Ruo Chen Gian Maria Milesi Ferretti Thierry Tressel

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1 Ruo Chen Gian Maria Milesi Ferretti Thierry Tressel IMF/DNB Workshop on Preventing and Correcting Macroeconomic Imbalances in the Euro Area The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management

2 Euro area crisis Introduction Causes of the crisis: External imbalances dimension focus on 5 largest net debtors: Greece, Ireland, Portugal and Spain (net liabilities around 100 % of GDP) Italy (much smaller net liabilities in relation to GDP) Conventional explanations ( good and bad ): Financial integration & neoclassical convergence (Blanchard & Giavazzi, 2002; IMF 2011) Loss of competitiveness intra euro area (Berger & Nitsch, 2010)

3 Conventional explanations correct but incomplete Characteristics of capital inflows not fully consistent with standard convergence story Trade and relative price developments vis à vis non euro area partners quantitatively important and asymmetric across countries ( core versus GIIPS ). Divergence in patterns of trade and external finance GIIPS deficits with ROW financed by euro area countries, with outside investors choosing core Europe

4 What do we do? External balance of GIIPS + core under EMU Export competitiveness and trade developments: Stylized facts: trade with China, CEE, oil exporters Supported by econometric analysis of trade elasticities and estimates of displacement effects of competition from China. Financing of current account deficits: absence of a borrowing constraint? Stylized facts on bilateral external financing Econometric analysis: trade and bank capital inflows

5 Main Findings (I) external balance under EMU Initial conditions At euro entry Greece & Portugal had Appreciated REER relative to trend Large CA deficits Euro appreciation and competitiveness Lion share of REER appreciation of the GIIPS accounted for by euro appreciation, especially for Greece & Portugal Patterns of Saving Investment only partially consistent with convergence

6 Main Findings (II): Asymmetric Trade Developments Stylized facts Trade with non euro countries (China, CEE, oil exporters) explains a large share of decline in trade balance in GIIPS In contrast, Germany s TB gained from rising exports to China, CEE and oil exporters. Econometric Analysis Some of the GIIPS had below average export demand elasticities and above average import demand elasticities for trade with China, CEE and oil exporters Evidence that Chinese exports displaced exports of Greece, Italy and Portugal Divergent external performance harmful if conditions of optimal currency area not met (mobile labor, flexible prices & wages, risk sharing mechanism)

7 Main Findings (III): Financing of deficits GIIPS deficits financed mainly by euro area investors. Outside investors purchased German and French securities Econometric analysis of trade and bank capital flows suggests that the latter helped close a financing gap arising because of competitiveness problem

8

9 External Balance under EMU Net foreign asset positions of the GIIPS and of core Europe (France, Germany)

10 External Balance under EMU Greece and Portugal exhibited signs of overvalued REER at euro entry: REER in 1999 relative to average Current account balance inclusive of capital transfers, 1999 Greece 9.4% -3.7% Ireland -5.7% 0.9% Italy -3.4% 0.9% Portugal 12.3% -6.2% Spain -1.0% -1.8% France -3.6% 3.2% Germany -2.4% -1.3% Source: IMF staff calculations based on IFS data.

11 External balance under EMU REER appreciation ( ) reflected relative prices but also strong euro appreciation ULC-based REER CPI-based REER 35% 40% 30% 25% NEER ULC changes 30% NEER CPI changes 20% 15% 20% 10% 5% 10% 0% 0% -5% -10% -10% -15% -20% -20% Source: ULC-based REER is from Eurostat, 36 trading partners. CPI-based REER is from INS

12 External Balance under EMU Main macro counterparts to rising CA deficits not all consistent with neoclassical convergence Spain, Ireland: saving, investment Greece, Portugal: corporate saving, investment Italy: corporate saving Germany: corporate saving, investment

13

14 Asymmetric trade developments (1) Rise of China may have affected euro area differentially: Import demand from China benefited some countries more than others Chinese exports displaced exports of Southern European countries Potential high import elasticity for Chinese exports (2) High oil prices raised the value of imports but, in the case of Germany, may have been offset by exports of capital goods (3) The integration of CEE countries may have resulted in higher imports in all euro area countries, but was compensated by higher exports in Germany (processing trade)

15 Cumulative Trade Balances ( ) 250% 200% 150% 100% World US Japan Euro Area Rest of Europe Emerging Asia Oil and commodity exporters 50% 0% Greece Ireland Italy Spain Portugal France Germany -50% -100% -150% -200% Source: Direction of Trade Statistics, IMF

16 Change in bilateral trade balance

17 Contributions to change in TB Emerging Asia: Greece (20 %), Italy (85 %) and Spain (26 %) in spite of low base CEE: almost 40 % of increased TB of Germany (also net gain for Italy) Oil exporters: Greece (15 %), Italy (42 %) and Spain (33%) but net gain for Germany (10 %)

18 Import and Export Elasticities Empirical specifications: (1) Export regressions: log Exports log( RER ) log DomDemand f T ijt ijt jt ij t ijt (2) Import regressions: log Imports log( RER ) log DomDemand f T ijt ijt it ij t ijt (3) Displacement effect: ijt RER ijt DomDemand it log Imports ichina, t fij Tt ijt log Imports log( ) log

19 Export Regressions (3) (4) (5) (6) (7) (8) CEE CEE China China Oil Oil RER 0.388*** 0.383*** 0.479*** 0.479*** 0.475*** 0.463*** DomDemand(j) 1.244*** 1.255*** 1.324*** 1.324*** 1.334*** 1.281*** DomDemand(j)X PRN(j) 0.843*** 0.848*** DomDemand(j)X Deu(i)PRN(j) * * DomDemand(j)X GIPS(i)PRN(j) *** DomDemand(j)X Grc(i)PRN(j) *** *** *** DomDemand(j)X Ita(i)PRN(j) *** *** * DomDemand(j)X Prt(i)PRN(j) 2.344*** DomDemand(j)X Esp(i)PRN(j) 1.175*** *** ** Observations R-squared Robust pval in parentheses, *** p<0.01, ** p<0.05, * p<0.1 Notes: PRN indicates different trading partner group. See column head for its definition in each regression.

20 Summary Export Regressions Cumulative export loss from lower export elasticities: From trade with China: Italy : 4 % of GDP From trade with CEE: loss for Greece (3.8 % of GDP) and Italy (1.5 % of GDP) From trade with oil exporters: Greece (2 % of GDP)

21 Import Regressions CEE China Oil RER 0.247*** 0.376*** 0.397*** DomDemand(i) 0.384*** 0.475*** 0.492*** DomDemand(i)X PRN(j) 1.566*** 2.343*** DomDemand(i)X Deu(i)PRN(j) 1.865*** 3.598*** DomDemand(i)X Grc(i)PRN(j) *** * DomDemand(i)X Ita(i)PRN(j) ** 1.952** DomDemand(i)X Prt(i)PRN(j) 3.785*** DomDemand(i)X Esp(i)PRN(j) 1.124*** * Observations R-squared Robust pval in parentheses, *** p<0.01, ** p<0.05, * p<0.1

22 Summary Import Regressions All countries have higher elasticities of import demand for trade with CEE or China Trade with CEE: Portugal, Spain but also Germany have higher than euro average import demand elasticities Trade with China: Italy and Germany have higher than euro average import demand elasticities oil imports: Portugal and Spain had higher import elasticities

23 Displacement Effect of Chinese Exports (2) (3) (4) (5) (6) (7) only Euro(j) only Euro(j) RER 0.270*** 0.283*** 0.284*** 0.285*** *** *** DomDemand(i) 1.430*** 0.933*** 0.940*** 0.928*** 0.930*** 0.966*** Import(i,China) 0.274*** 0.273*** 0.254*** *** *** Import(i,China) X Euro(j) *** *** Import(i,China) X GIPS(j) ** * Import(i,China) X GRC(j) *** *** *** Import(i,China) X ITA(j) ***-0.198*** *** Import(i,China) X PRT(j) *** Import(i,China) X ESP(j) 0.102*** *** Observations R-squared Robust pval in parentheses, *** p<0.01, ** p<0.05, * p<0.1

24 Summary: displacement effect Imports from China on average positively correlated with imports from other trading partners But correlation significantly lower for imports from euro area countries After controlling for euro area effect, additional negative effect for imports from Greece, Italy and to some extent Portugal Cumulative export loss due to differential effect: between 15 and 30 % of GDP for Greece, Italy and Portugal

25 Quantification of TB effects

26

27 Bilateral Financing

28 Asset substitutability Were other euro area countries were viewing GIIPS securities as closer substitutes to securities issued in core Europe, relative to outside investors? Some facts...

29 Share of foreign held debt securities held by other euro area countries (2008)

30 Share of outstanding debt securities held outside the euro area (2008)

31 External Positions of sectors

32 Regression analysis: Bank financing of trade deficits Specification: Y it KFlows it X it f i it Dependent variable (Y): TB/GDP, X/GDP or M/GDP Explanatory variable: net inflows of French & German Bank Claims / GDP Control variables: standard determinants of the CA (demographics, fiscal balance, NFA, oil TB, real GDP growth and initial per capita GDP) Sample: , Austria, Belgium, Finland, Greece, Ireland, Italy, the Netherlands, Spain and Portugal.

33 The Trade Balance and Bank net inflows Dependent variable: Trade Balance to GDP Explanatory variable: Total vis-à-vis euro vis-à-vis non euro Net bank inflows to GDP ** (0.195) (0.418) (0.033) Net bank inflows to GDP GIIPS *** *** (0.002) (0.000) (0.103) Other euro area (0.401) (0.189) (0.183)

34 Summary of findings Bank capital inflows from France and Germany helped close a gap in the financing of net exports of the GIIPS Bank capita inflows were stronger when export performance was weaker but counter intuitive correlation with imports (driven by imports of machinery & equipment) Findings consistent with the possibility that the inflow of capital associated with credit and asset market booms adversely affected the performance of manufacturing and export industries

35 Conclusion Even if relative prices important, euro appreciation explains lion share of REER of peripheral euro area countries Asymmetric trade developments with the ROW (China, CEE, oil prices) contributed to growing imbalances among euro area countries, in particular displacement effect of trade by China s exports In theory: REER should have depreciated No adjustment: continued financing by Germany & Fr continued NEER appreciation & lack of wage flexibility

36 Additional slides

37 Contributions to Change in Trade Deficits Contribution to change in: exports imports TB Greece World 100% 100% 100% euro area 42% 45% 46% Asia, oil, CEE 43% 45% 45% Ireland World 100% 100% 100% euro area 45% 36% 55% Asia, oil, CEE 32% 61% -1% Italy World 100% 100% 100% euro area 39% 39% 36% Asia, oil, CEE 48% 48% 49% Spain World 100% 100% 100% euro area 54% 46% 31% Asia, oil, CEE 28% 40% 64% Portugal World 100% 100% 100% euro area 58% 64% 74% Asia, oil, CEE 26% 24% 20% France World 100% 100% 100% euro area 48% 60% 89% Asia, oil, CEE 39% 35% 26% Germany World 100% 100% 100% euro area 41% 47% 17% Asia, oil, CEE 49% 49% 52%

38 Exports/Imports and Bank net inflows Exports to GDP Total vis-à-vis euro vis-à-vis non euro Net bank inflows to GDP * (0.225) (0.456) (0.082) Net bank inflows to GDP GIIPS *** *** *** (0.000) (0.000) (0.000) Other euro area (0.336) (0.291) (0.666) Imports to GDP Total vis-à-vis euro vis-à-vis non euro Net bank inflows to GDP (0.322) (0.724) (0.224) Net bank inflows to GDP GIIPS *** *** (0.001) (0.108) (0.000) Other euro area (0.390) (0.579) (0.285)

39 Sectoral balance sheets Greece Ireland Italy Sector Change Households Government Financial Sector Non-financial Sector Total Households Government Financial Sector Non-financial Sector Total Households Government Financial Sector Non-financial Sector Total Portugal Spain France Households Government Financial Sector Non-financial Sector Total Households Government Financial Sector Non-financial Sector Total Households Government Financial Sector Non-financial Sector Total Households Government Financial Sector Non-financial Sector Total Source: Eurostat statistics, OECD statistics Germany

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