The European Debt Crisis and the Global Economy

Transcription

1 The European Debt Crisis and the Global Economy Dr. Debra Glassman Department of Finance & Business Economics Michael G. Foster School of Business

2 Why I blame Greece for the fiscal cliff

3 European debt crisis Agenda Background launch of the euro Greek crisis Effect of Greek crisis on Europe (and US) Theme role of psychology: Importance of trust, confidence in government Contagion effects

4 Why the euro? Benefits of a single currency: Exchange rate fluctuations are barriers to a single market Growing percentages of intra-european trade Increase global competitiveness by reducing exchange costs Disadvantages of a single currency: Lack of monetary policy independence Cannot use exchange rate as a policy tool

5 Launching the euro Economic convergence was necessary to move to a single currency 1991 Maastricht Treaty criteria Government deficit 3% of GDP Government debt 60% of GDP Inflation 3% per year Convergence of long term interest rates Everyone in Exchange Rate Mechanism, no realignments for 2 years January 1, 1999 euro is launched

6 Euro-zone member states and joining dates Recent Austria Greece Slovenia (2007) Belgium Cyprus (2008) Finland Malta (2008) France Slovakia (2009) Germany Estonia (2011) Ireland Italy Luxembourg Netherlands Portugal Spain Non-members: Denmark (rejected euro in 2000 referendum) Sweden (rejected euro in 2003 referendum) UK ( Five tests ) Bulgaria Czech Republic Hungary Latvia Lithuania Poland Romania

7 Architecture of separate euro-zone policy responsibilities Monetary policy European Central Bank Fiscal policy national governments etc.

8 Fiscal policy in the euro-zone Fiscal policy governed by Stability Pact Fiscal policy coordination necessary in order to have a single monetary policy Pact: budget deficits cannot exceed 3% of GDP Germany was biggest supporter of pact Expected that smaller, weak currency countries would have most trouble with pact But quickly France and Germany ran into trouble Stability Pact was weakened in 2005

9 Greece joined euro-zone in 2001 As euro member, Greek government debt had no currency risk, looked attractive Greece was able to borrow a lot at low interest rates Government spending expanded Greek fiscal policy challenges Long history of tax evasion Inefficient government sector Government deficit numbers under-estimated Everyone in Brussels knew, but they saw it as a national issue that the EU should not meddle in Exporters like Germany benefitted from euro

10 10-year government bond yields Greece Portugal Ireland Spain Italy France Germany Source: European Central Bank, Statistical Data Warehouse, Long-term interest rate statistics; 1/16/13

11 Evidence of tax evasion? There are more Porsche Cayennes registered in Greece than taxpayers declaring an income of 50,000 euros ( 43,800) or more, according to research by [the] former head of the Greek prime minister s economic department Something can t be right when the modest city of Larisa, capital of the agricultural region of Thessaly with 250,000 inhabitants, has more Porsches per head of the population than New York or London. The Telegraph, 10/31/2011

12 Great Recession and sovereign debt Recession dramatically increased government debt Magnitudes raised questions of long-term sustainability

13 2009: beginning of Greek debt crisis Adam Zyglis copyright 2010 Cagle Cartoons, theweek.com

14 Greek crisis emerges Fall 2009: new government announced deficit was twice as big as previously reported Another upward revision in April 2010 May 2010: government deficit = 13.6% of GDP; debt =115% of GDP Evidence that Greek deficit figures were fudged in early 2000s Greece unable to roll over maturing government debt at low interest rates Rising rates made debt unsustainable Bailouts with IMF conditionality Required austerity measures with deadlines

15 10-year government bond yields Greece Portugal Ireland Spain Italy France Germany Source: European Central Bank, Statistical Data Warehouse, Long-term interest rate statistics; 1/16/13

16 Timeline Greece May B. bailout Mar nd bailout, 130 B. Mar 2012 private creditors accept 53% haircut May-June 2012 two elections result in pro-bailout government Nov rd bailout deal Dec 2012 private sector bond buyback (60% haircut) Euro-zone May 2010 European Financial Stability Facility created, 440 B. Nov B. bailout of Ireland May B. bailout of Portugal March 2012 EU members (except UK, Czech Republic) sign treaty to control deficits: Fiscal Compact Mar 2012 create permanent 800 B. fund, European Stability Mechanism June 2012 bailout to re-capitalize Spanish banks Proposals for euro-zone bond issues, banking union

17 3 kinds of contagion Markets punish other countries perceived as weak and/or heavily indebted Exposure contagion banks and other financial institutions exposed to Greek debt Increased political sensitivity to debt; austerity responses

18 Contagion effects: confidence spillover Loss of confidence spills over in Europe First to other PIIGS Then to other European countries

19 Bank exposure to Greek debt Source: BBC News, Q&A Greek Debt Crisis, viewed 2/21/12

20 Does US have financial exposure? US bank loans to Spain, Greece, Portugal, Ireland Euro-zone bank loans to Spain, Greece, Portugal, Ireland US bank loans to European banks $135 billion $1.6 trillion (61% of this from France and Germany) $1.2 trillion Sources: BIS Quarterly Review, June 2010, Table 9B and New York Times, 6/14/10

21 Austerity responses to Greek crisis EU governments prescribed austerity for themselves as well as Greece Cut government spending, raised taxes Reason: persuade markets to keep bond yields down Also argued that fiscal austerity can be expansionary Short-term role of consumer, business confidence Long-term productivity and growth effects

22 A conventional view of austerity s effects Economist Brad DeLong: My guess is that current deficit-reduction plans in Europe are unlikely to boost growth. They appear to do too much in the short term to diminish aggregate demand, and not enough in the long term to assure investors that the long-run financing dilemmas of the social insurance state are being tackled. Thus the deficit-reduction plans are likely to increase risk and reduce business confidence rather than to reduce risk. Source: Economist.com, July 30, 2010

23 Can Greece contract its way out of its debt problem?

24 US fiscal cliff Is US debt/gdp ratio unsustainable? What do the markets think? Is this the right time for deficit reduction? Does the US have more deficit reduction options than Greece?

25 US debt/gdp Source: seekingalpha.com, 12/31/10

26 US v. Greece default risk premia Greek v. US 10-year government bond yields Start of Greek crisis 10 5 S&P rating downgrade 0 Greece US

27

28