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?

2

60

70

80

90

100

110

120

130

140

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

3

Lacklustre recovery, output gap still not closed

Real GDP

(index 2008 = 100)

Output gap

(in %)

LU

EL

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.

-15

-10

-5

0

5

10

15

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

EL

Sl

4

Potential growth weak and steadily revised down, investment gap persistently large

Potential growth forecasts

(in %)

Investment

(% GDP)

Winter 16

Spring 14

Spring 12

Spring 10

Spring 2008

0.0

0.5

1.0

1.5

2.0

2.5

3.0

99 01 03 05 07 09 11 13 15 17

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.

10

15

20

25

30

35

40

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

IE

EL

5

Still high unemployment, increasingly structural

Unemployment rate

(in %)

Nawru

(in % labour force)

Source: European Commission spring 2016 forecast.

0

5

10

15

20

25

30

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

EL

DE

0

5

10

15

20

25

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

EL

DE

0

20

40

60

80

100

120

140

160

180

200

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

EL

EE

6

Sizeable fiscal consolidation, but public debt still very high

Structural balance

(in % potential GDP)

General government gross debt

(% GDP, EDP concept)

SGP threshold

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

-20

-15

-10

-5

0

5

10

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

EE

PT

7

Reduced financial market pressure, but continued fragmentation and insufficient bank balance sheet repair

Sovereign bond spreads vis-à-vis the German bund

Bank non-performing loans to gross loans (in %)

Source: Left side: Eurostat, monthly data, last observation April 2016; chart in the middle: ECB; right side: World Bank World Development Indicators.

0

2

4

6

8

10

12

14

2008 2010 2012 2014 2016

IE

ES

IT

PT

Lending rates for NFC (Jan 2003 — Apr 2016, in %)

0

1

2

3

4

5

6

7

8

EL

LU

0

10

20

30

40

50

1999 2003 2007 2011 2015

CY

NL

-2

0

2

4

6

8

10

12

14

16

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

EE

EL

8

Inflation persistently low, risk of unanchored inflation expectations

HICP inflation

(yoy % change)

HICP inflation excl. energy & unproc. food

(yoy % change)

ECB target

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.

-2

0

2

4

6

8

10

12

14

16

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

SPF - 2 yrsahead

SPF - 5 yrsahead

EE

CY

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

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

-150 -100 -50 0

ESIE

PTIT

-15 -10 -5 0 5

ESIE

PTIT

-5 0 5 10 15

ESIE

PTIT

-10 -5 0 5 10 15

ESIE

PTIT

-10 0 10 20 30

ESIE

PTIT

0 100 200 300

ESIE

PTIT

Imbalances in vulnerable countries: unwinding but still a long way to go

9

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

Source: Eurostat.

In

tern

al

imb

ala

nces

Exte

rn

al

imb

ala

nces

-150 -100 -50 0

ESIEPTIT

-15 -10 -5 0 5

ESIEPTIT

2008

-2 0 2 4

ESIEPTIT

-30 -20 -10 0

ESIEPTIT

-5 0 5 10 15

ESIEPTIT

-10 0 10 20

ESIEPTIT

-20 -10 0 10 20 30

ESIEPTIT

0 100 200 300

ESIEPTIT

0 50 100 150

ESIEPTIT

0 10 20 30

ESIEPTIT

-10 0 10 20

ESIEPTIT 2008 2014

MIP threshold indicated as:

Selected MIP scoreboard indicators 2008 versus 2015

-150 -100 -50 0

ESIEPTIT

-15 -10 -5 0 5

ESIEPTIT

-2 0 2 4

ESIEPTIT

-20 -15 -10 -5 0

ESIEPTIT

-5 0 5 10 15

ESIEPTIT

-10 0 10 20

ESIEPTIT

-10 0 10 20 30

ESIEPTIT

0 100 200 300

ESIEPTIT

0 50 100 150

ESIEPTIT

0 10 20 30

ESIEPTIT

-10 0 10 20

ESIEPTIT

2008 2015

6 15 133

-4 -35 9

-150 -100 -50 0

ESIEPTIT

-15 -10 -5 0 5

ESIEPTIT

-5 0 5 10 15

ESIEPTIT

-10 0 10 20

ESIEPTIT

-10 0 10 20 30

ESIEPTIT

0 100 200 300

ESIEPTIT

Adjustment capacity in vulnerable countries: slow, insufficient progress

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.

10

Sizeable budget deficits Fiscal

2008

Internal imbalances

High public debt-to-GDP ratios

External imbalances

Macro

Structural Rigid labour markets

Rigid product markets

ES IE PT IT

2015

ES IE PT IT

Financial High bond spreads 1

High NPL ratios

Sluggish potential growth 2

11

Limited leeway towards a more accomodative monetary policy

Policy rates set by the ECB and US Fed

(in %)

ECB and Fed balance sheet expansion

(in % of annual nominal GDP)

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

-1

0

1

2

3

4

5

6

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

ECB MRO rate

ECB deposit facility rate

US Fed target rate (upper bound)

0

5

10

15

20

25

30

35

Jan-07 Jan-09 Jan-11 Jan-13 Jan-15

FED ECB

-6

-4

-2

0

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

12

Limited fiscal buffers

S1 indicator

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

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

Weak resilience to economic shocks

13

Note: This assessment only serves for indicative purposes. Green / orange / red stands for a low / medium / high degree of vulnerability.

Source: Inspired by: Röhn et al. (2015): Economic resilience: A new set of vulnerability indicators for OECD countries, OECD Economics Department Working Papers, No.1249.

Financial sector

Non-financial sector

Institutional

• Excessive household debt

• Excessive corporate debt

• Efficient administration

• Government effectiveness

• Leverage and risk taking

• Liquidity and currency mismatches

• Interconnectedness and common exposures

Asset markets

• Housing booms

• Stock market booms

Structural • Labour market flexibility

• Product market flexibility

Political • Stable governments

• Degree of fractionalisation in parliaments

14

Substantial changes in the EA governance framework

National fiscal frameworks

Stronger preventive arm SGP

• Introduction of an expenditure rule (6-P) and balanced budget rule (TSCG)

• Possibility of imposing sanctions (6-P)

• Surveillance of draft budgetary plans by Commission (2-P)

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

Macro • Prevention and correction of macroeconomic imbalances via the introduction of

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

Stronger corrective arm SGP

• Introduction of a numerical debt benchmark (6-P)

• Earlier and more gradual sanctions (6-P)

• More automaticity in decision-making via new voting scheme (TSCG)

• Enhanced surveillance for MS threatened with financial difficulties (2-P)

Crisis resolution mechanism

• European Stability Mechanism (ESM)

• OMT programme by the European Central Bank (ECB)

Fiscal

Banking Union

• Single Supervisory Mechanism (SSM)

• Single Resolution Board (ERB) and Single Resolution Fund (SRB)

• Under construction: Common deposit insurance scheme

Financial

• Macro-prudential: European Systemic Risk Board (ESRB)

• Micro-prudential: European Supervisory Authorities (ESAs) with EBA (for banks), ESMA (securities), EIOPA (insurance), national authorities etc.

Eur. System of Financial

Supervision

14

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).

MIP

ESM, ECB OMT

Minimum governance requirements for a viable EMU

15

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.

Monetary

Banking

Fiscal

Economic

Possible w/o

Treaty change?

Political support?

Included in 5PR?

• ECB as a lender of last resort

• Establish a common European Deposit Insurance Scheme

• Implement a common backstop to the SRF

• Restore a credible no bail-out clause

• Create a centralised fiscal capacity

• Foster convergence towards similarly resilient economic structure

• Establish a sovereign debt restructuring mechanism

• Improve the effectiveness of direct bank recapitalisation in the ESM

• Create a European safe asset

• Establish a debt redemption fund