JE: Is the eurozone crisis now abating?
JCT: We have had already three acute episodes in the euro area crisis and now we are not in an acute episode. But I would say this is no time for complacency and we have a lot of appropriate reform to conduct, including of course at the level of each country and governance of the euro area as a whole. Yes—at this stage we are not in an acute episode of the crisis of the Euro area.
Let me mention that I make a difference between the euro as a currency, which has never been in question in all the crisis since 2007-8, and the euro area, the grouping of the 17 countries and as of next year 18, which has been in difficulty at several times, and is not experiencing presently an acute episode but has a lot of hard work to do.
JE: Do you think the euro area faces a continuing cycle of emergency summits, bailouts and haircuts?
JCT: No I would say there are four objective reasons why the tail risk of dramatic events in the Euro area has considerably alleviated.
First reason, a lot of adjustment has taken place in the countries that were under high pressure by the market. If I take Greece, Ireland, Portugal, Spain and Italy which were the five countries under stress—I put Cyprus apart—you could say that their current account deficit in 2008-9 was about 8 per cent of GDP and we are probably over the last 12 months very close to zero, perhaps less than one per cent to be sure. And that of course is the first reason. The market is seeing that we are in a totally different universe to that standpoint: vulnerability of the external current account.
Then we have a lot of reform in the euro area: the new reinforced Stability and Growth Pact; the Macroeconomic Imbalance Procedure; the Fiscal Compact; the start of the setting up of the Banking Union—all of this is a very strong second reason.
Third reason is very political: it has been demonstrated that there was no democracy in Europe that wanted a change in the nature of the euro area, by expelling some countries or by countries desiring to leave and that has been demonstrated both in Athens and in Germany, where a lot of observers were thinking that some forces in Germany would like to have a different euro area in terms of composition, but you might remember that at the time it was demonstrated by all political constituencies that they had an overwhelming majority in the Bundestag to support the euro area as it is.
And the last reason, was the demonstration that the ECB was able to contribute itself provided there was appropriate conditionality to diminish the tail risk of a catastrophe happening in one particular economy.
So that makes four reasons: they explain why the tail risk has considerably alleviated and never materialised. After all, we are in the worst crisis of the advanced economies since World War Two. And we still are there, not only in Europe but also in the other advanced economies, when you look at what the central banks are doing, clearly we are still in exceptional times.
JE: You raised the subject of current account imbalances. Can these imbalances ever be resolved within the euro zone? It seems that imbalance will always be there.
JCT: I am not sure personally. It is a question of appropriate management in the various countries. Don’t forget that when we started the Euro, Germany had a current account deficit. The overall constellation of surpluses and deficits was totally different. What has happened is Germany being used to solid currency was extremely careful in terms of cost evolution and all countries and societies learn the hard way that if you do not control your cost you pay a high price in terms of deficits of the current account and in terms of loss of competitiveness and that the reason why it is so important to have the reinforced Stability and Growth Pact, which concentrates on fiscal policy, but also the monitoring of the unit level cost and competitive indicators, which is the MIP.
When I was president of the ECB, I was campaigning among governments both for appropriate fiscal policies, when they were quite loose on that, as you know, and also on the fact that they had to monitor very closely the competitiveness of the various countries. So when you look at what is happening now, you see the important rebalancing inside the euro area. It’s important that there will be no complacency and the pursuit of strong governanace of the euro area as a whole. It is clear that when you have a single market with a single currency, you need a very solid governance at the centre.
JE: Should “solid governance” include a banking union and debt mutualisation?
JCT: Well, again, certainly a banking union, which has already been decided in principle, certainly a very close monitoring of fiscal policies, and certainly a close monitoring of unit level costs as I said and competitiveness evolution.
As regards mutualisation of debt, I would say that the partial mutualisation would be part of banking union if you have the single resolution authority at the level of Europe as a whole. Then you have some level of mutualisation of risk and of possible spending. Second you have de facto mutualisation of the crisis management tool, the European Stability Mechanism, ESM, which has been set up by treaty and which exists. That is the second point where you see the mutualisation that you were mentioning.
To go much further depends on political decisions of first magnitude. The idea that you could merge purely and simply the various budgets of various countries seems to me impossible, frankly speaking. You have no federation in the world where you have the total merger of, I would say, the Texas budget with the Florida budget, that does not exist. So what one could imagine and has been envisaged, particularly by the report in the four presidents, was that you could have some kind of embryo of a budget at the Euro area level as a whole which would serve as some kind of stabilisation mechanism, but that would not function as a permanent transfer from one country to another, but as something that would help counter differences in the business cycles. I think that this is a concept which could be envisaged. It has not been decided at all but could be envisaged.
The simple fact that the ESM exists, and which permits the Euro area to help finance the restructuring and the adjustment of one particular country is already a mechanism which entails some kind of collective share of risk.
JE: Has austerity in the periphery has worked and should continue? Or should it be wound down now there are some signs of the crisis beginning to abate.
JCT: The famous debate—austerity versus growth—is something which is totally legitimate in countries that have no problem of loss of confidence: countries that have no problems in terms of financing their possible current account deficits and countries that have no problem in financing very easily their budget. So say that in the US, at the moment, clearly there is no such problem of financing and one can understand that one can have a big debate on whether austerity is going to far, or whether more accommodation in terms of fiscal policy would not be better. I can understand that, even if there is always some kind of optimal in the long term. It is not that because you have no problem today that mean you can not have any problem tomorrow.
In countries which have a big current account surplus, which have a very good fiscal position, and which have absolutely no particular difficulty of any kind in the future at least in the present projection, then you clearly have room for manoeuvre. You can reflect on why is the best way to cope with the present situation. So I accept fully in the case of Germany you could say well, the more domestic demand, more domestic investment, might be better than being obliged to export massively the current account surplus which is big, something like 6.5 per cent of GDP.
But in countries that have had difficulty to finance themselves because there has been a dramatic loss of confidence from savers and investors abroad to finance them both in terms of current account and in terms of fiscal position, then clearly there is no choice. What you have to do is to take into account that the rest of the world is telling you that its intention is not to continue to finance eternally your deficits. So there also you have to see what is exactly the appropriate rapidity of going back to a normal situation, at least a situation where you have a balanced budget and a balanced current account. Because again the problem is that you have to find someone outside to finance you.
So the difficulty is not that you can chose between austerity and growth, you are bound to go back to a balanced situation.
Now, if you have friends around that are helping you, if you have some help of the euro area in particular or if you have some help on the international community through the IMF, you can do that more or less rapidly. But in any case you need to finance your deficits, so long as you have deficits, you see. So I would not say it’s austerity versus growth for those particular countries. I would say it’s finding out the appropriate speed to go back to the balanced situation and the appropriate conviction of the external observers that they can have confidence in this particular economy, in this particular country. That is something which is going on.
But of course it’s painful. When you are spending much more than you earn, going back to a balanced situation is always painful. My last remark on that is that you can adjust in various ways. One very bad way is to protect the people in your economy who have a job or to try to protect them as much as you can, and to neglect those totally who have no job. And then the adjustment is made on unemployment. It becomes dramatic. If you are adjusting in diminishing the revenues of all your citizens in order to have the full economy in a better balanced situation, you can protect jobs and you can adjust in protecting jobs, regaining competitiveness when the unit level costs are being much more competitive.
And if you look in the various European countries you can see the differences. In Ireland, if it is very painful, is proceeding with an adjustment which is protecting jobs in Ireland much better than is being done in Greece. Still, the external imbalances were as dramatic in both countries. So you see there are ways to try to adjust in protecting employment. I would say that this is something which is of extreme importance. We should advise countries and governments to do all that they can to protect employment when they adjust. It is difficult politically, as it calls for the insiders not to be privileged in comparison with the outsiders. It is easy to say, it’s difficult to do.
JE: Do you think there remains a chance that a peripheral country might exit the eurozone?
JCT: We are all living in democracies, and in democracies you always have to respect the people I am not able to be sure of the future. What I would say is that since the start of the crisis and since the start of the acute episode of the crisis, since Lehman Brothers, I have always heard this question. Of course it is sure that the euro area would not resist the worst crisis since WW2. My observation would be that each time the question was asked to the people of Europe they said, the Mediterranean countries in difficulty and all the countries of the north, the response each time was no we want to go on and pursue this historical endeavour which is so important for us. So based on the political response of our democracies since the beginning of this crisis, I would say that my intimate conviction is that, yes sir, it will go on.
And don’t forget we were 17 since the beginning of the crisis. We are now virtually 18, with a new country joining in as well as the EU as a whole which will be 28 not 27. It seems to me what is from time to time a little bit neglected out of continental Europe, if I may, which is that there is a historical endeavour of extreme importance, which has something which goes much further, much beyond an economic arrangement, or a financial arrangement, or a monetary arrangement, but which is of a historical nature which goes much beyond that, is something that is not fully priced in in a number of external observers’ analysis and again experience has proved at least since two thirds of a century that it had to be priced in to understand fully what was happening. I have experienced myself several times even some I would say very strong feeling that real history was at stake.
JE: I suppose Britain is one such “external observer”—can you envisage a time in future when Britain might join the euro?
JCT: Nothing can be excluded of course. Britain has an opting out clause, so they can opt in any time. That was very well negotiated by the way. I would say that there is no better negotiation than the negotiation that gives you an option without having anything to pay for that option. I think it was very well negotiated by John Major. But we will see. I have no doubt that the UK remains, if I may, a European country. I am absolutely sure of that. I know Britain quite well I have a lot of friends in Britain and I know that Britain is profoundly European. I know also that the ideas of Britain: the invention of representative democracy by Britain, the concepts that Britain is cherishing are part of the European wealth—part of the universal wealth—but part of the European wealth very profoundly. So the UK is welcome, not only in the EU but also in the euro area.
There is absolutely no country which would say “we would not like to have the UK with us.” So my own understanding, it entirely depends on the UK. And we will see what the UK people, not only the UK government or Parliament, but the UK people, because it’s been decided, if I understand well, by all constituencies in the UK that a referendum would be necessary in any case. We will see what happens. I would say that again I am confident that the UK will not leave. When will the UK join the euro area is another story and I would not embark on any guess on that.
JE: You mention that you have a lot of friends in Britain. Mark Carney is one of them.
JCT: Well Mark is a very close friend of course, when he was in his previous position and I appreciated Mark enormously as Governor of Bank of Canada and as head of the Financial Stability Board. So yes, yes indeed. Also I was thinking of the previous governor, Mervyn, and other friends. Ministers and permanent secretaries of the Treasury. I have been working with UK friends for decades.
JE: And what do you think of forward guidance.
JCT: Forward guidance was tried in Canada, applied in the US, and in the US it was the most important such experience. It’s now also more or less mentioned in the euro area.
I myself have always been a little bit prudent as regards forward guidance. My own understanding is that in any case, and it’s been demonstrated very clearly in the rhetoric of the Bank of England and Mark recently, in any case you have to prevent the wrong interpretation which would be that you do not care for price stability and for the overall stability of the inflation expectation. And so you have to mention that there are some knock-out clauses which would interrupt the forward guidance. Then I am not sure that you are really gaining a lot. I have always preferred myself to say in any case we are stabilising and are aiming at stabilising the inflation expectations medium and long term, which is a way to have medium and long-terms nominal rates as low as possible, because inflation expectations are incorporated in the nominal medium and long term. And so that would normally help you to have the appropriate environment you are looking for to help the economy recover.
So you see I look at it, I understand that it is now more or less a concept with is generalising, the UK being the last one to adopt such a concept. I am not absolutely sure that again it gives a lot, but certainly is a signal, which is appreciated by a number of observers.
The main danger is of course that if the market at any time would consider that the knock-out clause are negligible in comparison with the commitment to maintain for a very long time until unemployment is very much down, and if you make this assumption that the market will trust that the zero rate will be maintained for a very long period of time, then you are embarking on carry trade, which might be a real problem, because it is something artificial and it does not help global markets. And when carry trade interrupts, then it creates an enormous volatility. It seems to me this is more of less what happened in the US in the recent period.
So you see I am looking at it with great interest because it is something which is globally generalising and means something as well as all the measures that have been taken by all central banks of the advanced economies. For me it is one of the indicators that all advanced economies are not going very well—that they still have something like the continuation of the crisis, otherwise we would not need central banks to be that imaginative that creative perhaps taking a number of risky moves.
JE: Last question, but I suspect that you will decline to answer. It is simply—Yellen or Summers?
JCT: I can say only that they are both very good people, both good economists, excellent personalities and that’s all.
JCT: We have had already three acute episodes in the euro area crisis and now we are not in an acute episode. But I would say this is no time for complacency and we have a lot of appropriate reform to conduct, including of course at the level of each country and governance of the euro area as a whole. Yes—at this stage we are not in an acute episode of the crisis of the Euro area.
Let me mention that I make a difference between the euro as a currency, which has never been in question in all the crisis since 2007-8, and the euro area, the grouping of the 17 countries and as of next year 18, which has been in difficulty at several times, and is not experiencing presently an acute episode but has a lot of hard work to do.
JE: Do you think the euro area faces a continuing cycle of emergency summits, bailouts and haircuts?
JCT: No I would say there are four objective reasons why the tail risk of dramatic events in the Euro area has considerably alleviated.
First reason, a lot of adjustment has taken place in the countries that were under high pressure by the market. If I take Greece, Ireland, Portugal, Spain and Italy which were the five countries under stress—I put Cyprus apart—you could say that their current account deficit in 2008-9 was about 8 per cent of GDP and we are probably over the last 12 months very close to zero, perhaps less than one per cent to be sure. And that of course is the first reason. The market is seeing that we are in a totally different universe to that standpoint: vulnerability of the external current account.
Then we have a lot of reform in the euro area: the new reinforced Stability and Growth Pact; the Macroeconomic Imbalance Procedure; the Fiscal Compact; the start of the setting up of the Banking Union—all of this is a very strong second reason.
Third reason is very political: it has been demonstrated that there was no democracy in Europe that wanted a change in the nature of the euro area, by expelling some countries or by countries desiring to leave and that has been demonstrated both in Athens and in Germany, where a lot of observers were thinking that some forces in Germany would like to have a different euro area in terms of composition, but you might remember that at the time it was demonstrated by all political constituencies that they had an overwhelming majority in the Bundestag to support the euro area as it is.
And the last reason, was the demonstration that the ECB was able to contribute itself provided there was appropriate conditionality to diminish the tail risk of a catastrophe happening in one particular economy.
So that makes four reasons: they explain why the tail risk has considerably alleviated and never materialised. After all, we are in the worst crisis of the advanced economies since World War Two. And we still are there, not only in Europe but also in the other advanced economies, when you look at what the central banks are doing, clearly we are still in exceptional times.
JE: You raised the subject of current account imbalances. Can these imbalances ever be resolved within the euro zone? It seems that imbalance will always be there.
JCT: I am not sure personally. It is a question of appropriate management in the various countries. Don’t forget that when we started the Euro, Germany had a current account deficit. The overall constellation of surpluses and deficits was totally different. What has happened is Germany being used to solid currency was extremely careful in terms of cost evolution and all countries and societies learn the hard way that if you do not control your cost you pay a high price in terms of deficits of the current account and in terms of loss of competitiveness and that the reason why it is so important to have the reinforced Stability and Growth Pact, which concentrates on fiscal policy, but also the monitoring of the unit level cost and competitive indicators, which is the MIP.
When I was president of the ECB, I was campaigning among governments both for appropriate fiscal policies, when they were quite loose on that, as you know, and also on the fact that they had to monitor very closely the competitiveness of the various countries. So when you look at what is happening now, you see the important rebalancing inside the euro area. It’s important that there will be no complacency and the pursuit of strong governanace of the euro area as a whole. It is clear that when you have a single market with a single currency, you need a very solid governance at the centre.
JE: Should “solid governance” include a banking union and debt mutualisation?
JCT: Well, again, certainly a banking union, which has already been decided in principle, certainly a very close monitoring of fiscal policies, and certainly a close monitoring of unit level costs as I said and competitiveness evolution.
As regards mutualisation of debt, I would say that the partial mutualisation would be part of banking union if you have the single resolution authority at the level of Europe as a whole. Then you have some level of mutualisation of risk and of possible spending. Second you have de facto mutualisation of the crisis management tool, the European Stability Mechanism, ESM, which has been set up by treaty and which exists. That is the second point where you see the mutualisation that you were mentioning.
To go much further depends on political decisions of first magnitude. The idea that you could merge purely and simply the various budgets of various countries seems to me impossible, frankly speaking. You have no federation in the world where you have the total merger of, I would say, the Texas budget with the Florida budget, that does not exist. So what one could imagine and has been envisaged, particularly by the report in the four presidents, was that you could have some kind of embryo of a budget at the Euro area level as a whole which would serve as some kind of stabilisation mechanism, but that would not function as a permanent transfer from one country to another, but as something that would help counter differences in the business cycles. I think that this is a concept which could be envisaged. It has not been decided at all but could be envisaged.
The simple fact that the ESM exists, and which permits the Euro area to help finance the restructuring and the adjustment of one particular country is already a mechanism which entails some kind of collective share of risk.
JE: Has austerity in the periphery has worked and should continue? Or should it be wound down now there are some signs of the crisis beginning to abate.
JCT: The famous debate—austerity versus growth—is something which is totally legitimate in countries that have no problem of loss of confidence: countries that have no problems in terms of financing their possible current account deficits and countries that have no problem in financing very easily their budget. So say that in the US, at the moment, clearly there is no such problem of financing and one can understand that one can have a big debate on whether austerity is going to far, or whether more accommodation in terms of fiscal policy would not be better. I can understand that, even if there is always some kind of optimal in the long term. It is not that because you have no problem today that mean you can not have any problem tomorrow.
In countries which have a big current account surplus, which have a very good fiscal position, and which have absolutely no particular difficulty of any kind in the future at least in the present projection, then you clearly have room for manoeuvre. You can reflect on why is the best way to cope with the present situation. So I accept fully in the case of Germany you could say well, the more domestic demand, more domestic investment, might be better than being obliged to export massively the current account surplus which is big, something like 6.5 per cent of GDP.
But in countries that have had difficulty to finance themselves because there has been a dramatic loss of confidence from savers and investors abroad to finance them both in terms of current account and in terms of fiscal position, then clearly there is no choice. What you have to do is to take into account that the rest of the world is telling you that its intention is not to continue to finance eternally your deficits. So there also you have to see what is exactly the appropriate rapidity of going back to a normal situation, at least a situation where you have a balanced budget and a balanced current account. Because again the problem is that you have to find someone outside to finance you.
So the difficulty is not that you can chose between austerity and growth, you are bound to go back to a balanced situation.
Now, if you have friends around that are helping you, if you have some help of the euro area in particular or if you have some help on the international community through the IMF, you can do that more or less rapidly. But in any case you need to finance your deficits, so long as you have deficits, you see. So I would not say it’s austerity versus growth for those particular countries. I would say it’s finding out the appropriate speed to go back to the balanced situation and the appropriate conviction of the external observers that they can have confidence in this particular economy, in this particular country. That is something which is going on.
But of course it’s painful. When you are spending much more than you earn, going back to a balanced situation is always painful. My last remark on that is that you can adjust in various ways. One very bad way is to protect the people in your economy who have a job or to try to protect them as much as you can, and to neglect those totally who have no job. And then the adjustment is made on unemployment. It becomes dramatic. If you are adjusting in diminishing the revenues of all your citizens in order to have the full economy in a better balanced situation, you can protect jobs and you can adjust in protecting jobs, regaining competitiveness when the unit level costs are being much more competitive.
And if you look in the various European countries you can see the differences. In Ireland, if it is very painful, is proceeding with an adjustment which is protecting jobs in Ireland much better than is being done in Greece. Still, the external imbalances were as dramatic in both countries. So you see there are ways to try to adjust in protecting employment. I would say that this is something which is of extreme importance. We should advise countries and governments to do all that they can to protect employment when they adjust. It is difficult politically, as it calls for the insiders not to be privileged in comparison with the outsiders. It is easy to say, it’s difficult to do.
JE: Do you think there remains a chance that a peripheral country might exit the eurozone?
JCT: We are all living in democracies, and in democracies you always have to respect the people I am not able to be sure of the future. What I would say is that since the start of the crisis and since the start of the acute episode of the crisis, since Lehman Brothers, I have always heard this question. Of course it is sure that the euro area would not resist the worst crisis since WW2. My observation would be that each time the question was asked to the people of Europe they said, the Mediterranean countries in difficulty and all the countries of the north, the response each time was no we want to go on and pursue this historical endeavour which is so important for us. So based on the political response of our democracies since the beginning of this crisis, I would say that my intimate conviction is that, yes sir, it will go on.
And don’t forget we were 17 since the beginning of the crisis. We are now virtually 18, with a new country joining in as well as the EU as a whole which will be 28 not 27. It seems to me what is from time to time a little bit neglected out of continental Europe, if I may, which is that there is a historical endeavour of extreme importance, which has something which goes much further, much beyond an economic arrangement, or a financial arrangement, or a monetary arrangement, but which is of a historical nature which goes much beyond that, is something that is not fully priced in in a number of external observers’ analysis and again experience has proved at least since two thirds of a century that it had to be priced in to understand fully what was happening. I have experienced myself several times even some I would say very strong feeling that real history was at stake.
JE: I suppose Britain is one such “external observer”—can you envisage a time in future when Britain might join the euro?
JCT: Nothing can be excluded of course. Britain has an opting out clause, so they can opt in any time. That was very well negotiated by the way. I would say that there is no better negotiation than the negotiation that gives you an option without having anything to pay for that option. I think it was very well negotiated by John Major. But we will see. I have no doubt that the UK remains, if I may, a European country. I am absolutely sure of that. I know Britain quite well I have a lot of friends in Britain and I know that Britain is profoundly European. I know also that the ideas of Britain: the invention of representative democracy by Britain, the concepts that Britain is cherishing are part of the European wealth—part of the universal wealth—but part of the European wealth very profoundly. So the UK is welcome, not only in the EU but also in the euro area.
There is absolutely no country which would say “we would not like to have the UK with us.” So my own understanding, it entirely depends on the UK. And we will see what the UK people, not only the UK government or Parliament, but the UK people, because it’s been decided, if I understand well, by all constituencies in the UK that a referendum would be necessary in any case. We will see what happens. I would say that again I am confident that the UK will not leave. When will the UK join the euro area is another story and I would not embark on any guess on that.
JE: You mention that you have a lot of friends in Britain. Mark Carney is one of them.
JCT: Well Mark is a very close friend of course, when he was in his previous position and I appreciated Mark enormously as Governor of Bank of Canada and as head of the Financial Stability Board. So yes, yes indeed. Also I was thinking of the previous governor, Mervyn, and other friends. Ministers and permanent secretaries of the Treasury. I have been working with UK friends for decades.
JE: And what do you think of forward guidance.
JCT: Forward guidance was tried in Canada, applied in the US, and in the US it was the most important such experience. It’s now also more or less mentioned in the euro area.
I myself have always been a little bit prudent as regards forward guidance. My own understanding is that in any case, and it’s been demonstrated very clearly in the rhetoric of the Bank of England and Mark recently, in any case you have to prevent the wrong interpretation which would be that you do not care for price stability and for the overall stability of the inflation expectation. And so you have to mention that there are some knock-out clauses which would interrupt the forward guidance. Then I am not sure that you are really gaining a lot. I have always preferred myself to say in any case we are stabilising and are aiming at stabilising the inflation expectations medium and long term, which is a way to have medium and long-terms nominal rates as low as possible, because inflation expectations are incorporated in the nominal medium and long term. And so that would normally help you to have the appropriate environment you are looking for to help the economy recover.
So you see I look at it, I understand that it is now more or less a concept with is generalising, the UK being the last one to adopt such a concept. I am not absolutely sure that again it gives a lot, but certainly is a signal, which is appreciated by a number of observers.
The main danger is of course that if the market at any time would consider that the knock-out clause are negligible in comparison with the commitment to maintain for a very long time until unemployment is very much down, and if you make this assumption that the market will trust that the zero rate will be maintained for a very long period of time, then you are embarking on carry trade, which might be a real problem, because it is something artificial and it does not help global markets. And when carry trade interrupts, then it creates an enormous volatility. It seems to me this is more of less what happened in the US in the recent period.
So you see I am looking at it with great interest because it is something which is globally generalising and means something as well as all the measures that have been taken by all central banks of the advanced economies. For me it is one of the indicators that all advanced economies are not going very well—that they still have something like the continuation of the crisis, otherwise we would not need central banks to be that imaginative that creative perhaps taking a number of risky moves.
JE: Last question, but I suspect that you will decline to answer. It is simply—Yellen or Summers?
JCT: I can say only that they are both very good people, both good economists, excellent personalities and that’s all.
