Alexandra Zeitz (Global Economic Governance Programme, University of Oxford)
Presentation: Jeffrey Frank, Director, IMF Offices in Paris and Brussels
Blogpost: Alexandra Zeitz, St. Antony’s College
The numbers are striking and disheartening. Seven years on from the onset of the global financial crisis, Europe’s recovery remains shallow and vulnerable. Real GDP is ten percentage points higher in the US than it was in 2008. In the UK it is five percentage points higher. In Europe, by contrast, it is three percentage points lower than in 2008.
Unemployment in Europe remains extremely high. In August 2015, the average unemployment rate for the Eurozone was 11%. In Spain it was over 22%, having come down slightly from a height of 26.3% in early 2013. Estimated potential output growth, already lower in Europe than the US prior to the crisis, fell sharply during the crisis, from 1.3% in 2006-2007 to 0.6% in 2008-2010. It has remained low, sparking fears of a European slide into stagnation.
Why has the recovery in the Eurozone been so much more sluggish than in the neighboring UK and in the US? And what tools are available to policymakers to encourage a more robust recovery, improving the livelihoods of Europeans still afflicted by the aftermath of the crisis?
In late October, PEFM hosted Jeffrey Franks, Director of the IMF offices in Paris and Brussels, for a first-hand view of how the institution sees Europe’s economic prospects. Franks set out a clear narrative of why Europe experienced a more severe and longer downturn than the UK and US. Much of it boiled down to ‘too little, too late’. He also offered an original analysis of the factors impeding the financial sector playing a more substantive role in the economic recovery.
Monetary policy stimulus in Europe was later and more limited than in the US, UK or Japan. While the Fed’s balance sheet grew by 20-percentage points of GDP over the course of the crisis, the ECB was much slower to adopt unconventional monetary policy and begin purchasing assets. After it finally did so on a large scale 2011 (reaching a balance sheet of 31.52% of GDP in the second quarter of 2012), it then rolled back this policy fairly quickly after it seemed the policies had been effective. At present, there is again scope for a resumption of Eurozone quantitative easing to stimulate economic growth, argued Franks.
Fiscal policy in the Eurozone area during the crisis was also less conducive to a speedy or thorough recovery. By contrast to the US, where the fiscal deficit grew rapidly, from -2.86% in 2007 to -13.15% in 2009, Europe’s tight fiscal rules and politics limited the potential for fiscal stimulus.
In the Eurozone, fiscal deficits grew less than six percentage points, from -0.61% in 2007 to -6.21% in 2009. Franks stressed that European rules requiring deficit reductions were more restrictive and aggressive than the IMF advised. A recent IMF assessment concluded that fiscal policy in the Eurozone currently has had, on average, a neutral effect on the economy, neither acting as a drag on growth nor stimulating it. Recently proposed reforms to the Stability and Growth Pact, which allow countries to ‘exchange’ structural reforms for flexibility on deficit targets, may loosen constraints somewhat but the overall bias is likely to remain in place.
These monetary and fiscal policies were the most immediate reasons for the double-dip, prolonged recession. However, Franks also highlighted the structural factors that may be constraining the recovery. The structural reforms he suggested may allow for greater potential output growth, such as reforms to the labor market, are in many cases deeply political.
If anything, the European crisis has demonstrated how little convergence there is on political economic questions, whether among Eurozone countries or between European political elites and their publics. This suggests that such reforms may be difficult to adopt in a manner that is suitably democratic and sensitive to different Eurozone members’ political economic preferences.
The most original and exciting portion of Franks’ presentation, aside from the rich data charting the disappointing recovery, was his analysis of the weaknesses in the European financial sector that are inhibiting its contribution to economic recovery.
Banks in Europe are failing to return to productive pre-crisis lending. Credit growth in Europe has also experienced a ‘double dip,’ becoming negative again in March 2012 after a brief period of positive growth in late 2011 and early 2012. Franks attributed this largely to the high number of non-performing loans (NPLs) in the Eurozone. While US banks’ net NPLs decreased from 1.09% in 2010 to 0.32% in 2014, net NPLs steadily increased in Europe from 3.87% in 2010 to 5.33% 2014.
Banks are becoming ‘clogged up,’ according to Franks, by bad loans for which they have often not held aside sufficient capital (i.e. are under-provisioned). This is inhibiting their lending. He recommended several policy measures to get such bad loans off the balance sheets of banks: increasing capital surcharges on long-held NPLs, reforming insolvency and foreclosure arrangements to allow more rapid closure of NPLs, and establishing a market for distressed debt, allowing banks to sell bad debt to collection agencies.
These recommendations are modeled on the American system, where NPLs are in fact lower. However, these policies also have social and political implications. Foreclosure policies in the US were associated with a sharp spike in homelessness during the financial crisis. Deepening markets for distressed debt may have the moral hazard consequence of encouraging reckless or predatory lending, since lenders have more opportunities to sell bad debt.
The European financial sector has also failed to act as an engine for recovery since there are few alternatives to banks. When banks are ‘clogged up’ by NPLs or deleveraging in order to balance their risk exposure or in response to new financial regulation, European corporations have far fewer sources of alternative financing than their American counterparts.
Echoing the concerns of other commentators who see Europe as ‘over-banked,’ Franks applauded efforts to establish the European capital markets union (CMU). He recommended moving quickly to establish common standards for market disclosure, tax and accounting regimes to allow for the standardization of equities across the Eurozone. Eliminating national differences in procedures for clearing and settlement would also help to facilitate cross-border investment from European surplus economies to those in dire need of investment.