DG ECFIN Session III: Panel discussion Euro and macroeconomic stability Servaas Deroose Director DG ECFIN, European Commission Conference hosted by Mr

DG ECFIN

Session III: Panel discussionSession III: Panel discussionEuro and macroeconomic stabilityEuro and macroeconomic stability

Servaas DerooseServaas DerooseDirector DG ECFIN, European CommissionDirector DG ECFIN, European Commission

Conference hosted by Mr. Miroslav Kalousek, Conference hosted by Mr. Miroslav Kalousek, Minister of Finance of the Czech Republic,Minister of Finance of the Czech Republic,

November 25, 2008November 25, 2008

Ten Years of the EuroTen Years of the Euro

Inspirations for the Czech RepublicInspirations for the Czech Republic

DG ECFIN

S. Deroose, Director, Macroeconomy of the euro areaS. Deroose, Director, Macroeconomy of the euro areaEuropean Commission, Economic and European Commission, Economic and Financial AffairsFinancial Affairs

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OutlineOutline

Assessing macroeconomic stabilityAssessing macroeconomic stabilityo Domestic: from overheating to hard-landing?Domestic: from overheating to hard-landing?o Financial: Are financial systems resilient?Financial: Are financial systems resilient?o External: Are external positions sustainable?External: Are external positions sustainable?

Lessons from EMU@10 for future € Lessons from EMU@10 for future € membersmembers

o ChallengesChallenges

o Policy requirementsPolicy requirements

ConclusionConclusion

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Real convergence is advancing but Real convergence is advancing but remains a long-term challengeremains a long-term challenge

GDP per capita in 2007 (in PPS, EU=100) and average change, 2004-2007

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-2

0

2

4

6

8

10

12

14

2002 2003 2004 2005 2006 2007 H1-08

Bulgaria

Estonia

Latvia

Lithuania

0

2

4

6

8

10

12

14

2002 2003 2004 2005 2006 2007 H1-08

Czech Republic

Hungary

Poland

Romania

Slovakia

Growth is slowing considerably due to global and domestic factors

(in %, y-o-y)

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Price level convergence but Price level convergence but also demand pressuresalso demand pressures

-2

0

2

4

6

8

10

12

14

16

18

2002 2003 2004 2005 2006 2007 2008

reference value BulgariaEstonia LatviaLithuania -2

0

2

4

6

8

10

2002 2003 2004 2005 2006 2007 2008

reference value Czech RepublicHungary PolandRomania Slovakia

12-month average inflation (in %, y-o-y)

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Financially-driven convergence – large capital Financially-driven convergence – large capital inflows and extension of external balance inflows and extension of external balance sheetssheets

NMS - External debtin percentage of GDP

0

20

40

60

80

100

120

Average 9 NMS Baltics + BG CZ HU RO PL SK

2002

2007

Source: Eurostat and Commission services and ECB

Net capital inflows (surplus on the capital account and financial account of the BoP without reserves, % of GDP)

0

5

10

15

20

25

30

NMS-9 Fixers' Floaters'

2000 2007

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Very rapid financial deepening from a Very rapid financial deepening from a low base (less pronounced amongst low base (less pronounced amongst

‘floaters’)‘floaters’)

Domestic credit growth (in % of GDP)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2002 2003 2004 2005 2006 2007 H1-08

Bulgaria

Estonia

Latvia

Lithuania

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2002 2003 2004 2005 2006 2007 H1-08

Czech RepublicHungaryPolandSlovakiaRomania

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Large external imbalances Large external imbalances (especially in ‘fixers’)(especially in ‘fixers’)

-25%

-20%

-15%

-10%

-5%

0%

2002 2003 2004 2005 2006 2007

Bulgaria

Estonia

Latvia

Lithuania

-25%

-20%

-15%

-10%

-5%

0%

2002 2003 2004 2005 2006 2007

Czech RepublicHungaryPolandRomaniaSlovakia

Balance on current account (in % of GDP)

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CZ

EE

LV

LT

HU

PLSK

BG

RO

-8

-6

-4

-2

0

2

4

6

0 10 20 30 40 50 60 70government debt (in % of GDP)

bu

dge

t b

alan

ce (

in %

of

GD

P)

60%

-3%

Fiscal positionsFiscal positionsExternal constraints seem to matter for fiscal performance

General government balance and government debt (in % of GDP; 2007)

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70

80

90

100

110

120

130

2002 2003 2004 2005 2006 2007 2008

BGN

EEK

LVL

LTL

↓ depreciation

70

80

90

100

110

120

130

2002 2003 2004 2005 2006 2007 2008

CZKHUF

PLNRON

SKK

↓ depreciation

Exchange rate developmentsvs. euro, monthly averages (index numbers, Jan 2007 = 100)

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Price stabilityPrice stability: equilibrium real appreciation complicates inflation control ; shorter : equilibrium real appreciation complicates inflation control ; shorter history of anti-inflation policy and lower credibility ; conflict between fiscal and history of anti-inflation policy and lower credibility ; conflict between fiscal and monetary authorities ; wage catching upmonetary authorities ; wage catching up

Effective Effective adjustment capacityadjustment capacity (incl. (incl. stabilisationstabilisation))::

To deal with shocks without exchange rate instrument (but nominal exchange To deal with shocks without exchange rate instrument (but nominal exchange rate flexibility acts also as shock propagator, hence less ‘cost’ of giving up the rate flexibility acts also as shock propagator, hence less ‘cost’ of giving up the XR instrument); XR instrument);

Relatively more frequent and persistent common shocks with asymmetric impact Relatively more frequent and persistent common shocks with asymmetric impact (exchange rates, terms of trade, shifting comparative advantages…); (exchange rates, terms of trade, shifting comparative advantages…); asymmetric shocks still possible (see Spain, Ireland, …)asymmetric shocks still possible (see Spain, Ireland, …)

Correction of large current account imbalances may require long and painful Correction of large current account imbalances may require long and painful disinflation processes if coupled with stagnating productivitydisinflation processes if coupled with stagnating productivity

EMU and financial integrationEMU and financial integration help efficient resource allocation and allow for help efficient resource allocation and allow for longer adjustment periods, but managing credit booms can be a challenge (already longer adjustment periods, but managing credit booms can be a challenge (already well before euro adoption) well before euro adoption)

Do not lose sight of Do not lose sight of long-term challengeslong-term challenges: sustain high potential growth, in a : sustain high potential growth, in a context of ageing, globalisation (with more rapid scontext of ageing, globalisation (with more rapid shifts in comparative advantages)hifts in comparative advantages)

Lessons from EMU@10 for futureLessons from EMU@10 for future euro area members euro area members (1 - challenges)(1 - challenges)

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Improved budgetary control to reduce the risk of fiscal policy pro-Improved budgetary control to reduce the risk of fiscal policy pro-cyclicality; cyclicality; budgetary frameworks in NMS are less developed and budgetary frameworks in NMS are less developed and assessing cyclical component even more challengingassessing cyclical component even more challenging

Sustainability of public financesSustainability of public finances

Quality of public finances ; Quality of public finances ; bias towards current expenditure in NMSbias towards current expenditure in NMS

Flexible and integrated goods and factor marketsFlexible and integrated goods and factor markets

More efficient use of labour resources (participation rates, structural More efficient use of labour resources (participation rates, structural unemployment, skill mismatches)unemployment, skill mismatches)

Business environment and investment climate (innovation, FDI, education, Business environment and investment climate (innovation, FDI, education, favour entry /exit of firms)favour entry /exit of firms)

Growth-enhancing use of capital inflows ; Growth-enhancing use of capital inflows ; NMS are receiving huge NMS are receiving huge inflows , included EU funds; utilisation has differed a lot across inflows , included EU funds; utilisation has differed a lot across NMSNMS

Effective supervision and regulation of financial markets ; Effective supervision and regulation of financial markets ; NMS NMS experience experience accelerated financial developmentaccelerated financial development

Lessons from EMU@10 for futureLessons from EMU@10 for future

euro area members euro area members (2 – policy needs)(2 – policy needs)

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Fiscal policyFiscal policy

Fiscal policy has to balance multiple Fiscal policy has to balance multiple challenges challenges need for well-targeted public spending need for well-targeted public spending

(infrastructure, education and R&D)(infrastructure, education and R&D)vsvs fiscal policy key to rein in demand pressures and fiscal policy key to rein in demand pressures and

overheating risks, especially in fixed XR regimesoverheating risks, especially in fixed XR regimes

Preventing imbalances may require Preventing imbalances may require substantial surpluses of longer periodssubstantial surpluses of longer periods

Quality of public finances (pro-growth Quality of public finances (pro-growth priorities) priorities)

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Coping with financial Coping with financial deepening and credit growthdeepening and credit growth

Vigilance to prevent the build-up of Vigilance to prevent the build-up of imbalances and vulnerabilitiesimbalances and vulnerabilities

Prudential and administrative measuresPrudential and administrative measureso Raise minimum capital adequacy ratioRaise minimum capital adequacy ratioo Strengthen loan-loss provisioningStrengthen loan-loss provisioningo Mandatory loan-to-income or loan-to-value limitsMandatory loan-to-income or loan-to-value limits

Strengthen supervisory frameworkStrengthen supervisory frameworko Improvements in credit registersImprovements in credit registerso Strengthening risk management, expand stress Strengthening risk management, expand stress

testingtestingo Harness cross-border supervisionHarness cross-border supervision

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Structural policy implicationsStructural policy implications

Boost external competitivenessBoost external competitiveness

Ensure favourable business environment and investment Ensure favourable business environment and investment climate climate

Encourage innovation and entrepreneurship to maintain Encourage innovation and entrepreneurship to maintain competitiveness and move up the value-added chain competitiveness and move up the value-added chain

Move toward high value-added and fast-growing sectors Move toward high value-added and fast-growing sectors Sectoral composition of exportsSectoral composition of exports Productivity growth in the tradables sectorProductivity growth in the tradables sector

Enhance internal economic adjustmentEnhance internal economic adjustment

NMS will have to manage underlying structural divergences for NMS will have to manage underlying structural divergences for some timesome time

Ensure functioning of goods, services and labour marketsEnsure functioning of goods, services and labour markets labour mobility, skill development & wage flexibilitylabour mobility, skill development & wage flexibility wage setting in line with productivity gainswage setting in line with productivity gains Entrepreneurship, etc. Entrepreneurship, etc.

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ConclusionConclusion

Catching-up is proceeding but accompanied by Catching-up is proceeding but accompanied by varying imbalances varying imbalances

Euro adoption – readiness more important than Euro adoption – readiness more important than timingtiming

Ability to cope with country-specific adjustment needsAbility to cope with country-specific adjustment needs

Adequate preparation in fiscal, structural and Adequate preparation in fiscal, structural and prudential domainsprudential domains

Short-term challenges: deal with fall-out from the Short-term challenges: deal with fall-out from the financial crisis; manage orderly unwinding of financial crisis; manage orderly unwinding of imbalances among the ‘fixers’, keep progress towards imbalances among the ‘fixers’, keep progress towards convergence on track for the ‘floatersconvergence on track for the ‘floaters

Documents

DG ECFIN Session III: Panel discussion Euro and macroeconomic stability Servaas Deroose Director DG ECFIN, European Commission Conference hosted by Mr