Dr Marek Porzycki Chair for Economic Policy

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Presentation transcript:

Dr Marek Porzycki Chair for Economic Policy Monetary Law and Monetary Policy 11. Crisis in the euro area – overview Dr Marek Porzycki Chair for Economic Policy

Issues covered Underlying causes of the crisis From credit crunch to sovereign debt crisis Greece: insolvency of the state Ireland: oversized banking sector sunk by real estate bubble Spain: drawbacks of the common monetary policy Cyprus: a bailout gone foul Italy: „the elephant in the room” breakup of the euro area? Next presentation: Monetary response – ECB measures Fiscal response – bailouts and stability mechanisms Political response – the „fiscal compact” and quest for closer integration

Underlying causes of the crisis EMU as a political project to enhance European integration – was it justified from the OCA perspective? Fundamental weakness: monetary integration not backed by fiscal integration Inefficiency of the Stability and Growth Pact (1997) Impossiblity of „one-size-fits-all” monetary policy for „core” and „peripheral” Member States – credit booms and real estate bubbles Silent presumption of creditworthiness resulting from membership in the eurozone  similar interest rates on public debt of eurozone member states, regardless of soundness of their public finances

Direct trigger – global financial crisis of 2007/8 Subprime mortgage crisis and credit crunch in the U.S. Global financial crisis, wave of failures in the financial sector in 2008 Lack of liquidity on the global financial market and excessive public debt in some EU member states (Greece, Portugal)  difficulties in accessing the financial market for re-financing public debt Bursting of real estate bubbles in Ireland and Spain

Greece Structural weaknesses of the Greek economy large budget deficits and excessive public debt deficient tax collection euro adoption in 2001 based on misreported statistics early 2010 – a new govt reveals true extent of the budget deficit (15,4% in 2009) bond yields increased  difficulties in re-financing public debt actual insolvency of the state – rating downgrades, risk of default bailout loans (May 2010, July 2011 – Feb 2012) austerity measures, EU/IMF programme supervised by the ‘Troika’ (Commission, ECB and IMF representatives) debt restucturing – a nominal ‘haircut’ of 53,5% on Greek bonds deep recession caused by austerity measures no definite success of 2010 and 2011/12 bailout packages  return of the crisis in 2015 (see below)

Ireland ‘Celtic tiger’ – dynamic economic growth before 2008 real-estate bubble and oversized banking sector  recession and collapse of real estate prices in 2008 hits the banking sector 2008/09 - blanket guarantee issued by the govt to depositors and holders of bonds issued by banks bail-outs of banks caused budget deficit to skyrocket to 31% of GDP (2010)  actual insolvency of the state November 2010 – bail-out loan by the EU and IMF austerity measures, EU/IMF programme differencies in economic outlook between Ireland and Greece Economic recovery and exit from the bail-out program in December 2013

Spain underlying conditions: dynamic growth fuelled partly by public spending before 2008 high unemployment and inflexible ‘two-tier’ labour market real estate bubble  large exposure of banking sector to risk from real estate market restructuring of the ailing banking sector June 2012: EU bail-out loan to Spanish govt, for the financing of restructuring of the banking sector via a specific bank restructuring fund (FROB) January 2014: exit from the bail-out program

Portugal weak growth in the years preceding 2010 crisis of significant banks in 2008-9 (caused by misinvestment, embezzlement, unclear links to politicians)  bailout financed by public funds following Greek crisis in 2010  worsening situation of public finances, rising bond yields, inability to borrow on the financial markets bailout loan, EU/IMF programme, austerity measures renewed access to borrowing from the financial markets in 2014, exit from the bailout program in May 2014

Cyprus underlying conditions: role of off-shore financial center and ‘tax paradise’, with large involvement of Russian investors (in many cases including laundering proceeds from embezzlement and corruption) oversized banking sector relatively small size of Cypriot economy in relation to the whole EU direct trigger: Cypriot banks were hit by write-off on their holdings of Greek govt bonds request for bail-out loan from the EU insistence of the Eurogroup on the involvement of bank creditors and depositors first proposal (16 March 2013): ‘haircut’ would be imposed on all depositors, even those covered by the deposit guarantee scheme (below 100.000 EUR) closure of banks (‘bank holiday’) to prevent a bank run until the final deal was reached final deal – only depositors with deposits exceeding 100.000 EUR were involved; resolution of one of the biggest banks in Cyprus, restructuring of another bank.

Cyprus – solution (25 March 2013) resolution of two biggest banks, write-off of shareholders protection of deposits up to 100.000 EUR but imposition of significant losses on higher amounts (write-off and/or conversion into equity) re-opening of banks together with ‘temporary’ capital controls (gradually eased over time but lifted only in April 2015) restriction on withdrawals restriction on transferring funds abroad restriction on sending payments abroad and exporting cash fundamental question: are capital controls compatible with Treaty rules on free movement of capital (Art. 63-66 of the TFEU)? Art. 65(1)(b) TFEU allows member states to „take measures which are justified on grounds of public policy or public security”. Follow-up – Cyprus regained access to lending markets in 2015/16 and exited the bail-out program in March 2016

Greece 2 (2015) bailout program realised, somewhat improved economic outlook in 2014 anti-austerity Syriza party wins Jan 2015 election Dispute over Greece’s refusal to respect the terms of the bailout agreement causes the creditors („the Troika”) to suspend further financing under the programme  renegotations of the program Greek banks are kept solvent by access to the emergency liquidity assisstance (ELA) from the Eurosystem Negotiations are broken off on 26 June 2015 Greece’s government announces referendum on bailout terms closure of the stock market „bank holiday”  ATM withdrawals limited to 60 EUR per day capital controls introduced ELA maintained at previous levels  not sufficient to keep the banks solvent beyond the sort term

Greece 2 (2015) Greek voters reject bailout terms on 5 July 2015 a revised bailout deal is reached on 13 July 2015, under similar conditions to the previous draft banks are reopened on 20 July 2015 capital controls and withdrwal limits are gradually eased but remain in force

Italy „the elephant in the room” – the largest economy of the southern EU Member States with GDP of ca. 1,8tn EUR (larger than Spain by approx. 1/3) and budget of ca. 1tn EUR. history of slow growth, large deficits and high public debt In 2011 Italian bond yields (interest rate on Italian sovereign bonds) approached 7%, raising fears of losing access to borrowing from the financial market  the situation eased after the announcement of ECB monetary policy measures, including Outright Monetary Transactions In 2016 the Italian public debt amounts to 131% of the GDP Worries about long-term resilience of the Italian banking sector  need for recapitalisation of Monte dei Paschi di Siena, the third-largest Italian bank Political uncertainty after constitutional referendum in December 2016

Break-up of the euro area? Possible reasons for a break-up or withdrawal of a member state stimulating growth by expansionary monetary policy improving competitiveness by currency devaluation Scenario 1 – negotiated withdrawal Scenario 2 – expulsion Scenario 3 – unilateral withdrawal Legal aspects – euro adoption is irrevocable, there are no Treaty provisions on withdrawal from the euro area. Cf. Art. 50 of the EU Treaty on withdrawal from the EU. Economic aspects of a withdrawal or break-up.

Reading Ch. Proctor, Mann on the Legal Aspect of Money, 7th ed. 2012: Chapter 32, Withdrawal from the Eurozone, pp. 835-860 Additional: Ph. Athanassiou, Withdrawal and expulsion from the EU and EMU: some reflections, ECB Legal Working Paper Series, no. 10, December 2009, http://www.ecb.europa.eu/pub/pdf/scplps/ecblwp10.pdf Euro break-up – the consequences, Report by UBS, 6 September 2011, http://faculty.london.edu/mjacobides/assets/documents/Eur o_Breakup_UBS_2011.pdf