Session III: Panel discussion Euro and macroeconomic stability

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Ten Years of the Euro Inspirations for the Czech
Republic

• Session III Panel discussionEuro and
  macroeconomic stability
• Servaas Deroose
• Director DG ECFIN, European Commission
• Conference hosted by Mr. Miroslav Kalousek,
  Minister of Finance of the Czech
  Republic,November 25, 2008

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Outline

• Assessing macroeconomic stability
• Domestic from overheating to hard-landing?
• Financial Are financial systems resilient?
• External Are external positions sustainable?
• Lessons from EMU_at_10 for future members
• Challenges
• Policy requirements
• Conclusion

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Real convergence is advancing but remains a
long-term challenge
GDP per capita in 2007 (in PPS, EU100) and
average change, 2004-2007
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Growth is slowing considerably due to global and
domestic factors (in , y-o-y)
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Price level convergence but also demand pressures
12-month average inflation (in , y-o-y)
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Financially-driven convergence large capital
inflows and extension of external balance sheets
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Very rapid financial deepening from a low base
(less pronounced amongst floaters)

• Domestic credit growth (in of GDP)

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Large external imbalances (especially in
fixers)
Balance on current account (in of GDP)
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Fiscal positions External constraints seem to
matter for fiscal performance General government
balance and government debt (in of GDP 2007)
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Exchange rate developments vs. euro, monthly
averages (index numbers, Jan 2007 100)
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Lessons from EMU_at_10 for future euro area members
(1 - challenges)

• Price stability equilibrium real appreciation
  complicates inflation control shorter history
  of anti-inflation policy and lower credibility
  conflict between fiscal and monetary authorities
  wage catching up
• Effective adjustment capacity (incl.
  stabilisation)
• To deal with shocks without exchange rate
  instrument (but nominal exchange rate flexibility
  acts also as shock propagator, hence less cost
  of giving up the XR instrument)
• Relatively more frequent and persistent common
  shocks with asymmetric impact (exchange rates,
  terms of trade, shifting comparative
  advantages) asymmetric shocks still possible
  (see Spain, Ireland, )
• Correction of large current account imbalances
  may require long and painful disinflation
  processes if coupled with stagnating productivity
• EMU and financial integration help efficient
  resource allocation and allow for longer
  adjustment periods, but managing credit booms can
  be a challenge (already well before euro
  adoption)
• Do not lose sight of long-term challenges
  sustain high potential growth, in a context of
  ageing, globalisation (with more rapid shifts in
  comparative advantages)

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Lessons from EMU_at_10 for future euro area members
(2 policy needs)

• Improved budgetary control to reduce the risk of
  fiscal policy pro-cyclicality budgetary
  frameworks in NMS are less developed and
  assessing cyclical component even more
  challenging
• Sustainability of public finances
• Quality of public finances bias towards current
  expenditure in NMS
• Flexible and integrated goods and factor markets
• More efficient use of labour resources
  (participation rates, structural unemployment,
  skill mismatches)
• Business environment and investment climate
  (innovation, FDI, education, favour entry /exit
  of firms)
• Growth-enhancing use of capital inflows NMS are
  receiving huge inflows , included EU funds
  utilisation has differed a lot across NMS
• Effective supervision and regulation of financial
  markets NMS experience accelerated financial
  development

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Fiscal policy

• Fiscal policy has to balance multiple challenges
• need for well-targeted public spending
  (infrastructure, education and RD)
• vs
• fiscal policy key to rein in demand pressures and
  overheating risks, especially in fixed XR regimes
• Preventing imbalances may require substantial
  surpluses of longer periods
• Quality of public finances (pro-growth
  priorities)

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Coping with financial deepening and credit growth

• Vigilance to prevent the build-up of imbalances
  and vulnerabilities
• Prudential and administrative measures
• Raise minimum capital adequacy ratio
• Strengthen loan-loss provisioning
• Mandatory loan-to-income or loan-to-value limits
• Strengthen supervisory framework
• Improvements in credit registers
• Strengthening risk management, expand stress
  testing
• Harness cross-border supervision

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Structural policy implications

• Boost external competitiveness
• Ensure favourable business environment and
  investment climate
• Encourage innovation and entrepreneurship to
  maintain competitiveness and move up the
  value-added chain
• Move toward high value-added and fast-growing
  sectors
• Sectoral composition of exports
• Productivity growth in the tradables sector
• Enhance internal economic adjustment
• NMS will have to manage underlying structural
  divergences for some time
• Ensure functioning of goods, services and labour
  markets
• labour mobility, skill development wage
  flexibility
• wage setting in line with productivity gains
• Entrepreneurship, etc.

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Conclusion

• Catching-up is proceeding but accompanied by
  varying imbalances
• Euro adoption readiness more important than
  timing
• Ability to cope with country-specific adjustment
  needs
• Adequate preparation in fiscal, structural and
  prudential domains
• Short-term challenges deal with fall-out from
  the financial crisis manage orderly unwinding of
  imbalances among the fixers, keep progress
  towards convergence on track for the floaters