Europe and Finland – 20 years of Monetary Union Turku Europe Forum 30 August 2018 Intervention of Francesco Papadia Mistakes
Irrend lernt man (Learning through mistakes) Johann Wolfgang von Goethe 2
• Rome Mistakes • Italian fiscal policy 1965-1994 • Italian monetary policy 1972-1995 • Squandering the € bonus 1995-2007 • Frankfurt/Brussels mistakes • ECB interest rate increases in 2011 • Euro-area fiscal policy in 2011-2014 • German current account surplus 2000-2018 Six mistakes: 3 in Rome and 3 in Frankfurt/Brussels 3
Italian fiscal policy 1965-1994 Fiscal deficit and Government debt. Ratio to GDP. 1965-2005 . 140 16 14 120 12 100 10 % GDP 80 % GDP 8 60 6 40 4 20 2 0 0 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Gross Debt Net borrowing (rhs) Rome Mistakes I 4
• Italian monetary policy 1972-1995 Rome Mistakes II 5
An unrelenting devaluation of the lira. 1965-1998. Bretton Woods Snake in the ERM I-II 1200 tunnel 600 LIT/DM 300 150 1965 1965 1966 1967 1968 1968 1969 1970 1971 1971 1972 1973 1974 1974 1975 1976 1977 1977 1978 1979 1980 1980 1981 1982 1983 1983 1984 1985 1986 1986 1987 1988 1989 1989 1990 1991 1992 1992 1993 1994 1995 1995 1996 1997 1998 1998 exchange rate DM/LIT +2 S.D. -2 S.D. Rome Mistakes II 6
• High and unstable inflation and interest rates. 1965-1998. 16 Snake in the tunnel Bretton Woods ERM I-II 14 12 10 8 bps 6 4 2 0 -2 -4 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Int. rate spread Italy-Germany Inflation Germany Infl. Diff. Italy-Germany Rome Mistakes II 7
• Trend decrease of growth. 1960-2018. • Trend increase of unemployment. 1960-2018. 15 10 % 5 0 Pre € € -5 -10 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Growth of GDP per capita Unemployment rate Rome Mistakes II 8
• Squandering the € fiscal bonus • Primary surplus/deficit as a ratio of GDP. 1990 – 2017. 7 6 5 4 3 % GDP 2 1 0 -1 -2 -3 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Rome Mistakes III 9
• Squandering the € fiscal bonus • Debt to GDP ratio. 1990-2017. 140 130 120 110 % 100 90 80 70 60 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Rome Mistakes III 10
• Squandering the € bonus • Perfect interest convergence, imperfect inflation convergence • Differentials between Italian and German expected inflation and 10-year government bond yields. 1985 – 2017. 8 7 Great Moderation Stability period Great Recession Whatever it takes 6 5 4 % 3 2 1 0 -1 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 spread inflation differential Rome Mistakes III 11
• Squandering the macroeconomic bonus • Unemployment and economic growth in Italy. 1960-2018. 15 10 % 5 0 Pre € € -5 -10 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Growth of GDP per capita Unemployment rate Rome Mistakes III 12
• ECB interest rate increases 2011 • A surprising move • Effective Federal Fund Rate and MRO rate. 2008 – 2015 . 4.5 4.0 3.5 3.0 2.5 % 2.0 1.5 1.0 0.5 0.0 2008 2009 2010 2011 2012 2013 2014 2015 EFFR MRO Frankfurt/Brussels mistakes I 13
• With difficult to find motivations • With hindsight • With real-time information Frankfurt/Brussels mistakes I 14
• Euro-area fiscal policy 2011-2014 • A Diamond-Dybvig interpretation • Liquidity and solvency • An aggregate countercyclical fiscal policy Frankfurt/Brussels mistakes II 15
• And instead • Just coinciding with a serious recession • Output gap in the euro area, 2010-2019. 2 1 % 0 -1 -2 -3 -4 2010 2011 2012 2013 2014 2015 2016 2017 2018* 2019* European Commission IMF - WEO OECD Frankfurt/Brussels mistakes II 16
• And instead • A strong pro-cyclical fiscal policy 2.0 2.0 1.5 1.0 % potential GDP % potential GDP 1.0 0.0 0.5 -1.0 0.0 -2.0 -0.5 -3.0 -1.0 -4.0 2011 2012 2013 2014 2015 2016 2017 2018 2019 SPB OG Frankfurt/Brussels mistakes II 17
• German current account 2000-2018 • Exceptionally high and persistent • Too high and persistent, according to the IMF and the EU Commission • Caused by too low investment and too low wages • An insouciant attitude? Frankfurt/Brussels mistakes III 18
• Two unanswered questions • Genuine mistakes or something else? • Worse South or North of the Alps? Symmetric mistakes 19
• My Alpine/Suomi tenets: • Insufficient (excessive) demand should be countered by countercyclical policies • Histeresis and super histeresis can make recessions very damaging • Shifts from “good” to “bad” equilibria require liquidity and solvency measures • Sustainable fiscal policies and stability oriented monetary policy favour growth and welfare • Long term growth and welfare depend on appropriate structural policies Setting in the Alps, or maybe in Finland 20
• Are my tenets trivial or unattainable? Or both? • Will we be able not to repeat the same old mistakes? Conclusions 21
Lower real rates as macroeconomic 22 bonus
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