Abstract
This paper starts from the observation that two groups of European countries, neither of which could use the exchange rate as an adjustment instrument, experienced a sudden stop after the outbreak of the global financial crisis. The first group comprises Greece, Ireland, Italy, Portugal and Spain, while four newer EU Member States with the exchange rate pegged to the euro, Bulgaria, Estonia, Latvia and Lithuania, belong to the second group. The main finding is that the adjustment was quicker outside EMU than inside. The shock absorber provided by the Eurosystem reduced the pressure for a quick adjustment, while foreign ownership of banks in non-euro area countries favoured quick fiscal and external corrections but also averted the legacy of a banking crisis. A rudimentary welfare comparison of the two patterns over the whole period of adjustment suggests that the ‘short and sharp’ correction approach is preferable in terms of macroeconomic outcome.
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Notes
- 1.
Among others see Giavazzi and Spaventa (2010) on the why macroeconomic imbalances matter.
- 2.
By 2002 the existing pegs were aligned to the euro. At the end of 2001, Estonia replaced the peg to the German mark with the euro. In 2002 Lithuania changed the anchor of the existing currency board to the euro. Latvia opted to maintain the peg to the SDR, but in 2002 the share of the euro was increased to 30 % of the basket (see Pettai and Zielonka 2003). Since 1997 Bulgaria has been in a regime of currency board, with the German mark as anchor until the introduction of the euro.
- 3.
Calvo et al. (2004) conclude that empirical evidence suggests that sudden stops in capital flows are typical of emerging market economies and accompanied by large real exchange rate fluctuations. A priori, within EMU the risk of sudden stops should have been zero. Yet reality seems to have been different.
- 4.
The sudden stop, and therefore the beginning of the crisis, does not coincide in the two groups of countries. In the BELL the flows dried up already in 2008, while in the EMU in 2010, after the Greek emergency.
- 5.
See for instance Merler and Pisani-Ferry (2012).
- 6.
Countries in the EMU share an important feature with most emerging economies: their governments borrow in international capital markets in a currency they do not control. Indeed, the ECB is not allowed to monetise government debt. While this removes the inflation risk, it increases the risk of default. See De Grauwe (2011).
- 7.
In fact, however, one difference still exists. In the case of a currency board, the country can break its commitment to keep the exchange rate fixed without causing any problems for the country to whom the currency had been pegged (the collapse of the peg of the Argentine peso to the US dollar had no impact on the confidence in the dollar). However, in the case of the euro, the exit of any country would have a profound impact on the other member states of the currency area.
- 8.
See Purfield and Rosenberg (2010).
- 9.
Italy is likely to be responsible for the large difference. It is the largest country in the GIIPS group in terms of GDP and the one with the slimmest inflows of capital.
- 10.
It is worth noting that the scales in the charts are different, for the BELL is six times than for the GIIPS
- 11.
By contrast there was no significant increase in Greece and even a fall in Italy and Portugal.
- 12.
Swedbank had almost 50 % of the market share alone (OECD 2011)
- 13.
European Commission 2013
- 14.
Moreover, the ECB was not alone in this; the creation of the European Financial Stability Facility (EFSF) and then its permanent version, the European Stability Mechanism (ESM) worked together with the IMF to provide emergency support when necessary. In fact, the non–euro area countries had only the IMF for such kind of support. The latter is supposed to intervene only to offer balance-of-payments assistance, the spectrum of action of the ESM and ECB is much more extensive than that.
- 15.
The ECB refinancing is not unlimited, it depends on collateral availability. However since the start of the crisis a sequence of changes in the eligibility criteria of collateral have loosen remarkably the restrictions for banks to access refinancing windows on full allotment basis.
- 16.
While this cannot be directly attributed to expansionary fiscal policies, which remained limited (the European Recovery Plan amounted to €200 billion, i.e. about 1.5 percentage points of the EU GDP over 2 years, 2009–10), the existence of important welfare support provisions in euro area countries and interventions aimed at the rescue of the banking sector are responsible for the large falls.
- 17.
This is due to the fact that Greece is a quite closed and low-competitive economy, see Alcidi and Gros (2012).
- 18.
See for instance Schiantarelli (2010) for a comprehensive survey of the literature on the impact of product market regulation on macroeconomic performance.
- 19.
Among others, see e.g. Bouis and Duval (2011).
- 20.
Barkbu et al. 2012 highlights that while structural reforms can lift growth over the medium and long term, their near-term impact on output and employment is likely to be modest or even negative. Reforms are likely to force reallocation of resources and restructuring, which may be costly in terms of higher unemployment and for society at large.
- 21.
OECD 2012: Going for Growth.
- 22.
One of the few available studies, De Resende (2007), argues that the welfare costs of an IMF program are associated with the adjustment foreseen by the programme itself through the conditionality, while the benefits are expected to materialise as consumption-smoothing made possible by the ability to borrow both from the IMF as well as from the private sector, boosted by the elimination of the default risk. Overall the paper finds small welfare gains.
- 23.
The rate of 5 % is set in quite arbitrary way but the ranking it implies is robust.
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Acknowledgments
The authors are grateful to the participants in the Ecfin Annual Research Conference on Economic Growth Perspectives and the Future of the Economic and Monetary Union and the anonymous reviewers for their valuable comments. The financial support of European Commission is gratefully acknowledged.
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Gros, D., Alcidi, C. Country adjustment to a ‘sudden stop’: does the euro make a difference?. Int Econ Econ Policy 12, 5–20 (2015). https://doi.org/10.1007/s10368-014-0286-7
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Keywords
- Country adjustment
- Imbalances
- Sudden stop
- Monetary union
JEL classification
- E20
- F32
- F36
- H60