The Future of the Eurozone: Right and Wrong Turns On the Way Ahead Gabriel Glöckler Deputy Head of the EU Institutions Division European Central Bank Central.

The Future of the

Eurozone:

Right and Wrong Turns

On the Way Ahead Gabriel GlöcklerDeputy Head of the EU Institutions DivisionEuropean Central Bank

Central European University, Budapest, 24 March 2011

2

Outline

• The Untenable Status Quo– Succession of crises– Market and policy failure

• The Right Turns– Make fiscal consolidation a priority– Be serious about reinforcing governance

• The Wrong Turns– Default/restructuring are not the easy

options they may seem– What to do instead

• The Way Ahead

What future for the Eurozone?

3

Outline

• The Untenable Status Quo

• The Right Turns

• The Wrong Turns

• The Way Ahead

4

The crisis unfolds

5

Source: Eurostat, European Commission Autumn 2010 forecast

Dramatic impact on growth and employment

6

Public interventions in the banking sector

7

Situation is difficult worldwideGeneral government gross debt

(as a percentage of GDP)

Source: IMF WEO October 2010

0

50

100

150

200

250

Euro area UnitedStates

Japan UnitedKingdom

2007 2015

General government deficit(as a percentage of GDP)

Source: IMF WEO October 2010

0

2

4

6

8

10

12

14

Euro area UnitedStates

Japan UnitedKingdom

2007 2009

8

…though the crisis is only partially responsible…

9

May 2010: the sovereign debt crisis escalates

10

Non-linear market reactions & contagion effects

Spread over 10-year German government bond yield, in basis points

11

0

500

1000

1500

2000

2500

3000

Jan '10 Feb '10 Mar '10 Apr '10 May '10 Jun '10 Jul '10 Aug '10

Trading volumes in Greek government bonds(1 Jan - 23 Aug 2010; EUR mil, daily data)

Sources: Bank of Greece.Notes: Volumes traded on Secondary Market Platform run by the Bank of Greece (HDAT).

… a sudden stop in certain bond markets…

12

Daily changes in bond prices, in percentages

… leading to widespread market dysfunction

13

Systemic risk at all time high

Percentages, probability of default

Notes: Probability of simultaneous default of two euro area LCGBs, Source: Bloomberg, ECB calculations

14

0100200300400500600700800900

10001

6 A

pr

20

Ap

r

24

Ap

r

28

Ap

r

02

May

06

May

10

May

14

May

18

May

22

May

26

May

30

May

03

Ju

n

07

Ju

n

11

Ju

n

15

Ju

n

19

Ju

n

23

Ju

n

27

Ju

n 01002003004005006007008009001000

Greece

Ireland

Portugal

Spain9

10

11

12

1314

15

16

17

18

2019

21

9. April 22: Moody’s downgrades Greece for 2nd time in 2010. German MP Schaeffler says Greece should be prepared to leave the euro if it can’t push through enough austerity measures. 10. April 23: Greece requests activation of euro area/IMF support – EU says terms of aid may be agreed in a matter of days, Merkel says Greeks must satisfy stringent conditions. 11. April 26-27: Merkel says no agreement to support until Greece shows credible plan for a sustainable deficit reduction - “Germany will help when the correspondent conditions are fulfilled”. Standard & Poor’s downgrades Greece’s long-term credit rating to junk. 12. April 29-30: Loan programme for Greece announced to be concluded within days. Greece adopts €24 billion austerity package; Merkel confident it will keep the euro stable. 13. May 1: Merkel says EU should be able to temporarily revoke voting rights from member states who violate deficit rules. 14. May 2-3: €110 billion euro area-IMF support package for Greece adopted. ECB relaxes collateral policy for Greek sovereign debt. 15. May 7: German Parliament approves law to release funds (€22.4 billion) to Greece. 16. May 10: EU stabilisation mechanism adopted (€500 billion from euro area and EU; €250 from the IMF). ECB adopts Securities Markets Programme and reactivates US dollar swap lines with the Federal Reserve. German Constitutional Court refuses to block support package for Greece. 17. May 15-16: Merkel: “if euro fails, more fails”. Germany calls for more stringent euro area fiscal framework based on German model. 18. May 18: Germany adopts ban on short-selling. 19. June 7: Euro area ministers establish the €440 billion SPV (the European Financial Stability Facility) envisaged in the May 10 package. 20. June 14: Moody’s downgrades Greek sovereign debt to junk. 21. June 17: EU leaders decide that detailed results of stress tests on the health of 25 big European banks be made public.

Problematic feedback loops of politics markets Government bond spreads against German Bund in basis points – based on Carmassi & Micossi (2010) on voxeu.org

15

Latest observations: 25 July 2010.Source: ECB.

-400-300-200-100

0100200300400500600700800900

1000

Sep 09 Oct 09 Nov 09 Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10-400-300-200-10001002003004005006007008009001000

MRO + 6-day FTO 1-MP STROs 3-month LTROs

6-month LTROs 1-year LTRO CBPP and SMP

Recourse to DF FTO Absorbing Liquidi ty needs

New monetary policy decisions (€ billions, daily data)

16

European financial assistance for Greece

17

European Financial

Stability Facility (EFSF - €440bn.)

European Financial Stabilisation

Mechanism (EFSM – € 60bn)

Complementary IMF

financing (2:1 basis)

ECOFIN/Eurogroup decisions of 9 May 2010

A financial stability safety net in Europe

18

1. Failure of market discipline– Presumption of rational behaviour

– Expectation of enforcement of rules in a rule-based system

– Solidarity vs. ‘no bail-out’ clause

2. Failure of fiscal policy framework– Principle of “non-interference”

– Reluctance to give warnings and follow-up on recommendations

– Weak enforcement by Commission, Eurogroup and EU Council

3. Lack of a competitiveness framework– Lisbon Strategy did not deal with divergences

– Eurogroup processes informal

– Lack of overall coherence

The EU economic crisis – what went wrong?

19

Table 1: Compliance with the preventive arm of the Stability and Growth Pact (as a percentage of GDP) indicates budgetary position close to balance or in surplus prior to 2005 and compliance with medium-term objective thereafter indicates compliance with minimum benchmark only indicates non-compliance with minimum benchmark

General government structural net lending (+)/borrowing (-)

MB MTO 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Belgium -1.3 0.5 -0.6 -0.8 -0.9 0.1 -0.1 -1.1 -0.9 -0.2 -0.6 -0.3 Germany -1.6 BB -1.9 -1.3 -1.9 -3.4 -3.6 -3.3 -3.0 -2.4 -1.4 -0.3 Ireland -1.5 CTBOIS 2.0 1.5 3.0 -0.2 -1.7 -0.1 2.1 1.3 2.9 0.2 Greece -1.4 BB -3.3 -2.6 -3.3 -4.9 -4.7 -5.9 -8.0 -5.7 -3.7 -3.5 Spain -1.2 BB -3.1 -1.7 -1.9 -1.4 -0.9 -0.3 -0.2 1.2 2.0 2.4 France -1.6 BB -2.4 -2.1 -2.6 -2.5 -3.5 -4.0 -3.8 -3.6 -2.7 -2.7 Italy -1.4 BB -2.5 -1.6 -2.9 -4.1 -3.4 -5.1 -4.7 -4.5 -2.8 -1.5 Cyprus -1.8 BB -3.7 -4.5 -3.1 -3.4 -5.1 -8.1 -5.2 -2.8 -0.7 3.5 Luxembourg -1.0 -0.8 4.3 3.0 4.0 5.3 1.6 1.2 -0.9 0.4 1.4 2.8 Malta -1.7 BB -10.3 -8.5 -7.8 -6.5 -5.8 -6.5 -4.2 -4.1 -2.9 -2.4 Netherlands -1.1 -1 to -0.5 -1.3 -0.8 -0.4 -1.3 -1.9 -2.0 -1.1 0.8 1.1 0.3 Austria -1.6 BB -2.5 -2.8 -3.0 -0.3 -0.3 -0.6 -3.1 -0.8 -1.4 -1.0 Portugal -1.5 -0.5 -3.8 -3.5 -4.5 -5.4 -3.4 -4.7 -4.9 -5.2 -3.2 -2.2 Slovenia -1.6 -1.0 -2.5 -2.4 -4.1 -4.5 -2.2 -1.9 -1.6 -0.9 -1.3 -0.7 Finland -1.2 2.0 0.6 0.6 5.2 4.0 4.1 3.3 2.9 3.7 4.2 4.9 Euro area -2.1 -1.6 -2.0 -2.6 -2.7 -3.1 -2.9 -2.2 -1.2 -0.7

Poor compliance with SGP targets

20

Unit labour costs in selected euro area countries, nominal(index 2000Q4 = 100, relative to Germany, based on sa data)

Source: Eurostat. Quarterly data up to 2010 Q1 for EA, GR, IT, ES, FI, BE, FR; 2009Q4 for NL and AT; 2009Q3 for IE; PT is based on

annual data (up to 2009).

Note: The ULC indices are set to 100 in the last quarter before the euro area accession of Greece.

The ULC developments presented for Greece and Portugal might differ from the calculations made by the National Central Banks.

The quarterly pattern in Greek ULC is affected by substantial volatility in quarterly compensation of employees figures.

95

100

105

110

115

120

125

130

135

2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1

95

100

105

110

115

120

125

130

135

Germany France Italy SpainNetherlands Belgium Austria GreeceIreland Finland Euro area Portugal

Table 2: Compliance with the corrective arm of the Stability and Growth Pact (as a percentage of GDP)

indicates a deficit ratio below the 3% reference value (a debt ratio below the 60% reference value)

indicates a deficit ratio above the 3% reference value which was not recognised as excessive in the following year (usually because the deficit was revised upwards ex post)

indicates a deficit ratio above 3% of GDP which was recognised as excessive in the following year (a debt ratio above 60%)

General government:

Net lending (+)/borrowing (-) Gross debt 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1998 2007

Belgium -0.9 -0.5 0.1 0.4 0.0 0.0 0.0 -2.3 0.3 -0.2 117.1 84.8 Germany -2.2 -1.5 -1.1 -2.8 -3.7 -4.0 -3.8 -3.4 -1.6 0.0 60.3 65.0 Ireland 2.4 2.7 4.7 0.9 -0.6 0.4 1.4 1.6 3.0 0.3 54.0 25.5 Greece -3.9 -3.1 -3.7 -5.0 -4.7 -5.6 -7.4 -5.1 -2.6 -2.8 105.8 94.5 Spain -3.2 -1.4 -1.1 -0.6 -0.5 -0.2 -0.3 1.0 1.8 2.2 64.1 36.2 France -2.6 -1.8 -1.5 -1.6 -3.2 -4.1 -3.6 -2.9 -2.4 -2.7 59.4 63.9 Italy -2.8 -1.7 -2.0 -3.1 -2.9 -3.5 -3.5 -4.2 -3.4 -1.9 114.9 104.0 Cyprus -4.1 -4.3 -2.3 -2.2 -4.4 -6.5 -4.4 -2.4 -1.2 3.3 58.4 59.8 Luxembourg 3.4 3.4 6.0 6.1 2.1 0.5 -1.2 -0.1 1.3 2.9 7.4 6.9 Malta -9.9 -7.7 -6.2 -6.4 -5.5 -9.8 -4.6 -3.2 -2.5 -1.8 53.4 62.6 Netherlands -0.9 0.4 1.3 -0.2 -2.1 -3.1 -1.7 -0.3 0.5 0.4 65.7 45.4 Austria -2.3 -2.2 -2.1 0.0 -0.6 -1.4 -3.7 -1.5 -1.5 -0.5 64.3 59.1 Portugal -3.4 -2.8 -3.2 -4.3 -2.9 -2.9 -3.4 -6.1 -3.9 -2.6 52.1 63.6 Slovenia -2.4 -2.0 -3.8 -4.6 -2.5 -2.7 -2.3 -1.5 -1.2 -0.1 23.1 24.1 Finland 1.7 1.6 6.9 5.0 4.1 2.6 2.4 2.9 4.1 5.3 48.2 35.4 Euro area -2.3 -1.4 -1.0 -1.9 -2.5 -3.1 -2.9 -2.5 -1.3 -0.6 72.8. 66.3.

Slow correction of excessive deficits

21

20

40

60

80

100

120

140

160

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

IE

GR

ES

FI

FR

DE

PT

IT

Public Debt in % of GDP Source: EC and 2010 Stability Programmes targets for Government debt. For IT available up to 2012, for IE up to 2014 and for the remaining countries up to 2013. For GR EC/ECB/IMF programme

Resulting in an increase in public debt…

22

Diverging competitiveness developments…

23

Current account balances (in % of GDP)

Source: European Commission, Autumn 2010 Forecast. Note: Countries are ranked in descending order according to the average balance over

1999-2008.

-15

-10

-5

0

5

10

LU NL FI BE DE AT EA FR IT IE SI MT ES SK CY PT GR

Average 1999-2008 2009 2010

… and widening economic imbalances

24

Sovereign risk – an alternative explanation

25

Outline

• The Untenable Status

Quo

• The Right Turns

• The Wrong Turns

• The Way Ahead

26

Finding a way back should be priority…

Source: European Commission Autumn Forecast 2009

27

Source: European Commission Autumn Forecast 2009

No consolidation is not an option…

28

Source: European Commission, Morgan Stanley

Interest expenditures as % of GDP

… carrying a large debt burden…

29

Source: European Commission Ageing Report 2009

Projected change in age-related government expenditure, 2007-2060(percentage points of GDP)

Euro area

0

4

8

12

16

20

Bel

gium

Ger

man

y

Est

onia

Irel

and

Gre

ece

Spa

in

Fra

nce

Ital

y

Cyp

rus

Lux

embo

urg

Mal

ta

Net

herl

ands

Aus

tria

Por

tuga

l

Slo

veni

a

Slo

vaki

a

Fin

land UK

… with increasing age-related spending over the next 40-50 years…

30

… raising questions about debt sustainability

Sample of 32 high-grade sovereigns. Source: What A Change A Year Makes: Standard & Poor's 2007 Global Graying Progress Report

31

Inflating away the debt mountain is no option

Inflation expectations are well anchored

Five-year forward break even inflation rate five years ahead

Sources: Reuters, ECB, Federal Reserve Board staff calculations, Bank of England

1.75

2.00

2.25

2.50

2.75

3.00

3.25

3.50

Jan.09 Apr.09 Jul.09 Oct.09 Jan.10 Apr.10 Jul.10 Oct.10 Jan.11

Euro area US UK

32

Inflation expectations based on surveys - ECB policy and commitment credible

Source: Consensus Economics.

Inflation expectations six to ten years ahead

(annual percentage changes)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Euro area United Kingdom United States

33

Be serious about stronger governance

ECB Opinion on all 6 legislative acts (21 February 2011)

1. Greater automaticity

Non-compliance must have predictable consequences; Council to have less room for manoeuvre to halt or suspend procedures

2. Strict deadlines

to avoid lengthy procedures; deletion of “escape clauses”

3. Focus – asymmetrically – on problematic countries

i.e. those with current account deficits, competitiveness losses, high levels of public and private debt.

34

Be serious about stronger governance (II)

4. Political and reputational incentives

Increased reporting obligations; escalation to European Council; Commission/ECB surveillance missions.

5. Earlier and graduated sanctions (in macro-surveillance)

interest-bearing deposit after the first instance of non‑compliance in EIP, fine after repeated non-compliance

6. Ambitious benchmarks for establishing excessive deficit

Reduce scope of “relevant factors”

35

Be serious about stronger governance (III)

7. Ambitious medium-term budgetary objective

Improvement of structural balance to be significantly higher than 0.5% of GDP for high debt countries.

8. Quality and independence of economic analysis

Body of wise (wo)men to perform ex post assessment of surveillance

9. Strong national fiscal frameworks

Swift and uniform implementation of directive

10. Improved statistics

36

Important steps taken … more to come

In less than one year:

March 2010: financial support to Greece (€10bn)

May 2010: creation of EFSF (€440bn) and EFSM (€60bn)

September 2010: launch of economic governance reform

November 2010: EFSF/EFSM activated for Ireland (€85bn)

December 2010: Agreement to change Treaty

March 2010: “Pact for the Euro”

March 2011: Comprehensive package + ESM

37

Outline

• The Untenable Status

Quo

• The Right Turns

• The Wrong Turns

• The Way Ahead

38

A challenging environment: Sovereign redemptions and refinancing needs 2011

39

What it takes to stabilise debt

40

What if adjustment is beyond Greece’s & Ireland’s capacity?

Greece: primary balance to

adjust by 14.6% over 6 years (2009-2015)

Ireland: primary balance to

adjust by 13.8% over 6 years (2009-2015)

41

Such large adjustments in the primary balance are not unprecedented – e.g. Italy, Canada

Italy

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

General Government Primary Balance(as a percentage of GDP)

Source: OECD

Canada

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

1992

1993

1994

1995

1996

1997

1998

1999

2000

42

Markets have their doubts5-yr Sovereign CDS Spreads

(basis points)

Source: CMA DataVision via Datastream

0

250

500

750

1000

1250

Jan.09 Apr.09 Jul.09 Oct.09 Jan.10 Apr.10 Jul.10 Oct.10 Jan.11

GermanyFranceItalySpainGreeceIrelandPortugal

43

Stop scaring the markets

25/01/11: EFSF first bond issue.

16-17/12/10 : European Council confirms private creditors’ involvement in the ESM

18/10/10: Deauville Summit declaration: private creditors to be involved in the crisis resolution mechanism

28-29/10/10 : European Council endorses the Van Rompuy report but divided on sanctions.

23/11/10: Merkel: “We are facing an exceptionally serious situation.”

28/11/10 :ECOFIN approves €85 bn Irish package

Government bond spreads against German Bund in basis points (10 yr)

12/11/10: G-20 Joint F/D/IT/ES/UK statement “Any new [bail-out] mechanism only after mid-2013; no impact on current arrangements.’’

10/01/11: After China, Japan announces bond buys to boost confidence in EFSF.

44

Allegedly easy options are not easy (I)• Inconceivable expulsion from the euro

area

– not compatible with political

foundations of the euro

– inconsistent with crisis

response so far

– economic and political

“suicide” for countries

concerned

45

Allegedly easy options are not easy (II)

• Default or sovereign debt restructuring

– No recent precedents in

advanced economies

– not really a significant relief

– Costly and traumatic

economic and social experience

– “Orderly” restructuring in monetary union a

myth

– contagion effects in monetary union

46

Past experience with defaults/restructuring

Experience so far only from emerging markets

Reputational/penalty costs

• Loss of market access

• Higher future borrowing costs

• Trade sanctions by creditor countries

Broader costs to the domestic economy

• Output losses

47

Past experience with defaults/restructuring

Over the last 20 years, 19 countries out of 120 IMF programmes had debt restructuring:

• 1998 Ukraine, Russia, Pakistan, Venezuela • 1999 Gabon, Indonesia, Pakistan, Ecuador • 2000 Ukraine, Peru • 2001 Argentina, Cote d'Ivoire • 2002 Moldova, Seychelles, Gabon • 2003 Dominican Republic, Paraguay, Uruguay• 2004 Grenada • 2005 Dominican Republic • 2006 Belize

48

Defaults/restructuring nearly always associated with sharp output losses - but worse in case of default

Evolution of GDP growth around crisis episodes (in percent)

Source: IMF WEO.

Pre-emptive restructuring cases

-15

-10

-5

0

5

10

15

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

Dom. Republic (t=2003) Ukraine (t=1998)Moldova (t=1998) Pakistan (t=1998)Uruguay (t=2002)

-15

-10

-5

0

5

10

15

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

Ecuador (t=1999) Russia (t=1998)Argentina (t=2002)

Default cases

49

Default/restructuring associated with higher borrowing cost and contagion

Evolution of the EMBIG spreads around crisis episodes (in basis points)

Source: Haver Analytics.

Argentine crisis (2001-02)

0

1000

2000

3000

4000

5000

6000

7000

8000

2001 2002 2003 2004

0

500

1000

1500

2000

2500

3000Argentina Brazil (rhs)Uruguay (rhs)

50

… although some solutions tend to be less costly

• Extensive prior consultations with investors

• Inclusion of collective action clauses (CACs)

• Accompanying IMF programmes with strong conditionality

51

Restructuring would have major impact on domestic financial wealth…

Source: ECB

Euro area: holdings of government debt by residents and non-residents (end 2009)(share of total debt)

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

Debt held by non-residents of the Member State

Debt held by residents of the same Member States

52

… and the banking system Strong correlation between sovereign and banks’ CDS

Sources: CMA DataVisiosn via Datastream

0

250

500

750

1000

1250

Jan.09 Jul.09 Jan.10 Jul.10 Jan.11

Germany FranceItaly SpainGreece IrelandPortugal Netherlands

Banks Sovereigns

0

250

500

750

1000

1250

Jan.09 Jul.09 Jan.10 Jul.10 Jan.11

Deutsche BNP ParibasUnicredito SantanderNat. Bk of Gr. Bk. Of IrelandBanco Com. Port. ING

Latest observation: 25 Jan. 11. Note: Five-year CDS; basis points.

53

Industrialised countries differ from emerging markets

• Advanced economies have higher debt tolerance

• Stronger institutions

• More favourable composition of debt

• More stable revenue basis

• Advanced economies have highly integrated financial markets, especially inside a monetary union

• No government of an advanced economy has defaulted/ restructured since World War II

54

If no restructuring – then what?

• Seek new sources of growth

• structural reform

• regain competitiveness

• confidence effects

• Identify other measures to reduce debt burden

• privatisation

• improved tax collection

• debt buybacks

55

The Greek government ‘under supervision’Structural reforms demanded by EU/IMF:

– Pension reform

– Labour market and welfare system reform

– Health system

– Public administration reform

– Public procurement

– Opening up closed professions (transport, energy, retail sectors, pharmacists, notaries, etc.)

– Tackling tax evasion and the informal economy

– Privatisation (€50bn programme)

56

Need to improve growth prospects via structural reforms in Greece

Competition and productivity• Deregulation of transport and energy sectors• Opening up of closed professions • Implementation of Services Directive • Restructuring of state-owned enterprises and bringing in of private

management

Labour market flexibility and labour supply• Reduction of employment protection• Facilitating use of part-time work/flexible work arrangements• Reform of the arbitration system

Pension reform • Extensive reform to improving long-run sustainability, simplify

system and increase participation• New accrual rates with same profile for all workers• Increase in retirement age to 65 and contributory period for full

pension from 35 to 40 years

57

Greece – good progress but with pains

-1

0

1

2

3

4

5

6

-1

0

1

2

3

4

5

6

HICP HICP at constant tax rates

6

7

8

9

10

11

12

13

14

15

16

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

quarterly series monthly series Annual average

Unemployment% of the labour force

Source: Greek LFS for monthly, Eurostat for quarterly, green triangles give EC/ECB/IMF projection Last observations: October 2010 for monthly series, 2010 Q3 for quarterly.

HICP inflationAnnual % change

Source: Eurostat and ECB. Last observations: December 2010 for HICP and October 2010 for HICP at constant tax rates.

58

Initial impact on competitiveness

59

Create a credible financial safety net

European Stability Mechanism

• Effective lending capacity of €500bn; subscribed capital of €700bn (€ 80bn paid-in capital; €620bn guarantees)

• Interest rates: financing costs + 2%; further +1% for longer-term loans

• Link to adjustment programme (EU/IMF) – conditionality

• Instruments: (1) loans; (2) primary market purchases of government bonds

• To be ready by 2013 (Treaty change procedure underway)

• Private sector involvement: debt sustainability analysis; collective action clauses, preferred creditor status

60

Outline

• The Untenable Status

Quo

• The Right Turns

• The Wrong Turns

• The Way Ahead

61

Temporary decrease in market pressure should not lull sense of urgency

Government bond spreads against German Bund in basis points (10 yr)

4-Feb-11: France and Germany introduce a joint proposal for a ‘’’competitiveness pact’’ at the European Council, facing reluctance from the other members.

15-Feb-11: Comprehensive package: EU officials announce that extra meetings are needed; Olli Rehn admitted that ‘’there is work still to be done’’.

15-Feb-11:Finland to dissolve parliament by 15/03; last chance to agree on comprehensive package is the 11 March summit.

25-Feb-11: German coalition MPs rule out bond buying by ESM.

62

Way ahead

•Commission proposals +

•EP ambition

•Franco-German Competitiveness Pact

•“Comprehensive Package”+ agreement on ESM

•Demonstration effect of Spanish reforms

Make it work!

Markets will not forget & forgive

63

Debt burden not only relevant for euro area

Source: OECD, Eurostat, Morgan Stanley (estimates)

64

The euro area is ahead of others

65

Thank you!

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