<![CDATA[Publication Feed]]> http://www.bruegel.org Mon, 24 Nov 2014 12:07:39 +0000 http://www.bruegel.org/fileadmin/images/bruegel-logo.png <![CDATA[Publication Feed]]> http://www.bruegel.org Zend_Feed http://blogs.law.harvard.edu/tech/rss <![CDATA[Eurosystem collateral policy and framework: Was it unduly changed?]]> http://www.bruegel.org This Policy Contribution was prepared for the European Parliament Committee on Economic and Monetary Affairs. All Eurosystem credit operations, including the important open market operations, need to be based on adequate collateral. Liquidity is provided to banks against collateral at market prices subject to a haircut. The Eurosystem adapted its collateral framework during the crisis to accept lower-rated assets as collateral. Higher haircuts are applied to insure against liquidity risk as well as the greater volatility of prices of lower-rated assets. The adaptation of the collateral framework was necessary to provide sufficient liquidity to banks in the euro area periphery in particular. In crisis countries, special emergency liquidity assistance was provided. More than 80 percent of the European Central Bank’s liquidity (Main Refinancing Operations and Long Term Refinancing Operations) is provided to banks in five countries (Greece, Ireland, Italy, Portugal and Spain). The changes in the collateral framework were necessary for the ECB to fulfil its treaty-based mandate of providing liquidity to solvent banks and safeguarding financial stability. The ECB did not take on board excessive risks. Alvaro Leandro provided excellent research assistance.]]> Mon, 17 Nov 2014 00:00:00 +0000 <![CDATA[The twenty-first century needs a better G20 and a new G7+]]> http://www.bruegel.org Read also Jim O'Neill and Alessio Terzi's survey of the G20 sherpas 'The world is ready for a global economic governance reform, are world leaders?' During the 2008 financial crisis, the G20 was hastily elevated to ‘global economic steering committee’. In the early stages of the crisis, the G20 was an effective forum for crisis containment. As the crisis has eased, however, the G20 has lost both direction and momentum. Governments and policymakers have felt less need to act in unison and have rather refocused on their national agendas, as is their duty and primary function. However, effective global governance is needed permanently, not just in crisis times. It is desirable to have more representative and effective global governance that, among other things, is equipped to prevent crises rather than just react to them. In an environment of rapid change in global patterns of trade and wealth creation, a new revamped (but highly representative) grouping should be created within the G20, to provide leadership on key economic policy matters. Euro-area members should give up their individual seats in this G7+, allowing room for China and other large emerging economies. Without euro-area countries taking such a step, it would be impossible to reconcile effectiveness and representation in this new G7+, which would take charge of decision making on global economic imbalances, financial and monetary issues. All existing G20 countries, including individual euro-area countries, would however remain in the G20, which could potentially expand and would remain the prime forum for discussion on all remaining matters at global level.]]> Fri, 14 Nov 2014 00:00:00 +0000 <![CDATA[Defining Europe's Capital Markets Union]]> http://www.bruegel.org
  • regulation of securities and specific forms of intermediation;
  • prudential regulation, especially of insurance companies and pension funds;
  • regulation of accounting, auditing and financial transparency requirements that apply to companies that seek external finance;
  • a supervisory framework for financial infrastructure firms, such as central counterparties, that supports market integration;
  • partial harmonisation and improvement of insolvency and corporate restructuring frameworks;and
  • partial harmonisation or convergence of tax policies that specifically affect financial investment.
  • ]]>
    Thu, 13 Nov 2014 00:00:00 +0000
    <![CDATA[Does Money Matter in the Euro area? Evidence from a new Divisia Index]]> http://www.bruegel.org a database on euro-area Divisia monetary aggregates. We plan to update the dataset in the future and keep it publicly available. Using different SVAR models, we find sensible and statistically significant responses to Divisia money shocks, while the responses to simple-sum measures of money and interest rates are not statistically significant, and sometimes even the point estimates are not sensible.]]> Thu, 06 Nov 2014 00:00:00 +0000 <![CDATA[Developing an underlying inflation gauge for China]]> http://www.bruegel.org Thu, 09 Oct 2014 00:00:00 +0100 <![CDATA[A flexible, scaleable approach to the international patent 'name game']]> http://www.bruegel.org Source code on Github. Download data.]]> Mon, 29 Sep 2014 00:00:00 +0100 <![CDATA[A scaleable approach to emissions-innovation record linkage]]> http://www.bruegel.org Source code on Github. Download data.]]> Mon, 29 Sep 2014 00:00:00 +0100 <![CDATA[Remerge: regression-based record linkage with an application to PATSTAT]]> http://www.bruegel.org Source code on Github. Download data.]]> Mon, 29 Sep 2014 00:00:00 +0100 <![CDATA[The G20 financial reform agenda]]> http://www.bruegel.org Yesterday marked the five-years anniversary of the Pittsburgh Summit, the culmination of the initial phase of G-20 activity. Five years ago, the declarations of the G20 in landmark leaders’ summits in London and Pittsburgh listed specific commitments on financial regulatory reform. When measured against these declarations, as opposed to the surrounding rhetorical hype, most (though not all) commitments have been met to a substantial degree. However, the effectiveness of these reforms in making global finance more stable is not so far proven. This uncertainty on impact mirrors the absence of an analytical consensus on the 2007-08 financial crisis itself. In addition, unintended consequences of the reforms are appearing gradually, even as their initial implementation is still unfinished. At a broader level, the G20 has established neither an adequate institutional infrastructure nor a consistent policy vision for a globally integrated financial system. This shortcoming justifies increasing concerns about economically harmful market fragmentation. One key aim should be to make international regulatory bodies more representative of the rapidly-changing geography of global finance, not only in terms of their membership but also of their leadership and location.]]> Fri, 26 Sep 2014 00:00:00 +0100 <![CDATA[So far apart and yet so close: Should the ECB care about inflation differentials?]]> http://www.bruegel.org ]]> Mon, 22 Sep 2014 00:00:00 +0100 <![CDATA[Benefits and drawbacks of European Unemployment Insurance]]> http://www.bruegel.org Prepared for the ECOFIN in Milan on 13 September 2014. See also interactive simulation to design your own EUI scheme. The issue: Unemployment in Europe has increased to high levels and economic growth has remained subdued. A debate on additional policy instruments to address the situation is therefore warranted. Fiscal stabilisation mechanisms have not provided adequate fiscal stabilisation during the crisis in some countries nor in the euro area as a whole. Different preferences and historical developments mean that national labour markets are differently organised, which sometimes hinders the efficient working of the monetary union. European Unemployment Insurance (EUI) has been proposed as a measure to contribute to fiscal policy management and improve labour markets. Policy challenge: European Unemployment Insurance is one option for stabilising country specific economic cycles thanks to risk sharing, but it would not substantively influence the area-wide fiscal stance. Moral hazard problems are significant but can be reduced by a less generous design and more harmonisation of labour markets. The former would, however, reducethe scheme’s stabilisation effect. Reform and harmonisation of labour markets would improve the functioning of monetary union, but would undermine long-standing preferences and ideals which the subsidiarity principle guarantees. The complexity of the design and implementation of EUI and the question of the rightlegal base suggests that it would be a long-term project and not a measure to help quickly the millions currently unemployed. ]]> Sat, 13 Sep 2014 00:00:00 +0100 <![CDATA[Elements of Europe's energy union]]> http://www.bruegel.org Read Georg Zachmann's Memos to the new Commissioner for Energy and the new Commissioner for Climate Action The issue: European Union energy policy is guided by three objectives: sustainability, security of supply and competitiveness. To meet its goals in these areas, the EU is updating its energy strategy with new targets for 2030. The starting point for this is the assessment of the previous EU climate and energy package, at the centre of which were the 20-20-20 targets for 2020. Although the EU is largely on track to meet these targets, EU energy policy is generally not perceived as a success. Recent events have undermined some of the assumptions on which the 2020 package was built, and the policies for achieving the 2020 targets – although at first sight effective – are far from efficient. Policy challenge: ;To meet the EU's objectives for emissions, electricity supply and gas security of supply, well-designed European markets could provide better results at lower cost than uncoordinated national approaches. In other areas – such as energy efficiency and supporting innovation – markets alone might not be enough. Europe should thus rethink its quantitative headline targets for 2030.The proposed 40 percent decarbonisationtarget is in line with a stronger emission allowance market, but the target for renewables should be defined in terms of innovation rather than deployment, and the energy-efficiency target should be defined in terms of encouraged energy and cost savings, not the amount of energy consumed in a certain period.

    Introduction

    The European Union is largely on track to meet the so-called 20-20-20 climate and energy targets1, which were seen as quite ambitious when they were adopted in 2009. EU final energy consumption fell by 7 percent from 2005-11 (Figure 1), energy production from renewable sources increased by 4.2 percentage points from 2005-12 (Figure 1) and greenhouse gas emissions dropped by 13 percent in the same period (Figure 2). By 2012, emissions were already 19.2 percent below the 1990 level, leaving just a small gap before the EU meets the 20 percent reduction target for 20202. However, EU energy policy is generally not perceived as a success. Recent events have undermined some of the assumptions on which the 2020 package was built, and the policies for achieving the 2020 targets – although at first sight effective – are far from efficient. In terms of supply security, the Ukraine crisis has shown that energy efficiency and increased deployment of renewables have been so far insufficient to eliminate Europe’s reliance on Russian gas. In terms of sustainability, other major emitters have not wholeheartedly followed the EU lead to cut emissions. New fossil energy resources make it more difficult to believe that such a global agreement is feasible because it would imply not using most of the fossil-fuel bounty. So the global impact of Europe's emission reductions will be close to insignificant, while Europe’s decarbonisation strategy turned out less ambitious than originally claimed, because the recession (and some other factors) supplied much of the promised emissions reduction. In terms of competitiveness, various developments have made the energy mix envisaged in 2008 relatively more expensive. The Fukushima accident resulted in the closure of cheap nuclear plants while increasing the already high cost of new nuclear. It also became clear that carbon capture and storage technology3 is unlikely to become competitive any time soon relative to other low-carbon electricity generation technologies. Consequently, decarbonisation in Europe might have to rely even more on variable renewables, which is likely to drive up the cost of the transition. Meanwhile, the US shale gas boom caused a widening transatlantic energy price gap. All this happened during the EU’s most severe economic crisis, and shifted the focus of policymakers from long-term industrial policy projects such as developing renewables, to defending the competitiveness of sectors such as energy-intensive steel plants. In addition, the 2020 climate and energy policies have inherent problems. Decarbonisation has been mainly delivered by a combination of economic downturn and renewables policy (CDC, 2014). Consequently, the EU emissions trading system (ETS) – which would have been able to identify much cheaper abatement options – was barely used. Furthermore, most investments in power plants, networks and consumption have been based on national remuneration schemes, undermining the internal energy market and failing to deliver a well-balanced European energy system that could support the climate and energy policy objectives. Nevertheless, the EU package for 2020 was a valid hedging strategy in a world of scarce and expensive energy. It addressed the questions of its time, and could have been quite effective in a scenario that saw renewable energy quickly become indispensable in all parts of the world. Now, European Commission proposals for 2030 foresee an emissions reduction of 40 percent and a 27 percent share of renewables (European Commission, 2014). There is also some momentum for a binding energy efficiency target that could be set at 30 percent. The differentiated increase in the three targets indicates a change in priorities:
    • The 40 percent emissions reduction relative to 1990 is a compromise. It is an ambitious unilateral target as long as there is no global agreement. It provides a signal for low-carbon investment and allows the political decarbonisation instruments – such as emission trading – to be boosted without excessive cost. It therefore keeps the door to a more aggressive decarbonisation policy open, should other major economies join the battle. But the target is less than optimal to deliver Europe's share of the global 2050 objective4.
    • The 27 percent renewables target is essentially insignificant5. Its main justification is to form the legal basis for national renewable support schemes that might otherwise be challenged for undermining the internal energy market.
    • A 30 percent energy efficiency target would be an acknowledgement of the importance of efficiency to achieve the energy policy objectives. But the case for the chosen metric and the corresponding number is weaker than that for the other two targets.
    The proposed quantitative targets testify to the prioritisation within EU energy policy – 40-30-27 instead of 20-20-20 – but are not a consistent strategy to respond to the changing energy policy challenges6. The strategic task is to translate the prioritisation of objectives and the interaction between instruments into a consistent policy framework. From a strategic perspective, it is important to note that it is impossible to determine which menu of investments is most conducive to achieve security of supply, sustainability and competitiveness of energy supply. So the main role of policy is to develop reliable frameworks that will encourage the investment that will enable stable energy services at the lowest direct and external cost. A well-functioning internal energy market is the core of such a framework, complemented by an equally well-functioning European market for emission allowances and a market for supply security. Europe also needs an ambitious framework to speed up low-carbon innovation. The final element is a system to make energy efficiency policies at different levels of government comparable in order to come up with the best mix.

    Revamping the market

    A functioning internal energy market in which companies and technologies freely compete to provide the best services at the lowest price, while respecting societal and environmental constraints, could be hugely welfare enhancing. Despite three EU legal packages, neither the provisioning of gas nor of electricity is organised in such markets. In electricity, the attempt to create a European market by coupling national day-ahead markets proved only partially successful. While national prices have somewhat converged, no internal electricity market has developed because important parts of the electricity sector are still subject to widely differing national rules and arrangements7. Investment decisions in the electricity sector are thus based on national policies, not European markets. This non-cooperation is costly, and the corresponding welfare loss is set to increase with the rising shares of renewables in the power system8. A European electricity market will not spontaneously evolve based on the enforcement of some first principles. Functioning electricity markets need to be designed: products need to be defined and schemes for their remuneration need to be engineered. An efficient market design needs to include all parts of the relevant system. It must ensure efficient incentives for trade-offs such as demand response versus storage, transmission lines versus decentralised generation or solar versus lignite. And to be efficient, this design needs to be European. The first step is to ensure that national energy regulations are not used for domestic industrial or social policy. Regulated final consumer tariffs in France below what the market would offer, the same electricity price in south and north Germany despite a lack of interconnection, or paying premiums to domestic plants – which is essentially what capacity mechanisms and renewables support schemes do – are all inconsistent with a functioning internal market. This implies that the fuel mix prerogative of the member states should be restricted to preferences against certain technologies, such as ‘no nuclear in Germany’ or ‘no shale gas in France’. While restricting certain technologies, if done transparently and predictably, would be consistent with a functioning European market, there can be no European market if member states prescribe certain fuel mixes, such as ‘more than 40 percent of electricity from German renewables in Germany’ or ‘more than 80 percent of Polish electricity from Polish coal’. Given the substantial distributive effects9, a European energy market requires accountable governance. Market designs need to be regularly adapted to changing circumstances, so the governance structure needs to be institutionalised. But, the European Commission has neither been given the authority to strike a deal between vested interests, nor does it possess the manpower for such a complex task10. Consequently, the Commission relies on selected stakeholders to negotiate compromises over individual issues11. To develop a truly functioning internal market, the Commission needs to prepare a fourth legal package outlining the European energy market framework. This should not shy away from curtailing the role of national energy policymaking. It should propose one or several generic market designs. The European Parliament and Council should then decide which of those generic designs should be developed further. Because of the complexity, the substantial information asymmetries between stakeholders and the significant redistributive effects, this task of developing a market model should be entrusted to a well-staffed and accountable institution that will also be responsible for the ongoing implementation of the design12 – for example, the Agency for the Cooperation of European Regulators (ACER). This would, however, require resources matching its responsibility13 and an overhaul of the decision-making process. The final design would then be ratified by the European Parliament and Council. Creating a functioning internal energy market would be a major shift that will not be achieved through smooth convergence of national markets. The alternative would be to return to a system of more-or-less managed national electricity systems – with some unreliable cross-border exchanges of energy. This would not only make the systems less efficient. It will also make national security of supply more costly, and deployment of renewables beyond a certain level prohibitively expensive.

    Re-establishing the ETS

    The ETS covers most carbon-emitting industries and will run indefinitely, with a shrinking annual supply of allowances. It is an effective and efficient tool to mitigate emissions14. But, the price of ETS allowances has collapsed because of an oversupply15 and the undermining of the system’s credibility. The risk in these developments is that the ETS gets replaced by less-efficient national, sectoral and time-inconsistent measures. A revamp is therefore important to incentivise the use of current low-carbon alternatives (for example burning gas instead of coal) and to ensure low-carbon investment. The European Commission proposal to revamp the ETS is (1) to increase the speed by which the annual allocation of allowances are curtailed from 1.74 percent to 2.2 percent every year after 202017 and (2) to introduce a ‘market stability reserve’ through which any surplus of allowances above a certain level will be removed from the market, and reintroduced when the surplus falls below a certain level. Steeper reduction of annual allowance allocations after 2020 is a sensible step to ensure that Europe plays its part in the containment of global warming. There is however a risk that the sectors covered by the ETS could fall out of step with the emission reductions in sectors that do not fall under the ETS, such as transport and heating. For example, electricity for electric vehicles and heat pumps falls under the ETS, while combustion-engine cars and oil heating do not. The most elegant solution to avoid different carbon prices for different technologies would be to extend the scope of the ETS to all relevant sectors18. The Commission's proposed ‘market stability reserve’ is intended to avoid politically motivated intervention in the market. But the use and workability of such a mechanism are highly disputed19. A more promising way to effectively shield the ETS from political interference would be to ensure that future policymakers that decide to undermine the ETS have to compensate companies that invested based on the claims made by policymakers today that the ETS is stable. This could be organised through private contracts between low-carbon investors and the public sector. A public bank could offer contracts that will pay in the future any positive difference between the actual carbon price and a target level20. Low-carbon investors would bid to acquire such contracts to hedge their investments. This would produce three benefits. First, the public bank would be able to collect money upfront (a sort of insurance premium) and make a profit if a sufficiently tight climate policy is maintained. Second, the private investor significantly reduces its exposure to the – political – carbon market and hence accepts longer pay-back times for its investments. This would unlock long-term investment that is currently too risky. Third and most importantly, public budgets would be significantly exposed to the functioning of the ETS. If future policymakers take decisions that increase the number of available allowances, they might be called back by their treasuries because this would activate the guarantees pledged to investors. This would serve as a much more credible commitment to preserve the integrity of the ETS.

    Supply security

    The EU's perceived vulnerability to a reduction in gas (and oil) supplies from Russia in the context of the Ukrainian crisis has put supply security back on the agenda21. Security of gas supply is not primarily about reducing import dependency or increasing Europe’s negotiating power with foreign suppliers. Rather, it is about maintaining unused alternatives that could be tapped into for an indefinite period in case the most important supplier fails for technical or political reasons. There is a long-standing debate about whether completing the internal market will deliver supply security. A functioning internal market offers the most efficient rationing mechanism during crises and market-based long-term prices in Europe ensure that suppliers have the right incentives to develop new sources. On the other hand, the market – which typically goes for the cheapest available source – might fail to sufficiently diversify. For example, the current market design will not provide infrastructure to connect sources that are in normal circumstances uncompetitive, but which serve as insurance in case the cheapest supplies become unavailable. But managed approaches, such as providing security via public investment in certain infrastructure, could crowd out private investment if not properly shielded from the market. If, for example, Europe financially supports a pipeline from Turkmenistan, the business case for the corresponding volume from the Levant region might disappear. Furthermore, national managed approaches regularly fail to select the most efficient options (eg demand curtailment, storage, LNG plants, pipelines, domestic production, domestic fuels). So neither the current market design nor ad-hoc managed approaches appear well suited to efficiently ensure gas supply security. We therefore propose a market for ‘reserve supplies’. Each domestic gas supplier would be legally required to maintain a certain amount of alternative supply, such as 20 percent of the contracted energy demand for three years. Suppliers can meet their obligation through different options such as (i) interruptible contracts with their consumers, (ii) volumes in storage, or (iii) option contracts with other domestic and foreign suppliers. Europe's suppliers would need to make sure that the transport capacities – pipelines and terminals – needed to deliver the corresponding volumes to customers are available. Furthermore, ‘reserve supplies’ could not be met by options involving pivotal suppliers/infrastructure. That is, holding an option for additional supplies from Russia would not qualify as ‘reserve supplies’. To ensure this, pivotal suppliers/infrastructure will have to be identified. In case a supplier finds itself in a situation in which all existing infrastructure is either already used or pivotal, it will have to invest in new infrastructure. Suppliers would only be able to draw on these ‘reserve supplies’ in security crises following an official declaration. This system, the cost of which the domestic suppliers will largely pass through to their customers, should ensure security of supply for all at lowest cost and without undermining the internal market. Such an approach would obviously have distributive effects. Consumers in well-connected regions that face a very limited risk of supply disruptions will have to pay for ‘their’ share of reserves, which most likely only their less well-connected neighbours might need. But this solidarity will not wash away regional differences arising from different infrastructure endowments because suppliers in areas with less-developed infrastructure will find it more costly to ensure the level of supply security. This is efficient because it provides an incentive against locating the most vulnerable sectors in vulnerable markets. For example, a chemical plant in Cyprus will only get an interruptible contract because no supplier could affordably secure the required reserve capacities.

    RES-innovation target

    Since the EU 20 percent target for renewables was decided, some of the reasons for investing in renewables have become less urgent. There is less risk that fossil fuels will run out quickly, more reliable suppliers are entering the global energy market22 and a global agreement to mitigate greenhouse gases seems distant. Nevertheless, in the longer-term, issues such as dependence on imports from uncertain sources and rising hydrocarbon costs will return. Most importantly, affordable decarbonisation of the energy sector will require competitive renewable energy sources (RES). Consequently, the focus of renewables support should shift from a deployment target that encourages the quick roll-out of the cheapest currently renewable technology, to an ambitious innovation target that encourages investment to cut the cost of RES. If successful, an innovation target will be the largest possible contribution of Europe (and its partners) to saving the global climate, and might be instrumental in developing a competitive edge in what will become a major global market23. It is difficult to establish the optimal size, selection, balance and timing of 'push' and 'pull' measures – for example, public R&D support, or feed-in tariffs to create demand for a new technology. Zachmann et al (2014) indicate that both public support to boost innovation and the timing of instruments matters. It is not massive actual deployment24, but the prospect of deployment that is the carrot for industry to commercialise the technologies developed through publicly-supported R&D. A long-term deployment target – such as the 20 percent for 2020 – is helpful, not least because it incentivises innovation and investment in complementary technologies such as storage or networks. However, the deployment target should be broken down to technology-specific targets and developed as part of an innovation policy that optimally supports a broad portfolio of technologies at different stages of maturity. A revised Strategic Energy Technology Plan25 could form the basis for defining measures and allocating support to technologies. The current and envisaged renewables policies are not focused on innovation. Europe currently spends on relevant R&D about a hundredth of what it spends on renewables deployment (Figure 3)26. It does not integrate its deployment and R&D policies into a strategic innovation policy and does not coordinate its deployment policies across borders.

    Energy efficiency

    The key tool to ensure efficient energy usage is confronting all users with market-based price signals. Wasteful usage does not only refer to using more energy to produce a certain good, but also artificially maintaining a specialisation in energy-intensive goods. As Europe should not strive to subsidise labour costs to make the European textile industry competitive with Asia, Europe should not subsidise energy costs to make European aluminium production competitive with the US, especially as defending energy-intensive sectors at all cost locks in high energy consumption and implies that Europe needs to draw on more expensive supplies for all other sectors. Beyond the issue of prices, the question is if energy efficiency needs to be regulated and if this should be done at European level. The need for regulation is often deduced from the finding that even efficiency measures with positive net present values are not delivered by the market27. As energy efficiency is an issue in virtually all sectors, there is a myriad of existing and proposed measures. So, energy efficiency policies can be welfare enhancing, but their efficiency depends on their design. The same holds for the question of subsidiarity. The obvious argument for a European energy efficiency policy is its interdependence with the single market. National product energy-efficiency standards, national energy-efficiency schemes for energy companies or even distorting energy taxes could weigh on the single market’s integrity. On the other hand, national regulatory environments and structures for important energy consuming sectors (eg buildings) differ markedly. This might make a one-size-fits-all European energy efficiency policy very inefficient in these fields. So the somewhat generic conclusion on energy efficiency is that individual market failures should be addressed by the most efficient measures at the right level of government. For the broad portfolio of regional, national and European policies that is necessary, a binding EU 2030 energy consumption target is not well suited. It neither addresses who has to deliver nor does it properly take economic developments into account. To benchmark energy-efficiency policies we would suggest a bottom-up approach. Based on the ex-post evaluation of each individual energy efficiency policy, the incentivised demand reduction and the corresponding policy cost should be reported. For example, the energy-efficiency loans in Germany in 2011 had an estimated cost of about €1 billion and encouraged annual savings of 0.1 million tonnes of oil equivalent (Mtoe). Two targets would then serve to benchmark the success of the overall policy framework up to 2030: one for total incentivised energy savings (eg more than 400 Mtoe of induced energy savings between 2020 and 2030) and one for total energy efficiency policy cost (eg less than €100 billion). This target might be broken down by member state (or even to sub-national level) and even made binding.

    Conclusion

    Policy and market failures in the energy sector are common. There is too little energy saving, too little investment in security and innovation and emissions are too high. Governments tend to over-invest in big supply projects and use energy-sector regulation for other national policy purposes, preferring to solve the issues of the day instead of addressing the structural problems. The European 2030 framework should strive to address the market failures without falling for the government failures. Essential elements will be well-designed European markets for emissions, electricity supply and gas security of supply. Better policy frameworks are also needed to encourage energy efficiency and innovation in low-carbon energy technologies. This would be a radical step-change in European energy and climate policy, but so were the 2020 targets. But in planning for 2030, Europe cannot avoid substantially revising the governance of its energy sector, without compromising on security of supply, sustainability and competitiveness. Research assistance from Marco Testoni is gratefully acknowledged. The author would also like to thank those who provided valuable comments on an earlier draft. The research underpinning this paper benefited from support from the Simpatic project (EU Seventh Framework Programme, grant agreement 290597, www.simpatic.eu). All notes and full references are available in the .pdf.]]>
    Wed, 10 Sep 2014 00:00:00 +0100
    <![CDATA[EU to DO 2015-2019: Memos to the new EU leadership]]> http://www.bruegel.org The new EU leadership – the president of the European Commission and his team of commissioners, and the presidents of the European Council and of the European Parliament – will have to address pressing challenges.
    Go to eu2do.bruegel.org to read all the Memos, download the individual Memos and send the Memos to your Kindle.
    ‘THERE IS NOW A DISTINCT POSSIBILITY that this crisis will be remembered as the occasion when Europe irretrievably lost ground, both economically and politically’. This was the starting sentence of our memos to the new EU leadership five years ago. Five years later, it is fair to say that this possibility has become a reality. Unemployment has reached record levels and growth has disappointed. Meanwhile, the world outside the EU has continued to change rapidly. Emerging markets in particular have increased their weight in the global economy and in decision making. The new EU leadership – the president of the European Commission and his team of commissioners, and the presidents of the European Council and of the European Parliament – will have to address pressing challenges. Despite the significant steps taken by Europe – among them the creation of a European Stability Mechanism, the start of a banking union, the strengthening of fiscal rules and substantial structural reforms in crisis countries – results for citizens are still unsatisfactory. It is impossible to summarise all the memos in this volume but a common theme is the need to focus on pro-growth policies, on a deepening of the single market, on better and more global trade integration. Reverting to national protectionism, more state aid for national or European champions – as frequently argued for by national politicians – will not be the right way out of the crisis. On the contrary, more Europe and deeper economic integration in some crucial areas, such as energy, capital markets and the digital economy, would greatly support the feeble recovery. But in other areas, less Europe would also be a highly welcome signal that the new European leadership is serious about subsidiarity. Internal re-organisation of the European Commission to ensure that it better delivers would also be welcome. Beyond the pressing challenges – above all crisis resolution, jobs and growth – the memo to the presidents recommends that the new EU leadership should make sure that Europe makes the necessary treaty changes to strengthen Economic and Monetary Union and to permit the coexistence within the EU of countries belonging to the euro area and those that have no intention to join it. Working towards a consensus on this within the European Council and with European citizens is crucial for Europe’s future and to enable bold decisions on pressing issues. Our focus in these memos is on economics. But clearly, political and other challenges have multiplied in the last five years. We therefore offer strategic policy advice that we deem both sensible given the problem at hand and politically achievable. Regrettably, we have unexpectedly not been able to include in this volume a memo to the new Commissioner for Employment and Social Affairs. Yet, we believe that this Commissioner will have the major task of setting out how to improve Europe’s employment and social performance. In many countries, labour market institutions need to be modernised, for instance by making unemployment insurance systems more efficient. Benchmarking could be a way of converging on more sustainable and equitable social models. But reducing unemployment rates will also require better macroeconomic policies, on which the new Commissioner for Economic and Financial Affairs will have an important role to play. The memos have all been written by Bruegel scholars and their preparation has been coordinated by Senior Fellow André Sapir. Like all Bruegel publications, the content reflects the views of the author(s), and there has been no intention to write a ‘Bruegel programme’. But the memos have been discussed extensively within the team to improve quality and ensure coherence. Throughout the preparation of this volume, Bruegel’s editor Stephen Gardner has contributed considerably to improving the formal and substantive quality of the individual memos. Our gratitude goes to him as well as to all of those who have given feedback on drafts of specific memos. André Sapir and Guntram Wolff September 2014]]>
    Thu, 04 Sep 2014 00:00:00 +0100
    <![CDATA[Improving the role of equity crowdfunding in Europe's capital markets]]> http://www.bruegel.org Summary Crowdfunding is a growing phenomenon that encompasses several different models of financing for business or other ventures. Despite the hype, equity crowdfunding is still the smallest part of the crowdfunding market. Because of its legal framework, Europe has been at the forefront of equity crowdfunding market development. Equity crowdfunding is more complex than other forms of crowdfunding and requires proper checks and balances if it is to provide a viable channel for financial intermediation in the seed and early-stage market in Europe. It is important to explore this new channel of funding for young and innovative firms given the critical role these start-ups can play job creation and economic growth in Europe. We assess the potential role of equity crowdfunding in the overall seed and early-stage financing market and highlight the potential risks of equity crowdfunding. We describe the current state of play in this nascent industry, considering both the innovations introduced by market operators and existing regulation. Currently in Europe there is a patchwork of national legal frameworks related to equity crowdfunding and this should be addressed in a harmonised way.

    Introduction

    Crowdfunding is increasingly attracting attention, most recently for its potential to provide equity funding to start-ups. Providing funding to young and innovative firms is particularly relevant given their importance for job creation and economic growth (OECD, 2013; Haltiwangner et al, 2011; Stangler and Litan, 2009). In addition, at a time when banking intermediation is under pressure (Sapir and Wolff, 2013), it is important for European Union policymakers to further explore alternative forms of financial intermediation. But questions remain about the appropriateness of crowdfunding for providing seed and early stage equity finance to new ventures and how this market could be developed and regulated. While there is growing hype around crowdfunding, there are also many wrong perceptions. The bulk of crowdfunding is for philanthropic projects (in the form of donations), consumer products often for creative ventures such as music and film (in the form of pre-funding orders) and lending. Equity crowdfunding, sometimes called crowdinvesting is relatively new and currently comprises the smallest part of the crowdfunding market. However, it is currently more active in Europe than in other regions.

    Growth of crowdfunding

    Crowdfunding can be defined as the collection of funds, usually through a web platform, from a large pool of backers to fund an initiative. Two fundamental elements underpin this model and both have been enabled by the development of the internet. First, by substantially reducing transaction costs, the internet makes it possible to collect small sums from a large pool of funders: the crowd. The aggregation of many small contributions can result in considerable amounts of capital. Second, the internet makes it possible to directly connect funders with those seeking funding, without an active intermediary. Crowdfunding platforms assume the role of facilitators of the match. While people tend to talk about crowdfunding in general, the crowdfunding phenomenon encompasses quite heterogeneous financing models. There are four main types:
    • Donation-based, in which funders donate to causes that they want to support with no expected compensation (ie philanthropic or sponsorship-based incentive).
    • Reward-based, in which funders’ objective for funding is to gain a non-financial reward such as a token gift or a product, such as a first edition release.
    • Lending-based (crowd lending), in which funders receive fixed periodic income and expect repayment of the original principal investment.
    • Equity-based (usually defined as crowdinvesting), in which funders receive compensation in the form of fundraiser’s equity-based revenue or profit-share arrangements. In other words, the entrepreneur decides how much money he or she would like to raise in exchange for a percentage of equity and each crowdfunder receives a pro-rata share (usually ordinary shares) of the company depending on the fraction of the target amount they decide to commit. For example, if a start-up is trying to raise €50,000 in exchange for 20 percent of its equity and each crowdfunder provides €500 (1 percent of €50,000), the crowdfunder will receive 0.20 percent (1 percent of 20 percent) of the company’s equity.
    The four models vary in terms of complexity and level of uncertainty. The donation-based model is the simplest. Legally the transaction takes the form of a donation. The risk is that the project does not achieve its declared goals, but the backer does not expect any material or financial return from the transaction. Equity crowdfunding is the most complex. From a legal standpoint, the funder buys a stake in the company, the value of which must be estimated. Moreover, the level of uncertainty in equity crowdfunding is much greater compared to the other models because it concerns the entrepreneur’s ability to generate equity value in the company, which is extremely difficult to assess. Overall, these complexities pose problems that are distinct and more fundamental than those of the other crowdfunding models. These complexities require special attention from policymakers, as this Policy Contribution will discuss. In general, crowdfunding is experiencing exponential growth globally. In the period 2009-13, the compound annual growth rate (CAGR) of the funding volumes was about 76 percent with an estimated total funding volume of $5.1bn in 2013. In terms of geography, the biggest market has been North America (and mostly the US where the concept of crowdfunding started) with 60 percent of the market volume, followed by Europe, which has 36 percent. Equity crowdfunding is the smallest category of the overall industry and had a CAGR of about 50 percent from 2010 to 2012. Most of that growth was through European crowdfunding platforms because legal barriers currently prevent the development of equity crowdfunding in the US (see Box 2). As a result, Europe is currently the leading market for this financing model (see further discussion in section 4). While in Europe equity crowdfunding is growing, the understanding of its risks and opportunities is still limited. We first assess the potential role of equity crowdfunding in the overall seed and early-stage financing market. Second, we point out the potential risks of equity crowdfunding. Third, we describe the state of this nascent industry considering both the innovations introduced by market players and existing regulation. Finally, we discuss the implications of our analysis for policy.

    The seed and early-stage financing market

    Equity crowdfunding is receiving attention from policymakers as a potential source of funds for start-ups, a segment of the economy that has limited access to finance. Young firms have no track record and often lack assets to be used as guarantees for bank loans. In addition, information asymmetries make it difficult for investors to identify and evaluate the potential of these firms. Traditionally there have been three sources of equity funding for young innovative firms: founders, family and friends; angel investors; and venture capitalists.
    • The most common source of funding for new ventures is the founders’ own capital, even if that is funded through credit cards. Family and friends sometimes also provide finance to the entrepreneur in the first phases of development of the start-up (seed stage).
    • Angel investors are experienced entrepreneurs or business people that choose to invest their own funds into a new venture. They typically invest in seed and early stage ventures with amounts ranging from $25,000 to $500,000. Angels invest not only for the potential financial return, but in many cases to give back by helping other entrepreneurs.
    • Venture capital is considered ‘professional’ equity, in the form of a fund run by general partners, and aims at investments in firms in early to expansion stages. The source of capital pooled into venture capital funds is predominately institutional investors. Venture capital firms typically invest around $3m and $5m per round in a company.
    The contributions of angel investors and venture capital firms are not limited to the provision of finance. They are actively involved in monitoring the companies in which they invest and often provide critical resources such as industry expertise and a valuable network of contacts (Gorman and Sahlman, 1989; Baum and Silverman, 2004; Hsu, 2004). The importance of angel investors has increased in recent years given the difficulties young innovative firms face in securing finance from other channels (Wilson, 2011). As a result of the financial crisis, banks are even more reluctant to fund young firms because of their perceived riskiness and lack of collateral (Wilson and Silva, 2013). Meanwhile, venture capital firms are focusing more on later-stage investments and have left a significant funding gap at the seed and early stage. Angel investors, particularly those investing through groups or syndicates, are active in this investment segment and thus help to fill this increasing financing gap. Equity crowdfunding departs from the models of traditional angel investors and venture capital firms because transactions are intermediated by an online platform. Some platforms play a more active role in screening and evaluating companies than others (see section 4). Also, their role during the investment and post-investment stages can vary dramatically. While there is a great deal of variation among the approaches adopted by the different platforms (Collins and Pierrakis, 2012), equity crowdfunding platforms generally follow the phases described in Figure 3. Platforms usually charge companies a fee, typically 5-10 percent of the amount raised, plus sometimes a fixed up-front fee. Some platforms also charge fees to investors that are either fixed or a percentage of the amount invested or a percentage of the profit for investment. For example, Crowdcube charges entrepreneurs 5 percent plus a £1,750 fee for successful fund raising. Symbid charges entrepreneurs a €250 registration fee plus 5 percent of the amount raised and charges investors 2.5 percent of the amount invested. Seedrs charges entrepreneurs 7.5 percent of the amounts raised and charges investors 7.5 percent of the profits from the investment. To understand how equity crowdfunding can complement the market incumbents in seed and early-stage finance, we have to consider characteristics such as investment size, investment motives, the risk/return profile, the investment model and investor characteristics. Figure 4 shows the funding per project in equity-based crowdfunding. Compared to the other sources of finance described above, we can see that equity crowdfunding mostly operates in the financing segment covered by angel investors1. Another characteristic that equity crowdfunding has in common with angel investors is that financial return is not the sole motive for an investment. Crowdfunders might also derive social and emotional benefits from financing a company. In other words, they are likely to be motivated to provide funding to a company to be connected with an entrepreneurial venture that shares their own values, vision or interests. A survey of Seedrs2 users revealed that the three top motivations for investors to fund start-ups are the desire to help new businesses get off the ground, the ability to exploit tax reliefs3, and the hope of achieving meaningful financial returns (Seedrs, 2013). In terms of investment preferences, venture capitals tend to concentrate on technology-based companies, which typically are high-risk/high-return investments. Angel investors tend to invest in a wider range of sectors and geographies, covering some investment segments in which venture capital typically would not invest (Wilson, 2011). Because the crowd might encompass quite heterogeneous investment motives, the investment spectrum of equity crowdfunding can be even broader. For example, Seedrs users have invested in sectors as diverse as food and drink, high-tech, art and music, fashion and apparel, real estate and many others (Seedrs, 2014). The fact that crowdinvestors derive also non-financial benefits from the investment implies that they might also be willing to accept higher risks or lower returns than an investor seeking to maximise financial returns (Collins and Pierrakis, 2012). Unlike venture capital and angel investment, equity crowdfunding requires entrepreneurs to publicly disclose their business idea and strategy. This early information disclosure might be harmful for firms with an innovative business model that can be easily imitated (Hemer, 2011; Agrawal et al, 2013; Hornuf and Schwienbacher, 2014a). Therefore, crowdfunding might be most beneficial for start-ups that can protect their intellectual capital through means other than secrecy, or for start-ups whose business is not particularly innovative. Another common element shared by business angels and crowdinvestors is that neither type of financing model necessarily involves an active financial intermediary that makes the investment decisions. Venture capital firms pool financial commitments from institutional investors into funds and then select a portfolio of companies over time in which they invest. For angel investors and crowdinvestors, the decision to finance a company is ultimately made by the individual investor. Some equity crowdfunding platforms pool the funds of the crowd into an investment vehicle and act towards the company as the representative of the interests of the crowd. However, even in this case the platform does not act as a financial intermediary in portfolio management for the crowd, and the decision to invest in a specific company is taken by the individual investor. While angel investors are typically high net worth individuals who are sophisticated investors, crowdinvestors are individuals that might or might not have experience and knowledge of financial markets and early-stage financing. Moreover, while angel investors tend to invest locally, crowdinvestors might invest in start-ups that are quite distant from them. Agrawal et al (2011) show that the average distance between a revenue-sharing crowdfunding platform's entrepreneurs and investors was approximately 3,000 miles (4,828 km). According to their study, only 13.5 percent of the investors provided funds to entrepreneurs within 50 km. Table 1 summarises the key characteristics of equity crowdfunders, angel investors and venture capitalists, highlighting their similarities and differences. Overall, equity crowdfunding can provide a complementary channel through which start-ups can obtain finance. In addition, equity crowdfunding can provide some advantages by fully exploiting the potential of the internet. For example, crowdfunding allows a start-up to gain online visibility in the first phases of its development. As crowdinvestors are also potential consumers, an entrepreneur can benefit from crowdfunding through early advertisement of its products and by obtaining information on potential market demand and product preferences (Agrawal et al, 2013; Hornuf and Schwienbacher, 2014a). This early assessment of demand could help to reduce inefficient investments in start-ups with weak business potential. Compared with traditional angel investing transactions that rely mostly on word-of-mouth, crowdfunding can improve the efficiency of the market by enabling faster and better investor-company matches. Moreover, geographical factors that might affect traditional forms of seed and early-stage financing might be less important in crowdfunding (Mollick, 2013a; Agrawal et al, 2011 and 2013). Finally, the crowdfunding industry is well-positioned to benefit from the so-called 'big data' paradigm (Agrawal et al, 2013). Being online-based, crowdfunding deals leave data trails on investors, entrepreneurs, companies and deals, unlike angel investment and even most venture capital transactions. Through time, the analysis of this data could enable crowdfunding platforms to provide better matches between investors and companies and maximise the correlation between the crowd and product demand.

    Risks in equity crowdfunding

    Seed and early-stage financing can be high risk but with the hope of a high return. Eurostat data4 show that in EU the one-year survival rate for all enterprises created in 2009 was 81 percent, while the five-year survival rate of all enterprises started in 2005 was only 46 percent. Despite the expertise of professional investors, the risk of investing in start-ups remains high. Shikhar Ghosh, senior lecturer at Harvard Business School, analysed data from more than 2,000 US companies that received venture financing and found that about 30-40 percent of them fail, while more than 95 percent fail to generate the expected return on investment (WSJ, 2012). There is a misconception about success rates and returns on investment in start-ups (Shane, 2008) and the average individual is not aware of the risks. The characteristics of crowdfunding can make investments in seed and early-stage companies even riskier. Information asymmetry problems common to seed and early-stage financing are exacerbated in equity crowdfunding. Below we describe some of the issues that might arise in each phase of the investment.

    Selection and valuation

    Before investing in a company, business angels and venture capitalists routinely perform due diligence to assess the potential value of the firm. This can be costly in terms of time and resources. However, evidence shows that due diligence is a major determinant in achieving returns on the investment (Wiltbanks and Boeker, 2007). This expense is often justified in light of the considerable size of such investments. Because their investments are relatively small, crowdinvestors have less incentive to perform due diligence. Moreover, individual investors have the possibility of free-riding on the investment decisions of others. This implies that the crowdfunding community may systematically underinvest in due diligence (Agrawal et al, 2013). Crowdfunders also likely lack the expertise and skills to perform adequate due diligence. Since everyone is able to join, the crowd often includes non-professional investors, who do not have the knowledge or capabilities to properly estimate the value of a company. Finally, company valuation performed by a crowd might be affected by social biases and herding behaviour5. Evidence suggests that a crowdfunder’s investment decision might be affected by those of the other investors (Agrawal et al, 2011; Kuppuswamy and Bayus, 2013). Moreover, different studies have found that both the crowd and entrepreneurs are typically initially overoptimistic about potential outcomes (Mollick, 2013b; Agrawal et al, 2013).

    Investment

    Equity crowdfunding often relies on standardised contracts that are provided by the portal. However, equity investment into seed and early-stage firms often requires tailored contracts to align the interests of the entrepreneur to those of the investor. For example, venture capital and business angels use various covenants in their contracts, such as anti-dilution provisions that protect against down-rounds6, tag-along rights7 that facilitate exit opportunities, and liquidation preferences that secure higher priority in the distribution of value (Hornuf and Schwienbacher, 2014a). Moreover, in order to reduce risk exposure and increase control over the entrepreneur’s behaviour, seed and early-stage investors often split their investments into tranches that are conditional on the attainment of defined milestones. All of these mechanisms are difficult to replicate in the crowdfunding setting. Another strategy applied by venture capitalists and business angels is to invest in a portfolio of companies in order to diversify their risk. Equity crowdfunders might be able to replicate this strategy given that crowdfunding platforms expose them to a variety of projects. However, non-professional investors might not be aware of the importance of this strategy and could potentially concentrate all their investments in a single venture. For example, Seedrs statistics show that 41 percent of investors hold only one company in their portfolio (Seedrs, 2014). Moreover, crowdfunders might not be able to participate in follow-on investment rounds. The failure to do so might mean that the investor’s shares get diluted, thus reducing their chances to attain a positive return from the investment.

    Post-investment support and monitoring

    As we have described, business angels and venture capitalists not only provide finance to start-ups, but are also actively involved in increasing the value of the company. While the crowd could potentially provide active support to the venture, there are reasons to believe that this support can be less valuable than that provided by traditional seed and early-stage financiers. Given their typical small level of investment, crowdfunders have less incentive to provide active support to the company because the return for their action is lower (Agrawal et al, 2013). However, if too many investors choose to become active, it could be excessively costly for a small firm to manage a crowd of investors that want to participate. This is particularly relevant considering that the venture has limited ability to select its crowdinvestors. Moreover, high information asymmetry also characterises the post-investment phase, thus limiting the monitoring potential of the crowd. One of the elements contributing to the increase in information asymmetry is geographical distance between funders and the entrepreneur. While this characteristic enables backers to attain access to a wider pool of entrepreneurs (and visa-versa), it also entails higher monitoring costs. Literature suggests that distance increases the costs that an investor must bear in order to monitor the venture (Grote and Umber, 2007). This is in line with the observation that venture capital funds invest predominantly in firms close to them (Lerner, 1995). Finally, the lack of repeated interactions reduces the potential of reputation as a mechanism to incentivise the entrepreneur to behave in line with the interests of the investor (Agrawal et al, 2013). In other online marketplaces, such as eBay, participants have a low incentive to misbehave because, if they do, they might, in effect, be prevented from participating in the market in the future because of the feedback and ratings mechanisms. Since sourcing equity finance through the internet is often a one-time event for an entrepreneur, the incentives for behaving correctly are lower, which can lead to potential fraud. More active crowdfunding platforms screen companies. However, not all platforms have the same standards.

    Exit

    The lack of adequate monitoring is particularly worrisome in a setting in which investments often take 5-10 years or more to produce a return, if any. Crowd investors might not appreciate that long periods are necessary for these investments to either succeed or fail, or that most of these investments are unlikely to yield any return. Moreover, equity investments are mostly long-term illiquid assets. Therefore, it is important that non-professional investors are adequately informed about the illiquid characteristics of this asset class. For equity investments to provide a return to investors, a positive 'exit' must take place at some point. This can be through an initial public offering (IPO) or, as more often the case, through a merger or acquisition (M&A). Unfortunately, these positive exits became increasingly rare during the financial crisis. In Europe, EVCA data (2013) shows that only 15 percent of venture capital exits in 2012 (in terms of number of companies) were through trade sales, and even fewer, 5 percent, were IPOs. These numbers are clearly lower than pre-crisis (2007) figures that pointed to 22 percent of exits through trade sales and 8 percent through IPOs. For angel investments and equity crowdfunding investments, the path to a positive exit can be longer and even less likely. IPOs and M&As do not happen by chance. Venture capitalists and the firms themselves often have an exit strategy in mind from the beginning and proactively work towards making it a reality over a long period (Wilson and Silva, 2013). In conclusion, the lack of adequate pre-investment screening and due diligence, weaker investment contracts and poorer post-investment support and monitoring can make the risk associated with equity crowdfunding significantly higher than the risk usually borne by business angels and venture capitals. Moreover, while the potential for fraud is exacerbated in the equity crowdfunding setting, information asymmetry makes investments in the start-ups of even well-intentioned entrepreneurs riskier, since the competence of the entrepreneur and the quality of the business plan cannot be properly assessed. While there are some successful equity crowdfunding cases (such as the biotech start-up Antabio8 in France, which succeeded in producing a positive return for its investors) and failure cases (such as the liquidation of betandsleep9 or sporTrade10 in Germany), the industry still lacks a sufficient track record to assess its ability to create value for both investors and entrepreneurs.

    Crowdfunding platforms and the regulatory environment

    The issues we have raised demonstrate the greater exposure that equity crowdfunding market has compared to other forms of seed and early-stage investment. In particular, adverse selection problems could increase the cost of capital up to the point at which only low-quality ventures will eventually choose to seek financing through crowdfunding, while high-quality ventures will continue to secure venture capital or angel investor financing (Agrawal et al, 2013). Competition between platforms and between the crowdfunding industry and traditional financing is pushing platforms to design innovative solutions to avoid the unintended consequence of creating a ‘market for lemons’. Overall, the main limitation of equity crowdfunding is that it allows a non-professional investor, who might lack the incentive and/or capabilities to adequately assess and monitor a start-up, to make an investment. Efforts to address this limitation to date have included the introduction of an intermediary between the crowd and the company that is able to perform these tasks, or the reduction of the crowd to only qualified investors. The first approach involves the provision of an active intermediary that could act as a representative of the interests of the crowd in performing due diligence and monitoring start-ups. Following this trend, many platforms are active in performing due diligence, while others operate a nominee and management system in which they represent the interests of investors with the crowdfunded business (eg Seedrs). Another example is provided by platforms such as MyMicroInvest in Belgium, which allows investors to co-invest with an experienced business angel. In this case, the crowd benefits from the financial contracting skills and from the post-investment monitoring of an experienced active investor. While this approach provides some benefits, it also entails some risks: by leveraging the investment decisions of a business angel, this mechanism may increase the risk propensity of the angel, thus biasing his or her investment decisions. A second approach is to reduce the crowd, by limiting the investment to a restricted group of people, possibly accredited investors, each contributing more capital than the average crowd investor. In this case, crowdinvesting would more closely resemble angel investor groups than the typical crowdfunding model. Examples of this model are CircleUp and FundersClub in the US or Seedups based in Ireland, whose offers are restricted to accredited investors. Other examples are platforms that impose high investment minimums, thus reducing the crowd to a few investors. Finally, some platforms (such as Seedrs and Crowdcube in the UK) require crowdinvestors to pass a test before investing in a company, to certify that they are sufficiently aware of the investment risk. The efficacy of these measures needs to be evaluated and appropriate policies should take into account these assessments. Moreover, while the market gives incentives to platforms to adopt the best practice, some platforms could deviate from the best practices because of lack of long-term vision, incompetence or other hidden interests (Griffin, 2012). The financial crisis showed that leaving the financial market to self-regulate can be costly. Many of these crowdinvestors could lose their money before the market has time to self-correct and force out inadequate platform models. Crowdfunding platforms have an incentive to build a good reputation by securing attractive deals for their crowds, since in the long run reputation results in market-share gains. Apart from this reputational incentive, platforms differ in the structure of fees they derive from the deals. As described in section 2, most of the platforms derive revenues as a percentage of the amount raised, while only a few (eg Seedrs) derive monetary benefit from a successful exit by imposing a fee as a percentage of investor’s profits. This typical fee structure implies that platforms derive monetary incentive to close deals while there are only reputational incentives to provide successful deals in the long run. If long-run reputational incentives are lower than short-term monetary incentives, conflicts of interest could arise and platforms might downplay investment risk to the crowd in order to secure deals. In light of this potential conflict of interest, a supervisory body for crowdfunding platforms is probably desirable. From a legal standpoint, equity crowdfunding is currently possible in some jurisdictions by exploiting exemptions to existing securities regulations (Hornuf and Schwienbacher, 2014b). Securities laws generally require an issuer to register with the national securities authority and to comply with strict reporting standards in order to gain access to the general public. These requirements are prohibitively expensive for small firms, which are the typical beneficiaries of crowdfunding. In the EU, exemptions as defined in national regulations pertaining to prospectus and registration requirements, allow start-ups to gain access to the general public through equity crowdfunding (Hornuf and Schwienbacher, 2014b). Exemptions include the maximum amount that can be offered to the public, the maximum number of investors to whom the offer is made, the minimum contribution imposed on investors and whether the offer is made to ‘qualified’ or ‘accredited’ investors. While these exemptions to existing securities legislation allow small firms access to the general public for financing, they also imply weaker protections for investors. EU member states have adopted different practices on whether the equity crowdfunding platform must register as an investment intermediary or obtain a bank license. For example, in Germany, crowdinvesting platforms explicitly stating that they do not provide any investment advice or brokerage service have no obligation to provide any documentation in terms of advisory records or to act in the interest of the investor (Dapp and Laskawi, 2014). As a result, most German platforms are not registered as investment intermediaries (ECN, 2013). In the UK, platforms are regulated by the Financial Conduct Authority (FCA) (ECN, 2013; Hornuf and Schwienbacher, 2014b). In France, equity crowdfunding platforms such as Wiseed, Anaxago, Finance Utile and SmartAngels are registered as financial investment advisers, since their activities consist of advice in providing financing (ECN, 2013; Hornuf and Schwienbacher, 2014b). Finally, national corporate laws can also have an effect on equity crowdfunding (De Buysere et al, 2012; Hornuf and Schwienbacher, 2014b). For example, because they are relatively inexpensive in most countries, closely held company types (eg private limited liabilities companies) are the typical entity type chosen by start-ups. However, in many countries these company types have limitations or might be prohibited from offering equity to new investors. Even when allowed, equity transactions for these kinds of companies often require formalities, such as notarial intervention, which increases the costs for start-ups. Despite the harmonising role played by Directive 2010/73/EU (Box 1), the EU remains a patchwork of different regulations. This lack of uniformity inhibits the development of a pan-European industry by making cross-border deals more difficult, and highlights the lack of consensus on whether equity crowdfunding could be welfare-enhancing or not.

    Considerations for policymakers

    Crowdfunding can be an additional tool for providing seed and early-stage equity finance to new ventures. However, policymakers should proceed with caution by carefully assessing the risks of this new financial intermediation tool. We argue that the challenges that equity crowdfunding poses are distinct and more complex than those posed by other forms of crowdfunding. As we have outlined, the risks also differ from other forms of seed and early-stage equity finance, such as angel investing and venture capital. Equity crowdfunding can open up additional channels for new ventures to access finance at a time when securing funding is difficult, but the risks, including those related to investor protection, need to be addressed. These risks could result from potential fraudulent activities of start-ups or platforms or, more likely, poor investment decisions made by unsophisticated investors. The current legal framework mainly addresses this issue by reducing the exposure that individual investors can have to riskier assets. The goal is to make sure that the investor is able to bear a potential loss. However, as the equity crowdfunding volumes continue to grow, this solution does not prevent the potential loss of significant amounts of capital. Overall, the legal framework should not allow a crowd of investors, who might lack the incentive and/or the expertise to invest in a start-up, to do so without adequate intermediation and protection. If the crowd is made up of non-qualified investors, we argue that there should be at least one participant that legally represents the interest of the crowd in the investment in a business. This participant could be the crowdfunding platform. The crowd could also be allowed to co-invest alongside professional investors. However, also in this case, the platform should take significant steps to protect the interests of the crowd from the misbehaviour of other investors. Finally, in order to monitor potential conflicts of interest of platforms, supervision by national security authorities is important. Crowdfunding currently is a highly deregulated market with little legal protection provided to funders. In the EU, some member states have introduced ad-hoc legislation for crowdfunding, while some others will introduce new laws soon. The European Commission is currently studying equity crowdfunding, along with the other forms of crowdfunding, to assess its risks and opportunities. In this regard, the Commission started a public consultation late in 2013 and published a Communication in March 2014 (EC, 2014). At this stage, the Commission’s efforts are focused on increasing awareness of the opportunities and risks of crowdfunding, spreading best practice and improving the general understanding of this growing phenomenon. The Commission is also exploring the potential of a ‘quality label’ to spread good practice and build user confidence. Being based online, equity crowdfunding has the potential to contribute to a pan-European seed and early-stage financial market to support European start-ups. However, in order to maximise this benefit, harmonised policies to address equity crowdfunding models should be adopted in common by all member states. This approach would maximise the benefits of equity crowdfunding and help to reduce the risks. We urge the Commission to work with member states to address the current patchwork of national legal frameworks, which constitute an obstacle to the development of this nascent model of funding across Europe. Finally, legislators should take a holistic approach in assessing the regulatory burden on the industry. Corporate law in many countries imposes limitations or prohibits closely held company types – the typical legal form chosen by start-ups – from selling equity to new investors. These provisions are another significant obstacle to the development of equity crowdfunding. Corporate laws should be harmonised and should take into account this new financing channel for start-ups. In addition, other financial regulations which might interact with and have an impact on the market should be assessed. In conclusion, all types of crowdfunding can provide significant and new sources of funding for many types of organisations, ranging from charities to companies. Equity crowdfunding, however, is more complex and requires the proper checks and balances if it is to provide a viable channel for financial intermediation in the seed and early-stage market in Europe.

    Notes

    1. Nevertheless, this distribution might not reflect simply the investment preferences of the crowd. Legal constraints currently provide upper limits to the capital that can be raised from nonqualified investors. See section 4. 2. Seedrs is an equity crowdfunding platform based in the United Kingdom. It allows users to invest as little as £10 into the start-ups. In the first 18 months since its launch in July 2012, Seedrs collected more than €6.8 million through 56 funded campaigns and counted more than 29,000 users. 3. In particular, the Seed Enterprise Investment Scheme (SEIS) launched by the UK government in April 2012.

    REFERENCES

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    Fri, 29 Aug 2014 00:00:00 +0100
    <![CDATA[Ukraine: Can meaningful reform come out of conflict?]]> http://www.bruegel.org
  • Apart from threats to its national security and territorial integrity, Ukraine faces serious economic challenges. These result from the slow pace of economic and institutional reform in the previous two decades, the populist policies of the Yanukovych era and the consequences of the conflict with Russia.
  • The new Ukrainian authorities have made pro-reform declarations, but these do not seem to be supported sufficiently by concrete policy measures, especially in the critical areas of fiscal, balance-of-payment and structural adjustment. Also, the international financial aid package granted to Ukraine has not been accompanied by sufficiently strong policy conditionality.
  • Ukraine urgently needs a complex programme of far-reaching economic and institutional reform, which will include both short-term fiscal and macroeconomic adjustment measures and medium- to long-term structural and institutional changes.
  • Energy subsidies and the low retirement age are the two critical policy areas that require adjustment to avoid sovereign default and a balance-of-payments crisis.
  • Introduction Since the end of 2013 Ukraine has faced a series of dramatic geopolitical, domestic political and economic challenges. First, there was mass protest in Kyiv’s central square against former president Viktor Yanukovych after he declined to sign an association agreement with the European Union. After collapse of Yanukovych’s regime, the internal Ukrainian conflict became internationalised with the illegal annexation of Crimea by Russia, and Russia’s active role in a ‘proxy’ war in the Donetsk and Lukhansk regions. For this reason, international attention is concentrated on geopolitical threats and the violation of Ukraine’s territorial integrity. The geopolitical and security challenges are also at the top of the agenda for the new president and government of Ukraine. As result, the economic situation and economic reform are less prioritised, domestically and internationally. However, pressing economic questions must also be addressed. The unsatisfactory results of previous reform rounds were very much responsible for the recent political crisis and the fragility of the Ukrainian state. Most importantly, successful economic and institutional reforms are critical for attempts to consolidate both state and society and to prevent any new authoritarian drift. The new Ukrainian authorities have made general pro-reform declarations, but these do not seem to be supported sufficiently by concrete policy measures, especially in the critical areas of fiscal, balance-of-payment and structural adjustment. The same must be said about the international financial aid package granted to Ukraine in April and May 2014, which has not been accompanied by sufficiently strong policy conditionality.

    History of half-hearted reform

    The recent developments in Ukraine are not the first time since independence in 1991 that the country has found itself at a critical juncture. In 1991-92, under Leonid Kravchuk’s presidency and on a wave of independence enthusiasm, Ukraine had the chance to build new democratic and market institutions as was done, for example, by the Baltic countries. Unfortunately, all the political energy went to giving old Soviet institutions ‘new’ Ukrainian names. The macroeconomic and social populism of that period led to hyperinflation at the end of 1993. After Leonid Kuchma’s victory in the 1994 presidential election, some market reforms were finally enacted: most prices were liberalised, the exchange rate system was unified, subsidies and the fiscal deficit were reduced (but not eliminated), the issuing of money was brought under control and, finally, a new currency, the hryvna (UAH), was introduced in September 1996. This half-hearted reform process was stalled by a coalition of emerging oligarchs – the early winners from partial liberalisation and the macroeconomic disequilibria of early the 1990s, and the beneficiaries of various rents created by them – and old-style ‘red’ directors in industry and agriculture. The next reform push came after the financial crisis of 1998-99 and Kuchma’s re-election in 1999 alongside Prime Minister Viktor Yushchenko, the former governor of the National Bank of Ukraine. There was some fiscal adjustment, reform of the management of public finance and attempts were made to restructure the loss-making and heavily corrupted energy sector. However, the political life of Yushchenko’s government was short (17 months) and it was soon replaced by a government that was again dominated by ‘red’ industrialists and oligarchs. After the Orange Revolution at the end of 2004 and Yushchenko’s election as the third president of Ukraine, there was a political window of opportunity to start serious political, institutional and economic reform. Unfortunately, this was prevented by a political split inside the ‘Orange’ camp, in particular, the permanent political infighting between Yushchenko and twice Prime Minister Yulia Tymoshenko (2005 and 2007-10). The only success of the period were entering the World Trade Organisation (WTO) in 2008 and starting negotiations with the EU on the association agreement. The economic boom of 2000-07 did not create pressure for serious reform either. The macroeconomic situation improved: after 10 years (1990-99) of steep output decline and thanks to reforms that were partially completed at the beginning of the new millennium (especially privatisation of the larger part of the manufacturing industry), a rapid recovery started. This was also fuelled by the 2003-07 global boom (high prices of metals and agriculture commodities, Ukraine’s main exports) and an oil boom in Russia. The UAH exchange rate stabilised against the dollar, inflation diminished for a while, and the fiscal deficit and public debt to GDP ratio declined as result of rapid GDP growth. On the institutional front, the economic system could be considered largely a market system, but heavily distorted by pervasive corruption and nepotism, poor governance (which made implementation of market-related legislation and definition of the rules of the game a permanent problem) and state capture by oligarchic groups, similar to most other post-Soviet countries. The era of relative prosperity came to the abrupt end with the global financial crisis in 2008. The era of relative prosperity came to the abrupt end with the global financial crisis in 2008. Ukraine was particularly heavily hit, recording in 2009 a decline in GDP of 14.8 percent (Table 1), one of the steepest falls of all emerging-market economies. Despite a low public-debt-to-GDP level (12.3 percent of GDP in 2007), Ukraine was cut off from international markets because of a current account deficit (-7.1 percent of GDP in 2008), external debt exceeding 50 percent of gross national income, external debt service costs equal to 20 percent of export proceeds, and expectations of devaluation. Between September 2008 and January 2009, the UAH depreciated by almost 60 percent, from 4.85 to 7.70 UAH to the dollar, and then further down to 8 UAH to the dollar in 2009 (see Figure 1). Ukrainian authorities had to ask for the International Monetary Fund Stand-by Arrangement (SBA) in the second half of 2008.

    Legacy of the Yanukovych era

    After the victory of Viktor Yanukovych (who had been prime minister in 2002-04 and 2006-07) in the February 2010 presidential election, and the formation of the government of Mykola Azarov, a new reform effort was declared. Legislation was adopted related, among other issues, to social policy (a gradual increase in the retirement age of women from 55 to 60, lengthening the service period needed to obtain a minimum pension and, for various privileged groups, limiting the maxi-mum pension to 10 times the subsistence mini-mum), Ukraine’s WTO membership commitments, and preparing the legal ground for the forthcoming EU-Ukraine association agreement (including the Deep and Comprehensive Free Trade Agreement, DCFTA). However, corruption and predatory pressure from the narrow oligarchic elite around the president and his family led to a deterioration in the already poor business climate and further declining confidence in state institutions. The continuously deteriorating total investment rate, and the declining gross national savings rate (see Table 1) illustrate well the macroeconomic consequences of dysfunctional governance. Governance failings and authoritarian drift created fertile social ground for the wave of civil unrest that erupted as the Euro-Maidan protest movement in November 2013, after it became clear that the government would not sign the association agreement with the EU (see the next section). Another source of social disappointment was the deteriorating economic situation. After the 2008-09 crisis, Ukraine failed to return to its pre-crisis GDP level (Table 1). In 2010 and 2011, GDP grew by 4.1 and 5.2 percent, respectively (not enough to compensate for the 2009 output decline), followed by stagnation in 2012-13. Stagnation was a result of weak external demand (a consequence of the European debt and financial crisis), increasing domestic imbalances, a deteriorating business and investment climate and increasing Russian import restrictions – Russia wanted to discourage the government of Ukraine from signing the association agreement with the EU. The Azarov government’s populist policies, such as keeping domestic energy prices low and generous wage1 and pension increases, led to deteriorating fiscal and current account balances, a typical manifestation of the twin deficits. These policies also effectively derailed the two subsequent IMF SBAs (of 2008 and 2010), both backed by the EU’s Macro-Financial Assistance (MFA). As result, from summer 2013, Ukraine started to face the growing danger of the subsequent balance-of-payments crisis (the two previous balance-of-payments crises happened in 1998-99 and 2008-09).

    Relations with the EU

    In 1990s and early 2000s, the EU’s relationships with countries of the former Soviet Union other than the Baltic states were based on the bilateral Partnership and Cooperation Agreements (PCA) which included, in the economic sphere, the Most-Favoured Nation clause, and technical, legal and institutional cooperation in such sectors as transportation, energy, competition policy, and some legal approximation in the areas such as customs law, corporate law, banking law, intellectual property rights, technical standards and certification. Ukraine signed the PCA in June 1994 and the agreement entered into force on 1 March 1998. The next steps, after the start of the European Neighbourhood Policy in May 2004 and the Orange Revolution in Ukraine at the end of 2004, were the signing the of the EU-Ukraine Action Plan and the granting of market economy status to Ukraine (both in 2005). The action plan was updated and upgraded into the EU-Ukraine Association Agenda3 in 2009 and then, once again, updated in June 2013 with the focus on implementation of the forthcoming association agreement4. In March 2007, the EU and Ukraine started negotiations on a new enhanced agreement to replace the PCA. At the Paris EU-Ukraine Summit in September 2008, the negotiated agreement was upgraded to the association agreement and included the DCFTA as an integral part. The negotiation was concluded in December 2011, and the text of the association agreement was initialled on 30 March 2012 and signed on 27 June 2014 after a series of dramatic political events in 2013 and first half of 2014. These included the failure of Yanukovych’s administration to meet the political preconditions for signing the association agreement stipulated by the EU (related to fair elections, judicial reform and so-called selective justice against opposition leaders5), the subsequent last-minute refusal to sign the association agreement during the Third Eastern Partnership Summit in Vilnius on 28-29 November 2013, the resulting Euro-Maidan mass protests in Kyiv and regime change (November 2013 – February 2014), Russian annexation of Crimea and war in eastern Ukraine (since March 2014). The association agreement, in particular, its DCFTA component, will offer Ukrainian companies partial access to the European single market. At the same time, it might stimulate regulatory and institutional reforms in trade and investment-related spheres, and ease the business climate for domestic and foreign firms. It can also help to bring the country’s legal system, public administration and infrastructure services closer to EU standards (the acquis), depending on the political will and determination to reform on the Ukrainian side.

    Economic challenges posed by the current crisis

    The combination of recent dramatic political developments and the deteriorating economic situation has made the current crisis particularly serious and severe. Ukraine faces an existential threat to its independence and territorial integrity caused by Russia’s aggressive policy, and must also overcome the adverse consequences of its past failures in economic and institutional reform to secure its survival and rebuild domestic and international confidence. As result of the violent conflict in eastern Ukraine and the related political uncertainty, real GDP will decline in 2014. According to the IMF estimate built into the SBA assumptions, the decline could reach 5 percent; according to the European Bank for Reconstruction and Development May 2014 forecast it could even reach 7 percent. Decline in GDP and political turmoil, including war in the east, have undermined seriously the revenue flow to Ukraine’s budget and have created additional expenditure needs, especially in the area of national defence and security, humanitarian assistance and infrastructure repair. The same IMF estimates of April 2014 predicted an increase in the general government deficit to 5.2 percent of GDP in 2014 from 4.8 percent in 2013, despite the recommended fiscal adjustment. If the quasifiscal deficit of Naftogaz (the state-owned monopoly in charge of natural gas imports and distribution) is added, the combined deficit will increase from 6.7 percent of GDP in 2013 to 8.5 percent of GDP in 2014. Generally, the IMF projections are based on optimistic assumptions. They might underestimate the downside risks in the national security sphere, potential further disruption to trade relations with Russia and bank recapitalisation needs. In the first half of 2014, the hryvna depreciated from 8 UAH to more than 11.5 UAH to the dollar, i.e. more than 45 percent. In the face of a looming balance-of-payments crisis, such an adjustment was both unavoidable and necessary to improve trade and current account balances. However, it has also put an additional burden on the balance sheets of unhedged banks, companies (including Naftogaz) and households. The ratio of non-performing loans (NPL) to total loans in the banking sector amounted to 23.5 percent at the end of 2013, i.e. before the UAH depreciation. Overcoming these negative tendencies requires not only political stabilisation but also far-reaching fiscal adjustment and structural and institutional reforms to help eliminate macroeconomic disequilibria and unlock Ukraine’s long-term growth potential, as we detail in the next section.

    International aid package

    The international community supported the new Ukrainian authorities with a generous financial aid package. At the core of this package is the 24-month $17.1 billion IMF SBA, i.e. 800 percent of Ukraine’s quota in the Fund6, provided under so-called exceptional access7. The first tranche, which was disbursed immediately after the SBA’s approval (on 30 April 2014), amounted to about $3.2 billion, of which $2 billion could be used as budget deficit financing. In April 2014, the IMF SBA was backed by an EU MFA loan of €1 billion available in two instalments and the EU’s grant of €355 million (also in two instalments) under the State Building Contract. Recently, the World Bank approved two loans to Ukraine – the District Heating Energy Efficiency Project of $382 million and the Social Safety Nets Modernisation Project of $300 million. The US Government provided loan guarantees amounting to $1 billion. Investment loans can be provided by the European Bank for Reconstruction and Development and the European Investment Bank.

    Weak conditionality

    Even the most generous international aid package can provide only temporary respite to Ukraine’s balance of payments. To ensure the sustaining effect, aid must be supplemented by a domestic adjustment and reform package which aims at removing the roots of domestic and external imbalances. This is why the conditionality attached to financial aid should require reform of policies and institutions. However, such conditions are not obvious in the content of the IMF SBA and EU assistance. The IMF SBA said the following reforms should be implemented:
    • Changes to the monetary policy regime, i.e. replacing the de-facto fixed but adjustable peg of the UAH to the dollar by a flexible exchange rate and inflation targeting, with the targeting of monetary aggregates as the intermediate solution in 2014;
    • Financial sector stability, i.e. in-depth diagnosis of Ukrainian banks and their recapitalisation needs (if necessary), and bringing banking regulations into line with best international practices;
    • Gradual reduction of the structural fiscal deficit;
    • Modernisation and restructuring of the energy sector, gradual adjustment of end-user energy prices accompanied by development of the respective social safety net;
    • Structural and governance reforms, improving the business climate.
    At first glance, this looks like a comprehensive approach that aims to address key challenges faced by the economy of Ukraine. However, detailed proposals raise some doubts. In fact, structural and governance reforms which are essential for improving the business climate and investors’ confidence have not been detailed in the SBA at all. There are no structural bench-marks – they are to be the subject of a separate diagnostic study. The memoranda signed between the Government of Ukraine and the European Commission on the occasion of both the MFA and the State Building Contract are a bit more concrete in this respect. They set out some detailed conditions on fighting corruption, avoiding conflicts of interest for public servants, government transparency, changes in public procurement legislation and practices, public access to information, civil service reform, constitutional reform, election law and financing for political parties. However, very important areas such as deregulation of business activity, simplifying public administration structures and procedures, reform of the judiciary and law enforcement agencies and decentralisation (building genuine local and regional self-government) are virtually absent. As we have noted, exchange-rate adjustment was crucial in avoiding a full-scale and uncontrolled currency crisis earlier this year. Similarly, attempts to make the exchange rate more flexible, together with the abandoning of existing restrictions on current account convertibility, should be welcomed. However, moving to inflation targeting in a one-year period does not look feasible, especially in a time of political and security turmoil and continuous fiscal pressure on monetary policy, and considering the limited legal and actual independence of the National Bank of Ukraine. In order to create room for more independent monetary policy and an inflation-targeting regime, serious fiscal adjustment is needed, but on this the IMF programme looks rather weak and unconvincing. The fiscal adjustment target of 2 percent-age points of GDP annually plus another 1 percentage point of GDP of quasi-fiscal adjustment by Naftogaz cannot prevent further rapid increases in Ukraine’s fiscal deficit and public debt. According to the SBA targets, the general government deficit will stay at the level of 4.2 per-cent of GDP (without Naftogaz) and 6.1 percent of GDP (including Naftogaz) in 2015. Furthermore, several risks have been evidently underestimated in this projection, as we have noted. As result of lax fiscal policy, the public debt-to-GDP ratio will jump from 40.9 percent in 2013 to 56.5 percent in 2014 and further up to 62.1 percent in 2015. Then it will reduce slowly to 51.9 percent in 2018, under the assumption that the economy will grow by at least 4 percent annually from 2016. So far, the government of Ukraine faced problems accessing private financial markets even at a much lower level of public debt. Similar public-debt funding constraints have been experienced by other post-Soviet and developing countries with similar characteristics to Ukraine. In practical terms, this means that despite the IMF programme, Ukraine will remain cut off from private debt markets for several years, and will be totally dependent on official financial aid. Furthermore, without bolder fiscal adjustment there is no chance to increase substantially the very low rate of gross national savings (6 percent of GDP in 2013), because most private savings are absorbed by the public sector borrowing requirements, or to improve the current account balance. In turn, this will mean continuous balance-of-payments vulnerability and a limited pool of resources to finance investment. Some of the proposed fiscal adjustment measures go in the right direction, such as abandoning the previous populist decision to replace the 20 per-cent VAT rate with two much lower rates. However, the fiscal effects of some one-off steps, for example, fighting tax fraud, might be overestimated. Wage and hiring freezes in the public sector might complicate the badly-needed reform of the civil service and public services such as education and healthcare. The Ukrainian public sector suffers from an excessive number of employees, who are poorly paid and managed. In such a situation, targeting the public-sector wage bill would be a better strategy to create both financial room and incentives for deep restructuring of both public administration and major public-service sectors. In two areas of fiscal adjustment, the SBA looks particularly disappointing: elimination of energy subsidies and social welfare reform.

    Energy subsidies

    According to the IMF estimate8 post-tax energy subsidies in Ukraine amounted to 7.6 percent of GDP in 2012. They are much higher than in other countries of central and Eastern Europe and the former Soviet Union, apart from Turkmenistan, Uzbekistan and Kyrgyzstan. Most subsidies have the quasi-fiscal form (periodical recapitalisation of Naftogaz) and are aimed to support low house-hold tariffs for natural gas and district-heating services (which use natural gas as an input). The price paid by Ukrainian households for natural gas covers only about 20 percent of the cost-recovery level, and is ten times or more lower than the price paid by Lithuanian and Estonian households. Low domestic energy prices are not only responsible for high fiscal and quasi-fiscal deficits and the deteriorating current account balance. They do not help to reduce excessive energy consumption and increase energy efficiency, which in Ukraine is among the lowest in the world and has hardly improved since 1990 (Table 2). Furthermore, low energy prices do not create incentives to increase domestic energy production and invest in energy-saving technologies. They do not allow the elimination of one of the most obvious sources of corruption – trading in, and distribution of, subsidised energy imports – and they prevent the reorientation of the energy sector towards a competitive market environment. As long as Naftogaz is obliged to deliver gas at price below the cost-recovery level, its reorganisation, de-concentration and privatisation will not be possible. Low energy prices are also counterproductive for reducing Ukraine’s energy dependence on Russia. In this context, the discussion on economic sanctions against Russia has limited merit as long as the international community is ready to support financially Ukraine’s overconsumption of Russian gas. Unfortunately, despite a correct diagnosis, the IMF SBA sets only a very gradual price adjustment schedule with the aim of eliminating Naftogaz’s deficit only by 2018. The first round of tariff increases, for gas by 56 percent (from May 2014) and for district heating by 40 percent (from July 2014) looks drastic, but only if one disregards their very low initial level. In fact, the 2014 increase only compensates for the effect of UAH depreciation earlier this year. The next planned rounds of tariffs increases (by 40 percent in 2015 and by 20 percent in 2016 and 2017) might bring them closer to the cost-recovery level, but only if the UAH exchange rate and other cost components remain unchanged. And there is no certainty that the tariffs will reach the cost-recovery level even in 2017.

    Oversized and inefficient welfare state

    The general government total expenditure in Ukraine is close to the level of 50 percent of GDP, one of the highest in Europe and among emerging-market economies. In 2014, it might even exceed 50 percent of GDP. The biggest expenditure item is various social benefits (23.1 percent in 2013), of which public pensions account for 17.2 percent of GDP, again one of the highest shares in Europe and the world. The limited pension reform of 2011 (discussed previously) has stopped the growth in pension expenditure, but is unable to ensure system sustainability over the long term in the context of one of the least favourable demographic trends in Europe. The retirement age, both statutory and effective, remains low by international standards and taking into consideration the rapid ageing of Ukrainian society. Numerous group privileges and special pension schemes offer opportunities for earlier retirement and generous benefits. As result, 13.6 million pensioners account for about one third of the Ukrainian population. This implies dependency ratio of 1 or higher. Both the public components of benefits to better-off groups instead of lower-income groups. According to the World Bank’s Atlas of Social Protection, only 13.4 percent of total social-protection and labour-programme benefits went to the poorest 20 percent of the Ukrainian population in 2006.

    What should be done?

    Our analysis suggests there is an urgent necessity for the new Ukrainian authorities with the help and support of international community to elaborate a complex programme of far-going economic and institutional reforms. These should include both short-term measures of fiscal and macro-economic adjustment (much bolder than currently planned) and medium- to long-term structural and institutional changes. These are closely interlinked. For example, without removing energy subsidies, fiscal and balance-of-payments adjustment looks unrealistic and deeper reform of the energy sector (especially Naftogaz) cannot start, leaving serious distortions and sources of rents and corruption intact. Public pensions are a similar case: without increase in both the statutory and actual retirement age, the fiscal cost of the pension system will further expand, and labour market distortions and widespread informal employment will not be reduced. Fiscal adjustment must play a central role in short-term policies, i.e. in 2014-15 because of deep dis-equilibria and sovereign insolvency risk. The concern that a too-radical fiscal adjustment can hurt growth prospects through the demand channel might not be justified in the Ukrainian economy in which eliminating distortions (for example, in the energy sector) and uncertainties (related to macroeconomic imbalances), and returning business confidence, can boost both investment and consumption. Long-term growth will be impossible without increasing the national savings rate, which requires, in first instance, the elimination of fiscal imbalances. Discussion on the speed of reform must take into account both politics and economics. Obviously, fiscal adjustment which is crucial for rebuilding macroeconomic equilibrium and business confidence, will include politically unpopular measures, especially in relation to energy prices and the pension system. There will be social costs and various special interests will be threatened. How-ever, the unfavourable social consequences for the poor can be mitigated by well-targeted social safety nets. In turn, overcoming the resistance of special interest groups requires political mobilisation around the reform programme. A time of geopolitical confrontation with a powerful neighbour might be considered to be an unlikely opportunity for difficult economic and political reform. However, Ukraine does not have any more time to waste. It must quickly rebuild confidence in its state institutions and economy. Perhaps the current patriotic mobilisation of Ukrainian society in the face of a threat to the country’s independence and after political change can create sufficient window of opportunity for difficult reforms. Past experience tends to illustrate that such a window of opportunity is usually short-lived. Revolutionary mobilisation does not last long. People who do not see visible positive changes become disappointed, and enthusiasm is replaced by apathy and impatience. This opens door to populism and authoritarianism as experienced by Ukraine itself after the failure of the Orange revolution, or recently in Egypt. Easing social pain over longer period does not necessarily make life easier compared to a more radical and upfront reform package. The resignation of Prime Minister Arseniy Yatsenyuk’s government on 24 July 2014 with the objective of facilitating early parliamentary election in October 2014 might help build a stable pro-reform majority. However, it also means a further delay in implementation of reforms, and additional instability and uncertainty, which will accompany the forthcoming election campaign in the environment of the unresolved conflict in the east. For international donors, the best strategy is to offer a substantial aid package to Ukraine (which has partly happened) but with more stringent conditions on reform compared to the current pack-age, and immediate technical assistance. This means upgrading the existing aid package built around the IMF SBA, EU and World Bank programmes to ensure faster macroeconomic adjustment in short-term and deeper institutional and structural reform in the medium-to long-term, backed by more international resources.]]>
    Fri, 01 Aug 2014 00:00:00 +0100
    <![CDATA[Asset-backed securities: The key to unlocking Europe's credit markets?]]> http://www.bruegel.org “a market for prudently designed ABS has the potential to improve the efficiency of resource allocation in the economy and to allow for better risk sharing... by transforming relatively illiquid assets into more liquid securities. These can then be sold to investors thereby allowing originators to obtain funding and, potentially, transfer part of the underlying risk, while investors in such securities can diversify their portfolios... . This can lead to lower costs of capital, higher economic growth and a broader distribution of risk” (ECB and Bank of England, 2014a). In addition, consideration has started to be given to the extent to which ABS products could become the target of explicit monetary policy operations, a line of action proposed by Claeys et al (2014). The ECB has officially announced the start of preparatory work related to possible outright purchases of selected ABS1. In this paper we discuss how a revamped market for corporate loans securitised via ABS products, and how use of ABS as a monetary policy instrument, can indeed play a role in revitalising Europe’s credit market. However, before using this instrument a number of issues should be addressed: First, the European ABS market has significantly contracted since the crisis. Hence it needs to be revamped through appropriate regulation if securitisation is to play a role in improving the efficiency of resource allocation in the economy. Second, even assuming that this market can expand again, the European ABS market is heterogeneous: lending criteria are different in different countries and banking institutions and the rating methodologies to assess the quality of the borrowers have to take these differences into account. One further element of differentiation is default law, which is specific to national jurisdictions in the euro area. Therefore, the pool of loans will not only be different in terms of the macro risks related to each country of origination (which is a ‘positive’ idiosyncratic risk, because it enables a portfolio manager to differentiate), but also in terms of the normative side, in case of default. The latter introduces uncertainties and inefficiencies in the ABS market that could create arbitrage opportunities. It is also unclear to what extent a direct purchase of these securities by the ECB might have an impact on the credit market. This will depend on, for example, the type of securities targeted in terms of the underlying assets that would be considered as eligible for inclusion (such as loans to small and medium-sized companies, car loans, leases, residential and commercial mortgages). The timing of a possible move by the ECB is also an issue; immediate action would take place in the context of relatively limited market volumes, while if the ECB waits, it might have access to a larger market, provided steps are taken in the next few months to revamp the market. We start by discussing the first of these issues – the size of the EU ABS market. We estimate how much this market could be worth if some specific measures are implemented. We then discuss the different options available to the ECB should they decide to intervene in the EU ABS market. We include a preliminary list of regulatory steps that could be taken to homogenise asset-backed securities in the euro area. We conclude with our recommended course of action.

    The European ABS market: evolution and current size

    The ABS market peaked in Europe before the crisis, with a total of $1.2 trillion in new ABS issuance in 2008. By 2013, total new issuance was only $239 billion (Figure 1). Demand for these assets plummeted after 2008 because of the deterioration in the rating of the collateral behind the various types of ABS, leading to a major market price correction of ABS products. Figure 1: New issuance in the EU ABS market, 1999-2013 (2014Q2) Source: SIFMA (July 2014). Moreover, the freeze in European inter-bank lending reduced demand for these assets as collateral for repurchase (repo) agreements (in other words, agreement to sell an asset and buy it back at a later date). In particular, after the start of the financial crisis in 2007-08, the ECB progressively tightened the rating and structural requirements for ABS it would accept as repo collateral, with the result that using ABS as repo collateral became expensive, in particular compared to covered bonds. Hence, after 2008, the amount of eligible ABS declined by 38 percent while covered bonds increased by 14 percent, until in mid-2012 covered bonds overtook ABS as delivered repo collateral for the first time since 2007. A final blow to the ABS market during the crisis came from the insurance sector. Insurance funds, traditionally large buyers of ABS products, were also negatively impacted by the introduction of more restrictive regulation in response to the crisis, and consequently limited their ABS purchases. Country-by-country, the smallest players in the market (eg Belgium and Ireland) saw a decrease in new issuance of more than 95 percent from the peak, while, among the main issuers, new issuance in Italy, the Netherlands and Spain dropped by about 73 percent. In Germany, the decline was 80 percent. It is interesting to look at the United Kingdom: here, new issuance represented almost a third of total European issuance on average until 2008, but after the peak, UK flows dropped by 90 percent, with new issuance in 2013 representing less than 20 percent of the European total. Considering this change in the UK’s role in the structured product market, new issuance in the euro area rose to 73 percent of total European new issuance in 2013, from 63 percent in 2008. However, in volume terms, euro-area issuance was slashed from $766 billion to $175 billion. Interestingly, the collateral behind the ABS products also varied during the crisis, with the collapse in the issuance of Real Mortgage Backed Securities (RMBS) and European Collateralised Debt Obligations (CDOs), with issuance of both dropping by 90 percent between 2008 and 2013 (Figure 2). The composition of overall issuance thus changed, with a (relative) increase in ABS with consumer credit as collateral, and a marginal increase in ABS backed by loans to small and medium-sized enterprises. Figure 2: Breakdown of ABS issuance per type of collateral, various years Source: SIFMA (July 2014). Another indication of the reduction in the liquidity of this product is the amount of new issuance placed on the market relative to ABS retained by originators, such as banks that package securitised products (Figure 3). Before the crisis, almost 70 percent of new issuance was placed on the market, and the remainder retained by originators. After 2008, the share of new issuance placed on the market dropped to below 10 percent, signalling virtual market refusal of these securities. More recent figures point to a market placement rate of about 40 percent, though at much lower overall volumes. Figure 3: Retention rate of ABS products, various years and type of collateral Source: SIFMA (July 2014). However, originator retention rates vary by type of instrument. Despite the dramatic reduction in issuance of CDO and Commercial Mortgage Backed Securities (CMBS), currently around 90 percent of their new issuance is placed on the market, probably because of demand from specialised investors, who could no longer find these securities on the market. By contrast, there is weaker market demand for RMBS, generic ABS (car loans, leases, etc) and SME ABS. In particular, almost all new SME ABS are retained on banks’ balance sheets, with only 10 percent placed on the market.

    What is the potential for an increase in the size of the ABS market?

    The outstanding amount of European securitisation, at the end of 2013, was approximately €1 trillion, of which roughly half was placed on the market (Table 1 on the next page). For comparison, at its peak in 2008, the overall outstanding amount of the ABS market reached more than €2.2 trillion. About 60 percent of the market (€637 billion) is made up of mortgage-backed securities (residential and commercial), followed by standard ABS (car loans, leases, etc) with a volume of €150 billion, and SME ABS for €102 billion. CDOs stood at €113 billion. Table 1: Total outstanding amount of EU securitised products Source: SIFMA data Q1-2014. The quality of these securities varies in terms of collateral type, with about 77 percent of the amount outstanding rated above BBB, and therefore eligible for collateral transactions with the ECB3 (Figure 4). The highest presence of high-rated securities is in France and Germany, while Italian and Spanish ABS are more concentrated in the ‘single A’ category, in line with the evolution of the sovereign ratings in these countries. In terms of collateral type, SME ABS are the lowest quality, probably due to the heterogeneity of the collateral and the deterioration of companies’ balance sheets during the crisis. Moreover, in the case of SMEs the quality of financial information reported in balance sheets is in general less regular and accurate, an issue that also impacts negatively on the rating, because it implies a more negative assessment of the probability that loans will be repaid. From 30 to 40 percent of SME ABS are currently estimated to be sub-investment grade or not rated. Italy and Spain are also the countries with the main outstanding volumes of SME ABS. Figure 4: Rating of ABS products per type of collateral and country, 2013 Source: SIFMA Given these figures, what potential for growth does the ABS market have overall, on the basis that potential ECB purchases could create sufficient demand to revitalise the market? Looking at the markets for collateral, data from monetary financial institutions shows (Figure 5) that the outstanding amount of mortgages for house purchases (thus secured lending) stabilised at about €3.8 trillion in 2013 in the euro area, while the outstanding amount of bank loans to non-financial corporations (NFC) in the euro area reached about €4.2 trillion. Figure 5 also compares the trend in the mortgage market to that in the RMBS market (left panel), and NFC loans to SME ABS (right panel).
    In both cases, there has been an evident fall in volumes of both types of securitised product, with SME ABS performing relatively worse. The reason is the contraction of credit demand coupled with bank deleveraging, leading to a contraction of NFC loans, compared to relative stability in the volume of mortgage loans outstanding. Hence, collateral for SME ABS operations has been squeezed relatively more compared to RMBS. Moreover, one has to consider the negative regulatory impact on capital requirements associated with the issuance of this type of product. The question is, then, how much of these outstanding volumes of loans to NFCs or mortgage loans worth €8 trillion could be translated into new issuance of RMBS and SME ABS. In line with Batchvarov (2014), we make estimates on the basis of mortgage loans to households and loans to non-financial corporations, for the countries that represent 80 percent of the total portfolio of outstanding loans in the euro area (Germany, France, Italy, Spain, Ireland and Portugal). The share of SME loans in total NFC loans, as estimated by the OECD (2013), varies between these countries. Applying these shares to the euro area, the implied euro-area SME ABS share is approximately 25 percent of total outstanding NFC loans. On the basis of the conservative assumption that only 50 percent of the €8 trillion of existing loans is ultimately eligible for securitisation (eg for reasons of maturity or loan characteristics), we then introduce a different haircut so that the securitised products attain an investment grade rating (to be eligible as a collateral for the ECB). Unlike the standard assumption of a homogeneous 10 percent haircut for subordination for all categories of assets (Batchvarov, 2014), we apply a more prudential and differentiated haircut for the three main categories of assets selected, as retrieved from updated statistics for these securities (SIFMA): 35 percent for SMEs loans, 30 percent for ABS backed by loans to large corporations, and 15 percent for mortgages. Based on this, we estimate a maximum amount of securitisation of roughly €3 trillion (compared to €4 trillion estimated by Batchvarov, 2014), broken down as shown by Figure 6 on the next page. It should be noted that SME ABS would represent the smallest fraction (about 10 percent) of this market. Figure 6: Estimates of potential ABS market for the euro area (€ billions) Source: Bruegel. Table 2 on the next page shows that the estimated breakdown of the potential overall ABS market by country will vary according to the size and composition of each country’s underlying market for collateral5: Germany, France and Italy would each represent almost 20 percent of the total NFC-loan ABS, while in terms of SME ABS, Spain would count for a fifth of the whole amount, with Germany and France accounting for about 17 percent each. The role of Germany is also significant in the RMBS market, representing about 26 percent of the outstanding amount, followed by France, Spain and Italy. Table 2: Potential availability of ABS per country (%), est. Source: Bruegel estimates based on MFI data (March 2014) and OECD

    The revival of the ABS market: the options

    Our estimates show that the euro-area securitisation market has the potential to build significant volume and to be sufficiently liquid for use in possible non-conventional monetary operations. However, a number of trade-offs must be considered relating to the timing of ABS market measures, and the underlying size of the market at that moment: the earlier that measures are taken, the more restricted will be the type of ABS product that can be targeted for direct purchase (eg SME ABS only), reducing the impact of potential ECB operations on credit markets. These trade-offs arise because the current securitised products on the market differ in terms of underlying characteristics, ie collateral type and thus rating, borrowers’ quality and geographic distribution, loans’ residual maturity, frequency of repayment, cost of credit, type and amount of interest (fixed or variable), prepayment rates and possible credit enhancements built into the structure6. Because of these heterogeneous characteristics, only a fraction of existing ABS products are ‘ready to use’, if ever, by the ECB. Moreover, within the existing range of products, there are different implications of the ECB targeting for direct purchase only SME ABS rather than RMBS. Undertaking specific regulatory steps aimed at standardising the characteristics of securitised products in different countries might allow the full activation of the estimated €3 trillion in potential ABS market volume, but reaching such a figure would require time for implementation. In the following sections we detail the ECB’s options.

    Option 1: Act small and fast

    Option 1 would involve the direct purchase of very simple (‘plain vanilla’) existing ABS products with corporate credit exposure7. By pursuing this option, the ECB could act immediately, but would have a limited direct impact on credit markets. Existing ABS products limited to SMEs loans amount to €102 billion (Table 1). If the lease component of generic ABS is included, one could add a further €15 billion8. With respect to these figures, the volume of securitised products available for immediate use with a rating above investment grade is 60 percent of SMEs ABS and 50 percent of the lease components. As a result, with these constraints, the maximum theoretical size of the ABS market for immediate ECB intervention is about €68 billion. This is probably not enough to generate a direct impact on credit conditions in the euro area. This does not imply, however, that there is no role for an ABS market backed only by corporate credit exposure, even in its current form. In the wake of the crisis, origination of ABS products has been subject to the introduction of stricter regulations on capital requirements for insurance companies, and on risk-weighted assets for banks (see Annex 1 for a summary of ABS capital requirements/risk weights)9. Within the current set of rules, therefore, any type of non-conventional monetary policy under which ABS assets are purchased will ultimately free up capital in banks’ balance sheets. This is particularly true for SME ABS, since their average rating is low and therefore the capital absorption for senior tranches below AAA is huge and greater than capital absorbed by the loans themselves. Consequently, ECB intervention in the ABS market, even if potentially limited in size, could magnify the effects on credit origination of the ECB's targeted longer-term refinancing operation (TLTRO), announced in June 2014, although the exact additional magnitude of these effects is hard to predict. Option 1 could thus be a way of solving the trade-off for the ECB: intervening immediately in the relatively small (at its current volume) ‘plain vanilla’ ABS market, but limiting the scope of the operation to an ‘indirect’ vehicle through which the effects of the TLTRO could be magnified.

    Option 2: Act large and slow

    Option 2 essentially implies reviving, deepening and integrating the euro-area ABS market so it can be used as a new tool for non-conventional monetary policy. The ECB and the Bank of England (2014b) point at improving the regulatory environment for ABS products to better differentiate the necessary prudential requirements for relatively simple, robust and transparent ABS products (eg consumer finance ABS, RMBS and SME ABS) from more complex and potentially illiquid instruments. By revamping this market, these instruments could be used effectively as a ‘direct’ vehicle through which non-conventional monetary operations could be run. Clearly, the trade-off here is that developing the latter would require a number of changes to underlying regulation, and would thus take time. To achieve a high-quality, simple and transparent European ABS product, two areas of regulatory change should be developed: one on collateral rules, for the corporate loan market in particular; the other on ABS product characteristics, ie the format to be applied to various types of ABS10.

    Collateral rules

    Regarding the rules on collateral, two issues should be addressed:
    1 More selective regulation on capital requirements
    ABS are a tool that could provide more flexibility to financial institutions to achieve better capital ratios throughout the system, and to reduce leverage ratios, since securitisation, when sold by originators, would enable reductions in risk weighting. Changes in ABS risk weighting could lead to high-quality, simple and prudently-structured securitisation products receiving more consistent regulatory treatment across financial legislation11. In particular, regulators could work to reduce the discrepancy between regulatory treatment of ABS and collateral12. During 2013, progress was made on financial regulation, but further steps are necessary as part of the implementation of the Capital Requirements Directive IV to clarify whether and to what extent ‘European’ ABS would count as regulatory liquidity, the future risk weights they will have for securitisation in the banking and trading books and the extent to which their rating would be correlated with the sovereign credit rating of the originating country13. As far as insurance regulation is concerned, in relation to the Solvency II directive (which is to enter into force in 2016), the European Insurance and Occupational Pension Authority (EIOPA) is also examining regulatory capital requirements for insurers’ ABS investments, in order to reduce capital requirements for insurance companies.
    2 More transparent and available information on collateral
    In order to stimulate further the market for ABS, especially for SME loans, common guidelines on a minimum level of information to be reported in SME balance sheets should be agreed, in line with the ECB eligibility requirement that loan-level data should be publicly available. Balance sheets thus produced should be made available to originators, in order to increase transparency and comparability of collateral. At the same time, rules on standardised rating methodologies for securitised products should be enforced within the Single Supervisory Mechanism. The homogenisation of company reporting, to also encompass non-listed companies, will enable analysis of the performance of individual companies in European countries, and will facilitate access to credit at the same cost for companies within the same sector in different countries. In addition, steps towards the coordination of default laws in different countries should also be undertaken, to reduce uncertainty for bondholders in case of defaults.

    ABS product characteristics

    Two issues also need to be addressed in terms of the format of securities:
    1 Common guidelines on ABS structure
    The risks of ABS are embedded not only in the type of underlying collateral that is securitised, but also in the way collateral is sliced and packaged (see Box 1 for an overview of the basic elements constituting an ABS product). A common structure for each type of collateral would ease the origination process and imply that the spread between different bonds in each rating category would depend only on differences between collateral characteristics (such as geographical distribution, maturity or the legal framework applying to default). Common structure could tremendously boost market liquidity. Also, the cost of creating the instruments should decrease, as pan-European banks will be able to leverage the size of their loan pool across European markets. With a common structure, the rating framework should become more homogeneous as well, cutting the cost of providing ratings and making the European ABS market much more similar to the US market. Ratings will become more closely related to collateral characteristics and less to the sovereign rating of the originator, and monitoring by rating agencies during the life of the product will focus more on collateral evolution. A straightforward way of achieving this result would be to build on the idea, already hinted at by the ECB, that only an ABS format with a ‘plain vanilla’ structure would be eligible for purchase by the ECB.
    2 Common guidelines on the setup of SPVs within national borders
    Another key factor in the underlying heterogeneity of the securitisation process is also related to the different role that the ‘Special Purpose Vehicle’ (SPV) might acquire (see Box 1). The SPV is a unique entity the role of which is the acquisition of an identified pool of assets. The SPV is the holder of the collateral within the securitisation. The owner of the SPV, whether it is the originator or a pool of originators, bears the risk of the SPV. A possible guideline is that an originator could establish only one SPV for all the transactions of the same type to be issued, instead of one SPV for each transaction. In the case of a single SPV for all transactions, since the vehicle is immediately available, transaction costs will diminish and the process of securitisation will speed up. In cases in which a group of originators considers creating a common SPV for the ABS market (whether or not specialised by type of collateral) the risk will be borne by the owners of the SPV. A Banque de France initiative to re-start the securitised SME loan market has worked along these lines. The creation of a joint SPV within national borders allows for sharing of set-up and operating costs. Standardised legal documentation used by the originators will also reduce costs and operational frictions, and make the SPV a very efficient credit claims mobilisation tool. Whether such a set-up is legally compatible with each country's legal framework, and whether such a choice could be more efficient from the market point of view, are however open questions. The answer in part would depend on the risk weighting assigned to the shareholders of the SPV. Another reason for the creation of a joint SPV is that, once a common ABS structure with the same collateral type is defined ex ante, there will be less flexibility or creativity in the structuring phase, so that certain type of collateral, if available in volumes that are insufficient to respond to the structuring requirements (such as over- collateralisation criteria), could not be used. While in the past the lack of assets to create credit enhancement in the form of over-collateralisation was compensated for by other forms of internal or external credit enhancement, the absence of this choice in the new system could place a limit on the participation of small and medium players in the ABS market, because of lack of collateral. The problem could however be circumvented through the creation of an SPV at national level, or jointly created by small originators. This would stimulate more consolidation of the banking sector within countries. In summary for option 2, we can conclude that, under the Single Supervisory Mechanism headed by the ECB, there is ample room to refine all the existing regulation, as we have discussed, in order to create a large pan-European market for simple, robust and transparent ABS products. However, it is also clear that, because of the time it will take to implement the necessary regulatory changes, these developments might only be relevant for the next business cycle, unless this process is accelerated.

    Option 3: Act bold

    If direct outright purchases in the ABS market are really meant to significantly enhance the functioning of the monetary policy transmission mechanism within the next few months (ie working immediately, and not just as potential amplifiers of the TLTRO), there is a third alternative to the fast/small versus slow/large options we have analysed. A further option, already suggested by Claeys et al (2014), is the direct purchase of RMBS. An RMBS purchase programme would have a much greater impact on the economy, given the size of the market already at current volumes, ie €601 billion (Table 1), which becomes some €500 billion of targetable products once the minimum rating eligibility criteria are applied15 . On top of the size of the market, the argument for RMBS purchases also stems from the potential limited impact that the purchase of SME ABS (option 1) might have in terms of the ECB objective of combating the risk of deflation within the cycle. Even assuming that new loans stimulated by the TLTRO and SME ABS purchases ultimately foster the transfer of central bank liquidity directly to the productive sector of the economy, thus restarting credit markets in the euro-area periphery, part of this additional liquidity might have a muted effect on demand. This could happen because companies face a restructuring phase to increase productivity. Therefore, the additional liquidity companies will receive might be used partly for capital expenditure, helped by low rates, and partly for consolidation within sectors, both within or between countries, with a muted effect on employment. In other words, intervention aimed at increasing the flow of credit to the economy (TLTRO and direct purchase of SME ABS) might have positive effects on demand, and thus consumer prices, only later in the cycle, ie they might not be immediately successful in countering deflation. Nevertheless, considering that in Europe a relatively low share of households’ wealth is invested in the stock exchange, but a relatively high share is invested in the housing sector, intervening with outright purchases in an ABS market in which RMBS are also considered might have a larger, more immediate effect in revitalising the demand side of the economy, and therefore putting a floor on the trend of declining inflation within the euro area. In this sense, RMBS purchases would not only act as a mechanism to unlock credit markets in the euro area, but would rather be closer to a form of quantitative easing. In fact, the improvement in banks’ balance sheets would be marginal (given the lower capital absorption of these instruments), while clearly a careful assessment should be made of the need to minimise the impact of RMBS purchases on house prices (and the ensuing wealth effects for households) in the euro area, in order to avoid new bubbles, or to stop the correction of existing ones. While the monitoring exercise now routinely carried out as part of the Excessive Imbalance Procedure can be deployed to avoid such a risk, the fiscal implications of these actions should nevertheless be carefully assessed.

    Conclusions

    Our evidence shows how direct ECB intervention could turn ABS products into one of the mechanisms that could unlock credit markets in the euro area. A number of trade-offs arise in terms of the speed and efficacy of the actions that the ECB could take. Acting immediately on existing ABS products (SMEs and corporate-backed eligible ABS) is likely to produce little direct effect, given the small relative size of the targetable market, estimated at some €68 billion. However, an indirect and not necessarily insignificant effect can arise through this action, through the freeing up of capital on banks’ balance sheets, and thus the possibility to exploit on a larger scale (as more loans can be granted with the same amount of capital) the opportunities available through the new TLTRO programme. Working on the improvement of the regulatory environment for ABS products might revamp a market that can be conservatively estimated at some €3 trillion for the euro area (€1.6 trillion in RMBS and €1.4 trillion in corporate-backed ABS, of which about €300 billion in SMEs ABS), but these actions require time for implementation. Finally, resorting to the purchase of existing RMBS can achieve the target of an intervention that is both immediate and sizeable in terms of targetable instruments (we estimate a volume of about €500 billion). The characteristics of euro-area credit markets especially favour this option if, notwithstanding a revamped flow of credit to the economy, deflation risks remain critical over the next few months. However this option is closer to a form of quantitative easing and has implications for fiscal policy, and thus should be considered with care. On the basis of the above, we recommend parallel actions to be taken by the European institutions at the same time. In particular:
    • From a regulatory point of view, the resolution of the ongoing uncertainty about the selective treatment of ABS products in terms of capital requirements in the context of the implementation of the Basel III agreements for banks and insurance companies, should take priority over other pending issues;The European Commission and the ECB should start work on a common set of guidelines on data availability and reporting for collateral (loans), and on the definition of a simple and transparent ‘European’ ABS format (structure/set-up of the SPV);
    • In the near future, the ECB should start a programme of direct purchases of SME ABS (our option 1), while monitoring the indirect effects this might have on the TLTRO. If deflationary risks persist, notwithstanding positive developments in the credit market, the ECB should also consider purchases of RMBS.
    ]]>
    Thu, 24 Jul 2014 00:00:00 +0100
    <![CDATA[Tax harmonization in Europe: Moving forward]]> http://www.bruegel.org
  • Governments have been obliged to rapidly raise taxes while facing international tax competition and domestic discontent concerning the distribution of the burden;
  • Emergency assistance to crisis countries has sometimes been considered illegitimate given the low levels of taxation in some countries for companies or wealthy individuals;
  • The need for a “fiscal capacity” has emerged as a complement to the monetary union and to the banking union.
  • It should be noted at this stage that although they are often considered as synonymous, the words “coordination”, “cooperation”, “convergence” and “harmonization” cover somewhat different concepts. Tax harmonization (e.g. the minimum standard VAT rate, or common rules embodied in different directives on the corporate taxation), is a form of coordination. The Common Consolidated Corporate Tax Base project (CCCTB) envisages a harmonization of CIT bases, but also some cooperation through the consolidation and apportionment of tax bases.3 As for convergence, it is a broader concept that is compatible with both tax coordination and tax competition. In the following, we concentrate on tax harmonization and cooperation.]]>
    Thu, 17 Jul 2014 00:00:00 +0100
    <![CDATA[Did the German court do Europe a favour?]]> http://www.bruegel.org Contributions from, and collaboration with, Will Levine of Union Square Group Capital have greatly enriched this paper. For generous comments, the author is grateful to Kevin Cardiff, Paul de Grauwe, Aerdt Houben, Dan Kelemen, Rosa Lastra, Karl Whelan, Jeromin Zettelmeyer, and especially to Peter Lindseth and Guntram Wolff. The European Central Bank’s Outright Monetary Transactions (OMT) programme was a politically-pragmatic tool to diffuse the euro-area crisis. But it did not deal with the fundamental incompleteness of the European monetary union. As such, it blurred the boundary between monetary and fiscal policy. The fuzziness of this boundary helped in the short-term but pushed political and economic risks to the future. Unless a credible commitment to enforcing losses on private creditors is instituted, these conundrums will persist. The German Federal Constitutional Court has helped by insisting that such a dialogue be conducted in order to achieve a more durable political and economic solution. A study of the European Union Court of Justice’s Pringle decision (Thomas Pringle v Government of Ireland, Ireland and The Attorney General, Case C-370/12, ECJ, 27 November 2012) suggests that the ECJ will also not rubber-stamp the OMT – and, if it does, the legal victory will not resolve the fundamental dilemmas.

    Working paper 2014/09

    As the risk premia on Spanish and Italian bonds soared in the summer of 2012, Mario Draghi, the President of the European Central Bank, promised on 26 July to do “whatever it takes” to restore confidence in the euro area (Draghi, 2012a). In successive announcements in August and September, the Outright Monetary Transactions (OMT) programme was rolled out. Governments benefiting from the programme would be required to step up their fiscal discipline; in return, the ECB would buy their bonds in unlimited quantities to place a ceiling on their interest rates. Markets calmed down, the risks spreads began a steady fall, the lingering crisis abated and a nascent recovery began. Draghi (2013) himself later described the programme as “probably the most successful monetary policy measure undertaken in recent time”. On 14 January 2014, Germany’s Federal Constitutional Court (the German Court) made news. It determined that OMT is prima facie incompatible with the Treaty on the Functioning of the European Union (TFEU), the legal basis for the European Union[1]. However, before delivering its final judgment, the German Court chose – for the first time – to seek the opinion of the European Court of Justice (the ECJ). The eventual resolution of the questions raised will have wide-ranging implications for the economics and politics of the euro, and for European integration. ECB action via the OMT was needed because the fiscal options to deal with the crisis had been narrowed down to austerity, which was not paying dividends. European policymakers had determined that they would not – other than in exceptional circumstances – allow euro-area sovereigns to default on their debt to private creditors, although the option of such default was implied in the Treaty’s so-called 'no bailout' clauses (Articles 123 and 125). There was, moreover, no political will to compromise national interests in a fiscal union with a sizeable pool of budgetary resources. That placed the entire burden on austerity. While budget trimming would eventually reduce public debt-to-GDP ratios to acceptable levels, markets were losing confidence. The OMT was politically attractive. The German Chancellor, Angela Merkel, lent it her support even though the Bundesbank President, Jens Weidmann, steadfastly opposed it. For Merkel, who had bought into the ECB’s opposition to imposing losses on private creditors, the OMT was the only way to distance her actions in support of Europe from a sceptical German public. The heart of the German Court’s case is that the OMT could spread the losses across governments in the euro area. It thus creates a de-facto fiscal union, which is contrary to the political contract. The TFEU authorises a common currency shared among European Union’s member states but consciously leaves fiscal sovereignty and responsibility at the national level since the member states have remained unwilling to pay for the mistakes of other member states. The TFEU achieves economic consistency by permitting – arguably encouraging – that the burden of these mistakes be shared by the sovereign’s private creditors. But this outlet was closed by a policy decision. To the supporters of the OMT, the activist German Court is endangering a fragile economic and financial calm, while overstating the limits set by the political contract. The ECB’s position is that the OMT was required mainly to correct distortions in financial markets, which were pricing in unwarranted fears of euro-area exits by stressed countries[2]. Since this market fear blunted the ECB’s ability to conduct monetary policy, the OMT was designed to remove the threat of exit and, thereby, improve liquidity to countries under stress. Along with greater fiscal discipline on the part of the distressed sovereign, the OMT would achieve stability without imposing costs on other sovereigns. The German Court’s decision has forced a crucially-important discussion on the state of monetary and fiscal integration in the euro area. Put simply, does the survival of the euro require that the political contract be rewritten? In other words, do member states need to – and are they willing to – transparently subordinate their national fiscal interests to help distressed member states? Or, can creative flexibility within the existing framework allow reliance on OMT-like measures that skirt the limits of the TFEU? The ECJ might seek to appease many parties – as is common in European decisions – and matters might remain confused. However, a clear eventual judgment by the ECJ would have far reaching consequences for the legal and economic basis of the euro area. Also at stake is the relationship between national constitutional courts and the ECJ. The German Court has often been caricatured as biased against the monetary union and prone to nationalistic decisions. Some have read the latest decision in that light as politically confrontational (Pistor, 2014). However, this reputation and interpretation are ill-deserved. In October 1993, as much of Europe held its breath, the German Court determined that the Bundestag, the German parliament, had the authority to determine Germany’s participation in the monetary union as conceived in the Maastricht Treaty. Later when prominent German economists tried to again the stir the Court in a final bid to stop the euro, the judges summarily dismissed their case (Norman, 1998). In this latest instance, by forcing the discussion, the German Court has done Europe a favour. The Court’s uneasiness arises from the culture of quick fixes since the crisis started. An opening has been created for a more durable political and economic solution, necessary for the euro to survive. The issues raised by the German Court should not be viewed as reflecting a Germany-versus-Europe divide. Rather, they raise questions central to the design of the euro area. Specifically, does the TFEU permit a fiscal union? More controversially, can such a fiscal union be implicitly located in the ECB without the political willingness to transparently achieve that elusive goal? On process, the German Court’s deference to the ECJ’s opinion could be read as an effort to proactively build a cooperative relationship. The legal scholar and former judge of the German Court, Dieter Grimm, proposed some years ago that when national constitutional courts are concerned that European policies are creating national obligations greater than intended in the Treaty, it is best to ask the ECJ’s opinion rather than act unilaterally (Grimm, 1997). This approach makes particular sense since the OMT has not been reviewed or authorised by the Bundestag. The rest of this paper makes the following arguments. The euro is the common currency of an incomplete monetary union and the OMT was needed to plug the holes that became apparent at the height of the crisis. The German Court is concerned that the OMT blurred the boundary between monetary and fiscal policy defined in the TFEU. The ECJ, based on its so-called 'Pringle decision', will be sympathetic to the philosophy and details spelled out in the German Court’s decision. The German Court’s position is supported not only by the TFEU but also by a traditional view on the role and limits of central banks as lenders-of-last resort. I conclude by speculating on the prospects and possibilities that lie ahead.

    The OMT in an incomplete monetary union

    On 1 January 1999, the euro became the common currency of an incomplete monetary union. The monetary union remains incomplete because the member countries – having given up independent monetary policy – lack reliable alternative mechanisms for adjustment when under economic stress. Although there are no legal barriers to the movement of people, labour mobility across the countries of the euro area is limited. Since economic adjustment through a moderation in wages is also unreliable, Peter Kenen had proposed in 1969 that a fiscal union is needed to pool budgetary resources for providing relief to countries in distress. An additional problem is that as the central bank of the common currency, the ECB is not clearly authorised to act as a lender-of-last resort to sovereigns (Sims, 2012); such support is needed when access to market financing is temporarily lost and the sovereign needs to be tided over till confidence is restored. Despite the fall in the sovereign risk premia prompted by the OMT announcements, the President of the German Bundesbank, Jens Weidmann – also a member of the ECB’s Governing Council – openly criticised the programme. On 2 August 2012, when Draghi spoke of possibly unlimited purchases of sovereign bonds under the OMT, he also reported that Weidmann was opposed to the initiative (Draghi, 2012b). The Bundesbank publicly expressed concerns (Steen, 2012). First, by 'printing' reserves to finance the bond purchases, the ECB would ease the pressure on governments to maintain fiscal discipline. Second, ECB actions might ultimately impose costs on German and other taxpayers if the bonds purchased were not repaid in full. In contrast to Weidmann, the German Chancellor, Angela Merkel, lent the programme her implicit support. On 7 September, a day after the operational details of the OMT were unveiled, she helpfully noted that the ECB was an independent organisation and the risks to the OMT would be limited since the countries whose bonds were purchased would need to maintain strict fiscal discipline (Wearden, 2012). Merkel was echoing Draghi’s themes of enforcing country responsibility[3]. Despite the German Chancellor’s continued support of the OMT, in December 2012, the Bundesbank submitted an extensive critique of the OMT to the German Court[4]. That critique significantly influenced the Court’s views. The future of the OMT is so important because even as it eased market fears, it exposed key fault lines in the architecture of the euro. In creating a temporary fix for the incompleteness of the euro-area monetary union, the OMT blurred the line between monetary and fiscal policy. As the Bundesbank correctly stated in its submission to the German Court, the European monetary union was created as “… a community of countries which have assigned responsibility for monetary policy over to the supranational level, but which continue to decide on fiscal and economic policy primarily at a national level, and which deliberately did not enter into a liability or transfer union”[5]. This structure was embodied especially in Articles 123 and 125 of the TFEU. The legal and economic question of interest is whether the OMT tried to bypass the intent of the Treaty by creating a de-facto fiscal union (a liability or transfer union in Bundesbank terminology). If so, without their explicit authorisation, countries had become fiscally responsible for the mistakes of other member countries.

    The boundaries of monetary and fiscal policy in the euro area

    The TFEU requires that the ECB must not 'print' money to finance the government. This is the so-called 'monetary financing' concern. In particular, the ECB must not finance a specific government and, in the process, impose an eventual financial obligation on the taxpayers of another government. The Treaty’s intent is to prohibit one member state from 'bailing out' another member state and, thereby, enforce national responsibility of fiscal affairs. The German Court’s position is straightforward. The ECB’s mandate is to conduct monetary policy for the common currency area. However, the OMT would operate by selectively lowering interest rates for particular countries. The OMT’s focus on support for a particular country is not incidental – it is integral to the OMT. ECB financial capacity is intended to leverage lending to the distressed member state by the European Stability Mechanism (the ESM) under condition of prudent fiscal behaviour. For this reason, the German Court’s position is that OMT is not an instrument of monetary policy. Instead, it pursues economic policy in the interest of a particular member state and, hence, “manifestly violates” the distribution of authority between the central bank and member states. As such, it goes beyond the authority accorded to the ECB under Articles 119 and 127 of the TFEU. In addition, the OMT circumvents Article 123 of the TFEU, which prohibits the monetary financing and bailout of governments by the ECB. A widely-held presumption is that the ECJ, since it leans towards 'more Europe', will rule in favour of the OMT, possibly with some inconsequential restrictions to appease the German Court. However, there may be rather more common ground between the German Court and the ECJ than is generally presumed. The ECJ’s Pringle decision (ECJ, 2012) – which confirmed the legal standing of the European Stability Mechanism (the ESM) – suggests that the ECJ will be predisposed to support the German Court’s interpretation of the OMT. The ECJ’s room for manoeuvre will be limited by the positions it has taken on Articles 123 and 125 of the TFEU, which enshrine the fiscal sovereignty of the member state. The ESM was an intergovernmental agreement – and did not involve the ECB. As such, the issue at hand was Article 125, the 'no-bailout' clause that prohibits a member state from taking on the financial obligations of another member state. In July 2012, Irish parliamentarian, Thomas Pringle, claimed before the Irish Supreme Court that the ESM violated this provision. The Supreme Court referred the matter to the ECJ. In November 2012, the ECJ determined that the ESM did not violate Article 125. In doing so, the ECJ allowed rather more scope for bailout than had been generally presumed, but arguably that was appropriate in a critical phase of the crisis. The German Court similarly acted in sympathy with the policy objectives of the ESM. That makes the German Court’s concerns on the OMT particularly significant. By finding space between Articles 122 and 123 of the Treaty (paragraphs 131 and 132 of the judgment), the ECJ arrived at a creative interpretation of Article 125 to validate the ESM (Craig, 2013). But that very creativity implied clear restraints on the ECB. In essence, the ECJ found latitude in the Treaty for governments – responsible to their own taxpayers – to assist other governments. But the ECB, as the independent central bank, has no such leeway. Moreover, the German Court’s argument implies that the OMT’s reach transcends even the latitude within which the ESM operates. Article 122 allows for the possibility that the European Union or a member state may provide financial support to another member state facing exceptional circumstances beyond its control. In May 2010, the European Financial Stability Mechanism (the EFSM) was established on the basis of Article 122. However, because 'exceptional' circumstances could not be invoked readily for a permanent body such as the ESM, and because it was not straightforward to claim that problems on account of excessive sovereign debt were beyond the member’s control, Article 122 was not used directly to establish the ESM (de Witte, 2013). Instead, the ECJ used it mainly to note that Article 125 could not have prohibited financial assistance of any sort because then Article 122 would have been inconsistent with the Treaty (paragraph 131). To define the space for the ESM, the ECJ also highlighted that Article 123 of the TFEU creates a stricter prohibition on the ECB, denying it any form of lending (“overdraft or any other type of credit facility”) in favour of member states. Specifically, the ECJ found that the ESM could do what the ECB could not. Thus the ECJ allowed for latitude in governmental action authorised by national parliaments. But it insisted that the ECB is still bound by the limits set in the TFEU. Thus, although not called on to comment on Article 123, the ECJ did so to highlight the difference between the ECB and the ESM. Importantly then for the OMT, just as the ECJ opened the door for the ESM, it went out of its way to warn that, under Article 123, the ECB is barred from similar action. Presumably, when financial assistance to a specific member state becomes necessary, it must be a political decision since it implies a fiscal action. The ECJ’s reasoning in the Pringle decision is consistent with the German Court’s concern that the OMT blurs the distinction between common monetary and national fiscal policy. Moreover, the ECJ identified limits on the ESM, which place further question marks on the scope for OMT. Article 125 allows for “financial assistance” but prohibits the Union or a member state from taking on the commitments of another member state.“Financial assistance” can take the form of a loan (“credit line”) to a distressed member state provided it is repaid over time with “an appropriate margin” (paragraph 139). The fine distinction, presumably, is that financial assistance is to be repaid, but if commitments are assumed, the distressed member state is relieved of the burden of honouring its obligations. Thus, even if the OMT were to jump the hurdle set by Article 123, it would need to be deemed “financial assistance” rather than the assumption of a government’s obligations and, hence, a 'bailout'. Importantly, the definition of 'no bailout' requires that the member state being assisted pays an “appropriate margin”. Supporters of the OMT contend that it is a monetary policy tool. It would be triggered under extraordinary circumstances when the market’s risk assessments are distorted by an unwarranted 'fear' that a member state might leave the euro. Assistance under the OMT would be provided by helping the distressed member state regain market access at interest rates that are more in line with its economic fundamentals. This task is rightfully undertaken by the ECB because returning markets to normal functioning is essential for the conduct of euro-area monetary policy. While the Bundesbank took the strong position that the ECB should not be in the business of guaranteeing that a member state remains in the euro area, the basic contention of the German Court – a contention that finds support in the ECJ’s Pringle decision – is that a fiscal union cannot be created by the backdoor. That is a political decision and must occur through a change of the Treaty and not through its creative reinterpretation. Specifically, the German Court asked:
    • Whether the “fear factor” alleged to cause an “undue” rise in sovereign spreads could be differentiated from a real threat of insolvency;
    • Whether the OMT's offer to buy “unlimited” amounts of sovereign debt implied assuming the debt repayment obligations of the distressed government; and, moreover, whether the ECB’s commitment to be pari passu with private lenders – ie in the event of a default, being repaid on the same terms as private lenders – created additional risk that the ECB, and, by extension, to other sovereigns would incur losses.
    The next two sections elaborate on these concerns expressed by the German Court and argue that the ECJ will likely concur with them.

    The fear factor and monetary transmission

    The German Court sums up the ECB’s position on the OMT in this way:
    “[The ECB’s] monetary policy is no longer appropriately implemented in the Member States of the euro currency area because the so-called monetary policy transmission mechanism is disrupted. In particular, the link between the key interest rate and the bank interest rates is impaired. Unfounded fears of investors with regard to the reversibility of the euro have resulted in unjustified interest spreads. The Outright Monetary Transactions were intended to neutralise these spreads.
    But the German Court was unconvinced by this argument. Citing the Bundesbank and other experts, the German Court’s assessment reads: “…such interest rate spreads only reflect the scepticism of market participants that individual Member States will show sufficient budgetary discipline to stay permanently solvent. …one cannot in practice divide interest rate spreads into a rational and an irrational part…” The key empirical and analytical question, therefore, is whether the spreads can be decomposed into components representing 'fear of disruption' and 'country credit risk'. The ECB’s evidence on this has been less than persuasive. For example, in a September 2012 speech justifying the OMT, President Draghi chose a persistent outlier to make his point (Draghi, 2012c).He referred to rates on Spanish mortgages in the 5-10 year maturity range as having a larger risk premium than comparable German mortgages. However, an examination of that evidence shows that “both longer and shorter maturities had much lower rate differences than did his chosen category[6]. Strikingly, the chosen maturity category has de minimis volume in Spain”. This example is all the more curious because the OMT intends to target sovereign debt at maturities of 1-3 years; the link from there to mortgages of 5-10 years is a tenuous one. The scholarly evidence for market sentiments as drivers of risk premia is also unpersuasive. It is commonly stated that markets were unduly optimistic before the crisis and became excessively pessimistic towards the end of 2010 (for example, de Grauwe and Ji, 2012). But the roller-coaster movements in euro-area sovereign spreads are better explained by incoherent policy. Before the crisis, markets did not believe the threat that losses would be imposed on private creditors – and, hence, the Irish paid lower risk spreads than the Germans in 2007. After the crisis started, the countries receiving official assistance came under particularly severe market pressure because privately-held debt was now subordinated to the senior, official debt. The rise in spreads between late 2010 and mid-2011 is almost entirely explained by the subordination of private debt (Steinkamp and Westerman, 2013, and Mody, 2014). The fall in spreads, thereafter, is explained by the policy steps to subordinate official to private debt. In July 2011, the terms of official lending to the assisted countries were eased, sending a signal that official creditors will bear the initial burden of further sovereign distress. When that proved insufficient for Italy and Spain, the OMT was needed in the second half of 2012 to spread the Europhoria (Mody, 2014). The German Court goes on to argue that an ill-conceived attempt to make a distinction between a country’s real solvency risk and the market’s ill-founded fear and to act on that basis to lower the risk premia runs the risk of violating the core intent of the TFEU – and, in doing so, it invokes the ECJ’s Pringle decision:
    “… the existence of such [risk] spreads is entirely intended. As the Court of Justice of the European Union has pointed out in its Pringle decision, they are an expression of the independence of national budgets, which relies on market incentives and cannot be lowered by bond purchases by central banks without suspending this independence”.
    In his submission to the German Court, former ECB Executive Board member, Jorg Asmussen, conceded that the OMT was not just trying to dampen the 'fear factor' (Asmussen, 2013). The two-fold objective of the OMT programme, he said, is “protecting the market mechanism so as to urge the Member States to make the necessary reforms”. But if this is so – and since the OMT is to act in concert with ESM lending – the German Court and the ECJ are not so far apart. The German Court is concerned that rather than conducting 'monetary' policy, the ECB is also engaging in 'economic' policy – urging member states to undertake reforms, in Asmussen’s terms. There is, moreover, an operational problem. Even assuming that a 'fear' factor exists, its size and significance will depend on the country’s creditworthiness. Hence, in each instance, the ECB will be required to make a judgment. No simple rule, such as a transparent threshold, is possible. The ECB will, therefore, be necessarily drawn into making country-specific judgments and decisions. That, of course, is the antithesis of what the central bank should be doing. Especially because the OMT cannot be triggered unless a country asks for ESM support, governments and their creditors could pursue an unsustainable strategy until it is too late. At that point, the ECB will inevitably be sucked into political judgments.

    No bailout

    The ECB contends that by only purchasing bonds on the secondary market, it is neither extending credit nor is it influencing the market pricing mechanism, and, it is, therefore, not assuming a sovereign commitment. But the German Court is only stating the obvious when it notes that even if the ECB allows some time distance from the sovereign’s primary bond issue, the OMT “encourage[s] third parties to purchase the government bonds at issue on the primary market by providing the prospect of assuming the risk associated with the acquisition”. In other words, the German Court is saying that the OMT is either providing credit or a free 'put option' to investors. That interpretation leads to a violation of Article 123. It is hard to see how the ECJ could conclude otherwise. In his submission, Asmussen acknowledged the limits set by Article 123:
    “Article 123 of the Treaty prohibits monetary financing. In particular, we are not allowed to buy any government bonds directly, i.e. on the primary market. Government bonds can only be purchased if they are already on the market and traded freely”.
    But he did not clarify how the limits set by Article 123 would be honoured. The OMT was also sold as an 'unlimited' programme – the 'whatever it takes' bazooka. Along with being pari passu with creditors (discussed below), the promise of unlimited purchases helped calm markets. Once again, Asmussen reflected this tension in his submission.
    “No ex ante quantitative limits are set on the size of Outright Monetary Transactions. ...we announced that our OMT interventions would be ex ante ‘unlimited.’ We have no doubt that this strong signal was required in order to convince market participants of our seriousness and decisiveness in pursuing the objective of price stability. At the same time, however, the design of OMTs makes it clear to everyone that the programme is effectively limited, for one by the restriction to the shorter part of the yield curve and the resulting limited pool of bonds which may actually be purchased”.
    Perhaps, unlimited purchases at the short-end are sufficient to eliminate the so-called 'redenomination' risk – the risk that the euro could break up. The German Court is concerned:
    “The ‘factual’ limitation of the volume of bond purchases by the amount of the government bonds issued already in the currently scheduled maturity spectrum of one to three years – highlighted by the European Central Bank in the proceedings before the Federal Constitutional Court – is not likely to sufficiently ensure an adequate quantitative limitation. By changing their refinancing policies, the Member States that benefit can increase the volume of government bonds that are currently covered by the OMT Decision; it is unclear what would follow from the European Central Bank’s intention to observe the emission behaviour of individual Member States”.
    To this, the ECB response has been that the conditionality that accompanies the ESM programme could require that countries continue to issue longer maturity bonds. In addition, it will monitor countries subject to the OMT to ensure that they don’t begin issuing all of their new debt in the OMT-eligible 1-3 year maturity bucket (Cotterill, 2012). Thus, at least implicitly, the ECB recognises that 'unlimited purchases' violate Article 123 but limited purchases dilute the value of the programme. Moreover, once again, the intent of monitoring a country’s debt issuance strategy exposes the ECB to political terrain. But, perhaps, the most important German Court concern is the risk of default on the ECB’s holdings acquired under OMT. This could be rephrased in the ECJ’s Pringle terminology to ask whether the ECB is being compensated with an appropriate margin. Recall that in its expansive interpretation of Article 125, the ECJ, while determining that loans made by the ESM are consistent with the TFEU, required that the loan pay an adequate return to the lender. The ECJ was clear that the ESM Treaty “in no way implies that the ESM will assume the debts of the recipient Member State” (paragraph 139). The ECJ notion of return to the lender was a narrow one: it did not include the benefits achieved by providing systemic financial stability and resilience. Indeed, it reaffirmed the conventional TFEU interpretation that the goal of financial stability is to be achieved by the member states maintaining the needed fiscal discipline for honouring their debts. For this reason, if a particular OMT transaction were to face losses, it could not be legitimised on the basis of financial stability or a similarly broad dividend to the Union. By accepting losses on account of a particular sovereign, the ECB would be imposing a fiscal burden on the other member states – without the necessary political authorisation. In a country with a single fiscal authority, the central bank has recourse to fiscal support in the event of a loss. With multiple fiscal authorities, the authors of the TFEU were rightly concerned that such recourse would create incentives for fiscal indiscipline. In a recent, much-read, position, Paul De Grauwe (2014) claimed that a central bank cannot incur losses. Were a sovereign to default on its obligations to the ECB, the member states would recapitalise the ECB by lending it money. Over time, the ECB would pay interest to the member states for that loaned money. This process, De Grauwe asserts, is costless to all parties[7]. But, of course, the interest that the ECB pays to the member states would come from its profits. Thus, those profits would have been used, in effect, to pay for the losses incurred by the ECB. In so doing, the ECB would have acted to favour a particular sovereign, and thereby would have created a fiscal transfer mechanism. That transfer would be particularly costly if the assisted member state eventually left the euro area[8]. This matter is aggravated by the pari passu feature of the OMT. The ECB’s holdings of Greek debt acquired earlier under its Securities Markets Programme (SMP), starting May 2010, were effectively granted senior status to private creditors. When Greek debt was restructured in March 2012, the ECB exchanged its holdings for bonds that were not subject to the losses imposed on private creditors (Black, 2012). Thus, the ECB remained whole. However, since ECB seniority under SMP increased the losses borne by bondholders whose securities were not purchased by the ECB, the SMP was not popular in the market. For this reason, to further reassure market investors, the seniority claim was apparently relinquished under the OMT. In the OMT press release, the ECB said
    “The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds”.
    Note, therefore, in highlighting its pari passu status, the ECB recognised that it was moving beyond the central banking domain of managing liquidity disruptions into space were insolvency to become a real market concern. The German Court has concluded that such equal treatment in creditor status probably renders the OMT unconstitutional. Their interpretation of Article 123 of the TFEU is that “the possibility of a debt cut must be excluded”. Thus, the court is concerned not with the seniority issue per se but by the possibility that the ECB will not be repaid in full, in which case, the ECB would have acted to bailout the sovereign creditor in contravention to Articles 123 and 125. It is possible that the ECJ may invoke a broader community goal in validating the OMT. But that would be a departure both from how the OMT has been sold and how the TFEU has so far been interpreted. It would imply an interpretation that the TFEU permits a fiscal union.

    The economic analysis of the lender of last resort

    The ECJ will also need to contend with well-established central banking practices, which are implicit in the German Court’s reasoning. A central bank must address systemic liquidity risk arising from short-term financial disruption; it should not address solvency problems that are at the heart of the OMT’s design. The legal analysis, therefore, parallels an economic logic. At its centre is the distinction between liquidity and solvency. Temporary market disruption leads to short-term funding requirements that are met through liquidity provision by the central bank acting in its capacity as a lender of last resort. The risk of sovereign insolvency, however, is a fiscal problem. This is never an easy distinction to make in practice, requiring a presumption one way or another. Is the OMT intended to solve a solvency or liquidity problem? The way it is designed, the solvency concern looms large and, at best, the solvency and liquidity threats are rolled into one. The OMT is to be triggered precisely when a member state faces a real threat of insolvency; the market merely amplifies that threat into a broader financial panic. A central bank’s liquidity operation in such a situation places it in an untenable position. The strong preference of private creditors that they receive same treatment as the ECB in the event of a default, and discussion of the financial options in that event, reflect the concern that the OMT is designed for conditions in which a default risk is non-trivial. The German Court’s reservations on these matters mirror those voiced by central banking experts (Capie, 2002). The situation is clearly aggravated in the euro area since, were there to be insolvency, the losses would be distributed among member states whose governments and taxpayers were not party to the decisions made. A central bank’s role as a lender of last resort also requires that it not undertake operations primarily to assist specific entities in distress (Capie, 2002), because that creates the so-called 'moral hazard' risk that lenders will lend with reckless abandon in the knowledge that they will be protected. Thus, Sims (2012, p. 221) notes:
    “… with the expanded balance sheets of the central banks, returns on their assets will no longer necessarily move in parallel to the rate on reserve deposits. In the case of the ECB, sovereign debt assets could default. For both these reasons, future monetary tightening could require the central bank to ask for a capital injection from the treasury. For the ECB, there is no one treasury to respond. There is a formal “capital key,” a set of proportions according to which countries of the euro zone are required to share in providing capital to the ECB when needed. But if this were required, Germany would bear a large part of the burden, and it would be clear that German financial resources were being used to compensate for ECB losses on other countries’ sovereign debts”.
    Once again, the German Court’s concerns with 'selectivity' have echoes in the central banking literature. A thought experiment helps clarify the salience of the selectivity issue in an incomplete monetary union. Should the ECB tailor its policy rates to a particular member state? During the boom years, should interest rates have been raised to dampen the real estate booms in Ireland and Spain? The argument can be made that the failure to do so had systemic consequences. Or consider Italy today. The OMT is a promise to place a floor on the price of Italian bonds. If that falls within the authority of the ECB, then should the ECB have pursued more aggressive reduction of its policy interest rate early on to pre-empt deflationary conditions in the weakest economies; and should it not have long since being pursuing unconventional methods to prevent Italian deflation? Deflation can be at least as serious a risk to debt dynamics as excessively high interest rates. Fiscal austerity in a deflationary condition can be debilitating. Because the member states chose to move ahead with a monetary union without a fiscal union to backstop such eventualities, the TFEU is based on the promise of fiscal discipline by each member state to prevent such risks from arising in the first place. Where the presumed discipline proves insufficient, the TFEU’s intention – expressed in Article 125 – is that the country would not repay its private creditors. The effort today is to square a circle: sovereigns must repay private creditors (barring exceptional circumstances) but without the pooled resources of a fiscal union. The OMT steps into that breach.

    Prospects and possibilities

    The German Court has challenged the OMT on the basis of its congruence with European law. In the end, the German Court may, indeed, restrain Germany from cooperating with the OMT because it implies obligations that are not permitted by the German constitution. But for now, the task is very much on how to interpret the TFEU. The ECJ may be less fussy than the German Court in determining the circumstances under which the OMT could be triggered. The ECB may then be able to use that flexibility and not hang its OMT trigger on the fuzzy 'fear factor'. But a general state of financial instability, which creates a legitimate role for a central bank, does not imply support for a particular member state. That the ECB, nevertheless, has chosen to link the OMT to conditional lending by the ESM suggests that the ECB is aware that the OMT is not a proper lender-of-last resort function. It bridges into lending to sovereigns facing solvency risk. If so, the ECJ is very clear. It has interpreted Article 123 as strictly prohibiting any lending to a sovereign by the ECB. There appear no exceptions to fall back on for breathing new life into Article 123. This is all the more so since the economic conditions under which the OMT is to be operational are more dire than those stipulated for the ESM and, as such, might not even meet the standards of Article 125. The ESM was given the green light by the ECJ on the basis that the support would be through a loan that would be paid back with an appropriate return. In the case of the OMT, the support is to be provided when the ESM has proved insufficient and the conditions expressly raise the prospect of a loss to be borne by the ECB’s balance sheet and its shareholders. It, therefore, directly violates the 'no-bailout' intent of Article 125. Moreover, it does so by lowering the interest rate paid by the sovereign and, hence, raises the concern that market discipline is being diluted. The problem is a simple one. The authors of the TFEU wrote a document that was consistent with the vision of the euro as an incomplete monetary union. That construct was intended to work on the basis of fiscal discipline by countries accompanied by default on debt held by private creditors where the discipline proved insufficient. The threat of the default was intended to focus the minds of both the lenders and the borrowers. Decision makers today have concluded that default is too costly but the alternative of completing the monetary union through a fiscal union is not politically feasible. The fact that the OMT was successful in dampening market concerns is testament to the need for a fiscal union. It also is an indication of the size of such centralised fiscal resources that would be a credible bulwark against market speculation. A democratically-validated, political path to a fiscal union has proven to be a receding target. This should not have been a surprise to those who have observed the evolution of the euro. The OMT, in effect, offers an apparently elegant technocratic solution to the euro-area’s fiscal union conundrum. In highlighting the tensions between the TFEU and the OMT, the German Court is basically concerned that the OMT is a fiscal union by the backdoor. The ECJ could validate the current design of the OMT – locating the fiscal union in the central bank – in which case, the nature of the euro area will be fundamentally altered and the ECB will become a more political institution. Alternatively, if the ECJ were to determine that the German Court’s concerns need to be addressed by changes to the OMT – by imposing serious limits on purchases of sovereign bonds and requiring the ECB to claim seniority to private creditors – the OMT will be rendered ineffective. There is a third option. And that would be to agree that the OMT is needed as temporary support because an incomplete monetary union creates intolerable risks. The ECJ would ask the political actors to meet their responsibility by providing a transparent and legitimate mandate for a permanent OMT. They would do so by jointly guaranteeing the ECB against losses incurred if a particular transaction ends in a default. That guarantee may never be needed. But it would focus the minds and clarify who bears the cost. Then Europe would have taken a real step forward. References Asmussen, Jörg (2013) 'Introductory Statement by the ECB in the Proceedings before the Federal Constitutional Court', 11 June Black, Jeff (2012) 'ECB Is Said to Swap Greek Bonds for New Debt to Avoid Any Enforced Losses', 17 February Capie, Forrest (2002) 'Can there be an International Lender-of-Last-Resort?' International Finance 1(2): 311–325 Cotterill, Joseph (2012) 'The OMT and "limits"', Financial Times Alphaville, 18 September Craig, Paul (2013) 'Pringle: Legal Reasoning, Text, Purpose and Teleology', Maastricht Journal of European and Comparative Law 20 (1): 3-11 De Grauwe, Paul (2014) 'Why the European Court of Justice should reject the German Constitutional Court’s ruling on Outright Monetary Transactions' De Grauwe, Paul and Yuemei Ji (2012) 'Mispricing of Sovereign Risk and Multiple Equilibria in the Eurozone', Journal of Common Market Studies 50(6): 866–880 De Witte, Bruno (2013) 'Using International Law in the Euro Crisis', Centre for European Studies, University of Oslo, Working Paper 4 Draghi, Mario (2012a) 'Verbatim of the Remarks made by Mario Draghi', Global Investment Conference in London, 26 July Draghi, Mario (2012b) 'Introductory statement to the press conference (with Q&A)', Frankfurt am Main, 2 August Draghi, Mario (2012c) 'Building the Bridge to a Stable European Economy', The Federation of German Industries, Berlin, 25 September Draghi, Mario (2013) 'Questions and Answers at Press Conference', 6 June, Frankfurt am Main European Central Bank (2012) 'The OMT Press Release' European Court of Justice (2012) 'Judgment of the Court (Full Court): Thomas Pringle v Government of Ireland and The Attorney General', 27 November Federal Constitutional Court (2014) 'Principal Proceedings ESM/ECB: Pronouncement of the Judgment and Referral for a Preliminary Ruling to the Court of Justice of the European Union', judgment; press release Grimm, Dieter (1997) 'The European Court of Justice and National Courts: the German Constitutional Perspective after the Maastricht Decision', Columbia Journal of European Law 3: 229-242 Kenen, Peter (1969) 'The Theory of Optimum Currency Areas: An Eclectic View', in Robert Mundell and Alexander Swoboda (eds) Monetary Problems of the International Economy, Chicago: University of Chicago Press Mody, Ashoka (2014) 'Europhoria, Once Again' Norman, Peter (1998) 'German Court Rejects Emu Challenge', Financial Times, 3 April Pistor, Katharina (2014) 'German Court decision: Legal authority and deep power implications' Steen, Michael (2012) 'Weidmann isolated as ECB Plan Approved', Financial Times, 6 September Steinkamp, Sven and Frank Westermann (2014) 'The Role of Creditor Seniority in Europe’s Sovereign Debt Crisis', forthcoming in Economic Policy, 29(79): July Wearden, Graham (2012) 'Eurozone crisis live: Merkel backs ECB rescue plan as markets remain cheerful – as it happened', The Guardian, 12 September *** [1] The Lisbon Treaty, signed on 13 December 2007, consolidated the texts of the European Union Treaties, the Treaty of the European Union and the Treaty on the Functioning of the European Union. [2] Euro exits fears were, in no small measure, sparked by threats emanating from ECB and other euro-area officials. See 'European Officials as Source of Convertibility Risk'. [3] In August and September 2012, Draghi repeatedly insisted on national fiscal discipline. [4] The English translation of the Bundesbank submission to the German Court. [5] The English translation. [6] 'Convertibility Risk – Cherry Picking* Interest Rate Spreads', 2012. [7] The process of calling capital from the member countries is, moreover, far from straightforward. For instance, a vote on loss-sharing is required, not to mention the obstacles to sharing losses in the event of an exit from the euro. See 'Loss Sharing in the Eurosystem – excluding Target2 Losses'. [8] These same problems arise also in the context of ECB exposure to banks that are insolvent, and for the same reason – insufficient clarity on the policy and willingness to institute losses on private creditors. This may change, but the extent to which it will remains unclear.]]>
    Tue, 15 Jul 2014 00:00:00 +0100
    <![CDATA[Europe between financial repression and regulatory capture]]> http://www.bruegel.org Highlights The financial crisis modified drastically and rapidly the European financial system’s political economy, with the emergence of two competing narratives. First, government agencies are frequently described as being at the mercy of the financial sector, routinely hijacking political, regulatory and supervisory processes, a trend often referred to as “capture”. But alternatively, governments are portrayed as subverting markets and abusing the financial system to their benefit, mainly to secure better financing conditions and allocate credit to the economy on preferential terms, referred to as “financial repression”. We take a critical look at this debate in the European context. First, we argue that the relationship between governments and financial systems in Europe cannot be reduced to polar notions of “capture” and “repression”, but that channels of pressure and influence bet-ween governments and their financial systems have frequently run both ways and fed from each other. Second, we put these issues into an historical perspective and show that the current reconfiguration of Europe’s national financial systems is influenced by history but is not a return to past interventionist policies. We conclude by analysing the impact of the reform of the European financial architecture and the design of a European banking union on the configuration of national financial ecosystems.

    1. Introduction

    In the long shadow of the euro-area crisis, the relationship between governments and their banks has been brought to the the centre of the policy debate in Europe by the implementation of regulatory reforms, the risks associated with financial fragmentation, and the fight to sustain the flow of credit to governments and corporates. The attempt to interpret the patterns of pressure and influence running between governments and their financial system has led commentators to rediscover and give new life to concepts originating from academic debates of the 1970s such as “regulatory capture” and “financial repression”. Government agencies have been frequently described as being at the mercy of the financial sector, often allowing financial interests to hijack political, regulatory and supervisory processes in order to favouring their own private interests over the public good 1. An opposite view has instead pointed the finger at governments, which have often been portrayed as subverting markets and abusing the financial system to their benefit, either in order to secure better financing conditions to overcome their own financial difficulties, or with the objective of directing credit to certain sectors of the economy, “repressing” the free functioning of financial markets and potentially the private interests of some of its participants 2. But a closer look at the experience of European countries suggests that both the notion of “capture” and “repression” are too narrow to describe the complex relationship between financial stakeholders and their national governments. Instead, the history of European financial systems reveals how governments, central banks, public sector banks and financial institutions have historically been part of deeply interconnected European financial ecosystems bound both by political and financial relations. Patterns of pressures and influence within these financial ecosystems have always run in both directions and have been mutually reinforcing. As Andrew Shonfield argued in 1965 in one of the first detailed analyses of the role of governments and of the “balance of public and private power” in western capitalism after WWII, these different financial ecosystems in Europe varied across countries because of different histories and institutions that framed such relationships 3. These national differences have frequently been presented as declining with time and in response to deeper financial integration. The breakdown of the Bretton Woods system in the early 1970s, the removal of restrictions to the circulation of capital within Europe following the 1986 Single European Act, the creation of the single currency, and the process initiated in 2001 by the European Commission with the Lamfalussy Report to extend the single market to financial services have fostered a greater integration of banking and financial activities across national borders that have profoundly altered existing national ecosystems 4. The response to the euro-area crisis seems to have further encouraged this trend, and new institutional mechanisms, in particular the creation of a European banking union, typically aims at Europeanising further banking supervision and resolution thereby potentially reducing further the weight of national historical and institutional idiosyncrasies. However, claims suggesting the end of national financial ecosystems in Europe are at best premature. This paper discusses how national financial ecosystems in Europe continue in fact to exercise a significant influence over financial policy-making and how the transition towards a more integrated financial framework (ie banking union) influences these relations. Our conjecture is that the rapid reversal of financial integration and a re-domestication of financial flows and financial risks triggered by the crisis 5 have built on practices, ties and institutions that have deep historical roots. Meanwhile, the European policy response, which intended to repair financial fragmentation and recreate a more integrated financial sector has attempted to Europeanise the regulation, supervision, resolution of the financial sector thereby trying to break historical ties within national financial ecosystems. It is therefore important to take a critical look at these opposite movements and they way they affect not only the efficacy of capital allocation and credit intermediation at the national level, but also the policy-making process at the European level.

    2. Banks and governments: Competing narratives across the Atlantic

    Attitudes towards the relationship between governments and national financial institutions have historically varied significantly across the United States and Europe. Suspicions over the involvement of politically powerful banks in the political system have been an integral part of the US political debate. These can be traced as far back as the controversy between Alexander Hamilton and Thomas Jefferson about the establishment of the First Bank of the United States in 1791 6. More recently, many commentators seeking to explain the regulatory failures at the origin of the financial crisis have repeatedly pointed the finger towards the political clout of financial lobbies. The Report by the Financial Crisis Inquiry Commission established by the US Congress to investigate the roots of the crisis found that: “the financial industry itself played a key role in weakening regulatory constraints on institutions, markets, and products”. The Commission explained this influence by making reference to the $2.7 billion in federal lobbying expenses and $1 billion in campaign contributions spent by the financial sector between 1999 and 2008 7. Others have highlighted how the role of the preferential access allowed by the “revolving doors” between Wall Street and US regulatory agencies 8. The perception of financial industry groups capable to often act as rule-makers has brought a number of commentators to analyse the relationship between US financial firms and the political system through the lenses of “regulatory capture”. The origins of the term are usually attributed to the work of George Stigler in the early 1970s but this concept has been brought to the fore by Simon Johnson, former IMF chief economist, and other commentators during the recent financial crisis 9. This description of the financial industry as systematically “capturing” the design and implementation financial regulatory reforms has however resonated more broadly in the US than across the Atlantic. This is in part the result of the fact that the focus of most US-centric analyses on financial resources, campaign contributions and revolving doors as means through which the financial industry is capable to routinely “buy” regulatory policies does not sit comfortably with the experience of most European countries, where political party financing and electoral rules limit the importance of financial resources in buying political support, while bureaucrats in financial regulatory agencies and central banks are more likely to spend most of their career in the public sector. Campaign contributions and revolving doors are not the only channels through which the interest groups are capable to capture the policy-making process. On the contrary, while theories of regulatory capture developed from the US experience have focused on the resources that different financial groups are capable of deploying in the lobbying of the US Congress or federal regulatory authorities, the European experience is illustrative of the wider and often less visible channels through financial which banks often influence the design of financial policies. A number of structural characteristics of different financial ecosystems in Europe have bolstered the influence of European banks over the design of financial policies. These include for instance the formal and informal links between the political system and the banking system. For instance, German public saving banks (Sparkassen and Landesbanken) that held some 33 percent of the assets of the German Banking sector in 2009 remain owned and controlled by regional governments 10, which naturally create a peculiar relationship. In Italy, state-owned banks have been privatised over the last few decades, but many of these institutions remain still today under the influence or control of foundations (“fondazioni bancarie”) that maintain close ties with the political system and in some cases are directly appointed by political parties 11. In Spain, small and medium size Cajas remained partly owned by the public and largely under the influence and control of regional officials and religious leaders, thus weakening the hand of the central government in supervising and regulating them and favouring undue forbearance by the central authorities. These formal ties are frequently reinforced by informal ties, such as the social networks embedded in the French Grandes écoles where future civil servants, politicians and bankers are trained together and come to form networks of influence organises around the Grands Corps 12. These formal and informal ties between the political system and the banking system make banks particularly receptive to political guidance at the local, state and federal level but also allow these institutions to exercise a significant influence over the regulatory process through their political connections. Another characteristics of the European financial systems that is often ignored by US-centric analysis of regulatory capture is the greater reliance of European countries on bank credit for financing the real economy as well as sovereign debt. This structural feature of European financial systems, gives to banks rather than other financial intermediaries a particular importance and creates channels through which national financial institutions are likely to gain leverage over policy makers. As Cornelia Woll argues, “decision-makers will act in favour of the industry because they need finance for funding the so-called real economy, for funding the government and as a motor for growth” 13. These kinds of relations also explain why even without strong pressures by the financial industry, governments feel compelled to consider that the interest of the financial sector are aligned with those of the economy and the country as a whole. For example, Sir Howard Davies, the first Chair of the UK Financial Services Authority explained how during the pre crisis period “on the whole, banks [in the UK] did not have to lobby politicians, largely because politicians argued the case for them without obvious inducement” 14. Indeed, some of the same dynamics have been fully in display during the response to the global financial crisis when concerns about the potential impact of regulation on banks balance sheets and possible consequences on the extension of credit to the economy have brought politicians in a number of European countries to support the demands from their financial industry to water down these regulatory measures. The greater success of European banking lobbies in having their demands met during the implementation of Basel III at the European level has clearly been influenced by the link with the real economy that the financial industry was able to establish 15. Indeed, financial industry lobbies seem to have achieved concessions conditional on their capacity to highlight the impact of different pieces of regulation over their capacity to provide credit to the broader economy 16. At the same time, the watering down of key regulatory requirements has been accompanied by repeated calls from European politicians towards banks which were asked to commit to increase credit to the domestic economy. Overall, the experience of recent banking regulatory reforms in Europe are indicative not only of the fact that the significant political influence of banks is not uniquely a US phenomena. On the contrary, the influence of European banks over the design of financial policies frequently arises from a number of structural characteristics of the different financial ecosystems in which they find themselves operating. But shifting the focus from the direct lobbying of financial institutions towards the characteristics of different financial ecosystems in Europe also reveals a further corrective to notion of ‘capture’ that has frequently been used to interpret the relationship between banks and government agencies. While many US-centric have focused on the influence of financial actors and other interest groups over the state, channels of pressure and influence between European governments and their banking system within distinct European financial ecosystems have frequently been presented as running both ways and feeding from each other. These reciprocal channels of influence between European governments and their banking systems will be explored in the next section by looking at modern European history.

    3. Historical perspectives on financial ecosystems

    Examples of this symbiotic relationship between European governments and their financial system abound throughout modern European history. European governments have indeed frequently used banks to expand and broaden their reach over the economy either domestically or internationally. The creation of Deutsche Bank in 1870 in the context of the formation of the German Empire and the need to challenge the leadership of British banks in the global markets, as well as the creation of public credit institutions in Italy and France to support national financial development or postwar reconstructions are only some of the many examples throughout modern European history of the way through which financial nationalism and The promotion of “national banking champions” was also often intended to allow competition with European neighbours and the projection of power internationally to accompany the internationalisation of domestic firms 17. The involvement of the State in financial developments in the nineteenth century went beyond the promotion of international champions. During this period, financial liberalisation went hand in hand with the promotion of national credit and state intervention. Governments were indeed keen on rescuing banks in order to save bankers interests as well as the financing of the economy, and personal connections between politicians and bankers were crucial to this process 18. Central banks − which were still at the time institutions with private shareholders granted with a monopoly on the right to issue − were perfect examples of these connections between governments and financial capitalism that developed throughout the nineteenth century. European governments or monarchs also exerted controls on some large credit institutions that were crucial for the financing needs and debt repayments of local authorities, as the Caisse des Dépôts and Crédit Foncier in France and the Cassa Depositi e Prestiti in Italy. For a long period, the collusion between State and banks went hand in hand with significant government interference in the activities of financial firms in order to channel and allocate credit in a non-competitive way. But the controls of the State over financial systems strongly increased after the Great Crash throughout the 1930s in democratic and dictatorships alike, and were reinforced after the second world war with bank nationalisations and the increasing role given to public credit institutions. Also in the years following the end of the second world war, western European governments continued to strategically directs their domestic banking system towards the achievement of specific public policy objectives. The term “financial repression” − coined in the early 1970s to describe developing economies in Asia and Latin America 19 − has been used retrospectively to indicate a wide range of targeted prudential controls and requirements such as capital controls, reserve requirements, capital requirements, and various taxes and levies to favour – directly or indirectly – the holding of government debt. In addition, over the same period, interventionist credit policies were developed to influence the allocation of credit through price or quantity rules so as to offer a competitive advantage to certain economic sectors. A key feature of these interactions during this period was to force financial institutions to extend credit that would otherwise have to be funded by government deficits expenditures 20. This alternative financing of state intervention contained public debt while introducing political pressures and "distortions" of competition in the financial sector. Banks were sometimes requested to hold a certain amount of government bonds and of claims on certain sectors as a percentage of their total asset. The same outcomes could also be pursued indirectly by central banks in their design of monetary policy operations (reserve requirements, credit ceilings, liquidity ratios) and through collateral policy facilitating banks access to the discount window for certain categories of claims. The intervention of governments in the working of their respective domestic markets also frequently occurred through the development of public credit institutions as substitutes to banks and through the direct investment of Western European governments in some specific sectors (housing, agriculture, industry etc) and support industrial policies or resort to the development of state-owned credit institutions or public banks as substitutes to banks. All in all, these policies were used – at different degrees across countries– to control risk in the banking sector, to support industrial policy, facilitate government-financing needs and control inflationary risks 21. These tools also shared a strong national bias; most savings, investments, government financing came from domestic sources and financial regulation aimed to mitigate risks and influence the allocation of credit at the national level. As a consequence, the political economy of these systems relied on connections and coordination 22 at the national level between government agencies, public and private lending institutions and industries. Employees circulated easily and frequently between public administrations and nationalised firms or banks. In the name of the public interest, industries negotiated with governments in order to receive subsidies, to be given priority, and sometimes to be rescued 23. It is only in the late 1970s and 1980s, that these symbiotic relations between Western European governments and their national banking systems approach were challenged by profound intellectual changes about the merits of financial liberalisation and independent central banking and that the negative effects of governments interventions (unproductive rents, crowding out, over-saving by state owned institutions) became more central to economic thinking and policymaking. As a result, the recourse to these interventions and instruments gradually but rapidly vanished. Countries – prominently France– experienced a radical liberalisation in the mid 1980s and all converged towards and open financial system with a mature money market in the early 1990s. As a result of this new settlement, financial ecosystems were organically but deeply redesigned, and as a result, financial and political relationships were recomposed. The expansion and deepening of cross border capital flows supported further financial market openness, independence of central banks and disengagement from the public sector 24. In sum, while distinct financial ecosystems characterised by symbiotic relationship and reciprocal patterns of influence between governments and their banking industry have exercised a significant influence in the past, these differences have frequently been presented as in decline at the turn of the century. The question remains whether the current crisis has interrupted this decline and reinvigorated past behaviours and historical relationships?

    4. The European crisis and the recomposition of national ecosystems

    The abrupt interruption in cross border capital movement has triggered a clear renationalisation of finance over the last three years and has profoundly modified relations between national financial systems and governments in Europe 25. The vast and ubiquitous use of government expenditures and guarantees to support the financial system 26 has been followed by widespread calls for tighter regulation and supervision of the financial sector as a whole and of the banking sector in particular. In addition, in many instances, the crisis has unsettled governments' access to financial markets and increased their borrowing cost. The economic downturn has in turn woken up a certain desire and a need to address credit shortages and intervene more forcefully in the financial system to improve and augment the extension of credit and facilitate the recovery. However, if governments in Europe have not resorted completely and openly to the policies and instruments that had characterised the Bretton Woods era, a number of developments could indicate a redefinition of the relations between the public and the financial sector along the lines of pre-existing historical relations and behaviours. The most common and clearly identified aspect of these changing landscapes is the extent to which holdings of public debt have been on balance re-nationalised. Debt sustainability concerns, uncertainty about the integrity of the European monetary union and the reluctance of the central bank to address risks of multiple equilibria in sovereign debt markets in the euro area 27 have all contributed to put sovereign debt markets under strain and forced governments to rely on national savings and national financial institutions to finance their expenditures. Despite these developments, the current re-domestication of government debt holding does not appear to be an unseen phenomenon, nor a direct return to the pre-EMU situation. Among countries of the euro area, only Spain has today a level of sovereign debt held by residents (including central banks and financial corporations) higher than before it joined the euro. The huge exposure of government towards their banking system is therefore not a phenomenon that was born during the crisis but is a well-established feature of European economies since the 1980s. Nevertheless, what is true on average is not necessarily true on an individual basis. Ireland and Portugal for instance, have experienced a dramatic increase in this ratio from 2006 to 2011 while in Germany, Belgium and France, on the contrary, the financial crisis has not stopped a downward trend in the domestic holding of government debt. These trends are characterised by a strong path dependency, which supports the argument that historical trends are still important for the structure of bank holdings. A second aspect of these changing landscapes is the evolution in the centrality of central banks in the European national financial ecosystems. This role had significantly been curtailed after the demise of Bretton Woodswith the creation of the Eurosystem, the centralisation of key central prerogatives within the ECB and the emergence of principle of central bank independence. However, during the current crisis, with growing financial fragmentation, impaired transmission mechanisms, the European Central Bank was forced to take a more active role to repair transmission channels and it contributed to increase the holding of government bonds held by central banks of the Eurosystem. This modification of its collateral framework also allowed National Central Banks to exert some discretion in the types of claims they could accept as collateral which may have increased the national bias in the refinancing of credit claims 28. These dynamics have provoked a vivid reaction denouncing both financial repression and “fiscal dominance” 29 of central banks but these criticisms seem to ignore the fact that the most striking feature of European national central banks’ balance sheet expansion is not the result of greater accumulation of public debt but rather of an historically unprecedented increase in central bank credit to the private economy. Central bank balance sheet usually increased during wars and recessions mostly to ease government financing. After 1945, some central banks became more involved in directed credit and used their balance sheet to finance long-term investment and influence the allocation of credit through re-discount privileges and choices. However, even in the central banks that used these techniques extensively such as France, the ratio of central bank’s claim on the domestic banking sector never really exceeded 8-10 percent of GDP. In the euro area, it has now reached more than 30 percent of GDP. This contrasts starkly with the UK and the US where the Bank of England and the Fed assets purchase were largely government and quasi-government liabilities 30. Arguably, a large part of these claims, are in reality claims on the financial sector caused by the extension of large amounts of liquidity to the banking sector. Indeed, never in history did central banks support an entire financial system to this extent. While the UK stands out here as having provided relatively little liquidity support to its banking sector beyond purchase of government bonds, the ECB, on the contrary, has accumulated claims to the banking sector by a record amount. In 2011, central bank claims on the banking sector in the euro area was 30 percent of GDP, ranging from 0.1 percent for the Bank of Finland to 68.7 percent for the Bank of Ireland. Interestingly, those central banks that have the least government debt, tend to have the most claims on the private sector thereby potentially revealing important differences in the structures of national ecosystems. The intervention of central banks in the financial sector has further been increased by the acknowledgement that macro-prudential regulation is a necessary complement to modern central banking. The new macroprudential mandate acquired granted during the crisis to central banks is in part a return to the theory and practice of central banking 30 years ago in Europe (even though the term “macroprudential” was coined recently) when central bankers thought their role extended well beyond the narrow remit of monetary policy. A third significant evolution in the relationship between governments and the financial system that has in part turned the clock back can be found in the return of “public credit institutions” (also known as “development banks”). These state-owned lenders in France, Germany, Italy and Spain, respectively the Caisse des dépôts et consignations (CDC), the Kreditanstalt für Wiederaufbau (KfW), the Cassa depositi e prestiti (CDP) and the Instituto de Crédito Oficial (ICO) have considerably increased their scope as of recently. The CDC and CDP are old state owned institutions (created respectively in 1816 and 1863) that played an important historical role in the economic development of France and Italy. The KfW was created in 1948 to support the reconstruction of the German economy while the Spanish ICO is more recent (1971). Their role in the economy has increased greatly and rapidly during the financial crisis.While total assets of the credit institutions of the Euro Area increased by only 4 percent from 2008 to 2012, assets of public credit institutions increased by at least 30 percent and even 128 percent for the ICO. These institutions have also, together with the European Investment Bank, which has also expanded its lending activities quite substantially by 56 percent over the same period (2008-2012), collectively created the “long-term investors” club to promote their role in the economy as a provider of long term financing 31. The detailed balance sheets of these institutions show that they have performed various functions over time with different emphasis in each country. The Cassa de Depositi e Prestiti for example has expanded its credits to the public sector tremendously, extending some €85bn worth of loans to public (mainly local) entities and purchasing some €90bn in Italian government bonds and bills. In France, the CDC has repositioned its portfolios away from European peripheral countries’ debt into French sovereign debt where the exposure almost doubled. The CNP insurances company, which is the 6th European insurance company in assets size and which is owned by the CDC, has also accomplished a similar portfolio rebalancing towards domestic debt. Meanwhile, in Germany, KfW played a quite different role by first being largely used to provide capital, loans and guarantees to the financial sector 32 during the first wave of the crisis in particular in the case of IKB. It also expanded its financing to local SME and infrastructure in Germany and abroad. Indeed, the KfW played an important role in German financial aid to other European countries as in Greece with some €22bn of outstanding credits at the end of 2011, Italy with some €1.7bn, Ireland with €1.4bn, Spain with €3.2bn. These institutions are therefore not only important to understand the political economy of national eco-systems but also of new financial relationships between European nations during the crisis. Indeed, in Spain for instance, KfW lends to Spanish SMEs through the ICO. It is also interesting to observe that the countries that did not have an important “development bank” (such as Portugal and Greece) are now in the process of creating one 33. In essence, the existence of these institutions has allowed reactivating practices and mechanisms of intrusion in the intermediation system that were an essential part of the financial ecosystem over the last century. Their role is probably even reinforced in European countries today by the fact that national central banks and governments cannot provide direct public support or target specific sectors via subsidised loans as they used to do in the immediate post war period. In many countries (but not in all) national credit institutions never really disappeared, they just blended in. The CDC’s total assets for instance represent 15 percent of GDP in 2012 when it was equal to 17 percent of GDP in 1970. Governments for the most part therefore never really disbanded the institutions they had built of the last century and they proved relatively easy to awaken and mobilise as the crisis hit. Contrary to Carmen Reinhart’s argument, it is misleading to these developments as a mere “return of financial repression” 34. The intervention of European states in their financial system have not intended to become substitute for fiscal or industrial policy and thus differ drastically from historical quantitative tools used by central banks thirty years ago. Nonetheless, it is clear that the greater re-nationalisation in the holding of public debt by domestic financial institution, the unprecedented increase in central bank credit to the private economy, and the return of public credit institutions are three developments since the financial crisis that have reaffirmed the centrality of distinct European financial ecosystems after two decades in which these ties had been eroded by financial liberalisation and the process of European monetary integration.

    5. European financial ecosystems and the move towards a banking union

    The previous section has discussed how the changes in the patterns of financial intermediation and sovereign debt holding emerged in response to the crisis, but the implications of these trends extends well beyond economics and deep into the political arena and the debate concerning the reform in the European financial architecture. The long and troubled history of the construction of an integrated market for financial services in Europe has often been described as a “battle of the systems” across different European countries, in particular between systems such as Britain where capital markets played a key role as the main source of financing and the continent where banks dominated the provision of credit 35. But on the continent itself, national practices and structures also differ greatly and are somewhat embedded in the domestic institutions and possibly in different varieties of capitalism 36. The realisation of an integrated financial market encouraged first by the Banking Directive in 1977, the Single European act in 1986 and the Lamfalussy Report in 2001 had partially redesigned the fault lines in European financial policies. The traditional conflicts across different countries reflecting the preferences of their national champions was complemented by the emergence of coalitions of large pan-European groups with a strong interest in removing obstacles to the emergence of an integrated financial market for financial services in Europe, often pitted against firms with a more local or national outlook threatened by this trend. The dynamics triggered by the financial crisis have reinforced the channels of pressure and influence between European governments and their banking systems. The greater nationalisation of financial intermediation as well as the wave of re-regulation revive strong national preferences and tensions in the design of financial policies. Debates surrounding the design and implementation of Basel III for example, have instead witnessed the re-emergence of traditional national cleavages, with different European regulatory authorities frequently running in support of their banking industry at the negotiating table. The violent realisation that the monetary union did imply lesser avenues for economic adjustment in response to shocks has certainly strengthened the reluctance of national governments to deprive themselves of policy levers to influence credit intermediation. On the other hand, the financial sector seems to have been able to use this dependency in order to extract concessions from national regulatory authorities that would serve its own interests. The influence of financial industry groups over the position of their respective governments has not been confined to countries with large financial sectors, but it has been pervasive also in countries where the financial industry occupies a smaller position in the economy 37. The path towards a banking union – a single supervisory mechanism applying a single rulebook and eventually a single resolution mechanism – is therefore particularly important in this respect. If successful, it should precipitate a profound redefinition of national financial ecosystems in Europe and have broader consequences on the underlying structure of financial intermediation in Europe. This may not be completely compatible with sustaining national preferences as far as the organisation of the financial system is concerned. But it could also reduce the ability of member states to use their financial system to play a cushioning role in the event of economic downturns. This could imply a further reduction in the ability of member state to stabilise their economies and entail much more radical changes in the structures of national capitalisms. The tensions existing between these changes and the historical ties between different governments and their banking systems explain the opposition of domestic financial interests and some national governments have been source of resistance on the way for the establishment of a banking union. The resilience of history within national financial ecosystems and the symbiotic relationships remaining between western European governments and their national banking systems are a key factor shaping the path towards the Europeanisation in the regulation, supervision, resolution of the financial sector that the banking union entails. Will the union break national ties, create a new balance of public and private power at the European level or, on the contrary reinforce domestic specificities and relationships such that a dual system might emerge with two separate levels of activities and political economies (national and European)? There is a wide research agenda ahead as very little has been written up to now on the potential consequences of the banking union for the political economy of national financial ecosystems. The debate has not even fully started and insights from economics, history and political sciences are more than needed at this stage.

    6. Conclusion

    Despite their renewed popularity among economists and policymakers since 2008, neither the notions of “capture” nor “financial repression” appear sufficient to fully understand today’s European dynamic and complex patterns that characterise the relationship between governments and their financial industries at the national and increasingly at the European level. These seem to be evolving profoundly in two directions. First an apparent rapid reduction of banks’ balance sheets that will probably increase the role of non-banks in the provision of credit and thereby certainly affect profoundly the ties between banks and government insofar as they influence the extension and allocation and credit to the economy. Second, and maybe more importantly, the ongoing process of Europeanisation of financial policy is likely to have profound ramifications for both financial ecosystems themselves and for the relationships that governments and financial institutions develop. In particular, it could be expected that relationships that were so far developed within the confines of national borders would be gradually transferred over the to the European level via the process of the banking union, thereby side-lining or at least minimising the importance of national governments. However, developments in the last few years very much question this notion as it appears clearly that the financial crisis has actually awakened institutions, practices and relations that have strengthened the ties between governments and their respective financial ecosystems. Starting from the breadth and scope of financial support 38, to the reactivation of certain supervisory and even monetary practices, the ties between national governments and the banking system has been in many ways reactivated in a way that tends to blur the rigid categories of capture and repression. As a result, a more nuanced prism is needed, focusing on agency that national specificities will be able to develop within European contexts as well as on the non-trivial equilibria between public and private interests. The political science literature, which has highlighted the existence and persistence of “varieties of capitalism” in Europe and the resilience of national ecosystems, will be particularly helpful in this respect. This strand of work should also help us to introduce the perspective brought by the political economy literature in the debates about the European monetary union over and above the importance of the need for a banking union as a necessary stabilising feature of the single currency. *** 1 Baxter has defined capture as occurring “whenever a particular sector of the industry, subject to the regulatory regime, has acquired persistent influence disproportionate to the balance of interests envisaged when the regulatory system was established”. Lawrence G. Baxter (2011) 'Capture in Financial Regulation: Can We Redirect It Toward the Common Good?' Cornell Journal of Law & Public Policy 175-200. The origins of the concept: see George J. Stigler (1971) 'The Theory of Economic Regulation', The Bell Journal of Economics and Management Science, Vol. 2, No. 1. See also Dal Bó, Ernesto (2006) 'Regulatory Capture: A Review', Oxford Review of Economic Policy, 22(2), 203–225. For a recent discussion of the problem of capture in the context of the financial crisis see Carpenter, Daniel and David A. Moss (eds) (2013) Preventing Regulatory Capture: Special Interest Influence and How to Limit it, Cambridge University Press; Johnson, Simon (2009) 'The Quiet Coup', Atlantic Monthly, May; and Daron Acemoglu and Simon Johnson (2012) ‘Captured Europe’, Project Syndicate, May. 2 Reinhart, Carmen. M. (2012) 'The return of financial repression', Financial Stability Review, 16, 37-48; Kirkegaard, Jacob F. and Carmen M Reinhart (2012) 'Financial repression, then and now', VoxEU.org, May; Allianz Global Investors (2013) Financial Repression. It Is Happening Already. 3 Andrew Schonfield (1965) Modern capitalism: The changing balance of public and private power, Oxford University Press. A subsequent literature in political sciences has coined the term i>“varieties of capitalism” to study these differences and their institutional roots: Colin Crouch and Wolfgang Streeck (eds) (1997) The Political Economy of Modern Capitalism: Mapping Convergence and Diversity, London: Sage; Peter A. Hall, David Soskice (eds) (2001) Varieties of Capitalism. The Institutional Foundations of Comparative Advantage, Oxford University Press. 4 ;De Larosière Jacques (2009) Report on financial supervision to the European Commission; Mügge, Daniel (2006) 'Reordering the Marketplace: Competition Politics in European Finance', Journal of Common Market Studies, 44(5), 991– 1022. 5 For the literature on financial retrenchment globally see for example Lund, Susan et al (2013) Financial globalization: retreat or reset?McKinsey, available at Milesi-Ferretti, Gian Maria and Cedric Tille (2011) 'The Great Retrenchment: International Capital Flows during the Global Financial Crisis', Economic Policy vol. 26(4), pp. 285-342. Re-nationalisation of financial intermediation and financial policy has emerged as a response to the contradiction between international market integration and spatially limited political mandates, as highlighted in the political science literature: Pontusson, J. and Raess, D. (2012) 'How (and Why) Is This Time Different? The Politics of Economic Crisis in Western Europe and the United States', Annual Review of Political Science, 15, 13-33; Clift, B. and Woll, C. (2012) 'Economic patriotism: reinventing control over open markets', Journal of European Public Policy, 19(3), 307-323; Schmidt, V. A. and Thatcher, M. (eds) (2013) Resilient liberalism in Europe's political economy, Cambridge University Press. 6 Goldstein, Morris and Veron, Nicolas (2011) 'Too Big to Fail: The Transatlantic Debate', Working Paper No. 11-2, Peterson Institute for International Economics; Johnson, Simon and Kwak, James (2011) 13 bankers: the Wall Street takeover and the next financial meltdown, Vintage. 7 FCIC (2011) The Financial Crisis Inquiry Report. Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States. Washington, DC: The Financial Crisis Inquiry Commission. See also Johnson, Simon (2009) 'The Quiet Coup', Atlantic Monthly, May. 8 US GAO (2011) 'Securities and Exchange Commission. Existing Post-Employment Controls Could be Further Strengthened', Government Accountability Office, GAO-11-654 Report, Washington DC. 9 Stigler (1971). See footnote 1. 10 The Landesbanken are themselves partly owned by regional confederations of Sparkassen (saving banks) and respective federal states. See also Grossman Emiliano (2006) 'Europeanisation as an interactive process: German public banks meet EU competition policy', Journal of Common Market Studies, vol. 44, n°2, p. 325-347. 11 Giani, Leonardo (2008) ‘Ownership and Control of Italian Banks: A Short Inquiry into the Roots of the Current Context', Corporate Ownership & Control, Vol. 6, No. 1, pp. 87-98. 12 On the role of these networks for banking reforms, see Butzbach Olivier, Grossman Emiliano (2004) 'La réforme de la politique bancaire en France et en Italie : le rôle ambigu de l’instrumentation de l’action publique', in L’instrumentation de l’action publique (sous la dir. de Pierre Lascoumes et Patrick Le Galès), Presses de Sciences Po, Paris, pp. 301-330. More general references are Swartz, David (1985) 'French Interlocking Directorships: Financial and Industrial Groups', in Stokman, Ziegler and Scott (eds) Networks of Corporate Powers: A Comparative Analysis of Ten Countries; Kadushin, Charles (1995) 'Friendship Among the French Financial Elite', American Sociological Review, Vol 60, N_2, pp 202-221. For a quantitative approach highlighting the role of networks of former high ranking civil servants in shaping board composition of banks and other corporations, see Kramarz, Francis and Thesmar, David (2013) 'Social networks in the boardroom', Journal of the European Economic Association, 11:780–807. 13 Woll, Cornelia (2013) 'The power of banks', Speri, University of Sheffield, July. 14 Davies, Howard (2010) 'Comments on Ross Levine’s paper “The governance of financial regulation: reform lessons from the recent crisis”', Bank for International Settlements; see also The Warwick Commission on International Financial Reform (2009) In Praise of Unlevel Playing Fields, University of Warwick. 15 Howarth, David and Quaglia, Lucia (2013) 'Banking on Stability: The Political Economy of New Capital Requirements in the European Union', Journal of European Integration (May), 37–41. 16 Pagliari, Stefano and Young, Kevin L. (2014) 'Leveraged interests: Financial industry power and the role of private sector coalitions', Review of International Political Economy, 21(3), 575–610. 17 Morris and Veron (2011), see footnote 6. Gerschenkron, A. (1962) Economic backwardness in historical perspective. Economic backwardness in historical perspective, Harvard University Press. 18 Hautcoeur, Pierre Cyrille, Riva Angelo, and White Eugene N. (2013) 'Can Moral Hazard Be Avoided? The Banque de France and the Crisis of 1889', paper presented at the 82nd Meeting of the Carnegie-Rochester-NYU Conference on Public Policy; Caroline Fohlin (2012) Mobilizing Money: How the World’s Richest Nations Financed Industrial Growth, New York: Cambridge University Press. 19 McKinnon, Ronald (1973) Money and capital in economic development, Brookings Institution Press. 20 Hodgman Battilossi, Stefano (2005) 'The Second Reversal: The ebb and flow of financial repression in Western Europe, 1960-91', Open Access publications from Universidad Carlos III de Madrid; Monnet, Eric (2014) 'The diversity in national monetary and credit policies in Western Europe under Bretton Woods', in Central banks and the nation states, O.Feiertag and M.Margairaz (eds), Paris, Sciences Po, forthcoming; Monnet, Eric (2013) 'Financing a planned economy, institutions and credit allocation in the French golden age of growth (1954-1974)', BEHL Working Paper n°2, University of Berkeley; Hodgman, Donald (1973) 'Credit controls in Western Europe: An evaluative review', Credit Allocation Techniques and Monetary Policy, The Federal Reserve Bank of Boston.21 Monnet Eric (2012) 'Monetary policy without interest rates. Evidence from France’s Golden Age (1948-1973) using a narrative approach', Working Papers 0032, European Historical Economics Society (EHES). 22 Eichengreen, Barry (2008) The European economy since 1945: coordinated capitalism and beyond, Princeton University Press. 23 Pontusson & Raess (2012) 'How (and Why) Is This Time Different? The Politics of Economic Crisis in Western Europe and the United States', Annual Review of Political Science, vol. 15, pp. 13-33; Zysman, John (1983) Governments, markets, and growth: financial systems and the politics of industrial change, Cornell University Press. The academic literature that builds on the “varieties of capitalism” has studied extensively how these national characteristics and “institutional complementarities” were shaped and reinforced by the role of the state, then shaping these various forms of “capitalism”. Schonfield, A. (1965) Modern Capitalism: The Changing Balance of Public and Private Power, Oxford University Press. Peter Katzenstein (1985) Small States in World Markets, Ithaca, Cornell University Press; Peter Hall, David Soskice (eds) (2001) Varieties of Capitalism, Oxford University Press. 24 Mügge, Daniel (2006) 'Reordering the Marketplace: Competition Politics in European Finance', Journal of Common Market Studies, 44(5), 991–1022. 25 Carmen Reinhart (2012) 'The return of financial repression', CEPR, DP8947; Sapir, André, and Wolff, Guntram (2013) 'The neglected side of banking union: reshaping Europe’s financial system', Policy Contribution, Bruegel; Goodhart, Charles (2013) 'Lessons for monetary policy from the Euro-area crisis', Journal of Macroeconomics. 26 Stolz, S. M., and Wedow, M. (2010) 'Extraordinary measures in extraordinary times: Public measures in support of the financial sector in the EU and the United States', Occasional Paper 117, European Central Bank. 27 De Grauwe, Paul (2011) 'The European Central Bank: Lender of last resort in the government bond markets?' CESifo working paper: Monetary Policy and International Finance (No. 3569). De Grauwe, Paul, and Ji, Yuemei (2012) 'Mispricing of sovereign risk and multiple equilibria in the Eurozone', Centre for European Policy Working Paper 361. 28 Merler, Silvia, and Pisani-Ferry, Jean (2011) 'Hazardous tango: sovereign-bank interdependence and financial stability in the euro area', Financial Stability Review, (16), 201-210. 29 In a 25 November 2013 speech, J. Weidmann said that Monetary policy runs the risk of becoming subject to financial and fiscal dominance”. 30 For example, speech by David Miles from the BoE: 'Government debt and unconventional monetary policy', at the 28th NABE Economic Policy Conference, Virginia, 26 March 2012. 31 The long-term investors club: See also green paper by the European Commission on long-term finance. 32 Between the end of 2007 and February 2008, IKB had to go through several rounds of financial support in which banks and the KfW agreed to two more bailout packages, which ended up increasing KfW’s participation in IKB from 38 percent to 90.8 percent. For more details see Cornelia Woll (2014) The Power of Collective Inaction: Bank Bailouts in Comparison, Ithaca, Cornell University Press. 33 'Germany to help Spain with cheap loans', EUObserver, 28 May 2013, http://euobserver.com/economic/120278. 34 Reinhart, C. M. (2012) 'The return of financial repression', Financial Stability Review, 16, 37-48. 35 Story, Jonathan, and Walter, Ingo (1997) Political Economy of Financial Integration in Europe: The Battle of the Systems, MIT Press. 36 Hall, Peter and Soskice, David (2001) Varieties Of Capitalism: The Institutional Foundations of Comparative Advantage, Oxford University Press. 37 Howarth, David, and Quaglia, Lucia (2013) 'Banking on Stability:  The Political Economy of New Capital Requirements in the European Union', Journal of European Integration (May), 37–41; Bruegel blogpost by Nicolas Veron. 38 Woll (2014). See footnote 32.]]>
    Thu, 10 Jul 2014 00:00:00 +0100
    <![CDATA[The (not so) Unconventional Monetary Policy of the European Central Bank since 2008]]> http://www.bruegel.org This paper is one in a series of nine documents prepared by Policy Department A for the Monetary Dialogue discussions in the Economic and Monetary Affairs Committee (ECON) of the European Parliament.

    Abstract

    The global financial and economic crisis forced major central banks to act swiftly and to innovate to avoid a free fall of their economies. This paper reviews in depth the measures adopted by the European Central Bank, and compares them with the ones adopted by the Federal Reserve and the Bank of England since 2008. The ECB has been very active since the beginning of the crisis and its actions helped the financial sector to avoid a complete meltdown. However, the ECB adopted measures that were mainly directed at ensuring the provision of liquidity and repairing the bank-lending channel, through changes to its usual framework for the implementation of monetary policy. By contrast, the Fed and the Bank of England quickly pursued unconventional monetary policies by implementing quantitative easing programmes that appeared to have a positive impact on financial variables and also on the real economy. Today, the ECB is confronted by inflation well below 2% and has reacted by implementing a broad package of fairly conventional measures. This analytical note pleads for the ECB to implement a large-scale asset-purchase programme and makes recommendations about the design of such a programme.

    EXECUTIVE SUMMARY

    • The global financial and economic crisis that started in 2008 forced major central banks around the globe to act swiftly and to innovate in order to avoid a complete meltdown of the financial sector, and to limit the consequences for the real economy.
    • The ECB’s policy response to the crisis was mainly oriented towards ensuring the provision of liquidity and repairing the bank-lending channel. In order to do that, the ECB mainly modified its existing monetary policy tools. It increased the average maturity of its refinancing operations from months to years. It eased the collateral requirements to access those refinancing operations, and liquidity was allocated at a fixed rate and full-allotment basis. Retrospectively, those measures appear to have been a very appropriate and effective way to deal with the liquidity crisis of 2008-2012.
    • The ECB also introduced more unconventional measures with the Securities Market Programme and the Covered Bonds Purchase Programme, which it used to buy particular assets – government bonds from troubled countries and covered bank bonds – in order to repair the monetary transmission channel in the euro area. However, the scope and impact of those measures was limited and short-lived. The ECB also announced the Outright Monetary Transactions programme, in order to purchase unlimited amounts of government bonds of member states subject to a European Stability Mechanism (ESM) programme. This measure has not been used, but its announcement had a significant impact on government bond yields of the EMU member states because it demonstrated the determination of the ECB to maintain the integrity of the euro area.
    • The Federal Reserve (Fed) and the Bank of England chose a more radical and unconventional path in terms of monetary policy when they decided very quickly to implement large-scale asset-purchases programmes as their main response to the crisis. The sizes of these programmes were very significant (grossly equivalent to 20-25% of GDP) and, although it is very difficult to estimate their impact, there is a broad consensus in the literature that those measures had a positive impact on financial variables and also on GDP and inflation in the US and the UK.
    • The liquidity crises that have plagued the euro area in the last few years seem to be behind us. The ECB’s main problem now is the continuous decline of inflation in the euro area to a level well below its definition of price stability of close but below 2%. In order to counteract this fall and to bring inflation back to 2% in the medium term, the ECB announced a broad package of measures at its June 2014 Governing Council meeting. However, although we welcome the fact that the ECB finally recognised that inflation will be too low for a too-long period and decided to act, we believe that the measures it proposes arrive too late, are too limited, and might be too “conventional” to solve the current problem. That is why we urge the ECB to implement a large-scale asset-purchase programme as soon as possible. To do that, we propose monthly purchases of €35bn of ESM/EFSF/EIB bonds, corporate bonds and asset-backed securities (ABS) in order to anchor inflation expectations and bring euro-area inflation back to 2% in the medium-term.

    Introduction

    Since 2008, the central banks of the main advanced economies have been very active in order to avoid the complete meltdown of their financial sectors and limit the adverse consequences for the real economy. However, central banks around the globe chose different paths to take action. The main aim of this paper is to compare these different paths since the beginning of the crisis and to assess the impact of those policies. Another goal of this paper is to determine what kind of unconventional policies the ECB should adopt today in order to fulfil its price stability mandate for the euro area. In the first section of the paper, we will see that the ECB has mainly preferred to adapt its usual monetary policy framework to ensure the provision of liquidity to the banking sector and to repair the bank-lending channel to try to revive credit in the euro area, rather than to implement a more radical monetary policy. In the meantime, the Fed and the Bank of England embarked quickly on unconventional monetary policies by implementing quantitative easing programmes that seemed to have a positive impact on financial variables but also on the real economy through various channels. The second section of this briefing paper essentially summarizes and updates the analysis and recommendations of Claeys et al (2014a and 2014b). It describes the main challenge faced by the ECB today, i.e. the current downward trend in inflation. During its June 2014 Governing Council, the ECB decided to react to this dangerous situation by implementing a broad package of measures. We will try to assess if these measures are enough to bring inflation back to 2% in the medium term, and we will see what kind of unconventional monetary policy could be implemented to achieve price stability in the medium term in the euro area.

    1. Unconventional measures implemented by the ECB, the Fed and the Bank of England since 2008

    1.1. ECB 2008-2013: saving the banking system, solving the liquidity crises

    The ECB’s policy response to the crisis was mainly oriented towards ensuring the provision of the liquidity needed by the banking sector at a point at which the interbank market and other sources of short-term funding were almost frozen.
    1.1.1 Modifications to the ECB’s refinancing operations
    Together with the lowering of the policy rate from 4.25% to 1% between October 2008 and May 2009 (and later down to 0.15% from December 2011 to June 2014), the ECB introduced a number of measures to provide “enhanced credit support” to the economy. Liquidity started to be allocated, through main refinancing operations (MRO) and long-term refinancing operations (LTRO), at a fixed rate and full-allotment basis, meaning de facto that banks had unlimited access to central bank liquidity, on the basis of the provision of adequate collateral. Collateral requirements were in turn eased a number of times, and on top of that, the maturity of LTROs – originally of 3 months only – was lengthened, introducing operations with maturity of, first, 6 months, then 1 year and eventually by conducting two massive very long-term refinancing operations (VLTROs) with a maturity of 3 years (in December 2011 and February 2012). The cumulative take-up of these two operations exceeded €1 trillion (although part of it substituted the borrowing through other maturities). As a consequence, the maturity of the ECB’s balance sheet has lengthened. Figure 1 shows that about 80% of all the liquidity provided to the banks – which constitutes the biggest component on the asset side of the Eurosystem’s consolidated balance sheet – has now a maturity of 3 years. Not surprisingly, the use of the LTRO facility has been skewed towards certain countries, with banks in Spain, Italy, Greece, Ireland and Portugal accounting for 70 to 80% of the total borrowing since 2010. Symmetrically, banks from the North – which had benefited from inflows of capital in search of safety – reduced their reliance on the ECB operations to minimum levels. The VLTROs was constructed as a euro area-wide policy – i.e. open and directed to all banks in the euro area, but banks from the South of the euro area ended up using it more than the others because they were the most affected by the liquidity crisis taking place at the time in the European banking sector. Figure 1: Eurosystem refinancing operations Source: ECB Since January 2013, the ECB has allowed banks to repay the funds borrowed under the three-year LTRO, earlier than on maturity date. Banks have been using this opportunity quite sensibly, especially in Spain, where the reliance on the Eurosystem facility was previously the largest. As a consequence of frontloaded reimbursements, the amount of liquidity in the euro area has started to fall rapidly. Figure 2 shows that the excess liquidity in the euro area[1] has dropped significantly since the beginning of 2013 and is now almost completely re-absorbed. Figure 2: Excess liquidity – euro area, in €bn Source: ECB The empirical literature analysing LTROs suggest that those operations were very useful in improving monetary conditions at the height of the crisis[2]. While LTROs were a very appropriate and effective measure to deal with the liquidity crisis of 2011-12, these operations did little to trigger additional lending to the private sector (even though they might have helped to prevent the collapse of existing lending). To a great extent, banks either deposited the cheap central bank funding at the ECB for rainy days, or purchased higher yielding government bonds. Thereby, the LTROs in effect supported liquidity, ensured stable long-term (three-year) financing of banks, subsidised the banking system and helped to restore its profitability, and temporarily supported distressed government bond markets. Considering the alternative of a potentially escalating financial crisis, these developments were beneficial.
    1.1.2 The Securities Market Programme (SMP), Outright Monetary Transactions (OMT) and the Covered Bonds Purchase Programme (CBPP)
    Under the SMP, initiated in May 2010, the ECB bought around €220 billion of Greek, Irish, Portuguese, Italian and Spanish government bonds. At the time, the ECB announced that the bonds would be held to maturity and that the purchases are entirely sterilised. The intervention was justified in light of the severe tensions in certain market segments that were hampering the transmission of the ECB’s monetary policy. At present there are €175.5bn of SMP bonds left, the maturities of which are not publicly disclosed by the ECB. The empirical literature[3] has tried to assess the impact of SMP and concludes that it had a positive but short-lived effect on market functioning by reducing liquidity premia and reducing the level as well as the volatility of European government bond yields. However, the programme was stopped in September 2012, when the ECB introduced the new Outright Monetary Transactions (OMT), the announcement of which had a remarkable effect on European bond yields even without the programme having ever been used. The programme allows the ECB to purchase essentially unlimited amounts of government bonds of member states that are already subject to a European Stability Mechanism (ESM) programme, as long as the member states in question respect the conditions of the ESM programme. The ECB contends that this policy could be necessary on monetary policy grounds, namely to safeguard “an appropriate monetary policy transmission and the singleness of the monetary policy”[4]. The ECB also introduced in 2009 a Covered Bonds Purchase Programme (CBPP), which was not sterilised and aimed at reviving the covered bond market, which plays an important role for the financing of banks. The ECB initially bought covered securities such as Pfandbriefe worth an aggregate volume of €60 billion within a one-year period. In November 2011, the ECB launched a second CBPP with a total volume of €40 billion, but it decided to interrupt it in October 2012, after covered bonds totalling €16.4 billion had been purchased.
    1.1.3 Introduction of a Forward Guidance strategy
    In July 2013, the ECB formally introduced forward guidance as a new monetary policy tool when President Draghi announced during the introductory statement of the press conference that “the Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time”[5]. Initially, the main idea behind forward guidance, introduced by Krugman (1998) when analysing the deflation and liquidity trap problem of Japan in the 1990s, was that central banks could gain traction on the economy at the zero lower bound if they manage to convince the public that they will pursue a more inflationary policy than previously expected after the economy recovers, what Krugman calls a “credible promise to be irresponsible”. This policy should indeed result in low short-term rates for an extended period of time and an increase in inflation expectations, which should both have a negative effect on real long-term rates today and should therefore boost investment and consumption. However, the main problem of forward guidance is time-inconsistency. Central bankers do not want to commit themselves to future policy decisions and they will always have an incentive to raise rates when inflation returns to preserve their credibility to fulfil their price stability mandate. But if forward guidance is not time consistent, it is not credible and agents anticipate that rates will be raised earlier and it will therefore not be effective. To be credible it is possible that forward guidance needs a commitment or a time-consistency device to work better, a role that a massive asset purchase programme could play, given the potential delays resulting from a gradual and ordered exit strategy (as demonstrated by the current slow US QE tapering process). Contrarily to what was advocated in the theoretical academic literature, the ECB clarified[6] quickly its forward guidance strategy by saying that it did not promise either “irresponsibility” or a suspension – even temporarily – of its usual strategy. The ECB considers only forward guidance as a new way to communicate its strategy in order to better anchor expectations about the future path of interest rates, and not at all as a commitment to keep rates lower longer than necessary in order to have a more significant immediate impact of monetary policy. This may have therefore reduced the effectiveness of the measure.

    1.2. Unconventional measures adopted by the FED and the BoE: the quantitative easing experience

    In response to the global financial and economic crisis, the Federal Reserve (Fed) and the Bank of England engaged in large-scale asset purchase programmes, or quantitative easing (QE)[7]. From the beginning of 2009 to March 2014, the Federal Reserve purchased $1.9 trillion (11.9 percent of US GDP) of US long-term Treasury bonds and $1.6 trillion (9.6 percent of US GDP) of mortgage-backed securities. Between January 2009 and November 2012, the Bank of England purchased £375 billion (24 percent of GDP) of mostly medium- and long-term government bonds. In addition to such asset purchases, these central banks also implemented programmes to support liquidity in various markets. All those measures resulted in a significant expansion of the central banks’ balance sheets (see Figure 3). Unlike the two other major central banks, the ECB has made few asset purchases so far but reacted to the crisis by providing liquidity to the banking system as we have seen before. Figure 3: Size of balance sheets of various central banks, in % of GDP Source: FRED, IMF.
    1.2.1 Unconventional monetary policy in the US
    In the US, quantitative easing (QE) began immediately in November 2008 and is on-going. In total, it has expanded its balance sheet from $860 billion at the beginning of 2007 to $4.2 trillion today. The Fed announced in December 2013 a ‘tapering’ of its programme, and has reduced gradually its monthly purchases from $85 billion to $35 billion. On top of its QE policy the Fed also introduced some short-term liquidity measures, such as the Commercial Paper Funding Facility, which purchased 3-month unsecured and asset-backed commercial paper with top tier credit rating, to support the commercial paper market and reduce the rollover risk. Another programme, initiated in November 2008, was the TALF (Term Asset Backed Securities). This was aimed at addressing the funding liquidity problem in the securitisation markets for consumer and business ABS (Asset-Backed Securities) and CMBS (Collateralised Mortgage-Backed Securities). Under this programme, the Federal Reserve extended term loans collateralised by securities to buyers of certain high-quality ABS and CMBS, with the intent of reopening the new-issue ABS market. The programme provided both liquidity and capital to the consumer and small business loan asset-backed securities markets: the Fed lent money against asset-backed securities while the Treasury Department provided $100 billion in credit protection from its Troubled Asset Relief Program (TARP) to the TALF (as a cushion against losses on the ABS collateral). On top of this asset-buying programmes, the Fed also introduced a number of facilities aimed at helping the banks to meet their liquidity needs, such as the Term-Auction Facility (TAF) that was intended to provide liquidity with a maturity of one month against the same kind of collateral that could be used to borrow overnight at the Fed’s discount window, but without the ‘stigma effect’ that was associated with the use of the discount window. Figure 4: Size of asset side of the Fed’s balance sheet, in % of GDP Source: FED As noted in Joyce et al (2012), there is a broad consensus in studies estimating the impact of QE on financial markets that it has been successful in reducing government bonds rates. More precisely, Gagnon et al (2011) shows that the Fed’s QE1 between December 2008 and March 2010 had significant and long-lasting effects on longer-term interest rates on a variety of securities, including Treasuries', agency mortgage-backed securities and corporate bonds. Estimations suggest a fall in 10-year term premium by somewhere between 30 and 100 basis points overall[8] and substantial effects on international long-term rates and the spot value of the dollar. Concerning the MBS purchase programme, Hancock and Passmore (2011) focus specifically on whether it has lowered mortgage rates, and conclude that the programme’s announcement reduced mortgage rates by about 85 basis points in the month following the announcement, and that it contributed an additional 50 basis points towards lowering risk premiums once the programme had started. As far as liquidity measures are concerned, Ashcraft et al (2009) assess the effectiveness of the TALF by observing volumes and patterns of ABS and CMBS issuance as well as liquidity conditions in these markets. Overall, they find that improvement in market conditions and liquidity in the term ABS and CMBS markets in 2009 was dramatic, particularly in view of the lower-than-expected volume of lending through TALF. A total of $71.1 billion in TALF loans was requested and the volume of outstanding loans peaked in March 2010 at $48.2 billion, although the programme was authorised to reach $200 billion and at one point up to $1 trillion in loan volume was envisioned. Through the TALF programme, the Federal Reserve seems to have been able to prevent the shutdown of lending to consumers and small businesses, while limiting the public sector’s risk. Estimating the macro impact of QE poses a number of difficult challenges given other potential factors that could also have influenced the economic developments of the period in which QE has been implemented. Therefore, the various results found in the literature have a higher variance. That’s why we would recommend focusing on the sign of the effect more than on its size. According to Chung et al (2012), the combination of QE1 and QE2 raised the level of real GDP relative to baseline by 3%, and inflation is 1% higher than if the Federal Reserve had not carried out the programme. They calculate that this would be equivalent to a cut in the federal funds rate of around 300 basis points from early 2009 to 2012. In contrast, Chen et al (2012) find that QE2 policy increased GDP growth by 0.4% on impact and has a minimal impact on inflation (equivalent to an effect of a 50-basis point cut in the federal funds rate). These findings show that QE has been effective (even though the effect can appear to be quite small in comparison to size of the asset purchases in terms of GDP). In terms of choice of the asset to buy, some papers such as Woodford (2012) and Krishnamurthy and Vissing-Jorgensen (2013) suggest that QE is much more effective when it takes the form of credit easing, i.e. when private assets are bought.
    1.2.2 Unconventional monetary policy in the UK
    The Bank of England began its quantitative easing programme in January 2009 and purchased £200 billion worth of mostly medium- and long-term government bonds from the non-bank private sector by January 2010. It made further purchases in 2011 and 2012, which took the total amount to £375 billion. Figure 5: Size of asset side of the BoE’s balance sheet, in % of GDP Source: BoE There is also a broad consensus in the empirical literature that the Bank of England’s quantitative easing had significant effects on gilt yields but also on corporate bond rates and on the sterling exchange rate[9]. As in the US, conclusions on the impact on GDP and inflation in the UK differ in magnitude, but all research papers report positive impacts. For instance, in a recent paper Weale and Wieladek (2014) estimated that asset purchases equivalent to one percent of GDP led, respectively in the US and the UK, to a 0.36 and 0.18 percentage-point increase in real GDP and to a 0.38 and 0.3 percentage-point increase in CPI after five to eight quarters.

    2. 2014: Addressing weak inflation in the euro area

    2.1 What is the current problem to solve in the euro area?

    The ECB’s current situation is very different from the one it faced in the immediate aftermath of the financial crisis. The liquidity crises in the banking sector and in the periphery’s sovereign markets seem to be fading as speculation about the break-up of the euro area has clearly receded. The interbank market has been revived and European sovereign yields are now at very low levels, including for periphery countries, since uncertainty about the integrity of the euro area was dissipated by President Draghi’s commitment to do “whatever it takes” to preserve it, when he announced the OMT programme in September 2012. On top of that, the structural weaknesses of the European banking sector are gradually being mended thanks to the ECB’s Comprehensive Assessment currently taking place. The main problem for the ECB at the moment is that inflation in the euro area has been falling since late 2011 and has been below one percent since October 2013. Core inflation, a measure that excludes volatile energy and food price developments, has developed similarly. Five of the 18 euro-area member countries (Cyprus, Greece, Portugal, Slovakia and Spain) have experienced negative rate of inflation in the last few months. Even in the countries that are not in a recession, such as Belgium, France and Germany, inflation rates are well below the euro-area target of close to but below two percent. More worryingly, the ECB’s forecast suggests that inflation will not return to close to two percent in the medium term. In the current European circumstances, low overall euro-area inflation implies that in some euro-area member states inflation has to be very low or even negative in order to regain competitiveness relative to the core. The lower the overall inflation rate, the more periphery inflation rates will have to fall in order to achieve the same competitiveness gains. Given that wages are often sticky and rarely decline, significant unemployment increases can result from the adjustment process. In addition, lower-than-anticipated inflation undermines the sustainability of public and private debt if the debt contracts are long-term nominal contracts. For governments, falling inflation rates often mean that nominal tax revenues fall, which makes the servicing or repayment of debt more difficult. More worryingly for the ECB, inflation expectations have been falling since at least mid-2012. Figure 6 presents expectations from two sources (an ECB survey and a market-based indicator) and for two maturities. The two-year-ahead expectations are significantly below two percent and even below one percent according to the market-based indicator. In the period relevant for the ECB, inflation expectations have thus become de-anchored from 2 percent. Lack of ECB action when the ECB’s own medium-term inflation forecasts fell below the two percent threshold was a signal to markets that probably resulted in the downward revision of longer-term inflation expectations. The ECB is now less effective in anchoring longer-term expectations to, or close to, the 2 percent level. Figure 6: Inflation expectations: ECB’s survey of professional forecasters (SPF) and market-based inflationary expectations in the euro area, 2002Q1-2014Q2 Source: ECB’s Survey of Professional Forecasters and Datastream. Note: In the ECB’s survey the horizon of “Long term” is not specified. Market-based expectations refer to overnight inflation swaps (OIS), which can be used as a market based proxy for future inflation expectations. The 2014Q2 values of market-based expectations are the average during 1-23 April 2014, while the latest available values for the SPF are end of March 2014. There are two other reasons that suggest that the ECB should have adopted additional monetary stimulus since the beginning of 2014. First, at a low level of inflation, the costs of deviation from the ECB’s forecast inflation are highly asymmetric. If inflation is higher than forecast, it would mean that inflation would be closer to the two percent threshold – a benign development. But if inflation is lower than forecast, then countries in the euro-area periphery would have to maintain even lower inflation or higher deflation, with risks for the sustainability of public and private debt. Second, the ECB’s inflation forecasts and market expectations have been unable to predict significant deviations from the two percent threshold (Figure 6). When there was a sizeable deviation, ECB forecasts and market expectations both predicted a gradual return to two percent, which happened in some cases (see, for example, the December 2011 forecast of the ECB), but most of the time did not. Figure 7: Inflation forecasts/expectations and actual inflation in the euro area Source: Datastream, ECB. Note: The HICP is defined as a 12-month average rate of change; in panel A, the ECB Staff projections indicate a range referred to as „the projected average annual percentage changes” (see https://www.ecb.europa.eu/mopo/strategy/ecana/html/table.en.html). For simplicity, we take the average of the given range. In panel B, market-based expectations refer to overnight inflation swaps (OIS), which can be used as a proxy for future inflation expectations. Overall, inflation has been falling significantly and so have inflation expectations. Inflation forecasts have proved consistently too optimistic about the return of inflation to the two percent threshold in the euro area. The ECB’s own forecast suggests that euro-area inflation will not return to close to two percent in the medium term, and we see a substantial risk that it will not return to this level even in the longer term.

    2.2 Will the new measures announced in June by the ECB be enough to bring back inflation to the 2% threshold in the medium term?

    As previously explained in Claeys et al (2014b), the ECB announced during its June 2014 press conference a broad package of measures to try to tackle the low inflation problem. The package aims to (a) ease the monetary policy stance, (b) enhance transmission to the real economy, (c) reaffirm the ECB's determination to use unconventional instruments if needed. In our assessment, the package really aims to tackle (a) and (b) but it is not a serious attempt to change inflationary dynamics with quantitative easing. We expect that the bundle of measures will have an effect on inflation. However, it is not as aggressive as it may look at first sight and further measures will likely be needed later. This package is really about a slight easing of monetary policy and about an attempt to improve monetary policy transmission by restoring the bank-lending channel. However, the small cut in interest rates (including putting the ECB deposit rate in negative territory) will have minor effects, while the effectiveness of the targeted longer term refinancing operation (TLTRO) will depend on whether banks will be ready to take up the liquidity. The problem with the euro area currently is, however, not the lack of liquidity but the lack of lending to the real economy. As explained earlier, banks actually pay back their previous LTROs. One of the main improvements of the TLTRO over the previous LTROs is that it will carry a fixed rate (current MRO rate + 10 basis points, i.e. 0.25% at the moment), and thereby a financial incentive to borrow from the ECB, as rates cannot go down further but instead can increase during the next four years. The other main improvement is that TLTRO is conditional on new lending to the real economy and to corporations in particular. However, all depends on the willingness of banks to use the TLTRO, but most importantly on whether there will be significant demand for credit coming from the corporate sector. In many countries, debt in the corporate sector is actually quite high and the sector is attempting to deleverage. So our take is that the TLTRO will help to reduce fragmentation but its effect on inflation may be less significant than hoped. The decision to suspend the sterilisation of the liquidity injected under the Securities Markets Programme (SMP) is questionable. The SMP had a particular goal: to address the malfunctioning of securities markets and to restore an appropriate monetary policy transmission mechanism, while not affecting the stance of monetary policy. With this decision, its aim is now changed to affect the stance of monetary policy. Such a change of a key parameter of an ECB decision undermines the reliability of other ECB commitments, which in turn introduces uncertainty about the parameters of other longer-term ECB commitments. If the ECB wanted to inject €175 billion liquidity into euro-area money markets (the current amount of SMP holdings), it would have been preferable to announce a new asset purchase programme to this end. In our view, the announcement of preparatory work for an ECB ABS purchase programme is more significant (even though the ECB has not provided any details about the size or the timing of those purchases). We expect this to lead to the emergence of a larger ABS market. However, the ABS market is currently very small, and the ECB intends to focus on ABS based on real loans to corporations (and not on complex derivatives, which is a good thing) and to exclude the ABS for residential mortgage-backed securities (RMBS), which is by far the largest ABS market in the euro area (as explained in the next section). So in fact, if the ECB was to decide to buy, it would very quickly buy up the entire current market. Consequently, the ECB's asset-purchase programme might be quite limited in scope. Of course, one could hope that the market will increase if the ECB starts buying, but it needs to be seen if the market can develop sufficiently quickly, as there are some regulatory barriers. The effect of this measure is again going to be mostly via better credit conditions. It will not substantially operate through a portfolio re-balancing effect. In the absence of a large-scale ABS purchase programme and with subdued demand for credit, the impact on the exchange rate could be quite limited. The element that is still missing in the package is a monetary policy measure that would substantially kick-start inflation in the core euro-area countries. A significant QE programme would have effects on core-euro area inflation as well as periphery inflation. The current package might not do that. Even though we welcome that the ECB has finally acted with a broad package, we think that further measure will likely be needed. We continue to believe that a more aggressive quantitative easing programme would anchor inflation expectations more significantly.

    2.3 Towards a large-scale asset purchase programme?

    As explained in detail in Claeys et al (2014a), we believe that the only option left for the ECB to be able to bring back inflation to the 2% thresholds as soon as possible is to follow the path of the Fed and the BoE and the adopt a quantitative easing strategy. However, given the differences between the euro area and the US or the UK, asset purchase will have to take a different form than in these countries. The following section summarises our recommendations on how a significant ECB asset-purchase programme should be designed to be effective and to bring back inflation and inflation expectations towards the 2% threshold in the euro area in the medium term.
    2.3.1 Asset purchase: size of the programme
    Setting the appropriate size of asset purchases is far from easy. Some analysis considered the total amount of asset purchases by the Bank of England and the Fed and suggested similar magnitudes for the euro area (20 to 25% of GDP, i.e. €1.9 to 2.4 trillion). In our view, a more relevant benchmark is the amount of purchases by the Federal Reserve in its third round of quantitative easing (QE3), announced in light of the weak economic situation of the US economy at a time when the acute face of the financial crisis was over – a situation that has similarity to the current euro-area situation. In September 2012, the Federal Reserve announced it would purchase $40 billion (€29 billion) agency mortgage-backed securities per month, an amount increased to $85 billion (€61 billion) in December 2012 (by adding $45 billion per month of Treasuries). Given that the euro area’s economy is about 30 percent smaller than the US economy, the same size, as a share of GDP, would be between €20 and €40bn per month in the euro area.
    2.3.2 Asset purchase: design principles
    In our view, the ECB will have to choose which assets to buy using five main criteria.
    • First, the ECB should buy assets that lead to the most effective transmission to inflation.
    • Second, there should be sufficient volume of the asset available, to ensure that the ECB can purchase appropriate quantities while not buying up whole markets.
    • Third, the ECB should try to minimise the impact on the private-sector allocation process. While QE by definition changes relative prices, the ECB should avoid buying in small markets and distorting market pricing too much. The more the ECB becomes a player in a market, the more it can be subject to political and private-sector pressures when it wants to reverse the purchases.
    • Fourth, the ECB should buy only on the secondary markets in order to allow the portfolio-rebalancing channel to work effectively. Purchasing on the primary market would imply the direct financing of entities, which should be avoided.
    • Fifth, the assets should only originate from the euro area and be denominated in euros, because of the February 2013 G7 agreement.
    The Treaty gives a mandate to the ECB to maintain price stability, not to protect its balance sheet. Some criteria on riskiness should be adopted, but we recommend a reasonable low threshold for credit risk, such as restricting asset purchases only to the eligible collateral (without any additional eligibility criterion).
    2.3.3 Asset purchase: composition
    According to the ECB, total marketable assets eligible as collateral represented almost €14 trillion at the end of 2013 (Figure 8), equivalent to 146 percent of euro-area GDP[10]. About half of the Eurosystem’s eligible collateral pool at the end of 2013 consisted of government bonds, while the other half was split between uncovered bank bonds, covered bank bonds, corporate bonds, Asset Backed Securities and other marketable assets (which include the debts of EU rescue funds and the European Investment Bank). A natural starting point for an ECB asset purchase programme would be euro-area wide government bonds, which do not exist. The closest proxy would be the bonds of European debt such as bonds issued by the European Financial Stability Facility (EFSF), the European Stability Mechanism (ESM), the European Union and the European Investment Bank (EIB). The total available euro-denominated pool of these bonds is around €490bn (€230bn for EFSF/ESM, €60bn for EU, €200bn for EIB). Buying such pan-European assets would not affect the relative yields of euro-area sovereign debts and would not distort the market allocation process within the private sector. Figure 8: Eligible assets and assets used as ECB collateral (€ bns) Source: ECB; Note: Eligible assets are in nominal values; assets used as ECB collateral are after haircuts and valuation issues. Latest data available: 2013 Q4 National sovereign debt would be a natural step as the bond market is very large and the positive effects of such a QE would be significant, via portfolio rebalancing, as well as the exchange rate, wealth and signalling channels. However, the purchase of national government debt is more complicated for the ECB as a supranational institution without a supranational euro-area treasury as a counterpart, than it was for the Fed or the Bank of England. First, with 18 different sovereign debt markets, the ECB would have to decide, which sovereign debt to buy. The purchase would alter the spreads between countries and change the relative price of sovereign debts, which may expose the ECB to political pressure and lead to moral hazard. Second, the treaty prohibits the monetary financing of government debt, and since the goal of asset purchase will be to meet the ECB’s primary objective of price stability, purchase of government bonds would be allowed if the risk of monetary financing could be excluded. Experience proves that all ECB bond-buying programmes are controversial and politically sensitive in this respect. Third, the ECB has a well-defined sovereign bond purchase programme, the OMT, which is a tool to improve monetary policy transmission in countries under financial assistance. It is debatable whether a QE programme based on capital keys of the ECB would undermine the logic of the OMT programme, but this could be a risk and it should be avoided. The second largest asset class is bank bonds, with €3.8 trillion available in eligible covered and uncovered bonds. Among the other effects, the reduction in market yields would also reduce the yields on newly issued bank bonds, thereby allowing banks to obtain non-ECB financing at a lower cost. This would improve bank profitability and could improve the willingness of banks to lend. However, bank bonds should be excluded from the ECB asset purchase programme until the ECB’s Comprehensive Assessment is concluded. Until then, ECB purchases would lead to serious conflicts of interest at the ECB and would make a proper assessment by the ECB more difficult. Moreover, those banks, for which the outcome of the Assessment is unsatisfactory, should continue to be excluded from the ECB’s asset purchases until they have implemented all the required changes to their balance sheets. This might take several months after the completion of the Comprehensive Assessment. While there is no precise data on their magnitude, we estimate that the lower bound of eligible euro-area corporate bonds would be €900 billion. In addition, the supply of corporate bonds in the euro area has been growing considerably since 2009. The euro-area corporate bond market is highly concentrated (figure 9), with the main issuers of corporate bonds being French companies. However, for portfolio rebalancing to work, the origin of the corporate bonds is of less importance. The beneficial effect would come from the fact that the current owners of the corporate bonds would sell their bonds and use the cash for different purposes throughout the euro area. The purchases would encourage new issuance of corporate bonds everywhere and lead to a diversification of the sources of funding. Lower funding costs for corporations should induce more corporate investment. Figure 9: Bonds vs. loans – financing of EU non-financial corporations (€ bns) Source: ECB. Note: The difference between the amount reported in this figure and the total eligible corporate bonds shown on Figure 10 comes from the fact that here we only consider corporate bonds issued by euro zone corporations, whereas eligible collateral include corporate bonds issued in the whole European Economic Area (EU countries and Iceland, Liechtenstein and Norway); see here: Another class of assets that could be bought by the ECB is asset backed securities (ABS). Yearly securitisation issuance – which peaked in 2008 – is much lower than in the US and has been decreasing since 2008. The total outstanding stock of securitised products has been stagnating at around €1.06 trillion for the euro area compared to €2.5 trillion in the US (AFME, 2014). Products eligible as collateral for the ECB amount to about €761 billion, but some of them originate from outside the euro area. We estimate that the lower bound of eligible euro-area ABS would be €330 billion. It is worth highlighting that defaults on ABS in Europe have ranged between 0.6-1.5 percent on average, against 9.3-18.4 percent for US securitisations since the start of the 2007-08 financial crisis[11]. The regulatory landscape for securitised products has also changed considerably since the crisis and made the products safer and more transparent[12]. Considering the total amount of European ABS, more than half (€612 billion) is based on residential mortgages, while SME ABS constitute a smaller part (€116 billion). That is why we think that ECB should be buying also RMBS as they represent the biggest pool of ABS and would allow the ECB to have a more significant programme without buying the whole market. As shown in Wolff (2014), the ECB should not be afraid of a potential housing bubble in Germany given that the current price increase is not financed by a rise in the volumes of mortgages in Germany. The ABS stock outstanding is unequally distributed across countries[13], with the main issuers being different from the main issuers of corporate bonds. ABS purchases would be concentrated on the Netherlands, Spain and Italy and could therefore be a good geographical complement to corporate bond purchases, which would be concentrated in France, Germany and Italy. An ECB purchase could promote the development of securitisation in the euro area. The potential for securitisation is relevant, as many loans would qualify for securitisation and in March 2014 the outstanding amount of loans to non-financial corporation stood at €4.2 trillion and to household at 5.2 trillion in the EU[14]. From a monetary policy perspective, it would be very beneficial to create ABS that are based on a portfolio of European assets. Ideally, the credit risk should be pooled at the level of the private sector, thereby deepening cross-border financial integration. However, the ECB should not wait for developments in the ABS market to start buying securitised products.

    REFERENCES

    • Chen, Han; Cúrdia, Vasco and Ferrero, Andrea (2012) ‘The macroeconomic effects of large-scale asset purchase programs’, The Economic Journal, vol. 122(564), pp. F289–315, November
    • Chung, Hess; Laforte, Jean-Philippe; Reifschneider, David and Williams, John C. (2012), ‘Estimating the macroeconomic effect of the FED’s asset purchases’, FRBSF Economic Letter 2001/03, January
    • Claeys G., Z. Darvas, S. Merler and G. Wolff (2014a), ‘Addressing weak inflation. The European Central Bank's shopping list’, Bruegel Policy Contribution, 2014/05 May
    • Claeys G., Z. Darvas, and G. Wolff (2014b), ‘ECB shows activism but falls short of true QE’, Bruegel Blog, June 5
    • Darvas, Zsolt (2013), ‘Banking system soundness is key to more SME’s financing’, Bruegel Policy contribution 2013/10, July
    • Gagnon, Joseph; Raskin, Matthew; Remache Julie and Brian Sack (2011), ‘The Financial Market Effects of the Federal Reserve’s Large- Scale Asset Purchases’. International Journal of Central Banking 7, no. 1: 3–44.
    • Hancock, Diana and Wayne Passmore (2011), ‘Did the Federal Reserve’s MBS purchase program lower mortgage rates?’, Journal of Monetary Economics, vol.58 no.5, pp.498-514
    • Krishnamurthy, Arvind and Annette Vissing-Jorgensen (2013) ‘The Ins and Outs of LSAPs’
    • Krugman, P. (1998). ‘It's baaack: Japan's slump and the return of the liquidity trap’. Brookings Papers on Economic Activity, 137-205.
    • Joyce, M., D. Miles, A. Scott, and D. Vajanos (2012), ‘Quantitative easing and unconventional monetary policy – an introduction’ The Economic Journal, 122, pp. F271-288, November
    • Meier (2009) ‘Panacea, Curse, or Nonevent?’ Unconventional Monetary Policy in the United Kingdom.’ IMF Working Paper 09/163, August
    • Papadia, Francesco (2013) ‘Should the European Central Bank do more and go negative?’, Blog post: Money matters? Perspectives on Monetary Policy
    • Sapir, André and Wolff, Guntram B. (2013), ‘The neglected side of banking union: reshaping Europe’s financial system’, Note presented at the informal ECOFIN, September
    • Weale, Martin and Tomasz Wieladek (2014), ‘What are the macroeconomic effects of asset purchases?’, Bank of England, External MPC Unit, Discussion Paper no. 42, April
    • Wolff, Guntram (2013), ‘The ECB’s OMT programme and German constitutional concerns’, in Brookings, The G20 and Central Banks in the new world of unconventional monetary policy
    • Wolff, Guntram (2014), ‘Easier monetary policy should be no worry to Germany’, Bruegel Blog, June 4

    [1] Excess liquidity can be computed as (current account + deposit facility – minimum reserves) or as (MRO + LTRO + Marginal Lending – Autonomous Factors – minimum reserves) [2] ee Angelini et al. (2011); Lenza et al. (2010); Darracq Pariès and De Santis (2013); Abbassi and Linzert (2011) [3] See Manganelli (2012); De Pooter et al. (2012); Ghysels et al. (2012) [4] European Central Bank, 2012. “6 September 2012 - Technical features of Outright Monetary Transactions.” Available at http://www.ecb.europa.eu/press/pr/date/2012/html/pr120906_1.en.html [5] European Central Bank, 2013. “Introductory statement to the press conference (with Q&A)” available at http://www.ecb.europa.eu/press/pressconf/2013/html/is130704.en.html [6] Praet P. (2013). “Forward guidance at the ECB”, http://www.voxeu.org/article/forward-guidance-and-ecb [7] The expression credit easing is also used when private sector securities are purchased. [8] Other papers suggest similar results: D’Amico and King (2010), Krishnamurthy and Vissing-Jorgensen (2011), Neely (2012) and Hamilton and Wu (2012). [9] For instance Meier (2009) shows that initial QE announcements reduced gilt yields at least by 35–60 basis points whereas Joyce et al. (2011) estimated that medium-to- long-term gilt yields fell by 100 basis points overall, summing up the two-day reactions to the first round of the MPC’s announcements on QE purchases during 2009–10. They also found that similar falls occurred in corporate bond yields and that there were also announcement effects on the sterling exchange rate, therefore validating the existence of a portfolio rebalancing channel and exchange rate channel of QE. [10] In the permanent collateral framework, only euro-denominated securities are accepted, but under the temporary collateral framework introduced during the crisis, also assets denominated in USD, JPY and GBP are accepted. See: http://www.ecb.europa.eu/pub/pdf/other/collateralframeworksen.pdf [11] http://www.bis.org/review/r140407a.htm [12] Retention requirements – which should induce seller of ABS to monitor carefully the underlying collateral – have been introduced in the context of the EU Capital Requirements Directive, and the EBA is working on the technical details (i.e. 5% retention requirement):
    https://www.eba.europa.eu/-/eba-publishes-final-draft-technical-standards-on-securitisation-retention-rules [13] See details in Claeys et al. (2014a) [14] According to the calculation in Darvas (2013), out of these €4.2 trillion, the stock of SME loans in the EU in 2010 represents approximately €1.7 trillion and the largest stocks of SME loans were in Spain (€356bn), followed by Germany (€270bn), Italy (€206bn) and France (€201bn). ]]>
    Wed, 09 Jul 2014 00:00:00 +0100
    <![CDATA[Antitrust risk in EU manufacturing: A sector-level ranking]]> http://www.bruegel.org Based on a dataset of manufacturing sectors from five major European economies (France, Germany, Italy, Spain and the United Kingdom) between 2000 and 2011, we identify a number of key sector-level features that, according to established economic research, have a positive impact on the likelihood of collusion. Each feature is proxied by an ‘Antitrust Risk Indicator’ (ARI). We rank the sectors according to their ARI scores. At 2-digit level, sectors that appears more exposed to collusion risk are those that tend to score high in most of the ARIs: Tobacco, Pharmaceuticals, Beverages, Chemicals. The 4-digit analysis suggests higher anticompetitive risk in Tobacco products, Spirits, Sugar, Railway Locomotives and Aircraft (high concentration and fixed costs), Coating of Metals and Printing (low import penetration), Tobacco products, Meat products, Footwear and Clothing (high market stability), Plastic products and Spinning/Weaving of textiles (high symmetry of market leaders). We then rank sectors according to the distribution of antitrust intervention by the European Commission between 2000 and 2013, in terms of merger control and anti-cartel enforcement. Tobacco, Paper and paper products, Pharmaceuticals and Food products are the sectors for which a notified merger has a greater likelihood of being deemed problematic by the Commission. There has been a greater incidence of anti-cartel action in Chemicals, Tobacco, Beverages, Electric equipment and Rubber and plastic. Antitrust investigations are based on the identification of narrow product markets. The characteristics of these markets are not necessarily well represented by average measures at sector level. Nevertheless, a simple comparison exercise shows that the European Commission’s interventions have been largely consistent with sector rankings based on market concentration

    Introduction

    The object of this paper is twofold: to provide a broad descriptive analysis of the risk of collusive behaviour throughout Europe in the manufacturing sector; and to identify those manufacturing sectors in which the European Commission has been more active in the past in its capacity of antitrust authority. This paper is close in spirit to industry and market studies, although our target is wider and encompasses the whole manufacturing sector in Europe, as explained further below. Our methodology resembles Ilzkovitz et al (2008), in which the authors couple a variety of product market indicators to measures of antitrust enforcement to determine whether an economic sector is characterised by weak competition. In the manufacturing sector they identify Basic metals and Motor vehicles as the sectors in which competition issues are more likely to arise. Symeonidis (2003) asks in which United Kingdom manufacturing industries collusion is more likely, finding no clear link with industry concentration (industries where collusion had a higher incidence were Basic metals, Building materials and Electrical engineering). Yet Symeonidis's (2003) analysis is based on observed collusive agreements that were considered lawful during the period of observation1. Our aim instead is to investigate potential infringements of competition law that could be pursued by an antitrust authority. During our observation period, collusion is illegal and therefore participating to a cartel is risky: the inability to coordinate in an explicit and transparent manner between market players and the threat of antitrust intervention make collusion instable. We are looking after market characteristics that help counter-balancing those effects and make collusion more likely in this context. The exercise that we propose in this paper, ranking economic sectors according to their predisposition to collusion, has an intrinsic limitation. The antitrust definition of a market (our theoretical subject of study – referred to in this paper as 'antitrust market') is conventionally based on tests, such as the SSNIP test2, that identify the boundaries of a market by measuring the degree of competition that different products exert on each other. If two products are very good substitutes – such that a significant proportion of demand and/or of supply would shift to one product if the price of the other is changed - then the products are considered to belong to the same market. This often leads to markets the boundaries of which are much narrower than those captured by product classification at sector level. However, macroscopic analysis such as the one proposed in this paper, is necessarily based on sector data: that is, data that aggregate information from multiple markets that are grouped together for statistical purposes. In fact, we are only able to capture an imperfect link between antitrust markets and the observable average performance of the sectors they belong to. Previous research has been confronted with the same challenge (see, for example, Griffith et al, 2010, on the effect of the EU Single Market Programme on mark-ups and productivity). To partially mitigate that problem, we focus on market characteristics that we presume could be shared by the majority of products within the same statistical sector. This would be the case if, for example, antitrust product markets within a certain sector share regulatory features (eg similar barriers to entry), production features (eg similar levels of economies of scale) or demand characteristics (eg a customer base which is largely the same). To rank sectors according to their predisposition to collusion we follow the common wisdom in economic literature concerning the role of market’s structural features (see, for an exhaustive overview: Ivaldi et al, 2003, or Motta, 2004). The general intuition is that the more concentrated, stable and transparent markets are, the easier is for players to coordinate on a collusive price and stick to it without yielding to the temptation of undercutting the rivals and break the cartel agreement. On the basis of the available data (see Section 2 below), we are able to measure proxies and account for the following factors: (1) market concentration; (2) likelihood of entry; (3) stability of demand and supply; (4) market symmetry3. The treatment and measurement of each factor is described in the next Section. In the second part of our analysis we look at antitrust intervention by the European Commission. We look specifically at merger investigations and cartel infringement decisions. Both types of competition policy interventions give insights about the treatment of collusion likelihood by a competition authority. Regarding merger control, a merger has a higher chance to be considered 'problematic' from a competition policy perspective if it occurs in an already malfunctioning market where concentration levels are high, likelihood of entry is low, and supply and demand are relatively inelastic. A crucial determinant of a merger decision is, moreover, whether a merger has 'coordinated effects' ie whether the merger will make future collusion more likely. Finally we propose and discuss a simple comparison exercise: the European Commission’s antitrust action is matched with the ranking of manufacturing sectors according to their collusion risk. Gual and Mas (2011) have an approach broadly similar to ours. They focus on Commission antitrust investigations only (ie they do not look at merger decisions), between 1999 and 2004 and check whether the probability of dropping the investigation is lower when industry characteristics suggest a lower likelihood of antitrust infringement. They find positive and weakly significant links consistent with theoretical prediction. For example, higher industry concentration rates are positively correlated with the probability of antitrust sanctioning. It is important to stress that this exercise suffers from the fundamental limitation described above: that sector data does not necessarily convey information for antitrust product markets. Therefore, while the exercise can provide for an interesting consistency check between antitrust action and status of competition at sector level and deliver suggestions for follow-up inquiries, it should not in itself be used in a normative fashion to judge the quality of antitrust intervention. An ad-hoc case-by-case ex-post analysis should instead be performed for that purpose (see Neven and Zenger, 2008, for a good overview of the literature). The paper is organised as follows. We first provide an illustration of the Antitrust Risk Indicators. We then describe our data sample in Section 2. Section 3 reports the sectors’ rankings and discusses the results. Section 4 concludes.

    1. The Antitrust Risk Indicators

    Below we report and explain the construction of the Antitrust Risk Indicators (ARIs) used to rank sectors’ predisposition to collusion. A good summary of the underlying economic theory can be found in Motta (2004). Note that the indicators are computed at European wide level (ie they are cross-country averages) and on a 10 years-wide time period (with two exceptions described below). We are in fact interested in capturing the probability of potential cartels with boundaries that are wider than national, to identify true 'European' issues4. Moreover the time period of observation has to be sufficiently long as anti-competitive behaviours are usually put in place for years (for example: the average duration of an international cartel is between 6 and 14 years – See Mariniello, 2013). We note that market structures are generally stable over time; in other words, to give an example: the average market performance within the tobacco sector during the period 2000 and 2011 is a good proxy of the performance of the tobacco sector at any point of time during that period. Again, this is the case if, despite changes prompted by regulatory intervention, sectors tend to preserve their key structural features over time, at least in relative terms if compared with other sectors of the economy. The literature reports consistent findings5. (1) Market concentration A higher degree of market concentration is associated with higher likelihood of collusion. It is easier to coordinate and reach a collusive agreement within a smaller group of players. Also, if concentration is high, deviation from a collusive equilibrium is less profitable: the remaining slice of the market a player would grab by undercutting rivals is smaller if compared to a market where many players are active. This means that cartels are generally more stable when markets are more concentrated. We use three measures to proxy the average level of market concentration within a sector: the average price-cost margin for the period 2000 – 2011, the industry concentration ratio for 2010 and the Herfindal-Hirschman Index (HHI) for 2010. Price-cost margins have been widely used in the literature to proxy the degree of market concentration (See Griffith et al, 2010), as the companies’ ability to extract rents and increase the gap between marginal costs and prices is decreasing in the level of competition in the market. They are, however, imperfect indicators: margins may be high, for example, because companies are more efficient or because they benefit from economies of scale, but calculating exact firm-level marginal cost is an extremely difficult exercise affected by other limitations (see Altomonte et al, 2010, for an example of such an exercise). We resort to use sector-wide production value and average variable costs as proxy of marginal costs; that is: we use the sum of the costs of labour, capital and all intermediate inputs as in Griffith et al (2010)6. In order to accommodate for the limitations of price-cost margins measures, we complement that indicator with industry concentration ratios and HHI indexes, calculated respectively as the simple sum of companies’ market shares and the sum of the square of companies’ market shares. These are also widely used measures of concentration (see Ilzkovitz et al, 2007), even if they are possibly even more subject to the fundamental limitation that affect macro-analysis as described above: market shares at sector level are not necessarily a good proxy of market shares at market level. In our case, moreover, market shares are available only for the biggest 4 companies in the sector and only for year 2010. We construct the indicators accordingly: C4 is the sum of the market shares of the four biggest companies in the sector in 2010; HHI4 is the sum of the square of the market shares of the four biggest companies in the sector in 2010. (2) Entry Entry has a disruptive effect on collusive behaviour. The mere threat of entry makes collusion less sustainable: when effective entry is likely, incumbent players may find it difficult to maintain high prices in the market without risking sudden loss of customers. Moreover, a high firms’ turnover implies that coordination is less likely: instability in the identity and in the number of counterparts make collusive agreements more difficult to reach. Sectors where entry is more likely should therefore ceteris paribus be associated with lower probability of collusion. Our dataset does not contain information that can directly help measuring the likelihood of entry; likewise, it does not contain information on the pattern of actual entries by new companies that occurred in the period of observation. The data report just the change in number of companies and do not disentangle entry from exit. Low growth rates may therefore mean low entry rates or high entry rates accompanied by equally high exit rates. The change in the number of companies cannot therefore be used to proxy entry. We nevertheless can exploit the information available in our dataset to measure proxies that provides indications on the degree of a sector’s openness to outside competitive pressure. To do so, we build 2 indicators: (a) firms’ size and (b) import penetration. Firms’ size is computed as the average size of companies within the sector during the period of observation (2000-2011). Relatively bigger sizes imply the existence of economies of scale, possibly due to higher fixed costs and barriers to entry. Bigger average size should therefore imply lower likelihood of entry7. Import penetration is the yearly average of sector imports divided by sector production. This indicator is again computed over the period 2000-2011. A high ratio of imports over total production suggests that the sector tends to have relatively lower barriers to entry to foreign competitors. Moreover, it is reasonable to assume that reaching a collusive agreement with exporters is comparatively more difficult: exporters, for example, tend to be exposed to different costs shocks. Therefore it would be more difficult for local producers to explain price changes by exporters and detect potential deviation from collusive outcomes that may not be justified by change in production costs. (3) Market stability Stable markets are more predisposed to collusion. Collusive agreements crucially rely on players’ ability to capture other players’ deviation from the agreed price. When markets are subject to frequent and unpredictable demand or supply shocks, attributing a change in price to a deviation is more difficult, therefore collusion is less stable. We compute two indicators to capture markets’ stability: (a) variance in market size and (b) variance in import penetration. Variance in market size is computed as the variance of the yearly growth rate of production values in nominal terms. Variance in import penetration is the variance of the yearly growth rate of the ratio of imports over total production. The two variables are calculated over the full period of observation 2000-2011. High variance levels are presumed to indicate lower market predictability and lower likelihood of collusion. (4) Market symmetry The last dimension of analysis is market symmetry. Symmetric markets where players hold similar market shares tend to be more predisposed to collusion. Symmetry aligns players’ incentive to stick to a cartel agreement. Conversely, if a company is much smaller than the others, it may have a relatively higher incentive to deviate, undercut its rivals and enjoy all market’s profits. To test for symmetry we compute an Asymmetry Indicator based on Gini’s coefficient8. In our case we employ it on the distribution of the production shares of the top four companies in each sector for year 2010. If the asymmetry indicator is 0, that indicates that the four observed companies have identical production shares ie the market is perfectly symmetric. When the indicator instead approaches 100 that meansthat there exists a huge gap between the market share held by the biggest company and the one held by the smaller ones9.

    2. The Dataset

    Our dataset contains a number of widely-used data for European manufacturing sectors from 2000 to 2011 for 5 European countries: France, Germany, Italy, Spain and UK. The 5 economies together represent 71 percent of the EU GDP10, in 2011, while the manufacturing sector in the five countries observed represents on average 12.5 percent of a country’s GDP11. The primary sources for data are National Accounts, Structural Business Statistics and International Trade databases. The aggregate statistics were compiled by Euromonitor12. The market features variables contained in our database are: total production, value added, gross operating surplus, market size, imports, exports, production and number of firms by employment size, production value and production shares of up to five top companies (all monetary data is recorded in euro)13. Using Eurostat NACE 2-digit classification14, the manufacturing sector can be split in 22 categories: Food products, Tobacco, Textiles, Wearing apparel, Leather products, Wood and wood products, Paper and paper products, Reproduction of recorded media, Chemicals, Pharmaceuticals, Rubber and Plastics, Other non-metallic mineral products, Basic metals, Fabricated metal products, Computers and electronics, Electrical equipment, Machinery and equipment, Motor vehicles, Other transport equipment, Furniture, Other manufacturing15. The 4-digit disaggregation results in 92 sub-categories. The below table provides an overview of the database with few key descriptive statistics relative to 2010 for 2-digit sectors aggregated across the five economies. As it can be noted the total manufacturing production for our database amounted to €3.5 trillion, with the Food, Motor vehicles and Fabricated metal sectors topping the list in terms of production and value added. As for the demand-side, the five economies consumed €3.9 trillion with the Food and Motor vehicles sectors again on the top 3 by market size, and Computers and electronics coming third. The latter sector is ranked first also in terms of imports. Noticeably, imports and exports are originally defined at country level and therefore these aggregates include intra-group trade. The smallest sectors are Tobacco, Electrical equipment and Wood16 by either production or value added. The highest numbers of companies are in the Fabricated metal and Food sectors, with more than 180 thousands firms.

    3. Results

    3.1 Sector ranking – Antitrust Risk Indicators

    Table 2 and Table 3 above report the ranking of all sectors according to each of the ARI indicators (table 2 reports ranking based on 2-digit aggregation data, table 3 on 4-digit). In terms of market concentration, there is a general consistency between the three indicators, price-cost margins, C4 and HHI4, particularly in pointing to the most concentrated sectors: Tobacco, Beverages and Pharmaceuticals. Reproduction of recorded media and Chemicals, Motor vehicles and Electrical equipment score high respectively in terms of price cost margins and HHI(4) and C4. Divergences between indicators are possibly due to differences in cost structures (this should be the case for Motor vehicles and Other transport equipment for example)17 or differences in the size of antitrust markets. For example, Reproduction of recorded media scores very low for HHI(4) and C4. That is possibly due to the fact that products in these sectors tend to be more heterogeneous and therefore less substitutable to each other. Therefore, even if several players are active in the sector (hence market shares at sector level are low), each player can still enjoy a certain degree of market power (hence price-cost margins are high), because the products sold may not have immediate close substitutes, or be perceived as such by customers. The opposite holds for Electrical equipment and Basic metals: if price-margins are relatively low despite high market shares, that may be due to a higher degree of substitutability between products. Table 3 provides a more disaggregated insight by ranking 2-digit sectors according to the highest score reached by any of their 4-digit sub-sectors. No great difference is noted with the NACE-2 results. Tobacco, Pharmaceuticals and Beverages (Spirits and Beer) still rank high. Interestingly, Food climbs up the concentration ranking thanks to the low level of competition detected in the Sugar market. Other transport equipment (Locomotives and Aircrafts) scores high in terms of market share concentration. Concerning entry, we note that, consistently with intuition, the firm size indicator is highly correlated with concentration. Tobacco, Motor Vehicles, Pharmaceutical, Chemicals, Beverages, Electric equipment, Basic metals are in the upper half of the ranking. This is not surprising given the relevance of research and development or high fixed entry costs and economy of scale featuring most of the products manufactured in these sectors. The NACE-4 analysis confirms Sugar (Food category) as a potentially problematic market, together with Tobacco, Aircraft and Spacecraft (Motor Vehicles), Plastic (Chemicals). The other entry indicator we use, “import penetration”, scores low for sectors were production tends to have a more narrow geographic scope (Reproduction of recorded media and in particular at 4-digit level, Printing) or has a stronger local dimension (Tobacco, Fabricated/Coated Metals, Other Non-metalic/Cement, Beverages/Soft drinks), while import penetration is high where multinational companies tend to be more present: Computer and electronics, Pharmaceuticals, Chemicals, Motor vehicles. In terms of market stability, Tobacco, Food, Beverages and Pharmaceutical are amongst the sectors where demand varied the least during the period of observation (beside Wearing apparel, a result driven by the stability of the Clothing sector, as the 4-digit analysis shows). Import penetration is stable the most in Rubber and plastics, Wearing apparel, Electrical equipment, Wood and wood products. The lack of overtime variability may be due to the relevance of products where demand is notoriously less elastic (Meat products, Clothing, Tobacco, Beer and Footwear, Clothing, Pulp, paper and paper board, Plastic products, respectively for market size and import penetration variance at 4-digit level). Finally, the least “asymmetric” sectors according to our Gini-indicator seem to be Rubber and plastic, Textile, Electrical equipment and Tobacco.

    3.2 Sector ranking – European Commission Merger and Anti-Cartel Decisions

    Table 4 above reports the ranking of manufacturing sectors on the basis of European Commission’s merger and cartel investigations during the period 2000 - 2013.18 The database was assembled downloading the decisions’ record from the Commission’s website and allocating them to sectors according to the reported economic classification. If more than one sector was reported, all indicated sectors were compiled as affected by the decision. For merger investigations we collected three types of information: the number of mergers that were unconditionally cleared in ‘first phase’ ie after a preliminary inquiry usually requiring 1 month of investigation; the number of mergers that were cleared in first phase but did instead require the parties to commit to certain conditions; the number of mergers for which a deeper investigation (‘second phase’, usually lasting approximately 4 months) was deemed necessary. We define as ‘potentially problematic’ a merger that was deemed as such at the end of the first phase investigation by the European Commission either imposing conditions or requiring further scrutiny in second phase.19 The ratio between potentially problematic mergers and the total number of scrutinised cases is the likelihood indicator used to rank sectors. Sectors display a high heterogeneity in terms of incidence of merger control. The sector where merger scrutiny took place most often is Chemicals with an overall count of 259 decisions, while only 6 mergers were scrutinised in the Tobacco and the Leather sectors during the period of observation. Since most of mergers are cleared without conditions, the likelihood that a merger is deemed potentially problematic by the European Commission is on average low (approximately 11 percent for the manufacturing sector as a whole). The index however varies substantially across sectors. Sectors where the index scores higher are Paper and paper products (25.4 percent), Pharmaceuticals (25 percent), Chemicals (15.1 percent), Other manufacturing (14.6 percent). At the other end, the risk of a finding of problematic merger by the European Commission is lower in Motor vehicles (1.9 percent), Wearing apparel (5.6 percent), Electric equipment (6.5 percent). Tobacco (50 percent) and Furniture and Leather (0 percent) are clearly outliers (these results are due to idiosyncratic factors and the small number of observations). As for hard-core cartels, the Commission took decisions concerning 16 of the 22 sectors during the period of analysis. Chemicals account for the majority of rulings, 27 out of 65. Sectors with no uncovered cartels are Leather, Wood, Recorded media, Other transport equipment, Furniture and Other Manufacturing. To rank the sectors, we weighed the number of cartels to the size of the market as a share of total production in manufacturing. In the resulting ranking the sectors where the incidence of anti-cartel action was stronger in the period of observation are Chemicals, Beverages, Electrical equipment and Other non-metallic mineral products. Tobacco scores high as well, but again this might as well be due to the very small size of the sector compared to the other sectors, since just one cartel in Tobacco was sanctioned by the EC during the period of observation. It is interesting to note that the likelihood that a merger is deemed problematic and the weighed incidence of anti-cartel enforcement are highly and significantly correlated: 51.5 percent (5 percent significance level). This provides comfort that economic sectors’ features affecting the probability of collusion play a role in determining the outcome of merger decisions.

    3.3 Sector ranking - comparative exercise

    We now proceed with an illustrative comparative exercise. Figure 1 below attributes colours to sectors according to their performance with respect to the different computed indicators. The idea is to give a graphical glimpse of the consistency between Antitrust Risk Indicators and the action of the European Commission. As explained above, this exercise is useful to check whether antitrust intervention is more frequent where it is expected to according to from a macro-economic perspective. It is important to keep in mind, though, that this exercise cannot provide indications as regards the quality of antitrust intervention, given the fact that sector data are not disaggregated enough to capture the boundaries of product markets as defined in the course of antitrust investigations. The coloured squares in figure 1 reflect the ranking of the sectors ordered according to their anticompetitive risk or the intensity of antitrust action: red corresponds to the seven sectors at the top, green to the seven sectors at the bottom, and yellow to the eight sectors in the middle. Red sectors in terms of “problematic merger risk” are, as described above: Tobacco, Pharmaceuticals, Chemical, Food and Paper; in terms of risk of cartel conviction, red sectors are: Tobacco, Beverages, Other non-metallic, Chemicals, Electric equipment, Rubber and plastic, Wearing apparel. Figure 1 suggests a significant degree of consistency between European Commission’s action both in terms of merger control and anti-cartel enforcement and ARIs related to market concentration and firm’s average size (simple correlation analysis point to significant correlation coefficients between 45 percent and 75 percent). A much lower degree of consistency is observed as regards the other ARIs and correlation results are all not statistically significant. The variance of market size (a negative proxy of market stability) is however broadly consistent with merger decisions for what concerns negative decisions ie: sectors such as Tobacco, Food products, Pharmaceuticals, Paper and paper products are ranked top both in terms of lack of market variance and of probability of negative merger decision. Cartels discovery seems also overall consistent in the top ranking for what concern import penetration (Tobacco, Other non-metallic mineral products and Beverages), variance of market size (Wearing apparel, Tobacco and Beverages), variance of import penetration and market symmetry (Rubber and plastic, Wearing apparel, Electrical equipment and Other non-metallic mineral products).

    4. Conclusions

    In this paper we have analysed features of European manufacturing sectors. We ranked sectors according to their performance based on indicators that economic wisdom suggests positively affect the likelihood of collusive behaviour by market players. At 2-digit level, sectors that appear more exposed to collusion risk are Tobacco, Pharmaceuticals, Beverages, Chemicals. The 4-digit analysis suggests higher anticompetitive risk in Tobacco products, Spirits, Sugar, Railway Locomotives and Aircrafts (high concentration and fixed costs), Coating of Metals and Printing (low import penetration), Tobacco products, Meat products, Footwear and Clothing (high market stability), Plastic products and Spinning/Weaving of textiles (high symmetry of market leaders). We also have ranked sectors according to the distribution of European’s Commission’s antitrust intervention between 2000 and 2013 in terms of merger control and anti-cartel enforcement. Tobacco, Paper and paper products, Pharmaceuticals, Food products, are the sectors in which a notified merger has a greater likelihood of being deemed problematic by the Commission. The incidence of anti-cartel action has been higher in Chemicals, Tobacco, Beverages, Electric equipment and Rubber and plastic. We then checked the consistency of the European Commission’s action with the prediction of economic theory based on sector data, bearing in mind that sector data cannot provide for indications on the quality of antitrust intervention given the fact that antitrust investigations are based on very narrow product market definitions. The comparison exercise suggests that, by and large, both merger control and anti-cartel action have been focusing on sectors displaying a higher level of market concentrations and economic rents or economy of scale. This paper has a descriptive nature and should be taken as a starting point for a deeper reflection on the choice of appropriate instruments to foster competition in European manufacturing sectors and the definition of intervention priorities. Without appropriate regulatory intervention, ex-ante monitoring by the antitrust authority is warranted. The action of the European Commission is sometimes considered to be too much 'case-driven'. Cartels are discovered through whistle-blowers, abuse of dominance or anti-competitive agreements’ investigations are prompted by complaints. Because of such an approach, the restoration of normal competitive conditions that antitrust intervention is supposed to bring comes often with a significant delay with respect to the starting of the infringement. Uncovered cartels’ duration, for example, fluctuates between 6 to 14 years (see Mariniello, 2013) from their commencement. During that time, cartels affect the economy through a higher burden on customers and ultimately on consumers. It would thus be more efficient to anticipate the breaking down of cartels by investing resources in uncovering cartels to monitor markets in which infringements are more likely. The European Commission already has the tools to perform such a job through so-called 'sector inquiries'; an appropriate use of those tools in the identified sectors could yield significant social benefit. *** 1 Symeonidis (2003) uses agreements between competitors that were formally registered in compliance with UK Restrictive Trade Practice Act of 1956 as indication of an industry’s propensity to collusion; those agreements were at the time considered lawful. 2 See Amelio and Donath, 2009. 3 There are other factors which may be relevant to explain the likelihood of collusion in a certain market: for example, the existence of cross-ownership links between players or the frequency of their multi-market contacts. However, to our knowledge those factors are not available at sector level and are therefore excluded from our analysis. 4 We presume that the average markets’ performance across the 5 countries reported in our dataset is a good approximation of the average performance of a cross-border market within the European Union. For the sake of illustration, consider the following example: we assume that averaging out the concentration ratio within the tobacco sector in UK, France, Germany, Italy and Spain yields a good approximation of the average concentration ratio of a market within the tobacco sector that has an international dimension (that is: it is not confined to just one European country and therefore falls in the competence of the European Commission). The validity of this presumption crucially depends on the degree of commonality that sectors have across countries in Europe. If the tobacco sector is very open to competition in UK while little competition in the same sector occurs in Italy, then the cross-country average may bear little indication as to the level of competition of a hypothetical tobacco market affecting Italy and UK. Instead, if cross-country variability is limited, this would suggest that sectors have intrinsic characteristics that, despite idiosyncratic country characteristics (such as domestic regulatory policy) are conducive to similar market structures. For example: a production process typically implemented in a certain sector may give raise to sector-specific economies of scale, resulting in more concentrated markets. Strong and highly significant pairwise correlations between EU-wide and national indicators in our dataset support such presumption. Confirmations are also found in the empirical literature. Hollis (2003) for example finds that concentration ratios in 82 sectors are very similar across five European economies (Belgium, France, Germany, Italy and the UK), the US and Japan. 5 Veugelers (2004) analyses 67 manufacturing sectors in the EU15, finding that concentration ratios tend to be quite stable over time. Persistency checks ran on our database point to strong and highly significant cross-year correlations for price-cost margins, import penetration and firm size. 6 We implement Griffith’s methodology except that we do not subtract for the capital costs because of data availability. 7 Alternative measures could be used to proxy entry (such as ‘business’ churn rate’ ie the sum of firms’ birth and date rate) using Eurostat and OECD datasets. However, we believe that using average firm size as an indication of barriers to entry is a better option. First, because the data on firm size are reported at a higher level of disaggregation (up to 4-digit in our dataset, while business’ churn rate is limited to 2-digit in the Eurostat/OECD dataset). Second, because the number of companies that enter or exit a sector is less informative about the disruptive power that those firms can exert on potential collusive agreements. A high number of small firms entering small markets within a sector affect positively the sector’s business’ churn rate, but this is unlikely to represent a threat to collusive agreements between bigger companies in wider markets. An extended discussion on alternative indicators to measure entry likelihood is reported in the Appendix. 8 The Gini index expresses inequality among values of a frequency distribution and ranges from 0 (complete equality) to 100 (extreme inequality). 9 Formally, we compute the Gini index as follows: Index = 1- (7*x4 + 5*x3 + 3*x2 + x1)/4; where x1 is the production share of the top company normalized to the production share of the four companies (or concentration ratio). 10 Source: Eurostat. 11 Source: The World Bank. 12 Euromonitor International (link) is a research and data company that collects and aggregate data at sector level from official sources as well as through market research. The data obtained through market research in our dataset consists of production value and production shares for the year 2010 of up to five top companies for all manufacturing sectors in the 5 target economies for our analysis. 13 Total production is the total revenue of all locally-registered companies, excluding taxes and subsidies on products like VAT; valued added equals total production minus intermediate consumption; the gross operating surplus equals value added minus labour costs and taxes less subsidies on production and therefore includes the remuneration of equity and the depreciation of capital; market size consists of the value of all goods and services sold, either from local or foreign producers and recorded at purchaser prices; imports consist of the value of goods delivered at the frontier and consumed in the country; exports consist of the value of goods shipped out of the country, excluding re-exports; the number of firms is made up by all locally-registered companies, including 0 employees enterprises and single-employed; production values and shares of top companies refer to the revenues made by companies from industry-specific products. 14 http://epp.eurostat.ec.europa.eu/portal/page/portal/nace_rev2/introduction 15 Two 2-digit sectors – Coke and refined petroleum products, and Repair and installation of machinery and equipment – are left out of our analysis. 16 The great difference between market size and production for the Tobacco sector is given by secondary production, i.e. production of Tobacco products made by companies falling in other categories. 17 Profit margins are calculated with respect to estimation of marginal costs that includes intermediate goods and services. As explained above, this is a standard methodology in the literature, although alternative measures could rely on labour costs only – depending on what is considered a better approximation of total marginal costs. The methodology used in this paper therefore tends to bias downwards profit margins of sectors that rely heavily on intermediate goods and services, such as motor vehicles or other transport equipment. 18 Data were retrieved from the website of the European Commission’s Directorate-General of Competition through the case search tool: link. 19 We opted for this definition in order to guarantee the maximum degree of statistical compatibility between merger decisions, since the ones used for the indicators are taken all at the end of a first phase investigation. Alternative definitions could also be possible. For example it could be possible to further segment mergers that were investigated in ‘second phase’ in mergers cleared with conditions, mergers cleared with no conditions and blocked mergers. A problematic merger could then be defined as a merger for which conditions were imposed at the end of either first or second phase investigation or a blocked merger. However, this would have implied mixing decisions taken after different administrative processes and with different depth of scrutiny. It should be said in any case that the ranking of sectors is not affected by the choice between the two different definitions. 20 According to the Eurostat definition, “the enterprise is the smallest combination of legal units that is an organisational unit producing goods or services, which benefits from a certain degree of autonomy in decision-making, especially for the allocation of its current resources”. Births and deaths account for the creation or dissolution of entreprise units, thus excluding mergers, break-ups or restructuring of a set of enterprises. REFERENCES Altomonte, C., Nicolini, M., Rungi, A., and Ogliari, L. (2010) 'Assessing the Competitive Behaviour of Firms in the Single Market: A Micro-based Approach', Economic Papers No. 409, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission Amelio, A., and Donath, D. (2009) 'Market definition in recent EC merger investigations: The role of empirical analysis', Concurrences No. 3 Buccirossi, P., Ciari, L., Duso, T., Spagnolo, G., and Vitale, C. (2013) 'Competition policy and productivity growth: An empirical assessment', Review of Economics and Statistics No. 95.4: 1324-1336 Combe, E., Monnier, C., and Legal, R. (2008) 'Cartels: The probability of getting caught in the European Union', BEER paper No. 12 Davies, S. W., and Geroski, P. A. (1997) 'Changes in concentration, turbulence, and the dynamics of market shares', Review of Economics and Statistics No. 79.3: 383-391. Griffith, Rachel, Rupert Harrison and Helen Simpson (2010) 'Product Market Reform and Innovation in the EU*', The Scandinavian Journal of Economics No. 112.2: 389-415. Gual, Jordi, and Núria Mas (2011) 'Industry characteristics and anti-competitive behavior: evidence from the European Commission’s decisions', Review of Industrial Organization No. 39.3: 207-230. Ilzkovitz, F., Dierx, A., and Sousa, N. (2008) 'An analysis of the possible causes of product market malfunctioning in the EU: First results for manufacturing and service sectors', Economic Papers No. 336, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission Ivaldi, M., Jullien, B., Rey, P., Seabright, P., and Tirole, J. (2003) 'The economics of tacit collusion', IDEI Working Paper 186 Kee, H. L., and Hoekman, B. (2007) 'Imports, entry and competition law as market disciplines', European Economic Review No. 51.4: 831-858 Kelchtermans, S., Cheung, C., Coucke, K., Eyckmans, J., Neicu, D., Schaumans, C., Sels, A., Vanormelingen, S., and Verboven, F. (2011) 'Monitoring of Markets and Sectors Report', AGORA-MMS project, Katholieke Universiteit Leuven Konings, J., Van Cayseele, P., and Warzynski, F. (2001) 'The dynamics of industrial mark-ups in two small open economies: does national competition policy matter?' International Journal of Industrial Organization No. 19.5: 841-859. Mariniello, Mario (2013) 'Do European Union fines deter price-fixing?' Policy Brief 2013/04, Bruegel Motta, M. (2004) Competition policy: theory and practice, Cambridge University Press Neven, D., and Zenger, H. (2008) 'Ex post evaluation of enforcement: a principal-agent perspective', De Economist No. 156(4): 477-490 Symeonidis, G. (2003) 'In which industries is collusion more likely? Evidence from the UK', The Journal of Industrial Economics No. 51(1): 45-74 Veugelers, R., Davies, S., De Voldere, I., Egger, P., Pfaffermayr, M., Reynaerts, J., Rommens, K., Rondi, L., Vannoni, D., Benfratello, L., and Sleuwaegen, L. (2002) 'Determinants of industrial concentration, market integration and efficiency in the European Union', chapter 3 in Dierx, A; Ilzkovitz, F. and K. Sekkat (eds) European Integration and the functioning of product markets, European Economy, Special Report Number 2, EC, DG ECFIN: 103-212

    Appendix 1 – Alternative ways to measure likelihood of entry

    In this paper we have used firm size as an indication of entry costs. Firms in sectors with higher barriers to entry are expected on average to be bigger in size. Another way to proxy likelihood of entry consists in measuring the actual number of enterprise births and deaths using the Business Demography datasets of Eurostat and the OECD20. A summary indicator for firms’ turnover is the business churn, obtained as the sum of the birth rate and the death rate over the number of active enterprises in a given year. The higher is the churn rate, the easier is for firms to enter or exit a sector. Table A below reports the indicator used in this paper, firm size, and business churn in two separate columns at two-digits NACE 2. As it can be noted, the sectoral disaggregation of the two indicators differs. In particular, the Eurostat Business Demography/OECD dataset provides data at a more aggregated level than the level of analysis used in this paper. This makes the comparison between the two indicators difficult as sectors included in the same group in the Business Demography dataset may have very heterogeneous firms’ size. For example, the Tobacco sector has the highest average firm size but Tobacco is aggregated with Food and Beverages in Eurostat and OECD datasets, which have average firm size about 10 times smaller. A rough comparison yields mixed results. Sectors with the highest business churn (ie Textiles, Wearing apparel, and Leather products) have very low firm sizes – consistently with the approach adopted in our analysis. However, sectors with higher firm sizes (eg Motor vehicles and Transport Equipment) also display relatively high churn rates. A possible explanation for this divergence is that high entry and exit rates may be due to high flows of small companies in narrow markets within a sector. If a high number of small companies enter or exit small markets in a sector, this significantly increases the sector’s reported average churn rate. However, the ‘disruptive’ effect on collusion brought about by these companies can be very limited, given their small size. For that reason, we believe that using firm size is a better measure to indicate the exposure of the sector to external competition for the purposes of the analysis reported in this paper. Another way to measure barriers to entry is to use sector capital and R&D intensity as in Gual and Mas (2011) and Symeonidis (2003). A high capital intensity, as measured by investment in tangible goods over value added, might imply that firms need to make expensive investments in order to operate at an efficient scale. Similarly, a high R&D intensity, as measures by R&D spending over value added, may point to high costs incurred to differentiate or improve their products. Thus, capital and R&D costs may represent fixed or sunk costs that reduce likelihood of entry. The two indicators are also displayed in Table A. Again testing the similarity between these alternative measures and firm size is difficult due to the different level of aggregation of the sectors. Nevertheless, a rough comparison suggests a higher degree of consistency compared to what observed in the case of business churn rate. Excluding Tobacco, the correlations between capital intensity and firm size and between R&D intensity and firm size are respectively as high as 44 percent and 72 percent. Taking the sum of the capital and the R&D intensity the correlation with firm size reaches 89 percent.]]>
    Tue, 08 Jul 2014 00:00:00 +0100
    <![CDATA[The great transformation: Memo to the incoming EU Presidents]]> http://www.bruegel.org Bruegel Policy Brief 04/2014 is addressed to the incoming Presidents of the European institutions. It is the first in a series of memos to the new European leadership to be launched in September, which will address individual Commissioners with priorities for their portfolio. Take part in the debate using hashtag #EU2DO. The European Union’s leadership spent the last five years fighting an acute and existential crisis. The next five years, under your leadership, will be no less difficult. You will have to tackle difficult economic and institutional questions while being alert to the possibility of a new crisis. You face three central challenges:
    1. The feeble economic situation prevents job creation and hobbles attempts to reduce public and private debt;
    2. EU institutions and the EU budget need reform and you will have to deal with pressing external matters, including neighbourhood policy and the EU’s position in the world;
    3. You will have to prepare and face up to the need for treaty change to put monetary union on a more stable footing, to review the EU’s competences and to re-adjust the relationship between the euro area and the EU, and the United Kingdom in particular.
    The EU needs to adapt its economies to the global Great Transformation by deepening the single market, improving product markets and improving governance. This strategy needs to be combined with measures to boost the public capital stock to reap demand and supply-side benefits. A reform of the EU budget is imperative to orientate it more towards growth, while reform of the Commission should deliver a more coherent approach to growth policies. Neighbourhood policy should be redesigned to allow for different forms of collaboration and global trade should be promoted. Finally, the treaty reform will have to focus on concrete measures to create a fiscal capacity with appropriate legitimacy and a new relationship with the UK.

    State of affairs

    Your predecessors as presidents of the European Commission, European Council and European Parliament spent a good part of their mandate fighting the financial crisis and creating mechanisms – primarily the European Stability Mechanism and the European Banking Union – that were left out of the Maastricht design of Economic and Monetary Union (EMU). Your terms of office will be no less challenging. You will have to solve deep and difficult economic and institutional problems, while being alert in case of a new crisis. The European Council of 26-27 June 2014 defined a broad political agenda for the next five years, but you will have to take the lead in spelling out a more precise agenda. You face three challenges. First is the economic situation. The financial crisis is receding but huge economic problems remain. Unemployment in Europe is at record highs and goes a long way to explain voter dissatisfaction with national and European leaders. Debt levels are historically high. Economic growth has turned positive again but remains far too feeble to alleviate the high joblessness or meaningfully reduce public debt, in particular in countries with high debt levels. But it would be a mistake to think that Europe’s economic challenge stems only from the crisis. All European Union countries need to adapt their economies and even societies to the Great Transformation resulting from the combined forces of globalisation, demographic, technological and environmental change. This transformation started well before the crisis. European leaders agreed already in 2000 to modernise their societies: the Lisbon Agenda to create a competitive knowledge-based economy with sustainable growth, more and better jobs and greater social cohesion. Had Europe implemented the Lisbon Agenda, it would probably not have avoided the crisis, but it would have been in much better shape to rebound more strongly and quickly. Unlike Europe, emerging countries remained relatively immune to the financial crisis. They continue to forge ahead. In this respect it is good to consider two key facts: in 2013 emerging and developing countries together accounted – for the first time since at least 1850 – for more than 50 percent of global GDP; meanwhile, the average public debt-to-GDP ratio of these countries dropped below 40 percent, while it nearly reached 110 percent in the advanced economies. Your second challenge is twofold: reforming the functioning of the EU institutions while dealing with pressing external matters. You must deal with growing scepticism about the EU and tackle pressing strategic questions that have remained unresolved for several years. The success of eurosceptic parties in the European elections will force you to focus on results for citizens. For this, the work on economic growth is necessary but not sufficient. The EU is still perceived as wasteful, bureaucratic and undemocratic. You will have to improve the internal working of the EU and of its institutions, manage the relationship between the euro area and the EU countries outside it (the United Kingdom in particular). You will also have to rethink the EU’s neighbourhood strategy and strengthen the EU's place in the world. Your third challenge is to face up to the need for EU treaty change. The economic and financial crisis has resulted in calls for ‘More Europe’ but also for ‘Less Europe’. These contradictory demands are not necessarily addressed to the same areas of competences that are centralised or not at European level. Many citizens might be in favour of ‘More Europe’ in some areas and ‘Less Europe’ in others. A more fruitful approach is to seek a ‘Better Europe’, with some further competences allocated to European level while others remain at, or are even repatriated to, national level. This implies greater clarity in the division of responsibility between Europe and its member states, and also greater effort to ensure that Europe delivers better results in the areas for which it has clear responsibility. The crisis has shown that euro-area countries need deeper banking, economic, fiscal and therefore political integration than envisaged by the Maastricht treaty. Some of your predecessors suggested the creation of a ‘Genuine Economic and Monetary Union’ that would go well beyond the existing EU treaty and the inter-governmental treaties put in place to strengthen the euro area’s architecture. Although there might be a natural tendency to put aside this discussion while the pressure from the financial crisis hopefully continues to decrease, it would be a severe mistake to wait for the next crisis to reopen the discussion. Such deeper integration among euro-area countries inevitably raises urgent questions about the relationship between the EU and the euro area. You will need to work in parallel on these challenges but the timing of their outcomes should be different. The economic challenge is the most urgent. Europe needs to deliver growth and jobs soon to regain the trust of its citizens. You will need to put forward a credible growth strategy in time for the December 2014 European Council and start implementing the strategy by mid 2015. You will also have to settle some of the governance issues very soon, ideally by spring 2015. You should strive to have the June 2015 European Council adopt a Declaration on the Future of the European Union, involving a Committee on the Future of the European Union, which would make proposals for treaty changes relating to the governance of the euro area and the relationship between the EU and the euro area. It goes without saying that the challenges in front of you are immense. Success will only be achieved if the three of you work closely together and with the heads of state and government of the member states. Nevertheless it would be rational that the Commission, which has executive and surveillance responsibilities, leads on the economic issues and on the reform of the Commission, while all three lead on pressing external issues, and the European Council and Parliament lead on the institutional track. The rest of this memo will deal with each issue in turn.

    A European strategy for growth

    You will constantly have to remind your European Council colleagues that Europe is losing relative weight, and that its demographic developments are unfavourable. Europe needs a growth strategy based on deeper global trade integration, more openness to immigration, improved educational systems and a better functioning internal market. It will also need to step up public investment and domestic demand. In particular, your growth agenda must provide a convincing response to Europe’s immediate and medium-term economic challenges. This entails both closing the output gap and increasing potential output. The strategy therefore needs demand measures to increase aggregate demand and close the output gap, and supply measures to increase potential output. Investment, which remains depressed in most EU countries, is key. Boosting investment would increase aggregate demand in the short term and increase potential growth in the medium term. The focus of the European growth strategy should therefore be to improve the investment climate in Europe. In this respect, much of what needs to be done is ultimately the responsibility of member states. But Europe has its own instruments, which matter for investment and growth. Member states can and must implement structural measures in several areas. The first is the functioning of product markets, into which entry by new suppliers often remains hampered by various barriers. This is especially true in services. Second are labour market and social policies (including basic education, training and life-long learning), which badly need to be modernised. Greater flexibility and better security for workers are essential features in the age of Great Transformation. Third is the functioning of the state, including the justice system and public administration. Finally, higher education systems in many countries remain ill-adapted for the economies of the twenty-first century and continental Europe still lacks global top-notch universities. Although all EU countries need to implement structural measures, some will require your special attention because of their size: France, Germany and Italy. They account for two-thirds of euro-area and half of EU GDP. Germany is healthy with low unemployment and its public finances under control. Yet German investment remains fairly weak, which is a pity first and foremost for Germany, which could use more private investment to boost its competitive position and more public investment in education and in infrastructure. But it is also unfortunate for the rest of Europe, which would benefit from more aggregate demand and higher medium-term growth in the EU’s largest economy. The situation in France and Italy is much less promising. There, unemployment is dangerously high and public finances are over-stretched. Further economic difficulty in one of these two countries could reignite problems in the euro area, where the economic situation remains fragile. You have relatively little leverage over these three countries. For France and Italy, the Commission has the arsenal of fiscal rules at its disposal, but the size of the countries gives them bargaining power and everyone knows it. For Germany, which has large and persistent current account surpluses, the Commission has used and can use again the Macroeconomic Imbalance Procedure to demand reforms that would expand domestic aggregate demand. But again there are clearly limits to what can be achieved. Your real power lies not so much in the use of formal procedures, though clearly they should be used like for any EU country, but in your capacity to convince the three big countries to act in their own interests, and that not doing so would damage the euro area and the entire EU. Of Europe's own instruments, the most important is the single market. It is simply unacceptable that 30 years after the launch of the single market programme, and more than 20 years after it was supposed to have been completed, the single market is still far from reality in vital areas such as services, digital sectors, energy and research. Your commitment to complete the single market would be an important signal that Europe is again serious about fostering investment and growth. The second instrument is the EU budget, which needs substantial reform to enhance growth. Although the 2014-20 multiannual financial framework (MFF) contains useful tools to improve Europe's investment climate, you will have the opportunity to leave your mark in 2016 when the MFF is reviewed. The review should not just consider changes in expenditure, but also in the way the EU budget is financed. Moving away from national contributions, currently the main source of financing, is essential to turn the EU budget into a budget for Europe rather than one dominated by a national, ‘juste retour’ logic. This would allow the budget to be refocused on European public goods, for example energy security, energy efficiency, a digital single market and EU-wide mobility schemes for young workers, instead of ineffective redistribution. Luckily, your predecessors appointed a High-Level Group on EU Own Resources, which will make proposals in time for the 2016 MFF review. The EU budget, along with regulation, can and should be used to promote better the single market in industries that require trans-European networks to link regional and national infrastructure. This includes interconnection and interoperability, mainly for transport and energy, but also for information and telecommunications technology. In this respect, it would be important to expand the European Commission-European Investment Bank Project Bond Initiative, launched on a pilot basis in 2012. But the EU budget should also be used to promote structural reform in EU countries. This could include, for example, making the disbursement of Structural Funds conditional on administrative reform. The European Social Fund should be used primarily for the modernisation of labour markets and move social policies towards greater flexibility and better security. The European Regional Development Fund should be used as a matter of priority to improve the administrative capacity and effectiveness of regional and national public bodies. But these instruments alone will be insufficient to provide a meaningful demand stimulus to kick-start EU growth. You should broker a deal in the European Council to get a European investment boost. Public investment should be increased by about €100 billion in 2015 and 2016. About half of this should be the product of national fiscal policies, by increasing public investment and creating new incentives for private investment. You should also ask member states with fiscal space to stop over-performing on the achievement of fiscal targets. The other half of the investment programme should be conducted at EU level, by boosting the capital base of the EIB and implementing project bonds. Economically weaker, high unemployment countries should benefit disproportionally. This growth strategy will be critical for achieving higher growth, which will be paramount for employment creation and for the sustainability of public and private debt in Europe. Failure to achieve higher real and nominal growth would render debt trajectories problematic in countries with currently high debt levels.

    Reforming the EU Institutions and dealing with pressing external matters

    The European Commission needs reform to implement the growth strategy. This mostly concerns the European Commission president, but the European Council and Parliament presidents will also have to agree on certain issues.
    • An effective Commission would have only a dozen policy areas in which it would take action. While the number of commissioners cannot easily be reduced, you should acknowledge that not every commissioner can have a full portfolio without leading to inconsistency of policy and excessive activism. A solution would be for every commissioner to have the full rights of a commissioner with full vote in the College. However, not every commissioner would be responsible for a distinct portfolio. An alternative constellation would consist of several clusters of competences for which several commissioners would be jointly responsible.
    • Reducing and focusing the activities of commissioners would also allow you to pre-empt the criticism from many member states that the Commission is too active and involved in too many areas. While the assignment of competences cannot be changed without treaty change, you as Commission president could apply a more rigorous internal review of whether any new initiative is really necessary and whether major spillovers across the union justify it. You should ensure the strict application of the subsidiarity principle.
    • You as the new Commission president should appoint a senior vice president without portfolio responsible for the European growth strategy. The senior vice president would oversee all the relevant Commission activities to ensure that policies are implemented to their maximum effectiveness to promote growth. There would be a particular focus on single market and industry, digital agenda, science and research, education and skills, and regional policy. The senior vice president would have a small staff, consisting essentially of the part of the General Secretariat currently in charge of the Europe2020 strategy.
    • The enterprise and single market portfolios should be merged into a single market and industry portfolio to emphasise that European industrial policy should be about framework conditions and deepening the single market while reducing national regulatory fragmentation. Industrial policy based on subsidies and support for national champions is not the right approach for more growth and jobs in Europe.
    • Your economic and financial affairs commissioner must play a central role in the growth strategy, including by shaping the EU-wide fiscal stance, but she will have to operate independently of the many requests from within the Commission and focus on her mandate and the need to keep fiscal policy credible.
    • The rigorous enforcement of competition rules is central for economic performance. Attempts to make competition policy subject to narrow industrial policy interests are unwarranted, as are claims that it prevents the emergence of European champions. Many sectors remain dominated by national operators in the different national markets, and substantial regulatory barriers still prevent companies, in particular in the services sector, offering their products in other EU countries. The single market agenda is therefore more relevant than ever.
    • It is worth reflecting on competition policy decision making. Acknowledging the inherently complex nature of competition policy, a high-level committee of five impartial experts should be appointed to review once a year the actions of the European Commission, and give independent advice on the direction of competition policy. Their reports should be public and should be submitted to the European Parliament. Their recommendations would not be binding, but would guide the European Commission’s strategy and increase public awareness.
    The three of you have the daunting task of rethinking and improving Europe’s neighbourhood policy, in particular with eastern and southern neighbours. The association agreements promising a ‘deep and comprehensive free trade area’ with Ukraine, Georgia and Moldova are interpreted ambiguously by different EU countries and the three countries themselves. The relationship with Turkey is still seen only through the prism of potential EU membership. You will have to seek Council backing for a broader approach, that also includes the possibility of other types of institutional relationship with the EU, which would offer more options to stabilise trade relationships while respecting broader geopolitical goals. You will also have to define an immigration policy that not only makes sense from a European point of view but also respects the humanitarian values for which the EU stands, and you will have to re-think the various financial instruments that the EU has for its neighbourhood. But Europe’s interests extend, of course, far beyond the neighbourhood. You should further promote global trade integration and develop a strategy to deal with China’s rising trade power. By 2020, the end of your term, China will be the most important trading partner for several EU member states; already it is the second most important export partner for the EU as a whole. The Transatlantic Trade and Investment Partnership has the potential to deepen trade with the US, the EU's most important current trading partner, but does not give a convincing answer to global trade questions. Yet, for the EU as an open continent, the further development of global trade is central. Finally, the three of you have the task of reforming the EU’s administration to reduce costs and perceived inefficiency. This should include a review of its staffing needs, including at the Council, salary structures and conditions of entry, the organisation of the European Parliament, including the question of its double seat. Some of the current hostility to Brussels comes from negative perceptions of its administration. While overall the EU institutions are rather cheap and efficient, you should deal proactively with the perceptions, and not hold back from dealing with inefficiencies.

    Towards a new architecture for the EU and EMU

    Solving the pressing growth and unemployment problems and adjusting the current EU neighbourhood strategy, while improving the functioning of the EU institutions, is, however, unfortunately not enough. Arguably many of the problems you will have to fire-fight are the result of the still incomplete overall EU architecture and the lack of consensus on what the EU is and what it is not. You should initiate and drive a discussion on further constitutional change in the EU. Europe still needs a grand new bargain. Many of the growth reforms and other pressing reforms are only possible if you broker a deal on the need for a broader revision of the EU’s treaty base. Conversely, the broader revisions of the treaty base are only possible if citizens believe that further EU integration in some areas is actually to their benefit. You thus face the formidable challenge of solving many currently pressing problems while working on the long-term solutions. Reforms to the EU's architecture are critical because failure would mean that monetary union is based on an incomplete institutional set-up. In particular, fiscal mechanisms are critical for three reasons:
    • Without a fiscal union, the European Central Bank's policy measures will continue to be more controversial than those of a national central bank, because the ECB without a fiscal counterpart is more restrained in actions that could have distributional effects across different jurisdictions. In fact, arguably, the ECB’s mandate was designed by the fathers of the Maastricht treaty to prevent it from engaging in policies that could have fiscal consequences.
    • For the financial system to become fully integrated across borders, a banking union with a common fiscal backstop is necessary. While the banking union currently foresees some mutualisation of the risk that remains after significant bail-ins, there is no mutualisation of major risks, and the deposit insurance system remains fragmented along national lines. As a consequence, the financial system will remain fragmented, with banks and depositors behaving differently based on their location. More financial integration combined with the right regulation would be beneficial for growth and the efficiency of the EU economy.
    • During the crisis, fiscal policy reacted quite pro-cyclically in many instances because of the increasing market pressure on countries in distress. Moreover, the amount of aggregate fiscal stabilisation has been insufficient because coordination has proven inadequate across the union.
    It is time to significantly advance this discussion on a fiscal capacity and stronger mechanisms for economic reform. The first important step should be a serious review of the EU budget with a view to adapt its expenditures towards more growth. You should undertake this immediately within the existing treaties. Other elements should include (a) resolving the unresolved questions about burden sharing in case of ECB losses; (b) agreeing on how to increase the back-stop for the banking union – a potential measure could be to accept that taxation of banks becomes completely European; (c) working on a concrete measure that would support unemployed people – the creation of a European unemployment insurance mechanism could be envisaged if labour market institutions concurrently become Europeanised. This would also answer the pressing question of how to overcome the inconsistency between monetary union and national structural and labour market policies. Many of these changes would require treaty change to create the democratic legitimacy needed to justify moving such policies to the EU level. While fundamental reform of the architecture of monetary union is crucial, it will be equally important that you address the substantial mistrust between euro-area countries and some of the countries that do not want to join the euro, in particular the UK. The UK’s economy is of great importance to the single market and the UK is a vital EU member. EU reform is part of the answer and the UK is right that such reforms are in the interests of all EU members. But the question of the place of the UK in the EU will be core for the debate on treaty change. A result of treaty reform could be that the UK stops participating in the EU budget, while remaining in the single market for goods, services and capital, and ideally also labour. The UK would have to be granted some basic minority rights but should not be able to block vital steps needed to strengthen the single market. Such a 'second tier' EU membership could also offer a more realistic option for countries such as Turkey. This treaty debate on deepening EMU and adjusting the relationship with the UK will inevitably be connected with a review of EU competences. Reviews of competences have been started by a number of member states, most notably the UK. You should welcome such input. All EU countries would benefit from a better allocation of competences. You should therefore propose to the European Council in June 2015 that it adopts a Declaration on the Future of the European Union and that it appoints a High-Level Committee to make proposals for a new architecture for the EU and for the euro area. The High-Level Committee should conclude its work and report back to the European Council in December 2016. The High-Level Committee would address three sets of questions.
    1. Does a monetary union require a fiscal and economic union and what exactly would this imply? The following themes would need to be explored:
      • What kind of fiscal backstop does a genuine banking union require?
      • Does monetary union require a fiscal stabilisation mechanism?
      • Are the current fiscal rules adequate?
      • Is a mechanism for sovereign debt restructuring necessary? How can the no-bail-out clause be made credible?
      • Should the European Stability Mechanism and the European Resolution Mechanism become EU mechanisms and be part of a euro-area budget managed by a euro-area treasury? Is the EU budget reform a condition for the creation of a euro-area fiscal capacity?
      • Does the euro area require a ‘finance minister’ with veto power over national budgets and national structural and labour market policies? Should some of these policies become EU policies?
      • What mechanisms of political accountability should be put in place to oversee the euro-area treasury and finance minister and give them political legitimacy?
    2. What should the relationship be between euro-area and non-euro area EU countries? What safeguards should non-euro area countries receive and how closely should they be linked to the main EU decision-making processes? Should their involvement in the EU be more narrowly based on the single market only?
    3. Is the current assignment of EU competences adequate? Is the current method for assignment of competences adequate? The treaty specifies that limits to EU competences are governed by the principle of conferral. The use of EU competences is governed by the principles of subsidiarity and proportionality, the application of which is specified in a protocol. Has the time come to revisit this protocol?
    It is time to review all of these aspects thoroughly and come to a broader agreement about the EU's development path. Many of the essential topics are far-reaching and complex. But failure to tackle these issues would undermine progress on current problems, and could also leave the EU unprepared for new crises. The aim of the High-Level Committee would be to create a clear roadmap. Obviously not all the proposed treaty changes would need to be put in place at once; gradual change is conceivable. You should aim to have or at least to initiate a new treaty before the end of your mandate.

    ***

    [1] ‘Strategic agenda for the Union in times of change’, European Council conclusions, 26-27 June 2014, available at http://www.consilium. europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/143478.pdf. [2] Also, the President of the European Parliament should accept that national parliaments use the subsidiarity review more often.]]>
    Thu, 03 Jul 2014 00:00:00 +0100
    <![CDATA[New investment approaches for addressing social and economic challenges]]> http://www.bruegel.org The OECD wishes to thank the Bertelsmann Foundation for their generous support of this work. Paper at the OECD]]> Tue, 01 Jul 2014 00:00:00 +0100 <![CDATA[No Industry, no Future?]]> http://www.bruegel.org Thu, 19 Jun 2014 00:00:00 +0100 <![CDATA[The long haul: debt sustainability analysis]]> http://www.bruegel.org See comment 'Despite lower yields, euro-periphery is not yet out of the woods' This working paper details and updates the debt sustainability analysis of Darvas, Sapir and Wolff (2014) for Greece, Ireland and Portugal. The goal is not the calculation of a baseline scenario which best corresponds to our views, but to set-up a baseline scenario which broadly corresponds to official assumptions and current market views and to assess its sensitivity to deviations from these assumptions. The simulated public debt/GDP ratios are slightly lower compared to Darvas, Sapir and Wolff (2014), eg for 2020 our new results are 2-3 percent of GDP lower than in our February projections. This is because of the European Commission’s downward revision of the 2013 debt level for Greece and Ireland, higher expected primary surpluses in Ireland, slightly lower interest rates for all three countries, and a 1.5 percent of GDP higher reduction in the debt ratio due to the stock-flow adjustment in 2014-15 for Portugal. Our findings suggests that the public debt ratio is set to decline in all three countries under the maintained assumptions, but the debt trajectory remains vulnerable to negative growth, primary balance and interest rate shocks, even though we do not examine extremely negative scenarios.]]> Wed, 18 Jun 2014 00:00:00 +0100 <![CDATA[Undercutting the future? European research spending in times of fiscal consolidation]]> http://www.bruegel.org Tue, 10 Jun 2014 00:00:00 +0100 <![CDATA[Financial openness of China and India: Implications for capital account liberalisation]]> http://www.bruegel.org See comment by Guonan Ma China's financial liberalisation: interest rate deregulation or currency flexibility first? In this working paper we gauge the de-facto capital account openness of the Chinese and Indian economies by testing the law of one price on the basis of onshore and offshore price gaps for three key financial instruments. Generally, the three measures show both economies becoming more financially open over time. Over the past decade, the Indian economy on average appears to be more open financially than the Chinese economy, but China seems to be catching up with India in the wake of the global financial crisis. Both have more work to do to open their capital accounts. Our price-based measures suggest strong inward pressure on Chinese money markets, in contrast to the consensus projection that China is likely to experience net private capital outflows when it thoroughly opens up financially. Policymakers need to monitor and to manage the risks along the dynamic path of capital account liberalization.]]> Thu, 15 May 2014 00:00:00 +0100 <![CDATA[Addressing weak inflation: The European Central Bank's shopping list]]> http://www.bruegel.org See comments by the authors 'Addressing weak inflation: The ECB’s Shopping List' and comment 'Negative ECB deposit rate: But what next?'

    1. Introduction

    There are clear benefits to price stability. High inflation can distort corporate investment decisions and the consumption behaviour of households. Changes to inflation redistribute real wealth and income between different segments of society, such as savers and borrowers, or young and old. Price stability is therefore a fundamental public good and it became a fundamental principle of European Economic and Monetary Union. But the European Treaties do not define price stability. It was left to the Governing Council of the European Central Bank (ECB) to quantify it: "Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%"[1]. The Governing Council has also clarified that it aims to maintain inflation below, but close to, two percent over the medium term, though it has not quantified what 'closeness' means, nor has it given a precise definition of the 'medium term'[2]. The clarification has been widely interpreted to mean that the actual target of the ECB is close to, but below, two percent inflation in the medium term. In the current European circumstances, low overall euro-area inflation implies that in some euro-area member states inflation has to be very low or even negative in order to regain competitiveness relative to the core. The lower the overall inflation rate, the more periphery inflation rates will have to fall in order to achieve the same competitiveness gains. Given that wages are often sticky and rarely decline, significant unemployment increases can result from the adjustment process. In addition, lower-than-anticipated inflation undermines the sustainability of public and private debt if the debt contracts are long-term nominal contracts. For governments, falling inflation rates often mean that nominal tax revenues fall, which makes the servicing or repayment of debt more difficult. Inflation in the euro area has been falling since late 2011 and has been below one percent since October 2013. Core inflation, a measure that excludes volatile energy and food price developments, has developed similarly. Five of the 18 euro-area member countries (Cyprus, Greece, Portugal, Slovakia and Spain) are already in deflation. Even in the countries that are not in a recession, such as Belgium, France and Germany, inflation rates are well below the euro-area target of close to but below two percent. More worryingly, the ECB’s forecast suggests that inflation will not return to close to two percent in the medium term. Given the need to regain competitiveness, lower-than-target inflation in the euro-area periphery can be expected and is even desirable. However, to facilitate adjustment and achieve the overall ECB inflation objective, inflation in the euro area’s core countries needs to stabilise and reach levels above two percent. A key question for policymakers is therefore why inflation rates are subdued in core countries despite very accommodative monetary policy conditions and the gradual revival of economic growth. Policymakers must also consider which monetary policies are suitable for increasing aggregate inflation in the euro area, while ensuring that the inflation differential between the core and periphery remains. Finally, unresolved banking-sector problems are making the task of the ECB more difficult. It is against this background that we discuss monetary policy options to address low inflation in the euro area. Evidently, structural and banking policies, wage-setting mechanisms and fiscal policies also need to play a role in addressing the recession and the low-inflation problem. They are, however, not discussed in this Policy Contribution.

    2. Heterogeneous inflation developments in the euro area

    Panel A of Figure 1 shows that the euro-area headline inflation rate has been moving downwards since late 2011, while Panel B indicates a similar trend for core inflation[3]. Panels A and B also highlight major differences between euro-area countries. Countries in the euro-area periphery (which we define as Cyprus, Greece, Ireland, Italy, Spain and Portugal) had higher inflation rates than other euro-area counties before the crisis, persisting well into the crisis period. Only since 2013 has inflation in the periphery clearly fallen below that of the euro area as a whole[4]. Figure 1: Inflationary developments in the euro area (percent change compared to the same month of the previous year), January 1999 – March 2014 Source: Bruegel calculation using data from Eurostat’s Harmonised Index of Consumer Prices dataset. Note: core inflation is defined as the ‘Overall index excluding energy and unprocessed food’. Data for core inflation in Slovenia is not available for the full period and therefore this country is not included. Several countries are already experiencing deflation. Cyprus, Greece, Portugal, Slovakia and Spain are in deflation, while the March 2014 inflation rates in the Netherlands (0.1 percent), Ireland (0.3 percent), Italy (0.3 percent) and Latvia (0.2 percent) are rather close to zero when measured by headline inflation. But even in Germany and France inflation has fallen below one percent.

    Is there a risk that the euro area as a whole will fall into outright deflation?

    Inflation expectations have been falling since at least mid-2012. Figure 2 presents expectations from two sources (an ECB survey and a market-based indicator) and for two maturities. The two-year-ahead expectations are significantly below two percent and even below one percent according to the market-based indicator. In the period relevant for the ECB, inflation expectations have thus become de-anchored from 2 percent. Lack of ECB action when the ECB’s own medium-term inflation forecasts fell below the two percent threshold was a signal to markets that probably resulted in the downward revision of longer-term inflation expectations. The ECB is now less effective in anchoring longer-term expectations to, or close to, the 2 percent level. Figure 2: Inflation expectations: ECB’s survey of professional forecasters (SPF) and market-based inflationary expectations in the euro area, 2002Q1-2014Q2 Source: ECB’s Survey of Professional Forecasters and Datastream. Note: In the ECB’s survey the horizon of “Long term” is not specified. Market-based expectations refer to overnight inflation swaps (OIS), which can be used as a market based proxy for future inflation expectations. The 2014Q2 values of market-based expectations are the average during 1-23 April 2014, while the latest available values for the SPF are end of March 2014. There are four further reasons suggesting that the ECB should already have adopted additional monetary stimulus:
    1. The cost of deviations from the current inflation baseline is asymmetric;
    2. The track record of inflationary forecasts and expectations suggests that significant changes in inflation are often unforeseen;
    3. The Japanese experience suggests that long-term market expectations can be persistently upward-biased;
    4. Earlier action can prevent being forced into much larger unconventional policy measures later, when inflation falls so much that no other option remains.
    First, at a low level of inflation, the costs of deviation from the ECB’s forecast inflation are highly asymmetric. If inflation is higher than forecast, it would mean that inflation would be closer to the two percent threshold – a benign development. But if inflation is lower than forecast, then countries in the euro-area periphery would have to maintain even lower inflation or higher deflation, with risks for the sustainability of public and private debt. Second, the ECB’s inflation forecasts and market expectations have been unable to predict significant deviations from the two percent threshold (Figure 3). When there was a sizeable deviation, ECB forecasts and market expectations both predicted a gradual return to two percent, which happened in some cases (see, for example, the December 2011 forecast of the ECB), but most of the time did not. Figure 3: Vintages of inflation forecasts/expectations and actual inflation in the euro area Source: Datastream, ECB. Note: The HICP is defined as a 12-month average rate of change; in panel A, the ECB Staff projections indicate a range referred to as „the projected average annual percentage changes” (see here). For simplicity, we take the average of the given range. In panel B, Market-based expectations refer to overnight inflation swaps (OIS), which can be used as a proxy for future inflation expectations. Third, the fact that long-term inflation expectations in the euro area have so far not deviated too much from two percent should not be taken as a guarantee that inflation will return to the two percent level without additional monetary policy measures. In Japan, long-term inflation expectations remained about one percent on average between 1996 and 2013, though actual inflation was slightly below zero (-0.1 percent, Figure 4). The average forecast error for the 6-10 year inflation forecasts made in Japan between 1996 and 2003 was 1.1 percentage points[5]. Figure 4: Long-term inflation expectations and actual outcomes in Japan Source: Consensus Economics (2014) (expectations) and IMF (actual inflation). Note: this figure is reproduced using our data sources from Figure 7 in Antolin-Diaz (2014). There are two observations per year, in April and October. For actual inflation we plot the change in the all-items consumer price index compared to the same quarter of previous year in the quarter before the forecast was made. At the same time, price developments in the euro area are still significantly different from Japan during the past two decades. In Japan, about half of the items in the consumption basket fell in price during the period when the average inflation rate was almost zero (Claeys, Hüttl and Merler, 2014). In the euro area there has been an increase in the share of items in the HICP basket that are already in deflation in recent months (to about 20 percent of the entire HICP basket), but this share is not very high (and similar to shares observed in 2005 when the inflation rate was close to two percent in the euro area) and is still significantly lower than in Japan. Overall, inflation has been falling significantly and so have inflation expectations. Inflation forecasts have proved consistently too optimistic about the return of inflation to the two percent threshold in the euro area and the one percent target in Japan. The ECB’s own forecast suggests that euro-area inflation will not return to close to two percent in the medium term, and we see a substantial risk that it will not return to this level even in the longer term.

    3. How to address low inflation in a heterogeneous monetary union?

    3.1. Key constraints

    The ECB's task is complicated by two very special circumstances. First, the euro area is a heterogeneous monetary union in which the process of relative price adjustment between its different parts is ongoing. This adjustment is a consequence of the very substantial past divergence in prices. To better understand the resulting problem for the ECB, it is useful to resort to a simple example of a two-country monetary union. In the monetary union, one region (say periphery) is depressed and runs a zero inflation rate, while the other region (say core) has an inflation rate of one percent, still below the two percent target, even though there is almost full employment. The monetary stimulus should result in aggregate inflation in the monetary union increasing to the two-percent target. However, since there has to be a relative price adjustment between the periphery and the core, the monetary stimulus should ensure that the inflation differential between the two regions remains in place. The stimulus must therefore increase inflation and activity both in the core and the periphery. The necessary relative price adjustment implies that inflation in the core should increase to above the target, while inflation in the periphery has to stay below it. If the stimulus would not have an impact on the core, but only the periphery, then it would undermine the necessary price-adjustment process. The second problem for the ECB is that the process of bank balance-sheet repair is ongoing. When several banks have vulnerable capital and liquidity positions, a monetary stimulus aimed at increasing bank lending to the private sector is less effective, similar to what happened after the three-year longer-term refinancing operations (LTRO) in late 2011 and early 2012, when banks increased lending to governments and accumulated reserves at the ECB. In addition, the ECB is dealing with the quality of banks’ balance sheets in the context of the asset quality review and stress test. Clearly, fixing the bank-lending channel cannot be done by monetary policy but requires action on the structural weaknesses of banks’ balance sheets. A key question is if possible monetary policy measures (like new long-term liquidity provision to banks, asset purchase programmes from banks and/or from other private sector asset holders, or negative ECB deposit rates for banks) would be conducive to increased inflation under current circumstances. An equally important question is whether such a monetary policy measure would remove the incentive to fix the structural problems in the banking system where necessary.

    3.2. Policies to address low inflation in the special euro-area setting

    Different policies could be deployed to increase inflation and inflationary expectations:
    • Reduce the Main Refinancing Operation (MRO) rate to zero percent;
    • Negative deposit rates for banks’ deposits at the ECB;
    • Ending the sterilisation of bond holdings from the Securities Markets Programme (SMP);
    • New long-term (eg three years or longer) refinancing operations, possibly made conditional on net lending to the private sector;
    • Asset purchases:
    • Purchase of euro-area or European debt (debts of various European rescue funds and the European Investment Bank);
    • Purchase of sovereign debt of euro-area member states;
    • Purchase of non-sovereign debt such as the debt of non-financial corporations, asset backed securities (ABS) or debt of financial institutions;
    • Foreign exchange intervention: purchase of foreign assets, such as non-euro area sovereign debt or corporate debt. Given the G7 statement of February 2013 by central bank governors and finance ministers reaffirming the “longstanding commitment to market determined exchange rates and to consult closely in regard to actions in foreign exchange markets”, this policy measure is not discussed further[6].

    Reducing ECB interest rates

    The current 0.25 percent ECB main refinancing rate could be marginally reduced, but the impact of such a small reduction is unlikely to significantly change inflation expectations. In addition, the ECB could reduce the deposit rate, which banks receive when depositing liquidity at the ECB, from zero currently to negative territory. Since currently banks can hold excess reserves on their current account at the ECB at zero interest, a negative deposit rate should be accompanied by the same negative interest rate on excess reserves, to avoid the shifting of all deposits to excess reserves (Figure 5 shows that banks shifted half of their deposits to excess reserves when the deposit rate was reduced to zero). A negative deposit rate would mean that banks pay interest for placing a deposit at the central bank. This would reduce the incentive for banks to hold deposits and excess reserves at the central bank and should therefore promote other uses by the banks of liquidity, such as greater lending to the rest of the economy. However, the sum of banks’ deposits and their excess reserves at the ECB is declining fast (Figure 5), and with the normalisation of money markets they may return to their pre-crisis close-to-zero values. This implies that the direct impact of a negative deposit rate, in terms of changing the incentives to hold deposits and excess reserves, would be minimal. Figure 5: The ECB’s interest rate on the deposit facility, banks’ deposits at the ECB’s deposit facility and banks’ excess reserves at the ECB, January 2007 – April 2014 Source: Bruegel calculation based on ECB data. Note: banks’ excess reserve is the reserves banks hold at their current account with the ECB minus the minimum reserve requirement. It is difficult to assess the quantitative impact of a negative deposit rate on credit and inflation, but the example of Denmark does not suggest strong effects. In July 2012, the Danish central bank reduced its deposit rate for banks to -0.2 percent and kept a negative rate until the 24 April 2014. The main motivation for the negative deposit rate was to discourage the inflow of capital into Denmark, because with the intensification of the euro crisis, investors searched for safe assets. The most direct effects were the reduction of Danish treasury-bill yields below zero and a depreciation of the Danish Krona against the euro by about half a percent from 7.43 to 7.46. This change was quite sizeable for Denmark, where the euro exchange rate is kept very stable. A negative ECB deposit rate may lower treasury-bill yields especially of core euro-area countries and weaken the exchange rate of the euro, which would increase inflation. Some commentators (eg Papadia, 2013) have argued that banks would in fact increase loan interest rates in order to compensate for the loss from their deposits at the ECB. However, the Danish experience also showed that a negative deposit rate does not necessarily have any impact on banks’ loan rates to their clients. Another concern is the impact of negative deposit rates on money-market activity. The ECB’s decision to cut the deposit rate to zero has already led to the closure of various money-market funds and could drain liquidity in the money markets[7]. In Denmark, however, money-market volumes decreased only slightly after the introduction of the negative central bank deposit rate. Investors exiting money-market funds would need to find other investments, pushing liquidity to markets with characteristics similar to money markets.

    Stopping the sterilisation of SMP holdings

    Another possible measure would be stopping the sterilisation of the ECB’s Securities Market Programme (SMP) holdings. Under the SMP, the ECB bought about €220 billion of Greek, Irish, Portuguese, Italian and Spanish government bonds. At present, there are €175.5 billion of SMP bonds left, the maturities of which are not publicly disclosed by the ECB. The bonds are held to maturity and the purchases are entirely sterilised. Stopping their sterilisation would inject €175.5 billion into euro-area money markets. However, the SMP was launched to address the malfunctioning of securities markets and restore an appropriate monetary policy transmission mechanism, while not affecting the stance of monetary policy[8]. A key feature of the programme was sterilisation. Falling short of that commitment and changing the objective at this point would be problematic, because it might undermine trust in the ECB’s other commitments. Importantly, the Outright Monetary Transaction (OMT) programme is also designed to be sterilised[9]. In the ongoing judicial discussions on the OMT[10], stopping the sterilisation of SMP holdings would give a powerful argument to the plaintiffs, who could say that the ECB’s OMT commitments are unreliable.

    New long-term (eg three years or longer) refinancing operations

    In normal times, central banks do not engage in long-term liquidity operations. One reason for this is moral hazard: long-term central bank financing at rates below what banks could get from the market might encourage excessive risk taking and keep insolvent banks alive. However, when the interbank market became dysfunctional during the crisis, several countries in the euro-area periphery underwent a sudden stop in external financing. To address the problem, the ECB provided ample liquidity. The maturity of the ECB’s liquidity operations were then extended from three months to six and twelve months. In December 2011 and in February 2012 the ECB also conducted two extraordinary Longer Term Refinancing Operations (LTROs) with maturities of three years, from which banks in the euro area borrowed almost €1 trillion. The ECB also introduced a policy of ‘full allotment’ for all ECB liquidity operations. Under this procedure, the control of central bank liquidity is effectively moved from the central bank to the banking system, because banks can access all the central bank liquidity they need at a variable rate (if they provide sufficient eligible collateral). These operations, along with the revised collateral policy (expanding and changing assets’ eligibility requirements in order to mitigate possible constraints arising from collateral shortage) allowed liquidity-strained banks to refinance a large portion of their balance sheets through central bank lending, available at a low interest rate and long-term maturity. In a heavily bank-based system, such as the euro area, these measures were essential to avoid a financial and economic meltdown[11]. However, these operations did little to trigger additional lending to the private sector (even though they may have helped to prevent a collapse of existing lending). To a great extent, banks either deposited the cheap central bank funding at the ECB for rainy days, or purchased higher yielding government bonds. Thereby, the LTROs in effect supported liquidity, ensured stable long-term (three-year) financing of banks, subsidised the banking system and helped to restore its profitability, and temporarily supported distressed government bond markets. Considering the alternative of a potentially escalating financial crisis, these developments were beneficial. However, the LTROs might have delayed bank restructuring and prolonged the existence of non-viable banks. For two main reasons, the current situation is very different from the situation when the two three-year LTROs were adopted. First, one reason for the failure of the 2011-12 LTROs to foster lending was the weak balance sheet of the banks and uncertainty about the integrity of the euro area. With the ECB’s Comprehensive Assessment, the structural weaknesses of the banking sector are gradually being mended. In addition, speculation about the break-up of the euro area has become less relevant. Therefore, a new LTRO might be more effective, in particular if ECB financing is made conditional on banks increasing their net lending to the non-financial private sector economy (similar to the Bank of England’s Funding for Lending Scheme; see Darvas, 2013; Wolff 2013). Such conditions, by definition, would exclude the use by banks of ECB liquidity to purchase government bonds. With collateralised lending to banks, the ECB exposure to credit risk is minimal. In addition, the central bank would not replace the banking system in supplying and allocating credit to the non-financial private sector. A new LTRO could therefore be a good option to foster credit growth. Second, the current situation is different because there is no longer a liquidity crisis. In fact, some banks are repaying their loans from the ECB early (Figure 6), even though they have to replace that funding at a higher cost from other sources. The take-up of LTRO liquidity might therefore be limited and the programme could be ineffective in triggering lending and inflation. Figure 6: Use of Eurosystem liquidity (€ billions), January 2003-February 2014 Source/note: the ECB does not provide a country breakdown of the use of its facilities. Data come from National Central Banks but the reporting standards differ. Therefore the length of the time series is not the same for all countries and for some countries data does not seem to be publicly available.

    4. Asset purchases

    For any central bank, asset purchases always involve difficult choices about what and how much to buy. The central bank becomes an important buyer in financial markets and therefore can be subject to pressure from politicians and companies. This is a powerful argument for central banks to act early in order to avoid a low-inflation trap, in which standard monetary policy measures become less effective. The longer an asset-purchase programme is delayed in a situation in which inflation is already very low, the greater the risk that an even larger purchase programme will ultimately be needed. In response to the global financial and economic crisis and its, the Federal Reserve, Bank of England and Bank of Japan engaged in large-scale asset purchase programmes, or quantitative easing (QE)[12]. From the beginning of 2009 to March 2014, the Federal Reserve purchased $1.9 trillion (11.9 percent of US GDP) of US long-term Treasury bonds and $1.6 trillion (9.6 percent of US GDP) of mortgage-backed securities. Between January 2009 and November 2012, the Bank of England purchased £375 billion (24 percent of GDP) of mostly medium- and long-term government bonds. The Bank of Japan started a new round of asset purchases in March 2013 and plans to buy per year 50 trillion yen of government bonds (10.4 percent of 2013 GDP), 1 trillion yen of exchange-traded funds (0.2 percent of GDP) and 50 billion yen of Japanese real estate investment trusts (0.01 percent of GDP), in order to double the country’s monetary base in two years. In addition to such asset purchases, these central banks also implemented programmes to support liquidity in various markets. The ECB has made few asset purchases so far but reacted to the crisis by providing liquidity to the banking system. The size of the balance sheets of the central banks therefore increased for different reasons (Figure 7). Figure 7: Size of balance sheets of various central banks (in % of GDP) Source: FRED, IMF. Asset purchases can be used if interest rates reach the zero lower bound and refinancing operations are ineffective, as discussed above. There are a number of channels through which asset purchases can influence monetary conditions and thereby economic activity and prices:
    • Money multiplier: if the money multiplier (the ratio of broad monetary aggregates to the monetary base) is stable, then the asset-purchase-induced increase in the monetary base will increase monetary aggregates, through more credit to non-financial corporations and households, which can boost demand.
    • Altering yields: purchase by the central bank of a particular asset will reduce the net supply of that asset to the private sector and increase its price and thereby reduce the return that it yields.
    • Portfolio rebalancing: Unless the purchased asset is a very close substitute for cash (such as short-term treasury bills), investors who sold the asset will search for other investment opportunities, pushing up prices and reducing yields in other markets too.
    • Exchange rate: via portfolio rebalancing, previous asset holders could invest in assets denominated in other currencies and thereby depreciate the home currency. This in turn might increase import prices and thereby inflation, but could also boost export production and thereby economic activity.
    • Wealth effect: the increase in asset prices can lead to a wealth effect for the asset holders, which can also increase consumption or investment[13].
    • Signalling: asset purchases by the central bank when the zero lower bound on interest rates is reached could signal to market participants that the central bank is serious about further easing monetary conditions. This can have an impact on inflation expectations and the expected future path of policy rates, which would lead to a reduction in real interest rates today.

    4.1. How would these channels work in the euro area, and in particular, in core and periphery countries?

    The experience of the past few years in countries that have implemented asset purchases is that the money multiplier is unstable and fell significantly in parallel to the expansion of the monetary base. Figure 8 shows that the in the US and the UK, M3 kept growing at about the same rate even when the monetary base doubled, thus halving the money multiplier. Most likely the money multiplier would be similarly unstable in the euro area after asset purchases, so the money multiplier channel would not be effective. Figure 8: Monetary aggregates and money multipliers Source: FRED, ECB, BOE. The ECB’s balance sheet increased by 112 percent between September 2008 and June 2012, and has decreased by 30 percent since then primarily because of the repayment by banks of the LTROs. The decline in the balance sheet as such is not an indication of tighter monetary conditions, but rather reflects the fact that liquidity conditions in the inter-bank market have normalised. The lowering of nominal yields is unlikely to be a powerful channel in the core, while it might have a somewhat greater impact in the periphery. In core euro-area countries, both government bond yields and private-sector borrowing costs are currently very low. The yield on the 10-year German bund is about 1.5 percent per year, but even in Italy and Spain 10-year yields are about 3.1 percent, close to yields of the US government. In terms of corporate lending rates, nominal private sector borrowing rates are lower in the euro-area core than in the UK and just slightly higher than in the US – these two countries that have already implemented large-scale asset purchases (Panel A of Figure 9). Since inflation is also expected to be lower in the euro-area core than in the US, real lending rates are slightly higher in the euro area than in the US, but still well below their pre-crisis values. Therefore, lowering real yields by shifting inflation expectations could be somewhat more effective in the core, but the decline in real rates is likely to be limited. For the periphery, nominal lending rates to non-financial corporations are higher than in the core, and because of even lower inflation expectations than in the core, real interest rates are significantly higher. To what extent the yield differential between the lending rates in core and periphery countries reflects financial fragmentation and greater credit risk in the periphery remains an open question. At the height of the euro crisis in the summer of 2012, both factors likely played major roles. Since then, fragmentation within the euro area has eased. To the extent that financial fragmentation continues to play a significant role, ECB measures to limit fragmentation, such as asset purchases impacting either directly or indirectly the borrowing costs of non-financial corporations, are justified. At the same time, asset purchases can have an indirect impact on credit risk via improved economic conditions. A major question is the importance of changes to real interest rates for the ongoing relative price adjustment between the euro-area core and periphery. Taylor (1999) estimated the semi-elasticity of consumption and investment with respect to the real interest rate in G7 countries. He found that interest sensitivity was significantly higher in France and Germany than in Italy. Therefore, the same decline in real interest rates (either because of an increase in inflationary expectations or a lower nominal yield) would be more expansionary in core countries than in Italy (and probably in other periphery countries too). As we have argued, the scope for a decline in real rates is less in the core than in the periphery. Therefore, cutting real rates to the private sector could be broadly neutral for the ongoing relative price adjustment within the euro area, because in the core, limited scope for reduction is accompanied by large interest rate sensitivity, while in the periphery, greater scope for reduction is accompanied by small interest rate sensitivity. Figure 9: Lending rates to non-financial corporations in the euro area, UK and US Source: Bruegel calculations based on ECB (lending rates in EU countries), IMF (inflation forecasts) and St. Louis FRED (US nominal interest rates). Note: Two data points per year are shown, one corresponding to the spring publication of the IMF’s World Economic Outlook (WEO, published typically in April) and the other corresponds to the autumn WEO (published typically in October). The nominal interest rate is the average over six months before the publication of the WEO. The real lending rates were calculated using a 2-year ahead inflation forecast from the WEO databases up until October 2007 (due to lack of forecasts for longer horizons), while a 5-year ahead forecast average was used starting from April 2008. Inflation forecasts were relatively stable in pre-2008 WEOs but showed larger variations after 2008 and therefore our choice for considering different time horizons for inflation forecast before 2008 and from 2008 may not distort much the comparability of the two periods. The latest data for the US is Q1 2014, and Feb 2014 for the Euro area and the UK. The Euro area core and periphery is calculated as a GDP weighted average with fixed weights. Portfolio rebalancing would probably work both in the core and the periphery. For example, investors holding long-term German government bonds probably have a preference for safe long-term assets. If the net supply of such assets to the private sector declines, previous asset owners would most likely search for other fixed-income instruments with similar characteristics, such as bonds of major banks or non-financial corporations headquartered in Germany or other core countries. Such a rebalancing would favour the financing of these corporations, which might have an impact on their investment decisions, in particular for companies that finance investment through credit. A weaker euro exchange rate could directly help to lift inflation because of its impact on import prices. The exchange-rate effect through exports would likely favour both the core and periphery, but would have different impacts. Since core countries with large trade surpluses have bigger tradable sectors, their export performances would likely be boosted more than the exports of periphery countries. Since labour markets are tighter in core countries, an export expansion would more likely translate into wage increases, while this is less likely to happen in the periphery because of high unemployment rates. A weaker euro exchange rate could thus help maintain the inflation differential between the core and periphery. However, we also acknowledge that a weaker exchange rate would mean that the euro area’s current account surplus would increase further. It would mean a sort of beggar-thy-neighbour policy, yet the mandate of the ECB is to maintain price stability in the euro area and not to safeguard global imbalances, which have many other causes. Finally, asset purchases could also have a ‘signalling’ impact on financing conditions in the euro area. Buying assets would show the determination to act, which would affect inflation expectations and the anticipated path of policy rates. How this would work in different countries is uncertain.

    4.2. Size of the asset purchase programme

    Working out the appropriate size of asset purchases is far from easy. Some analysis considered the total amount of asset purchases by the Bank of England and the Fed and suggested similar magnitudes for the euro area (20 to 25 percent of GDP, ie €1.9 trillion to €2.4 trillion). In our view, that is an inadequate benchmark, because a large share of asset purchases by the Fed and Bank of England were crisis-response measures, and the assets were accumulated over five years. The ECB dealt with the crisis in a different way (using liquidity operations) and the situation in the euro area is very different now. A more relevant benchmark could be the amount purchased by the Federal Reserve in its third round of quantitative easing (QE3). This round of QE was announced in light of the weak economic situation of the US economy at a time when the acute phase of the financial crisis was over – a situation that is similar to the current euro-area situation. In September 2012, the Fed announced it would purchase $40 billion (€29 billion) of agency mortgage-backed securities per month, increased to $85 billion (€61 billion) in December 2012 (by adding $45 billion per month of Treasuries). Given that the euro area’s economy is about 30 percent smaller than the US economy, the same size, as a share of GDP, would be between €20 and €40bn per month in the euro area. The ideal way to select the size of asset purchases in the euro area would be through assessing its expected impact on inflation. However, it is rather difficult to measure this impact even in the US and the UK, where large-scale asset purchases have been conducted, and it even more difficult to assess in the euro area. Joyce et al (2012), Gagnon et al (2011) and Meier (2009) argued that asset purchase programmes have had a strong direct effect by reducing long-term government bond yields by about 50-100 basis points in the UK and US. Hancock and Passmore (2011) and Krishnamurthy and Vissing-Jorgensen (2013) reported similar findings for the Fed's mortgage-backed security (MBS) purchase programme in the US. Conclusions on the impact on GDP and inflation differ in magnitude, though all research papers report positive impacts. For the US for instance, Chung et al (2012) estimated that the combination of QE1 and QE2 raised the level of real GDP by three percent and inflation by one percent (an impact equivalent to a cut in the federal funds rate of around 300 basis points). Chen et al (2012) found that QE2 increased GDP growth by 0.4 percent, but had a minimal impact on inflation (equivalent to an effect of a 50-basis point cut in the federal funds rate). In a recent paper Weale and Wieladek (2014) estimated that asset purchases equivalent to one percent of GDP led, respectively in the US and the UK, to a 0.36 and 0.18 percentage-point increase in real GDP and to a 0.38 and 0.3 percentage-point increase in CPI after five to eight quarters. The share of capital markets is smaller in the euro area than in the US and the UK, the health of euro-area banks has not been restored and nominal interest rates are rather low in core euro-area countries. It is therefore difficult to estimate the impact of asset purchases on inflation in the euro area, but most likely the effects are different from those in the US and UK. Assuming a 0.20 percentage point inflation effect of a one percent of GDP asset purchase in the euro area, a yearly asset purchase of about four percent of euro area GDP (~€400 billion) would lead to an inflation increase of approximately 0.8 percentage points after 18 months. Since core inflation in the euro area is about 1.0 percent now, such an increase would move it close to two percent. Since we do not know the exact size of the impact, we propose to commence with €35 billion of asset purchases per month, which would be close (as a share of GDP) to the $85 billion per month purchase of the Fed under QE3. Starting with a much lower volume could be seen as too timid to have a substantial effect. Due to the uncertainty in the transmission, we propose that the size of the purchases should be reviewed after three months. The relevant criteria for the review should be the impact on actual (headline and core) inflation as well as on inflation expectations. Tapering should start only once inflation and inflation expectations have increased substantially.

    4.3. Design principles for an asset-purchase programme

    How could an ECB asset-purchase programme be designed and what would the purchase of different assets mean for monetary conditions in the periphery and the core, given the potentially different quality of bank balance sheets? What are the limits of the different instruments? In our view, the ECB will have to choose which assets to buy using five main criteria.
    • First, the ECB should buy assets that will be most effective in terms of influencing inflation, through the channels we have described.
    • Second, there should be sufficient volumes of assets available, to ensure that the ECB can purchase enough while not buying up whole markets.
    • Third, the ECB should try to minimise the impact on the private-sector financing process. While QE by definition changes relative prices, the ECB should avoid buying in small markets in which its purchases would distort market pricing too much. The more the ECB becomes a player in a market, the more it can be subject to political and private sector pressures when it wants to reverse the purchases.
    • Fourth, the ECB should buy only on the secondary markets in order to allow the portfolio-rebalancing channel to work effectively. Purchasing on the primary market would imply the direct financing of entities, which should be avoided.
    • Fifth, the assets should only originate from the euro area and be denominated in euros, because of the 2013 G7 agreement noted in section 3.2.
    In principle, the ECB could decide to buy any asset, except government securities on the primary market, which is clearly ruled out by the Treaty. In practice, the ECB’s task will be more complex than it has been for the Fed, the Bank of England and the Bank of Japan given the peculiarities of the euro area:
    1. Bank lending is much more important than in the UK and the US;
    2. There is no euro-area wide sovereign asset (beyond the limited amounts of securities issued by the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM) and the EU-wide bonds of the European Investment Bank and European Commission); instead, each member state issues sovereign debt and there are major differences in public debt levels (and thereby in their perceived sustainability) in different member states;
    3. The outstanding stock of privately-issued debt securities is smaller (relative to GDP) than in the US and the UK, and the roles of privately-issued debt securities vary widely in different euro-area member states.
    4.4. Should there be a credit rating requirement for the assets to be purchased? An important question is to what degree the ECB should care about risk. A number of points need to be considered:
    • The risks in purchasing asset are fundamentally different from the risks inherent in collateralised central-bank lending. In the latter case, the risk to the ECB is well contained by the high haircuts applied and the fact that the bank is the counterparty, which remains liable for repayment even if there is a default on the collateral. In the case of a purchase, the haircut to the face value is determined by the markets and the risk is taken directly onto the ECB’s balance sheet.
    • The ECB would take on board significant risk via asset purchases under three circumstances: (a) systemic risk, ie risk when all asset classes are highly correlated, (b) when the purchased portfolio is not diversified enough and concentrated on a few assets in large volumes, and (c) when market prices are distorted and therefore do not reflect well the riskiness of assets.
    • Systemic risk: it is the role of a central bank to address systemic risk and the ECB would in any case be heavily exposed to it also via normal central bank operations.
    • Diversification: given the quantities that would be bought under an asset purchase programme and assuming a proper diversification of risk, the ECB could make a profit on its portfolio if it buys assets at non-distorted prices. Buying many high-risk assets is therefore not problematic as such, because high returns would on average compensate for defaulting assets.
    • Distorted market pricing: market prices can be distorted because of market failures (eg the pricing of US subprime securities before the crisis) or because of central bank intervention in markets. To reduce the magnitude of the latter, it is imperative that the ECB does not buy up whole markets, but limits its purchase in each market to a small share. The less the ECB buys in any given market, the less risk it will take on board because the market distortion would be kept to a minimum. If market-pricing mechanisms are fundamentally wrong or if the ECB’s purchases (including the anticipation of such purchases) materially changes the market pricing of the asset, only then would the ECB risk significant losses.
    • The Treaty gives a mandate to the ECB to maintain price stability, not to protect its balance sheet.
    Given these considerations, we recommend a reasonably low threshold for credit risk, but suggest that some criteria on riskiness should be adopted, because the ECB should not turn itself into a high-risk investment fund. Restricting asset purchases only to the eligible collateral (without any additional eligibility criterion) is an appropriate threshold and therefore this is our recommendation[14]. The pool of eligible collateral has also the great advantage that the ECB already has a well-defined list of eligible assets and therefore the use of this list would limit lobbying activities for what the ECB should buy. It is important to highlight that our suggestion differs from the ECB’s revealed preference, because during the 2009-12 Covered Bond Purchase Programmes (CBPPs), the only previous examples of ECB unsterilised asset purchases, the criteria for purchases was the eligibility of the assets as collateral for refinancing operations with the ECB and a minimum rating of AA or equivalent, awarded by at least one of the major rating agencies[15].

    4.5. The pool of eligible assets

    According to the ECB, total marketable assets eligible as collateral represented almost €14 trillion at the end of 2013, equivalent to 146 percent of euro-area GDP[16]. Figure 10 shows that about half of the Eurosystem’s eligible collateral pool at the end of 2013 comprised government bonds, with €6.37 trillion of central government securities and €0.42 trillion of regional government securities. The other half was split between uncovered bank bonds (€2.28 trillion), covered bank bonds (€1.53 trillion), corporate bonds (€1.46 trillion), asset-backed securities (€0.76 trillion) and other marketable assets (€1.17 trillion). Other marketable assets include European debt (the debts of EU rescue funds and the European Investment Bank). On top of those marketable assets, the ECB also accepts as collateral non-marketable assets, mostly credit claims[17]. Being non-marketable, such assets cannot be within the scope of an asset-purchase programme, unless they are securitised. Part of the eligible collateral has already been pledged in the context of the ECB’s refinancing operations and is therefore not available for purchase for the moment (Figure 10). With the repayment of the three-year LTRO, at the latest on its terminal date of February 2015, a considerable part of the currently-used collateral pool will be freed. It is difficult to compare the size of the total eligible assets to the pool of assets already used as collateral, because the former is available in nominal terms whereas the latter is only available in net terms, ie taking into account the haircut applied by the ECB. Figure 10: Eligible assets and assets used as ECB collateral (EUR bns) Source: ECB; Note: Eligible assets are in nominal values; assets used as ECB collateral are after haircuts and valuation issues. Latest data available: 2013 Q4

    4.6. What to buy? A shopping list for the ECB

    European debt

    A natural starting point for an ECB asset-purchase programme would be euro-area wide government bonds, which do not exist. The closest existing asset, which could be bought without creating too many distortions, would be bonds issued by the EFSF and the ESM. The bonds of the European Union (issued by the European Commission) and the European Investment Bank (EIB) represent EU-wide supranational assets, but since the ECB is an EU institution, it could also consider EU assets. The total available euro-denominated pool of these bonds is around €490 billion (€230 billion for EFSF/ESM, €60 billion for EU, €200 billion for EIB). Buying such pan-European assets would not affect the relative yields of euro-area sovereign debts and would not distort the market-allocation process within the private sector, which would be advantages. While the transmission channel through lower yields may be weak, other channels (portfolio rebalancing, exchange rate, wealth and signalling) would probably work well. We therefore recommend that the ECB buys from this pool of assets.

    Government bonds

    National sovereign debt offers the largest pool for ECB purchases. The portfolio rebalancing effect would work well, as would the exchange rate, wealth and signalling channels. The purchases would not distort the market allocation process within the private sector. In principle, the case for a government bond purchase programme is therefore strong. However, the purchase of national government debt would be more complicated for the ECB as a supranational institution without a supranational euro-area treasury as counterparty, than it was for the Fed or the Bank of England. Several relevant issues should therefore be discussed carefully to decide if government debt should be purchased by the ECB. The first issue is practical. Since there are 18 different sovereign debt markets, the ECB would have to decide which sovereign debt to buy. A proposal often made is to purchase government debt based on the share of each national central bank in ECB capital (which reflects the size of the countries in terms of GDP and population). However, to the extent that debt-to-GDP ratios are different and the demand for sovereign debt is different in different countries, the ECB purchase would alter the spreads between countries and change the relative price of sovereign debt. Even though probably all ECB measures have different implications for different euro-area members (eg the SMP directly benefitted only five governments, the three-year LTROs were primary used by euro-area periphery banks), influencing relative yields may expose the ECB to political pressure by individual countries to increase or decrease the speed of purchases or change its portfolio. It could also lead to moral hazard as market pressure for reforms would be altered. Second, the Treaty on the Functioning of the European Union prohibits extension of any kind of ECB credit facility to public bodies, or the purchase of government securities on the primary markets by the ECB (the same applies to national central banks). This treaty provision was agreed in order to avoid the monetary financing of government debt that could result in cross-border transfers between taxpayers. Therefore, a purchase of government debt is allowed in the secondary bond markets only if it is done for monetary policy purposes and without the risk that it would lead to the financing of government debt. Since the goal of asset purchase will be to meet the ECB’s primary objective of price stability, purchase of government bonds would be allowed if the risk of monetary financing could be excluded. Third, the ECB has a well-defined sovereign bond purchase programme, the OMT programme, which we support (Darvas, 2012; Wolff, 2013). The basic idea of the OMT programme is to give the ECB a tool to buy government bonds in order to improve monetary policy transmission in countries under financial assistance. It is debatable whether a QE programme based on ECB capital keys would undermine the logic of the OMT programme. However, we note that a purchase based on capital keys would lead to small purchases relative to what an OMT programme would require. For example, buying €17.5 billion of EU sovereign debt (one-half of our proposed €35 billion purchases) based on capital keys, would imply that the ECB buys €3.1 billion Italian debt per month. Conditionality as required by the OMT programme may therefore be less relevant in a QE programme. If a country was under an OMT programme, its bonds could be excluded from the broader QE programme. On the other hand, buying government debt of countries with uncertain debt dynamics without the political OMT agreement could expose the ECB to greater political pressures when it wants to exit. Fourth, experience shows that an ECB government-bond purchase programme would be politically controversial. So far, the ECB has had two government-bond purchasing programmes (SMP and OMT). Both were introduced under severe stress and both were motivated by the goal of restoring the monetary transmission mechanism. Both programmes were and are highly controversial, not least because of different assessments of to what extent they constitute monetary financing of government debt. Overall, government-bond purchases would be a natural step because the bond market is very large and the positive effects of such a QE would be significant. However, in a monetary union with 18 different treasuries, such purchases are difficult for the economic, political and legal reasons we have outlined. Purchases of private sector assets – if well designed – would achieve similarly beneficial effects on euro-area inflation and would protect the ECB better from political pressure. We therefore do not recommend the purchase of government bonds at this stage.

    Bank bonds

    The second largest asset class is bank bonds, with €3.8 trillion available in eligible covered and uncovered bonds. Purchasing bank bonds could have an effect through all the major channels we discussed: portfolio-rebalancing, lowering yields, exchange rate, wealth and signalling. In particular, the previous holders of those bonds would have to find other assets to buy, while the reduction in market yields would also reduce the yields on newly issued bank bonds, thereby allowing banks to obtain non-ECB financing at a lower cost. This would improve bank profitability and may improve the willingness of banks to lend. However, bank bonds should be excluded from the ECB asset-purchase programme until the ECB’s Comprehensive Assessment is concluded. Until then, any ECB purchases would lead to serious conflicts of interest at the ECB and would make a proper assessment by the ECB more difficult. Moreover, those banks for which the outcome of the Assessment will be unsatisfactory should continue to be excluded from the ECB’s asset purchases until they have implemented all the required changes in their balance sheets. This might take several months after the completion of the Comprehensive Assessment.

    Corporate bonds

    Figure 11, Outstanding stock of debt securities and loans of non-financial corporations (EUR billions) Source: ECB. Eligible corporate bonds comprise the third largest asset class with almost €1.5 trillion outstanding. However, this amount also includes non-euro area corporate bonds and euro-area bonds issued in other currencies. European corporate bonds are behaving well in terms of default: Moody’s default report for February 2014 – which included a prediction of the forward trend for defaulters – shows that the baseline expectation is on a downward path towards levels rarely seen since 2008, for Europe and globally, and that the pessimistic forecast is also less severe than it was in 2013. While there is no precise data on their magnitude, we estimate that the lower bound of eligible euro-area corporate bonds would be €900 billion. In addition, the supply of corporate bonds in the euro area has grown considerably since 2009 (Figure 11). Figure 12 shows the heterogeneity of corporate bond markets in the euro area. The euro-area corporate bond market is highly concentrated. The main issuers of corporate bonds are French companies, whose bonds make up 44 percent of the total outstanding (ie €466 billion). German and Italian corporate bonds follow at significant distance with each about 12 percent (or around €126 billion) of the outstanding corporate bonds. The Netherlands comes fourth with 9.6 percent of the outstanding (€107 billion). But thanks to the portfolio rebalancing effect, the origin of the corporate bonds is of less importance. The beneficial effect would come from the fact that the current owners of the corporate bonds would sell their bonds and use the cash for different purposes throughout the euro area. The origin of the bond says little about the owners of bonds, which are in some cases US funds. In any case, the ECB should not choose its purchases according to geographic origin, similar to the way it implemented the LTRO/MRO, which led to large amounts of liquidity going to some countries only. In addition, the purchases would encourage new issuance of corporate bonds everywhere and lead to a diversification of the sources of funding (Sapir and Wolff 2013). Lower funding costs for corporations should induce more corporate investment. Figure 12: Bonds vs. loans – financing of EU non-financial corporations (EUR bns) Source: ECB. Note: The difference between the amount reported in this figure and the total eligible corporate bonds shown on Figure 10 comes from the fact that here we only consider corporate bonds issued by euro zone corporations, whereas eligible collateral include corporate bonds issued in the whole European Economic Area (EU countries and Iceland, Liechtenstein and Norway); see https://www.ecb.europa.eu/paym/coll/standards/marketable/html/index.en.html

    Asset-backed securities

    Another class of assets that could be bought by the ECB is asset-backed securities (ABS). Yearly EU securitisation issuance – which peaked in 2008 – is much lower than in the US and has been decreasing since 2008 (Figure 13). Figure 13: European and US historical issuance of securitised products (€ billions) Source: AFME – SIFMA. The total outstanding stock of securitised products has been stagnating at around €1.06 trillion for the euro area compared to €2.5 trillion in the US (AFME, 2014). Products eligible as collateral for the ECB amount to about €761 billion, but some of them originate from outside the euro area. We estimate that the lower bound of eligible euro area ABS would be €330 billion. It is worth highlighting that defaults on ABS in Europe have ranged between 0.6-1.5 percent on average, against 9.3-18.4 percent for US securitisations since the start of the 2007-08 financial crisis[1]. The regulatory landscape for securitised products has also changed considerably since the crisis and made the products safer and more transparent[2]. Considering the total amount of European ABS, more than half (€612 billion) is based on residential mortgages (see Table 1 below), which were among the best performing category of securitised products (S&P, 2013) and would therefore be a natural target for ECB asset purchases. SME ABS constitute a smaller part (€116 billion). The ABS stock outstanding is unequally distributed across countries, with the main issuers being different from the main issuers of corporate bonds. ABS purchases would be concentrated on the Netherlands, Spain and Italy, and could therefore be a good geographical complement to corporate-bond purchases, which would be concentrated in France, Germany and Italy. Table 1: Securitisation in Europe, outstanding stock in 2013Q4 (€ billions) Source: AMFE (2014). Note: All volumes in Euro. ABS: asset-backed securities for which collateral types include auto loans, credit cards, loans (consumer and student loans) and other. CDO: Collateralised Debt Obligations denominated in a European currency, regardless of country of collateral. CMBS: Commercial Mortgage Backed Securities. RMBS: Residential Mortgage Backed Securities. SME: Securities backed by Small- and Medium- sized Enterprises. WBS: Whole Business Securitisation: a securitisation in which the cash flows derive from the whole operating revenues generated by an entire business or segmented part of a larger business. 1. Collateral from multiple European countries is categorised under 'PanEurope' unless collateral is predominantly (over 90 percent) from one country. 2. Multinational includes all deals in which assets originate from a variety of jurisdictions. This includes the majority of euro-denominated CDOs. An ECB purchase could promote the development of securitisation in the euro area. The potential for securitisation is relevant, because many loans would qualify for securitisation. In March 2014, the outstanding amount of loans in the EU to non-financial corporations stood at €4.2 trillion, and to households at €5.2 trillion[1]. From a monetary policy perspective, it would be very beneficial to create ABS that are based on a portfolio of European assets. Ideally, the credit risk should be pooled at the level of the private sector, thereby deepening cross-border financial integration. However, the ECB should not wait for developments in the ABS market before it starts buying securitised products.

    5. Conclusions

    Low inflation in the euro area is particularly dangerous, given high private and public debt levels in several euro-area countries and the need for relative price adjustment between the euro-area core and periphery. According to recent ECB forecasts, average euro-area inflation is not expected to return to close to two percent in the medium term. The ECB’s commitment to its communicated objective of keeping inflation "below but close to two percent inflation in the medium term" has therefore been undermined. In our view, it was a major mistake not to ease monetary conditions at the time that the ECB’s own forecast signalled that inflation will not return to two percent in the medium turn. Also, government policies, including on bank restructuring and public investment, should have been implemented some time ago as a safeguard against the disinflationary process. We also demonstrated that inflation forecasts and expectations about the return to normal inflation rates have proved to be too optimistic, both in the euro area recent years and in Japan for almost two decades. To effectively address the risk of persistently low inflation, the ECB should act. Cutting ECB interest rates further and reducing the ECB’s deposit rate for banks below zero would help but is unlikely to have a sizeable impact. Designing a new very long-term (eg three years or longer) refinancing operation would not be very effective either, because liquidity conditions have normalised and banks now have a preference for paying back three-year LTROs earlier. Stopping the sterilisation of the government bond holdings from the Securities Markets Programme (SMP) would be unwise, because that programme had a specific purpose with the stated feature of sterilisation. The best option for the ECB, with the greatest potential to sizeably influence inflation and inflationary expectations, is an asset-purchase programme. We recommend that the ECB starts an open-ended programme of €35 billion per month of asset purchases and reviews this amount after three months to see if its size needs to be changed. Using empirical estimates from the literature and our assessment, €35 billion per month of purchases over the course of a year could lift inflation by 0.8-1.0 percentage points. The asset-purchase programme should only start to be cut back when inflation has increased and medium-term inflation expectations are anchored at two percent. When inflation has stabilised close to but below two percent, the purchased assets should be sold gradually at a pace that does not undermine inflationary expectations. However, if inflation expectations rise significantly above two percent, the sale of assets should be accelerated and standard monetary policy tools should also be deployed to fight inflation. In terms of available assets, we recommend that the ECB purchases privately-issued debt securities and EFSF, ESM, EU and EIB bonds, but not government bonds. The purchase of government bonds can be problematic if there is a government solvency risk, and would be politically controversial. The combined stock of EFSF/ESM/EU/EIB bonds suitable for purchases is €490 billion. In terms of private debt instruments, we advise that the whole range of assets that are eligible as collateral at the ECB without further credit rating requirements should be considered. The total pool of such assets is €7 trillion. Of these, corporate bonds (for which we estimate that at least €900 billion are suitable for purchases) and asset backed securities (ABS, at least €330 billion suitable for purchases) are preferable, while the bonds of sound banks could be considered only after the ECB’s comprehensive assessment of the banking system has been completed. We therefore recommend that before the completion of the comprehensive assessment, the ECB starts monthly purchases of €15 billon of corporate bonds, €8 billon of ABS and €12 billion of EFSF/ESM/EU/EIB bonds. Given the relative size of the purchases compared to the total size of the respective markets, the mispricing of risk would be limited and the ECB would not take on board much risk if a sufficiently diversified portfolio of assets is purchased. We also highlight that the ECB’s Treaty-based primary mandate is maintaining price stability and there is no prohibition of monetary operations that exposes the ECB to potential losses and profits. However, it is also clear that the ECB should avoid exposure to unchecked political and private sector pressures that could result in delays to the reversal of asset purchases, which would undermine the bank’s price stability mandate.

    References

    • Antolin-Diaz, Juan (2014) ’ Deflation risk and the ECB’s communication strategy’, Fulcrum Research Papers, available at: http://www.fulcrumasset.com/files/frp201402.pdf
    • Bank of England (2012) ‘The Distributional Effects of Asset Purchases’, 12 July 2012 http://www.bankofengland.co.uk/publications/Documents/news/2012/nr073.pdf
    • Chen, Han; Cúrdia, Vasco and Ferrero, Andrea (2012) ‘The macroeconomic effects of large-scale asset purchase programs’, The Economic Journal, vol. 122(564), pp. F289–315, November
    • Chung, Hess; Laforte, Jean-Philippe; Reifschneider, David and Williams, John C. (2012), ‘Estimating the macroeconomic effect of the FED’s asset purchases’, FRBSF Economic Letter 2001/03, January
    • Consensus Economics (2014)
    • Claeys, Hüttl and Merler (2014), ‘Is there a risk of deflation in the euro area’, Bruegel Blog, April 3
    • Darvas, Zsolt (2012) ‘The ECB’s magic wand’, Intereconomics: Review of European Economic Policy, Springer, vol. 47(5), pages 266-267, September
    • Darvas, Zsolt (2013), ‘Banking system soundness is key to more SME’s financing’, Bruegel Policy contribution 2013/10, July
    • ECB (2009), ‘Decision of the European Central Bank of 2 July 2009 on the implementation of the covered bond purchase programme’, Official Journal of the European Union, ECB/2009/16, July
    • ECB (2013), ‘Collateral eligibility requirements – A comparative study across specific frameworks’, July
    • Gagnon, Joseph; Raskin, Matthew; Remache Julie and Brian Sack (2011), ‘The Financial Market Effects of the Federal Reserve’s Large- Scale Asset Purchases’. International Journal of Central Banking 7, no. 1: 3–44.
    • Hancock, Diana and Wayne Passmore (2011), ‘Did the Federal Reserve’s MBS purchase program lower mortgage rates?’, Journal of Monetary Economics, vol.58 no.5, pp.498-514
    • Krishnamurthy, Arvind and Annette Vissing-Jorgensen (2013) ‘The Ins and Outs of LSAPs’
    • Joyce, Michael; Miles, David; Scott, Andrew and Vajanos, Dimitri (2012), ‘Quantitative easing and unconventional monetary policy – an introduction’ The Economic Journal, 122, pp. F271-288, November
    • Meier (2009) ‘Panacea, Curse, or Nonevent? Unconventional Monetary Policy in the United Kingdom.’ IMF Working Paper 09/163, August
    • Moody’s (2014), ‘EMEA Non-Financial Corporates: Positive Credit Trends Likely to Continue Through 2014’, February
    • Papadia, Francesco (2013) ‘Should the European Central Bank do more and go negative?’, Blog post: Money matters? Perspectives on Monetary Policy http://moneymatters-monetarypolicy.blogspot.be/2013/11/should-ecb-go-negative.html
    • Sapir, André and Wolff, Guntram B. (2013), ‘The neglected side of banking union: reshaping Europe’s financial system’, Note presented at the informal ECOFIN, September
    • S&P (2014) - Transition Study: Six Years On, Only 1.5% of European Structured Finance Has Defaulted
    • S&P (2014) - 2013 Annual European Corporate Default Study And Rating Transitions
    • Tabakis, Evangelos and Kantaro Tamura (2013) ‘The use of credit claims as collateral for Eurosystem credit operations’, ECB occasional paper, no. 148, June
    • Weale, Martin and Tomasz Wieladek (2014), ‘What are the macroeconomic effects of asset purchases?’, Bank of England, External MPC Unit, Discussion Paper no. 42, April
    • Wolff, Guntram (2013), “The ECB’s OMT programme and German constitutional concerns”, in Brookings, The G20 and Central Banks in the new world of unconventional monetary policy

    [1] According to the calculation in Darvas (2013), out of these €4.2 trillion, the stock of SME loans in the EU in 2010 represents approximately €1.7 trillion and the largest stocks of SME loans were in Spain (€356bn), followed by Germany (€270bn), Italy (€206bn) and France (€201bn).]]>
    Tue, 06 May 2014 00:00:00 +0100
    <![CDATA[Japan and the EU in the global economy]]> http://www.bruegel.org This publication compiles a collection of papers presented at Bruegel's event Japan and the EU in the global economy - challenges and opportunities]]> Wed, 09 Apr 2014 00:00:00 +0100 <![CDATA[Europe's social problem and its implications for economic growth]]> http://www.bruegel.org See also comment 'Interactive map: Europe’s social polarisation and the generational struggle' The European Union faces major social problems. More than six million jobs were lost from 2008-13 and poverty has increased. Fiscal consolidation has generally attempted to spare social protection from spending cuts, but the distribution of adjustment costs between the young and old has been uneven; a growing generational divide is evident, disadvantaging the young. The efficiency of the social security systems of EU countries varies widely. Countries with greater inequality tended to have higher household borrowing prior to the crisis resulting in more subdued consumption growth during the crisis. The resulting high private debt, high unemployment, poverty and more limited access to education undermine long-term growth and social and political stability. Policymakers face three main challenges. First, addressing unemployment and poverty should remain a high priority not only for its own sake, but because these problems undermine public debt sustainability and growth. Second, bold policies in various areas are required. Most labour, social and fiscal policies are the responsibility of member states, requiring national reforms. But better coordination of demand management at European level is also necessary in order to create jobs. Third, tax/benefit systems should be reviewed for improved efficiency, inter- generational equity and fair burden sharing between the wealthy and poor.]]> Tue, 01 Apr 2014 00:00:00 +0100 <![CDATA[Cross-country insurance mechanisms in currency unions]]> http://www.bruegel.org Thu, 27 Mar 2014 00:00:00 +0000 <![CDATA[Rulemaking in Super-RTAs: Implications for China and India]]> http://www.bruegel.org Mon, 10 Mar 2014 00:00:00 +0000 <![CDATA[The global race for talent: Europe's migration challenge]]> http://www.bruegel.org See also comment '"Give me your tired, your poor, your huddled masses"' In an ageing world with demographic and economic imbalances, the number of international migrants is likely to rise during the twenty-first century. The geography of migration flows is changing, however. Mobile people will be increasingly attracted by faster-growing economies. Therefore, some traditional destinations in western Europe will face stronger competition for skilled labour – not least from countries like China where the working-age population will shrink after 2020. At the same time, the sentiment in many European receiving societies is turning against migration and intra-European Union mobility. In the short run, Europe needs more labour mobility between EU member states given excessively high unemployment reported in some regions, while others face a shortage of skills. In the long run this will not be sufficient to close gaps in European labour markets. But many Europeans are not ready to accept more international migrants, and give their support to political parties with restrictive agendas. This creates at least three challenges. First: organising political majorities in favour of more proactive migration policies. Second: making Europe more attractive for mobile people with talent and skills. Third: moving away from unilateral migration policies towards negotiated win-win solutions aiming at reducing the costs of, and enhancing the welfare gains from, migration and remittances]]> Tue, 04 Mar 2014 00:00:00 +0000 <![CDATA[European Central Bank accountability: how the monetary dialogue could be improved]]> http://www.bruegel.org Mon, 03 Mar 2014 00:00:00 +0000 <![CDATA[Changing trade patterns, unchanging European and global governance]]> http://www.bruegel.org See also comment 'The World in 2020' The world economy is going through its biggest transformation in a relatively short space time. There have been many explanations for this phenomenon but the unprecedented scale and pace of this change and, most crucially, its implications, still seems little understood. In turn, there has been little preparation for, or adjustment to, this changing world, though if the change continues at this pace, the effectiveness of many global institutions in their current form will be threatened. We highlight the dramatic degree of the shifts taking place in world GDP and trade and include fresh projections of what world trade patterns might look like in 2020, should the trends observed over the past decade to continue. We also show the resulting shift in trade relationships for many key countries. European member states tend to have quite different trading partners’ profiles, and this heterogeneity is quite likely to become more pronounced with time. This, in turn, suggests a significant challenge for the effective functioning of the euro area and weakens the original rationale of its creation. If our projections to 2020 are broadly right, then many established frameworks for the running of the world economy and its governance are not going to be fit for purpose, and will need to change. The global monetary system itself, and global organisations such as the IMF, G7, and G20 are going to have to adapt considerably if they want to remain legitimate representatives of the world order. The alternative is their relegation to irrelevance.]]> Tue, 25 Feb 2014 00:00:00 +0000 <![CDATA[The long haul: managing exit from financial assistance]]> http://www.bruegel.org Thu, 20 Feb 2014 00:00:00 +0000 <![CDATA[The Troika and financial assistance in the euro area: successes and failures]]> http://www.bruegel.org See also Blueprint 'EU-IMF assistance to euro area countries: an early assessment' This study provides a systematic evaluation of financial assistance for Greece, Ireland, Portugal and Cyprus. All four programmes, and in particular the Greek one, are very large financially compared to previous international programmes because macroeconomic imbalances and the loss of price competitiveness that accumulated prior to the programmes were exceptional. Yet programmes were based on far too optimistic assumptions about adjustment and recovery in Greece and Portugal. In all four countries, unemployment increased much more significantly than expected. Although fiscal targets were broadly respected, debt-to-GDP ratios ballooned in excess of expectations due to sharp GDP contraction. The GDP deterioration is due to four factors: larger-than-expected fiscal multipliers, a poorer external environment, including an open discussion about euro area break-up, an underestimation of the initial challenge and the weakness of administrative systems and of political ownership. The focus of surveillance of conditionality evolved from fiscal consolidation to growth-enhancing structural measures. The Greek programme is the least successful one. Ireland successfully ended the programme in December 2013, but problems remain in the banking system. Exit from the Portuguese programme in May 2014 appears feasible but it should be accompanied by a precautionary credit line. It is too early to make pronouncements on the Cypriot programme, which only started in May 2013, but it can safely be said that there have been major collective failures of both national and EU institutions in the run-up of the programme.]]> Wed, 19 Feb 2014 00:00:00 +0000 <![CDATA[Inflation persistence in central and eastern European countries]]> http://www.bruegel.org This external publication is available though Taylor & Francis online (paywall).]]> Mon, 17 Feb 2014 00:00:00 +0000 <![CDATA[Pour une Communauté politique de l'euro]]> http://www.bruegel.org This text is also available as a blog post 'For a Euro Community' in English and as a pdf in French and German. The Eiffel Group: Agnès Bénassy-Quéré - Yves Bertoncini - Jean-Louis Bianco - Laurence Boone - Bertrand Dumont - Sylvie Goulard - André Loesekrug-Pietri - Rostane Mehdi- Etienne Pflimlin - Denis Simonneau - Carole Ulmer - Shahin Vallee.
    Nous voulons susciter une prise de conscience en France mais aussi lancer un appel qui aille bien au-‐delà. Convaincus que Français et Allemands conservent une responsabilité particulière, nous partageons l’essentiel du diagnostic et des propositions du groupe Glienicker allemand.
    Wir wollen das Bewusstsein in Frankreich erhöhen, aber auch einen Appell formulieren, der weit darüber hinausgeht. In der Überzeugung, dass Franzosen und Deutsche eine besondere Verantwortung tragen, teilen wir im Kern die Diagnose und Vorschläge der deutschen Glienicker Gruppe.
    We want to raise awareness in France but also to launch an appeal which goes much further. We are convinced that France and Germany retain a particular responsibility in Europe, thus we share most of the diagnoses and proposals made by the German Glienicker group.]]>
    Fri, 14 Feb 2014 00:00:00 +0000
    <![CDATA[In sickness and in health: protecting and supporting public investment in Europe]]> http://www.bruegel.org See also blog post 'In sickness and in health: protecting and supporting public investment in Europe' The long-term decline in gross public investment in European Union countries mirrors the trend in other advanced economies, but recent developments have been different: public investment has increased elsewhere, but in the EU it has declined and even collapsed in the most vulnerable countries, exaggerating the output fall. The provisions in the EU fiscal framework to support public investment are very weak.The recently inserted ‘investment clause’ is almost no help. In the short term, exclusion of national co-funding of EU-supported investments from the fiscal indicators considered in the Stability and Growth Pact would be sensible. In the medium term, the EU fiscal framework should be extended with an asymmetric ‘golden rule’ to further protect public investment in bad times, while limiting adverse incentives in good times. During a downturn, a European investment programme is needed and the European Semester should encourage greater investment by member states with healthy public finances and low public investment rates. Reform and harmonisation of budgeting, accounting, transparency and project assessment is also needed to improve the quality of public investment.]]> Fri, 07 Feb 2014 00:00:00 +0000 <![CDATA[When and how to support renewables? Letting the data speak]]> http://www.bruegel.org See also blog post 'Does Europe need a renewables target?' Low-carbon energy technologies are pivotal for decarbonising our economies up to 2050 while ensuring secure and affordable energy. Consequently, innovation that reduces the cost of low-carbon energy would play an important role in reducing transition costs. We assess the two most prominent innovation policy instruments (i) public research, development and demonstration (RD&D) subsidies and (ii) public deployment policies. Our results indicate that both deployment and RD&D coincide with increasing knowledge generation and the improved competitiveness of renewable energy technologies. We find that both support schemes together have a greater effect that they would individually, that RD&D support is unsurprisingly more effective in driving patents and that timing matters. Current wind deployment based on past wind RD&D spending coincides best with wind patenting. If we look into competitiveness we find a similar picture, with the greatest effect coming from deployment. Finally, we find significant cross-border effects, especially for winddeployment. Increased deployment in one country coincides with increased patenting in nearby countries. Based on our findings we argue that both deployment and RD&D support are needed to create innovation in renewable energy technologies. However, we worry that current support is unbalanced. Public spending on deployment has been two orders of magnitude larger (in 2010 about €48 billion in the five largest EU countries in 2010) than spending on RD&D support (about €315 million). Consequently, basing the policy mix more on empirical evidence could increase the efficiency of innovation policy targeted towards renewable energy technologies]]> Wed, 05 Feb 2014 00:00:00 +0000 <![CDATA[Policies for seed and early stage finance]]> http://www.bruegel.org Tue, 04 Feb 2014 00:00:00 +0000 <![CDATA[Commitments or prohibition? The EU antitrust dilemma]]> http://www.bruegel.org Fri, 31 Jan 2014 00:00:00 +0000 <![CDATA[Banking Union and Beyond: Discussion papers for Brussels Think Tank Dialogue]]> http://www.bruegel.org
  • Single rulebook for the European financial market;
  • Single Supervisory Mechanism (SSM);
  • Single Resolution Mechanism (SRM), ideally supported by a Single Resolution Fund (SRF) and a fiscal backstop;
  • Harmonisation of the Deposit Guarantee Schemes (DGS).
  • The stated rationale behind a European Banking Union is to preserve the singleness of the European financial market, to ensure consistent high-quality supervision and to break the vicious circle between banks and sovereigns. Discussion has been on-going for a long while at the academic, as well as the political, level and agreement (or preliminary agreement) has been reached on these elements. Borrowing conditions for sovereigns have improved markedly after the European Central Bank (ECB) introduced the new Outright Monetary transactions in September 2012, but the fragmentation of the European financial market induced by the crisis is far from being reversed. Starting in 2009 (and accelerating since 2010) Eurozone banks have been massively retrenching within domestic borders. This has led, especially in countries perceived to be weaker, to an impressive re-domestication of banks’ assets in general and of debt portfolios in particular. Doubts about the quality of banks’ balance sheets remain, still weighing on borrowing conditions for the private sector. Credit volume has contracted by 6% in the Eurozone since early 2010, and the worsening of financing conditions seems unevenly distributed across the EMU, with borrowing costs showing diverging dynamics along the peripheral-core divide. Due to their strong reliance on the banking sector, small and medium businesses seem to pay a disproportionately high price in terms of lending conditions not only because of the economic slowdown, but also because of deleveraging undertaken by the banks. The phase in of the SSM that will start in 2014 can help reduce uncertainty about the quality of banks’ assets and about the thoroughness of financial supervision, thus helping to address also the divergence in the private sector borrowing conditions. However, several questions remain open, which is the reason why the issue of banking union is due to remain topical in early 2014. First, some of the central elements of the ECB’s balance sheet-assessment exercise have not yet been decided (or they have not yet been communicated). These include, in particular, the treatment of sovereign debt, the magnitude of the stress test, and the treatment of systemic risk. The choices that will be made on these issues will potentially significantly affect the results. Uncertainty should also be dispelled about the rules that will apply to bank recapitalisation, bank restructuring and bank resolution in 2014 and thereafter, including how remaining recapitalisation costs should be distributed between national taxpayers and taxpayers of other European countries. Second, the recent deal on SRM leaves open the question of how far the present arrangements go towards achieving the stated aim of the banking union i.e. breaking the link between banks and sovereigns. The decision-making process envisioned in the proposed SRM Regulation is very complex and at least for the immediate future, no credible backstop is envisioned for resolution. The recent deal includes a commitment to establish a common backstop of 55bn by 2025 at the latest but during the transition the EU’s fund will be split into national compartments that will be merged over time. In the immediate future, the construction will not differ much from the status quo, meaning that the link between banks and their sovereigns would not be weakened and that different member states’ positions could still lead to potentially very large heterogeneity in the approach to financial sector problems]]>
    Tue, 28 Jan 2014 00:00:00 +0000
    <![CDATA[Supervisory transparency in the European banking union]]> http://www.bruegel.org Fri, 03 Jan 2014 00:00:00 +0000 <![CDATA[Ending uncertainty: recapitalisation under European Central Bank supervision]]> http://www.bruegel.org Tue, 17 Dec 2013 00:00:00 +0000 <![CDATA[Can border carbon taxes fit into the global trade regime?]]> http://www.bruegel.org Mon, 09 Dec 2013 00:00:00 +0000 <![CDATA[Life after Bali: renewing the world trade negotiating agenda]]> http://www.bruegel.org Wed, 04 Dec 2013 00:00:00 +0000 <![CDATA[Who decides? Resolving failed banks in a European framework]]> http://www.bruegel.org Fri, 29 Nov 2013 00:00:00 +0000 <![CDATA[Global and regional financial safety nets: lessons from Europe and Asia]]> http://www.bruegel.org Wed, 20 Nov 2013 00:00:00 +0000 <![CDATA[A Schuman compact for the euro area]]> http://www.bruegel.org Ashoka Mody and published today by Bruegel, is based on the idea that since the very inception of the EU, Europe’s leaders have been unwilling to cross a threshold that compromised core national sovereignty. Instead, the solidarity visualized by Robert Schuman in his 1950 speech can be achieved through three agreements that allow national governments to move forward within a coherent framework.
    • The Fiscal Compact: The delegation of European fiscal governance to the European Commission has created complex structures that have encouraged costly delays, deceptions and half-measures. For this reason, fiscal policy should be the responsibility of the member states where the sovereignty lies. This concept is already present in the Fiscal Compact to which states voluntarily commit.
    • The Sovereign Debt Compact: To minimise the risk of excessive future sovereign borrowing, a credible “no bailout” regime must ensure that private lenders bear losses when sovereign debt becomes unsustainable. This will require writing the possibility of restructuring in debt contracts, using sovereign CoCos.
    • The Banking Compact: The current debate is focused on the intractable financing details of the complex banking union. But financial stability requires a much smaller euro-area banking system. The compact would encourage states to pro-actively downsize the growing crowd of zombie banks (using debt-equity swaps) while bolstering viable banks. A centralised banking union is desirable; but tackling the here and now must be the priority.
    Ashoka Mody’s Schuman Compact creates a decentralised resting stop to reflect on the best course toward a more stable, more integrated Europe. Continuing to stumble forward could lead to a debilitating, if not fatal, fall.
    I sincerely hope that this essay helps policymakers to reflect on the current approach to crisis resolution. Bruegel’s role as a think tank at the heart of Europe is to do exactly this: provide policymakers and citizens with new ideas and approaches to the most burning policy questions of strategic relevance. Decision-makers may decide to continue their current approach, to go forward with a strategy as outlined by me with colleagues of the Glienicker Gruppe, or decide to follow the path towards a Schuman Compact as outlined here. Reading well-argued pieces like this essay, and debating the central questions with the Bruegel community, will help in making the right decision. Guntram Wolff, Director, Bruegel Brussels, November 2013"
    ]]>
    Wed, 20 Nov 2013 00:00:00 +0000
    <![CDATA[Prospects for regulatory convergence under TTIP]]> http://www.bruegel.org Mon, 04 Nov 2013 00:00:00 +0000 <![CDATA[The Dragon awakes: Is Chinese competition policy a cause for concern?]]> http://www.bruegel.org Blog post 'China’s catching up on competition policy enforcement' China’s Anti-Monopoly Law, adopted in 2007, is largely compatible with antitrust law in the European Union, the United States and other jurisdictions. Enforcement activity by the Chinese authorities is also approaching the level seen in the EU. The Chinese law, however, leaves significant room for the use of competition policy to further industrial policy objectives. The data presented in this Policy Contribution indicates that Chinese merger control might have asymmetrically targeted foreign companies, while favouring domestic companies. However, there are no indications that antitrust control has been used to favour domestic players. A strategy to achieve convergence in global antitrust enforcement should include support for Chinese competition authorities to develop the institutional tools they already have, and to improve merger control by promoting the adoption of a consumer-oriented test and enforcing M&A notification rules.]]> Tue, 22 Oct 2013 00:00:00 +0100 <![CDATA[Aufbruch in die Euro-Union]]> http://www.bruegel.org This text is also available as a blog post 'Towards a Euro Union' in English and as a pdf in French and German. See also the French Eiffel prosals 'For a Euro Community' on our blog. Glienicker Group: Armin von Bogdandy(Max-Planck-Institut for Comparative Law and International Law),Christian Calliess(FU Berlin),Henrik Enderlein(Hertie School of Governance),Marcel Fratzscher(DIW),Clemens Fuest(ZEW),Franz Mayer(Uni Bielefeld),Daniela Schwarzer(SWP),Max Steinbeis(Verfassungsblog),Constanze Stelzenmüller(German Marshall Fund), Jakob von Weizsäcker (Thüringer Wirtschaftsministerium),Guntram Wolff(Bruegel) Warum ohne mehr Integration weitere Krisen drohen. Elf deutsche Ökonomen, Politologen und Juristen – die Glienicker Gruppe – entwickeln Vorschläge für ein vertieftes Europa Krise, welche Krise? Nimmt man die öffentliche Stimmung in Deutschland ernst, dann gibt es wenig Anlass, sich über Europa noch große Sorgen zu machen. Die dramatischen Wochen, als man täglich mit dem Schlimmsten rechnen musste, liegen lange zurück. Die Finanzmärkte haben sich beruhigt. Die Konstruktionsfehler der Währungsunion scheinen entschärft, Ratspräsident Herman van Rompuy kann vor der UN-Vollversammlung in New York unwidersprochen behaupten, die „existenzielle Bedrohung des Euro“ sei „vorbei“ – und er ist nicht der einzige.
    Sans plus d'intégration, de nouvelles crises se profilent. Onze économistes, politologues et juristes allemands - le Groupe Glienicker - élaborent des propositions pour une Europe approfondie. La crise? Quelle crise? Si l’on prend au sérieux l’opinion publique allemande, il n’y a pas vraiment de raison de s’inquiéter pour l’Europe. Les semaines dramatiques durant lesquelles on craignait que l’euro s’effondre sont loin derrière nous. Les marchés financiers se sont calmés. Les erreurs de construction de l’Union économique et monétaire (UEM) semblent désamorcées ; le président du Conseil européen, Herman Van Rompuy, peut annoncer devant l’Assemblée générale des Nations Unies à New York, sans être contredit, que « la menace pesant sur l’existence même de l’euro est derrière nous ».
    Without more integration, further crises are looming. Eleven German economists, political scientists and jurists – the Glienicker Group – develop proposals for a deeper Europe. Crisis, what crisis? If public sentiment in Germany is anything to go by, there is little reason to worry about Europe. The period when it was feared that the euro might collapse seems a long time ago. Financial markets have calmed down. The design flaws of the monetary union seem to have been papered over, and European Council President Herman van Rompuy was able to claim, unchallenged, before the UN General Assembly in New York that the "existential threat to the euro" is over.]]>
    Sat, 19 Oct 2013 00:00:00 +0100
    <![CDATA[Will income inequality cause a middle-income trap in Asia?]]> http://www.bruegel.org Thu, 10 Oct 2013 00:00:00 +0100 <![CDATA[The European Central Bank in the age of banking union]]> http://www.bruegel.org Thu, 03 Oct 2013 00:00:00 +0100 <![CDATA[Manufacturing Europe’s future]]> http://www.bruegel.org edited by Reinhilde Veugelers
    Publication Launch 'Manufacturing Europe's Future'
    'Industrial policy is back!’ This is the message given in the European Commission’s October 2012 communication on industrial policy (COM(2012) 582 final), which seeks to reverse the declining role of the manufacturing industry, and increase its share of European Union GDP from about 16 percent currently to above 20 percent. Historical evidence suggests that the goal is unlikely to be achieved. Manufacturing’s share of GDP has decreased around the world over the last 30 years. Paradoxically, this relative decline has been a reflection of manufacturing’s strength. Higher productivity growth in manufacturing than in the economy overall resulted in relative decline. A strategy to reverse this trend and move to an industrial share of above 20 percent might therefore risk undermining the original strength of industry – higher productivity growth. This Blueprint therefore takes a different approach. It starts by looking in depth into the manufacturing sector and how it is developing. It emphasises the extent to which European industry has become integrated with other parts of the economy, in particular with the increasingly specialised services sector, and how both sectors depend on each other. It convincingly argues that industrial activity is increasingly spread through global value chains. As a result, employment in the sector has increasingly become highly skilled, while those parts of production for which high skill levels are not needed have been shifted to regions with lower labour costs. But this splitting up of production is not driving the apparent manufacturing decline.Participation in global value chains within Europe is strongly EU-oriented with a central position for the EU15 and in particular Germany in EU manufacturing. This internationalisationof production has resulted in deeper integration of EU manufacturing,withmember states specialising in sectors according to their comparative advantage.It has therefore helped to raise productivity and growth. As a result, the foreign content of countries’ exports has increased. Germany, in particular, has been able to benefit from the greater possibilities to outsource parts of production to central and eastern Europe and to emerging markets, and is in fact one of the countries with the smallest manufacturing share declines in the last 15 years. The Blueprint also highlights the importance of energy for the structure and specialisation of manufacturing. Capital-intensive manufacturing faces both urgent challenges and medium-term challenges. In the short-term, one of the most pressing problems is the fragmentation of financial markets in Europe,which undermines access to finance. This affects small to medium-sized firms in particular because they are the most dependent on bank credit. In some southern European countries, even the financing of working capital is endangered. It should therefore be a high priority for policymakers to fix Europe’s banking problems and create better functioning capital markets, including for venture capital. A second important conclusion is that, given the strong links between innovation,internationalisation and firm productivity, it is important to erase the dividing lines between industrial policy, single market policy, ICT policy and service sector policy. A highly integrated economic system needs a coherent set of policies that aim at improving business conditions everywhere. Attempts to promote one sector at the expense of another one are likely to result in significant inefficiencies and weaker overall growth. Governments are notoriously bad at picking winners. Instead, Europe needs policies that are conducive to a better business climate, less-burdensome regulations and the right framework conditions. Third, public policies need to be more supportive of industry and other parts of the economy. For example, the education system is of central importance for the economy and needs to be adapted to the needs of modern economies. The single market is important for both manufacturing and services and progress is needed to unleash its potential for growth. Reducing trade barriers is particularly important for industrial firms that increasingly rely in global value chains. Distortions in energy prices are also detrimental to industrial activity and should be avoided. ‘Manufacturing Europe’s future’ therefore means getting the policies right for firms to grow and prosper. It is not about picking one sector over another, but primarily about setting the right framework conditions for growth, innovation and jobs. Guntram Wolff, Director of Bruegel Brussels, September 2013]]>
    Wed, 02 Oct 2013 00:00:00 +0100
    <![CDATA[Memo to Merkel: Post-election Germany and Europe]]> http://www.bruegel.org
  • Competitiveness adjustment is incomplete, casting doubt on the sustainability of public debt.
  • Banking remains unstable and fragmented along national lines, resulting in unfavorable financial conditions, which further erode growth, job creation and competitiveness.
  • Rising unemployment, especially among the young, is inequitable, unjust and politically risky.
  • Germany has a central role to play in addressing these risks. The new German government should work on three priorities:
    1. Domestic economic policy should be more supportive of growth and adjustment, with higher public investment, a greater role for high-value added services, and more supportive immigration policy.
    2. Germany should support a meaningful banking union with a centralised resolution mechanism requiring a transfer of sovereignty to Europe for all countries including Germany.
    3. The establishment of a private investment initiative combined with a European Youth Education Fund and labour market reforms should be promoted.
    Building on these priorities, a significant deepening of the euro area is needed, with a genuine transfer of sovereignty, stronger institutions and democratically legitimate decision-making structures in areas of common policy.]]>
    Tue, 24 Sep 2013 00:00:00 +0100
    <![CDATA[Does the European Semester deliver the right policy advice?]]> http://www.bruegel.org Economic and Monetary Affairs Commitee of the European Parliament. The July 2013 European Council recommendations to the euro area recognise a number of fiscal and macrostructural challenges, but do not fully exploit the options made possible by the European economic governance framework. There are particular problems with the Council's suggestions for the euro area as whole, which are not (or not adequately) reflected by the country-specific recommendations. A major drawback is that the Council recommendations do not give sufficient importance to symmetric intra-euro area adjustments. Reference to the euro area's ‘aggregate fiscal stance’ is empty rhetoric. Insufficient attention is paid to demand management.The most comprehensive recommendations are made on structural reforms. The July/August 2013 Article IV IMF recommendations on macroeconomic policies could also have been more ambitious, but they correspond better to the economic situation of the euro area than the Council’s recommendations. The President of the Eurogroup should continue discussions on the completion of the economic governance framework, including completion of the banking union and the setting-up of a euro-area institution responsible for managing the euro area’s aggregate fiscal stance.]]> Fri, 20 Sep 2013 00:00:00 +0100 <![CDATA[The neglected side of banking union: reshaping Europe’s financial system]]> http://www.bruegel.org the informal ECOFIN in Vilnius on September 14. It discusses how Europe's financial system could and should be reshaped. It starts from two basic points: First, the banking system needs to be credibly de-linked from the sovereigns and banks should operate across borders. Europe needs fewer national champions. Second, other forms of financial intermediation need to be developed. Both steps require a significant stepping up of the policy system, including a single resolution mechanism. Together, this will render Europe’s financial system more stable, more efficient and more conducive to growth.]]> Sat, 14 Sep 2013 00:00:00 +0100 <![CDATA[Electricity without borders: a plan to make the internal market work]]> http://www.bruegel.org
  • First, we suggest adding a European system-management layer to complement national operation centres and help them to better exchange information about the status of the system, expected changes and planned modifications. The ultimate aim should be to transfer the day-to-day responsibility for the safe and economic operation of the system to the European control centre. To further increase efficiency, electricity prices should be allowed to differ between all network points between and within countries. This would enable throughput of electricity through national and international lines to be safely increased without any major investments in infrastructure.
  • Second, to ensure the consistency of national network plans and to ensure that they contribute to providing the infrastructure for a functioning single market, the role of the European ten year network development plan (TYNDP) needs to be upgraded by obliging national regulators to only approve projects planned at European level unless they can prove that deviations are beneficial. This boosted role of the TYNDP would need to be underpinned by resolving the issues of conflicting interests and information asymmetry. Therefore, the network planning process should be opened to all affected stakeholders (generators, network owners and operators, consumers, residents and others) and enable the European Agency for the Cooperation of Energy Regulators (ACER) to act as a welfare-maximising referee. An ultimate political decision by the European Parliament on the entire plan will open a negotiation process around selecting alternatives and agreeing compensation. This ensures that all stakeholders have an interest in guaranteeing a certain degree of balance of interest in the earlier stages. In fact, transparent planning, early stakeholder involvement and democratic legitimisation are well suited for minimising as much as possible local opposition to new lines.
  • Third, sharing the cost of network investments in Europe is a critical issue. One reason is that so far even the most sophisticated models have been unable to identify the individual long-term net benefit in an uncertain environment. A workable compromise to finance new network investments would consist of three components: (i) all easily attributable cost should be levied on the responsible party; (ii) all network users that sit at nodes that are expected to receive more imports through a line extension should be obliged to pay a share of the line extension cost through their network charges; (iii) the rest of the cost is socialised to all consumers. Such a cost-distribution scheme will involve some intra-European redistribution from the well-developed countries (infrastructure-wise) to those that are catching up. However, such a scheme would perform this redistribution in a much more efficient way than the Connecting Europe Facility’s ad-hoc disbursements to politically chosen projects, because it would provide the infrastructure that is really needed.
  • ]]>
    Thu, 05 Sep 2013 00:00:00 +0100
    <![CDATA[The euro area's tightrope walk: debt and competitiveness in Italy and Spain]]> http://www.bruegel.org Tue, 03 Sep 2013 00:00:00 +0100 <![CDATA[The ECB's OMT Programme and German Constitutional Concerns]]> http://www.bruegel.org Thu, 29 Aug 2013 00:00:00 +0100 <![CDATA[Sovereign debt and its restructuring framework in the euro area]]> http://www.bruegel.org Mon, 12 Aug 2013 00:00:00 +0100 <![CDATA[Inflation persistence in Central and Eastern European countries]]> http://www.bruegel.org Mon, 22 Jul 2013 00:00:00 +0100 <![CDATA[The response speed of the International Monetary Fund]]> http://www.bruegel.org Wed, 17 Jul 2013 00:00:00 +0100 <![CDATA[Banking system soundness is the key to more SME financing]]> http://www.bruegel.org Mon, 15 Jul 2013 00:00:00 +0100 <![CDATA[A realistic bridge towards European banking union]]> http://www.bruegel.org Thu, 27 Jun 2013 00:00:00 +0100 <![CDATA[Central bank cooperation during the great recession]]> http://www.bruegel.org Thu, 20 Jun 2013 00:00:00 +0100 <![CDATA[EU-IMF assistance to euro area countries: an early assessment]]> http://www.bruegel.org Read update 'The Troika and financial assistance in the euro area: successes and failures' (coming 19/02) Three years ago, in May 2010, Greece became the first euro-area country to receive financial assistance from the European Union and the International Monetary Fund in exchange for implementing an economic programme designed by the Troika of the European Commission, the European Central Bank and the IMF. Within a year, Ireland and Portugal went down the same path. This study provides an early evaluation of these assistance programmes implemented by the Troika in these three countries. The study assesses the economic impact of the programmes and the consequences of their particular institutional set-up.]]> Mon, 17 Jun 2013 00:00:00 +0100 <![CDATA[Bank versus non-bank credit in the United States, Europe and China]]> http://www.bruegel.org Wed, 05 Jun 2013 00:00:00 +0100 <![CDATA[Do European Union fines deter price-fixing?]]> http://www.bruegel.org Wed, 22 May 2013 00:00:00 +0100 <![CDATA[Deleveraging and global growth]]> http://www.bruegel.org Thu, 25 Apr 2013 00:00:00 +0100 <![CDATA[EU-Korea Economic Exchange]]> http://www.bruegel.org Zsolt Darvas, Bruegel April 2013 ]]> Tue, 23 Apr 2013 00:00:00 +0100 <![CDATA[Europe's growth problem (and what to do about it)]]> http://www.bruegel.org here.]]> Fri, 12 Apr 2013 00:00:00 +0100 <![CDATA[You'd better bet on the ETS]]> http://www.bruegel.org Policy challenge The ETS must be stabilised by reinforcing the credibility of the system so that the use of existing low-carbon alternatives (for example burning gas instead of coal) is incentivised and investment in low-carbon assets is ensured. Further-more, failure to reinvigorate the ETS might compromise the cost-effective synchronisation of European decarbonisation efforts across sectors and countries. To restore credibility and to ensure long-term commitment to the ETS, the European Investment Bank should auction guarantees on the future emission allowance price.This will reduce the risk for low-carbon investments and enable stabilisation of the ETS until a compromise is found on structural measures to reinforce it in order to achieve the EU's long-term decarbonisation targets.]]> Tue, 09 Apr 2013 00:00:00 +0100 <![CDATA[The changing landscape of financial markets in Europe, the United States and Japan]]> http://www.bruegel.org Mon, 18 Mar 2013 00:00:00 +0000 <![CDATA[Should non-euro area countries join the single supervisory mechanism?]]> http://www.bruegel.org Wed, 13 Mar 2013 00:00:00 +0000 <![CDATA[Electricity infrastructure: More border crossings or a borderless Europe?]]> http://www.bruegel.org Fri, 22 Feb 2013 00:00:00 +0000 <![CDATA[From supervision to resolution: next steps on the road to European banking union]]> http://www.bruegel.org Listen to the press conference call. The European Council has outlined the creation of a Single Resolution Mechanism (SRM), complementing the Single Supervisory Mechanism. The thinking on the SRM’s legal basis, design and mission is still preliminary and depends on other major initiatives, including the European Stability Mechanism’s involvement in bank recapitalisations and the Bank Recovery and Resolution (BRR) Directive. The SRM should also not be seen as the final step creating Europe’s future banking union. Both the BRR Directive and the SRM should be designed to enable the substantial financial participation of existing creditors in future bank restructurings. To be effective, the SRM should empower a central body. However, in the absence of Treaty change and of further fiscal integration, SRM decisions will need to be implemented through national resolution regimes. The central body of the SRM should be either the European Commission, or a new authority. This legislative effort should not be taken as an excuse to delay decisive action on the management and resolution of the current European banking fragility, which imposes a major drag on Europe’s growth and employment.]]> Mon, 18 Feb 2013 00:00:00 +0000 <![CDATA[Can Europe recover without credit?]]> http://www.bruegel.org Fri, 15 Feb 2013 00:00:00 +0000 <![CDATA[European antitrust control and standard setting]]> http://www.bruegel.org Wed, 06 Feb 2013 00:00:00 +0000 <![CDATA[Standard-setting abuse: the case for antitrust control]]> http://www.bruegel.org Wed, 06 Feb 2013 00:00:00 +0000 <![CDATA[The World innovation landscape: Asia rising?]]> http://www.bruegel.org Fri, 01 Feb 2013 00:00:00 +0000 <![CDATA[Options for a Euro-area fiscal capacity]]> http://www.bruegel.org Thu, 10 Jan 2013 00:00:00 +0000 <![CDATA[Private long-term investment in uncertain times]]> http://www.bruegel.org Wed, 19 Dec 2012 00:00:00 +0000 <![CDATA[Policy Lessons from the Eurozone Crisis]]> http://www.bruegel.org Co-authored by Chiara Angeloni, Silvia Merler and Guntram Wolff. The current European crisis has shed light on several weaknesses and the institutional incompleteness characterizing the euro area. The manifestation of Europe's fragility was preceded by a large build-up of debt in the private sector, associated with national current account divergences and the deterioration of competitiveness particularly of the euro periphery countries. With the economic situation deteriorating, private sector debt became less credible, contaminating banks' balance sheets and placing a heavy burden on governments. A sovereign-bank vicious circle emerged: on the one hand, with banking risk translating into higher sovereign risk because of the governments' guarantor role and, on the other hand, with the deterioration of government's creditworthiness affecting the banking systems through banks' sovereign bond holdings. In principle, this negative feedback can be stopped by breaking one of the channels of transmission. A banking union at the European level is proposed as one solution. Published in 'The International Spectator: Italian Journal of International Affairs'. See the original publication in English here.]]> Thu, 13 Dec 2012 00:00:00 +0000 <![CDATA[A budget for Europe's monetary union]]> http://www.bruegel.org Mon, 03 Dec 2012 00:00:00 +0000 <![CDATA[Smart choices for growth]]> http://www.bruegel.org Wed, 28 Nov 2012 00:00:00 +0000 <![CDATA[The long-term EU budget: size or flexibility?]]> http://www.bruegel.org • To improve flexibility a commitment device should be created that places the EU budget above continuous political disagreement. We suggest the creation of a European Growth Fund, on the basis of which the European Commission should be allowed to borrow on capital markets to anticipate pre-allocated EU expenditure, such as Structural and Cohesion Funds. Markets would thus be a factor in EU budget policymaking, with a potentially disciplining effect. Attaching conditionality to this type of disbursement appears legitimate, as capital delivered in this way is a form of assistance.]]> Fri, 23 Nov 2012 00:00:00 +0000 <![CDATA[On the effectiveness and legitimacy of EU economic policies]]> http://www.bruegel.org This policy brief was presented to the Assemblée nationale of France on the 19th February 2014.]]> Fri, 09 Nov 2012 00:00:00 +0000 <![CDATA[The Greek debt trap: an escape plan]]> http://www.bruegel.org Fri, 09 Nov 2012 00:00:00 +0000 <![CDATA[Assurance mutuelle ou fédéralisme: la zone euro entre deux modèles]]> http://www.bruegel.org Published in Journées de l'economie de Lyon 2012]]> Wed, 07 Nov 2012 00:00:00 +0000 <![CDATA[The known unknowns and the unknown unknowns of the EMU]]> http://www.bruegel.org Fri, 26 Oct 2012 00:00:00 +0100 <![CDATA[The euro crisis: ten roots, but fewer solutions]]> http://www.bruegel.org This Policy contribution was published in 'The Aftermath of the Global Crisis in the European Union' in May 2013. Many factors have contributed to the euro crisis. Some have been addressed by policymakers, even if belatedly, and European Union member states have been willing to improve the functioning of the euro area by agreeing to relinquish national sovereignty in some important areas. However, the most pressing issue threatening the integrity, even the existence, of the euro, has not been addressed: the deepening economic contraction in southern euro-area member states. The common interest lies in preserving the integrity of the euro area and in offering these countries improved prospects. Domestic structural reform and appropriate fiscal consolidation, wage increases and slower fiscal consolidation in economically stronger euro-area countries, a weaker euro exchange rate, debt restructuring and an investment programme should be part of the arsenal. In the medium term, more institutional change will be necessary to complement the planned overhaul of the euro area institutional framework. This will include the deployment of a euro-area economic stabilising tool, managing the overall fiscal stance of the euro area, some form of Eurobonds and measures to make euro-area level decision making bodies more effective and democratically legitimate.]]> Fri, 19 Oct 2012 00:00:00 +0100 <![CDATA[The growth effects of EU cohesion policy: a meta-analysis]]> http://www.bruegel.org Thu, 11 Oct 2012 10:15:49 +0100 <![CDATA[The EU-EFIGE/Bruegel-Unicredit dataset ]]> http://www.bruegel.org • The database, for the first time in Europe, combines measures of firms’ international activities (eg exports, outsourcing, FDI, imports) with quantitative and qualitative information on about 150 items ranging from R&D and innovation, labour organisation, financing and organisational activities, and pricing behaviour. Data consists of a representative sample (at the country level for the manufacturing industry) of almost 15,000 surveyed firms (above 10 employees) in seven European economies (Germany, France, Italy, Spain, United Kingdom, Austria, Hungary). Data was collected in 2010, covering the years from 2007 to 2009. Special questions related to the behaviour of firms during the crisis were also included in the survey. • We illustrate the construction and usage of the dataset, capitalising on the experience of researchers who have exploited the data within the EFIGE project. Importantly, the document also reports a comprehensive set of validation measures that have been used to assess the comparability of the survey
    data with official statistics. A set of descriptive statistics describing the EFIGE variables within (and across) countries and industries is also provided.]]>
    Thu, 04 Oct 2012 14:45:04 +0100
    <![CDATA[Europe's single supervisory mechanism and the long journey towards banking union]]> http://www.bruegel.org This Policy Contribution was prepared as a briefing paper for the European Parliament Economic and Monetary Affairs Committee’s Monetary Dialogue.]]> Thu, 04 Oct 2012 09:55:30 +0100 <![CDATA[An Assessment of the European Semester]]> http://www.bruegel.org Mon, 01 Oct 2012 17:10:46 +0100 <![CDATA[The euro crisis and the new impossible trinity]]> http://www.bruegel.org 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. Introduction 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:
    • In 2011, the EU adopted new legislation, effective from 1 January 2012, that reinforces preventive action against fiscal slippages, sets minimum requirements for national fiscal frameworks, toughens sanctions against countries in excessive deficit and tightens up enforcement through a change in the voting procedure.
    • On 26 October 2011, the euro area heads of state and government decided to go further and committed themselves to adopting constitutional or near-constitutional rules on balanced budgets in structural terms, to basing national budgets on independent forecasts and, for countries in an excessive deficit procedure, to allowing examination of draft budgets by the European Commission before they are adopted by parliaments. A few weeks later, in November 2011, the European Commission put forward proposals for new legislation (the "two-pack") requiring euro area member states to give the Commission the right to assess, and request revisions to, draft national budgets before they are adopted by parliament.

    • Speaking in the European Parliament in early December, European Central Bank President Mario Draghi asked for a “new fiscal compact” which he defined as “a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made”, so that these commitments “become fully credible, individually and collectively”.

    • On 9 December 2011, EU heads of states and government, with the significant exception of the United Kingdom, committed themselves to introducing fiscal rules stipulating that the general government deficit must not exceed 0.5 percent of GDP in structural terms. They also agreed on a new treaty that would allow automatic activation of the sanction procedure for countries in breach of the 3 percent of GDP ceiling for budgetary deficits. Sanctions as recommended by the European Commission will be adopted unless a qualified majority of euro area member states is opposed.
    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.]]>
    Wed, 26 Sep 2012 10:36:24 +0100
    <![CDATA[Fiscal rules: Timing is everything]]> http://www.bruegel.org Mon, 17 Sep 2012 15:09:11 +0100 <![CDATA[The fiscal implications of a banking union]]> http://www.bruegel.org The findings of this paper were presented at the Informal ECOFIN in Nicosia on 14 September 2012.]]> Fri, 14 Sep 2012 15:09:31 +0100 <![CDATA[Intra-euro rebalancing is inevitable but insufficient]]> http://www.bruegel.org
  • The share of intra-euro trade has declined.
  • Intra-euro trade balances have already adjusted to a great extent.
  • The intra-euro real exchange rates of Greece, Portugal and Spain have also either already adjusted or do not indicate significant appreciations since 2000.
  • There are only two main current account surplus countries, Germany and the Netherlands.
  • A purely intra-euro adjustment strategy would require too-significant wage increases in northern countries and wage declines in southern countries, which do not seem to be feasible.
  • Before the crisis, the euro was significantly overvalued despite the close-to balanced current account position. The euro has depreciated recently, but more is needed to support the extra-euro trade of southern euro-area members. A weaker euro would also boost exports, growth, inflation and wage increases in Germany, thereby helping further intra-euro adjustment and the survival of the euro.]]>
    Fri, 31 Aug 2012 11:27:17 +0100
    <![CDATA[New ICT sectors: Platforms for European growth?]]> http://www.bruegel.org Wed, 29 Aug 2012 00:00:00 +0100 <![CDATA[Breaking down the barriers to firmgrowth in Europe The fourth EFIGE policy report]]> http://www.bruegel.org Tue, 28 Aug 2012 11:30:56 +0100 <![CDATA[Money demand in the euro area: new insights from disaggregated data]]> http://www.bruegel.org https://springerlink3.metapress.com/content/gq60432737628667/resource-secured/?target=fulltext.pdf&sid=dzqotsigt4ocxztxxyee3jg0&sh=www.springerlink.com]]> Tue, 21 Aug 2012 11:41:46 +0100 <![CDATA[The challenges of Europe's fourfold union]]> http://www.bruegel.org This Policy Contribution reproduces Nicolas Véron’s statement delivered at the hearing on 'The Future of the Eurozone: Outlook and Lessons' at the Subcommittee on European Affairs of the US Senate Committee on Foreign Relations, in Washington DC on 1 August 2012.]]> Thu, 16 Aug 2012 00:00:00 +0100 <![CDATA[The simple macroeconomics of North and South in EMU]]> http://www.bruegel.org
  • 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.
  • ]]>
    Mon, 30 Jul 2012 12:05:32 +0100
    <![CDATA[Transatlantic economic challenge in an era of growing multipolarity]]> http://www.bruegel.org Tue, 24 Jul 2012 12:49:39 +0100 <![CDATA[Golden Growth: Restoring the lustre of the European economic model]]> http://www.bruegel.org http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/0,,contentMDK:23069550~pagePK:146736~piPK:146830~theSitePK:258599,00.html
    The report documents the impressive achievements of the European growth model over the last 50 years. Accounting for the stresses it is experiencing and assessing the longer-term challenges that Europe will face, the report then evaluates the six principal components of the model: Trade, Finance, Enterprise, Innovation, Labor, and Government. It finds that the European growth model has been a powerful engine for economic convergence, helping developing countries in Europe catch up to their richer neighbors and become high-income economies. But recent changes in and outside Europe necessitate change. The report proposes the adjustments needed to make trade and finance work even better, to encourage enterprise and innovation in parts of Europe which have begun to lag, and address shortcomings in the functioning of labor markets and governments. The changes proposed would restart the European convergence machine, make Europe's enterprises competitive, and help Europeans afford the highest standards of living in the world.
    ]]>
    Fri, 20 Jul 2012 00:00:00 +0100
    <![CDATA[Monetary transmission in three central European economies: evidence from time-varying coefficient vector autoregressions]]> http://www.bruegel.org A version of the Bruegel Working Paper Monetary transmission in three central European economies: evidence from time-varying coefficient vector autoregressions has been published in Empirica We study the transmission of monetary policy to macroeconomic variables with structural time-varying coefficient vector autoregressions in the Czech Republic, Hungary and Poland, in comparison with that in the euro area. These three countries have experienced changes in monetary policy regimes and went through substantial structural changes, which call for the use of a time-varying parameter analysis. Our results indicate that the impact on output of a monetary shock changed over time. At the point of the last observation of our sample, the fourth quarter of 2011, among the three countries, monetary policy was most powerful in Poland and not much less strong than the transmission in the euro area. We discuss various factors that can contribute to differences in monetary transmission, such as financial structure, labour market rigidities, industry composition, exchange rate regime, credibility of monetary policy and trade openness. ]]> Thu, 19 Jul 2012 16:29:26 +0100 <![CDATA[The triggers of competitiveness: The EFIGE cross-country report]]> http://www.bruegel.org Competitiveness is one of the most debated issues in policy circles. But, what triggers it? Capitalising on the first existing harmonised cross-country dataset measuring the entire range of international activities of firms in seven European countries (Austria, France, Germany, Hungary, Italy, Spain, United Kingdom), we first confirm a number well-established results of the firm heterogeneity literature. Secondly, and more importantly, we identify several innovational, financial, organizational and managerial triggers of competitiveness at firm level. Finally, we argue that enhancing-competitiveness policymaking could be improved by firm-level evidence if there were less reluctance to the use of micro-founded indicators to inform policy decisions.

    ]]>
    Tue, 17 Jul 2012 10:57:04 +0100
    <![CDATA[Productivity, labour cost and export adjustment: Detailed results for 24 EU countries]]> http://www.bruegel.org Compositional effects on productivity, labour cost and export adjustment’, this working paper presents detailed results for 24 EU countries on: • The sectoral changes in the economy;
    • The unit labour costs (ULC) based real effective exchange rate (REER) and its main components;
    • Export performance. The ULC-REERs are calculated: • For the total economy, the business sector (excluding agriculture, construction and real estate activities), and some main sectors;
    • Using both actual aggregates and fixed-weight aggregates, as the latter are free from the impacts of compositional changes;
    • Against 30 trading partners and against three subsets of trading partners: euro-area, non-euro area EU, non-EU.
    • The REERs calculated in this paper are freely downloadable.]]>
    Thu, 12 Jul 2012 12:08:50 +0100
    <![CDATA[Paths to eurobonds]]> http://www.bruegel.org Tue, 03 Jul 2012 18:47:41 +0100 <![CDATA[The creation of euro area financial safety nets]]> http://www.bruegel.org Mon, 02 Jul 2012 18:31:33 +0100 <![CDATA[What kind of European banking union?]]> http://www.bruegel.org 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.

    ]]>
    Mon, 25 Jun 2012 08:51:56 +0100
    <![CDATA[Compositional effects on productivity, labour cost and export adjustments]]> http://www.bruegel.org , Zsolt released the working paper Productivity, labour cost and export adjustment: Detailed results for 24 EU countries which presents detailed results for 24 EU countries on: sectoral changes in the economy;Unit labour costs (ULC) based real effective exchange rate (REER) and its main components; Export performance.]]> Fri, 22 Jun 2012 15:40:30 +0100 <![CDATA[ICT for growth: a targeted approach]]> http://www.bruegel.org
  • This Policy Contribution assesses the broad obstacles hampering ICT-led growth in Europe and identifies the main areas in which policy could unlock the greatest value. We review estimates of the value that could be generated through take-up of various technologies and carry out a broad matching with policy areas.
    • According to the literature survey and the collected estimates, the areas in which the right policies could unlock the greatest ICT-led growth are product and labour market regulations and the European Single Market. These areas should be reformed to make European markets more flexible and competitive. This would promote wider adoption of modern data-driven organisational and management practices thereby helping to close the productivity gap between the United States and the European Union.
    • Gains could also be made in the areas of privacy, data security, intellectual property and liability pertaining to the digital economy, especially cloud computing, and next generation network infrastructure investment.
    Standardisation and spectrum allocation issues are found to be important, though to a lesser degree. Strong complementarities between the analysed technologies suggest, however, that policymakers need to deal with all of the identified obstacles in order to fully realise the potential of ICT to spur long-term growth beyond the partial gains that we report.]]>
    Wed, 20 Jun 2012 14:27:47 +0100
    <![CDATA[Investment and growth in the time of climate change]]> http://www.bruegel.org See also comment 'Investment and growth in the time of climate change' Climate scientists mostly agree that, if current trends continue, global greenhouse-gas emissions are very likely to result in dangerous interference by mankind in the earth’s climate. Against this background, the world community has set itself the goal of limiting the increase in the global average temperature by the end of this century to no more than 2°C compared to pre-industrial times. To get there, global emissions will have to fall substantially.
    Largely focussing on the European dimension of this goal, this report considers investment and economic growth on a greenhouse-gas emissions trajectory that breaks with the past. Investment-related questions that this report pursues include: how should Europe properly balance investment in mitigating greenhouse-gas emissions and adaptation to climate change? How urgent is it to invest in both? How do global cooperation on climate action and fear of climate catastrophe impact on the balance between mitigation and adaptation? What are the key obstacles to climate investment? Which policies promise to remove these obstacles and make investment profitable, thereby encouraging investment finance? What are the respective roles of the private and the public sector? Growth-related questions include: how are climate action and economic growth linked and, specifically,what is the role of innovation? Are there only trade-offs between climate action and growth or are therewin-wins, too? Can climate action help Europe emerge from its economic crisis? How can climate action be made as growth-friendly as possible? In addressing these questions, this report takes an economic perspective. More specifically, at the heart of the analysis is the quest for economic efficiency. Not surprisingly for this type of analysis, a key theme running through the report is one of trade-offs and difficult choices that society needs to make. Cognisant of the fact that markets left alone will not make economically efficient choices, another common theme is the role of government policies in bringing about efficient outcomes. Considering trade-offs and government policy together, the key message from this report is that there is unexploited scope for making Europe’s climate action more efficient, growth-friendly, and in tune with fiscal constraints.
    The report is the result of a joint research effort by the Economics Department of the European Investment Bank and Bruegel. It is our hope that it will help to clarify some of the complexities involved in designing effective policies to address climate change without sacrificing too much economic growth, in a world in which international cooperation on climate action is so difficult to achieve.]]>
    Thu, 14 Jun 2012 00:00:00 +0100
    <![CDATA[Macroeconomic coordination: what has the G-20 achieved?]]> http://www.bruegel.org Tue, 05 Jun 2012 10:36:58 +0100 <![CDATA[Arithmetic is absolute: euro area adjustment]]> http://www.bruegel.org adjustment during 2009-11. Only Ireland, which is too small to trigger a symmetric reaction, had significantly lower inflation rates than the average. Some asymmetry is visible in total economy unit labour costs (ULC) during 2009- 11, whereas wages appear to develop more symmetrically. ULC adjustment has been largely disconnected from consumer price developments. This makes it difficult for the monetary transmission channel to operate fully and ensure consumer price adjustments. Structural reforms to remove price rigidities are key. The forecast is worrying. While the European Commission forecasts that Greek inflation rates will fall, German and Italian inflation rates will not adjust in the right direction during 2012-13. Less inflation in Italy and more inflation in Germany are urgently needed to achieve rebalancing in the euro area."]]> Wed, 23 May 2012 12:08:12 +0100 <![CDATA[How wide is the Mediterrenean?]]> http://www.bruegel.org This policy contribution provides up-to-date evidence of the strong heterogeneity in the relationships between the five biggest EU economies with the Southern Mediterranean Countries (SMCs). Algeria, Morocco and Tunisia are still strongly tied to France, Italy and Spain, in terms of investments, financial flows and migration. This pattern is in line with the pattern of sizable French and Spanish official bilateral development assistance for Algeria, Morocco, and Tunisia. However, the economic connection of Germany, the UK and the US to the western SMCs is negligible. German and US bilateral development assistance is focused in Egypt, while the four other SMCs appear not to be priorities for non-Mediterranean EU countries. These differences cannot be explained by geographical distance alone. The unbalanced economic relationship of the SMCs with a small number of European countries risks exposing the SMCs to shocks in partner countries. Stronger economic ties also results in a higher degree of mutual political attention, as exemplified by bilateral development assistance that flows more strongly between countries with strong economic links. EU external policy is still largely driven by member states’ interests. Hence building economic ties between the SMCs and non-traditional EU partners could both improve the SMCs’ external economic relationships, and make the SMCs’ political relationship with the EU more resilient. Bruegel gratefully acknowledges the support of the German Marshall Fund]]> Mon, 21 May 2012 00:00:00 +0100 <![CDATA[Monetary transmission in three central European economies: evidence from time-varying coefficient vector autoregressions]]> http://www.bruegel.org Wed, 02 May 2012 14:41:09 +0100 <![CDATA[Propping up Europe?]]> http://www.bruegel.org Tue, 24 Apr 2012 00:00:00 +0100 <![CDATA[Hazardous tango: sovereign-bank interdependence and financial stability in the euro area]]> http://www.bruegel.org Mon, 16 Apr 2012 00:00:00 +0100 <![CDATA[The messy rebuilding of Europe]]> http://www.bruegel.org
  • Make room for deeper integration within the euro area, beyond the limited remit envisaged in the Lisbon treaty
  • Preserve the integrity of the EU27 and its essential governance arrangements
  • Ensure equal treatment in the application of common rules
  • Ensure that candidates for euro-area membership have a voice in the definition of its rules
  • Balance the requirements of legal clarity, accountability and efficiency with the desirability of experimentation through variable geometry
  • This paper was presented to the Economic and Financial Affairs Ministers of the European Union on 30 March 2012 in Copenhagen.]]>
    Fri, 30 Mar 2012 13:20:02 +0100
    <![CDATA[Sudden stops in the euro area]]> http://www.bruegel.org Thu, 29 Mar 2012 11:13:54 +0100 <![CDATA[Are banks affected by their holdings of government debt?]]> http://www.bruegel.org
  • Banks’ holdings of the sovereign bonds of vulnerable countries generally decreased during the period December 2010 to September 2011.
  • The average stock market performance of each country’s banks was very uneven during 2011. The long-term refinancing operation (LTRO) had no material effect on banks’ stock market values.
  • Greek debt holdings had an effect on banks’ market values in the period July to October 2011 while after October this effect disappeared. Holdings of Italian and Irish debt had a material effect on banks’ market value in the period October to December 2011. Holdings of debt of other periphery countries, in particular Spain, were not an issue. The July PSI deal did not substantially affect the risk resulting from holdings of debt other than Greek debt.
  • The location of banks matters for their market value. This highlights the need to form a banking union in the euroarea.
  • ]]>
    Mon, 26 Mar 2012 11:16:41 +0100
    <![CDATA[Real effective exchange rates for 178 countries: a new database]]> http://www.bruegel.org Click here for the most recently updated database
    The real effective exchange rate (REER), which measures the development of the real value of a country’s currency against the basket of the trading partners of the country, is a frequently used variable in both theoretical and applied economic research and policy analysis. It is used for a wide variety of purposes, such as assessing the equilibrium value of a currency, the change in price or cost competitiveness, the drivers of trade flows, or incentives for reallocation production between the tradable and the non-tradable sectors. Due to the importance of the REER in economic research and policy analysis, several institutions, such as the World Bank, the Eurostat, the BIS, the OECD, just to name a few, publish various REER indicators which are freely downloadable. Altogether, these institutions publish data for 113 countries. The countries for which data are available include all advanced and several emerging and developing countries. However, different databases may have different methodologies and even the 109 countries included in the World Bank database miss several dozen countries of the world. Our database has three novelties:
    1. Using a consistent methodology, we calculate CPI-based REER for 178 countries (plus the euro area) for annual data and for 153 countries (plus the euro area) for monthly data.
    2. We calculate the REER for all countries up to date, eg in the current vintage of the database we calculate up to January 2012.
    3. It is relatively easy to calculate REER against any arbitrary group of countries – what is needed for this is a re-scaling of the weighting matrix.
    The database will be irregularly updated.]]>
    Thu, 15 Mar 2012 15:50:56 +0000
    <![CDATA[The internationalisation path of the renminbi]]> http://www.bruegel.org As China’s economic might grows, its standing and that of its currency in the international monetary system become increasingly pressing issues. The crisis seems to have reminded the Chinese authorities of the dangers of a unipolar monetary system, and they have therefore accelerated their plans to internationalise the renminbi (RMB). The goal of this internationalisation strategy is not clear and China has not defined publicly the monetary system it aims to achieve.

    Nevertheless, there are more and more signs that the internationalisation of the RMB is progressing, notwithstanding major challenges. Conventional wisdom and the majority of the literature posits that the RMB will not succeed in its internationalisation process until China fully opens its capital and financial accounts, makes its exchange rate flexible and liberalises its financial sector. These three obstacles are real but circumventable. However, if China's internationalisation strategy follows a path that concentrates on overcoming immediate challenges in order to raise the status of the RMB to that of a second-tier world currency, the Chinese authorities will still have to undertake substantial reforms if they intend to place the RMB on a footing comparable to the dollar or the euro.

    ]]>
    Tue, 13 Mar 2012 12:49:28 +0000
    <![CDATA[The G20: characters in search of an author]]> http://www.bruegel.org
  • in today’s global economy (with its trade and financial market integration and its institutional architecture) a “G20-type” institution is necessary– if it didn’t exist, it should be created;
  • the G20 had its high noon moment in 2008-09 and some recalibration of expectations was inevitable, but its achievements in 2010-11 have nevertheless been disappointing;
  • to be fair there is, in detailed and technical work, more progress than there seems to be at first sight;
  • from a governance standpoint, the G20 is not an efficient forum; improvements in working methods are urgently needed;
  • more fundamentally, for the G20 to retain its role, its members need to develop a common vision of global economic problems and the way to approach them.
  • ]]>
    Tue, 13 Mar 2012 11:42:06 +0000
    <![CDATA[Challenges for the euro area and implications for Latvia]]> http://www.bruegel.org
  • The euro area faces three major challenges: (1) high private and public debt in some of its parts together with a requirement for competitiveness adjustment that in some countries has barely started; (2) weak growth outlook; (3) continued banking-sector fragility that, with sovereign stress, feeds a negative feedback loop. The euro area has agreed many significant measures to overcome these problems, including the European Stability Mechanism and the fiscal compact. The 21 February agreement on Greece removes a major source of financial instability even though it is likely that further debt reductions will be needed. Significant concerns remain, the most important of which are the slow real economic adjustment and the largely unaddressed banking-sovereign fragility. The fiscal compact raises the issue of appropriate fiscal stabilisation tools at the euro-area level.
    • Countries that will soon join the euro should actively shape the debate about the further development of the overall set-up. For Latvia, joining the euro makes sense because Latvia has kept its exchange rate fixed and has undergone internal adjustment. In its euro-area accession negotiations, Latvia should ensure that it does not participate in any of the currently ongoing financial assistance programmes.
    This Policy Contribution reproduces evidence given by Guntram B. Wolff to the Latvian parliament’s European affairs committee, 22 February 2012.]]>
    Fri, 02 Mar 2012 15:05:01 +0000
    <![CDATA[Innovation in EU merger control: walking the talk]]> http://www.bruegel.org
    The author acknowledges the excellent research assistance of Joan de Solà-Morales and Hendrik Meder, and would like to thank Lars-Hendrik Röller for discussing and commenting on earlier versions of the paper.]]>
    Wed, 29 Feb 2012 11:40:05 +0000
    <![CDATA[Corporate balance sheet adjustment: stylized facts, causes and consequences]]> http://www.bruegel.org Mon, 06 Feb 2012 10:52:38 +0000 <![CDATA[Who's afraid of sovereign bonds?]]> http://www.bruegel.org The crisis has underlined the strong interdependence between the euro-area banking and sovereign crises. To understand the role domestic banks have played in holding sovereign debt, a breakdown of government debt by holding sectors is required.
    The data shows that at the start of the crisis, most continental euro-area countries were characterised by the large size of their banks’ portfolios of domestic government bonds, which were markedly larger than in the UK or the US. Consequently, concern about sovereign solvency was bound to have major consequences for banks.
    The structural vulnerability of euro-area countries has increased, reinforcing the sovereign/ banking crisis vicious cycle. All countries for which concerns about state solvency arose in recent years have seen a reversal in the previously steady increase of the share of government debt held by non residents. Germany, by contrast, has seen an increase in the share held by non residents.
    In the short term, these observations raise a question about the effectiveness of ECB provision of liquidity to banks as a means to alleviate the sovereign crisis. At a point when government bonds are considered risky assets, euro-area banks are faced with both balance sheet and reputational risks compared to their non-euro area counterparts, and may prove reluctant to increase this exposure further.
    In the longer term, the question is if and how euro-area regulators should set incentives to reduce banks’ heavy exposure to sovereigns. This issue should be given more attention in European policy discussions on how to strengthen the euro area.]]>
    Mon, 06 Feb 2012 09:57:39 +0000
    <![CDATA[Don’t let the euro-area crisis go east]]> http://www.bruegel.org On Thursday 2 February Chinese premier Wen Jiabao signalled intention to move towards helping the euro area extricate from its trouble and declared that China was “investigating and evaluating concrete ways in which it can, via the IMF, get more deeply involved in the European debt problem”. Why is China, and more generally Asia, taking this stance? A new paper by Jean Pisani-Ferry together with European and Asian colleagues from the Asia-Europe Economic Forum (AEEF) discusses the implications of the euro crisis for Asia, reasons for Asia-Europe cooperation in solving it, and obstacles on the way to this cooperation. ]]> Fri, 03 Feb 2012 10:23:00 +0000 <![CDATA[Cutting carbon, not the economy]]> http://www.bruegel.org The great transformation: decarbonising Europe’s energy and transport systems. The research leading to these results has received funding from the Fuel Cell and Hydrogen Joint Undertaking (FCH). The views expressed in this publication are those of the author alone and do not necessarily reflect the views of FCH.]]> Thu, 02 Feb 2012 14:01:30 +0000 <![CDATA[The great transformation: decarbonising Europe’s energy and transport systems]]> http://www.bruegel.org cannot be reversed. The technological, economic and political challenge ahead is vast. But choosing the right decarbonisaton strategy offers huge economic, environmental and societal benefits. We should not overlook this debate because of the euro crisis.]]> Thu, 02 Feb 2012 13:55:51 +0000 <![CDATA[The debt challenge in Europe]]> http://www.bruegel.org Tue, 31 Jan 2012 10:21:27 +0000 <![CDATA[Financial reform after the crisis: an early assessment]]> http://www.bruegel.org Fri, 27 Jan 2012 00:00:00 +0000 <![CDATA[The Euro crisis and the new impossible trinity]]> http://www.bruegel.org
    At the core of euro-area vulnerability is an impossible trinity of strict no-monetary financing, bank-sovereign interdependence and no co-responsibility for public debt. This Policy Contribution assesses the corresponding three options for reform: a broader European Central Bank (ECB) mandate, the building of a banking federation, and fiscal union with common bonds. None will be easy.

    The least feasible option is a change to the ECB’s mandate; changing market perceptions would require the ECB to credibly commit overwhelming forces, and the ECB is simply not in a position to make such a commitment.
    The building of a banking federation, meanwhile, involves reforms that are bound to be difficult. Incremental progress is likely, but a breakthrough less so.

    This leaves fiscal union. It faces major obstacles, but a decision to move in this direction would signal to the markets and ECB a commitment to stronger Economic and Monetary Union. One possibility would be to introduce a limited, experimental scheme through which trust could be rebuilt. This Policy Contribution draws on presentations made at the XXIV Moneda y Crédito Symposium, Madrid, 3 November 2011, at the Asia-Europe Economic Forum conference in Seoul, 9 December, and at De Nederlandsche Bank in Amsterdam on 17 December. I am very grateful to Silvia Merler for excellent research assistance. I thank participants in these seminars and Bruegel colleagues for comments and criticisms.]]>
    Sun, 15 Jan 2012 10:09:26 +0000
    <![CDATA[Fiscal federalism: US history for architects of Europe's fiscal union]]> http://www.bruegel.org Ever since first the blueprints for monetary union in Europe were drawn up, the United States, considered as a collection of individual states or regions, has served as a benchmark for assessing its feasibility and evaluating alternative policy options. Starting with Robert Mundell’s seminal 1961 article on optimal currency areas, countless papers have explored the inner workings of US labour, product and capital markets, and of its public finances, in the hope of learning lessons for Europe.

    It could be argued that this US inspiration is mistaken. After all, it is not the only economic and monetary federation in the world. Other federations work on different principles – especially when it comes to public finances – and there is no guarantee that US arrangements are optimal – especially, again, regarding public finances. But we know the US better and we think we understand it better, so success or failure relative to the US test carries much more weight than with the Australian, Canadian, Indian or Swiss tests. For better or worse, the US remains our ultimate policy laboratory.

    This essay on US fiscal federalism by Randall Henning and Martin Kessler builds on the established tradition. But unlike many papers that take current US features as a given, they tell us what present arrangements governing responsibility over public debt gradually emerged from, and why. By bringing in the historical dimension and the trial-and-error process that took place over more than two centuries, they help us understand the logic behind alternative arrangements and why the current one has in the end prevailed.

    Their careful historical account yields several important lessons. It first recalls that the US system as we know it, with its combination of a large federal budget responsible for the bulk of public debt and limited thrifty state budgets subject to balanced budget rules, emerged gradually from a sequence of events; in fact the initial set-up, as designed and enforced by Alexander Hamilton, was almost exactly the opposite.

    Second, it makes clear that beyond economic principles, attitudes towards what was in the aftermath of independence called the ‘assumption’ of state debt were shaped by broader political considerations – not least the aim of building a genuine federal government.

    Third, it explains how after the US was firmly established as a federation, changing political conditions led to a reversal of the federal government’s stance and to the enforcement of a ‘no bail-out’ principle.

    An intriguing feature of US history is therefore that the competences and features of federal government grew out of its assumption of state debt, and that the centre imposed a de-facto no bail-out regime only after having assumed essential powers.

    Another interesting observation by Henning and Kessler is that balanced budget rules were adopted spontaneously by states in response to financial stress and defaults, rather than as a disciplinary device mandated by the centre. Thus, there is still significant variability between states regarding the modus operandi and strictness of budget rules. The question remains if what matters is the strictness of the rule, or deeper political preferences at state level, of which the rule is only an expression.

    Finally, Henning and Kessler emphasise, a no less important lesson for Europe is that policy principles and institutions should be looked at as a system rather than in isolation. As the authors point out, it may seem obvious to recall that states in the US can abide by strict budget balance
    rules to the extent the federal government is responsible for stabilisation and the bail-out of insolvent banks, but this simple lesson is sometimes overlooked in European discussion.

    Jean Pisani-Ferry

    Director of Bruegel

    ]]>
    Tue, 10 Jan 2012 15:24:15 +0000
    <![CDATA[Assessing the potential for knowledge-based development in the transition countries of Central and Eastern Europe, the Caucasus and Central Asia ]]> http://www.bruegel.org Society and Economy Volume 33, Number 3/December 2011]]> Mon, 09 Jan 2012 00:00:00 +0000 <![CDATA[Financial transaction tax: Small is beautiful]]> http://www.bruegel.org Society and Economy Volume 33, Number 3/December 2011 A revised version of this paper was published as a Bruegel Policy Contribution in February 2010. Please see here to download the Policy Contribution.]]> Mon, 09 Jan 2012 00:00:00 +0000 <![CDATA[A tale of three countries: recovery after banking crises]]> http://www.bruegel.org Thu, 29 Dec 2011 16:04:58 +0000 <![CDATA[Still standing: how European firms weathered the crisis - The third EFIGE policy report]]> http://www.bruegel.org Thu, 22 Dec 2011 18:58:32 +0000 <![CDATA[Mind Europe's early-stage equity gap]]> http://www.bruegel.org Mon, 19 Dec 2011 14:41:04 +0000 <![CDATA[Rating agencies and sovereign credit risk assessment]]> http://www.bruegel.org Thu, 15 Dec 2011 00:00:00 +0000 <![CDATA[The group of G20: Trials of global governance in times of crisis]]> http://www.bruegel.org G20 Monitor.]]> Wed, 07 Dec 2011 09:36:51 +0000 <![CDATA[What kind of fiscal union?]]> http://www.bruegel.org Wed, 23 Nov 2011 12:49:40 +0000 <![CDATA[Assessing competitiveness: how firm-level data can help]]> http://www.bruegel.org www.efige.org), a project to help identify the internal policies needed to improve the external competitiveness of the European Union. ]]> Wed, 16 Nov 2011 10:27:28 +0000 <![CDATA[Financing high-growth firms: The role of angel investors]]> http://www.bruegel.org Download publication (external)]]> Wed, 16 Nov 2011 00:00:00 +0000 <![CDATA[The international monetary system is changing: what opportunities and risks for the euro?]]> http://www.bruegel.org Wed, 02 Nov 2011 11:11:03 +0000 <![CDATA[Wanted: a stronger and better G20 for the global economy]]> http://www.bruegel.org Mon, 31 Oct 2011 17:02:23 +0000 <![CDATA[Rate expectations: what can and cannot be done about rating agencies]]> http://www.bruegel.org Mon, 31 Oct 2011 10:22:03 +0000 <![CDATA[An evaluation of IMF surveillance of the euro area]]> http://www.bruegel.org Mon, 31 Oct 2011 00:00:00 +0000 <![CDATA[Europe's growth emergency]]> http://www.bruegel.org There is a negative feedback loop between the crisis and growth, and without effective solutions to overturn the crisis, growth is unlikely to resume. National and EU level policies should aim to foster reforms and adjustment and should not risk medium term objectives under the pressure of events. A more hands-on approach, including industrial policies, should be considered. Earlier versions of this Policy Contribution were presented at the Bruegel-PIIE conference on Transatlantic economic challenges in an era of growing multipolarity, Berlin, 27 September 2011, and at the BEPA-Polish Presidency conference on Sources of growth in Europe, Brussels, 6 October 2011.]]> Fri, 21 Oct 2011 16:41:52 +0100 <![CDATA[Is recent bank stress really driven by the sovereign debt crisis?]]> http://www.bruegel.org Stress in the interbank market has increased dramatically since July and bank stock market valuation has fallen by 22 percent on average for 60 of the most important banks tested in the EBA stress tests. I find evidence that bank stock valuation is significantly and economically meaningfully affected by the bank’s exposure to Greek debt. Greek banks are particularly affected. Holdings of debt of the other four periphery countries does not however appear to be a strong determinant of stock price movements. Policy announcements of 21 July of no haircut on any sovereign but Greece appear to be perceived as credible. The exposure to Greece cannot explain the general and large decline in euro area banks’ market cap. Instead, a general confidence crisis of the euro area banking system, or more deeply the euro area construction, might be driving the fall in stock prices. The summit of 23 October should focus on restoring confidence in euro-area policymakers’ ability and determination to put the euro area on a sound footing. Recapitalisation of banks can only be only one aspect. A credible solution to Greece and a way forward for the larger institutional set-up, including a federal fiscal back-stop of the banking system, are of at least equal importance.]]> Thu, 20 Oct 2011 13:01:03 +0100 <![CDATA[Rules and risk in the euro area]]> http://www.bruegel.org Anna Iara and Guntram Wolff develop a model of sovereign spreads that are determined by the probability of default in interaction with the level of risk aversion. Estimation of the model confirms the central predictions. The legal basis for the rules, and mechanisms for enforcing them, are the most important dimensions of rulesbased fiscal governance.]]> Tue, 04 Oct 2011 00:00:00 +0100 <![CDATA[Testimony on the European debt and financial crisis]]> http://www.bruegel.org This Policy Contribution reproduces the written statement prepared by the author for the hearing "The European debt and financial crisis: origins, options and implications for the US and global economy" presented at the Subcommittee on Security and International Trade and Finance of the US Senate Committee on Banking, Housing,and Urban Affairs, on 22 September 2011. Europe’s banking system has been in a state of systemic fragility since 2007-08. The current phase is marked by a sequence of interactions between sovereign problems and banking problems, resulting in gradual contagion to more countriesand more asset classes. The banking and sovereign crises are compounded by a crisis of the European Union institutions. Successful crisis resolution will need to include at least four components at the European level, in addition to steps to be taken by individual countries: fiscal federalism; banking federalism; a profound overhaul of EU/euro-area institutions; and short-term arrangements that chart a path towards the completion of the previous three points. These requirements for crisis resolution cannot be met unless political conditions change sharply in their favour, which leaves the United States and the global economyexposed to the risk of financial contagion. However, only the Europeans themselves can solve their current predicament. ]]> Fri, 23 Sep 2011 10:06:42 +0100 <![CDATA[How effective and legitimate is the European semester? Increasing role of the European parliament]]> http://www.bruegel.org The European Semester is a new institutional process that provides EU member states with ex-ante guidance on fiscal and structural objectives. The Semester’s goals are ambitious and it is still uncertain how it will fit into the new EU economic governance framework. We find that member states are only slowly internalising the new procedure. Furthermore, the Semester has so far lacked legitimacy due to the minor role assigned to the European Parliament, the marginal involvement of national parliaments and the lack of transparency of the process at some stages. Finally, there remains room to clarify the implications from a unified legal text. In fact, diluting the legal separation of recommendations on National Reform Programmes and Council opinions on Stability and Convergence Programmes may compromise effective surveillance and governance. The European Parliament has an important role to play. It needs hold the Commission and the Council accountable. This and the overall objective of enhancing the new procedure’s effectiveness and legitimacy can be done by means of a regular Economic Dialogue on the Semester.]]> Thu, 22 Sep 2011 12:24:15 +0100 <![CDATA[Rethinking central banking]]> http://www.bruegel.org Tue, 13 Sep 2011 10:22:25 +0100 <![CDATA[Changing of the guard - Challenges ahead for the new ECB president]]> http://www.bruegel.org
    First, trust of citizens in the ECB has fallenmassively according to the Eurobarometer survey inmany euro area countries, including Germany and Greece. Trust needs to be regained. Second, the ECB’s stance on Greece needs to be reversed both as regards financial sector participation and SMP. The SMP for Italy can be justified but can only be a temporary solution. The ECB will therefore have to further push for a fiscal lender-of-last-resort back-stop that can also exercise conditionality.

    Third, a rate cut should be considered at this point in time but upcoming political pressure to increase inflation needs to be resisted.]]>
    Mon, 12 Sep 2011 11:09:08 +0100
    <![CDATA[How effective and legitimate is the European Semester? Increasing the role of the European Parliament]]> http://www.bruegel.org Thu, 08 Sep 2011 09:33:44 +0100 <![CDATA[Identifying Discretionary Fiscal Policy Reactions with Real-Time Data]]> http://www.bruegel.org Guntram Wolff co-authored with Ulf von Kalckreuth a paper published on the Journal of Money, Credit and Banking. Go to the publication In this paper, the authors propose a method of identifying discretionary fiscal policy reactions using real-time data. Automatic stabilizers should depend on true GDP, while discretionary fiscal policy is contingent on the information that policy makers have in real time. We can compute a real-time measurement error by comparing the first release of GDP data with later revisions.

    Discretionary fiscal policy is influenced by this measurement error, whereas automatic fiscal policy is not. The authors use this identification approach to test the central identifying assumption of Blanchard and Perotti’s (2002) seminal structural vector autoregression (VAR). According to this assumption, fiscal policy makers do not react to GDP developments contemporaneously in a discretionary fashion. This analysis finds that government expenditure is adjusted upward if GDP growth in real time is lower than true GDP. This suggests that fiscal policy makers use short-term funds to buy goods and services in response to their perception of GDP dynamics.]]>
    Tue, 16 Aug 2011 00:00:00 +0100
    <![CDATA[Economic governance and varieties of capitalism]]> http://www.bruegel.org Europe Today. Click here to view a description of the book. The author's research describes the structure and evolution of European economic governance using a varieties-of-capitalism approach. It accounts for the constant tention between the devolution of sovereignty to the EU and the preservation of national specificities regarding product, labour, financial markets and aggregate demand regimes.]]> Thu, 04 Aug 2011 11:50:52 +0100 <![CDATA[Global currencies for tomorrow: a European perspective ]]> http://www.bruegel.org
    After the collapse of the Bretton Woods system forty years ago, the IMS gradually developed into its present state, a hybrid mix of exchange-rate flexibility, capital mobility and monetary independence. The US dollar retains a dominant, but not exclusive, role and the IMS governance system blends regional and multilateral surveillance. It combines IMF-based and ad-hoc liquidity provision. Although it has proved resilient during the crisis, partly thanks to ad-hoc arrangements, the IMS has serious flaws, which are likely to be magnified by the rapid transformation of the global economy and the increasing economic power of emerging economies.]]>
    Sat, 23 Jul 2011 00:00:00 +0100
    <![CDATA[The global operations of European firms - The second EFIGE policy report]]> http://www.bruegel.org Thu, 21 Jul 2011 00:00:00 +0100 <![CDATA[An action plan for the European leaders]]> http://www.bruegel.org Wed, 20 Jul 2011 00:00:00 +0100 <![CDATA[Assessing the impact of the EU ETS using firm level data]]> http://www.bruegel.org Fri, 15 Jul 2011 14:26:57 +0100 <![CDATA[Fiscal and Monetary Institutions in Central, Eastern and South-Eastern European Countries]]> http://www.bruegel.org OECD Journal on Budgeting ]]> Fri, 15 Jul 2011 00:00:00 +0100 <![CDATA[Eastern European lessons for the southern Mediterranean]]> http://www.bruegel.org Thu, 14 Jul 2011 14:34:41 +0100 <![CDATA[Dodd Frank: One year on]]> http://www.bruegel.org
    This publication was edited by Viral Acharya, Thomas F Cooley, Matthew Richardson and Ingo Walter. Including contributions from Michael Barr, Thomas Cooley, Martin Baily, Patrick Parkinson, Kermit Schoenholtz, Vincent Reinhart, J Nellie Liang, Thomas Hoenig, Viral Acharya, Matthew Richardson, Stijn Van Nieuwerburgh, Lawrence J. White, Tobias Adrian, Neil Barofsky, and Nicolas Véron]]>
    Tue, 12 Jul 2011 00:00:00 +0100
    <![CDATA[Keeping the promise of global accounting standards]]> http://www.bruegel.org Thu, 07 Jul 2011 00:00:00 +0100 <![CDATA[Das Blue Bond-Konzept und seine Implikationen]]> http://www.bruegel.org The Blue Bond proposal" published in May 2010, and on the policy contribution "Eurobonds: The blue bond concept and its implications" published in March 2011 ]]> Fri, 24 Jun 2011 12:34:20 +0100 <![CDATA[Debt restructuring in the euro area: A necessary but manageable evil? ]]> http://www.bruegel.org Tue, 21 Jun 2011 15:19:38 +0100 <![CDATA[Rethinking industrial policy]]> http://www.bruegel.org Thu, 16 Jun 2011 10:30:25 +0100 <![CDATA[TGAE report - The contribution of 16 European think tanks to the Polish, Danish, and Cypriot trio presidency of the European Union]]> http://www.bruegel.org Notre Europe, this report focuses on the medium-term, covering the Polish, Danish and Cypriot Trio Presidency, which will run from July 2011 to December 2012. Such a focus allows for an in-depth analysis of the Trio’s role, both front-stage and back-stage, as it develops in the context of the Lisbon Treaty’s implementation. Accordingly, the authors of this report, coming from 16 European think tanks, take stock of the initiatives adopted during the past Trio Presidency, identify emerging challenges and formulate concrete short- to medium-term proposals aiming for rapid policy-progress. Overall, the 18-month time frame to which each new edition of TGAE is devoted produces, from one report to the next, a comprehensive chronological picture of the EU’s development.]]> Wed, 15 Jun 2011 16:49:07 +0100 <![CDATA[Exchange Rate Policy and Economic Growth after the Financial Crisis in Central and Eastern Europe ]]> http://www.bruegel.org Eurasian Geography and Economics on the influence of exchange rate policies on the region's recovery. The author argues that post-crisis corrections in current account deficits in CEE countries do not in themselves signal a return to steady economic growth. Disagreeing with Åslund over the role of loose monetary policy in fostering the region's economic problems, he outlines a number of competitiveness problems that remain to be addressed in the 10 new EU member states of CEE, along with improvements in framework conditions supporting future macroeconomic growth. Click here to download this paper ]]> Fri, 10 Jun 2011 00:00:00 +0100 <![CDATA[Europe's clean technology investment challenge]]> http://www.bruegel.org Wed, 08 Jun 2011 00:00:00 +0100 <![CDATA[Green exports and the global product space: Prospects for EU industrial policy]]> http://www.bruegel.org Sun, 22 May 2011 00:00:00 +0100 <![CDATA[The Euro area's macroeconomic balancing act]]> http://www.bruegel.org Wed, 18 May 2011 00:00:00 +0100 <![CDATA[Suggestions for reforming the governance of global accounting standards]]> http://www.bruegel.org Thu, 12 May 2011 12:50:20 +0100 <![CDATA[Heterogeneity in money holdings across euro area countries: the role of housing]]> http://www.bruegel.org Guntram B. Wolff (co-authored with Paulvan den Noord and Ralph Setzer) has just been published by the European Journal of Political Economy. Click here to download the paper This paper studies why monetary aggregates of euro area Member States have developed differently since the inception of the euro. A money demand equation that incorporates housing wealth and collateral as well as substitution effects on real money holdings. Empirically, it is shown that cross-country differences in real balances are determined not only by income differences, a standard determinant of money demand, but also by house price developments. Higher house prices and higher user costs of housing are both associated with larger money holdings. Country-specific money holdings are also connected with structural features of the housing market. ]]> Wed, 04 May 2011 00:00:00 +0100 <![CDATA[A G2 for science?]]> http://www.bruegel.org are to deliver long-term international competitiveness.]]> Sun, 03 Apr 2011 00:00:00 +0100 <![CDATA[What international monetary system for a fast-changing world economy]]> http://www.bruegel.org Which of these alternatives will materialise depends on the degree of cooperation within a multilateral framework.]]> Sat, 02 Apr 2011 00:00:00 +0100 <![CDATA[ Reform of the international monetary system: Some concrete steps]]> http://www.bruegel.org Mon, 28 Mar 2011 13:34:37 +0100 <![CDATA[Eurobonds: The blue bond concept and its implications]]> http://www.bruegel.org Mon, 21 Mar 2011 00:00:00 +0000 <![CDATA[An ocean apart: Comparing transatlantic responses to the financial crisis]]> http://www.bruegel.org Sat, 12 Mar 2011 00:00:00 +0000 <![CDATA[A comprehensive approach to the euro-area crisis: Background calculations]]> http://www.bruegel.org Zsolt Darvas, Jean Pisani-Ferry and André Sapir "A comprehensive approach to the euro-area debt crisis", Bruegel Policy Brief No 2011/02, February 2011. An assessment of the results and policy conclusions can be found in the Policy Brief.]]> Thu, 24 Feb 2011 10:14:23 +0000 <![CDATA[From convoy to parting ways? Post-crisis divergence between European and US macroeconomic Policies]]> http://www.bruegel.org In response to this situation this working paper suggests a critical quantum of coordination. Key measures include a commitment to avoiding deliberate currency depreciation and unilateral intervention; agreement to give the IMF an enhanced monitoring role; the adoption by parliaments of medium-term fiscal plans ; and cooperation on the issue of Chinese undervaluation. ]]> Tue, 15 Feb 2011 18:19:04 +0000 <![CDATA[A European fund for economic revival in crisis countries]]> http://www.bruegel.org Wed, 09 Feb 2011 00:00:00 +0000 <![CDATA[A comprehensive approach to the euro-area debt crisis]]> http://www.bruegel.org Zsolt Darvas, André Sapir and Jean Pisani-Ferry, propose a comprehensive solution to the current European crisis based in three pillars: a plan to restore banking sector soundness, a resolution of sovereign debt crisis including a reduction of the Greek public debt and a strategy to foster growth and competitiveness. The paper provides novel estimates and analysis focusing on the current situation of Greece, Ireland, Portugal and Spain. Bruegel produced a video of the authors Jean Pisani-Ferry, André Sapir and Zsolt Darvas commenting on the "A comprehensive approach to the euro area debt crisis".
    Watch the video
    ]]>
    Mon, 07 Feb 2011 00:00:00 +0000
    <![CDATA[Too big to fail: the transatlantic debate]]> http://www.bruegel.org Nicolas Véron and Morris Goldstein examines the debates on the problem posed by "too big to fail" financial institutions. The authors then turn to possible remedies and how they may be differentially implemented in America and Europe. They conclude on the policy developments that are likely in the near future.]]> Sat, 05 Feb 2011 00:00:00 +0000 <![CDATA[The fiscal and monetary institutions of CESEE countries]]> http://www.bruegel.org OECD Journal on Budgeting]]> Fri, 04 Feb 2011 15:04:38 +0000 <![CDATA[Is European climate policy the new CAP?]]> http://www.bruegel.org In its third phase (2013-20) the European Union's emissions trading system (ETS) will issue allowances for around two billion tonnes of CO2 equivalent each year. The emission rights are valued at around €30-35 billion at current prices, between one-half and two-thirds of the amount the EU spends on the Common Agricultural Policy. The redistributive effects of the allocation of emission allowances are therefore potentially significant. Quantitative indicators for the relative degree to which individual countries will be affected by the ETS suggest that economic consequences for the member states will be quite different. In this policy brief, Georg Zachmann finds that countries with less favourable initial conditions are eventually largely compensated. Click here here  to download the ETS indicators by country Bruegel also produced a video of the author Georg Zachmann commenting on the findings of his policy brief.
    Watch the video
    ]]>
    Thu, 27 Jan 2011 15:46:13 +0000
    <![CDATA[Corporate governance practices and companies' R&D orientation: evidence from European countries.]]> http://www.bruegel.org Bruno van Pottelsberghe found that an executive remuneration system that is linked to the firm's financial performance has a particularly strong negative impact on R&D. This confirms the hypothesis that incentive mechanisms lead managers to focus on more predictable and easily measurable short-term activities,ultimately hampering the commitment to innovative projects.]]> Mon, 24 Jan 2011 14:45:34 +0000 <![CDATA[Beyond the crisis: prospects for emerging Europe]]> http://www.bruegel.org Zsolt Darvas assesses the impact of the 2008-09 global financial and economic crisis on the medium-term growth prospects of CEES countries, the Caucasus and Central Asia, which starting their economic transition about twenty years ago. Evidence shows that the crisis has had a major impact on the within-sample fit of the models used and that the positive impact of EU enlargement on growth is smaller than previous research has shown. The crisis has also altered the future growth prospects of the countries studied, even in the optimistic but unrealistic case of a return to pre-crisis capital inflows and credit booms. A version of this publication was also released as an article for Comparative Economic Studies (2011) 53, 261–290; published online 28 April 2011]]> Tue, 04 Jan 2011 17:41:17 +0000 <![CDATA[The case for reforming euro area entry criteria]]> http://www.bruegel.org click here. To download the working paper version, click here.]]> Wed, 15 Dec 2010 00:00:00 +0000 <![CDATA[The threat of 'currency wars': a European perspective]]> http://www.bruegel.org he threat of currency wars: global imbalances and their effect on currencies, held on 30 November 2010. Bruegel Fellows Jean Pisani-Ferry and Zsolt Darvas argue the so-called currency war is manifested in three ways: 1) the inflexible pegs of undervalued currencies; 2) attempts by floating exchange-rate countries to resist currency appreciation; 3) quantitative easing. Europe should primarily be concerned about the first issue, which relates to the renewed debate about the international monetary system. The attempts of floating exchange-rate countries to resist currency appreciation are generally justified while China retains a peg. Quantitative easing cannot be deemed a "beggar-thy-neighbour" policy as long as the Fed's policy is geared towards price stability. Central banks should come to an agreement about the definition of price stability at a time of deflationary pressures, as current US inflationary expectations are at historically low levels. Finally, the exchange rate of the Euro has not been greatly impacted by the recent currency war; the euro continues to be overvalued, but less than before.]]> Mon, 13 Dec 2010 16:52:20 +0000 <![CDATA[EU financial regulatory reform: a status report]]> http://www.bruegel.org Nicolas Véron argues that the EU regulatory response to the crisis has been generally slower in the EU than in the United States, for four main reasons: swifter financial crisis management and resolution in the US; structural differences in legislative processes; the EU’s front-loading of institutional reform, most notably the creation of European Supervisory Authorities; and the timetable of renewal of the European Commission in 2009-10. The EU has nevertheless initiated or completed significant regulatory initiatives in terms of banking, market structures, private equity and hedge funds, rating agencies and accounting. However, major further challenges loom. ]]> Thu, 09 Dec 2010 00:00:00 +0000 <![CDATA[The threat of "currency wars"]]> http://www.bruegel.org Jean Pisani-Ferry and Zsolt Darvas argue that the ‘currency war’ has three manifestations: 1. currency pegs, 2. recent attempts by floating exchange rate countries to resist currency appreciation and 3. quantitative easing. Europe should primarily be concerned about the first issue, which is related to the renewed debate on the international monetary system.]]> Tue, 30 Nov 2010 00:00:00 +0000 <![CDATA[Whither growth in central and eastern Europe? Policy lessons for an integrated Europe]]> http://www.bruegel.org Zsolt Darvas, Jean Pisani-Ferry, André Sapir and their co-authors Torbjörn Becker, Daniel Daianu, Vladimir Gligorov, Michael A Landesmann, Pavle Petrovic, Dariusz K. Rosati and Beatrice Weder di Mauro argue that in view of the depth of integration in Europe, the development model of the central, eastern and south-eastern Europe (CESEE) region, despite its shortcomings, should be preserved. But it should be reformed, with major implications for policymaking both at national and EU levels. If so, what are the required changes? Bruegel and The Vienna Institute for International Economic Studies (wiiw) cooperated to form this expert group of economists from various European countries to research these issues. ]]> Wed, 24 Nov 2010 00:00:00 +0000 <![CDATA[Facts and lessons from euro area divergences for enlargement]]> http://www.bruegel.org "The Euro And Economic Stability: Focus on Central, Eastern and South-Eastern Europe". Click here for more information on the publication and list of contents.]]> Thu, 18 Nov 2010 00:00:00 +0000 <![CDATA[A European mechanism for sovereign debt crisis resolution: a proposal]]> http://www.bruegel.org Francois Gianviti, Anne O. Krueger, Jean Pisani-Ferry, André Sapir and Jürgen von Hagen, present the rationale for such a mechanism in the euro area and details of how an ECRM would work. The ECRM would be a permanent tool to deal with sovereign debt crises in an effective and predictable way.]]> Tue, 09 Nov 2010 00:00:00 +0000 <![CDATA[The unequal effect of new banking rules in Europe]]> http://www.bruegel.org Benedicta Marzinotto and Jörg Rocholl focus on the tightening of credit conditions for banking rules (Basel III), particularly the estimated macroeconomic costs range, monetary policy and the aggregate costs of the measures. The authors report that the monetary policy response to these changes is not likely to be accommodating and that the aggregate costs of the measures will be differently distributed across countries depending on a variety of issues.]]> Fri, 22 Oct 2010 00:00:00 +0100 <![CDATA[Reform of the Global Financial Architecture]]> http://www.bruegel.org Tue, 19 Oct 2010 00:00:00 +0100 <![CDATA[Young leading innovators and EUÂ’s R&D intensity gap]]> http://www.bruegel.org Reinhilde Veugelers and Michele Cincera give evidence to show that compared to the US, the EU has fewer young firms among its leading innovators and the primary driver of this private R&D gap is due to the fact that young leading innovators in the EU are less R&D intensive than their US counterparts. This paper complements the Bruegel policy brief, Europe’s missing yollies.]]> Thu, 30 Sep 2010 00:00:00 +0100 <![CDATA[An assessment of the G20's initial action items]]> http://www.bruegel.org Fri, 10 Sep 2010 00:00:00 +0100 <![CDATA[Monitoring Macroeconomic Imbalances in Europe: Proposal for a Refined Analytical Framework]]> http://www.bruegel.org Wed, 08 Sep 2010 00:00:00 +0100 <![CDATA[The relationship between health and growth: when Lucas meets Nelson-Phelps]]> http://www.bruegel.org Philippe Aghion combines the Lucas and Nelson-Phelps approaches to human capital to give us a better understanding of the relationship between health and growth.]]> Mon, 06 Sep 2010 00:00:00 +0100 <![CDATA[Not all financial regulation is global]]> http://www.bruegel.org Nicolas Véron and Stéphane Rottier, National Bank of Belgium, explain why now is the time to focus on building stronger global public institutions, ensuring globally consistent financial information, creating globally integrated capital-markets infrastructure and addressing competitive distortions among global capital-market intermediaries to set the foundation for global harmonisation of all aspects of financial regulation.]]> Tue, 31 Aug 2010 00:00:00 +0100 <![CDATA[Europe's missing yollies]]> http://www.bruegel.org Reinhilde Veugelers and Michele Cincera, Professor at ULB, draw our attention to young leading innovators ('yollies'). They explain why the European Union's business research and development deficit, relative to the United States, can be attributed to the EU having fewer yollies, especially those that are less R&D intensive. This paper raises important and timely questions about the EU's innovation policy. The authors argue why policy makers should pay attention to the heterogeneity across young sectors and design sector-specific measures to boost innovation and growth in the EU.]]> Wed, 25 Aug 2010 00:00:00 +0100 <![CDATA[The quality factor in patent systems]]> http://www.bruegel.org Bruno van Pottelsberghe develops a methodology to compare the quality of examination services in different patent offices. Quality is defined as the extent to which patent offices comply with their patentability conditions in a transparent way. The methodology consists of a two-layer analytical framework encompassing 'legal standards' and their 'operational design', which includes several interdependent components that affect the stringency and transparency of the filtering process.]]> Tue, 13 Jul 2010 00:00:00 +0100 <![CDATA[Fiscal federalism in crisis: lessons for Europe from the US]]> http://www.bruegel.org Zsolt Darvas answers three questions in this Policy Contribution- Why has the euro been hit so hard? How would a more federal European fiscal union closer to the US model have helped? How do the euro area’s fiscal architecture reform plans stand up in light of the US example? He concludes that a higher level of fiscal federation is not inevitable for the viability of the euro area, but current European fiscal reform proposals carry political risk and their implementation could be deficient or lack credibility. Introduction of a Eurobond covering up to 60 percent of member states’ GDP would be a much more preferable solution.]]> Mon, 12 Jul 2010 00:00:00 +0100 <![CDATA[The opening up of eastern Europe at 20-jobs, skills, and ‘reverse maquiladorasÂ’ in Austria and Germany]]> http://www.bruegel.org To address these questions, this paper makes use of new survey data of 660 German and Austrian firms with 2,200 investment projects in eastern Europe during the period 1990-2001. The new survey data represent 100 percent of Austrian and 80 percent of German direct investment in eastern Europe.]]> Mon, 12 Jul 2010 00:00:00 +0100 <![CDATA[Why Germany fell out of love with Europe]]> http://www.bruegel.org Thu, 01 Jul 2010 00:00:00 +0100 <![CDATA[Boosting innovation in Europe]]> http://www.bruegel.org Mathias Dewatripont, Solvay Brussels School of Economics and Management; Bruno van Pottelsberghe and André Sapir, Senior Fellows at Bruegel and professors at ULB; and Reinhilde Veugelers, senior fellow at Bruegel and professor at Katholieke Universiteit Leuven, makes suggestions based on three principles: to give primacy to merit-based selection of projects at the European level, to strengthen the single market to make it conducive for research and innovation and to remove barriers that hinder dynamic restructuring. This paper is addressed to the July 2010 informal Competitiveness Council (Research) under the Belgian Presidency. ]]> Mon, 28 Jun 2010 00:00:00 +0100 <![CDATA[The global operations of European firms]]> http://www.bruegel.org Fri, 18 Jun 2010 00:00:00 +0100 <![CDATA[Euro area governance: What went wrong in the euro area? How to repair it?]]> http://www.bruegel.org Jean Pisani-Ferry focuses on the institutional response to the euro area crisis with the Van Rompuy Task Force being set up to reform economic governance. The task force is due to present its progress report shortly and the author examines two basic questions in this context– what went wrong in the euro area (and the lessons learnt from this) and consequently what are the three choices for reforming governance. He explains why implementation of existing rules need to be strengthened and why the Van Rompuy Task Force should revisit the fundamental principles on which the EMU is founded and resist the temptation to solely address divergences. ]]> Tue, 08 Jun 2010 00:00:00 +0100 <![CDATA[Euro Area Governance: What went wrong? How to repair it?]]> http://www.bruegel.org Tue, 08 Jun 2010 00:00:00 +0100 <![CDATA[Power to the people of Europe]]> http://www.bruegel.org Mon, 07 Jun 2010 00:00:00 +0100 <![CDATA[Assessing the potential for knowledge-based development in transition countries ]]> http://www.bruegel.org Reinhilde Veugelers examines the potential for a knowledge-based growth path in transition countries of central and eastern Europe, the Caucasus and Central Asia. The paper looks closely at how total-factor productivity, a residual growth factor commonly interpreted as reflecting technological progress, drives growth rates in these economies which exhibit a much lower GDP per capita compared to the EU15 or the United States.  By analysing the prerequisites for knowledge-based growth, the author explains why transition countries are at a systemic disadvantage relative to the EU15, US and Japan and have limited potential for knowledge-based growth. ]]> Mon, 31 May 2010 00:00:00 +0100 <![CDATA[The role of state aid control in improving bank resolution in Europe]]> http://www.bruegel.org André Sapir, Mathias Dewatripont, ULB and CEPR; Gregory Nguyen, National Bank of Belgium, and Peter Praet, National Bank of Belgium, show how in the short-term, the European Commission, through its state aid control discipline, can set the foundation for a new crisis resolution architecture. It can act as a substitute to improve coordination among member states and complement a European resolution authority once it is set up.]]> Mon, 17 May 2010 00:00:00 +0100 <![CDATA[The Blue Bond Proposal]]> http://www.bruegel.org Jakob von Weizsäcker and Jacques Delpla from Conseil d'Analyse Économique, Paris, explain the economics behind their proposal, its institutional underpinnings and the implication of it on various participating countries.

    ]]>
    Thu, 06 May 2010 00:00:00 +0100
    <![CDATA[Europe should stop taxing innovation]]> http://www.bruegel.org Bruno van Pottelsberghe makes the argument in favour of a single EU patent system. The author explains that the absence of a one-stop-shop for EU-wide patents hampers innovation and will pose serious challenges to small and medium-sized companies in the face of global competition. This paper analyses how a uniform patent system can sustain long-term competitiveness and boost growth and thereby achieve EU2020 targets. It makes policy recommendations in four key areas of a single patent system - language, complexity, affordability and governance.    ]]> Tue, 30 Mar 2010 00:00:00 +0100 <![CDATA[Two crises, two responses]]> http://www.bruegel.org Jean Pisani-Ferry, Senior Fellow André Sapir and Resident Fellow Benedicta Marzinotto emphasises the need for a more nuanced understanding of the different kinds of crises affecting euro members. Using Spain and Greece as examples, this paper makes policy recommendations for both scenarios. It explains how budgetary surveillance can be strengthened to prevent crises. It says the scope of Article 143 of the Lisbon Treaty should be extended and a clear and predictable conditional assistance regime put in place for effective crises management in the euro area.]]> Mon, 22 Mar 2010 00:00:00 +0000 <![CDATA[Future developments of global imbalances ]]> http://www.bruegel.org Jean Pisani-Ferryand Research Fellow Zsolt Darvas examine the role of global imbalances to the crisis and explain how changes in the international monetary system can mitigate global imbalances. This document was requested by the European Parliament's Committee on Economic and Monetary Affairs.]]> Mon, 15 Mar 2010 00:00:00 +0000 <![CDATA[China and the world economy: a European perspective]]> http://www.bruegel.org Jean Pisani-Ferry discusses the emergence of China as a key economic and global player from a European perspective. Looking ahead, this paper focuses on two key aspects, the rebalancing of global growth and the strengthening of global governance, and explains how these will shape Sino-European economic relations. The author argues that now is the time for high-quality dialogue between policymakers from both sides. China and the European Union must overcome their institutional differences to pave the way for fruitful economic cooperation. ]]> Fri, 12 Mar 2010 00:00:00 +0000 <![CDATA[Think Global Act European II]]> http://www.bruegel.org Thu, 04 Mar 2010 00:00:00 +0000 <![CDATA[Monetary Policy and Risk Taking]]> http://www.bruegel.org In this paper Bruegel Visiting Scholar Ignazio Angeloni (European Central Bank), Ester Faia (Goethe University Frankfurt, Kiel IfW and CEPREMAP)  and Marco Lo Duca (European Central Bank) examine the links between monetary policy, financial risk and the business cycle, combining data evidence and a new DSGE model with banks. The model includes banks (modeled as in Diamond and Rajan, JF 2000 and JPE 2001) and a financial accelerator (Bernanke et al., 1999 Handbook). A monetary expansion increases the propensity of banks to assume risks. In turn, financial risks affect economic activity and prices. This "risk-taking" channel of monetary transmission, absent in pure financial accelerator models, operates via the leverage decisions of banks. The model results match certain features of the data, as emerged in recent panel data studies and in our own time series estimates for the US and the euro area. ]]> Mon, 15 Feb 2010 00:00:00 +0000 <![CDATA[Financial-Transaction Tax: Small Is Beautiful]]> http://www.bruegel.org Society and Economy Volume 33, Number 3/December 2011]]> Mon, 08 Feb 2010 00:00:00 +0000 <![CDATA[Crisis resolution in the euro area: an alternative to the European Monetray Fund ]]> http://www.bruegel.org Mon, 01 Feb 2010 00:00:00 +0000 <![CDATA[Memo to the New Digital Agenda Commissioner]]> http://www.bruegel.org Reinhilde Veugelers and Bruno van Pottelsberghe provide recommendations for the term of new Digital Agenda Commissioner Neelie Kroes in this supplement to Bruegel's Memos to the New Commission: Europe's Economic Priorities 2010-2015. They argue that Kroes should move past a focus on infrastructure and concentrate more on ICT's potential to contribute to growth in the European Union. This should include a focus on emerging ICT products and services to helpl foster an ICT single market and more public support for R&D and innovation, through tailored programmes designed to aid high-risk innovative projects conceived by new ICT companies.]]> Mon, 25 Jan 2010 00:00:00 +0000 <![CDATA[Financial Transaction Tax: Small is Beautiful]]> http://www.bruegel.org here for the authors' accompanying presentation. A revised version of this paper was published as a Bruegel Policy Contribution in February 2010. Please see here to download the Policy Contribution. ]]> Mon, 11 Jan 2010 00:00:00 +0000 <![CDATA[The EU's Role in Supporting Crisis-Hit Countries in Central and Eastern Europe]]> http://www.bruegel.org Thu, 31 Dec 2009 00:00:00 +0000 <![CDATA[Memo to the new Commissioner for Energy]]> http://www.bruegel.org ]]> Wed, 30 Dec 2009 00:00:00 +0000 <![CDATA[Cost Benefit Analysis of the Community Patent]]> http://www.bruegel.org Bruno van Pottelsberghe and Jérôme Danguy use simulations to take a look at the advantages, disadvantages, winners and losers from the creation of the COMPAT. They find that it would drastically reduce the relative patenting costs for applicants while generating more income for the European Patent Office and increased savings for the business sector. They also explain that the lost of economic rents for patent attorneys, translators and lawyers specialised in patent litigation and the drop of controlling power for national patent offices may explain why there has been such resistance to the COMPAT thus far.]]> Wed, 23 Dec 2009 00:00:00 +0000 <![CDATA[Monetary Policy on the Way Out of the Crisis]]> http://www.bruegel.org Thu, 17 Dec 2009 00:00:00 +0000 <![CDATA[Banking Crisis Management in the EU: An Interim Assessment]]> http://www.bruegel.org Wed, 09 Dec 2009 00:00:00 +0000 <![CDATA[IFRS Sustainability Requires Further Governance Reform]]> http://www.bruegel.org Wed, 09 Dec 2009 00:00:00 +0000 <![CDATA[The Crisis: Policy Lessons and Policy Challenges]]> http://www.bruegel.org Wed, 02 Dec 2009 00:00:00 +0000 <![CDATA[Monetary Policy on the Way out of the Crisis]]> http://www.bruegel.org In this paper, commissioned by the European Parliament, Bruegel Visiting Scholar, Juergen von Hagen analyses the European and US monetary strategies during the crisis and points out that at the current moment coordination of monetary and fiscal exit strategies will be essential in order to avoid killing off the recovery before it has acquired full force. The author suggests that the risks of adverse macroeconomic developments are considerably less if fiscal policy exists from crisis mode first and monetary policy second.]]> Tue, 01 Dec 2009 00:00:00 +0000 <![CDATA[The Baltic Challenge and Euro-Area Entry]]> http://www.bruegel.org Zsolt Darvas takes a look at the issue of the Baltic states - Estonia, Latvia and Lithuania - and the challenges facing those three countries in the aftermath of the financial crisis. He argues that because it is in the broader European interest to prevent a collapse in the Baltics, the best option is immediate euro entry at a suitable exchange rate supported by appropriate resolution in order to manage the resulting debt overhang. However, there seems to be no legal basis for this under the current euro accession criteria. Furthermore, the economic foundations of the criteria are fundamentally flawed, as euro-area members continue to violate the criteria while the EU's expansion to 27 members has made the criteria tougher for new member states to meet themselves. Ultimately, the European Council has the ability to reform the criteria without a formal treaty change. The Council should do so, the author argues, and allow for more meaningful benchmarks for all future euro-area applicants.]]> Mon, 30 Nov 2009 00:00:00 +0000 <![CDATA[No Green Growth Without Innovation]]> http://www.bruegel.org Philippe Aghion, Senior Resident Fellow Reinhilde Veugelers and David Hemous of Harvard University, attempts to change the terms of the debate surrounding climate change policy. The authors argue that policymakers should do more to encourage innovation and investment in ‘green’ research and development rather than focusing solely on the setting of a carbon price. Using a model developed by Aghion in a previous paper, they argue that a carbon price would have to be about 15 times higher in the first five years and 12 times higher in the next five years if innovation is not properly subsidized by governments. The authors also provide several policy recommendations for incentivising this type of ‘green growth’ in the private sector.]]> Mon, 23 Nov 2009 00:00:00 +0000 <![CDATA[Cold Start for the Green Innovation Machine]]> http://www.bruegel.org “No Green Growth Without Innovation”. Written by Senior Non-Resident Fellow Philippe Aghion, Senior Resident Fellow Reinhilde Veugelers and Researcher Clément Serre, this paper discusses the state of green innovation and goes into more depth in discussing the current problems in the area. Examining research and development, patent, and venture capital data, the authors point out that there is momentum for private investment in green technologies. However, they argue that, thus far, the implicit tax rate on energy in the EU27 is too low and fragmented, the carbon price in the EU Emissions Trading System is too volatile, and the public R&D expenditures dedicated to energy and environment are too low. They conclude that immediate state intervention is necessary, at least at the onset, to ensure that the ‘green innovation machine’ gets properly started.]]> Mon, 23 Nov 2009 00:00:00 +0000 <![CDATA[More Than One Step to Financial Stability]]> http://www.bruegel.org Wed, 28 Oct 2009 00:00:00 +0000 <![CDATA[A European Exit Strategy]]> http://www.bruegel.org Wed, 14 Oct 2009 23:00:00 +0100 <![CDATA[Can A Less Boring ECB Remain Accountable?]]> http://www.bruegel.org Monetary Dialogue with the European Central Bank meeting on 28 September. In this briefing paper for the Panel, Director Jean Pisani-Ferry and Resident Fellow Jakob von Weizsäcker point out that, in the wake of the financial crisis, the ECB will take on much more responsibility for macro-prudential supervision of the financial system. With this added responsibility, however, comes serious questions about the mechanisms in place to ensure the ECB's accountability. Previously focused almost solely on price stability, the ECB will now likely be asked to increase its discretionary decision-making, especially in dealing with financial regulation. The accompanying accountability questions, the authors say, need to be addressed proactively.]]> Sun, 27 Sep 2009 23:00:00 +0100 <![CDATA[The G20 is not just a G7 with extra chairs ]]> http://www.bruegel.org International Cooperation in Times of Global Crisis: Views from G20 Countries conference in Delhi  on 14th and 15th of September, organised by Bruegel, CEPII and ICRIER. The publication draws together the authors‘ conclusions from the Delhi conference and reviews the real role of the G20, while questioning where the non-G7 interests fit into the group‘s agenda. ]]> Mon, 21 Sep 2009 23:00:00 +0100 <![CDATA[The Pittsburgh G20 Checklist]]> http://www.bruegel.org Ignazio Angeloni suggests that the Pittsburgh G20 may represent policymakers' last chance at real financial market reform. He develops a shortlist of recommendations for world leaders to tackle at the summit and says that world leaders at the summit must strengthen the stability of the financial sector while avoid micro-management. G20 leaders must also strengthen the global financial governance structures and work on an IMF-led framework to containing the development of future current-account imbalances across nations. This latest version also includes a postscript written by Angeloni and published in the October 2009 issue of Intereconomics: Review of European Economic Policy judging the outcome of the summit.]]> Fri, 18 Sep 2009 09:46:19 +0100 <![CDATA[Beyond Copenhagen: A climate policymaker's handbook]]> http://www.bruegel.org
    This book looks realistically at the options for a deal to succeed the Kyoto Protocol. It sets out some of the main ingredients that will have to be included for finalisation of an economically rational agreement that stands a real chance of addressing the threat to the climate system. It critically analyses the European Union's climate policies before reviewing the key elements of such an agreement: carbon markets, flexible mechanisms for transferring money and technology to developing countries, innovation, and the effective enforcement of a global climate deal.

    The contributors to the volume are Joseph E Aldy, Valentina Bosetti, Carlo Carraro, Juan Delgado, Denny Ellerman, Dieter Helm, Axel Michaelowa, Robert N Stavins and Massimo Tavoni. The French Ministère de l‘Ecologie, de l‘Energie, du Développement durable et de la Mer, under the auspices of the 2008 French Presidency of the Council of the European Union, contributed financial support to the production of this volume.]]>
    Thu, 17 Sep 2009 14:57:55 +0100
    <![CDATA[The monetary mechanics of the crisis]]> http://www.bruegel.org
    This is what central banks have done in the current crisis – and rightly so. They have learned the lessons of the Great Depression. This framework helps understand differences across countries. The crisis affected the euro area money and credit supply process much less than the US and the UK. Therefore, the European Central Bank was right to respond to the crisis with a less expansionary monetary policy than the Bank of England and the Federal Reserve. However, stabilising the money supply may not have been enough to stabilise the supply of credit.]]>
    Thu, 27 Aug 2009 12:39:31 +0100
    <![CDATA[Memos to the new Commission- Europe's economic priorities 2010-2015]]> http://www.bruegel.org André Sapir and Jean Pisani-Ferry propose that effective leadership will be necessary to give strategic direction to the Commission, "you [the president] should therefore be ready to fight for ideas and take risks" (JPF-AS). The Memos suggest that the EU will need to assert a position on commonly agreed rules, propose new solutions and, importantly, has an opportunity now to redefine the European narrative in the global arena. Focusing on the most important economic questions at EU level, the Bruegel memos are intended to be strategic, outlining the state of affairs that will be met by the new Commission and the key challenges and priorities they will need to consider over the next five years. ]]> Thu, 27 Aug 2009 11:02:02 +0100 <![CDATA[The impact of the crisis on budget policy in Central and Eastern Europe]]> http://www.bruegel.org Zsolt Darvas concludes with some thoughts on the appropriate policy response from a more normative perspective. The key message of the paper is that the crisis should be used as an opportunity to introduce reforms to avoid future pro-cyclical fiscal policies, to increase the quality of budgeting and to increase credibility. These reforms should include fiscal responsibility laws comprising medium-term fiscal frameworks, fiscal rules, and independent fiscal councils. When fiscal consolidation is accompanied by fiscal reforms that increase credibility, non- Keynesian effects may offset to some extent the contraction caused by the consolidation.]]> Thu, 30 Jul 2009 23:00:00 +0100 <![CDATA[A better process for a better budget]]> http://www.bruegel.org reform.]]> Tue, 28 Jul 2009 17:54:39 +0100 <![CDATA[Lost property: The European patent system and why it doesn't work]]> http://www.bruegel.org
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    Mon, 29 Jun 2009 11:09:01 +0100
    <![CDATA[The euro at ten: the next global currency? ]]> http://www.bruegel.org Jean Pisani-Ferry and then-PIEE Deputy Director and current Bruegel board member Adam Posen. The papers and remarks in this volume demonstrate that the euro has proved to be attractive as a fair weather currency for countries and investors well beyond its borders. But it remains to be seen whether it is equipped to also succeed as a stormy weather currency. Contributors: Joaquín Almunia, Maria Celina Arraes, Leszek Balcerowicz, C. Fred Bergsten, Lorenzo Bini Smaghi, Kristin J. Forbes, Linda S. Goldberg, C. Randall Henning, Mohsin S. Khan, Antonio de Lecea, Erkki Liikanen, Philippe Martin, Thomas Mayer, André Sapir, Dominique Strauss-Kahn, Lawrence H. Summers, and György Szapáry.]]> Sun, 14 Jun 2009 23:00:00 +0100 <![CDATA[A solution for Europe's banking problem]]> http://www.bruegel.org Nicolas Véron and Adam Posen believe Europe should build new long term European joint-action to face the likely high rising number of insolvent banks on the continent. The authors propose on the one hand, a centralised triage and restructuring process of bad European banks lead by a new temporary European Institution, a European Bank Support Authority (EBSA), and on the other hand, long-term EU Institutions dedicated to the completion of an integrated market.]]> Thu, 11 Jun 2009 23:00:00 +0100 <![CDATA[EU Cohesion policy: some fundamental questions]]> http://www.bruegel.org Indhira Santos analyses the impact of the European Union‘s cohesion policy both in terms of economic efficiency and redistribution to needy areas of the EU. She illustrates with data the confusion created by the multiple objectives of current EU cohesion policy and by the political horse-trading over levels of aid granted to different member states and regions. Finally, sh shows how a significant part of EU structural funds involves – ine net economic terms – simply transferring funds between individuals within one and the same region.]]> Sun, 31 May 2009 15:37:27 +0100 <![CDATA[Reframing the EU budget- decision-making process]]> http://www.bruegel.org Sun, 31 May 2009 15:20:44 +0100 <![CDATA[Cyclical dimensions of labour mobility after EU Enlargement]]> http://www.bruegel.org
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    Sun, 31 May 2009 15:12:10 +0100
    <![CDATA[A US strategy for IFRS adoption]]> http://www.bruegel.org Wed, 22 Apr 2009 23:00:00 +0100 <![CDATA[Handle with care! Post-crisis growth in the EU]]> http://www.bruegel.org Wed, 15 Apr 2009 23:00:00 +0100 <![CDATA[Estimating the size of the European stimulus packages ]]> http://www.bruegel.org Wed, 15 Apr 2009 00:00:00 +0100 <![CDATA[Politique budgétaire: Stabilisateurs ou politique discrétionnaire?]]> http://www.bruegel.org Fin de monde ou sortie de crise, edited by Pierre Dockès and Jean-Hervé Lorenzi.]]> Thu, 02 Apr 2009 01:00:00 +0100 <![CDATA[Reshaping the global economy]]> http://www.bruegel.org Tue, 31 Mar 2009 00:00:00 +0100 <![CDATA[International governance- is the G20 the right forum?]]> http://www.bruegel.org Mon, 30 Mar 2009 23:00:00 +0100 <![CDATA[The G20 in the aftermath of the crisis: a Euro-Asian view]]> http://www.bruegel.org Tue, 24 Mar 2009 00:00:00 +0000 <![CDATA[Weathering the storm- Fair weather versus stormy-weather governance in the euro area]]> http://www.bruegel.org

    ]]>
    Wed, 18 Mar 2009 23:00:00 +0000
    <![CDATA[A lifeline for Europe's young radical innovators]]> http://www.bruegel.org Mon, 16 Mar 2009 23:00:00 +0000 <![CDATA[The battle for talent: globalisation and the rise of executive pay]]> http://www.bruegel.org Mon, 09 Feb 2009 23:00:00 +0000 <![CDATA[Of markets, products and prices- the effects of the euro on European firms]]> http://www.bruegel.org Mon, 09 Feb 2009 23:00:00 +0000 <![CDATA[Beyond the WTO? An anatomy of EU and US preferential trade agreements]]> http://www.bruegel.org Mon, 09 Feb 2009 23:00:00 +0000 <![CDATA[Rating agencies: an information privilege whose time has passed]]> http://www.bruegel.org Wed, 04 Feb 2009 23:00:00 +0000 <![CDATA[Politics and trade: lessons from past globalisations]]> http://www.bruegel.org Sat, 31 Jan 2009 23:00:00 +0000 <![CDATA[Economic incongruities in the European patent system]]> http://www.bruegel.org Bruno van Pottelsberghe argues that the consequences of the fragmentation of the European patent system are more dramatic than the mere prohibitive costs of maintaining a patent in force in many jurisdictions. The authors first show that heterogeneous national litigation costs, practices and outcome induce a high level of uncertainty. But also that a high degree of managerial complexity results from systemic incongruities due to easier parallel imports, possible time paradoxes and the de facto paradox of having EU-level competition policy and granting authority, ultimately facing national jurisdictional primacy on patent issues.]]> Tue, 13 Jan 2009 23:00:00 +0000 <![CDATA[Avoiding a new European divide]]> http://www.bruegel.org Zsolt Darvas and Jean Pisani-Ferry show that some of the non euro-area new member states suffer from serious vulnerabilities, to which policy has been slow to respond. They believe that the crisis management in the euro area has had the unintended consequence of putting non euro-area new member states at disadvantage. These are unhealthy developments and without decisive action, a new political and economic divide within Europe may emerge.]]> Sun, 21 Dec 2008 23:00:00 +0000 <![CDATA[The International agenda: immediate priorities and longer-term challenges]]> http://www.bruegel.org Thu, 04 Dec 2008 23:00:00 +0000 <![CDATA[A European recovery programme ]]> http://www.bruegel.org Tue, 25 Nov 2008 23:00:00 +0000 <![CDATA[Safe and Sound: an EU approach to Sovereign Investment]]> http://www.bruegel.org Thu, 06 Nov 2008 23:00:00 +0000 <![CDATA[Will the current crisis trigger a revival of the IMF? ]]> http://www.bruegel.org Fri, 31 Oct 2008 23:00:00 +0000 <![CDATA[Testing times for global financial governance]]> http://www.bruegel.org Ignazio Angeloni believes that the increase in financial interdependence in recent decades has not been matched by sufficient progress in the international coordination among regulatory authorities. In fact, the international financial system has suffered from insufficient globalisation of regulatory and supervisory policies, not excessive globalisation of financial markets.]]> Sun, 19 Oct 2008 23:00:00 +0100 <![CDATA[Asia-Europe: The Third Link]]> http://www.bruegel.org Sun, 12 Oct 2008 23:00:00 +0100 <![CDATA[Divisions of labour: rethinking Europe's migration policy ]]> http://www.bruegel.org Jakob von Weizsäcker identifies three priority areas for EU policy action and concrete policy suggestions which could fit with the immigration agenda of the French presidency. ]]> Wed, 08 Oct 2008 23:00:00 +0100 <![CDATA[The London Agreement and the cost of patenting in Europe]]> http://www.bruegel.org Bruno van Pottelsberghe analyses the potential consequences of the recently ratified London Agreement, which reduces the patent translation requirements in 15 out of 34 EPC Member States. The simulations suggest that the cumulated costs of patenting have been reduced by 20 to 30 percent thanks to the coming into force of the London Agreement, in May 2008. In nominal terms, the total saving for the business sector is about €220 million. As well as these substantial cost savings, the authors expect an increase in the demand for patents of eight to 12 percent.]]> Wed, 01 Oct 2008 00:00:00 +0100 <![CDATA[Portrait of the Union as a player on the world stage]]> http://www.bruegel.org Confrontations Europe book "Looking for the European interest", a collective work directed by Philippe Herzog. ]]> Wed, 24 Sep 2008 23:00:00 +0100 <![CDATA[The new corporation in Europe]]> http://www.bruegel.org Dalia Marin argues that firms are adapting to heightening global competition by shifting decision-making processes. The author gives policy recommendations in the areas of EU neighbourhood and trade policies.]]> Tue, 02 Sep 2008 23:00:00 +0100 <![CDATA[The new food equation: do EU policies add up?]]> http://www.bruegel.org Sat, 19 Jul 2008 23:00:00 +0100 <![CDATA[Europe's R&D: Missing the Wrong Targets?]]> http://www.bruegel.org
    Published in Intereconomics, July 2008. ]]>
    Tue, 15 Jul 2008 23:00:00 +0100
    <![CDATA[Empower users of financial information as the IASC Foundation‘s stakeholders]]> http://www.bruegel.org Thu, 10 Jul 2008 23:00:00 +0100 <![CDATA[The demographics of global corporate champions]]> http://www.bruegel.org Mon, 30 Jun 2008 23:00:00 +0100 <![CDATA[Higher aspirations: an agenda for reforming European universities]]> http://www.bruegel.org Tue, 03 Jun 2008 00:00:00 +0100 <![CDATA[A tail of two countries]]> http://www.bruegel.org Sun, 01 Jun 2008 00:00:00 +0100 <![CDATA[Policy-makers and the R&D-patent relationship ]]> http://www.bruegel.org Bruno van Pottelsberghe and Gaétan De Rassenfosseargue that the number of priority filings should be used as a patent-based measure of Europe‘s innovation performance.  The paper identifies several policies that may affect the R&D-patent relationship.]]> Thu, 29 May 2008 23:00:00 +0100 <![CDATA[Fair value accounting is the wrong scapegoat for this crisis ]]> http://www.bruegel.org Thu, 29 May 2008 23:00:00 +0100 <![CDATA[Politique économique : avons-nous appris ?]]> http://www.bruegel.org Sat, 10 May 2008 23:00:00 +0100 <![CDATA[Public pensions and intra-EU mobility: an unfinished agenda]]> http://www.bruegel.org Wed, 30 Apr 2008 23:00:00 +0100 <![CDATA[Two Learning Curves on Sovereign Wealth Funds]]> http://www.bruegel.org Wed, 30 Apr 2008 23:00:00 +0100 <![CDATA[Progressive governance and globalisation]]> http://www.bruegel.org Tue, 29 Apr 2008 23:00:00 +0100 <![CDATA[Reducing the climate change bill]]> http://www.bruegel.org the Think Global Act European project Juan Delgado argues that early, effective and cost-efficient policies are crucial to achieving the objective of keeping future temperature changes below two degrees celsius. He calls for a concentration of efforts in two areas: a functioning carbon market and a broad post-Kyoto international agreement.]]> Sun, 27 Apr 2008 23:00:00 +0100 <![CDATA[Government size and output volatility: should we forsake automatic stabilisation?]]> http://www.bruegel.org Mon, 31 Mar 2008 23:00:00 +0100 <![CDATA[Is structural spending on solid foundations?]]> http://www.bruegel.org Tue, 19 Feb 2008 23:00:00 +0000 <![CDATA[Europe's R&D: missing the wrong targets?]]> http://www.bruegel.org Sat, 02 Feb 2008 23:00:00 +0000 <![CDATA[Early Lessons of the Financial Crisis]]> http://www.bruegel.org Europe's World, a Brussels-based quarterly, I try to draw tentative lessons from the first few months of the still unfolding financial crisis.]]> Thu, 31 Jan 2008 23:00:00 +0000 <![CDATA[Financing Europe's fast movers]]> http://www.bruegel.org Sat, 19 Jan 2008 23:00:00 +0000 <![CDATA[Coming of age: report on the euro area ]]> http://www.bruegel.org Mon, 14 Jan 2008 23:00:00 +0000 <![CDATA[The end of Europe's longstanding indifference to the renminbi]]> http://www.bruegel.org Jean Pisani-Ferry observes the lack of European interest towards China‘s exchange policy rate. He believes that Europeans, compared to Americans, are slower to react to external developments. The absence of significant external deficit, doubts about which policy stance is desirable, internal disagreements, an untested governance of exchange-rate relations, and a habit of following US leadership may have all contributed to a slow European response. That said, the Europeans have recently woken up to the issue as the euro has appreciated quickly against both the dollar and the renminbi, and they can be expected to adopt an increasingly active stance on China‘s exchange rate policy.]]> Mon, 14 Jan 2008 23:00:00 +0000 <![CDATA[Why Europe is not carbon competitive]]> http://www.bruegel.org Mon, 19 Nov 2007 23:00:00 +0000 <![CDATA[The happy few: the internationalisation of European firms]]> http://www.bruegel.org Sun, 11 Nov 2007 23:00:00 +0000 <![CDATA[EU adoption of the IFRS 8 standard on operating segments ]]> http://www.bruegel.org Nicolas Véron discusses whether the EU should adopt the controversial IFRS 8 standard, a convergence project on how companies should report the performance of their individual business segments. Véron‘s recommendation is for the European Union not to adopt the current version of IFRS 8.]]> Sat, 29 Sep 2007 23:00:00 +0100 <![CDATA[Why Reform Europe's Universities?]]> http://www.bruegel.org Fri, 31 Aug 2007 23:00:00 +0100 <![CDATA[Fragmented power: Europe and the global economy]]> http://www.bruegel.org
    To date there has been no comprehensive study of European international economic relations. This book fills that gap. It examines the main areas of Europe‘s foreign economic policy: trade, development, external competition policy, external financial markets, external monetary policy, migration and external energy/environment policy.

    This book explains why it is time for the EU to wake up to its global responsibilities, and why, in the absence of reform of its governance system, Europe risks remaining a fragmented power.
    The contributors to the volume are Alan Ahearne, Marco Becht, Olivier Bertrand, Arne Bigsten, Herbert Brücker, Beno?Æt Coeuré, Luis Correia Da Silva, Barry Eichengreen, Simon J. Evenett, Marc Ivaldi, Jean Pisani-Ferry, André Sapir, Coby van der Linde and Jakob von Weizsäcker.
    The book is sold out. You may download it from this page.]]>
    Fri, 31 Aug 2007 23:00:00 +0100
    <![CDATA[EU climate policy: dividing up the commons ]]> http://www.bruegel.org Wed, 29 Aug 2007 23:00:00 +0100 <![CDATA[Le fonds Européen d'ajustement à la mondialisation: pour quoi faire?]]> http://www.bruegel.org Published in La revue de l'OFCE, no 102]]> Fri, 17 Aug 2007 23:00:00 +0100 <![CDATA[Is Europe ready for a major banking crisis? ]]> http://www.bruegel.org Thu, 09 Aug 2007 23:00:00 +0100 <![CDATA[10 lessons about budget consolidation ]]> http://www.bruegel.org Jens Henriksson seeks to pinpoint, and to convey to fellow policymakers, what equations and econometrics do not capture. His ten lessons provide essential reading for the many countries where budget sustainability still remains an issue.]]> Sun, 29 Jul 2007 23:00:00 +0100 <![CDATA[Transparency would help to address the audit market problem ]]> http://www.bruegel.org Sun, 29 Jul 2007 23:00:00 +0100 <![CDATA[What should a cautious immigration policy look like?]]> http://www.bruegel.org Mon, 30 Apr 2007 23:00:00 +0100 <![CDATA[Irregular and high-skilled migration not such strange bedfellows]]> http://www.bruegel.org Think Global Act European project, Jakob von Weizsäcker dicusses which aspects of migration policy should be coordinated or harmonised and which should remain a national prerogative. He argues that European migration policy during the incoming French, Czech and Swedish trio of EU Presidencies requires a dual focus: on irregular migration and on high-skilled migration.

    ]]>
    Fri, 27 Apr 2007 23:00:00 +0100
    <![CDATA[The global accounting experiment ]]> http://www.bruegel.org Wed, 11 Apr 2007 23:00:00 +0100 <![CDATA[Real Convergence, Price Level Convergence and Inflation in Europe]]> http://www.bruegel.org Sat, 31 Mar 2007 23:00:00 +0100 <![CDATA[Energy: choices for Europe ]]> http://www.bruegel.org Follow the link below to see the complete dataset (data sources and methodology) of the Energy Policy Index (EPI)
    Energy_Report_Data_and_Methodology.pdf]]>
    Thu, 22 Mar 2007 23:00:00 +0000
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    Jean Pisani-Ferry discusses the fact that Europe's financial integration is significantly more advanced than the integration of products and labour markets. He advocates a more strategic approach to financial sector reforms and an explicit identification of the way in which they can help to alleviate the main constraints on growth or contribute to improving the stability of the euro area.]]>
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