1. Europe under stress - A German perspective Dr. Jürgen Pfister Finance seminar at Aarhus University Aarhus, 4 December 2013 © 2013 phz Economics| 4 December 2013, Aarhus

2. Agenda  Introductory remarks  Adjustment in crisis countries: taking stock  The role of the ECB © 2013 phz Economics| 4 December 2013, Aarhus page 1

3. The practitioner‘s approach to economic analysis  1st layer academic research (universities)  2nd layer international organizations (supranational, intergovernmental, e.g. ECOFIN/Eurogroup), research institutes, governments, central banks, advisory bodies (e.g. The German council of economic experts)  3rd layer practitioners (e.g. bank economists) general public (directly or via media) © 2013 phz Economics| 4 December 2013, Aarhus page 2

4. Monetary union: The historical background  A central idea from the beginning  Monetary union and political union  The D-mark and German unification: myth and reality  An experience of life: „one mistake brings on the next“  No political union  lax interpretation of the convergence criteria in 1998 (eleven countries)  insufficient surveillance by the EU Commission from the start  watering down of the Stability and Growth Pact (SGP) in 2005 …… © 2013 phz Economics| 4 December 2013, Aarhus page 3

5. Is there a German view on EMU and the sovereign debt crisis?  Denmark said no to the Maastricht Treaty (2 June 1992), the Germans were not asked.  The D-mark already fulfilled all the promises of the euro: a stable currency, an international role, an independent central bank.  The non-negotiable core principles: price stability, central bank independence, no-bailout.  Should the Treaty (and the SGP) be observed literally (e.g. 3%, 60%)?  The German Constitutional Court. © 2013 phz Economics| 4 December 2013, Aarhus page 4

6. Euro area: Split economic situation Inflation and seasonally-adjusted GDP, first quarter 2008=100 © 2013 phz Economics| 4 December 2013, Aarhus page 5

7. Crisis countries: Fiscal consolidation on track General government fiscal balance in percent of GDP © 2013 phz Economics| 4 December 2013, Aarhus [Excluding recapitalization of banks] page 6 [2.9] [8.6] [5.8] [7.1] [3.1]

8. Crisis countries: Marked improvements in current account balances In billions of euros © 2013 phz Economics| 4 December 2013, Aarhus page 7

9. Competitiveness: Considerable progress Real exchange rate deflated by GDP deflator, January 1999=100 © 2013 phz Economics| 4 December 2013, Aarhus Source: Joint forecast of leading research institutes, October 2013. page 8 Spain Greece Italy Ireland Portugal France Germany

10. Government debt: Sharp increase due to recession and financial crisis Gross debt as percent of GDP © 2013 phz Economics| 4 December 2013, Aarhus page 9

11. Euro area: Massive rise in private debt in crisis countries Liabilities of non-financial firms and private households as percent of GDP © 2013 phz Economics| 4 December 2013, Aarhus Memorandum item:DE 1995:108.4 2012:106.7 page 10

12. Fiscal consolidation: The right way? Change in the government outlay- and revenue-to-GDP ratios, 2013 compared with 2004-08, in percentage points © 2013 phz Economics| 4 December 2013, Aarhus page 11

13. Private wealth: Is the South richer than thought? Average net wealth per household in thousands of euros, Eurosystem Household Finance and Consumption Survey, April 2013 © 2013 phz Economics| 4 December 2013, Aarhus DE, FR, IT, PT: 2010, GR: 2009, ES: 2008 page 12

14. Foreign debt: No improvement yet Net foreign investment position in percent of GDP © 2013 phz Economics| 4 December 2013, Aarhus Memorandum item:DE 2006:27.9 2012:40.5 1) 2011. page 13

15. € Monetary union: Shift in focus  Growing impatience of people with the economic situation leads to political changes. The election in Germany in September might tip the balance to the anti-reform side.  Increased participation in rescue operations of owners, bond holders and depositors – instead of tax payers – is appropriate (principle of owner liability). But it should follow clear and pre- announced rules.  The shift of emphasis from austerity to growth is basically welcome. Unfortunately, often “growth” is misinterpreted as higher government spending (less consolidation).  The debate on who should bear the burden: No progress in 30 years!  The struggle between shared liability and shared responsibility in fiscal policy must not be won by the former. © 2013 phz Economics| 4 December 2013, Aarhus page 14

16. Euro area: Danger for cohesion Unemployment rate 2013 in percent (Eurostat) © 2013 phz Economics| 4 December 2013, Aarhus page 15

17. € Reform programmes: Three preconditions for success  Communication between governments and the people/voters must be transparent.  There has to be a “light at the end of the tunnel”.  The distribution of the burden needs to be considered fair by the (overwhelming) majority of the people/voters © 2013 phz Economics| 4 December 2013, Aarhus page 16

18. € ECB: Euro rescue approaching its limits  “Ordnungspolitik” vs. pragmatism.  The ECB is compensating for insufficient action by governments.  Cyclical divergence is impairing a uniform interest rate policy.  Securities purchases (SMP, OMT) are in a grey area of the ECB’s mandate.  The exit from an extremely expansive monetary policy is easy from an instrument point of view. But may not be possible from a political perspective.  For 2014/15 low inflation danger (including asset prices). © 2013 phz Economics| 4 December 2013, Aarhus page 17

19. Euro area: Strong growth of monetary base, weak money supply Monetary base and broad money M3, December 2007=100 © 2013 phz Economics| 4 December 2013, Aarhus page 18

20. Outlook: From an existential crisis to a chronic problem  Citizens in the crisis countries won’t start to benefit from the recovery until 2015. Will the political/social consensus last that long?  The political shift from “austerity to growth” won’t lead to greater efforts for structural reforms, but rather to a lengthening of the time period of the consolidation. This may provoke a reaction on the bond markets and increase pressure on the ECB.  Of the two major reform projects – banking union and fiscal union – the main aspects of the former are disputed (Which banks? Role of the ECB? Structure of the SRM? Deposit insurance?), the latter is probably unachievable in the foreseeable future.  The survival of the euro with all (large) countries is still more likely than a collapse. Sovereign debt restructuring in the large countries is not expected.  The euro will remain internally stable – medium-term inflation rate around 2% p.a.; a somewhat higher rate in Germany than in the past – and stable against the dollar – unsolved fiscal problems in the US, (much) higher inflation risk than in the euro area. © 2013 phz Economics| 4 December 2013, Aarhus page 19

21. Thank you for your attention! © 2013 phz Economics| 4 December 2013, Aarhus Dr. Jürgen Pfister www.juergenpfister.com page 20