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The Euro Crisis


The Euro Crisis & Greece: Five Mistakes Jeffrey Frankel Harpel Professor Greek and European Debt Crisis panel, Harvard College Hellenic Society, 105 Emerson Hall ... – PowerPoint PPT presentation

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Title: The Euro Crisis

The Euro Crisis Greece Five MistakesJeffrey
FrankelHarpel Professor
  • Greek and European Debt Crisis panel,
  • Harvard College Hellenic Society, 105 Emerson
    Hall, Harvard University, Dec. 6, 2011 

  • 5 mistakes made by eurolands leaders regarding
  • Slender rays of hope
  • The hour of the technocrats
  • Proposals for the future

5 mistakes made by euro leaders
  • Admitting Greece to the in the first place,
  • a country that was not yet ready.
  • Pretending to enforce the fiscal criteria
  • BD lt 3 of GDP Debt lt 60 of GDP.
  • Allowing Mediterranean countries bonds spreads
    near 0
  • helped by investors under-perception of risk
  • and artificial high credit ratings. But also
  • ECB acceptance of Greek bonds as collateral.
  • When the crisis hit, the leaders buried their
    heads in the sand
  • 2 years ago, sending Greece to the IMF was
  • 1 year ago, restructuring of the debt was

The Treaty of Maastricht (1991) surprised many
economists by emphasizing fiscal criteria as
qualifications for membership.
  • Why did the designers do it?
  • Theory I Jason the Golden Fleece
  • Theory II Theseus the stone
  • Theory III Odysseus the mast.

Frankel, Economic Policy (London) 16, April 1993,
The motivationfor the Maastricht fiscal criteria
is clear
  • the same as for the No Bailout Clause
  • and the Stability Growth Pact (1997)
  • Skeptical German taxpayers believed that, before
    the was done, they would be asked to bail out
    profligate Mediterranean countries.
  • European elites adopted the fiscal rules to
    demonstrate that these fears were groundless.

After the euro came into existence
  • it became clear the German taxpayers had been
  • and the European elites were wrong.
  • E.g., Greece persistently violated the 3 deficit
  • The large countries violated the rule too.
  • SGP targets were met by overly optimistic
  • SGP threats of penalty had zero credibility.
  • Yet each year the ostrich elites stuck their
    heads deeper deeper into the sands.

The Greek budget deficitnever got below the 3
of GDP limit,nor did the debt ever decline
toward the 60 limit
Spreads for Italy, Greece, other Mediterranean
members of were near zero, from 2001 until
Market Nighshift Nov. 16, 2011
When PASOK leader George Papandreou became PM in
Oct. 2009,
  • he announced
  • that foul play had misstated the fiscal
    statistics under the previous government
  • the 2009 budget deficit ? 3.7, as previously
    claimed, but gt 12.7 !

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
  • The fault egregiously lay with Greece itself.
  • Unlike Ireland or Spain, which had done much
  • It is small enough that the damage from debt
    restructuring could have been contained at that
  • Unlike Italy now, if the worst happens.
  • They should have applied the familiar IMF
    formula serious bailout, but only conditional
    on serious policy reforms serious Private
    Sector Involvement.

  • But the ostriches stuck their heads ever
    further down in the sand.
  • There is even less reason now to think Brussels
    can impose fiscal constraints on borrowers or ask
    unlimited transfers from creditor country
    taxpayers than before.

Slender rays of hope, 1
  • Greece, Ireland Portugal did finally go to the
    IMF Germany banks did finally agree to write
    down Greek debt.
  • But it has always been much too little, too
  • The only solution for the short-term
  • a lot more money
  • from ECB
  • national governments,
  • conditional on reforms PSI, country-by-country.

Slender rays of hope, 2
  • A government of technocrats under Mario Monti in
    Italy is a huge improvement over the disaster of
  • Similarly Lucas Papademos in Greece
  • But he has been given even less freedom of
    action than Monti his term is only 3 months
    and he wasnt allowed to pick his cabinet.

References by the speaker
  • The ECBs Three Big Mistakes, VoxEU, May 16,
  •  Optimal Currency Areas Governance", slides
    session on the Challenge of Europe at the Annual
    Conference of George Soros INET, April 2011
    video available, including my presentation.
  • "Let Greece Go to the IMF," Jeff Frankels blog,
    Feb.11, 2010.
  • Over-optimism in Forecasts by Official Budget
    Agencies and Its Implications," 2011, forthcoming
    in Oxford Review of Economic Policy.
  • 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,

Appendix A The missing mechanism to discourage
  • At the time of Maastricht, some economists had
    hoped that euro countries with deficits/debts
    would be kept in line, as U.S. states are,
  • esp. by an automatic market rise in interest
  • with no expectation of federal bailout.
  • Alesina, et al (EP, 1992) and Goldstein Woglom
  • Why didnt that mechanism work?

Spreads help keep profligate US states in line
reason why no state has ever been bailed out by
the Federal government, despite some defaults.
Yield tomaturity in
Source W.B. English, Understanding the costs of
sovereign default , p. 269. as used by
Holtfrerich (2011)
California Municipal Bonds(now the lowest rated
of the 50- states)Credit Default
Appendix B Proposals for the future 1
  • Emulate Chiles successful fiscal institutions
  • Phrase budget targets in structural terms.
  • Give responsibility for determining what is
    structural to an independent professional agency,
    to avoid forecast bias. (Frankel, 2011)

Even the primary budget deficithas been far in
excess of 3 since 2008
Source IMF, 2011.I. Diwan, PED401, Oct. 2011
Even though in most years true Greek budget
deficits were far in excess of the supposed
limit (3 of GDP).
the official budget forecasts were always rosy.
Until, in 2009, the bottom fell out of the budget.
Source Frankel Schreger (2011)
Proposals for the future 2
  • Penalty when a euro country misses its
  • The ECB then stops accepting new bonds as
  • gt Sovereign spread rises, with automaticity.
  • Proposal from Brueghel (JvW ZD) All of
    euroland is liable for blue bonds (issued up to
    SGP limits) Issuing country is liable for red
    bonds (beyond those limits) .
  • Blue bonds share advantages with other eurobond
  • ? ECB can conduct monetary policy.
  • ? They could offer an alternative to US TBills
    for PBoC other desperate global investors

Blue bonds red bonds
Gavyn Davies, FT