What caused the great recession in the Eurozone? What could have avoided it?
Philippe Martin, Thomas Philippon 11 November 2014
Economists disagree over the origin of the Eurozone Crisis. This column uses a quantitative framework to sort through the various channels and policy impacts. It argues that fiscal and macroprudential policies are complements, not substitutes. Prudent fiscal policy is helpful but cannot by itself undo private leverage booms. Both prudent fiscal policies and macroprudential policies are required to stabilise the economy and make the Eurozone a viable monetary union.
There is a wide disagreement about the nature and cause of the Eurozone crisis. Some see it as driven by fiscal indiscipline, some emphasise excessive private leverage, while others focus on external imbalances, sudden stops, or competitiveness divergence due to fixed exchange rates, as these quotes illustrate:
Global crisis Macroeconomic policy
EZ crisis, Macroprudential policy, peripheral countries
Revisiting the pain in Spain
Paul De Grauwe 07 July 2014
There has been a stark contrast between the experiences of Spain and the UK since the Global Crisis. This column argues that although the ECB’s Outright Monetary Transactions policy has been instrumental in reducing Spanish government bond yields, it has not made the Spanish fiscal position sustainable. Although the UK has implemented less austerity than Spain since the start of the crisis, a large currency depreciation has helped to reduce its debt-to-GDP ratio
The different macroeconomic adjustment dynamics in Spain – a member of a monetary union – and the UK – a stand-alone country – is stark. Paul Krugman popularised this contrast in his New York Times blog with the title “The Pain in Spain” (Krugman 2009, 2011), and commented on my own analysis in De Grauwe (2011).
Europe's nations and regions Global crisis Macroeconomic policy
ECB, monetary policy, euro, EMU, Spain, monetary union, fiscal policy, UK, government debt, austerity, EZ crisis, Outright Monetary Transactions, currency depreciation
Lessons from history for the European Financial Crisis
Selin Sayek, Fatma Taskin 05 July 2014
The European Monetary Union is unprecedented, but the Eurozone Crisis is not. This column draws upon the experiences of previous banking crises, and compares the Eurozone Crisis countries. Like Japan before the 1992 crisis, Spain and Ireland had property bubbles fuelled by domestic credit. The Greek crisis is very distinct from crises in other Eurozone countries, so a one-size-fits-all policy would be inappropriate. The duration and severity of past crises suggest the road ahead will continue to be very rough.
As of July 2014, we continue to debate whether the European economy is out of the woods. The effectiveness of policies and the prospects of full recovery are under scrutiny. The unique nature of Europe’s monetary union begets further questions of whether policies should be designed to resolve a single euro crisis, or whether they should be designed to resolve multiple European crises occurring simultaneously. A discussion of whether the sui generis European project has led to a sui generis set of financial crises would provide a framework for these policy discussions.
Economic history Europe's nations and regions Global crisis
eurozone, financial crisis, EZ crisis, GIIPS
Orderly debt reduction rather than permanent mutualisation is the way to go
Vesa Vihriälä, Beatrice Weder di Mauro 02 April 2014
The EZ debt overhang needs to be fixed. This column argues that making market discipline credible requires an orderly debt restructuring mechanism combined with a strictly regulated temporary mutualisation scheme or a well-designed debt conversion scheme. This combination could reduce the current debt overhang in an orderly fashion and cement strong incentives against over-borrowing in the future.
High levels of public debt have been at the centre of the euro crisis. Perceived unsustainability of individual member states’ public debt resulted in high interest rates and the threat of exclusion from the bond market. This prompted emergency financial assistance, the establishment of institutions for assistance, and ultimately the Outright Monetary Transactions (OMT) promise by the ECB. The effective partial mutualisation of sovereign risk has been important in calming down market turbulence and allowing a modest recovery to take hold.
EU institutions International finance
EZ crisis, EZ debt restructuring mechanism, EZ debt crisis, debt mutualisation
The European crisis in the context of historical trilemmas
Michael Bordo, Harold James 19 October 2013
The Eurozone’s tangle of conflicting goals – a series of ‘trilemmas’ – is not without precedent. This column argues that it is reminiscent of the interwar situation. The interwar slump was so intractable not just due to financial issues, but also a crisis of democracy, of social stability, and of the international political system. The big difference in the EZ is that nations cannot go off the euro as they went off the gold standard. That is why the initial EZ crisis may not have been so acute as some of the gold standard sudden stops, but the recovery or bounce back is painfully slow and protracted.
The European financial crisis has often produced comparisons with the historical problems of the classical gold standard. Many of the key political figures who drove forward European monetary integration admired the discipline and certainty of the gold standard. Both Valéry Giscard d’Estaing and Helmut Schmidt shared this view. But recently, the comparison is more usually a negative or hostile one.
EZ crisis, trilemmas
Unemployment, labour-market flexibility and IMF advice: Moving beyond mantras
Olivier Blanchard, Florence Jaumotte, Prakash Loungani 18 October 2013
The state of labour markets in advanced economies remains dismal despite recent signs of growth. This column explains the IMF’s logic behind the advice it provided on labour markets during the Great Recession. It argues that flexibility is crucial both at the micro level, i.e. on worker reallocation, and at the macro level, e.g. on collective agreements. It suggests that the IMF approach is close to the consensus among labour-market researchers.
Growth in advanced economies is gaining some speed. The IMF projects these economies will grow 2% next year, up from an expected 1.2% this year. The average unemployment rate in advanced economies is expected to inch down from its peak of 8.3% in 2010 to 8% next year. This is progress, but it is clearly not enough. The state of labour markets remains dismal for a number of reasons.
Labour markets Welfare state and social Europe
unemployment, institutions, IMF, trust, Unemployment insurance, labour-market flexibility, EZ crisis, collective bargaining
The IMF and the legacy of the euro crisis
Susan Schadler 15 October 2013
The IMF loans to Greece, Ireland and Portugal are considered controversial by some analysts. This column argues that these loans – granted without having agreed on convincing paths to manageable debt levels – constituted a substantial departure from IMF principles. The situation is costly for Europe and, having now permanently changed the principles guiding large IMF loans, it will be costly for crises to come. A serious rethink of the management and decision-making structure of the IMF is needed.
The IMF will live with the legacy of its role in the European debt crisis for years — if not decades.
Global governance International finance
IMF, debt, EZ crisis
Cyprus: What are the alternatives?
Thorsten Beck 22 March 2013
Cypriot banks urgently need restructuring and downsizing, but a functioning financial system is necessary to handle Cyprus’s transformation to an economic model not based on an oversized banking sector. This column argues that splitting the Cypriot banking system into a bad ‘legacy’ part and a good forward-looking part seems the only feasible and effective solution to resolve the current crisis and restore trust. The Eurozone's resources would be most useful in this bank-resolution process.
The Cypriot banking system is insolvent; it needs a large capital injection. As in several other peripheral states of the Eurozone, Cyprus cannot resolve the crisis alone. Given an already high debt-to-GDP ratio and an oversized banking system, recapitalising the banks via sovereign debt would produce unsustainable sovereign-debt levels and, ultimately, sovereign default. In short, Cyprus’s banks are too big to fail, and too big to save.
EU institutions Macroeconomic policy
EZ crisis, Cyprus, European Recapitalisation Agency
Walking back from Cyprus
Mitu Gulati, Lee C. Buchheit 20 March 2013
Eurozone leaders’ radical step of putting insured depositors in Cypriot banks in harm’s way was not their only option. This column argues that none of the alternatives were pleasant but some were less ominous.
On Friday 15 March 2013, European leaders trespassed on consecrated ground. They insisted that Cyprus impose losses – euphemistically dubbed a 'solidarity levy' – on insured depositors with Cypriot banks as a condition to receiving EZ/IMF bailout assistance. Entering Friday’s meeting, the leaders had four options on the table:
bailout, Eurozone crisis, EZ crisis, Cyprus
Why the rush? Short-term crisis resolution and long-term bank stability
Thorsten Beck 16 October 2012
The Eurozone crisis has shown that the traditional approach of EU supervisory cooperation is not enough. This column argues the gaps in cross-border bank regulations have to be addressed on three levels: A short-term crisis resolution mechanism for the Eurozone, a functioning banking union, and stronger cooperation agreements across the EU and beyond. Critically, such reforms have to start from the resolution component.
The recent crisis has exposed a critical gap in financial safety nets across Europe and many other developed countries, i.e. a deficient if not absent bank resolution framework. This gap in the financial safety net has become even more critical in the case of cross-border banks. The crisis has shown that the traditional approach of home-host country supervisory cooperation in the form of Memorandums of Understanding and Colleges of Supervisors falls short in case of bank failures. Memorandums of Understanding are non-binding documents and have turned out to be very patient paper.
EU institutions Europe's nations and regions
banking stability, EZ crisis, EZ banking union