Can the Euro Hold? Michael A Landesmann

Wiener Institut für Internationale Wirtschaftsvergleiche

The Vienna Institute for International Economic Studies

www.wiiw.ac.at

IDEAS Tenth Anniversary Conference, Chennai, 24-26 January 2012

Can the Euro Hold?

Michael A Landesmann

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Main Issues

Why has the crisis in the Eurozone escalated that much?

Where are we at the moment? Is there a policy master-plan?

Is the Euro-zone going to pull through? In which shape?

What is the predicament of Europe’s ‘periphery’?

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Why has the crisis in the Eurozone escalated that much?

Pronounced developments of external imbalances within the Euro-zone, driven by financial market integration and – mostly – fast private sector debt accumulation

Policy-mechanisms to deal with these imbalances non-existent or in-effective: financial markets insufficiently (and nationally) regulated; real exchange rates diverge persistently driven by capital inflows (interest rate convergence before the crisis); relative price adjustment very slow – hence rebalancing through incomes; no established crisis management mechanism at EU/Euro level (ECB mandate, no pooling of debt responsibility; no fiscal stabilisation function)

Banks very weak; no effective re-capitalisation; implicit liability of states – sovereign debt problem and feed-back processes; national segmentation of responsibility

Fiscal policies, deleveraging and weak banks generate stagnation; sustainability of debt of both private and public sectors judged (by markets) as unresolved

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Portugal

0

50

100

150

200

250

20002001200220032004200520062007200820092010

Spain

0

50

100

150

200

250

20002001200220032004200520062007200820092010

Public and private debt in % of GDP

Greece

020406080

100120140160

20002001200220032004200520062007200820092010

Ireland

0100200300400500600

20002001200220032004200520062007200820092010

Source: wiiw Annual Database incorporating Eurostat statistics.

Public debt Private debt Corporations Banks Households

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Romania

01020304050607080

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Croatia

020406080

100120140160

20002001200220032004200520062007200820092010

Public and private debt in % of GDP

Bulgaria

0

50

100

150

200

2000200120022003200420052006200720082009


Public debt Private debt Corporations Banks Households

Poland

01020304050607080

2000 2001 2002 2003 2004 20052006 2007 2008 2009 2010

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Where are we at the moment? Is there a policy master-plan?

Exclusive focus on fiscal consolidation: Germany sees this as a pre-condition for any move towards joint action/mutualisation on the debt problem and widening ECB’s mandate – focus to bring long-term public debt ratios down (constitutional amendments; tightening of fiscal control)

Recapitalisation of banks asked for, but happens through shrinkage of balance sheets – credit crunch

Some moves towards EU-wide regulatory and supervisory bodies; but lacking teeth so far; in the short-run more national segmentation of banking

Measures to monitor development of competitiveness in the future; details to be worked out; unlikely to be very effective

No growth strategy, except lip-service to change revenue and expenditure structures in ‘growth enhancing’ manner; plus liberalisation

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Is the Euro-zone going to pull through? In which shape?

Economic issues:

- recession(s) 2012/13; then medium-term stagnation/low growth

- unfolding of fiscal consolidation; widening of ECB activity – important transitory role; slow build-up of EFSF/ESM (role vis-a-vis banking system and sovereign debt); Greek default – contagion effects – ‘ring-fencing’; access to capital markets will remain/become very problematic for a range of countries (IT,SP,PO,GR,HU, Ro,...)

Political issues:

- How are polities going to react? espec. in high austerity countries

- Technocratic handling of the crisis; reaction against MerkMontozy; tensions in and towards inter-governmental processes; reactions in national parliaments/polities; field for populist/nationalist parties; little debate on alternative strategies

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What is the predicament of Europe’s ‘periphery’? In many countries (Southern and Eastern periphery) high debt levels of private

sectors (corporate and household sectors) – deleveraging processes; public sector debt has significantly increased

Foreign banks in retrenchment – credit constraints severe; cross-border banking goes through a process of re-nationalisation

Current accounts adjust strongly – mechanisms different in fix- and flex-exchange rate countries; big differences across countries in underlying strength of export sector; in a range of economies strong legacy of distorted tradable/non-tradable sector structures

The strong slowing down/contraction of German, Italian etc. growth affects peripheral region strongly

FDI and inward capital flows sharply down – ‘catching-up model’ (‘downhill capital flows’) will have to be significantly rethought (stronger focus on industrial policy; emphasis on tradable sector; less reliance on fixed exch. regimes; EMU?)

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Composition of the current account of the balance of payments, 1995-2009

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

Goods&Services Income Transfers Current account

LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 SEE-2 B-3 WB-6 TR

Note: ASIA-6 excl. Taiwan.Source: IMF International Financial Statistics and IMF WEO October 2010.

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Net private financial flows in % of GDP, 1993-2009

Source: IMF Balance of Payments Statistics. ASIA-6 excl. Taiwan.


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Is the Eurozone/the EU likely to disintegrate?

Analytical approaches to this question: Bolton/Roland; Alesina et al; Rodrik

- heterogeneity issues; impact of international liberalisation; importance of EU wide public goods (and scale effects in their supply); problems with transfer Union; role of mobility

2008-2012 crisis is an historical threshold event for the EU:

- weakness of the institutional/policy set-up has become very apparent

- a large number of institutional reforms are emerging: fiscal policy frameworks (‘fiscal compact’; six-pack); EU wide regulation and supervision; increased tax base of EU?; evolution of crisis and risk management (EFSF/ESM; Bank Risk Fund?; sovereign default procedures); widening of ECB mandate also de jure?

Political commitment of European elites (is it changing?); popular resentment towards crisis management/technocratic/legitimacy issues

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‘... As it is, men have devised ways to impoverish themselves and one another; and prefer collective animosities to individual happiness.’

J.M. Keynes: The Economic Consequences of the Peace, 1920

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Economic Integration and Emerging Economies: Main lines of the argument

International financial markets integration can strongly accentuate the possibility of external and internal imbalances

Exchange rate regimes are very important in this context

Catching-up processes can be seriously derailed due to the build-up of imbalances

Impact on distorting economic structures (domestic savings behaviour, capital allocations across tradable/non-tradable sectors, asset prices, competitiveness, etc.)

The setting for catching-up economies in (EU)rope is special: affects not only EU members but also economies in the neighbourhood (e.g. Balkans)

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Comparing emerging market economies (EMEs)

European EMEs:CE-5; B-SEE (B-3, SEE-2; WB-6); EU-COH; Turkey

Non-European EMEs: ASIA-6 (w/o China, India); LATAM-8; MENA-6 (non-oil)

Focus areas: specific characteristics of European integration; European vs. global capital market integration; evolution of disequilibria; policy environment and policy choices

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Comparing emerging market economies (EMEs) CE-5: Czech Republic, Hungary, Poland, Slovakia, Slovenia B-3: Estonia, Latvia, Lithuania SEE-2: Bulgaria, Romania WB-6: Albania, Bosnia and Herzegovina, Croatia,

Former Yugoslav Republic of Macedonia, Montenegro, Serbia B-SEE: B-3 + SEE-2 + WB-6 EU-COH: Greece, Portugal, Spain, Ireland Turkey

ASIA-6: Indonesia, Korea, Malaysia, Philippines, Taiwan, Thailand LATAM-8: Argentina, Brazil, Chile, Columbia, Ecuador, Mexico, Peru,

Uruguay MENA-6: Egypt, Jordan, Lebanon, Morocco, Syria, Tunisia

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Capital market integration and emerging economies

The question of ‘downhill’ vs. ‘uphill’ capital flows in the global economy (see e.g. Prasad/Rajan/Subramanian, 2006; Gourinchas/Jeanne, 2009; Abiad/Leigh/Mody, 2009)

The issue of financial and monetary integration and catching-up economies (‘threshold’ effects, ‘institutional anchoring’)

The nature of external disequilibria and the composition of capital (in)flows; role of exchange rate regimes

Which disequilibria are ‘sustainable’ and under which external circumstances?

The available spaces for policy choices

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The European integration model of catching-up

targeted at integration with the EU/Euro area associated with very far-reaching internal and external

liberalization (trade, capital transactions, financial market integration, labour mobility)

benefits: ‘downhill’ capital inflows, trade integration, ‘technology’ transfer; institutional convergence

the model worked - ‘convergence process’ – but emergence of severe structural imbalances in important groups of European EMEs; heterogeneity of pre- and post-crisis experience of European EMEs

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Growth - GDP at constant pricesAverage annual growth rates, 1995-2010, in %

Source: IMF World Economic Outlook, October 2010. EBRD and wiiw Annual Database incorporating national statistics, Eurostat..

av. 1995-2002 av. 2002-2008 av. 2008-2010 -6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0


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Quarterly GDP developments3rd quarter 2008 = 100

2005

Q1

2005

Q2

2005

Q3

2005

Q4

2006

Q1

2006

Q2

2006

Q3

2006

Q4

2007

Q1

2007

Q2

2007

Q3

2007

Q4

2008

Q1

2008

Q2

2008

Q3

2008

Q4

2009

Q1

2009

Q2

2009

Q3

2009

Q4

2010

Q1

2010

Q2

2010

Q3

2010

Q4

80.0

85.0

90.0

95.0

100.0

105.0

110.0

LATAM-8 ASIA-6 EU-15 EU-COH CE-5 SEE-2 + HR B3

MENA-6

MENA-6

Source: Eurostat, wiiw calculations.

B-3

SEE-2 + HR

EU-COHCE-5

LATAM-8ASIA-6

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Differentiating features of EMEs

Degree of openness: - trade integration; financial market integration

Private sector borrowing and debt External disequilibria: current accounts, composition of capital

flows; real exchange rate developments Sectoral ‘distortions’ (tradable/non-tradable sectors); FDI

allocation Fiscal policy during the crisis; public debt development Recovery from the crisis: level and trend effects

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Openness indicators: trade and financial integration, 2007in % of GDP

Exports plus Imports0.0

50.0

100.0

150.0

Note: Assets and liabilities: EU-COH: 618.1%; ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon.

Source: IMF International Financial Statistics.

Assets and liablities 0.0

50.0

100.0

150.0

200.0

250.0

300.0

0.0

50.0

100.0

150.0

200.0

250.0

300.0

Exports plus Imports Assets and liablities


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Financial integration - Changes in: (i) assets plus liabilities; (ii) credit to private sector in % of GDP (percentage point change), 2001-2007

Note: Assets and liabilities: EU-COH: 265.82%; WB-6: 212.14%. Source: IMF International Financial Statistics. ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon.

Assets and liabilities -50.0

0.0

50.0

100.0

150.0

200.0

Credit to private sector-10.0

0.0

10.0

20.0

30.0

40.0

50.0

60.0

0.0

50.0

100.0

150.0

200.0

250.0

300.0

Exports plus Imports Assets and liablities


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Foreign bank ownership, 1998-2005(assets owned by foreign banks as % of banking system assets)

Note: ASIA-6 excl. Taiwan, MENA-6 excl. Syria.Source: from Claessens et al (2008).

0.010.020.030.040.050.060.070.080.090.0

1999 2000 2001 2002 2003 2004 2005

LATAM-8 ASIA-6 MENA-6 CE-5 SEE-2 B-3 WB-6 TR

B-3

SEE-2

WB-6CE-2

LATAM-8

MENA-6Turkey

ASIA-6

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Industrial Production - Index 1993=100, 2000, 2008

LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 B-SEE TR0.0

50.0

100.0

150.0

200.0

250.0

1993 2000 2008

Note: ASIA-6 excl. Taiwan. B-SEE excl. Bosnia and Herzegovina, Montenegro and Serbia.Source: World Bank.

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Change in openness to trade, 1995-2008in % of GDP (percentage point change)

Source: IMF International Financial Statistics.

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Summarizing some of the features of European EMEs compared to other EMEs

High growth prior to the crisis High indicators for openness: trade and particularly strong

growth in international financial integration Much greater role of foreign banks in European EMEs compared

to other EMEs Fast growth of credit to private sector in many European EMEs Differences in industrial production growth and the build-up of

export capacity in different EMEs Next: the build-up of significant disequilibria before the crisis

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Composition of the current account of the balance of payments, 1995-2009

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

Goods&Services Income Transfers Current account


Note: ASIA-6 excl. Taiwan.Source: IMF International Financial Statistics and IMF WEO October 2010.

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Net private financial flows in % of GDP, 1993-2009

Source: IMF Balance of Payments Statistics. ASIA-6 excl. Taiwan.


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Real exchange rate developments, 1995 to 2010

20

30

40

50

60

70

20 30 40 50 60 70

Rel

ativ

e pr

ice

leve

l (pe

rcen

t)

CE-5BB-5WB-5ASIA-7LATAM-9

1995

1997

1995

1995

1995

2010

2010

2010

2010

2010

Relative GDP per capita at PPP (percentage points)

Appreciation hand-in-hand with catching-up in Central Europe

Misalignment in the Baltics/Balkans

Stable real X-rate in Asia post crisis

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Differences in the composition of FDI

35

Large part in manufacturing, infrastructure, trade in central Europe

Large part in real estate, finance in Baltic region

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CZE

HUN

POL

SVK

SVN

BGR

ROU

EST

LVA

LTU

ALB

BIH

HRVMKD

MNE

SRB

TUR

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

-60.0 -40.0 -20.0 0.0 20.0 40.0 60.0 80.0

ARGBRA

CHL

COL

ECUMEX

PERURY

IDN KOR

MYS

PHL

TWN

THAEGY

JORLBN

MAR

SYRTUN

GRC

IRL

PRT ESP

Relationship between pre-crisis credit growth and current account balances

Source: IMF World Economic Outlook.

aver

age

CA

/GD

P 20

04-2

007

Change in credit/GDP 2004-2007

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Real lending NB/ECB interest rates, 2003-2010 CPI-deflated, in % p.a.

2003M01

2003M02

2003M03

2003M04

2003M05

2003M06

2003M07

2003M08

2003M09

2003M10

2003M11

2003M12

2004M01

2004M02

2004M03

2004M04

2004M05

2004M06

2004M07

2004M08

2004M09

2004M10

2004M11

2004M12

2005M01

2005M02

2005M03

2005M04

2005M05

2005M06

2005M07

2005M08

2005M09

2005M10

2005M11

2005M12

2006M01

2006M02

2006M03

2006M04

2006M05

2006M06

2006M07

2006M08

2006M09

2006M10

2006M11

2006M12

2007M01

2007M02

2007M03

2007M04

2007M05

2007M06

2007M07

2007M08

2007M09

2007M10

2007M11

2007M12

2008M01

2008M02

2008M03

2008M04

2008M05

2008M06

2008M07

2008M08

2008M09

2008M10

2008M11

2008M12

2009M01

2009M02

2009M03

2009M04

2009M05

2009M06

2009M07

2009M08

2009M09

2009M10

2009M11

2009M12

2010M01

2010M02

2010M03

2010M04

2010M05

2010M06

2010M07

2010M08

2010M09

2010M10

2010M11

2010M12

2011M01

-10.0

-5.0

0.0

5.0

10.0

15.0

LATAM-8 ASIA-6 EU-COH CE-5 SEE-2 B-3 WB-6

Source: IMF International Financial Statistics. ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon.

B-3

SEE-2EU-COH

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Debt in % of GDP

Gross external debt Public debt Private debt

Bulgaria

020406080

100120140160180

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Romania

0102030405060708090

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Slovenia

020406080

100120140

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Croatia

020406080

100120140160

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010


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Debt in % of GDP


Greece

0

50

100

150

200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Ireland

0

200

400

600

800

1000

1200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Portugal

0

50

100

150

200

250

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Spain

0

50

100

150

200

250

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010


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Debt in % of GDP


Czech Republic

0102030405060708090

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Slovakia

01020304050607080

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Hungary

020406080

100120140160180

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Croatia

020406080

100120140

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010


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CESEE: GDP growth was well above the interest rate before the crisis

Nominal interest rate on government debt and nominal GDP growth (%), 2000-2010

Note: Interest rate = government interest expenditures / previous year gross debt.

-5.0

0.0

5.0

10.0

15.0

20.0

2000

2002

2004

2006

2008

2010

Nominal GDP growthNominal interest rate

CESEE

-5.0

0.0

5.0

10.0

15.0

20.0

2000

2002

2004

2006

2008

2010

Nominal GDP growthNominal interest rate

OECD (non-CESEE)

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General government balance and gross debt (% GDP), 2000-2010

0.010.0

20.030.0

40.050.0

60.070.0

80.0

2000

2002

2004

2006

2008

2010CESEEOECD (non-CESEE)

Debt

-6.0-5.0

-4.0-3.0-2.0

-1.00.0

1.02.0

2000

2002

2004

2006

2008

2010

CESEEOECD (non-CESEE)

Balance

CESEE: low debt (on average), even after the crisis

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External debt: public and private (% of GDP), 2008

Note: ASIA-4 excl. PH, TW. MENA-4 excl. LB, SY. B-3 excl. FYROM, BA, RS.

Source: World Bank, World Databank.

LATAM-8

ASIA-4

MENA-

4

CE-5

SEE-2

B-3 WB-3

0

20

40

60

80

100

120

Intercompany lending Other Sectors Banks Monetary AuthoritiesGeneral Government

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External debt: public and private (% of GDP), 2008

Note: ASIA-4 excl. PH, TW. MENA-4 excl. LB, SY. B-3 excl. FYROM, BA, RS.

Source: World Bank, World Databank.

LATAM-8

ASIA-4

MENA-4

EU-

COH

CE-5

SEE-2

B-3 WB-3

0

50

100

150

200

250

Intercompany lending Other Sectors Banks Monetary AuthoritiesGeneral Government

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Structural features: European and other EMEs

LATAM-8 ASIA-6 MENA-6 CE-5 EU-COH B-SEE

Credit/GDP, change from 2004 to 2008 (percentage points) 15.85 -8.97 7.02 6.68 56.88 39.21

Real interest rate average, 2005-2007 4.33 3.17 -0.09 1.10 -3.10 -0.26

Current account balance/GDP, 2007 (%) 0.14 3.35 -1.42 -4.88 -10.09 -15.21

Gross external debt, 2009 (% of GDP) 20.8 34.8 20.9 62.7 229.6 80.4

GDP growth, 2008-2010 3.82 3.47 5.38 0.50 -1.67 -1.55

Source: wiiw calculations.

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Summarizing the build-up to the crisis – differentiated patterns in the EMEs

Different developments amongst European EMEs EU-Coh, CE-5, B-SEE and compared to other EMEs

Current account developments; real exchange rate appreciation Composition of net capital inflows (credits, portfolio, FDI) Credit growth to the private sector; low (partly negative) real

interest rates Public debt situation not that different between European EMEs

and other EMEs Clear link between private credit growth and current account

deterioration; and hence foreign debt positions

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The impact of the crisis and patterns of recovery

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52

CZE

HUN

POL

SVK

SVN

BGR

ROU

EST

LVA

LTU

ALB

BIH

HRV

MKD

MNE

SRBTUR

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

-60.0 -40.0 -20.0 0.0 20.0 40.0 60.0 80.0

ARG BRA

CHLCOLECU

MEX

PERURY

IDN KORMYSPHL

TWNTHA

EGYJOR

LBN

MARSYR

TUN

GRC

IRLPRT

ESP

Pre-crisis credit growth and GDP growth in 2009


GD

P gr

owth

in 2

009


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CZE

HUN

POLSVK

SVNBGR

ROU

EST

LVA

LTU

ALB

BIH

HRV

MKD

MNE

SRB

TUR

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

-60.0 -40.0 -20.0 0.0 20.0 40.0 60.0 80.0

Pre-crisis credit growth and GDP growth in 2010


GD

P gr

owth

in 2

010


ARG BRA

CHLCOL

ECU

MEX

PERURY

IDN KORMYSPHL

TWN

THA

EGY

JOR

LBN

MAR

SYR

TUN

GRC

IRL

PRT

ESP

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Structural features: the role of exchange rate regimes ‘Fixers’ and ‘floaters’ amongst the CESEEs

CESEE float CESEE fix

Credit/GDP, change from 2004 to 2008 (percentage points) 20.5 32.8

Real interest rate average, 2005-2007 1.6 -1.6

Current account balance/GDP, 2007 (%) -6.6 -11.8

Gross external debt, 2009 (% of GDP) 78.8 95.6

GDP-growth, 2008-2010 1.18 -1.78

FDI to finance and real estate sectors, 2007 (per cent of total FDI stock) 26.5 40.2

Change in unemployment rate from 2007 to 2010 (percentage points) 1.5 3.9

Source: wiiw calculations.

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Fiscal policy reaction: huge adjustment in CESEE

Average annual changes in total general government expenditures, 2008-2010

Note: Nominal from data in EUR.Source: IMF World Economic Outlook, wiiw Database and Eurostat.

Nominal per cent change Real per cent change2008 2009 2010 2008 2009 2010

CE-5 3.7 1.4 4.1 10.3 -9.0 9.4B-3 20.5 -4.4 1.4 6.5 -7.9 0.2SEE-2 27.7 2.9 4.0 7.1 -12.0 -1.7WB-6 16.8 4.5 6.0 4.7 -5.8 -2.2

EU-15 6.3 5.4 1.8 2.8 4.8 0.6

ASIA-6 14.2 6.9 4.7 7.3 5.3 1.4

LATAM-8 20.8 13.0 10.1 12.7 8.0 5.2

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GDP development, 2005-20122008=100

2005 2006 2007 2008 2009 2010 2011 201280.085.090.095.0

100.0105.0110.0115.0120.0

LATAM-8 ASIA-6 EU-COH CE-5 SEE-2 B-3 WB-6 TR

Source: wiiw forecast and IMF World Economic Outlook, October 2010.

WB-6CE-5

SEE-2B-3

EU-COH

LATAM-8ASIA-6

TR

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Summarizing the crisis impact

Stronger impact of the crisis on European EMEs than on other EMEs (level and – medium-term – trend effect)

Countries with high current account deficits and high credit growth prior to the crisis have stronger downturn

Significant differences between ‘fixers’ and ‘floaters’ amongst European EMEs

Substantial pro-cyclical contraction of real government spending in European EMEs during the downturn

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Summary: Specific features of European EMEs

Opening of the capital account: a rule of the game in the EU; deep financial integration

Reliance on massive imports of capital; only 4 CESEE-countries could avoid skyrocketing external (private) debt

Bank credit: the overwhelming source of external funding

Financial integration: major channel for transmitting shocks (EU-Coh, B-SEE regions hit hardest by the crisis)

In general no meltdown of financial systems in CESEE (advantage of the presence of foreign banks? Implies also less socialization of private debt in CESEE – i.e. lower public debt effects); difference to EU-Coh in which there was massive nationalisation of private sector debt

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The outlook on recovery after the crisis

Which pattern of recovery after the crisis? European EMEs show level and trend effect of crisis impact

Fiscal policy: less room for manoeuvre because of reduced growth expectations and higher interest rates; in EU-Coh socialisation of private debt; full blown sovereign debt crisis

Household deleveraging process and fragile banks (lasting credit constraint); some countries banking system on the brink

Capital flows to European vs. non-European EMEs: pattern reversed from before the crisis; depending on built-up debt positions and (revised) growth expectations

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Policy space in different environments: Specific policy environment for European EMEs:

- no capital controls

- highly integrated financial markets; Euro-zone members or Eur anchorage

- compliance with Single Market regulations

- Maastricht criteria and Growth and Stability Pact (GSP) set fiscal criteria

Advantages of this policy environment:

- institutional and policy anchorage for trade and production networks and for fast growth of financial intermediation

- fast institutional and behavioural convergence

Disadvantages:

- De facto no independent monetary policy; use of exchange rate as policy instrument severely restricted; prone to credit/asset bubbles

- use of industrial policy restricted; other supply side policies (education/training, labour mobility, R&D, regional) encouraged

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Principal policy lessons:

In national and EU policy frameworks: neglect of private sector debt build-up relative to public sector

Financial market regulation severely underdeveloped; but very high degree of financial market integration; specific issue in CESEE region: high level of cross-border banking

Fixed exchange rate regimes bear high risks; but what are the options of highly euroized EU members and candidates?

Scope for counter-cyclical fiscal policy was used much less in European CE-EMEs during crisis; post-crisis: task to restructure public finance in growth-enhancing manner

Current situation characterised by very fragile banking system; protracted deleveraging processes; severe drag on recovery

Documents

Can the Euro Hold? Michael A Landesmann