H.-W. Sinn

H.-W. Sinn

Austerity in Europe Hans-Werner Sinn January 2014

H.-W. Sinn

Summary of the

argument

H.-W. Sinn

Austerity of a currency union as a whole versus Austerity of a sub-region within a currency union

H.-W. Sinn

• Exits may be better than austerity

• The Eurozone needs austerity in the south to realign relative prices • Austerity comes from markets; policy softens the budget constraints

H.-W. Sinn

The Euro Trap

On Bursting Bubbles, Budgets and Beliefs

Hans-Werner Sinn CESifo Munich

2014 Oxford University Press

H.-W. Sinn, „Austerity, Growth and Inflation: Remarks on the Eurozone’s Unresolved Competitiveness Problem,“ The World Economy 36, 2013

H.-W. Sinn

The bubble

H.-W. Sinn

1985 1990 1995 2000 2005 2010 2013

%

Irrevocably fixed conversion rates

Source: Thomson Reuters Datastream.

0

5

10

15

20

25

30

40

35

Summit of EU governments

in Madrid

Net yields for 10-year government bonds

December 2013

Germany

Italy

Greece

Spain Portugal

Ireland

France Belgium

H.-W. Sinn

1985 1990 1995 2000 2005 2010 2013

%

Irrevocably fixed conversion rates

Source: Thomson Reuters Datastream.

0

5

10

15

20

25

30

40

35

Summit of EU governments

in Madrid

Net yields for 10-year government bonds

December 2013

Germany

Italy

Greece

Spain Portugal

Ireland

France Belgium

H.-W. Sinn

2012 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2013

Spain

Ireland

%

Source: Eurostat; December 2013.

Portugal

2

9

16

23

30 Greece

Italy

Unemployment rates in Europe

Cyprus

H.-W. Sinn

0

10

20

30

40

50

60

70

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Spain Greece

%

Cyprus

Source: Eurostat, December 2013.

Ireland

Italy Portugal

Youth unemployment (< 25 years)

H.-W. Sinn

60

70

80

90

100

110

120

130

00 01 02 03 04 05 06 07 08 09 10 11 12 13

Advanced economies

Emerging and developing economies

Spain Greece

Italy

Portugal

Source: Eurostat; OECD; CPB Netherlands Bureau for Economic Policy Analysis, World Trade Monitor.

2008Q1=100

Industrial production

Ireland

H.-W. Sinn

The realignment problem

H.-W. Sinn

60

80

100

120

140

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

Greece Italy Ireland

Portugal

Spain

France

Germany

Q3/2008=100

Real exchange rates (GDP deflator relative to rest of euro area)

& necessary realignment according to Goldman Sachs

Long run target

Italy

Lehman

H.-W. Sinn

Four dismal options

1. Transfer union

H.-W. Sinn

Four dismal options

2. Deflation in the periphery (austerity)

1. Transfer union

H.-W. Sinn

Four dismal options

2. Deflation in the periphery (austerity)

3. Inflation in the core

1. Transfer union

H.-W. Sinn

Four dismal options

2. Deflation in the periphery (austerity)

4. Exits

3. Inflation in the core

1. Transfer union

H.-W. Sinn

Austerity or

soft budget constraints?

H.-W. Sinn

Bail out with the printing press: Non-investment grade collateral for ECB refinancing credit

H.-W. Sinn

0

10

20

30

40

50

60

70

80

90

100

2007 2008 2009 2010 2011 2012 2013

%

Base money originating in

GIPSIC

81%

Monetary base GIPSIC

Inside money and outside money

55%

Monetary base Eurozone

Inside money non-GIPSIC Monetary base

non-GIPSIC

Outside money ( GIPSIC Target balance)

26%

H.-W. Sinn

639

56

72

116

213

61

41

1090

5

Target liabilities* (GIPSIC)

Purchases of GIPSIC government bonds by the central banks of the other euro countries*

Greece (euro countries, EFSF, IMF)

Ireland (EFSM, EFSF, IMF) Portugal (EFSM, EFSF, IMF)

Claims related to the under-proportionate

issuance of banknotes )

(64%) ECB

(36%) Parliaments Spain (ESM)

Lending funds to euro countries (Billion euros)

Paid-out to date

* Updated 13 December 2013

Cyprus (ESM)

698

392

H.-W. Sinn

= abolishment of risk premia ex ante = credit bubbles and overheating = lack of reforms and realignment efforts ex post

Soft budget constraints

H.-W. Sinn

Harold James, Princeton: The Hamiltonian scheme of federal finance did not guarantee a peaceful commonwealth. “In fact the fiscal union proved to be explosive rather than cement.”

Soft budget constraints are dangerous

H.-W. Sinn

Unsustainable debt

H.-W. Sinn

Debt sustainability requires real devaluations, but real devaluations increase the debt-to-GDP ratios.

H.-W. Sinn

Greece

Ireland Portugal Spain Italy

NB: without haircut

Official public debt

157

118 124 84

127

211

Official public debt at

competitive GDP prices

197

114 173 118

141

294

Actual and hypothetical public debt-to-GDP ratios ( 2012, % )

H.-W. Sinn

The way out

H.-W. Sinn

Three basic measures to rescue the EU and the euro

1. Debt conference to forgive part of the public debt, the bank debt and the Target debt

3. Harder local budget constraints for central banks (settlement of new Target balances, internal gold standard like US until 1975)

2. Temporary exits of severely uncompetitive countries

H.-W. Sinn

A “breathing currency union”

placed between

Bretton Woods and the dollar

until the

United States of Europe

is founded

H.-W. Sinn