Àäìèí
04.01.2011, 14:26
Fixing Europe's single currency
Making the euro area work requires reforms in all its countries, including those with stronger public finances and current-account surpluses
Sep 23rd 2010
http://media.economist.com/images/images-magazine/2010/09/25/bb/20100925_bbd001.jpg
HISTORIANS may look back on 2010 as the year when time sped up in continental Europe. A region that has been habitually slow to tackle its economic problems and that puts greater emphasis on reaching “consensus” than on reform has packed a decade’s worth of change into a few short months.
First Greece, the euro zone’s most fiscally incontinent country, was spared from default by a ?110 billion ($145 billion) bail-out, mainly from other euro-zone countries, partly from the IMF. As the sovereign-debt crisis threatened Ireland, Portugal, Spain and perhaps others, a ?440 billion fund, the European Financial Stability Facility (EFSF), was conjured up in a weekend (with promises of ?250 billion more from the IMF) as a backstop for countries should they be shut out of bond markets. The three big ratings agencies gave the EFSF a AAA grade on September 20th.
The European Central Bank (ECB) has since spent more than ?60 billion buying the government bonds of troubled euro-area countries to help put a cap on yields and keep markets in these bonds functioning. Countries from troubled Portugal to well-off Germany have set out plans for cutting their budget deficits. Spain has embarked on reforms to free its notoriously rigid jobs market that would have seemed unthinkable a year earlier.
These efforts have staved off the sense of emergency, but the euro zone’s underlying problems are not easily fixed. Investors are again demanding much higher interest rates for holding the debt of the most troubled sovereign borrowers than for German Bunds (see chart 1). Growing awareness of the likely cost of Ireland’s bank rescues is adding to market nerves. Ireland had hoped to limit its budget deficit to around 12% of GDP this year. But the European Union’s statisticians are likely to insist that an injection of capital into state-owned Anglo-Irish Bank should be included in the budget figures. That will increase the ratio to around 20%, maybe more.
http://media.economist.com/images/images-magazine/2010/09/25/bb/20100925_bbc331.gif
Then there are concerns about the unevenness of economic recovery in the currency block. Its GDP grew more than twice as fast as America’s in the second quarter, but that was mostly because of Germany’s best figures since reunification. Austria and the Netherlands, closely tied to the German export machine, also grew strongly. But in Spain and Portugal growth was feeble and GDP in Greece fell sharply. Because central banks elsewhere are more committed to keeping monetary policy lax (or are intervening directly in foreign-exchange markets), the euro has strengthened against the world’s other main currencies, making it harder for the region’s exporters to compete (see article (http://www.economist.com/node/17093549)).
Against this background, Eurocrats are about to set out detailed plans to fix the euro. On September 29th the European Commission will make recommendations for legislation on the “economic governance” of the euro area. These will inform a subsequent report from a task force led by Herman Van Rompuy, the president of the European Council. Both are likely to concentrate on new strictures to limit government deficits and debts, and to say rather less about tackling the region’s growing imbalances. A focus on fiscal discipline seems appropriate given the panic over sovereign debt. But without additional measures to revive the sluggish economies on the periphery of the euro zone, investors will continue to fret about these countries’ growing debt burdens—and about the euro itself.
One money, several problems
Why should euro-zone countries agree on fiscal rules, or worry if fellow members’ economies are too rigid to foster much growth? After all, it was fear of the bond markets, not strictures from Brussels, that spurred Ireland to slash its budget, Spain to cut civil-service pay and Portugal to raise taxes. “Ministers now look anxiously at their country’s bond-market spread against Germany just as their predecessors used to monitor their currency’s exchange rate against the D-mark,” says Jean Pisani-Ferry of Bruegel, a Brussels think-tank.
The answer is that bond-market vigilantes have not always been this vigilant. They have woken up to the varying risk of sovereign default across the euro zone. But had they stirred sooner, Greece might not have got into such a pickle. And they might one day go back to sleep.
When the euro was being designed, its creators decided, in effect, not to rely on market discipline alone. They assumed that without rules fiscal laxity by one member would impose costs on all. One concern was that deficits would boost spending and so put upward pressure on inflation, and thus on the zone’s interest rates. Another, chiefly German, worry was that unchecked deficits would build pressure on the ECB to monetise public debts. A related German nightmare, that countries with sound finances would be forced to bail out the profligate, came true.
The architects of the euro at least predicted such problems, even if they could not solve them. The “stability and growth pact” was supposed to limit each country’s budget deficit to 3% of gdp and public debt to 60% of GDP. It failed, in part because France and Germany refused to abide by it—and even rewrote the rules when they breached the deficit limit.
In contrast, the problems that arose because different economies responded differently to the zone’s common monetary policy were underestimated. The sudden drop in real interest rates on joining the euro in Greece, Ireland and Spain fuelled huge spending booms. (Portugal had enjoyed its growth spurt in the late 1990s in anticipation of euro membership.) Rampant domestic demand pushed up unit-wage costs relative to those in the rest of the euro area, notably in Germany, hurting export competitiveness (see chart 2) and producing big current-account deficits.
http://media.economist.com/images/images-magazine/2010/09/25/bb/20100925_bbc307.gif
The euro allowed these internal imbalances to grow unchecked and now stands in the way of a speedy adjustment, because euro-area countries whose wages are out of whack with their peers’ cannot devalue. For critics of the euro this only points up how far the zone is from being an “optimal currency area”. America’s regional economies may often diverge: a drop in oil prices might prompt a consumer boom in California while leaving Texas depressed. But wages and prices are far more flexible in America and workers have generally been more inclined to move from state to state to find work. By contrast, say the sceptics, the economies of the euro area are too diverse to live with the same money and too inflexible to adjust to imbalances when they arise.
That is too pessimistic. The euro’s weaknesses can, with difficulty, be addressed and measures can be put in place that should at least mitigate the build-up of similar problems in future. The zone’s woes are not unique. Few single countries would meet the academic criteria for optimal currency areas. America has its share of depressed spots—and since almost a quarter of those with mortgages owe more than their houses are worth, America’s workers are less mobile than they were. Nor is the euro wholly to blame for the credit booms in parts of the zone. Low interest rates and an underpricing of risk were widespread: credit boomed in many countries—America, Britain, Iceland—with floating exchange rates.
The fiscal fix is in
New rules to encourage fiscal discipline should help the euro area. They will reassure the bond-market vigilantes—and should come in handy if the vigilantes drop off again. Now would be a good time for national governments to adopt home-grown fiscal rules, as Germany already has. And as euro members are to underwrite each other’s debts through the EFSF, it is natural that they should demand more say in each other’s budgets. European reviews of national budgets for the coming years have already been brought forward by six months. Firmer sanctions, such as withholding of EU funds or suspending members’ voting rights in the euro group, may be considered, but they would be politically fraught.
If the collective is the ultimate paymaster, should more fiscal power be held centrally, as euro-federalists hope? The vast bulk of taxation and public spending is carried out by individual euro-area countries, and the EU’s budget is a tiny 1% of GDP. In America, the federal government collects around two-thirds of all taxes.
In theory, there are good arguments for greater centralisation. It is cheaper and more efficient to raise taxes centrally. And it is also cheaper to borrow that way: no American state on its own could rival the liquidity in the market for Treasuries. A big central budget means that borrowing risks are pooled, too, rather than falling on small, troubled countries such as Greece.
But there are also good arguments against. A country with high unemployment, say, would have less incentive to make its labour market more supple if jobless benefits were financed federally. Anyway, European countries are nowhere near ready to cede so much fiscal autonomy.
Euro-zone countries could try to build their own version of the Treasury market through a common bond issue. Analysts at Bruegel have proposed such a scheme, which might also be used to impose fiscal discipline. Countries would be allowed to issue jointly guaranteed (“blue”) bonds but only up to a limit of 60% of their GDP. Additional “red” bonds would be backed only by the standing of the sovereign issuer. Blue bonds would be senior to red ones, which would be subject to an “orderly” restructuring in default.
Such a scheme would be tricky to implement swiftly. Most euro-zone countries’ debts are way above the 60% limit and rising each year (see chart 3). So withdrawing the implicit guarantee on the rest of their bonds would be likely to cause tremors in financial markets. In its favour, the Bruegel idea may be a way to set long-term limits on each country’s debt levels. The requirement to meet the terms of a blue bond issue is likely to be a more powerful disciplinary device than penalties from Brussels for missing a fiscal target.
http://media.economist.com/images/images-magazine/2010/09/25/bb/20100925_bbc309.gif
At the height of the sovereign-debt crisis in May, bond markets penalised euro-zone countries, like Greece, whose large budget deficits were adding to an already high stock of public debt. Now investors may have started to worry more about prospects for GDP growth. Sluggish economies cannot sustain a heavy debt burden for ever, and for many countries improving export competitiveness is a harder task than repairing their budgets.
Broadly, there are three ways for a country to restore competitiveness: devaluation (which reduces wages relative to those in other exporting countries), wage cuts or higher productivity. In the euro area, the first option is out. The other two rely on easing job-market rules so that pay matches workers’ efficiency more closely, and workers can move freely from dying industries and firms to growing ones. Governments also have to tackle the lack of competition in markets for goods and services, notably in non-tradables (eg, utilities), whose prices affect the costs of other firms, including exporters. A bigger push from Brussels to open services to greater cross-border competition might do far more good than more prescriptions about debts and deficits.
Adjustment by cutting wages is quite brutal, especially without the support of an expansionary fiscal policy. An alternative would be for competitive, trade-surplus countries, such as Germany and the Netherlands, to spend more: the combined deficits of the euro zone’s “periphery” are more or less offset by surpluses at the zone’s “core” (see chart 4). John Maynard Keynes believed that in a fixed exchange-rate system, the burden of adjustment to trade imbalances should fall equally on deficit and surplus countries. So he proposed that excess trade surpluses should be taxed (see article (http://www.economist.com/node/17093331)). A scheme such as this would not be easy to implement: it would be hard to gauge the point at which the saving surpluses of an ageing country like Germany become harmful. But such a proposal would at least put “creditor adjustment” on the agenda.
http://media.economist.com/images/images-magazine/2010/09/25/bb/20100925_bbc337.gif
It is possible to come up with other heretical answers to the euro area’s imbalances—for instance, tolerating a higher inflation rate, at least temporarily. Workers are usually reluctant to accept the pay cuts required to regain competitiveness. A higher inflation rate would make it easier for relative wages in different countries to adjust, because a cut in real wages would be easier to disguise with inflation of, say, 4% or 5% than the 2% that the ECB now aims for. But that may embed expectations of permanently higher inflation, which would have to be squeezed out later. And it would be anathema to the ECB, Germany and others. Even in this year of upheaval, it would be an upheaval too far.
An interactive guide to the EU's debt, jobs and growth worries (http://www.economist.com/blogs/freeexchange/2010/09/europes_economies)
Making the euro area work requires reforms in all its countries, including those with stronger public finances and current-account surpluses
Sep 23rd 2010
http://media.economist.com/images/images-magazine/2010/09/25/bb/20100925_bbd001.jpg
HISTORIANS may look back on 2010 as the year when time sped up in continental Europe. A region that has been habitually slow to tackle its economic problems and that puts greater emphasis on reaching “consensus” than on reform has packed a decade’s worth of change into a few short months.
First Greece, the euro zone’s most fiscally incontinent country, was spared from default by a ?110 billion ($145 billion) bail-out, mainly from other euro-zone countries, partly from the IMF. As the sovereign-debt crisis threatened Ireland, Portugal, Spain and perhaps others, a ?440 billion fund, the European Financial Stability Facility (EFSF), was conjured up in a weekend (with promises of ?250 billion more from the IMF) as a backstop for countries should they be shut out of bond markets. The three big ratings agencies gave the EFSF a AAA grade on September 20th.
The European Central Bank (ECB) has since spent more than ?60 billion buying the government bonds of troubled euro-area countries to help put a cap on yields and keep markets in these bonds functioning. Countries from troubled Portugal to well-off Germany have set out plans for cutting their budget deficits. Spain has embarked on reforms to free its notoriously rigid jobs market that would have seemed unthinkable a year earlier.
These efforts have staved off the sense of emergency, but the euro zone’s underlying problems are not easily fixed. Investors are again demanding much higher interest rates for holding the debt of the most troubled sovereign borrowers than for German Bunds (see chart 1). Growing awareness of the likely cost of Ireland’s bank rescues is adding to market nerves. Ireland had hoped to limit its budget deficit to around 12% of GDP this year. But the European Union’s statisticians are likely to insist that an injection of capital into state-owned Anglo-Irish Bank should be included in the budget figures. That will increase the ratio to around 20%, maybe more.
http://media.economist.com/images/images-magazine/2010/09/25/bb/20100925_bbc331.gif
Then there are concerns about the unevenness of economic recovery in the currency block. Its GDP grew more than twice as fast as America’s in the second quarter, but that was mostly because of Germany’s best figures since reunification. Austria and the Netherlands, closely tied to the German export machine, also grew strongly. But in Spain and Portugal growth was feeble and GDP in Greece fell sharply. Because central banks elsewhere are more committed to keeping monetary policy lax (or are intervening directly in foreign-exchange markets), the euro has strengthened against the world’s other main currencies, making it harder for the region’s exporters to compete (see article (http://www.economist.com/node/17093549)).
Against this background, Eurocrats are about to set out detailed plans to fix the euro. On September 29th the European Commission will make recommendations for legislation on the “economic governance” of the euro area. These will inform a subsequent report from a task force led by Herman Van Rompuy, the president of the European Council. Both are likely to concentrate on new strictures to limit government deficits and debts, and to say rather less about tackling the region’s growing imbalances. A focus on fiscal discipline seems appropriate given the panic over sovereign debt. But without additional measures to revive the sluggish economies on the periphery of the euro zone, investors will continue to fret about these countries’ growing debt burdens—and about the euro itself.
One money, several problems
Why should euro-zone countries agree on fiscal rules, or worry if fellow members’ economies are too rigid to foster much growth? After all, it was fear of the bond markets, not strictures from Brussels, that spurred Ireland to slash its budget, Spain to cut civil-service pay and Portugal to raise taxes. “Ministers now look anxiously at their country’s bond-market spread against Germany just as their predecessors used to monitor their currency’s exchange rate against the D-mark,” says Jean Pisani-Ferry of Bruegel, a Brussels think-tank.
The answer is that bond-market vigilantes have not always been this vigilant. They have woken up to the varying risk of sovereign default across the euro zone. But had they stirred sooner, Greece might not have got into such a pickle. And they might one day go back to sleep.
When the euro was being designed, its creators decided, in effect, not to rely on market discipline alone. They assumed that without rules fiscal laxity by one member would impose costs on all. One concern was that deficits would boost spending and so put upward pressure on inflation, and thus on the zone’s interest rates. Another, chiefly German, worry was that unchecked deficits would build pressure on the ECB to monetise public debts. A related German nightmare, that countries with sound finances would be forced to bail out the profligate, came true.
The architects of the euro at least predicted such problems, even if they could not solve them. The “stability and growth pact” was supposed to limit each country’s budget deficit to 3% of gdp and public debt to 60% of GDP. It failed, in part because France and Germany refused to abide by it—and even rewrote the rules when they breached the deficit limit.
In contrast, the problems that arose because different economies responded differently to the zone’s common monetary policy were underestimated. The sudden drop in real interest rates on joining the euro in Greece, Ireland and Spain fuelled huge spending booms. (Portugal had enjoyed its growth spurt in the late 1990s in anticipation of euro membership.) Rampant domestic demand pushed up unit-wage costs relative to those in the rest of the euro area, notably in Germany, hurting export competitiveness (see chart 2) and producing big current-account deficits.
http://media.economist.com/images/images-magazine/2010/09/25/bb/20100925_bbc307.gif
The euro allowed these internal imbalances to grow unchecked and now stands in the way of a speedy adjustment, because euro-area countries whose wages are out of whack with their peers’ cannot devalue. For critics of the euro this only points up how far the zone is from being an “optimal currency area”. America’s regional economies may often diverge: a drop in oil prices might prompt a consumer boom in California while leaving Texas depressed. But wages and prices are far more flexible in America and workers have generally been more inclined to move from state to state to find work. By contrast, say the sceptics, the economies of the euro area are too diverse to live with the same money and too inflexible to adjust to imbalances when they arise.
That is too pessimistic. The euro’s weaknesses can, with difficulty, be addressed and measures can be put in place that should at least mitigate the build-up of similar problems in future. The zone’s woes are not unique. Few single countries would meet the academic criteria for optimal currency areas. America has its share of depressed spots—and since almost a quarter of those with mortgages owe more than their houses are worth, America’s workers are less mobile than they were. Nor is the euro wholly to blame for the credit booms in parts of the zone. Low interest rates and an underpricing of risk were widespread: credit boomed in many countries—America, Britain, Iceland—with floating exchange rates.
The fiscal fix is in
New rules to encourage fiscal discipline should help the euro area. They will reassure the bond-market vigilantes—and should come in handy if the vigilantes drop off again. Now would be a good time for national governments to adopt home-grown fiscal rules, as Germany already has. And as euro members are to underwrite each other’s debts through the EFSF, it is natural that they should demand more say in each other’s budgets. European reviews of national budgets for the coming years have already been brought forward by six months. Firmer sanctions, such as withholding of EU funds or suspending members’ voting rights in the euro group, may be considered, but they would be politically fraught.
If the collective is the ultimate paymaster, should more fiscal power be held centrally, as euro-federalists hope? The vast bulk of taxation and public spending is carried out by individual euro-area countries, and the EU’s budget is a tiny 1% of GDP. In America, the federal government collects around two-thirds of all taxes.
In theory, there are good arguments for greater centralisation. It is cheaper and more efficient to raise taxes centrally. And it is also cheaper to borrow that way: no American state on its own could rival the liquidity in the market for Treasuries. A big central budget means that borrowing risks are pooled, too, rather than falling on small, troubled countries such as Greece.
But there are also good arguments against. A country with high unemployment, say, would have less incentive to make its labour market more supple if jobless benefits were financed federally. Anyway, European countries are nowhere near ready to cede so much fiscal autonomy.
Euro-zone countries could try to build their own version of the Treasury market through a common bond issue. Analysts at Bruegel have proposed such a scheme, which might also be used to impose fiscal discipline. Countries would be allowed to issue jointly guaranteed (“blue”) bonds but only up to a limit of 60% of their GDP. Additional “red” bonds would be backed only by the standing of the sovereign issuer. Blue bonds would be senior to red ones, which would be subject to an “orderly” restructuring in default.
Such a scheme would be tricky to implement swiftly. Most euro-zone countries’ debts are way above the 60% limit and rising each year (see chart 3). So withdrawing the implicit guarantee on the rest of their bonds would be likely to cause tremors in financial markets. In its favour, the Bruegel idea may be a way to set long-term limits on each country’s debt levels. The requirement to meet the terms of a blue bond issue is likely to be a more powerful disciplinary device than penalties from Brussels for missing a fiscal target.
http://media.economist.com/images/images-magazine/2010/09/25/bb/20100925_bbc309.gif
At the height of the sovereign-debt crisis in May, bond markets penalised euro-zone countries, like Greece, whose large budget deficits were adding to an already high stock of public debt. Now investors may have started to worry more about prospects for GDP growth. Sluggish economies cannot sustain a heavy debt burden for ever, and for many countries improving export competitiveness is a harder task than repairing their budgets.
Broadly, there are three ways for a country to restore competitiveness: devaluation (which reduces wages relative to those in other exporting countries), wage cuts or higher productivity. In the euro area, the first option is out. The other two rely on easing job-market rules so that pay matches workers’ efficiency more closely, and workers can move freely from dying industries and firms to growing ones. Governments also have to tackle the lack of competition in markets for goods and services, notably in non-tradables (eg, utilities), whose prices affect the costs of other firms, including exporters. A bigger push from Brussels to open services to greater cross-border competition might do far more good than more prescriptions about debts and deficits.
Adjustment by cutting wages is quite brutal, especially without the support of an expansionary fiscal policy. An alternative would be for competitive, trade-surplus countries, such as Germany and the Netherlands, to spend more: the combined deficits of the euro zone’s “periphery” are more or less offset by surpluses at the zone’s “core” (see chart 4). John Maynard Keynes believed that in a fixed exchange-rate system, the burden of adjustment to trade imbalances should fall equally on deficit and surplus countries. So he proposed that excess trade surpluses should be taxed (see article (http://www.economist.com/node/17093331)). A scheme such as this would not be easy to implement: it would be hard to gauge the point at which the saving surpluses of an ageing country like Germany become harmful. But such a proposal would at least put “creditor adjustment” on the agenda.
http://media.economist.com/images/images-magazine/2010/09/25/bb/20100925_bbc337.gif
It is possible to come up with other heretical answers to the euro area’s imbalances—for instance, tolerating a higher inflation rate, at least temporarily. Workers are usually reluctant to accept the pay cuts required to regain competitiveness. A higher inflation rate would make it easier for relative wages in different countries to adjust, because a cut in real wages would be easier to disguise with inflation of, say, 4% or 5% than the 2% that the ECB now aims for. But that may embed expectations of permanently higher inflation, which would have to be squeezed out later. And it would be anathema to the ECB, Germany and others. Even in this year of upheaval, it would be an upheaval too far.
An interactive guide to the EU's debt, jobs and growth worries (http://www.economist.com/blogs/freeexchange/2010/09/europes_economies)