- Options for a Euro-area fiscal capacity (with Erkki Vihriälä and Guntram B. Wolff), January 2013
Europe has responded to the crisis with strengthened budgetary and macroeconomic surveillance, the creation of the European Stability Mechanism, liquidity provisioning by resilient economies and the European Central Bank and a process towards a banking union. However, a monetary union requires some form of budget for fiscal stabilisation in case of shocks, and as a backstop to the banking union.
This paper compares four quantitatively different schemes of fiscal stabilisation and proposes a new scheme based on GDP-indexed bonds. The options considered are: (i) A federal budget with unemployment and corporate taxes shifted to euro-area level; (ii) a support scheme based on deviations from potential output;(iii) an insurance scheme via which governments would issue bonds indexed to GDP, and (iv) a scheme in which access to jointly guaranteed borrowing is combined with gradual withdrawal of fiscal sovereignty.
Our comparison is based on strong assumptions. We carry out a preliminary, limited simulation of how the debt-to-GDP ratio would have developed between 2008-14 under the four schemes for Greece, Ireland, Portugal, Spain and an ‘average’ country.The schemes have varying implications in each case for debt sustainability.
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The known unknowns and the unknown unknowns of the EMU, october 2012
The euro crisis and the new impossible trinity, september 2012
The fiscal implications of a banking union (with Guntram Wolff), September 2012
The simple macroeconomics of North and South in EMU (with Silvia Merler), August 2012
What kind of European banking union? (with André Sapir, Nicolas Véron and Guntram Wolff), June 2012
Propping-up Europe? (with Guntram Wolff), April 2012
Hazardous tango: sovereign-bank interdependence and financial stability in the euro area (with Silvia Merler), April 2012
The messy rebuilding of Europe (with André Sapir and Guntram Wolff), March 2012
Sudden stops in the euro area (with Silvia Merler), March 2012
The G20: Characters in search of an author (with Ignazio Angeloni), March 2012
Who's afraid of sovereign bonds? (with Silvia Merler), February 2012
Don't let the euro crisis go East (with other co-authors), February 2012
The euro crisis and the new impossible trinity, January 2012
Complete publications list
The response to the euro zone crisis, which has gradually developed since 2010, has not led to a search for federalism and it has hardly taken the community model of division of powers. It gave rise to the emergence of a new model of mutual insurance among states with consideration for a gradual strengthening of fiscal discipline.
Published in Journées de l'economie de Lyon 2012
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Extensive prior research on the economics of European monetary union highlighted some potential risks (the known unknowns) but overlooked others (the unknown unknowns). Asymmetries among participating countries, the potentially destabilising character of a one-size-fits all monetary policy, the weakness of adjustment mechanisms, the lack of incentives for fiscal discipline, the possibility of sovereign solvency crises and their adverse consequences were all known and understood. But policymakers often relied on a complacent reading of the evidence.
• The potential for financial disruption was vastly underestimated. Economists generally did not consider, or underestimated, the possibility of balance of payment crises such as those experienced by southern European countries, or the risk of a feedback loop between banks and sovereigns.
• Remedying EMU’s systemic deficiencies is on the policy agenda. Banking union would go a long way towards addressing the fault lines. The urgent question for economists is if it is going to be enough and, if not, what else should complement the ‘bare-bones’ EMU of Maastricht.
This Policy Contribution is based on a keynote address at the conference The European Sovereign Debt Crisis: Background and Perspectives, held at the Danish National Bank on 13-14 April 2012.
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Since the euro crisis erupted in early 2010, the European policy discussion has mostly emphasised its fiscal roots. Beyond short term assistance, reflection on reform has focused on the need to strengthen fiscal frameworks at European Union and national levels.
The sequence of decisions and proposals is telling:
The question is, are the Europeans right to see the strengthening of the fiscal framework as the main, possibly the only precondition for restoring trust in the euro? Or is this emphasis misguided? It is striking that in spite of a growing body of literature drawing attention to the non-fiscal aspects of the development of the crisis, other problems that emerged during the euro crisis have almost disappeared from the policy discussion at top level.
Credit booms and the perverse effects of negative real interest rates in countries where credit to the non-traded sector gave rise to a sustained rise in inflation were the focus of policy discussions in the aftermath of the global crisis, but these issues are barely discussed at head-of-state level. Real exchange rate misalignments within the euro area, and current-account imbalances, are largely considered to be either of lesser importance, or only symptoms of the underlying fiscal imbalances. Finally, the role of capital flows
from northern to southern Europe and their sudden reversal, are merely discussed by academics and central bankers, although the sudden reversal of north-south capital flows inside the euro area is fragmenting the single market and creating major imbalances within the Eurosystem of central banks.
"The Euro Crisis and the New Impossible Trinity" was published in Moneda y Credito 234/2012. This external paper draws from the Bruegel Policy Contribution The Euro crisis and the new impossible trinity released on 15th January 2012.
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Systemic banking crises are a threat to all countries whatever their development level. They can entail major fiscal costs that can undermine the sustainability of public finances. More than anywhere else, however, a number of euro-area countries have been affected by a lethal negative feedback loop between banking and sovereign risk, followed by disintegration of the financial system, real economic fragmentation and the exposure of the European Central Bank. Recognising the systemic dimension of the problem, the Euro-Area Summit of June 2012 called for the creation of a banking union with common supervision and the possibility for the European Stability Mechanism to recapitalise banks directly.
The findings of this paper were presented at the Informal ECOFIN in Nicosia on 14 September 2012.
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The euro area today consists of a competitive, moderately leveraged North and an uncompetitive, over-indebted South. Its main macroeconomic challenge is to carry out the adjustment required to restore the competitiveness of its southern part and eliminate its excessive public and private debt burden. This paper investigates the relationship between fiscal and competitiveness adjustment in a stylised model with two countries in a monetary union, North and South. To restore competitiveness, South implements a more restrictive fiscal policy than North.
We consider two scenarios. In the first, monetary policy aims at keeping inflation constant in the North. The South therefore needs to deflate to regain competitiveness, which worsens the debt dynamics. In the second, monetary policy aims at keeping inflation constant in the monetary union as a whole. This results in more monetary stimulus, inflation in the North is higher, and this in turn helps the debt dynamics in the South.
Our main findings are:
The differential fiscal stance between North and South is what determines real exchange rate changes. South therefore needs to tighten more. There is no escape from relative austerity.
If monetary policy aims at keeping inflation stable in the North and the initial debt is above a certain threshold, debt dynamics are perverse: fiscal retrenchment is self-defeating;
If monetary policy targets average inflation instead, which implies higher inflation in the North, the initial debt threshold above which the debt dynamics become perverse is higher. Accepting more inflation at home is therefore a way for the North to contribute to restoring debt sustainability in the South.
Structural reforms in the South improve the debt dynamics if the initial debt is not too high. Again, targeting average inflation rather than inflation in the North helps strengthen the favourable effects of structural reforms.
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This paper discusses the creation of a European Banking Union. First, we discuss questions of design. We highlight seven fundamental choices that decision makers will need to make: Which EU countries should participate in the banking union? To which categories of banks should it apply? Which institution should be tasked with supervision? Which one should deal with resolution? How centralised should the deposit insurance system be? What kind of fiscal backing would be required? What governance framework and political institutions would be needed?
In terms of geographical scope, we see the coverage of the banking union of the euro area as necessary and of additional countries as desirable, even though this would entail important additional economic difficulties. The system should ideally cover all banks within the countries included, in order to prevent major competitive and distributional distortions. Supervisory authority should be granted either to both the ECB and a new agency, or to a new agency alone. National supervisors, acting under the authority of the European supervisor, would be tasked with the supervision of smaller banks in accordance with the subsidiarity principle. A European resolution authority should be established, with the possibility of drawing on ESM resources. A fully centralized deposit insurance system would eventually be desirable, but a system of partial reinsurance may also be envisaged at least in a first phase. A banking union would require at least implicit European fiscal backing, with significant political authority and legitimacy. Thus, banking union cannot be considered entirely separately from fiscal union and political union.
The most difficult challenge of creating a European banking union lies with the short-term steps towards its eventual implementation. Many banks in the euro area, and especially in the crisis countries, are currently under stress and the move towards banking union almost certainly has significant distributional implications. Yet it is precisely because banks are under such stress that early and concrete action is needed. An overarching principle for such action is to minimize the cost to the tax payers. The first step should be to create a European supervisor that will anchor the development of the future banking union. In parallel, a capability to quickly assess the true capital position of the system’s most important banks should be created, for which we suggest establishing a temporary European Banking Sector Task Force working together with the European supervisor and other authorities. Ideally, problems identified by this process should be resolved by national authorities; in case fiscal capacities would prove insufficient, the European level would take over in the country concerned with some national financial participation, or in an even less likely adverse scenario, in all participating countries at once. This approach would require the passing of emergency legislation in the concerned countries that would give the Task Force the required access to information and, if necessary, further intervention rights. Thus, the principle of fiscal responsibility of respective member states for legacy costs would be preserved to the maximum extent possible, and at the same time, market participants and the public would be reassured that adequate tools are in place to address any eventuality.
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G-20 macroeconomic coordination went through three successive phases. In the first one, from Washington to Pittsburgh, the focus was on stimulating the global economy across the board. All countries were requested to contribute, to the extent permitted by the domestic fiscal situation.
In the second one, from Toronto to Cannes, it shifted toward a more complex set of objectives, with the aim of combining continued support for growth, budgetary consolidation, and the avoidance of a resurgence of global imbalances. In the third phase, from Cannes onwards, the focus was on the European crisis and potential contributions to its solution from the rest of the world.
In this note, I give a broad-brush assessment of the priorities and achievements in the three phases, before offering a few conclusions on the overall performance of the G-20.
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