1. European economic outlook A.Boltho Magdalen College University of Oxford and Oxford Economics OXFORD ECONOMICS USA World Outlook Conference (Washington, 16 September 2010) (New York, 17 September 2010) The Outlook for Europe

2. REVISIONS TO OXFORD ECONOMICS FORECASTS (GDP; percentage changes) 201020112012 Euro Zone1.01.62.1 U.K.1.12.33.0 East. Eur.1.53.75.1 Euro Zone1.51.41.8 U.K.1.62.12.7 East. Eur.1.52.44.6 Euro Zone0.5-0.2-0.3 U.K.0.5-0.2-0.3 East. Eur.0-1.3-0.5 March 2010 September 2010 Differences

3. RECESSION AND RECOVERY (GDP; per cent changes; 3 qtrs. mv. avrgs.) 2007200820092010201120122013 0 2 4 6 -2 -4 -6 United States Euro zone Eastern Europe U.K.

4. Why has Europe outpaced the US? Confidence benefits from fiscal austerity measures? Weaker euro Dependence on trade Depth of downturn

9. RECESSION AND RECOVERY (GDP; levels; 2007 Q1 = 100) 2007200820092010 95 97 99 101 103 Euro zone United Kingdom United States Germany

10. THE MAJOR RISKS Deficits, debts and fiscal policy Can Germany save Europe ? The Euro's longer-run future

12. OECD COUNTRIES: PUBLIC DEBT AND GROWTH, 1946-2009 5 4 3 2 1 0 Aver. Med. Debt/GDP below 30% Aver. Med. Debt/GDP 30 to 60% Aver. Med. Debt/GDP 60 to 90% Aver. Med. Debt/GDP above 90% Source: C.Reinhart and K.Rogoff, NBER Working Paper No.15639, 2010. Note: Central government debt only; 20 countries,1186 observations. GDP growth

13. CROWDING-OUT The standard crowding-out effects could be stronger at present because of: i) The possible presence of a non-linear relation between deficits and interest rates given that all major OECD countries are in debt today ii) Debt levels could be less sustainable than in the past given that potential growth is almost certainly lower iii) Rapidly rising deficits raise the danger of monetary accommodation and/or currency depreciation iv) There are fears of sovereign default, at least in countries such as Greece, Ireland, Portugal and possibly others

15. LONG-TERM INTEREST RATES (bond yields; 3 quarter moving averages) 199920012003200520072009 2.5 3.5 4.5 5.5 Italy Germany France United Kingdom

19. FISCAL POLICY SIMULATION A very simple simulation was carried out on the Oxford Economics global model: Public expenditure in each OECD country was cut by the equivalent of ½ a percentage point of GDP at the beginning of 2011, 2012 and 2013, so as to achieve a reduction in the budget deficit, ex ante, of 1½ percentage points of GDP by 2013 Interest rates and exchange rates were left to be endogenously determined by the model

20. FISCAL POLICY SIMULATION Euro Zone 1.71.4-0.3 U.K.2.72.5-0.2 Euro Zone -4.2-3.21.0 U.K.-6.3-5.40.9 2010-13 Differnc. Base forc. Simulat. Effect on GDP growth (average annual percentage changes) Effect on budget balance* (in per cent of GDP) * In 2011-13.

21. WESTERN EUROPE'S PROSPECTS (GDP; percentage changes) 20092010201120122013 Eurozone-4.01.51.41.82.0 Germany-4.73.11.81.72.0 France-2.51.51.62.02.1 Italy-5.10.80.91.4 Spain-3.7-0.50.40.91.5 U.K.-4.91.62.12.73.2

22. GERMANY - BUSINESS CONFIDENCE AND GDP GROWTH 1992199419961998200020022004200620082010 80 85 90 95 100 105 110 0 2 4 -2 -4 -6 ifo index (l.h.scale) GDP growth (3 qtrs.mv.av. r.h.scale)

23. 4.0 20072008200920102011 94 96 98 100 102 104 106 Employment GDP Employment GDP 2007-11 20072008200920102011 94 96 98 100 102 104 106 2007-11 Employment GDP GERMANY UNITED STATES (Indices;2007 Q1=100) (Indices;2007 Q1=100)

25. GROWTH IN LENDING TO CORPORATE SECTOR (per cent changes; 3 mnths. mov.avrgs.) 0 4 8 12 16 20 24 -4 -8 -12 -16 -20 2006 2007 2008 2009 2005 2010 United States United Kingdom Germany

26. GERMANY - MANUFACT. ORDERS AND INDUSTRIAL PRODUCTION (per cent changes; 3 months mov. avrgs.) 0 10 20 30 -10 -20 -30 -40 0 10 20 -10 -20 2006 2007 2008 2009 2010 Foreign orders (t-3) Domestic orders (t-3) Industrial product.

27. FOREIGN TRADE/GDP SHARE (exports and imports of goods and services; constant prices) 0 10 20 30 40 50 60 70 80 90 100 U.K. France Italy Spain Germany 1990 1995 2000 2008 -91 -96 -01 -09 1990 1995 2000 2008 -91 -96 -01 -09 1990 1995 2000 2008 -01 -06 -01 -09 1990 1995 2000 2008 -01 -06 -01 -09 1990 1995 2000 2008 -01 -06 -01 -09

31. EXPORT PERFORMANCE Difference between growth of exports and growth of markets for goods and services; volumes, annual averages, 1998-2009 USJapan Germ.Fr.ItalySpn.U.K. 0 -2 -4

35. GERMANY - GROWTH AND FOREIGN BALANCE CONTRIBUTION (three years moving averages) 1990199219941996199820002002200420062008201020122014 0 1 2 3 4 GDP Growth Foreign Balance Contribution Averages 1990-2015: GDP growth 1.5 For. bal. contrib. 0.2

37. THE EURO ISSUE The immediate problem is one of public sector deficits and debt which are seen as excessive by financial markets (at least in some countries) But Greece (and other Eurozone members) also face a longer-run low competitiveness problem, generating external deficits Since financing both domestic and external deficits in these countries has become much more difficult, they must be reduced, but, absent devaluation, this could be very painful Could EMU fall apart ? Very unlikely given the huge political capital invested Yet, this is no longer totally impossible

39. INTRA EUROZONE REAL EXCHANGE RATES (1999 Q.1 = 100) 199920002001200220032004200520062007200820092010 80 90 100 110 120 130 140 Germany Spain Italy Portugal Netherlands Ireland Source: EU Commission.

41. WHAT'S WRONG WITH THE EUROZONE ? A simple view: "The fiscal (policy) rules are good, but... implementation has been weak" Jean Pisany-Ferry, FT 17.06.10 A more complicated view: The fiscal policy rules are a necessary, but not sufficient, condition for a successful monetary union What else is needed ? For some, fiscal transfers (i.e. political union) For others, similar policies for deregulation, the labour market, the welfare state, etc. so as to avoid real exchange rate misalignments

42. HOW TO LEAVE THE EURO ? Europe's Monetary Union does not foresee defections. On the other hand, a sovereign country should be able to leave the Union if it so wished How can it be done ? The issue is not just legally complex, but involves, in particular, some serious financial dangers Thus, if financial markets were to anticipate that a country wanted to leave EMU, they might well raise bond spreads to levels that would quickly become unsustainable And if the citizens of that country were to harbour similar expectations, they could, almost costlessly, transfer their liquid balances to banks in other Euro members, leading to what has been called "the mother of all (domestic) banking crises" Both such events would make exit from the Union both inevitable and... chaothic !

43. WHAT WOULD GREECE GAIN BY LEAVING THE MONETARY UNION ? Monetary independence: Hence lower short-term interest rates (as long as the Central Bank agrees) Opportunity to devalue the currency But also: A massive increase in its debt burden (unless debt was redenominated) Almost certainly an increase in inflation and in inflationary expectations Hence a rapid erosion of any short-run competitiveness gain Hence a likely increase in long-term interest rates And, in addition, almost certainly, much greater economic instability

44. This would be very popular with public opinion which overwhelmingly believes that EMU is a burden for the country It would be less popular with business The country's new currency would appreciate massively overnight Companies would be facing significant menu costs as all prices and contracts had to be redefined Frankfurt would lose importance as an international financial centre relative, in particular, to London WHAT WOULD GERMANY GAIN BY LEAVING THE MONETARY UNION ?