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IGLP Eurocrisis2012
IGLP Eurocrisis2012
Jeffrey Frankel
Harpel Professor
Advanced Workshop on Global Political Economy, Institute for Global Law & Policy, Harvard Law School
Pros:
Monetary: A firm nominal anchor to end inflation among Mediterranean countries. Trade: To promote EU economic integration. Political: To improve cohesion.
Cons:
Monetary: Loss of ability by each to respond to local conditions by adjusting money supply, interest rate, or exchange rate.
Political
(according to M.Feldstein):
euro members would find it very difficult to abide by a common monetary policy. E.g., when a periphery country suffered a loss in demand, the interest rates set in Frankfurt would be too high for it.
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Comments on The euro: It cant happen, Its a bad idea, It wont last. U.S. economists on the EMU, 1989-2002, by Jonung & Drea. Euro at 10, 2009 ASSA mtgs.
But the Maastricht Treaty (Dec. 1991) focused on fiscal criteria as qualifications for euro membership:
BD < 3% of GDP & Debt < 60% of GDP. One might have thought that, giving up the instrument of monetary policy, it would become more important for countries to retain the instrument of fiscal policy.
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Why did the designers of Maastricht emphasize fiscal criteria? Theory I: Jason & the Golden Fleece Theory II: Theseus & the stone
Theory III: Odysseus & the sirens.
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Frankel, Economic Policy (London) 16, April 1993, 92-97.
European elites adopted the fiscal rules to render these fears were groundless.
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Pretending to enforce the fiscal criteria. Allowing Mediterranean countries bond spreads near 0
helped by investors under-perception of risk (2003-07) and artificial high credit ratings. But also ECB acceptance of Greek bonds as collateral.
Burying their heads in the sand when the crisis hit in late 2009: In early 2010, sending Greece to the IMF was unthinkable. In early 2011, restructuring of the debt was unthinkable. The current strategy: austerity for now, unenforceable Fiscal Compact for the future.
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E.g., Greece persistently violated the 3% deficit rule. All members violated the rules at some time, large & small. SGP targets were met by overly optimistic forecasts.
The Greek budget deficit never got below the 3% of GDP limit,
nor did the debt ever decline toward the 60% limit
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Even Greeces primary budget deficit has been far in excess of 3% since 2008
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Spreads for Italy, Greece, & other Mediterranean members of were near zero, from 2001 until 2008.
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Missed opportunity
The EMU elites had to know that someday a member country would face a debt crisis. In early 2010 they should have viewed Greece as a good opportunity to set a precedent for moral hazard:
The fault egregiously lay with Greece itself,
unlike Ireland or Spain, which had done much right.
It is small enough that the damage from debt restructuring could have been contained at that time.
They should have applied the familiar IMF formula: serious bailout, but only conditional on serious policy reforms & serious Private Sector Involvement.
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But the ostriches stuck their heads ever further down in the sand. Eventually
Greece, Ireland and Portugal went to the IMF; and Greek debt was restructured.
But by then
interest rates and debt/GDP ratios were far higher, it was too late to draw a line credibly distinguishing Greece from the others, even Spain and Italy.
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= the definition of unsustainable financially, even if you thought the economic hardship was sustainable politically.
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EMU
Ostrich
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"Let Greece Go to the IMF," Jeff Frankels blog, Feb.11, 2010. Over-optimism in Forecasts by Official Budget Agencies and Its Implications," Oxford Review of Economic Policy, 2011. A Solution to Fiscal Procyclicality: The Structural Budget Institutions Pioneered by Chile, Fiscal Policy and Macroeconomic Performance, Central Bank of Chile, 2011. NBER WP 16945, April 2011. The Estimated Effects of the Euro on Trade: Why are They Below Historical Evidence on Effects of Monetary Unions Among Smaller Countries? in Europe and the Euro, Alberto Alesina & Francesco Giavazzi, eds. (U.Chic.Press), 2010. "Comments on 'The euro: It cant happen, Its a bad idea, It wont last. U.S. economists on the EMU, 1989-2002,' by L.Jonung & E.Drea," slides. Euro at 10: Reflections on American Views, ASSA meetings, San Francisco, 2009. "The UK Decision re EMU: Implications of Currency Blocs for Trade and Business Cycle Correlations," in Submissions on EMU from Leading Academics (H.M. Treasury: London), 2003. "The Endogeneity of the Optimum Currency Area Criterion," with Andrew Rose, The Economic Journal, 108, no.449, July 1998. Excessive Deficits: Sense and Nonsense in the Treaty of Maastricht; Comments on Buiter, Corsetti and Roubini, Economic Policy, Vol.16, 1993. 21
Appendices:
(A) In the US system, how do the fiscal policies of the 50 states avoid moral hazard?
(B) The ECBs LTROs (Dec. 2011-Feb 2012)
But that is not due to the budget rules that (49 of) the states have.
Their rules are voluntary, varied, and flexible. Some states do have debt troubles,
and even default.
When one state begins to run its debt too high, the private market automatically imposes an interest rate penalty.
E.g., California today. Gives states the incentives to get back in line. This mechanism was expected to operate in euroland
Alesina, et al (EP, 1992) and Goldstein & Woglom (1992).
but conspicuously failed from the first day.
Nobody expects the U.S. Federal government to bail out indebted states: The precedent was set 170 years ago, when 8 states were allowed to default.
In the early 1940s, 5 states repudiated their debts completely
(Michigan, Mississippi, Arkansas, Louisiana & Florida) while a few
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c) Proposal from Brueghel (JvW & ZD): All of euroland is liable for blue bonds
(issued up to SGP limits);
d) Blue bonds share advantages with other eurobond proposals: a) ECB can conduct monetary policy. b) They could offer an alternative to US TBills for PBoC & other desperate global investors
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31
28,0
4,5
zlotys / $
4,2
Contribution of Net X to GDP:
23,0
2009: 2,5 3,4 3,2 3,4
> 100% of
18,0
kroon / $
Estonia
13,0
Latvia
8,0
I III V VII 2009 IX XI I III V 2010 VII IX
Jeffrey Frankel