 Well thank you very much. I'm absolutely delighted to be back here in Dublin. I came from my hotel where I stayed this night walking from Brooks over here and I was thinking the first time I was a young student in 71 or 72 I came the first time to Dublin and walking down here through Dublin I thought Europe has been good to Ireland. This was like really it's nice to see that. Despite all the problems we have, you had and everyone else. And so it's in this spirit maybe that I would like to give you my presentation which is on a very special issue but we could broaden it up and in a broader context maybe some of you have seen that last week I had organized an appeal signed by many intellectuals in Europe was published in English by The Guardian last Friday where we call for the election of Jean-Claude Juncker not necessarily because we side with his party political views or with the personality but in order to rebalance the institutions in the European Union and maybe we can have a quick discussion about the end I don't know but it is slightly related to what I'm going to do. However I'm going to talk about a very specific technical issue which nevertheless I believe is absolutely crucial which is the issue of internal imbalances and the flow of funds which is a technical issue and related to that. There are two explanations for the crisis basically we can say there is the fundamentalist thesis which is either there was excessive deficits or of the German view and break of fiscal discipline or and this is more the commission's view imbalances regional imbalances and to an essential degree these imbalances are measured by current account deficits and I think this is wrong and I think this leads to policy recommendations which have made the crisis worse and therefore I would like to question that whole theoretical approach. There's of course also another dimension which I will not discuss here today which is that maybe the crisis has to a large degree also been the financial crisis banking crisis and related to that were issues of liquidity and risk premium and mismanagement of the risk perception during the crisis and so on which is I think an important part of the whole drama but this is not my subject today. So the question of macroeconomic imbalances what action does it mean? Well you see here the chart on the current account the GDP ratios you see that for the euro area as a whole it was very much close to zero but if you split it between the north and the south and I consider Ireland to be south because I don't like when people talk about peaks and things like that you see that the north has been having current account surpluses until the crisis which is this line here and the south has had huge deficits so looking at that a lot of people including European Commission said ah that's a problem and we need therefore to do something to reduce these imbalances. If you look at the countries you see Germany huge from the deficit into a huge surplus you see also with Ireland here a continuous deterioration of the current account positions same for Italy, Portugal, Greece and so on so Spain you see that there are it looks like that's really the problem there. However we have to be a little bit more subtle about this the current accounts we don't have a separation of current account payments within the euro area and the rest of the world partly because there are these payments that go in addition to trade but the trade balance is a good proxy for what is the relative weight and here what you see is trade balances within the euro area the red line the the the European Union 27 as a whole and the the green one is rest of the world outside the euro area well outside the European Union and what you see for the euro area as a whole the external one trade balance has improved but if you look at Germany what is interesting this is zero and this is six percent of GDP up here you see that huge surpluses between the European trade a little less in the euro area because they do a lot of business with the UK and the green one is rest of the world you see also that the green part was more or less the same as the euro area but then after the current or during even after the crisis German countercount surpluses or trade balance surpluses have been reduced to zero but they have accumulated huge surpluses to the rest of the world particularly with China look at France the rest of the world is balanced but the big deficit is in the European trade Ireland is here which is starting at four and going up to 20 percent here I mean enormous surpluses but this is straight if you look at the current accounts this we saw just before there was a tendency to move into deficit why because a lot of the profits that are generated by exporting from Ireland are done by international companies that repatriate their profits back to the US or wherever else it goes so that's why this trade balance is not in Ireland is not reflecting the current accounts in Germany they are really identical but what we see here is that okay European coming okay there was a tendency also to deteriorate a little bit after the crisis up and now it's coming down in intra euro area trade and international trade pretty much the same way between for the two in in in Ireland in in Greece everything is in deficit and you may say oh that is isn't that terrible how can they survive how can they pay for all the stuff they are importing and I will come back to that issue because I think it's at the core but what I want to say is the performances of individual member states are all very different Netherlands has services in European trade and deficits in international trade so that picture needs to be integrated and we need to understand properly what it means in terms of the functioning of European monetary now during the first decade of monetary union European societies ECB also the Commission treated have treated currently current imbalances with the 90 like nobody thought that would really matter and in fact not even the Maastricht Treaty gave any consideration to come the current deficits and Ingraham already in 1973 really formulated the reason he said inter-community payments become analogous to inter-regional payments within the single country so in other words payments between Greece and Ireland are essentially of the same nature as part of payments from Dublin to Limerick Blanchard and Javazzi in 2002 also looked at the rising current income deficits in Greece and Portugal and they said they're exactly what theory suggests can and should happen when countries become more closely linked in goods and financial markets and I still think they're right nevertheless there is this revisionist approach which has been developed particularly by the Baroso Commission over the last few years including the fact that then they created the so-called avoidance of excessive deficit avoidance of excessive macroeconomic imbalances and so we need to understand why did they revise it what does it mean what what is the rationale of it now the I'm the Commission pretends they are looking at more than just current account imbalances and in some ways this is this would be a good thing the imbalance procedure could actually be a useful tool if it would be used correctly but if you focus on current account deficits I argue you are misusing this tool and I will explain you why now the current account balances are a balance of payment item what is the balance of payment the balance of payment reports cross-border payments between currency areas because it is about how much foreign exchange you have in order to make your international payments the idea being traditionally for the last 300 years or so that if you don't have enough foreign exchange reserves you can't pay outside the rest of the world and therefore you have about an accounting system to look at what that means in the old days that they shift gold and silver back and forth and then they realize they don't need to do that so we have nowadays the current accounts financed by the capital balance meaning capital flows and if there is an excess of that it is a change of foreign exchange reserves so in other words you may have the current account trade deficit that gets financed because someone lends you the money to buy these things but also you'll have autonomous capital movements like buying property in Ireland or shares or bonds or things like that and those together are affecting the foreign exchange reserves which are held by the central bank so they are in other words a part of the balance sheet of the central bank and therefore of the factors that determine money supply so the important thing to understand this why I say taking the euro seriously is that monetary union is not not not a fixed exchange rate arrangement and this is one of the things that you hear mistaken have heard mistakenly during the crisis and especially in Germany like oh well when Greece could just leave oh they can come back once they have done this no that might have been appropriate under the old European monetary system but monetary union works absolutely and totally differently in fact the the reason why it's different is because you have a union of payments and the money in the payment union comes from the central bank and these monetary flows in euros between Ireland and Germany and Greece they are not related to foreign exchange reserves there are no foreign exchange reserves for Ireland in the terms of euros what you have is euro balances in Irish banks so the imbalances within the single market and the monetary union reflect imbalances in effective demand but they are not affecting foreign exchange reserves you have had some observers I know two of them in Germany who kind of talk about Irish euros German euros this is utter and total nonsense now if you understand that then it's useful to simply look at some national accounts a simple thing that we economics professors teach first-year economics is that national income is consumption investment government spending and net exports and on the other hand the income is government taxes and savings and so you can combine these two and you will get an equation which is here which shows that the talent account balance is a function of the government deficit the difference between tax income and government spending and the savings investment balance now what does that mean it means that if you have a current account deficit you must have either a high deficit from the government or you must have an excessive amount of investment so that foreign savings are financing your domestic investment that's just a simple identity there's nothing not big theory in any of this but what it implies of course also is that if you have a deficit here and you want to reduce it like the UP commission says reduce imbalances what are you going to do well you will either reduce investment and public spending by the governments or you increase savings and taxes which is basically saying you have to implement severe austerity and that means that you are slowing down economic demand and probably economic growth and as we have seen during the crisis wherever those policies have been imposed they have dramatically reduced growth rates and that is a serious issue for other reasons which i come back to in a moment so i think that kind of policy although it might be appropriate in modest proportions when you use it in a severe crisis like we have had it has made the crisis worse now then it means in monetary union looking at current account and currently on deficits makes no sense to which some people say oh but you're crazy if you have a deficit you have to pay for it the commission even says it increases foreign debt i mean come on foreign debt what is foreign debt of ireland when it's it denominated in euro and has been financed by a german bank it's not foreign it's european debt so what exactly is happening when euro member states i mean states i mean by that the statistical system of the state because it's private as well as public debt if they are reporting inter-trade imbalances well it's very simple monetary union is a payment union so it means that there has been more payments going out than payments going in which means what it means that the money balances have been shifted from let's say Greece to Germany it's just a redistribution of euro money balances that exist the ecb looks at the aggregate they don't care whether you keep the money in ireland or in germany or in italy and when you have these trade imbalances in order to pay for the imports you are sending the money there where has the money come from that we will need to see but it means on aggregate for the euro area as a whole these imbalances do not affect the money supply which is the purpose of monetary policy but what it might cause and create is what Olivier Blanchard has called rotating slumps and i would add there is a counterpart to it rotating booms now this to me sounds rather how should i say close to reality you remember in the early 2000s we had booms in ireland in spain and we had a slump in germany everyone said hard germany is terrible you know it's like slow growth they are so sclerotic they need structural reforms they did all kinds of things which ruined his party and the germany welfare system but suddenly then things turned around now it is germany wonderful these reforms they have done all the difference as the imf they have calculated what the effect of these labor market reforms have been the result is economically a homeopathic impact but what has clearly happened is there has been a huge shift from the south where the boom was before into germany where it is now as a little footnote if you ask me what's going to happen next i would say given this logic what we probably will hear is that in about three four years time when the minimum wage has been implemented if you are the retirement has been increased with the present social democratically influenced the government people will say oh germany they have ruined everything they have had it's a very bad country now they are too expensive and then the capital will go somewhere the question is where will it go now it might be um the south there wasn't such a good idea germany is off so then maybe i at the moment i hesitate either it will be italy because renzi is doing the right thing but i don't believe in italy so i think more likely it will go to france and then everyone that's oh france is a fantastic country the only question i have is will it happen before the election re-election of euland or after the election of marina le pen anyhow i'm not going to bore you with the details of this but this is to show that i'm academically sound and you can read this in my book on competitiveness in the european union what does this show it shows what's happening with inter-euro area payments we have the balance sheet of the buddhist bank bunker the tire and the euro system the stylized thing a little bit and you see okay there's they aggregate up and you have the total balance sheet some meaning some money supply of 1500 and then you shift it around you make a payment from italy to germany so it increases a little bit the balances in germany it reduces them in italy but overall it remains the same which is what i said before now that's the first thing now what if germany exports to the us or to china well then it changes foreign exchange balances where not well not really in germany for the euro system as a whole so therefore we get a surplus in the euro area and that affects the balance sheet of the ecp and therefore money supply so in that case we see here money supply has increased from 1900 to 2050 given that there's been a sale from 150 here but you could also say how is the inter current account deficit financed within the euro area so that the irish current account deficit the greek deficits and so on who's financed that and the answer is extremely simple it's paid by borrowing money from banks and then um you are taking that money you go to anglo irish bank you get a loan and you buy a property in i don't know spain why not and and that's it where did the banks get the money from from the ecp central bank that's the system and so in other words um you could also go your irish company you go borrow from deutsche bank huge lender to island as a matter of fact and that's it now the effect of that of course is an increase in money supply in total here here is the the statistical effects the the central bank could intervene on in that by sterilizing it you know shifting it from here to there by raising interest rates if they think this is too big and so on but the bottom line is that's the business of monetary policy the question you may want to ask is well how if they have borrowed the money from the bank how is it paid back and in particular if it is borrowed from germany don't we need to have a current account surplus to pay it back in germany well in the good old days of the gold standard or whatever that would have been right even under the european monetary system that would have been right we would have needed to earn foreign currency so that we can pay back the the the money we have borrowed in foreign currency but now we just get the money from the ecp so we don't need that anymore but what we do need is we need to pay back the money we have borrowed so in other words the source of funds to pay back our debt and the interests are a surplus in income which means we need economic growth and this growth will have can come both from the tradeable and the non-tradable sector so in other words um if you are generating sufficient domestic growth you have the income to pay back your bank and it doesn't matter whether it's exporting things to germany or to america or not now that is important because the commission recommendation in the avoidance of macroeconomic imbalances focusing on the current accounts they said you need to reduce by with austerity the demand etc etc here we say the opposite you need to maintain the economic growth in both the export sector and in the domestic non-tradable sector so that's why i said before i think the commission's recommendation are really making a serious mistake because they are imposing policies that have slowed down growth and now servicing the interest and the debt becomes more difficult than before so you need growth and you need profitability and that's an issue of competitiveness which i will come back in a moment but what does all that mean for economic imbalances does it mean imbalances are totally irrelevant not entirely but it means that the current account category is the wrong one to look at this what is more important is flow of funds now flow of funds are the macroeconomic equivalent of a cash flow statement for a country and what they are showing are functional categories within the economy between essentially households which under tax book assumptions should save corporations which borrow in order to invest and in the tax book thing government and the rest of the world should be imbalanced in the Keynesian assumption we have households that save and then Keynesian argument was that if the corporations do not borrow someone else needs to borrow to maintain the demand and that would be the government to absorb the excessive savings in that case so that means the flow of funds is the correct instrument to assess imbalances and what we find when we look at that is that Europe's weakness is the corporate sector borrowing now here you see it for the euro area as a whole the blue line on the top this is lending this is borrowing the households are lending saving and lending that's how it should be we see that there are variations and after the crisis in the uncertainty households started to save much more we see the green line as the rest of the world which is the current account position of the euro area as a whole but what is relevant for our discussion now is the black one is the corporate sector and what will we find especially during the crisis first 2009-10 and now again the corporate sector is actually lending all to put it differently they are saving instead of borrowing why are they doing it they are paying back previous debt it's deleverging and this aggregate effect of deleverging is the same as household savings in macroeconomic terms now immediately in the government in the in the crisis the first response of governments was what Keynesian theory would say you have to borrow so they did but then as soon as the economy started to stabilize like in the u.s the europeans said how stability and growth pack you have to now consolidate this can't go on forever so they quickly started to to to reduce the borrowing again the stimulating effect was becoming weaker weaker remember the governments have the corporate sector is deleveraging but they are starting to do the same thing in a way and the households okay reduce a little bit their lending but not much why are they doing it probably also because now there's no demand anymore so there's slowdown economic growth and there's less saving less income and therefore also there's savings and all that so what we find here is that the the the corporate sector in the deleveraging and we can show the similar dynamics have happened in japan over the last 20 years and so on with an early exit from stimulus policies in the euro area have made the recession worse compare that with the u.s i don't have the data here now but when you look at the data for the u.s you see that the obama administration has been much more gradual in their fiscal consolidation which of course is criticized by the republicans but overall has maintained the economic growth in the u.s at a much better rate a further advantage of flow of fund analysis is that it also can be used for regional analysis and here we see that the corporate sector in the north has been lending to the south this is the north this is the south you see the corporate sector here is blue in the north after 2000 it has always remained in the landing territory and the south has borrowed until the crisis now it has also started to stop borrowing but what it really was is that the north shifted the money to the south through the banks to give you an example i i professor in italy um and i bought a car i went to i bought a folks one and um they have their own bank internal bank i wanted to pay the loan back a little bit earlier um i go to my bank where i got the credit they say okay this we have this is the arrangement we had with um folks one finance i look at folks one finance where is it demissilated well it's right foot of course right and so it's germany lending money so that in the south they can buy german products now is that bad no it's not bad if we know what we are doing if we have the tools and instruments to maintain all this correctly because it it also has helped german exporters and so on now all in all if you look at especially in the recent time now in the crisis you see that um or before the crisis you see german dutch finish and greek corporations have been net lenders since the early 2000s but there's a difference germany and the netherlands have been lending abroad while greece and finland has been lending to households so the households were borrowing more than they were actually saving so um since the financial crisis all corporations have started to deleverage and and pay back so no wonder there is no more investment no more growth no more job creation and all that here you see it for some ember states the um households are the blue lines and the corporate sector is the red one you see germany always lending the corporate sector in france mostly the corporate sector has been borrowing how it should be in indily since the crisis they are also moving into lending greece interesting case greece has always had a corporate sector that was lending and the households were actually borrowing so some world upside down um now island okay island this this is not nice to be seen because the peak here is up to 20 percent of the corporate deleveraging which is the debt restructuring that happened with the banking system here of course um but but you see also that um the households before the crisis were actually borrowing and not lending and so what we find is before the crisis we had really consumer booms in finland in the netherlands in spain island in greece and we had investment booms to some degree in spain portugal italy and to a lesser degree in france but in germany we had the rotating slump since the crisis generalized the leveraging and public debt consolidation so no wonder that there is no economic growth returned now we could say from a canesian point of view fiscal policy should become a stimulus has it been a stimulus well if households and corporations are savings the government must be borrowing otherwise you're just getting into a very vicious spiral down in the early crisis i just showed you this is what happened since 2011 um corporations and governments are reducing debt we get recessions and we get countercount surpluses returning which is the commission who says hooray you see our policy recommendations are working yeah they're working with total um collapse of the european economy now is there any evidence for kensin policies statistically speaking it's very interesting we find that um you could test that with the so-called ranger causality in terms of these borrowings between the government and the corporate sector and what we find is that it works kensin effects can be found for the euro area as a whole but not really for the member states oh this is a collapse here we don't see the statistics but um what what the the so-called ranger causality tests show is that um they test whether in terms of lending and borrowing which comes first so you could say the kensin effects are if the government follows the government starts to borrow when the corporate sector stops to borrow or alternatively if the first the government borrows and then the corporate sector stops then you would say it's crowding out if this policy is negative so you could actually test that and this range of causality i don't know why it has disappeared here but what we find is that it's significant on the euro level as a whole for a number of countries including ireland and germany um what the data here that you can't see show is that it goes both ways so it's not really significant for these individual countries there are few small countries france being one where you have evidence of kensin effects but what is the conclusion from that i think the conclusion from that is that you want to have fiscal policy on the aggregate of the euro area so that you can actually compensate these um aggregate demand effects that are slowing down economic growth but we also need to look at the regional redistribution what we see and have seen now for the last two decades is that on aggregate the euro area works quite well with the regional redistributions of course a different issue and that is an issue of competitiveness now one thing that often i said rotating booms that is really about attracting investment opportunities some of that is about risk and the return on capital but the risk factor is extremely important and the other is competitiveness in that sense now typically you have often probably heard or seen this kind of chart which starts in the year 2000 that permission calculates its indices for unit labor costs and you say ah these terrible countries italy or where is ireland ireland is this one here you see ireland we had this discussion area unit labor costs for ireland far higher than they were on the average of the euro area and even much higher than what the ecb target of two percent should have been now of course ireland has brought them down dramatically and germany has been down here um pulling it all down so no wonder germany competitive the gap between italy and germany 22 percent this can't go on it's terrible something needs to be done on this fair enough the question is who tells you that the year 2000 everyone should have been at the same point there is a base year problem what is the equilibrium level a few years ago i was at the seminar at ecb some of the top european economists discussed nearly nearly for a full day how did deal with it nobody knew an answer and then in my bathtub i had an idea afterwards and i calculate a competitiveness index for unit labor costs that takes the equilibrium level and derives it from the assumption which i think is reasonable in a single market with a single currency that return on capital should be the same as the average in the euro area so in other words if you return on capital in ireland is higher than the average it means you must be more competitive you must be able to attract more investment into ireland if it is less then of course you should not get much investment whether domestic or foreign doesn't matter but it's just a measure for that so from that we can then calculate backward what should be the unit labor cost and to make a long story short here's the index and what you see is this level this horizontal line here gives you the equilibrium level take germany in the 1990s germany was about 12 to 10 percent overvalued above the unit labor cost above the equilibrium level which means of course the return on capital in germany in those years was less than the average of the euro then they did all kinds of measures in order to bring it down and now germany is undervalued not enormously but nearly eight percent france you see the opposite in france it used to be undervalued then the the critical years 2002 it starts to deteriorate why 2002 it's the year of the re-election of shirk it is when shirk in the second round has to face up to le pen and i think that this has led to a political dynamic whereby the right wing parties who have governed france since then pretty much have resist have not had the courage to resist wage increases because they were afraid that they lose what voters to the to the to the front national so you you have a fairly disastrous development there in france italy had been undervalued partly because of the er m crisis in the early 90s but now they're a little bit above them ireland has always since the mid 1990s i mean really we go back in the chart you see it starts with the er m crisis island has been undervalued significantly which means it has this great competitive advantage in aggregate and that's probably also why island is pulling out more easily from the crisis by portugal also undervalued but less than ireland grease however always been overvalued so here's a here's one chart for all member states of the euro area and it's quite interesting because the sea grease is now 2013 overvalued by i thought 13 percent when comes france overvalued by eight austria also close to eight italy two and a half percent spain also one two percent everyone else is undervalued germany now six percent but the really big business is in the new member states in eastern europe slovakia topping it with 55 percent unit labor cost below the average of the equilibrium of the euro area and of course that leads to enormous shift of restructuring in terms of competitive advantages investment in the euro area and ireland is at minus 22 so i mean really doing very well but of course the others like slovakia and latvia they are doing much better laxi but sort of not really relevant for this kind of exercise so the conclusion of all this what do i say i say we have to stop thinking of the euro area as a fixed exchange rate regime which means we live in euroland it is our integrated economic space and it works like any other integrated economic space but it means a unified single macroeconomy needs also an institution to manage this integrated single economy and we need a single macroeconomic management institution for that having said that i believe that the implication is that if you have that and you delegate more and you centralize more decision making to the european union then you need also more democratic control of that that's pretty obvious in itself and that's why i think what is right now going on in terms of the power struggle between the european parliament and the european council about who's going to be the next president of the commission is absolutely crucial it is it is the the democratic moment of the european union it is it is england in the 17th century it is caught against country council against parliament however competitiveness is important for regional divergences and one has to look at competitiveness issues and also to see maybe how to support some regions in becoming more competitive but the bottom line is economically speaking also that a sustainable euro requires balanced growth growth not the reduction of current account deficits thank you very much