Overcoming the crisis by promoting stability and growth

Dr. Barbara Kauffmann Head of Unit

Coordination of country-specific policy surveillance European Commission, DG Economic and Financial Affairs

Alpbach Perspectives - European Forum Alpbach 2013 "The Financial Crisis as Litmus-Test:

The Union between Austerity and Growth"

Overview

1. Crisis development and underlying problems

2. The Response to the crisis

3. Current situation: adjustments & challenges

4. Fiscal consolidation – flexibility and limits

5. Conclusion

2

1. Crisis development and problems

Worldwide financial/economic crisis turned into a euro area sovereign debt crisis before long.

Factors underlying euro area debt crisis include:

• Insufficient budgetary consolidation/debt reduction in good times; failing market discipline.

• Accumulation of macro imbalances due to wage dynamics, excessive credit growth, lack of reforms.

• Excessive risk taking by financial sector; contagion.

Need to improve governance/crisis resolution.

4

Financial crisis Economic crisis Sovereign debt

crisis

Crisis of confidence – EA

cohesion

Perm

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sti

tuti

on

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fram

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eco

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ary leg

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Treati

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Measu

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et

in a

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c,

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rary,

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orks

European Semester

Six-Pack (SGP; MIP)

European Economic

Recovery Plan

ECB liquidity measures: SMP, LTRO

Greek Loan Facility

Bank Rescue

European Supervision

Single Superv.

Mechanism

EFSF

ECB: OMT

ESM

Temp. State Aid Framework

1. Banking

Union

2. Fiscal Union

3. Integrated Econ. Policy Framework

Compact for Growth and

Jobs

4. Political Union

Financial Sector Legislation

Bank Restr Resol D Cap. Requirem D/R

TSCG: Compact

Two-Pack (EA: fiscal;

surveillance)

2. The EU's crisis response in perspective

EFSM

5

Closer monitoring budget/EDP 1 • COM assesses all EA draft budg. plans

• Reporting ex ante debt issuance TSCG

• indep. institutions monitor nat. fiscal rules; indep. macro forecasts TSCG

• Ec. Partnership Agreements TSCG

• Closer monitoring of EDP; COM rec.

Macro Imbalances Procedure 1 • Prevention of macro imbalances:

alert mechanism, in depth reviews

• Correction: Excess. Imbal. Proced.

Sanctions if no / insufficient action 1

Stepped up Surveillance 1 • COM: enhanced surveillance if financial

problem or precautionary assistance

• Financial assistance programmes concentrate all monitoring; SGP applies

• Post-Programme Surveillance (≤75%)

Fiscal surveillance – SGP 2 • signif. deviation from MTO / path

• debt-reduction/expend. benchmarks

• opening EDP also based on debt

EA: earlier, graduated sanctions 1

Fiscal frameworks Directive 1

2. EU Response: Enhanced economic governance

Six pack Two pack (EA)

3. Current Situation: Continued rebalancing as deficit countries adjust

Current account balance, euro area

0.1

-0.1

0.5

1.2 1.2

2.1 2.1

2.6 2.7

2.1 2.0

2.4 2.4 2.6 2.6 2.6

0.2

-0.5-0.4

-0.5 -0.7-0.9

-1.6

-2.1-2.4

-2.8

-1.8 -1.9-1.7

-0.7

-0.1

0.1

-4

-3

-2

-1

0

1

2

3

4

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

% of GDP

Surplus

Deficit

EA

forecast

0

5

10

15

20

25

30

35

IE LV PT ES EL IT

Exports

pps. of GDP

2007-11 2011-14

Increase in share of exports in GDP, 2007-14

Source: Commission services 2013 spring forecast.

Note: Bars show cumulative increase of the contribution of

exports to GDP between 2007 and 2014.

Source: Commission services 2013 spring forecast.

3. Current situation: Growth gradually recovering, unemployment still rising

Real GDP growth, euro area Unemployment rate, selected Member States

0,0

5,0

10,0

15,0

20,0

25,0

30,0

19

99

Q1

19

99

Q4

20

00

Q3

20

01

Q2

20

02

Q1

20

02

Q4

20

03

Q3

20

04

Q2

20

05

Q1

20

05

Q4

20

06

Q3

20

07

Q2

20

08

Q1

20

08

Q4

20

09

Q3

20

10

Q2

20

11

Q1

20

11

Q4

20

12

Q3

Euro area (17 countries)

Ireland

Greece

Spain

Latvia

Portugal

average % of labour force

2,9

3,8

2,0

0,9 0,7

2,2 1,7

3,2 3,0

0,4

-4,4

2,0 1,5

-0,6 -0,4

1,2

-5,0

-4,0

-3,0

-2,0

-1,0

0,0

1,0

2,0

3,0

4,0

5,0

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

GDP growth (annual rate) Euro area (17countries)

Data: Eurostat. Data: Eurostat.

3. Current situation: Bond markets are stabilising but financial markets remain fragmented

0

4

8

12

16

09 10 11 12 13

DE IE ES

FR IT PT

%

Bond markets in selected Member States

0

0.5

1

1.5

2

2.5

3

06 07 08 09 10 11 12 13

ES IT

DE FR

* interest rate fixation period of up to 1 year

% (3-month moving average)

Interest rate spreads, small and large loans to non-financial corporations

Source: Commission services 2013 spring forecast. Source: Commission services 2013 spring forecast.

3. Current situation: deficit decreasing but fiscal risks & sustainability concerns are high

General government budget balance, euro area

General government debt, EU and euro area

9

50

55

60

65

70

75

80

85

90

95

100

07 08 09 10 11 12 13 14

% of GDP

EA

EU

Source: Commission services 2013 spring forecast.

Note: Forecast for 2014 based on no-policy-change assumption.

Source: Commission services 2013 spring forecast.

Note: Forecast for 2014 based on no-policy-change assumption.

4. Fiscal consolidation and its impact on growth and debt – the multiplier debate

The growth impact depends on the size of multipliers, which depend on country/situation:

higher in crises but lower than some suggest; it is not sure when/how much they drop, making postponement very risky

lower when sustainability concerns are high and the adjustment is credible.

Consolidation can therefore first raise debt but

- this is normally short-lived unless there is a high degree of financial market myopia,

- the counterfactual is worse (further rise in debt, market reactions, possible partial default, deeper recession).

10

DEBT REACTION: NORMAL FINANCIAL MARKETS BEHAVIOUR

11

Baseline: "counterfactual" SCP + adjustment from SCP

Self-defeating: Max 3 years, driven by multipliers & "persistence" (if financial mkt normal)

80

90

100

110

120

130

140

2012 2013 2014 2015 2016 2017 2018 2019

Baseline

Multiplier=1 until 2015

Multiplier=1.5 until 2015

Spain% GDP

100

110

120

130

140

2012 2013 2014 2015 2016 2017 2018 2019

Baseline

Multiplier=1 until 2015

Multiplier=1.5 until 2015

Italy% GDP

80

85

90

95

100

2012 2013 2014 2015 2016 2017 2018 2019

Baseline

Multiplier=1 until 2015

Multiplier=1.5 until 2015

France% GDP

115

125

135

145

155

2012 2013 2014 2015 2016 2017 2018 2019

Baseline

Multiplier=1 until 2015

Multiplier=1.5 until 2015

Portugal% GDP

4. Fiscal Consolidation: The flexibility of the SGP is used where appropriate

Focus on structural effort allows adjusting deadlines and targets when headline targets are missed due to -negative growth surprise or -revenue shortfalls although efforts have been made.

-

Due to crisis context longer correction periods than usual.

Recent revisions of Council recommendations:

- extended deadlines longer than the usual 1 year,

- reduced speed of consolidation where possible, but where high debt/sustainability considerable efforts still needed.

12

Overview of EDP Steps (2008-2016)

13

2008 2009 2010 2011 2012 2013 2014 2015 2016

Finland 1 Abrogation

Germany 1 1 1 Abrogation

Bulgaria 1 1 Abrogation

Malta 1 1 1-year ext. Abrogation New procedure

Hungary (from 2004) 1-year ext. 2 -year extension Step up + 1 Abrogation

Lithuania 1 1 1 1-year ext. Abrogation

Romania 1 1 1 1-year ext. Abrogation

Latvia 1 1 1 1 Abrogation

Italy 1 1 1 1 Abrogation

Belgium 1 1 1 1 Step up + 1

Denmark 1 1 1 1

Austria 1 1 1 1 1

Slovakia 1 1 1 1 1

Czech Republic 1 1 1 1 1

France 1 1 1 1 1-year ext. 2 -year extension

Netherlands 1 1 1 1 1 1-year ext.

Poland 1 1 1 1 2-year extension

United Kingdom 1 1 Step up + 4 1-year ext.

Ireland 1 1 1 1 1 1-year ext. 1-year ext.

Portugal 1 1 1 1 1 1-year ext. 1-year ext.

Slovenia 1 1 1 1 1 2-year extension

Spain 1 1 1 1 1-year ext. 1-year ext. 2-year extension

Greece 1 1 2-year extension 2-year extension 2-year extension

Cyprus 1 1 1 4-year extension

5. Conclusion: To ensure sustainability continued consolidation is needed …

Public and private imbalances accumulated before the crisis and public debt has been rising further with automatic stabilisers, stimulus measures, bank rescue, increasing spreads.

Despite signs of recovery, the medium-term growth outlook is moderate, sustainability risks are high, & interest burdens drive out productive expenditure.

Therefore credible consolidation needs to be continued with budget balances substantially below 3% of GDP, aiming at debt levels below 60% of GDP in the medium term.

5. ... accompanied by structural reforms to boost growth.

Structural reforms to ensure competitiveness, growth, employment and sustainability are needed guided by CSRs / MoUs (notably labour, product, and service markets; financial sector and business environment; social security systems; public administr.),

minimizing the impact of stabilisation and reforms (e.g. through progressivity in cutting public wages and pensions; targeting of welfare system, property tax, etc),

providing financial assistance and incentives (Structural Funds, EIB, Programme support).