Euro crisis

are we out of the woods?

Servaas DEROOSE

Deputy Director-General
European Commission, DG Economic and Financial Affairs

22nd Dubrovnik Economic Conference

13 June 2016
 Questions

1. Economic situation: Acute phase of the crisis

over, but elevated short-term risks?

2. Vulnerable countries: Unwinding of

imbalances completed or still on the ropes?

3. Policy response: Too little, too late or

buffers insufficiently re-established?

4. EMU governance reforms: Gone too far or

still need to go deeper?

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 Lacklustre recovery,
output gap still not closed
Real GDP Output gap
(index 2008 = 100) (in %)
140 15
LU

130
10
120

5
110
Sl

100 0

90
-5
EL
80

-10
70
EL

60 -15
1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
Note: Dark blue line shows the weighted EA-19 average; dotted line shows the simple un-weighted EA-12 average. Light blue
area defines the whole range of observed values (from maximum to minimum), while the darker blue area defines the area
between the first and second quartile based on un-weighted data for EA-19. Green line shows the US.
Source: European Commission spring 2016 forecast. 3
 Potential growth weak and steadily revised down,
investment gap persistently large
Potential growth forecasts Investment
(in %) (% GDP)
3.0 40

2.5 35

2.0 30
Spring 2008
IE

1.5 25

Spring 10 Winter 16
1.0 20
Spring 12

0.5 Spring 14 15

EL
0.0 10
99 01 03 05 07 09 11 13 15 17 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Note: Left side: Euro area based on EA-15 (spring 2008), EA-16 (spring 2010), EA-17 (spring 2012), EA-18 (spring 2014), EA-
19 (winter 2016). Right side: Investment measured as gross fixed capital formation. Red lines indicate the pre-crisis (post-
crisis) average, ranging from 1999-08 (2009-17).
Source: European Commission spring 2016 forecast.
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 Still high unemployment,
increasingly structural
Unemployment rate Nawru
(in %) (in % labour force)

30 25
EL EL

25
20

20
15

15

10
10

5
5
DE DE
0 0
1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Source: European Commission spring 2016 forecast.

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 Sizeable fiscal consolidation,
but public debt still very high
Structural balance General government gross debt
(in % potential GDP) (% GDP, EDP concept)

10 200 EL

180
5
EE 160

140
0
120

-5 100
PT
80
-10
60 SGP
threshold
40
-15
20 EE

-20 0
1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Source: Left side: IMF WEO, April 2016; right side: European Commission spring 2016 forecast.

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 Reduced financial market pressure, but continued
fragmentation and insufficient bank balance sheet repair
Sovereign bond spreads Lending rates for NFC Bank non-performing loans
vis--vis the German bund (Jan 2003 Apr 2016, in %) to gross loans (in %)
14 8 50
CY
IE 7
12 ES EL
IT 40
PT
6
10

5
30
8
4
6
20
3

4
2
10
2 1
LU NL
0 0 0
2008 2010 2012 2014 2016 1999 2003 2007 2011 2015

Source: Left side: Eurostat, monthly data, last observation April 2016; chart in the middle: ECB; right side: World Bank
World Development Indicators.
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 Inflation persistently low,
risk of unanchored inflation expectations
HICP inflation HICP inflation excl. energy & unproc. food
(yoy % change) (yoy % change)
16 16
SPF - 2 yrs
14 14 ahead
SPF - 5 yrs
12 12 ahead

10 10

8 8

6 6
EE
4 4 EE

ECB
2 2
target

0 0
EL CY
-2 -2
1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
Note: Right side: Black lines show the 2-year- (dotted line) and 5-year- (straight line) ahead inflation expectations according to
the ECB Survey of Professional Forecasters (SPF).
Source: European Commission spring 2016 forecast.
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 Imbalances in vulnerable countries:
unwinding but still a long way to go

Selected MIP scoreboard indicators 2008 versus 2015

House price index (yoy % change) Private credit flow (% GDP) Private debt (% GDP)
imbalances

-10 -5 0 56 10 15 -10 0 10 15 20 30 0 100 133 200 300

Internal

ES ES ES
IE IE IE
PT PT PT
IT IT IT

Current account (% GDP, 3y average) NIIP (% GDP) Nominal ULC (3y % change)
imbalances

-5 -4 -50 -35 9 10
External

-15 -10 0 5 -150 -100 0 -5 0 5 15

ES ES ES
IE IE IE
PT PT PT
IT IT
IT

2008 2015
MIP threshold indicated as:

Note: Data for private debt and private credit flow are only available until 2014.
Source: Eurostat.

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 Adjustment capacity in vulnerable countries:
slow, insufficient progress
2008 2015

ES IE PT IT ES IE PT IT

High bond spreads 1

Financial
High NPL ratios

External imbalances

Macro Internal imbalances

Sluggish potential growth 2

Rigid labour markets

Structural
Rigid product markets

Sizeable budget deficits

Fiscal
High public debt-to-GDP ratios
Note: Green / orange / red stand for a low / medium / high degree of vulnerability. Comparisons made between 2015 and 2008
indicators except for: 1 2009-2011 period,. 2 longer-term average for the pre- (1999-2008) and post-crisis (2009-15) period to take
into account for the longer-term nature of potential growth.

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 Limited leeway towards a
more accomodative monetary policy
Policy rates set by the ECB and US Fed ECB and Fed balance sheet expansion
(in %) (in % of annual nominal GDP)
6 35
ECB MRO rate

5 ECB deposit facility rate 30

US Fed target rate (upper bound)
4 25

3 20

2 15

1 10
FED ECB

0 5

-1 0
Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15

Source: Left side: IHS, last observation 15 March 2016; right side: Datastream, last observation 31 March 2016.

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 Limited fiscal buffers

S1 indicator
Fiscal adjustment required (in % of GDP) to reach a 60% public debt-to-GDP ratio by 2030
6

-2

-4

-6
PT IT FR BE ES SI FI EA CY IE AT LT NL DE MT SK LV EE LU
COM baseline spring 2016 scenario SCP scenario

Source: Commission services. 2016 Stability and Convergence Programmes (SCP).

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 Weak resilience to economic shocks

Leverage and risk taking

Financial
Liquidity and currency mismatches
sector
Interconnectedness and common exposures

Non-financial Excessive household debt

sector Excessive corporate debt

Asset Housing booms

markets Stock market booms

Labour market flexibility

Structural
Product market flexibility

Efficient administration
Institutional
Government effectiveness

Stable governments
Political
Degree of fractionalisation in parliaments

Note: This assessment only serves for indicative purposes. Green / orange / red stands for a low / medium / high degree of vulnerability.
Source: Inspired by: Rhn et al. (2015): Economic resilience: A new set of vulnerability indicators for OECD countries, OECD Economics
Department Working Papers, No.1249.

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 Substantial changes in the EA governance framework
Stronger Introduction of an expenditure rule (6-P) and balanced budget rule (TSCG)
preventive Possibility of imposing sanctions (6-P)
arm SGP Surveillance of draft budgetary plans by Commission (2-P)
Introduction of a numerical debt benchmark (6-P)
Stronger
Fiscal Earlier and more gradual sanctions (6-P)
corrective
More automaticity in decision-making via new voting scheme (TSCG)
arm SGP
Enhanced surveillance for MS threatened with financial difficulties (2-P)

National fiscal Mandatory minimum requirements at the national level (accounting & statistics,
frameworks forecasts, fiscal rules monitored by independent bodies, transparency)

Prevention and correction of macroeconomic imbalances via the introduction of

Macro MIP
the Macroeconomic Imbalance Procedure (MIP) (6-P)

Crisis resolution ESM, European Stability Mechanism (ESM)

mechanism ECB OMT OMT programme by the European Central Bank (ECB)

Eur. System of Macro-prudential: European Systemic Risk Board (ESRB)

Financial Micro-prudential: European Supervisory Authorities (ESAs) with EBA (for banks),
Supervision ESMA (securities), EIOPA (insurance), national authorities etc.
Financial
Single Supervisory Mechanism (SSM)
Banking Single Resolution Board (ERB) and Single Resolution Fund (SRB)
Union
Under construction: Common deposit insurance scheme
Note: Key reforms steps taken in the area of fiscal and macroeconomic policies are shown in italics in brackets, namely 6-Pack (6-P), Treaty
on Stability, Coordination and Governance in the Economic and Monetary Union (TSCG), 2-Pack (2-P).
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 Minimum governance requirements for a viable EMU

Possible
Included w/o Political
in 5PR? Treaty support?
change?

Monetary ECB as a lender of last resort

Establish a common European Deposit Insurance Scheme

Implement a common backstop to the SRF
Banking
Improve the effectiveness of direct bank recapitalisation in the ESM
Create a European safe asset

Restore a credible no bail-out clause

Create a centralised fiscal capacity
Fiscal
Establish a sovereign debt restructuring mechanism
Establish a debt redemption fund

Economic Foster convergence towards similarly resilient economic structure

Note: This assessment only serves for indicative purposes. Inspired by Baldwin and Giavazzi (2016): How to fix the Eurozone: Views of leading
economists, 12 February 2016, VoxEU.

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