ENSURING AN EuropEan RECOVERY

ENSURING AN EUROPEAN RECOVERY

Prakash Loungani Advisor, Research Department, IMF

Co-Chair, Jobs & Growth Working Group, IMF October 12, 2013

VIEWS EXPRESSED ARE THOSE OF THE PRESENTER AND SHOULD NOT BE ASCRIBED TO THE IMF .

I thank Ezgi Ozturk for excellent research assistance.

Outline

1. Recovery is here (fingers crossed)

2. Why did it take so long?• Comparison with Asian crisis countries• Comparison with previous global recoveries

3. How to keep it going

1. Recovery is here (fingers crossed)

4

World U.S.Euro Area Japan Brazil Russia India China

2013(Oct. 2013) 2.9 1.6 -0.4 2.0 2.5 1.5 3.8 7.6

2013(Jul. 2013) 3.1 1.7 -0.6 2.0 2.5 2.5 5.6 7.8

2014(Oct. 2013) 3.6 2.6 1.0 1.2 2.5 3.0 5.1 7.3

2014(Jul. 2013) 3.8 2.7 0.9 1.2 3.2 3.3 6.3 7.7

WEO Real GDP Growth Projections (percent change from a year earlier)

Source: IMF, World Economic Outlook. 8

The annual projections …

A closer look

2009 2010 2011 2012 2013 2014 2015

Euro area -4.4 2.0 1.5 -0.6 -0.4 1.0 1.4Germany -5.1 3.9 3.4 0.9 0.5 1.4 1.4France -3.1 1.7 2.0 0.0 0.2 1.0 1.5Italy -5.5 1.7 0.4 -2.4 -1.8 0.7 1.1Spain -3.8 -0.2 0.1 -1.6 -1.3 0.2 0.5

Source: IMF, World Economic Outlook database.

Euro Area and Selected European Countries: GDP Growth(Percent)

A dire unemployment situation

A lost generation?

Correlation between Change in Unemployment and Change in GDP

(2012, in percent)

-8 -6 -4 -2 0 2 4-3

-2

-1

0

1

2

3

4

5

6

7Euro Area

Real GDP Growth

Cha

nge

in U

nem

ploy

men

t Rat

e

2. Why did it take so long?

Europe had worse initial fiscal position than Asian crisis countries

0 20 40 60 80 100 120 140

-14.0

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

2.43.0 2.7

-10.4

-12.5

-7.5

General government debt (% of GDP)

Fisc

al b

alan

ce (a

s % o

f GDP

)

Data for Asian and European countries is for respectively 1996 and 2009.

Asia adjusted more via exchange rates, Europe via domestic adjustment

-6 -4 -2 0 2 4 6 8 10 12-55

-45

-35

-25

-15

-5

5

-51.1

-24.0

-13.7

-2.5-4.6

-0.5

Fiscal adjustment (% of GDP)

REER

adj

ustm

ent

REER adjustment measured over 1997-98 for Asian countries and 2010-12 for European countries. Fiscal adjustment measured as change in fiscal balance between 1996-2000 for Asian countries and 2009-2012 for European countries.

EUR access higher in % quota but not in % of financing needs

0 500 1000 1500 2000 2500 3000 35000.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.047.5

43.7

8.47.1

11.9

2.6

14.2

IMF financing as % of Quota

IMF

finan

cing

as

% o

f gro

ss fi

nanc

ing

need

s

Financing needs comprise current account balance and short-term debt (at remaining maturity). For Korea, short-term debt is on a

maturity basis. The first Greek program (GRC1) was not fully disbursed.

Asia rebounded faster

t-1 t t+1 t+2 t+3 t+485

90

95

100

105

110

Eurozone program countries Asian program countries

Real

GDP

leve

l, cr

isis s

tart

= 1

00

Simple group averages of real GDP levels

A Recovery on Track? World Real GDP per capita

Notes: Dashed lines denote WEO forecasts. Indexed to 100 in the year before global recession. Zero is the time of the global recession year. Each line show the PPP-weighted average of the countries in the sample.

Figure 1. Real GDP Per Capita(index, PPP weighted)

80

90

100

110

120

130

-4 -3 -2 -1 0 1 2 3 4

World

Global Recession Year

Average of previous recoveries

Recovery from the Great Recession

The Divergence in Recoverybetween Advanced Countries and Emerging Markets

Figure 2. Real GDP per Capita: Advanced Countries and Emerging Markets

Notes: Dashed lines denote WEO forecasts. Indexed to 100 in the year before global recession. Zero is the time of the global recession year. Each line show the PPP-weighted average of the countries in the respective group.

(index, PPP weighted)

80

90

100

110

120

130

-4 -3 -2 -1 0 1 2 3 4

Advanced Countries

Global Recession YearAverage of previous recoveries

80

90

100

110

120

130

-4 -3 -2 -1 0 1 2 3 4

Emerging Markets

Recovery from the Great Recession

Divergence in Government Spending between this Global Recovery and Past Global Recoveries

Notes: Dashed lines denote WEO forecasts. Indexed to 100 in the year before global recession. Zero is the time of the global recession year. Each line show the PPP-weighted average of the countries in the respective group.

Figure 3. Real Primary Expenditure(index, PPP weighted)

60

90

120

150

-4 -3 -2 -1 0 1 2 3 4

Advanced Countries

Average of previous recoveries

60

90

120

150

-4 -3 -2 -1 0 1 2 3 4

Emerging Markets

Recovery from the Great Recession

Divergence in Government Spending between this Global Recovery and Past Global Recoveries:

US and Euro Area

Deleveraging

3. How to keep it going

The (overloaded) policy agenda• Banking union

• Macro policies– Fiscal– Monetary

• Labor market & structural policies

**• External conditions

– US monetary policy actions– Emerging market growth

Banking union

• Ongoing reforms should be expedited, including a final agreement on the Bank Recovery and Resolution and Deposit Guarantee Scheme (DGS) Directives by the European Parliament.

• European partners should agree on a strong resolution mechanism based on a centralized authority, supported by a common fiscal backstop, with powers to trigger resolution and make decisions on burden-sharing to ensure timely and least-cost resolution.

Fiscal policy• Fiscal consolidation inevitable in high-debt countries, but

it also reduces short-term growth. Getting the pace and composition of consolidation right is therefore essential.

• The pace and composition of adjustment should be attuned to country circumstances.

– Pace: Where financing allows, adjustment should be conducted at a gradual pace that balances the need to reduce structural deficits against that of not undermining the recovery, and automatic stabilizers should be allowed to operate.

– Composition: The expenditure and revenue mix in adjustment plans should be calibrated to reduce negative short-term effects on economic activity, while enhancing long-term growth prospects and protecting the most vulnerable.

• Fiscal adjustment should be based on credible medium-term plans.

Monetary policy

• Forward guidance that rates will remain low

• But also dependent on US monetary policy actions

25

Jan. 2013

2013m2

Mar. 13

2013m4

May 13

2013m6

Jul. 13 2013m8

Sep. 13

1.0

1.5

2.0

2.5

3.0

GDP growth in 2013

GDP growth in 2014

10-year government bond yields

Government Bond Yields and GDP Growth From Consensus Forecast (percent

2006 07 08 09 10 11 12 134

5

6

7

8

9

10

44

45

46

47

48

49

50

Unemployment rate (left scale)

Employment as percent of popula-tion

Unemployment Rate(percent)

Sources: Bloomberg, L.P., Consensus Forecast; and IMF staff estimates.

May 22, 2013

US conditions

26

3908401/08/200701/12/200701/18/200701/24/200701/30/200702/05/200702/09/200702/15/200702/21/200702/27/200703/05/200703/09/200703/15/200703/21/200703/27/200704/02/200704/06/200704/12/200704/18/200704/24/200704/30/200705/04/200705/10/200705/16/200705/22/200705/28/200706/01/200706/07/200706/13/200706/19/200706/25/200706/29/200707/05/200707/11/200707/17/200707/23/200707/27/200708/02/200708/08/200708/14/200708/20/200708/24/200708/30/200709/05/200709/11/200709/17/200709/21/200709/27/200710/03/200710/09/200710/15/200710/19/200710/25/200710/31/200711/06/200711/12/200711/16/200711/22/200711/28/200712/04/200712/10/200712/14/200712/20/200712/26/200701/01/200801/07/200801/11/200801/17/200801/23/200801/29/200802/04/200802/08/200802/14/200802/20/200802/26/200803/03/200803/07/200803/13/200803/19/200803/25/200803/31/200804/04/200804/10/200804/16/200804/22/200804/28/200805/02/200805/08/200805/14/200805/20/200805/26/200805/30/200806/05/200806/11/200806/17/200806/23/200806/27/20080807/09/200807/15/200807/21/200807/25/200807/31/200808/06/200808/12/200808/18/200808/22/200808/28/200809/03/200809/09/200809/15/200809/19/200809/25/200810/01/200810/07/200810/13/200810/17/200810/23/200810/29/200811/04/200811/10/200811/14/200811/20/200811/26/200812/02/200812/08/200812/12/200812/18/200812/24/200812/30/200801/05/200901/09/200901/15/200901/21/200901/27/200902/02/200902/06/200902/12/200902/18/200902/24/200903/02/200903/06/200903/12/200903/18/200903/24/200903/30/200904/03/200904/09/200904/15/200904/21/200904/27/200905/01/200905/07/200905/13/200905/19/200905/25/200905/29/200906/04/200906/10/200906/16/200906/22/200906/26/200907/02/200907/08/200907/14/200907/20/200907/24/200907/30/200908/05/200908/11/200908/17/200908/21/200908/27/200909/02/200909/08/200909/14/200909/18/200909/24/200909/30/200910/06/200910/12/200910/16/200910/22/200910/28/200911/03/200911/09/200911/13/200911/19/200911/25/200912/01/200912/07/200912/11/200912/17/200912/23/200912/29/200901/04/201001/08/201001/14/201001/20/201001/26/201002/01/201002/05/201002/11/201002/17/201002/23/201003/01/201003/05/201003/11/201003/17/201003/23/201003/29/201004/02/201004/08/201004/14/201004/20/201004/26/201004/30/201005/06/201005/12/201005/18/201005/24/201005/28/201006/03/201006/09/201006/15/201006/21/201006/25/201007/01/20101007/13/201007/19/201007/23/201007/29/201008/04/201008/10/201008/16/201008/20/201008/26/201009/01/201009/07/201009/13/201009/17/201009/23/201009/29/201010/05/201010/11/201010/15/201010/21/201010/27/201011/02/201011/08/201011/12/201011/18/201011/24/201011/30/201012/06/201012/10/201012/16/201012/22/201012/28/201001/03/201101/07/201101/13/201101/19/201101/25/201101/31/201102/04/201102/10/201102/16/201102/22/201102/28/201103/04/201103/10/201103/16/201103/22/201103/28/201104/01/201104/07/201104/13/201104/19/201104/25/201104/29/201105/05/201105/11/201105/17/201105/23/201105/27/201106/02/201106/08/201106/14/201106/20/201106/24/201106/30/201107/06/201107/12/201107/18/201107/22/201107/28/201108/03/201108/09/201108/15/201108/19/201108/25/201108/31/201109/06/201109/12/201109/16/201109/22/201109/28/201110/04/201110/10/201110/14/201110/20/201110/26/201111/01/201111/07/201111/11/201111/17/201111/23/201111/29/201112/05/201112/09/201112/15/201112/21/201112/27/201101/02/201201/06/201201/12/201201/18/201201/24/201201/30/201202/03/201202/09/201202/15/201202/21/201202/27/201203/02/201203/08/201203/14/201203/20/201203/26/201203/30/201204/05/201204/11/201204/17/201204/23/201204/27/201205/03/201205/09/201205/15/201205/21/201205/25/201205/31/201206/06/201206/12/201206/18/201206/22/201206/28/201207/04/20121207/16/201207/20/201207/26/201208/01/201208/07/201208/13/201208/17/201208/23/201208/29/201209/04/201209/10/201209/14/201209/20/201209/26/201210/02/201210/08/201210/12/201210/18/201210/24/201210/30/201211/05/201211/09/201211/15/201211/21/201211/27/201212/03/201212/07/201212/13/201212/19/201212/25/201212/31/201201/04/201301/10/201301/16/201301/22/201301/28/201302/01/201302/07/201302/13/201302/19/201302/25/201303/01/201303/07/201303/13/201303/19/201303/25/201303/29/201304/04/201304/10/201304/16/201304/22/201304/26/201305/02/201305/08/201305/14/201305/20/201305/24/201305/30/201306/05/201306/11/201306/17/201306/21/201306/27/201307/03/201307/09/201307/15/201307/19/201307/25/201307/31/201308/06/201308/12/201308/16/201308/22/201308/28/201309/03/20139/9/20139/13/20139/19/20130

1

2

3

4

5

6

7

Germany

United States

U.S. average 30-year fixed rate

mortgage

Key Interest Rates 2/(percent)

Sep.13

t 1 Month

2 Months

3 Months

4 Months

5 Months

6 Months

7 Months

8 Months

9 Months

10 Months

11 Months

t+12

13 Months

14 Months

15 Months

16 Months

17 Months

18 Months

19 Months

20 Months

21 Months

22 Months

23 Months

t+24

25 Months

26 Months

27 Months

28 Months

29 Months

30 Months

31 Months

32 Months

33 Months

34 Months

35 Months

t+36

0

0.1

0.2

0.3

0.4

0.5

0.6

United States

Europe

Policy Rate Expectations 1/(percent; months on x-axis; dashed lines are from the April 2013 WEO)

Source: Bloomberg, L.P. 1/ Expectations are based on the federal funds rate for the United States, the sterling overnight interbank average rate for the United Kingdom, and the euro interbank offered forward rate for Europe; updated September 24, 2013.2/ Interest rates are 10-year government bond yields unless noted otherwise.

Impact on Europe from US developments

27

Global aggregates: Headline Inflation(year-over-year percent change; dashed lines are the six-to-ten-year inflation expectations)

But inflation pressures are very low. Thus, our WEO assumes that monetary policy stays very accommodative in advanced economies.

-2

-1

0

1

2

3

4

5

6

Euro area United States

Sources: Consensus Forecast; and IMF staff estimates.

Inflation and inflation expectations remain subdued

14:Q4

Getting macro right will help labor markets

• “There is sometimes the naïve belief that unemployment must be due to a defect in the labor market, as if the hole in a flat tire must always be at the bottom, because that is where the tire is flat” (Solow, 2000).

• "It takes a heap of Harberger triangles to fill an Okun's gap.” (Tobin, 1977)

Framework

Large increase in unemployment in advanced economies during the crisis– Cyclical or structural unemployment?– How to achieve the relative price adjustment in

periphery Euro countries?– Can labor market reforms reduce the natural

unemployment rate and raise potential growth?

Staff Discussion Note (Blanchard, Jaumotte, Loungani) looks at IMF advice in this light

29

• Initial increase cyclical rather than structural

• Greater uncertainty about relative proportions now, but remains largely cyclical in our view

• Beveridge curve quite stable; moreover shifts may not be sign of increase in natural rate (Diamond 2013)

• Other measures of mismatch back to normal• Lack of deflation not a sign of small unemployment

gap

• Stability of Okun’s Law (even during the Great Recession) suggests jobs will return if the growth returns.

• Hence focus of IMF policy recommendations remains on getting growth back

Unemployment during the Great Recession

30

“Labor Market Flexibility”: Moving Beyond Mantras

• Extension of unemployment benefits• Iceland, Greece• But reduction in Portugal

• Targeted interventions to help some groups • Youth; Low-skilled; Long-term unemployed (see chart that

follows)

• Move away from duality• Too late to stop layoff of temporary workers• But reduction in employment protection on permanent

contracts could help hiring as recovery takes hold

Recommendations: Labor Market Policies

32

‘Recovery’ differs across groups

33

90.0

95.0

100.0

105.0

110.0

115.0

Youth (aged 15-24) Older workers (aged 55-64)

Low-skilled (aged 25-64) High-skilled (aged 25-64)

Ratio of each group's employ ment relativ e to ov erall employ ment, a OECD av erage, b 2008 Q1-2011 Q4, index = 100 at the start of the

crisis

• In some Euro area countries, need reduction in relative wages

• Best way to achieve would be through national tripartite agreement

• Experience of Latvia, Ireland, Greece

• Without such an agreement• More flexibility in wage-setting • Reduction in public sector wages• Reduction in minimum wage• Fiscal devaluations

• Higher inflation in North relative to South

Competitiveness

34

• Higher potential growth and lower natural rate of unemployment desirable

• Product market reforms– essential for medium-run but can hurt in the short-run

• Labor market reforms– move away from duality– more flexible wage-setting– Reduce tax distortions to raise participation, particularly for

females– Raising retirement age and adjusting benefits to raise participation

of older workers

Medium-run Growth

35