Towards the 'new normal' Financial and economic challenges in post-crisis European Union recovery
Servaas DEROOSE
Deputy Director-General European Commission, DG Economic and Financial Affairs
European Ideas Network (EIN) Summer University
Copenhagen, 2 October 2015
Outline
1. Economic outlook
2. Policy strategy
3. The way forward for EMU deepening
2
3
Economic outlook (ST)
• Cyclical recovery is underway: is this time different?
• Several tailwinds, but impact uncertain and temporary
o ECB actions, including quantitative easing
o Low oil price
o Weak euro
o Neutral fiscal stance
o Lagged impact of structural reforms in some vulnerable countries
• Risks to the short-term outlook tilted to the downside
o Weakness in emerging markets/Asia
o Market volatility and changes in asset valuation
o Greece: no contagion but work ahead
o Geo-political risks
o New elements: Refugee inflows and VW emissions scandal
4
Economic outlook (MT)
• Medium-term prospects: Not out of the woods yet
o Economic activity still below pre-crisis level
o Downward revisions to potential growth
o Falling behind major competitors
• Pre-crisis structural impediments to growth and jobs
o Unfavourable demographics
o Weak productivity growth
o High unemployment
o Rigid product and labour markets
5
Economic outlook (MT)
• Legacy of the crisis
o Investment gap
o Deleveraging private and public debt
o Bank capitalisation and high non-performing loans
o Still high unemployment, increasingly youth and long-term
o Ongoing sectoral adjustment in countries that e.g. underwent housing boom-bust
o Protracted low inflation
o Halt/reversal in convergence process
o Elevated uncertainty and depressed animal spirtis
o Rising inequality
o Citizens' declining systemic trust
6
Policy strategy
• Turning green shoots into a sustained, balanced recovery: A concerted four pillar policy response
o Continuing demand support
Maintain accommodative monetary stance; quid broadening/extending QE
Deficit-neutral, targeted fiscal expansion: strengthening automatic stabilisers / automating discretionary fiscal policies; tax shift;
Expediting investment: Juncker plan
o Cleaning up bank balance sheets
Strengthening prudential supervision
Addressing high level of NPLs
Discouraging ring-fencing
o Incentivizing structural reforms
Use of SGP flexibility
Benchmarking
o Completing EMU
7
Completing EMU
• Rationale
o Despite significant progress, EMU architecture remains incomplete
o Doubts about long-term viability; undermining economic recovery
• Sequencing logic
o Front-loading private sector risk sharing (BU; CMU)
o Linking public sector risk sharing to progress on pooling sovereignty
o Moving from rules to institutions
8
Completing EMU
• Stage I (to 30 June 2017)
o Complete Banking Union (add EDIS) and launch Capital Market Union
o Create European Fiscal Board
o Set up European system of Competitiveness authorities
o Streamline and reinforce European Semester
o Consolidate external representation of the euro area
• Stage II
o Fiscal capacity to better cushion asymmetric shocks
o Euro Area Treasury
o Common high-level standards to formalise convergence process
o Strengthen democratic accountability
9
Background
Oil price decline, QE and euro depreciation are driving euro-area growth
10
Euro-area real GDP growth in 2015 (%)
2015 Spring forecast 1.5
Potential growth 0.8
Oil price decline 0.5
Quantitative easing 0.4
Euro depreciation 0.4
EU-Russia sanctions -0.2
Residual -0.4
Recovery perspectives
Recoveries after major recessions and after the global financial crisis
11
12
Private and public debt
13
The investment gap in the EU is sizeable
14
3,039
2,527 2,543
2,528
2,567
2,640 2,717
3,021
2,657
2,714
2,659 2,647
230
370
Gap compared to sustainable trend
2,869
"Sustainable" trend of investment assuming a share in GDP of 21-22%
2,416
2,606
Real gross fixed capital formation EU-28, in 2013 prices, EUR bn
Source: European Commission
Slump in investment Total investment in levels Index, 2007Q4=100
Source: European Commission, Autumn Forecast 2014 15
EU INVESTMENT TRIANGLE
Strong boost to strategic investments
Better access to investment finance
for SMEs and mid-cap companies
Strategic use of EU budget
Better use of the European Structural and
Investment Funds
MOBILISING FINANCE FOR INVESTMENT
Project pipeline preparation and selection
Technical assistance at all levels
Strong cooperation between National
Promotional Banks and the EIB
Follow-up at global, EU, national and regional
level, including outreach activities
MAKING FINANCE REACH THE REAL ECONOMY
Predictability and quality of regulation
Quality of national expenditure, tax systems
and public administration
New sources of long-term financing
for the economy
Removing non-financial, regulatory barriers
in key sectors within our Single Market
IMPROVED INVESTMENT ENVIRONMENT
16
Structure and Investment target
European Fund for Strategic Investments (EFSI)
21bn
16bn 5bn
Infrastructure and
innovation window(through EIB)
SME
window(through EIF)
5bn16bn
European Union budget EIB
Own
resources
guarantee
11bn 5bn 2.5bn
Debt
portfolio
Equity-type
portfolio
Fully guaranteed
by EUFrom EIB
2.5bn
Total EIB/EIF financing
Total investment mobilised
49bn 12bn
240bn 75bn
17
GDP effects of closing half the gap with best practice
Potentially large GDP effects if each MS closes half the gap vis-à-vis best performers:
• GDP after 5 years: EU +3½%
< SE +1% ; EL +5% >
• GDP after 10 years: EU +6½%
< SE +2% ; EL +10% >
Effects take time to materialise
• - Effects of tax shift relatively fast
• - Labour market reforms slower
• - Innovation and education slowest
Source: Varga and in 't Veld (2014) 18
Banks ran into trouble Non-performing loans % total gross loans
19
From boom to bust Unemployment rate % civilian labor force
20
21
Strong nominal convergence pre-EMU; limited further progress due to weak market pressure and policy complacency
HICP inflation
(dispersion)
10-year govt. bond yield (dispersion)
Public gross debt / GDP
(dispersion)
0
1
2
3
4
5
6
1995 2000 2005 2010
EA-11
Current EA-19
EA changing
composition
20
25
30
35
40
1995 2000 2005 2010 2015*
EA-11
Current EA-19
EA changing composition
Note: Dispersion measured as an unweighted standard deviation. "*" indicates projected values. HICP inflation measured as y-o-y growth rate of the HICP index. 10-year nominal govt. bond yield. Public gross debt in line with EDP definition based on ESA 2010.
Source: Ameco.
0
1
2
3
4
5
6
7
8
1995 2000 2005 2010 2015*
EA-11
Current EA-19
EA changing
composition
22
Real convergence: Catching-up process mostly driven by 'new' euro area Member States
Note: Countries which were in 1999 (left chart) and in 2008 (right chart) not members of the euro area are highlighted in red.
The black regression line is based on the full sample of countries, the blue one excludes the 'new' euro area Member States, which are highlighted in red.
Source: Eurostat.
GDP per capita (in PPS) before and after the start of the financial crisis
AT
BE
EE
FI
FR DE
EL IE
IT
LU
NL PT
SK
SI
ES CY
LV
LT
MT
0
2
4
6
8
10
12
0 10 20 30 40 50
GD
P p
er
capita in P
PS
(avera
ge g
row
th 1
999-2
007)
GDP per capita in thousands PPS (1999)
excl. 'new' EA MS
all countries
AT BE
EE
FI
FR
DE
EL
IE
IT LU NL PT
SK
SI ES CY
LV LT
MT
-4
-3
-2
-1
0
1
2
3
4
5
0 20 40 60 80
GD
P p
er
capita in P
PS
(avera
ge g
row
th 2
008-1
3)
GDP per capita in thousands PPS (2008)
excl. 'new' EA MS
all countries
23
Heterogeneity can be costly, but it can
be overcome by appropriate adjustment mechanisms
Insufficient real convergence: a problem?
Reduce heterogeneity by reinforcing single market integration, risk-sharing financial market integration and cross-border labour mobility, whilst allowing for
system competition and national idiosyncracies
Ensure adequate adjustment mechanisms which make heterogeneous economies resilient to shocks (asymmetric/common) and respond effectively to
internal and external imbalances
Economic argument
Political-economy argument
A monetary union of heterogeneous
economies depends on political
cohesion and identity
Monetary unions with heterogeneous economies can be sustainable as long as a certain degree of
political cohesion and identity exists, e.g. US, Belgium, Germany
If political cohesion is defined in terms of convergence of economic welfare levels and in the absence of large transfers, the sustainability
of heterogeneous monetary unions is less clear.
Preventing a meltdown Asset purchases Lending to banks
ECB refinancing operations in euro area
24
24
QE impact
Signalling effect on inflation expectations and confidence
Portfolio balance effect, crowing investors out into riskier asset classes and driving down risk and term premia
Exchange rate channel, resulting from increasing monetary policy divergence with the US
Credit channel, increasing banks' incentives and ability to extend credit
TRANSMISSION CHANNELS
25
Liquidity trap: increasing money supply may have limited effect on prices and output at the zero lower bound
Increased search for yield may push asset valuations to fundamentally unjustified levels; interaction with macro-prudential tools untested
QE exit remains unchartered territory
CB profitability/capital position may suffer when increasing short-term rates amid excess liquidity
UNCERTAINTIES AND RISKS
Fiscal responsibility remains key as government debt is high and fiscal adjustment needs are large
S1 indicator: required fiscal adjustment by 2020 to reach a 60%
debt-to-GDP ratio in 2030
Government debt (% of GDP)
Structural balance and medium-term objectives, 2014
(% of GDP)
26 Source: European Commission
-5
-4
-3
-2
-1
0
1
2
3
UK
HR IE BG FR PL
MT
HU BE SI ES SK LT RO LV SE PT
AT FI IT CY EE CZ
NL
DK
DE
LU EL
structural balance MTO 0
20
40
60
80
100
120
140
160
180
EE LU BG
RO LV SE LT DK CZ PL
SK FI NL
MT
DE
HU
HR SI AT
UK FR ES BE
CY IE PT IT EL
2009 2014-2009
-5
-3
-1
1
3
5
7
9
LV EE DK
LU SK SE LT HU DE
RO CZ PL
MT
NL
AT
BG EA EU ES SI IT FI PT IE UK FR HR BE
Autumn2010
Winter2015
Preventive arm Corrective arm
Investment Allowed deviation from the MTO or the adjustment path towards it
EFSI contribution SGP-neutral
Structural reform Allowed deviation from the MTO or the adjustment path towards it
Whether to open or not an EDP (relevant factors) -Deficit (if breach is close and temporary) -Debt EDP recommendation -Setting the deadline and length of poss. Extension
Cyclical conditions
Modulation of fiscal effort with economic conditions (and sustainability risks)
Effective action methodology
Severe economic downturn clause: redefining fiscal effort
Using SGP flexibility to promote investment and structural reforms
27
• Effect of fiscal policy on monetary policy Risk of overburdening monetary policy in the short run by lack
of demand support
Risk of overburdening monetary policy in the long run via pressure for debt monetisation
• Effect of monetary policy on fiscal policy Interest rate falls impact national budgets differently
according to the debt structure in terms of maturity
Propensity of governments to use lower interest rate payment as a windfall to relax fiscal discipline.
Lesson from the crisis: fiscal policy with constrained monetary policy
28
Lesson from the crisis: stabilisation vs sustainability
• The large increase in public debt reduces fiscal space even if the increase in debt is the consequence of the crisis
• Fiscal multipliers may be higher under financial constraints, but risk of loss of market access
• A clever balancing-act is required between stabilisation ans sustainability
29
Five Presidents' Report: 3 stages, 4 unions
Economic Union
Financial Union
Fiscal Union
"Political Union"
Stage 1
• "Deepening by doing"
• by 30 June 2017
Stage 2 • "Completing EMU"
Stage 3
• "Final stage"
•At the latest by 2025
30