Getting the Story Right
HOW YOU SHOULD CHOOSE BETWEEN DIFFERENT INTERPRETATIONS OF THE E UROPEAN CRISIS (AND WHY YOU SHOULD CARE)
ERIK JONES
JOHNS HOPKINS UNIVERSITY SAIS AND NUFFIELD COLLEGE
The European crisis is over-determined
The e a e at least fou expla atio s fo Eu ope’s ece t c isis
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The euro was a mistake
Governments wasted money and borrowed excessively
Households lived beyond their means
Market participants (banks, investors) got startled and lost confidence
These explanations are complementary and not competitive
◦ They can all be true at the same time
◦ They are (often) reinforcing
◦ The presences of one factor can repair the absence of another
Over-determination is a problem
It distorts data collection
◦ Stop at confirmatory data
◦ Ignore differences between cases
◦ Exclude cases
It obscures causal mechanisms
◦ Imbues symptoms with causal significance
◦ Complicates tests for necessity, sufficiency, and sequencing
◦ Result is a loss of leverage and therefore also control
The European response is underpowered
Solutions compete even if interpretations do not
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Political attention (cherry-picking)
Burden sharing (winners and losers)
Economic outcomes (reinforcing, negating)
Timing (inside and outside lags)
Muddling through is risky
◦ Mistakes happen (Cyprus)
◦ Key actors run out of room for manoeuvre (ECB)
◦ Structural damage accumulates (lost generation)
How do we assign priority?
Three-fold test
◦ Necessity – does the condition exist in every case of crisis?
◦ Sufficiency – does the condition exist in any case of non-crisis?
◦ Sequencing – does the condition come before or after the crisis?
Confirmation strategy
◦ Standard causal pattern – does the causality look familiar?
◦ Fair causal comparison – can the argument explain more variation?
◦ Leverage – does the argument point to a policy response?
Necessity
Were there countries outside the euro that got into trouble? [Iceland, UK, Hungary, Latvia]
Were there countries that got into trouble without excessive government borrowing? [Ireland,
Spain, Portugal]
Were there countries that got into trouble without excessive household leverage? [Greece, Italy]
Were there countries that got into trouble without a sudden loss of confidence from market
participants? [tautology – see sequencing]
Sufficiency
Were there countries in the euro area that escaped attention? [Luxembourg, Malta]
Were there countries that managed high public debt? [Belgium]
Were there countries that got away with high household leverage? [Denmark, Netherlands]
Were their countries that lost market confidence without falling into crisis? [Belgium; Vienna
Initiatives 1 and 2]
Household Debt (percent GDI, OECD)
Sequencing – focus on capital flight
Does a rise in the current account deficit precede a flight of capital? [Ireland]
Does a rise in government borrowing precede a flight of capital? [Greece]
Does a rise in household borrowing precede a flight of capital? [Italy]
Does a flight of capital undercut competitiveness, government finances, and household
balances?
0
-20000
-40000
-60000
-80000
-100000
-120000
-140000
-160000
Jan-03
Apr-03
Jul-03
Oct-03
Jan-04
Apr-04
Jul-04
Oct-04
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Ireland
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
Jul-12
Oct-12
Jan-13
Apr-13
Jul-13
Oct-13
Current account and capital flight
(Ireland)
Euro Millions
Fiscal balance and capital flight (Greece)
3,50
Greek-German 10-year sovereign yield spread
3,00
Percentage Points
2,50
2,00
1,50
1,00
0,50
0,00
IHS Global Insight
Jan-04
Apr-04
Jul-04
Oct-04
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Italy
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
Jul-12
Oct-12
Jan-13
Apr-13
Jul-13
Oct-13
150000
Oct-03
100000
Jul-03
50000
Apr-03
0
-50000
-100000
-150000
-200000
-250000
-300000
-350000
Jan-03
Household leverage and capital flight
(Italy)
Euro Millions
Sudde Stop as sta dard causal pattern
Basic mechanism familiar to students of balance of payments crises
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Capital market liberalization
Gradual increase in cross-border capital flows
Accumulation of cross-border asset positions
Shock to confidence
Liquidation and flight
Few e ui e e ts Occa ’s Razo
◦ No specific exchange rate regime
◦ No specific banking structure
◦ No necessary government or household balances
Sudde Stop versus Co petitive ess
Some of these countries were both flexible and competitive: Ireland
Others were inflexible and yet oddly successful in world markets: Italy
Still others were more successful than you might suspect: Greece
Meanwhile, there were countries that had worse competitiveness problems prior to the crisis in
terms of world market shares and manufacturing employment.
World market shares
World Export Market Shares (AXGT)
12,0
11,0
Percent
10,0
9,0
8,0
7,0
6,0
1991
1992
1993
1994
1995
1996
1997
1998
Germany
1999
2000
PC5
USNDS
2001
2002
2003
2004
2005
2006
2007
Manufacturing employment
Employment in Manufacturing (NETM)
11000
10000
Thousands
9000
8000
7000
6000
5000
4000
1991
1992
1993
1994
1995
1996
1997
1998
Germany
1999
PC5
2000
USNDS
2001
2002
2003
2004
2005
2006
2007
Sudde Stop versus Gover
Fi a ces
e t
The question is solidarity as much as sustainability: Greece
There is also a consideration of who holds the debt: Italy
Finally, there is the question of whether you can reassure market participants: Belgium
Solidarity and sustainability
7,00
Greek-German Interest Rate Differential
6,00
5,00
Percent
4,00
December European Council
3,00
March European Council
First Greek Restatement
February European Council
2,00
Van Rompuy Calls for Special Council
1,00
Second Greek Restatement
0,00
01.07.2009
01.08.2009
01.09.2009
01.10.2009
01.11.2009
01.12.2009
Date
01.01.2010
01.02.2010
01.03.2010
01.04.2010
Global Insight
Sudde Stop versus Household
Leverage
Here I have some trouble – particularly with Ireland, Spain and Portugal
The question is whether household borrowing is cause or effect?
Really this is two questions:
◦ Is it easier to make a country borrow or to make it lend?
◦ Do countries that borrow have an adverse selection problem when lending?
Prioritizi g Sudde Stops
Positive Agenda
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Outright Monetary Transactions (OMT)
Banking union
Comprehensive assessment
Mutualized sovereign debt obligations (common risk-free asset)
Negative Agenda
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Renationalization of finance
More conservative fiscal policy
Tighter restrictions on household balances
[NB: Competitive labour and product reforms may be useful for other reasons but are largely irrelevant
in this context.]