Papademos: An Exclusive Interview: The Retiring European Central Bank Vice President Speaks out on the European Banks, Chances for a Double Dip, and the Survival of the Euro
TIE: With European policymakers calling for aggressive budget austerity, and with most of the world rejecting the American call for additional fiscal stimulus, is the world at risk of a so-called double-dip economic recession scenario, or perhaps even a depression?
Papademos: Let me first point to some facts before assessing the scope for fiscal stimulus and the potential risks of fiscal consolidation to economic growth. The economic and financial crisis has resulted in a significant deterioration in public finances in most advanced economies. In a number of countries, including the United States and several EU member states, government budget deficits as a percentage of GDP approached or exceeded double-digit levels in 2009 and in many cases no discernible improvement is expected this year. If decisive measures are not taken to reduce government budget deficits in the years to come, market concerns about the sustainability of public finances will eventually translate into higher risk premia and real bond yields, with adverse effects on economic activity. This has already happened in countries where debt dynamics have been assessed as particularly unfavorable.
These facts and likely future market outcomes show that the room for further fiscal stimulus is either extremely limited or nonexistent. On the contrary, there is a need for fiscal consolidation in most advanced economies. Unless sizeable and credible fiscal consolidation is implemented to address the risk of rising public debt and unsustainable debt dynamics, growth will be adversely affected. Since fiscal adjustment is inevitable--and the extent of the required adjustment will be greater the more it is delayed-markets and the public at large are likely to adapt their behavior to this prospect sooner rather than later. It is dangerous to assume that the majority of consumers and investors are short-sighted and that they will ignore the future consequences of rising public debt on the real cost of financing and the evolution of real income. Consequently, both private consumption and investment could turn outland in some countries will surely turn out--to be weaker over the medium term in the absence of prompt fiscal consolidation. Moreover, the prospect of high and increasing debt-to-GDP ratios could raise concerns about future inflation and unanchor long-term inflation expectations from price stability.
Indeed, a strong case can be made that, under the circumstances prevailing in many economies, systematic and convincing policy action to address the large budget deficits will reduce uncertainty, boost confidence in the sustainability of public finances, and thus foster conditions conducive to economic growth. I do not see a so-called double-dip economic recession scenario as the likely outcome of pursuing policies of budgetary prudence that will prevent a serious fiscal and economic crisis in the future.
TIE: What are the odds the euro survives? How about the chances that certain members of the monetary union drop off? What will the European monetary system look like five years from now? If the eurozone shrinks, will Germany face serious deterioration in its export markets as exiting countries engage in currency depreciation against the euro to counter rising bond yields?
Papademos: The euro is here to stay. It is totally unrealistic, indeed absurd, to doubt the euro's survival. No member of the European monetary union will "drop off' and abandon the single European currency. Such a prospect is not legally feasible. More importantly, there are no convincing economic and political incentives for member states to do so.
The arguments that have been advanced by some economists, including distinguished friends of mine, are based on partial assessments that do not take fully into account all the relevant economic and political consequences of such a hypothetical scenario, as well as the commitment of all euro-area countries, despite the recent difficulties and tensions, to the European integration process. …