Peter Praet: The "Great Rebalancing" of the euro area and the global
economy
Keynote speech by Mr Peter Praet, Member of the Executive Board of the European Central
Bank, at the Hamburg Summit "China meets Europe", Hamburg, 30 November 2012.
* * *
I wish to thank Maurizio Michael Habib and Arnaud Mehl for their contributions to this speech.
Many thanks for your kind invitation to speak at this summit on the future of China and
Europe in the global economy.
The pre-crisis period is sometimes referred to as the "Great Moderation",1 and the onset of
the crisis in 2007 and 2008 as the "Great Recession".2 Today I'd like to provide an additional
perspective and suggest that we may now be experiencing a "Great Rebalancing".
The period before the crisis was marked by the global build-up of large external and
domestic imbalances. The United States had large current account deficits and China large
surpluses, while there were serious macroeconomic imbalances across the euro area.
However, the eruption of the global crisis about five years ago marked the start of a major
rebalancing. Demand patterns - both at the global level and within the euro area - have
been undergoing a significant rebalancing process, which has admittedly been painful in
some ways, but necessary from an overall perspective.
A key question now is whether this process is cyclical or structural. Today I will argue that
part of the "Great Rebalancing" is structural, which is welcome. But another part is cyclical,
meaning that it might fade out as soon as global economic growth turns a corner. So it's a
concern that if countries are not sufficiently committed to carrying out the necessary reforms,
unsustainable imbalances might re-emerge which would then put the global recovery at risk.
Let me now focus, in turn, on signs of a "Great Rebalancing" in the United States, the euro
area, and China, as well as on the role of macroeconomic policies in this process.
Let me start with the United States. Before the collapse of Lehman Brothers in 2008, the
large external deficits of the United States were a major source of concern. The US current
account deficit reached 6% of GDP in 2006, its highest level since 1945. Such deficits
reflected a wide array of factors, including a housing bubble, increasingly leveraged
households and growing fiscal deficits. Many observers feared an abrupt unwinding of these
deficits, leading to a disorderly adjustment in global financial markets.3
The adjustment started with the collapse of Lehman Brothers. Some of the internal and
external imbalances in the US economy that were at the origin of the crisis have now begun
to correct. The real estate market has gone through a major adjustment, declining by 30%
compared to its pre-crisis peak; excessive leverage of households and financial firms has
been reduced; and the US current account deficit has roughly halved relative to pre-crisis
levels, to about 3% of GDP.
The adjustment will only remain durable, however, if efforts to complete the necessary
reforms continue. These include continuing financial sector and regulatory reform; designing
a credible strategy for medium-term fiscal consolidation to ensure the sustainability of public
finances; and pursuing structural reforms to help strengthen the competitiveness of the
export sector.
Consider now the situation on this side of the Atlantic.
The euro area as a whole was not imbalanced prior to the crisis, nor is it so even today. The
current account of the euro area has been roughly balanced since the start of Economic and
Monetary Union in 1999. On average, the general government primary budget of euro area
Member States will be almost in balance this year, and will record a small surplus next year,
according to the IMF.
However, this has masked significant intra-euro area imbalances in terms of current account
positions, competitiveness and public finances. For instance, the real effective exchange
rates of Greece, Ireland, Italy, Portugal and Spain had appreciated on average by 16%
relative to that of Germany between 1999 and 2008, whereas the real effective exchange
rate of the euro appreciated by only 3% over the same period.
A significant process of rebalancing is now under way in Europe, particularly in the euro
area. After several years of artificial calm in global financial markets and the hunt for yield
before the crisis, there has been a major repricing of risk. This has led to a marked tightening
of borrowing conditions, initially for financial corporations and subsequently for sovereigns.
Some of the most severely affected sovereigns were euro area Member States that had
enjoyed relatively benign financing conditions before 2008. But they had not taken sufficient
advantage of these conditions to put public finances on a sustainable path, or implement
structural reforms that would have improved their economic competitiveness and smoothed
their adjustment.
A sometimes painful, but necessary, rebalancing process has started within the euro area.
Some fundamental progress has already been made in tackling intra-euro area imbalances:
•
Budgetary deficits are being reduced. The IMF expects the euro area to have a
primary budget deficit of 0.5% of GDP this year, well below the average of the G20
advanced economies (4.8% of GDP). Moreover, it is those countries most in need
that are making the largest structural adjustments;
•
Competitiveness in programme and vulnerable countries is being restored. In the
countries most affected by the crisis, noticeable progress is being made in the
correction of unit labour costs and current account imbalances. In full EU-IMF
programme countries (Greece, Ireland and Portugal), unit labour costs have
improved by around 10% since 2008, relative to the euro area average. This has
translated into current account deficits that are on average more than five
percentage points of GDP lower than they were then;
•
Thanks to the ECB's non-standard measures, which have given European banks
the breathing space needed to implement their restructuring plans in an orderly
fashion, those banks have substantially increased their capital buffers. There has
been no disorderly deleveraging, which was perceived as a major concern at the
end of last year.
This process of rebalancing within the euro area is coupled with sluggish growth and slower
euro area import growth, which is arguably not without cyclical implications for the rest of the
world. In particular, trade between the euro area and China has recently declined. In the first
half of 2012 China's exports to euro area countries contracted by around 3% in nominal
terms, compared with growth of about 30% between 2002, when China joined the WTO, and
2008, when the crisis erupted. In 2008 more than 15% of Chinese goods exports were
destined for the euro area, a share which was also rising relative to that of the United States
and Japan. By contrast, that share has since declined to about 13%.
The crisis not only exposed the imbalances existing within the euro area but also revealed
the incomplete character of Economic and Monetary Union (EMU). The governance
framework underpinning EMU proved insufficient to create adequate incentives to address
macroeconomic imbalances, foster sound public finances and prevent the propagation of
shocks to the European financial system.
In order to secure long-term stability in the euro area and ensure a durable rebalancing,
some of the initial design flaws in the euro area's governance structure need to be fixed
permanently. This requires a concerted effort from governments to complete EMU.
In this regard, the "Four Presidents" (of the European Council, the European Commission,
the Eurogroup and the ECB) have identified four pillars on which to build a genuine EMU and
so a more stable and prosperous Europe. These pillars are: a banking union with a single
supervisor; a fiscal union that can effectively prevent and correct unsustainable budgets; an
economic union that can guarantee sufficient competitiveness to sustain high employment;
and a political union that can deeply engage euro area citizens.
Progress is being made on all four pillars to build a genuine EMU. However, the road
towards a complete EMU is still long. A firm commitment from governments is the best
insurance that we are building the bridge to a more stable and prosperous euro area, one in
which the rebalancing we observe today will be here to stay.
There is evidence that rebalancing has also started in China. The current account surplus
has narrowed markedly, from 10% of GDP in 2007 to less than 3% of GDP in 2011; foreign
exchange reserve accumulation has slowed down significantly, with reserve holdings
remaining roughly stable in the course of 2012; and, finally, there seem to be signs that the
economy is gradually shifting from external sources of demand to domestic sources . A key
question is how much of this rebalancing is due to cyclical factors, in particular slower growth
in advanced economies. There have been concerns that China's growth model remains
overly reliant on investment at the expense of consumption, and that house price valuations
are stretched.
So in China, too, a permanent rebalancing hinges on the continuation of structural reforms,
including: the continued expansion of social safety nets; the reform of the banking sector; the
gradual liberalisation of the capital account; and the strengthening of exchange rate flexibility,
as envisaged by Chinese authorities. The latter two are pre-conditions for further currency
internationalisation to allow foreign investors to invest in China, deepen financial markets and
improve the allocation of capital in the economy.
What is the role of monetary and fiscal policies in this process? In those cases where
unsustainable fiscal policies were at the very origin of imbalances, the priority is to restore
and ensure the medium-term sustainability of public finances. Another priority is to
strengthen financial sector stability and avert the build-up of risks and vulnerabilities,
including unsustainable lending booms, through adequate regulatory, supervisory and
macro-prudential tools.
As regards monetary policy, central banks in advanced economies have also been doing
their part, helping to make the rebalancing process as smooth as possible. Central banks
acted within their particular mandates, which in the euro area is to preserve price stability
over the medium term. They have taken non-standard measures, which have helped avoid
an abrupt deleveraging of the banking sector, which might have had highly-damaging
consequences.
There have also been concerns, notably among emerging market policy-makers, that
measures taken by central banks in advanced economies could foster excessive flows of
capital to their economies, put upward pressure on their exchange rates and lead to bubbles
in domestic financial asset prices. The relation between monetary policy in advanced
economies and global financial flows is not purely mechanistic, however. Financial flows to
emerging economies depend on a host of factors over and beyond interest rate differentials,
including the attractiveness of emerging market economies themselves in terms of growth
potential or global risk aversion. Moreover, the monetary policy of major advanced
economies is not only beneficial to their domestic economies, but has positive externalities
for the growth of the global economy as a whole, including emerging market economies.
Let me now conclude.
The outbreak of the crisis triggered a "Great Rebalancing" process at the global level. It is a
painful, but necessary, process, which is partly cyclical. Each continent, America, Europe
and Asia, must continue making every effort to ensure that this process remains durable.
In recent years, particular attention has been paid to the situation and reform agenda in the
euro area. However, not only euro area countries, but all other countries too, have to
implement structural reforms, many of which are discussed within the G20, to progress
towards more sustainable and balanced growth. We, in Europe, are doing our part by
endeavouring to advance on the reforms needed for a durable intra-euro area rebalancing.