1. Recent Reforms to Deal with Recurrent Sovereign Debt Crisis in the Euro Area Waltraud Schelkle w.schelkle@lse.ac.uk LSBU Centre for International Business 22 February, 2011

2. Overview What is this a crisis of?  Competitiveness  Private Debt  Sovereign Debt How promising are reforms and proposals?  ‘Strengthening economic governance’  The proposed Pact for Competitiveness  The proposed Eurobond  Ideas for debt reduction Conclusion

3. Competitiveness (1): How bad are divergences?

4. ..but who paid for rising NULC – firms or workers? In SP, PT and IT, the worsening performance was ‘paid for’ by workers, ie lower real wages.

5. Competitiveness: Growth IR, GR and SP grew fastest, IT and GE grew least..

6. Private Debt (1): Asset bubbles

7. ..driven by high lending to households

8. ..while current account deficits were high only in some. GR and PT had high current account deficits, SP only more recently and IR had sustainable ones; BE had a higher surplus on average than GE

9. Private Debt (2): When the bubble burst, central banks became the lender of last resort..

10. Private Debt  Public Debt: Fiscal authorities had to step in where the bursting bubble became a solvency problem for banks. Acknowledgement: Some of the following graphs are taken from a presentation by Lorenzo Bini- Smaghi (ECB), February 2011.Lorenzo Bini- Smaghi (ECB)

11. Public Debt (1): After 2009, the banking crisis became a sovereign debt crisis

12. ..for some in the Euro area more so than others.

13. But a virtual banking crisis it still is. Exposure of banks by nationality (bn US-$, 6/2010) Ger- man Spa- nish Fren- ch Other Euro BritishAll banks GRE65.41.383.138.417.0252.1 IRL186.417.777.388.9187.5746.8 POR44.398.348.528.929.0292.6 SPA216.6n.a.201.3300.6136.5989.8 Source: BIS Quarterly Review December 2010

14. Public Debt (2): How about growing out of your difficulties?

15. A bit difficult at these interest rates..

16. ..and these growth rates, in normal times.

17. Summary on the first question: What is this a crisis of? No simple answer: the four or six at risk have very different growth-debt-competitiveness patterns. For the Euro area as a whole, it is a banking crisis in disguise, turned into and dealt with as a sovereign debt crisis. Debt levels in GR and IR are now clearly unsustainable and only some relief will help to get them – and the Euro area – back on track.

18. Reforms already decided (Dec 2011): ‘Strengthening economic governance’ A European Stability Mechanism, replacing the present EFSF, from 2013 onwards  Bailing in of private creditors on a case by case basis (Collective Action Clauses in bond issues)  Strict conditionality of the loan An excessive debt and an excessive imbalances procedure (asymmetric) A ‘European Semester’: scrutiny of draft budgets before they go to national parliaments

19. Sealed with a kiss: The proposed ‘Pact for Competitiveness’ Franco-German 'Pact for Competitiveness' hits immediate opposition 4 Feb 2011 (Photo: consilium.europa.eu)..to be decided at a special summit in March 2011

20. Six points that will do exactly nothing to deal with a Euro crisis.. Abolishing indexation of wages to inflation A recognition agreement for educational diplomas and vocational certifications Raising retirement ages Harmonizing the corporate tax base Implementation of legal “debt-brakes” Establishment of a national crisis regime for banks

21. A Eurobond (proposed by Juncker and Tremonti in Dec 2010) A bond issue that is collectively guaranteed by all Euro area member states To ensure market access, albeit served at the national interest rate (De Grauwe and Moesen 2009) To ensure fiscal coordination for the Euro area as a whole, rewarded by a low common interest rate (Mabbett and Schelkle 2010)

22. Proposals for reducing existing debt (Gros and Meyer 2011) Force banks to mark to market their bond holdings Exchange of country bonds against bonds by EFSF (European Financial Stabilisation Facility)  at market prices before country came under the umbrella of the EFSF EFSF then negotiates with the country a reduction in the nominal value of its debt and a fiscal adjustment programme No financial commitment of other member states to the extent that the debt reduction does not exceed the discount in the banks-EFSF exchange

23. Summary on the second question: How promising are reform proposals? The ESM is a way forward, although possibly destabilising until bondholders know how it will work in a default. The entire Pact for Competitiveness is useless, addressing an overrated problem in a counter- productive way. Relevant problems are: liquidity and solvency of banks and countries, coordinated counter-cyclical fiscal policy for the Euro area as a whole. A Eurobond plus an orderly debt reduction mechanism would go a long way to alleviate all three of these problems.