />
Oct-…<br />
Jul-…<br />
Apr…<br />
Jan-…<br />
Oct-…<br />
Jul-…<br />
Denouement<br />
• Agreement on Banking Union and the Fiscal compact<br />
• Draghi’s “whatever it takes”<br />
10 yr gov't bond yields (%)<br />
40<br />
35<br />
30<br />
25<br />
20<br />
15<br />
10<br />
5<br />
0<br />
Draghi speech<br />
Greece<br />
Ireland<br />
Italy<br />
Spain<br />
Portugal<br />
Austria<br />
Belgium<br />
France<br />
Germany<br />
Lux'g<br />
NL<br />
Finland<br />
Figure: Yields converged again after Draghi’s intervention
Proximate causes, and causes of the causes<br />
Proximate cause<br />
• Sudden stop in inter-<strong>EZ</strong> lending<br />
• Loss of independent monetary policy after euro adoption<br />
Cause of the cause<br />
• Policy failures that allowed the imbalance to get so large<br />
• Failure to control national debt<br />
• Failure to control excessive bank leverage<br />
• Lack of institutions to absorb shocks at the <strong>EZ</strong> level<br />
• Failings in real-time crisis management
Concluding remarks<br />
This essay has identified proximate causes, the causes of the proximate<br />
causes of the RZ crisis and provide and crisis narrative.<br />
How we got here…<br />
• Fundamental design flaws of the EMU<br />
…the way ahead<br />
• Lots of suggestions, no consensus<br />
• Both on where to go, and on how<br />
• We need a systematic rethinking how to get Europe working again
The End
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