1. The Euro in Crisis Uri Dadush Carnegie Endowment for International Peace Chicago, June 14, 2010

2. Main Points 1.Resource misallocation and competitiveness central 2.Fiscal is most immediate risk 3.EMU poses big constraints 4.…Requiring aggressive use of available policy tools

3. Inflation and Interest Rates Converge Annual Inflation and Long-term Government Bond Yields Source: IMF. Bond Yields Inflation

4. Source: Eurostat. Total Increase in Prices of Goods and Services Percent increase, 1997 – 2007 Prices of Non-tradables rise

5. Source: Ahrend, Cournède, and Price, Monetary Policy, Market Excesses and Financial Turmoil, OECD, 2008. Divergence of Policy Interest Rates from Taylor Rule Basis points, 2001 – 2006 Appropriateness of Monetary Policy

6. Competitiveness Loss * Actual value: - 45 Source: European Commission. Change in Real Effective Exchange Rate Based on unit labor costs, percent change, 2001 – 2008

7. Governments Grow Rapidly Source: Eurostat. Annual Growth of Government Expenditure Current Euros, average percent increase, 1997 – 2007

8. Source: Eurostat. Increase in Government Deficit Percent of GDP, 2007 – 2009 Deficits Increase in Crisis

9. EMU Constraints Wide differences in income, economic structure Weak equilibrating mechanisms (labor mobility, fiscal transfers, shared financing) Rigidities in labor and product markets..but with loss of monetary and exchange rate autonomy…

10. Use Available Instruments Aggressively Restructure Greek debts In troubled countries: cut deficit (stabilize debt/GDP in 3 years); recover competitiveness (6% over 3 years). Euro zone: maintain low policy interest rates; promote lower Euro; Germany and others adopt expansionary policy (stimulus worth 1% of euro zone GDP). IMF, US provide support