The participants:
- Robert Barrie, head of European economics, Credit Suisse
- Steen Bocian, chief economist, Danske Bank
- Wim Boonstra, chief economist, Rabobank
- Olivier Garnier , chief economist, Societe Generale
- Miguel Jiménez, chief economist for Europe at BBVA Research
- Thomas Mayer, chief economist, Deutsche Bank
- Marco Valli, chief eurozone economist, UniCredit
The issues:
- Sovereign debt crisis
- Monetary policy
- Fiscal integration
- European financial stability facility fund
- European banking sector
The focus of the sovereign debt crisis is threatening to move from peripheral European countries to wider continental Europe. Can these problems be contained and what further steps need to be taken to stave off any further crises?
Robert Barrie: It feels as if we may be past the worst of the peripheral crisis. The problems haven’t gone away – they won't for some time – but the policy response is at last starting to look as if it might be proportionate.
Steen Bocian: The problems might be confined to peripheral regions if there is sufficient willingness among the eurozone countries to implement relief measures. The core European problem is not the total debt in the eurozone but the distribution of the debt. The distribution of debt among the countries can be handled, but probably not without further political and economic integration.
It is crucial that individual countries show sufficient willingness to tighten fiscal policy and implement reforms. We expect Portugal will be covered by a help package and cannot rule out that Spain might need to be covered if the problems in the Spanish savings banks (cajas) grow.
Wim Boonstra: We are witnessing a bout of market hysteria. It is clear that the eurozone has a few (very small) member states with serious fiscal problems, but on average the fiscal position of the eurozone is in much better shape than the UK, US and certainly Japan. The real debt crisis is, again, evolving in the US.
Oliver Garnier: There is little doubt that this crisis can be contained as the eurozone records lower deficit or debt ratios than the US, UK or Japan. However, stopping contagion requires a more comprehensive and pre-emptive strategy than the piecemeal and reactive policies implemented so far. There are some signs that European governments are more ready to agree on such a strategy and that key decisions could be announced at the EU summit in March.
Miguel Jiménez: The risk of contagion from small peripheral countries to large ones has diminished. Until now, financial stress in the periphery has barely affected growth in the euro area as a whole. To resolve the risk of contagion, three elements are needed:
- Peripheral countries have to continue implementing the reforms. So far they are broadly in line with targets.
- The EU has to provide the right framework to prevent and manage future crises, with a stronger Stability Growth Pact (SGP) and a crisis-resolution mechanism. For the current crisis, ensuring the solvency of Greece is important, probably with a debt reduction that is not traumatic for private investors. For the rest of the periphery, the problems are more of liquidity than of solvency.
- More credible stress tests in June, followed by necessary recapitalisation.
Thomas Mayer: The smaller countries at the periphery – Greece, Ireland and Portugal – have significantly weaker fundamentals than the rest of the euro area countries. These countries need adjustment support and, in some cases, debt relief through bond buyback programmes in the secondary market where their debt trades at a discount. All other countries have to pursue strict adjustment policies so as to regain the confidence of the markets.
Marco Valli: But policymakers have to act pre-emptively. The most important decisions have to come at country level with aggressive fiscal consolidation, growth-enhancing measures and a timely and credible recognition of bank losses.
The systemic response should be an extension of European Financial Stability Facility (EFSF) fund lending capacity, allowing it to recapitalise banks too. Nonetheless, sovereign debt restructuring will eventually be needed in at least one country. The timing is a political decision and should be chosen with care: 2012 at the earliest.
Is a one-size-fits-all monetary policy still a viable economic policy for the eurozone?
Mr Barrie: I don't see why it shouldn't be. What is interesting is that the divergences around the aggregate or the average look likely to be reversed in the next few years. So Germany looks likely to grow faster and, possibly, to have a higher inflation rate than Spain after 10 years or more of doing the opposite.
Mr Bocian: I believe the euro can survive the current crisis but the existing mechanisms need to be expanded by increasing the size of the EFSF, lowering the interest rates that periphery countries have to pay and allowing peripheral countries to use the money from the EFSF to buy their own bonds in the market. There is a need for enhanced fiscal coordination in Europe, if one-size-fits-all is to survive.
It is difficult to say exactly what will restore market trust in the euro project, but the politicians have to get ahead of market worries.
Mr Boonstra: [A common monetary policy] is a core element of any monetary union. There are several flaws in the design of the European Monetary Union (EMU). First, the issuance of government bonds is fragmented. This gives markets an opportunity to voice their discontent with individual countries. This should be solved.
Second, a single monetary policy without a large central government requires more flexible fiscal policies to correct the economy when a country is out of sync with the EMU average business cycle.
Given the SGP, countries should have structural equilibrium (or even surpluses) of their public budget. But even when countries follow the SGP (such as Ireland), they can still run into problems. The EMU needs a mechanism to deal with this, without political bickering and without every single problem of a small member state translating into a life-threatening crisis for the euro itself.
Third, financial markets completely failed to play a disciplinary role between 1999 and mid-2008. We should learn lessons from this as well.
Mr Garnier: Monetary union was not the primary cause of the debt crisis in the eurozone. Excess credit and asset price bubbles have been global phenomena throughout the 2000s. The first European countries that requested International Monetary Fund (IMF) assistance at the beginning of the crisis were not part of the EMU: Iceland, Latvia, Romania and Hungary. Having said that, this crisis has revealed some major deficiencies in the governance and functioning of the euro that have to be amended.
Mr Jiménez: [Monetary union] is viable but it probably needs more fiscal coordination. A eurobond market associated with it would be also desirable. We must not forget that the monetary union is not only an economic project but also a political one.
Mr Mayer: It is the only option. Countries need to follow domestic economic and fiscal policies to mitigate any unfavourable effects of a supranational monetary policy.
Mr Valli: But that doesn’t mean we can expect monetary policy to be a substitute for structural reforms. Investors believe the European Central Bank (ECB) can continue to deliver: the eurozone recovery is strengthening and inflation expectations remain firmly anchored. Later this year, the ECB will probably have to raise rates, leaving some non-standard measures in place. That would fit all.
Is fiscal integration of the eurozone needed?
Mr Barrie: Fiscal discipline is needed so that we don't get into the same situation again, together with a degree of understanding and neighbourliness when external shocks make things difficult.
Mr Bocian: There is a need for further fiscal integration. However, it is not the same as aligning fiscal policy. There is a need to take the SGP seriously – and to be pre-emptive to avoid future debt crises.
Moreover, one can consider whether the individual countries' budgets must be approved by the EU – not with a view to aligning economic policy but only to ensure that countries do not expose themselves to budget deficits and debt.
Mr Boonstra: [Fiscal integration] would certainly help but I doubt whether it is absolutely necessary. Central funding of public deficits (plus an effective spread mechanism) can do the job as well.
Mr Garnier: Tighter surveillance of national fiscal policies is desirable but moving towards fiscal union is neither realistic nor absolutely necessary. Instead of trying to enforce budget discipline through sanctions at EU level, it would be simpler and more effective to require eurozone member states to include fiscal rules (such as 'debt-brakes') in their national constitutions.
Mr Jiménez: There are many possible definitions of integration. A political union is not needed but additional limited fiscal coordination and more integration of markets (especially financial markets) would be highly desirable
Mr Mayer: [Fiscal integration is needed] up to a point. The nature of the EMU as a community with limited liability needs to be maintained. Full fiscal union – unlimited liability – without political union runs foul of basic democratic principles (no taxation without representation).
Mr Valli: Not necessarily. Sound fiscal and macroeconomic policies at national level would be sufficient to have the eurozone working properly. However, some degree of fiscal integration would be desirable, and this would eventually make eurobonds a viable option. But current fiscal positions across the area are too divergent to think seriouslyabout integration in the medium term. It will be an issue for the long term.
The role of the EFSF fund is currently under debate. Does the fund have a place in future economic policy or should it remain solely as part of a rescue package?
Mr Barrie: The EFSF is a pragmatic response to current circumstances. It is about to acquire the scale and functionality that it needs to be fully effective in those circumstances for the next couple of years. After that, its permanent replacement – the European Stability Mechanism (ESM) – will have a slightly different set-up and is designed to reduce the risk of another crisis rather than resolve this one.
Mr Bocian: Unless the goal is full economic union, it is desirable to have a permanent mechanism to ensure that countries in trouble can get help. So, yes, the fund could also have a role in the future. Without a mechanism, one has to be inventive in case of future problems, which might prove politically difficult.
Mr Boonstra: It should be a temporary measure that is part of the rescue package. It is a way of improvising, which may help to calm markets. But it is less than a halfway solution. Moreover, it is a new issue in a market that is already too fragmented.
Mr Garnier: Strengthening the EFSF, both in size and in scope, would be welcome. Indeed, we have already learned from the crisis of the Gold Standard in the 1930s that a system of fixed exchange rates needs a multilateral institution capable of providing emergency funding and monitoring national adjustment programmes as well as enforcing broader economic surveillance. The permanent ESM to be created in 2013 could lay the groundwork for a future Eurozone Monetary Fund.
Mr Jiménez: The EFSF has to be permanent and large enough. It must be an additional instrument in a governance framework that includes stronger vigilance, more integrated financial markets and eventually steps in the direction of a closer fiscal union.
Mr Mayer: The EFSF is a temporary placeholder for a future permanent institution, a European Monetary Fund.
Mr Valli: We see an active role for the fund in the longer term. Once there is a move towards a higher degree of fiscal integration, or at least a clear convergence of fiscal policies across the area, eurobonds would probably become appealing for core countries of the eurozone. The fund could turn into a supranational agency for the issuance of these bonds. The whole eurozone would benefit from it.
How stable is the region’s banking sector to withstand any further shocks?
Mr Barrie: It probably needs more capital but it is not obvious, with one or two exceptions, that it need have difficulty putting it in place.
Mr Bocian: It is obviously a risk that must be monitored closely.
Mr Boonstra: It depends on the size of the shock and the losses banks have already accepted in silence. The new stress tests should shed more light. The ECB is increasingly acting as a lender of last resort for weak banks and weak countries. It is essential to free its hand to concentrate on monetary policy again.
Mr Garnier: Most banks have reduced their vulnerabilities by strengthening their capital ratios. However, some countries need to restructure their banking systems further. This process, combined with the preparation for the new Basel III standards (including on the liquidity side), implies that bank credit growth will remain subdued in the coming years.
Mr Jiménez: So far [the European banking sector] has proved to be more resilient than many critics thought (except Ireland's). In any case, stress tests should help to dissipate any further doubts on this issue.
Mr Mayer: Unfortunately, Europe has not taken decisive steps to fortify its banks against further shocks. The upcoming stress tests should be used as an opportunity to wind down or recapitalise weak banks.
Mr Valli: The bulk of the sector is moving towards normalisation but a full recovery is not around the corner. First, there are still pockets of weakness (mostly in Ireland and Spain) that pose a systemic risk. Second, the sovereign debt crisis remains a key downside risk for the whole banking sector. Third, there is a large stock of bank debt due in the next 18 months and higher funding costs could put margins under pressure.
