THE GES AT 50 SEMINAR

European Central Bank headquarters Frankfurt, Germany.

GES at 50 seminar: ‘Fixing the euro area’ Agnes Benassy-Quere (Paris School of Economics)

Problems in the euro area

Here is a concise report on the GES seminar I attended, where The professor discussed the rationale behind the Euro, many common misconceptions, policy considerations and crisis management plans. The professor also went on to explain the various challenges the European monetary union faces, and what steps need to be taken in order to make the euro a success – outlining the obstacles that are ahead in the short-term and long-term.

Why The Euro?

The Euro does have many economic benefits including:

-       Competitive advantage – Provides basis for trade

-       Lower transaction costs

-       Trade creation and trade diversion

-       Unification of member states

Theory of the single market – what are the gains of the euro?

-       Convergence of prices – increased price transparency

-       Lower transaction costs

-       Elimination of exchange rate risks – promotes longer-term investment

-       Downward convergence of trade prices

Target liabilities

Euro zone Misconceptions

   

     Trade between euro-zone members has not been as free flowing as many anticipated

-       There has been downward convergence in trade price.

-       Divergence in real interest rates – is increasing the fragmentation between Eurozone members

-       Companies in the euro zone’s weakest economies face higher borrowing costs compared to countries such as Germany – extent of divergence has fallen since its peak in 2013 but still higher than mid-2011.

Monetary Unions do not work without a banking union

-       The ECB in 2012 decided to become a banking union.

-       Mainly commercial banks that finance credit – have micro-prudential control, they set their own interest rates without supervision from the ECB.

-       The Single Supervisory Mechanism (            SSM) – Is a new system of banking supervision for Europe, compromising the ECB and the national supervisory authorities of participating countries.

3 Main principles:

·       Ensure the safety and soundness of the European banking system
·       Increase financial integration and stability
·       Ensure financial integration and stability

Maastricht Criteria heavily fixated on fiscal policy

  

     There needs to be more focus on macro-policy regulation.

-       Symmetric shocks need to be tackled by prudent monetary policy (Many asymmetric shocks occur due to lack of convergence in the EU).

-       Financial integration will help to ease idiosyncratic shocks.

-       Macro-economic policy must be adjusted – there is a palpable lack of interest rate convergence between member states.

-       Transaction costs must be lowered

-       Fiscal balancing – counter-cyclical policies

-       SGP – implemented to ensure that fiscal discipline would be maintained and enforced in the EMU. However the SQP has failed to do so.

Crisis management

-       The ESM has failed to work – has led to lack of government accountability

-       Discretionary policy (mainly intergovernmental) – as Maastricht criteria is too broad.

-       Two views held;

1. Germany – Do not believe in bail outs of heavily indebted nations e.g Greece

2. France – Do not want any financial disruption.

-       Liquidity insurance should be offered (deposit insurance):

-       ‘When you purchase a car you buy insurance, not because you are a bad driver... it is only fair that you should be given liquidity insurance’

-       Implementation of a resolution mechanism.

Deleveraging has still not occurred.

How to fix the Euro

-       Fiscal discipline – Should the ECB keep bailing out member states in crisis without enforcing strict fiscal regimes? – as the ESM has failed to work.

-       Deposit guarantee schemes to be offered – loan income limits

-       The conflicts of interests in the ECB need to be resolved, as it is resulting in greater instability.

-       Testing of macro prudential policy, to measure the strength of individual banks and the resilience of the system to future stressed conditions.

Purpose of stress tests:

1.     Measuring the impact of potential systemic risk – do banks have enough capital to survive exogenous shocks.

2.     A macro-prudential policy tool to address banking sector vulnerabilities (e.g. recapitalisation, capital planning, manage investor confidence, assess need for macro-prudential policy intervention)

-       Introduce counter-cyclical capital buffers.

Managing deleveraging – using monetary policy and prudential supervision

Banks need to raise capital and need to get rid of targeted impaired assets – that need to be introduced in the Banking union framework. (Will enable strong economic recovery through the monetary transmission mechanism)

Prompt and efficient deleveraging will revive the European financial market, if not may prolong the fragmentation of the market, leaving the euro area’s financial system extremely fragile.

The European central bank needs to reach the 2% inflation target – without affecting the financial stability within the euro area – need to dampen fluctuations in the HICP

Many economies within the European Union are experiencing deflation ( Portugal, Greece), where others are experiencing disinflation(UK, Germany) –such fragmentation produces instability.

Quantitative easing may affect such targets being reached.

The EU Budget

Stabilisation mechanism (EFSM) – there is much debate around this mechanism especially in regards to the financial problems in Ireland, Portugal, Greece, Italy and Spain. Should the ECB carry on bailing out these indebted nations? Rather that enforcing prudent fiscal reforms. (Largest beneficiary has been Ireland since 2011)

What must be included:

-       Indirect support risk sharing devices

-       Promote financial integration, stability and labour mobility – by creating an optimal currency area

-       Allocation of resources – Counter cyclical investment strategies

Inter-government Fiscal policy coordination

-       An imperative measure, in order to ensure real economic convergence between member states.

-       Heavy investment in infrastructure to resolve the structural imbalances many of the PIIGS economies suffer from.

-       Much depends on the size/estimate of the fiscal multiplier – these reforms must stimulate economic growth – growth in GDP/GVA.

-       Select equilibrium

-       Eurobond – lower bond yields

-       Eurobills – riskless liquid assets

-       A debt reduction pact