4 Lectures on the

1
4 Lectures on the uropean crisis

• Lecture 4 The philosophy of the EMU economic
  polices fiscal policies of the monetary union
  fiscal governance the debate on the fiscal
  multipliers

2
The philosophy of the EMU economic policies

• Independent CB ? monetary policy is ineffective
  in the long run price stability is the
  predominant target
• Budget deficit crowds out private investment. So
  balanced budget rules ? Maastricht Treaty and
  Stability and Growth Pact reinforced by most
  recent measures (six and two packs fiscal
  compact)
• Full employment pursued at national level through
  market and (mainly) labour market flexibility.
• A full anti-Keynesian program no ex-ante
  coordination of budget and monetary policies.
• Otmar Issing ? no need for ex ante coordination.
  If countries follow the rules there will be an ex
  post coordination by he market.

3
Alternative view

• Monetary policy is effective of course,
  expansionary policies raise inflation, but a
  natural unemployment rate defined at a zero (or
  very low) inflation rate is a fiction useful to
  keep wages under control. Income policy should be
  used to keep inflation under control.
• Fiscal policy does not crowd out private
  investment which are, in general, not at full
  employment level
• Coordination between fiscal and monetary policy
  at an international level is necessary in order
  to permit fiscal expansions, when necessary, at
  low interest rates.
• Full employment is an international question, not
  a national one! International coordination is
  necessary.
• There is not a potential output at which, with
  price and wages flexibility, the economy tends
  to potential output depends on long term
  aggregate demand and if AD is depressed,
  productive capacity is lost.

4
The European economic governancehttp//europa.eu/
rapid/press-release_MEMO-13-979_en.htm

• Crisis prevention Fiscal policy regulated by the
  GSP (Amsterdam 1997) and by a baroque number of
  new regulations approved in the last years.
• The Stability and Growth Pact was established at
  the same time as the single currency in order to
  ensure sound public finances. However, the way it
  was enforced before the crisis did not prevent
  the emergence of serious fiscal imbalances in
  some Member States.
• It has been reformed through the Six Pack (which
  became law in December 2011) and the Two Pack
  (which entered into force in May 2013), and
  reinforced by the Treaty on Stability,
  Coordination and Governance (which entered into
  force in January 2013 in its 25 signatory
  countries).
• The new rules (introduced through the Six Pack,
  the Two Pack and the Treaty on Stability,
  Coordination and Governance) are grounded in the
  European Semester, the EU's policy-making
  calendar.
• Crisis management
• EFSF and ESM

5
The European economic governance Growth and
stability pact

• The SGP contains two arms the preventive arm
  and the corrective arm. The preventive arm seeks
  to ensure that fiscal policy is conducted in a
  sustainable manner over the cycle. The corrective
  arm sets out the framework for countries to take
  corrective action in the case of an excessive
  deficit.
• The cornerstone of the preventive arm is the
  country-specific medium-term budgetary objective
  (MTO), defined in structural terms (i.e. in
  cyclically adjusted terms and net of one-off and
  other temporary measures). Member States outline
  their medium-term budgetary plans in stability
  and convergence programmes (SCP), which are
  submitted and assessed annually in the context of
  multilateral fiscal surveillance under the
  European Semester.
• The corrective arm is made operational by the
  Excessive Deficit Procedure (EDP), a step-by-step
  procedure for correcting excessive deficits that
  occur when one or both of the rules that the
  deficit must not exceed 3 of GDP and public debt
  must not exceed 60 of GDP (or at least diminish
  sufficiently towards the 60) defined in the
  Treaty on the Functioning of the EU (TFEU or
  Treaty) are breached.
• Non-compliance with either the preventive or
  corrective arms of the Pact can lead to the
  imposition of sanctions for euro area countries.
  In the case of the corrective arm, this can
  involve annual fines for euro area Member States
  and, for all countries, possible suspension of
  Cohesion Fund financing until the excessive
  deficit is corrected.

6
The European economic governance the European
semester

• The European Semester represents a yearly cycle
  of EU economic policy guidance and
  country-specific surveillance. Each year the
  European Commission undertakes a detailed
  analysis of EU Member States' programmes of
  economic and structural reforms and provides them
  with recommendations for the next 12-18 months.
• Within the European semester the European
  authorities intervene in the formulation of
  national fiscal policies (ex ante coordination)
• (e.g. the Commission in November had reservations
  about the Italian budget )

7
The European semester some relevant dates

• October Euro area Member States submit draft
  budget plans for the following year to the
  Commission (by 15 October). If a plan is out of
  line with a Member State's medium-term targets,
  the Commission can ask it to be redrafted.
• November The Commission publishes its opinions
  on draft budget plans. The Alert Mechanism Report
  (AMR) screens Member States for economic
  imbalances.
• December Euro area Member States adopt final
  annual budgets, taking into account the
  Commission's advice and finance ministers'
  opinions.
• February/March It is around this time that the
  Commission publishes in-depth reviews of Member
  States with potential imbalances (those
  identified in the AMR).
• April Member States submit their
  Stability/Convergence Programmes (medium-term
  budget plans) and their National Reform
  Programmes (economic plans), which should be in
  line with all previous EU recommendations.
  Eurostat publishes verified debt and deficit data
  from the previous year, which is important to
  check if Member States are meeting their fiscal
  targets.
• June/July The European Council endorses the
  CSRs, and EU ministers meeting in the Council
  discuss them. EU finance ministers ultimately
  adopt them in July.

8
Six pack

• Entered into force on 13 December 2011
• Five Regulations and one Directive (that is why
  it is called six-pack)
• Applies to 27 MS with some specific rules for
  euro-area Member States, especially regarding
  financial sanctions
• The six-pack does not only cover fiscal
  surveillance, but also macroeconomic surveillance
  under the new Macroeconomic Imbalance Procedure.
• In the fiscal field, the six-pack strengthens the
  Stability and Growth Pact (SGP). According to the
  SGP Member States' budgetary balance shall
  converge towards the country-specific medium-term
  objective (MTO) - so-called preventive arm - and
  the general government deficit must not exceed 3
  of GDP and public debt must not exceed 60 of GDP
  (or at least diminish sufficiently towards the
  60 threshold). The six-pack reinforces both the
  preventive and the corrective arm of the Pact,
  i.e. the Excessive Deficit Procedure (EDP), which
  applies to Member States that have breached
  either the deficit or the debt criterion.

9
Six Pack

• The six-pack ensures stricter application of the
  fiscal rules by defining quantitatively what a
  "significant deviation" from the MTO or the
  adjustment path towards it means in the context
  of the preventive arm.
• Moreover, the six-pack operationalizes the debt
  criterion, so that an EDP may also be launched on
  the basis of a debt ratio above 60 of GDP which
  would not diminish towards the Treaty reference
  value at a satisfactory pace (and not only on the
  basis of a deficit above 3 of GDP, which has
  been the case so far).
• Financial sanctions for euro-area Member States
  are imposed in a gradual way, from the preventive
  arm to the latest stages of the EDP, and may
  eventually reach 0.5 of GDP. The six-pack
  introduces reverse qualified majority voting
  (RQMV) for most sanctions, therefore increasing
  their likelihood for euro-area Member States.
  (RQMV implies that a recommendation or a proposal
  of the Commission is considered adopted in the
  Council unless a qualified majority of Member
  States votes against it.)

10
Treaty on Stability, Coordination and
Governance (TSCG)

• Entered into force on 1 January 2013.
• The fiscal part of the TSCG is referred to as
  "Fiscal Compact". Requires contracting parties to
  respect/ensure convergence towards the
  country-specific medium-term objective (MTO), as
  defined in the SGP and Six Pack (e.g. convergence
  to 60 at the pace of 1/20 per year).
• Lower limit of a structural deficit (cyclical
  effects and one-off measures are not taken into
  account) of 0.5 of GDP (1.0 of GDP for Member
  States with a debt ratio significantly below 60
  of GDP).
• These budget rules shall be implemented in
  national law through provisions of "binding force
  and permanent character, preferably
  constitutional". (? this is the real novelty of
  the TSCG). Compliance with the rule should be
  monitored by independent institutions
• European Court of Justice (CoJ) may impose
  financial sanction (0.1 of GDP) if a country
  does not properly implement the new budget rules
  in national law and fails to comply with a CoJ
  ruling that requires it to do so.

11
Two Packs

• Approved 13 May 2013. Reinforces the role of the
  Commission in the evaluation of national budgets
• As part of a common budgetary timeline, euro-area
  Member States shall submit their draft budgetary
  plan for the following year to the Commission and
  the Eurogroup before 15 October, along with the
  independent macro-economic forecast on which they
  are based.
• This builds on the Stability and Growth Pact
  (SGP), under which Member States present the main
  characteristics of their medium-term public
  finance plans to the Commission and the Council
  in spring (in Stability or Convergence
  Programmes). The exercise in autumn introduced by
  the two-pack allows monitoring and sharing
  information on MS budgetary policies closer to
  their adoption. The Commission analyses if the
  draft budget is in line with the SGP and the
  recommendations from the European Semester (which
  the country has received in May/June).
• If the Commission assesses that the draft
  budgetary plan shows serious non-compliance with
  the SGP, the Commission can require a revised
  draft budgetary plan.

12
Macroeconomic Imbalance Procedure (MIP) (Included
in the Six Pack)

• The Macroeconomic Imbalance Procedure (MIP) is a
  surveillance mechanism that aims to identify
  potential risks early on, prevent the emergence
  of harmful macroeconomic imbalances and correct
  the imbalances that are already in place.
• The alert mechanism consists of an
  indicator-based scoreboard complemented by an
  economic reading thereof presented in an annual
  Alert Mechanism Report (AMR).
• On this basis, the Commission decides for which
  countries it will prepare country-specific
  in-depth reviews.
• In the preventive arm this is part of the
  integrated package of recommendations under the
  European semester. If the Commission instead
  considers that there are severe or excessive
  imbalances that may jeopardise the proper
  functioning of the Economic and Monetary
  Union, it may recommend to the Council to open an
  Excessive Imbalance Procedure (EIP) which falls
  under the corrective arm of the new procedure.
• In case the in-depth review points to severe or
  excessive imbalances in a Member State that may
  jeopardise the proper functioning of the Economic
  and Monetary Union, the Council may declare the
  existence of an excessive imbalance and adopt a
  recommendation asking the Member State to present
  corrective actions within a specified deadline.

13
Scoreboard indicators a boring and expected list
with few (limited) exceptions

• 3 year backward moving average of the current
  account balance as percent of GDP, with
   thresholds of 6 and -4
• net international investment position as percent
  of GDP, with a threshold of -35
• 5 years percentage change of export market shares
  measured in values, with a threshold of -6
• 3 years percentage change in nominal unit labour
  cost, with thresholds of 9 for euroarea
  countries and 12 for non-euroarea countries
• 3 years percentage change of the real effective
  exchange rates based on HICP/CPI deflators,
  relative to 41 other industrial countries, with
  thresholds of -/5 for euroarea countries and
  -/11 for non-euroarea countries
• private sector debt (consolidated) in of GDP
  with a threshold of 133
• private sector credit flow in of GDP with a
  threshold of 15
• year-on-year changes in house prices relative to
  a Eurostat consumption deflator, with a threshold
  of 6
• general government sector debt in of GDP with a
  threshold of 60
• 3-year backward moving average of unemployment
  rate, with a threshold of 10
• year-on-year changes in total financial sector
  liabilities, with a threshold of 16.5.

14
Limits bad Economics and morality play

• Why the asymmetry 6/-4 CA surpluses? ? CA
  surpluses are a vice from the international
  economy point of view. Stop the morality play in
  Economics.
• Why only a negative NIP is sanctioned? Huge
  positive NIP must as well.
• Why in case of imbalances action must be taken at
  national level only? This is again a morality
  play (YOU are guilty) and bad Economics
• In case the in-depth review points to severe or
  excessive imbalances in a Member State that may
  jeopardise the proper functioning of the Economic
  and Monetary Union, the Council may declare the
  existence of an excessive imbalance and adopt a
  recommendation asking the Member State to present
  corrective actions within a specified deadline.
  Then, , the Member State is obliged to present a
  corrective action plan (CAP) setting up a roadmap
  to implement corrective policy actions. The CAP
  should be a detailed plan for corrective actions
  with specific policy measures and implementation
  timetable. As regards the content of the CAP it
  is clear that the policy response to
  macroeconomic imbalances has to be tailored to
  the circumstances of the Member State concerned
  and where needed will cover the main policy
  areas, including fiscal and wage policies, labour
  markets, product and services markets and the
  financial sector. Moreover, efficiency and
  credibility derive from consistent approaches
  across policy strands.

15
Macroeconomic Imbalance Procedure for Germany
much ado about nothing

• Daniel Gros argues that the 13 November
  announcement of the European Commission that
  Germany is running an excessive current account
  surplus appears to be much ado about little. All
  the Commission can, and will, do is to start an
  in depth analysis. This might lead to strong
  political reactions and an enormous echo in the
  media. But nothing of concrete substance is
  likely to follow. (http//www.ceps.eu/book/macroec
  onomic-imbalance-procedure-and-germany-when-surplu
  s-E2809CimbalanceE2809D)

16
The mysterious Golden rule Let us (Lettas) have
a dream

• In principles well behaved countries, those not
  under a EDP, will be able to exclude the
  following year some public investment from the
  deficit. Spain and France decided not to well
  behave, and are in principle subject to the EDP.
  But they grew (or better, they declined less)
  than Italy. In spite of huge austerity Oli Rehn
  (I refrain from defining its intelligence) said
  no. We do not trust Italys efforts. They asked
  more austerity! They are right not to trust the
  Italian government. The question is that all the
  European policy framework is mad.

17
European acronymia EFSF and ESM

• The European Financial Stability Facility (EFSF)
  was created by the euro area Member States
  following the decisions taken on 9 May 2010
  within the framework of the Ecofin Council. The
  EFSFs mandate is to safeguard financial
  stability in Europe by providing financial
  assistance to euro area Member States within the
  framework of a macro-economic adjustment
  programme.
• To fulfill its mission, EFSF issues bonds or
  other debt instruments on the capital markets.
  The proceeds of these issues are then lent to
  countries under a programme. The EFSF may also
  intervene in the primary and secondary bond
  markets, act on the basis of a precautionary
  programme and finance recapitalisations of
  financial institutions through loans to
  governments.
• EFSF was created as a temporary rescue mechanism.
  In October 2010, it was decided to create a
  permanent rescue mechanism, the European
  Stability Mechanism (ESM). The ESM entered into
  force on 8 October 2012.
• From this date onwards, the ESM will be the main
  instrument to finance new programmes. In parallel
  to the ESM, the EFSF will continue with the
  ongoing programmes for Greece, Portugal and
  Ireland.

18
EFSF

• The Facility act after a support request is made
  by a euro area Member State and a country
  programme has been negotiated with the European
  Commission and the IMF and after such a programme
  has been accepted by the euro area finance
  ministers and a Memorandum of Understanding (MoU)
  is signed. This would only occur when the country
  is unable to borrow on markets at acceptable
  rates.
• any financial assistance to a country in need is
  linked to strict policy conditions which are set
  out in a Memorandum of Understanding (MoU)
  between the country in need and the European
  Commission.
• Following the increase of guarantee commitments
  to 780 billion, EFSFs effective lending
  capacity is intended to be 440 billion. This is
  explained by the credit enhancement structure
  which includes an overguarantee of up to 165
• On 28 November 2010, the ECOFIN Ministers
  concurred with the European Commission and the
  ECB that providing a loan to Ireland was
  warranted to safeguard the financial stability in
  the euro area and the EU as a whole. The total
  lending programme for Ireland is 85 billion.
• Following the formal request for financial
  assistance made by the Portuguese authorities on
  7 April 2011, the Eurogroup and ECOFIN Ministers
  agreed to grant financial assistance on 17 May.
  The financial package of the programme will cover
  financing needs up to 78 billion.
• At the euro zone summit held on 26 October 2011,
  euro zone Heads of State or Government agreed to
  a second financial assistance programme for
  Greece. The details of this programme were agreed
  by the Eurogroup on 21 February 2012. As part of
  the second bailout for Greece, the loan is
  shifted to the EFSF, amounting to 164 billion

19
ESM

• The European Stability Mechanism is the permanent
  crisis resolution mechanism for the countries of
  the euro area. The ESM issues debt instruments in
  order to finance loans and other forms of
  financial assistance to euro area Members States.
• The decision leading to the creation of the ESM
  was taken by the European Council in December
  2010. The euro area Member States signed an
  intergovernmental treaty establishing the ESM on
  2 February 2012. The ESM was inaugurated on 8
  October 2012.
• For this purpose, the ESM is entitled to raise
  funds by issuing financial instruments or by
  entering into financial or other agreements with
  ESM Members, financial institutions or other
  third parties.
• All financial assistance to Member States is
  linked to appropriate conditionality.
• The ESM may provide stability support by
• -providing loans to countries in financial
  difficulties,
• purchasing bonds of an ESM Member State in
  primary and secondary debt markets,
• providing precautionary financial assistance in
  the form of a credit line,
• ? financing recapitalisations of financial
  institutions through loans to governments
  including in non-programme countries.
• The ESMs maximum lending capacity is 500
  billion. During the Eurogroup meeting held on 30
  March 2012, it was decided that the EFSF would
  continue to fund the existing Facility Agreements
  for Portugal, Ireland and Greece.

20
ESM

• Stability support loans within a macro-economic
  adjustment programme. The objective is to assist
  ESM Members that have significant financing needs
  but have to a large extent lost access to market
  financing, whether because they cannot find
  lenders or because lenders will provide financing
  only at excessive prices that would adversely
  impact the sustainability of public finances.
• Precautionary financial assistance The objective
  of ESM precautionary financial assistance in the
  form of credit lines is to support sound policies
  and prevent crisis situations by allowing ESM
  Members to secure ESM assistance before they face
  major difficulties raising funds in the capital
  markets. Precautionary financial assistance aims
  at helping ESM Members whose economic conditions
  are still sound to maintain continuous access to
  market financing by reinforcing the credibility
  of their macroeconomic performance while ensuring
  an adequate safety-net.
• Primary Market support facility The ESM may
  engage in primary market purchases of bonds or
  other debt securities issued by ESM Members to
  allow them to maintain or restore their
  relationship with the dealer/investment community
  and therefore reduce the risk of a failed
  auction. It would also serve to increase
  efficiency of ESM lending.
• Conditions would be those of the macroeconomic
  adjustment programme or precautionary programme.
• As announced by ECB President Mario Draghi on 6
  September 2012, Outright Monetary Transactions,
  i.e. is the purchase of euro area sovereign bonds
  on the secondary market by the ECB, will be
  considered for future cases of EFSF/ESM
  macroeoconomic adjustment programmes or
  precautionary programmes, provided that they
  include the possibility of EFSF/ESM primary
  market purchases.

21
ESM

• Secondary Market Support Facility The Secondary
  Market Support Facility aims to support the good
  functioning of the government debt markets of ESM
  Members in exceptional circumstances where the
  lack of market liquidity threatens financial
  stability, with a risk of pushing sovereign
  interest rates towards unsustainable levels and
  creating refinancing problems for the banking
  system of the ESM Member concerned. An ESM
  secondary market intervention is intended to
  enable market-making that would ensure some debt
  market liquidity and incentivise investors to
  further participate in the financing of ESM
  Members.
• Bank recapitalisations The aim of a loan for
  recapitalising financial institutions is to
  preserve financial stability of the euro area as
  a whole and of its Member States by addressing
  those specific cases in which the roots of a
  crisis situation are primarily located in the
  financial sector and not directly related to
  fiscal or structural policies.
• Will the ESM make loans directly to financial
  institutions?
• Currently, the ESM may only lend to euro area
  Member States. However, at the euro area summit
  on 29 June 2012, it was proposed that once an
  effective supervisory mechanism is established
  for banks in the euro area, involving the ECB,
  following a regular decision the ESM could have
  the possibility to recapitalise banks directly.

22
ESM

• On 25 June 2012, the Spanish government made an
  official request for financial assistance for its
  banking system to the Eurogroup for a loan of up
  to 100 billion.The results of the diagnostic
  exercise, commissioned by the Spanish authorities
  to external evaluators, indicated that the
  additional capitalisation needs of the Spanish
  banking sector as a whole could be estimated to
  be in a range of 51-62 billion. Including an
  additional safety margin, these capital needs
  would remain within the envelope approved by the
  Eurogroup of up to 100 billion in total.
• The programme will address the exceptional
  financial, budgetary and structural challenges
  that Cyprus is facing. The total amount of
  financial assistance, agreed by the Eurogroup, is
  up to 10 billion. Out of this amount, the ESM
  will provide approximately 9 billion, and the
  IMF will contribute around 1 billion.

23
Comments

• Funds collected by the ESM are guaranteed by the
  same troubled states, a vicious circle. Only the
  ECB can guarantee the ESM.
• The ESM plays the role of the ECB without the
  printing press!
• Proposals that the ESM functions as a bank, that
  is uses its capital as leverage to borrow from
  the ECB (this is a way to circumvent the
  prohibition to the ECB to buy sovereign debt).
• Prohibition to the ESM to lend directly to
  troubled banks
• Small size in the case of a default risk of a
  major country. Indeed the ECB is the only
  institution that can avoid big defaults. It has
  always been so, it cannot be otherwise CBs have
  been invented with that purpose!

24
The debate on the fiscal multiplier

• When G falls or t rises, Y will fall. The
  question is the dimension of the fall. Strong
  debate over 2011-13 on the size of the
  multipliers, that is on the effects of fiscal
  austerity (or of the opposite fiscal expansion).
• A multiplier of 1.5, for instance, means that 1
  in government-spending cuts reduces GDP by 1.50
  a multiplier of 0.5 means a 1 cut in spending
  only reduces GDP by 50 cents.
• Keynesians ? the multipliers are large
• supporters of expansionary fiscal retrenchment or
  of Ricardo-Barro effect ? multipliers are low

25
The conservatives viewpoint

• Ricardo-Barro effect if t falls, Y will remain
  constant since people expect more future taxes,
  so they will save they save all the extra-income
  they receive via tax-reductions. Likewise, in
  case of fiscal austerity if t rises, people will
  save less expecting to pay less taxes in the
  future, so non effects on Y.
• On Ricardo-Barro ? during a crisis people consume
  less than they like to so if they get
  extra-income (through lower taxes or by getting a
  subsidy or a job), they will spend more.
  Conversely ? if during a crisis taxes are
  increased, people will might save less but just
  because they feel impoverished! Or, if they can,
  they save the same being afraid of the future.
• Expansionary fiscal retrenchment (Alberto
  Alesina and Bocconi boys) ? austerity and leads
  to higher credibility of long-run budget
  sustainability and to lower interest rates that
  help the adjustment in a virtuos circle

26
In Europe conservatives have lost in theory but
(unfortunately) prevail in practice (they have
not won in Germany)

• Further and further empirical estimates of the
  fiscal multipliers have shown that they are
  larger than 1, often much larger they are large
  in depressions, when capacity and labour are
  under-utilised they are larger if monetary
  policy is cooperative keeping interest payments
  low.

27
This is from Krugman
28
References

• http//ec.europa.eu/economy_finance/articles/gover
  nance/2012-03-14_six_pack_en.htm
• http//ec.europa.eu/economy_finance/economic_gover
  nance/
• http//ec.europa.eu/economy_finance/economic_gover
  nance/macroeconomic_imbalance_procedure/index_en.h
  tm
• http//www.efsf.europa.eu/attachments/EFSF20FAQ2
  001072013.pdf
• http//www.esm.europa.eu/pdf/FAQ20ESM2022102013.
  pdf
• Gerhard Illing, Sebastian Watzka, Fiscal
  Multipliers and Their Relevance in a Currency
  Union A Survey, German Economic Review, 2013.