Ensuring a stable euro
John (Iannis) Mourmouras, Deputy Governor of the Bank of Greece, and Danae Kyriakopoulou, OMFIF’s chief economist and head of research, discuss the future of the euro as it caps off a turbulent decade, and Greece’s post-bail-out prospects.
Danae Kyriakopoulou: What will the euro’s third decade be like and what role will Greece play? Are fears of a breakup of monetary union still justified and what needs to be done to strengthen the currency union’s architecture?
John (Iannis) Mourmouras: The euro is the official currency of 19 countries and 340 million citizens, and the second most important global reserve currency. Its introduction was a milestone in post-war Europe, comparable to the reunification of Germany and the breakup of the Soviet Union.
The first decade of a prolonged cycle of economic expansion and prosperity was followed by the 2010-12 sovereign debt crisis, resulting in high levels of unemployment and poor growth performance. Despite the continuing divergence between the North and the South with regard to real wages and productivity, overall the single currency has been a success. Nevertheless, it would be naïve to attribute the debt crisis solely to the failings of some European Union member states without recognising the shortcomings of monetary union’s architecture.
To address the next global downturn and ensure a stable euro, economic and monetary union must be deepened. The agreement, at last December’s euro summit, on developing a budget instrument for the euro area and setting the terms of reference for the common backstop to the single resolution fund, was a welcome step. But progress is needed on the banking union’s third pillar, the European deposit insurance scheme, and the capital markets union. Proposals such as a European safe bond and a European monetary fund will help mitigate the divergence between core and periphery countries and break the vicious cycle between banks and sovereigns.
DK: How do you see the European Central Bank’s role evolving in the post quantitative easing era and what would its role be in the next downturn?
JM: The ECB will continue reinvesting the principal payments from maturing securities purchased for an extended period of time, contributing to accommodative monetary policy and favourable liquidity conditions.
The main medium-term challenge for the ECB is the question of how long it will take to reduce the size of its balance sheet. There is no need to rush; itis important to take into account the uncertainty created among market participants and avoid any potential market disruptions. There are other – conventional– tools to use if tightening is deemed necessary, including raising interest rates, increasing reserve requirements and using reverse repurchase operations to drain excess liquidity. No matter what the optimal size is, the central bank must communicate to markets what the new ‘normal’ balance sheet size will be.
DK: The Greek bail-out programme ended in August2018. How confident are you in the economy’s long-term prospects and what should be the reform priorities to ensure a successful return to market financing?
JM: There should be no complacency or slackening of effort on behalf of the national authorities, especially in 2019, an election year in Greece. The government must commit to the implementation of growth-enhancing reforms, particularly in the public sector (including administrative reform and speeding up of judicial procedures). This will enhance the country’s credibility in the eyes of international capital markets and credit rating agencies.
Following a period of prolonged fiscal consolidation and private investment, the country needs an investment shock. In 2014, I suggested reducing primary surplus targets, along with slashing corporate tax rates drastically and gradually, in line with the fiercely competitive corporate tax rates applied by Greece’s neighbours. Some EU member states, such as Belgium, Denmark, Finland, Ireland, Sweden and Italy, have continuously recorded primary surpluses above 3.5% (on average) of their respective GDP. Their growth rate was more than 1.8%. However, economic activity is affected mainly by changes in fiscal policy. The composition of already achieved primary surpluses determines growth impact, more so than their levels.
DK: What lessons do you draw on the relationship between central banks and national governments at times of crisis management, and did these put central bank independence to the test in the case of Greece?
JM: Central bank independence and its sister concept, accountability, were challenged during the 2008 financial crisis and the euro sovereign debt crisis. These challenges fall into two categories: first, the independence of central banks has been put into question by external parties. Second, even if independence is not formally challenged, it may be compromised as a result of altered conditions.
External challenges to central bank independence stem mainly from political pressure. For instance, in the euro area, QE has been challenged both for being too expansive and too limited. On the other hand, the independence of central banks may be scrutinised due to concerns relating to whether a central bank with an extended mandate can operate transparently and have an appropriate degree of accountability in a democratic political and economic system.
All in all, an accountable, independent central bank needs broader support from the public. Clearly, with persistent negative rates, support for central banks is likely to drop. If a significant problem remains unsolved (for instance, a high stock of non-performing exposures), the public is bound to question the role of the supervisor. Fiscal and monetary authorities should have distinct roles in the economy and respect each other’s autonomy.
Given an increased role today for forward guidance in monetary policy and the management of expectations, the head of a central bank must be selected with the utmost care. It goes without saying the right candidate should have a spotless reputation and possess formidable technical expertise and communication skills.