<![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Sat, 31 Jan 2015 12:41:17 +0000 http://www.bruegel.org/fileadmin/images/bruegel-logo.png <![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Zend_Feed http://blogs.law.harvard.edu/tech/rss <![CDATA[Europe's Energy Union]]> http://www.bruegel.org/videos/detail/video/145-europes-energy-union/ vide145

Highlights of the event on 29 January at Bruegel with Commission Vice President Maroš Šefčovič. 

Full Recording of the event will be soon available

The timely presentation by Maroš Šefčovič – just three days after presenting his plan on the Creation of a European Energy Union to the European Parliament, was followed by comments by Simone Mori (ENEL) and Georg Zachmann (Bruegel) and a open discussion.

Thu, 29 Jan 2015 17:24:26 +0000
<![CDATA[Who’s (still) exposed to Greece?]]> http://www.bruegel.org/nc/blog/detail/article/1557-whos-still-exposed-to-greece/ blog1557

Since the start of the crisis, the structure of Greek debt has changed considerably (almost 80 percent of government financial liabilities are now accounted for by loans, against slightly less than 20 percent back in 2008). At the same time, the weight of public creditors has increased among the creditors of the government. Figure 1 shows a breakdown of the Greek general government financial liabilities across the main creditor sectors (with public creditor included in non-residents). At the end of 2013, debt due to official creditors amounted to 216 billion of loans (IMF/EU loans) and 38 billion of securities (under SMP). This means that, at the end of 2013, official creditors accounted for about 94 percent of the total loans due to non-residents and 89 percent of the total securities held by non residents.

But the government is not the only Greek sector to which foreign investors are exposed, and official creditors are not the only investors in Greece. After Greece came under market pressure and eventually obtained an EU/IMF macroeconomic financial assistance programme in 2010, foreign banks started to rapidly reduce their exposure to Greece (figure 2). Euro area banks’ consolidated foreign claims on Greece – which peaked at about 128 billion euro in 2008 – reached a low of about 12 billion euro in September 2013. UK banks’ exposure reached a peak of 13 billion in March 2008 and dropped to 4.3 billion in December 2012. US banks’ exposure instead was about 14 billion in September 2009 and down to 2.5 billion at the end of 2012.

Interestingly, US and UK banks have been increasing their Greek exposure again, since March 2013, reaching back to levels not very far from those of end 2009 /early 2010. US banks’ exposure to Greece as of September 2014 was in fact 8 billion (down from 13 billion in June) and UK banks’ exposure was 10 billion. Euro area banks have behaved very differently and total exposure to Greece has in fact continued to decline in almost all countries. Even more interestingly, the only country where banks have been continuously increasing their exposure to Greece since 2013, is Germany. German banks’ foreign claims on Greece in fact reached 32 billion in March 2010, dropped to as low as 3.9 billion at the end of 2012 and were back to around 10 billion in June 2014. Therefore the recent increase is small compared to the historical level, but it has been continuous (at least until September 2014).

As of the latest available data (September 2014), euro area banks’ exposures to Greece amounted to 96.6 million for Austria, 29.4 million for Belgium, 1368 million for France, 10203 million for Germany, 55.9 million for Ireland, 800 million for Italy, 923 million for the Netherlands, 263 million for Portugal and 301 million for Spain.

The composition of such exposures, however, varies across countries and has significantly changed over time. Figure 3 compares the exposure of selected foreign banks to Greek sector as of september 2014 versus December 2012 (chosen as a starting point because so that comparison is made between two post-PSI dates).

In 2012, exposures to the Greek private non-financial sectors accounted for the largest share of banks’ exposure to the country, with the exception of Belgian banks. In 2014, exposures to Greek banks have significantly increased as a share of total exposures in all countries but for Belgium and Spain. In terms of absolute numbers, only Belgium and Germany have increased their exposure to the Greek private non-financial sector. In absolute numbers, also exposure to the public sector has increased everywhere (apart from Belgium), but the only country where public exposure has significantly increased as a share of the total is Italy.

Anybody who has followed the development of the euro crisis know about the important increase in the weight of public creditor for Greek government debt. This data show, however, that since 2012 (when the ECB introduced the OMT programme) private investors have been timidly and slowly coming back also to Greece. While exposures of euro area banks are still at very low levels compared to the pre-crisis period, it is tempting to interpret this as a first trace of normalisation and resume in confidence, which the present political turmoil risks to revert.

Thu, 29 Jan 2015 17:01:31 +0000
<![CDATA[The Italian malaise]]> http://www.bruegel.org/nc/blog/detail/article/1556-the-italian-malaise/ blog1556

Whether looking at GDP figures or unemployment statistics, confidence indicators or inflation numbers, the perception is that European countries are at very different points of the economic cycle.

The chart above provides yet another measure of the wide (and still widening) divergence within Europe’s economy. The figure offers an illustration of an index of the number of enterprises facing bankruptcy, setting Q1 2007 equal to 100. This allows to effectively compare trends, cutting through the different inherent economic characteristics of countries. As this data is cumbersome to produce, it is only available for a limited set of countries. Interesting patterns can however nonetheless be detected.

As is to be expected, most countries experienced an increase in the number of enterprise bankruptcies as the financial crisis hit its darkest moment in early 2009. From then onwards, different economies behaved in different ways, with the UK progressively normalising, France stabilising at higher levels, and the Netherlands experiencing a second bout in 2012-2013. Germany’s firm mortality was not significantly affected throughout the time period analysed, possibly also thanks to its flexible working part-time arrangements.

Italy stands out of the crowd as a country where enterprise bankruptcy has now more than doubled (266% in Q2 2014) with respect to the pre-crisis period, and we still see no sign of a reversal in this trend. The more ‘supply-side’ economists among us might partially welcome this as good news as, the Schumpeterian ‘creative destruction’ story goes, when more unproductive firms leave the market, factors of production (capital and workers) get redistributed to the surviving/higher productivity firms. Moreover, this will open up space for new firms entering the market. Although true in principle, we still see very little signs of these positive mechanisms being at play, with the country now having the second highest NEET rate (27.3% for the age bracket 15-34 in 2013) in the whole EU after Greece. Moreover, the number of new firms entering the market in Q2 2014 was roughly 20% less than what it used to be before the crisis (83.5%).

In a compelling recent paper, Pellegrino and Zingales (2014) suggest that the origins of the Italian malaise are to be identified in an incapacity of Italy’s firms to face up to competition from China, to embrace the ICT revolution, and a generic lack of meritocracy in managerial selection and promotion. At the same time, ECB (2014) illustrates how in Italy firm size and productivity levels are weakly correlated, suggesting resources are poorly allocated not only across sectors but also within the same sector.

If this is the case, support to existing firms is not the right cure, but rather a temporary palliative, for the Italian malaise. What is rather needed is a set of broad-based reforms that ensure that, as these old inefficient firms fail and exit the market, resources do flow to where they can be used productively. This includes less stringent employment protection legislation, active labour market policies aimed at re-training dismissed workers, abridging cumbersome procedures now required to set up a business, decentralised wage bargaining, just to mention a few. The longer this is procrastinated, the more Italy will experience unused talents and entrepreneurial destruction, rather than ‘creative destruction’. 

Thu, 29 Jan 2015 15:31:15 +0000
<![CDATA[The global race for innovation]]> http://www.bruegel.org/nc/blog/detail/article/1555-the-global-race-for-innovation/ blog1555

Ladies and gentlemen, esteemed guests,

First of all, it is a real pleasure to be here. Today's discussion is one I've been looking forward to a great deal. I want to take this opportunity to tell you why I think Europe is well positioned in the global race for innovation and knowledge creation.

If there is one thing Europe does well it's "pessimism". Pessimism always sells, even in politics. So let me instead focus on the strengths we have, not forgetting, of course, the many things we need to improve.

Innovation is much more than a technical process.

The first thing I want to tell you is, I am happy that now it is almost a truism, to state that innovation is much more than a technical process. Innovation reaches from fundamental research to business process and plans, to marketing and to design. The second thing I want to say, is that I believe in a more democratic paradigm of innovation.

We have moved from a world in which Schumpeter would say, and I quote, "The producer initiates the change and educates the user", to a world in which innovation is, in many cases, created by the user. Von Hippe, from MIT gives several examples:

  • Irrigation machines
  • The Heart lung machine

Harry Chesbourough has a good image for this: that the funnel between producer and users now has many holes.

Third, I believe that this evolution can open more opportunities for disruptive innovation. Disruptive innovation is and often quoted term, but sometimes, it is not used in its precise form. Disruptive innovation creates new markets by making something – a product or service – simpler, more affordable, and more accessible. This is the kind of innovation that creates solid growth, jobs and a sustainable future.

In Europe, we are better positioned than most people assume.

So, considering this more precise view on innovation, where does Europe stand? I will argue that we are better positioned than most people assume. Saying that we are well positioned is not saying that everything is great. On the contrary. What I am saying, is that we have tremendous untapped potential.  In Europe, many things are working. If we build on our strengths, on the things that make us who we are, our solutions will be legitimate, effective and sustainable.

And here I must thank Professor Reinhilde Veugelers for her thoughtful and insightful memo "To the Commissioner for Research". It makes many astute observations of our current situation, and is refreshingly frank in its recommendations.

It is true that some areas of the world are moving faster than Europe. Economic and political circumstances are rarely perfect. We overcome one challenge to face another. But there are ways to make our economies more resilient: our breakthroughs more socially and commercially valuable. Ways to lead global markets with European innovation.

We have almost limitless potential. The EU is the world's largest trading block, with 500 million consumers looking for goods and services. The EU benefits from being one of the most open economies in the world. The kind of openness I want to see benefitting research, science and innovation.

Our global standing in these three arenas rests on the creative freedom of our scientists and researchers. On the people engaged in fundamental, curiosity-driven research. Research that will pay for itself in the long run.

There is one thing we certainly don't have and that is a fully integrated market across the EU. We came a long way in our internal market and we can still achieve much more in several areas, including the European Research Area. But gaining from a more integrated European market.

Still, we have to accept that we will always be different from, say, the United States. Despite all our efforts, we will always have a more fragmented market. We have 28 governments, 28 science and innovation policies, 23 languages, and diverse cultural and historical experiences.

That fragmentation is an enemy of efficiency, it prevents some gains from scale  - no doubt about it.  But we should also embrace its benefits. The main one is "diversity". Diversity is a source of creativity and innovation. Linda Hill, at Harvard University, studies creativity in groups and she highlights the fact that diversity may slow thing does, but leads to more innovation and creativity. The thing is, that in Europe, we tend to focus on the negatives, on the fragmentation of our markets. In the EU we have the great advantage, and privilege, of a pool of talent from 28 member states, not to mention those who come from outside to work and study in our centres of excellence.

Each scientist brings their own outlook and expertise. Each researcher brings a different perspective to the table. Europe is an ideas factory for everyone within our shores.

The diversity of Europe creates challenges, but also a lot of potential.

So, for me the diversity of Europe creates challenges that we have to address – with policy responses, like ERA and other measures, to better coordinate science policies across Member States. But this diversity also creates a lot of potential. We need this fragmentation for healthy competition. And for that we need a rising tide of all Member States improving their incentives for research and innovation.

This is why addressing the knowledge divide is crucial! All European countries, even the most advanced, have to have an enlightened, self-interest approach in this: they will all benefit from a rising tide!

A second, often heard criticism of Europe in this area lies in cultural explanations. I really don't agree with these kind of explanations, that statement that we are more risk averse, or more conformist. The great Venture Capitalist Marc Andresseen once said that his experience is that on average, European Entrepreneurs are better than Americans…adding "they have to be".

That is the crucial thing!

The problem is not our culture, it is the incentives we have. And it is true that we need a lot of work to improve the framework conditions for innovation and research. We have far too many barriers in our markets. This is why my first priority is precisely the reforms to lower these barriers.

So, what are we to do in the next 5 years?

In my hearing, I stated my three main priorities. In my view, these are the ones that will help tap into the huge potential I see in Europe.

First, create the framework conditions for a more productive exchange of research results, fundamental science and innovation. Things like:

  • Screen the regulatory framework in key sectors in order to remove bottlenecks
  • Accelerate the implementation of standardisation
  • Promote the  public procurement of innovation and innovation in the public sector
  • Promote a venture capital culture
  • Reduce bureaucracy in science and innovation systems

Second, is to consolidate fundamental research as the flagship for Europe. As the essential foundation for a knowledge-based society. Working towards a single, open market for knowledge though open science. Third: implement Horizon 2020 and the new Investment Plan to leverage the Europe economy towards a higher plane as a research and innovation-based area. Working towards a single, open market for knowledge though open science. It is better to focus on our potential than to dwell on illusions. We will always be different from other parts of the world. But that difference has many benefits!

We need to focus on these benefits; we need to have a rising tide, in which the full diversity of Europe works for us, not against us. We need to focus on incentives, not on convenient cultural explanations. Our scientists and entrepreneurs are world class. But they still face far too many barriers. Let's focus on those. Let's focus on reforms.

I look forward to debating this with you! And not just today!

Check Against Delivery.

Thu, 29 Jan 2015 13:38:00 +0000
<![CDATA[A European approach to corporate tax]]> http://www.bruegel.org/nc/blog/detail/article/1554-a-european-approach-to-corporate-tax/ blog1554

When a crowd of angry Americans threw 45 tonnes of tea into Boston harbour in 1773, their concern was the under-enforcement of the principle of ‘no-taxation without representation’ – that governments should not impose fiscal obligations on their citizens without them having a saying on it. More than two centuries later, some European Union member states might feel they have concerns of the same nature. The recent ‘tax-sweetener’ state-aid cases against Ireland for its agreements with Apple, Luxembourg with Amazon and Fiat, and the Netherlands with Starbucks have created momentum for those that believe that the European Commission should act to ensure that European countries coordinate their fiscal policies and possibly converge to harmonised corporate tax levels. Countries that use aggressive fiscal policies to attract foreign investors feel under threat of losing their fiscal autonomy.

Recent tax-sweetener state-aid cases created momentum for those who believe that the Commission should act to ensure that European countries coordinate their fiscal policies

State aid rules however have little to do with convergence of fiscal policies, and the Commission has never said that this should ultimately be the outcome of its investigations. The idea of state aid control is not to prevent free-riding as such. In the current framework, like it or not, it is legitimate for countries to offer advantageous conditions to investors seeking a cheap foothold in Europe from which to serve the entire single market. But state aid is illegal whenever such a policy is discriminatory in the sense that other companies, be they European or not, cannot access the same treatment.

But the impact of tax-sweetener cases could be broader than obliging member states to recover illegal state aid. On January 17, the Commissioners for Competition, Ms Vestager, and for Economic Affairs, Mr Moscovici, vowed to ‘put the EU tax house in order’.[1] With the aim of increasing transparency and preventing tax avoidance, they promised to revive the Commission’s proposal for a common consolidated corporate tax base – in other words, a common methodology to calculate and allocate multinational companies’ taxable incomes to member states. This would be most welcome (the initiative could even have a new acronym, such as Tax Union Base for Enterprises, or TUBE, to distinguish it for previous attempts).

The single market is seen as the key to the reignition of European growth. This requires cross-border competition and harmonised regulatory frameworks. At a time when Europe desperately needs to revive investment, a harmonised tax-base system would greatly enhance Europe’s ability to attract FDI. There is an extensive economic literature suggesting that corporate tax can have a significant effect on investment location decisions. However, when other business environment factors such as bureaucracy and regulatory uncertainty are taken into account, tax becomes much less important. An efficient system in which companies can anticipate more easily how much it will cost to locate their investment in multiple European countries would make Europe as whole more attractive, regardless of corporate tax levels.

The single market is the key to the reignition of growth. This requires cross-border competition and harmonised regulatory frameworks

The tax sweetener scandals have created an appetite for coordination that the Commission would be smart to exploit. Even Vice President Katainen has recently stressed that a common tax base proposal would help capital union. The drive for more coordination can easily dwindle as time passes and member states that oppose tax-base harmonization might succeed in stalling the process, as has happened since the project was launched in 2001. The Commission should therefore assess the reasons why some member states oppose the project. Concerns might be economic, because countries fear gradual loss of their fiscal autonomy and perceive tax-base harmonisation as a backdoor to fiscal convergence. Or they might be purely strategic: that a common methodology and enhanced transparency would reduce their leeway to hide illegal state aid that attracts foreign investors. The Commission can address the first concern through a clear public commitment that implicit tax harmonisation will never be an objective. There are good economic reasons why a degree of tax competition between jurisdictions can be good: it disciplines countries’ fiscal strategies, for example, and reduces the risk of protectionist measures. In the US, states are not bound by a common corporate tax policy. There are also good political reasons: the democratic backing for the EU institutions is too feeble to meet the ‘no taxation without representation’ principle. And institutional constraints: the Treaty explicitly forbids tax harmonisation. Meanwhile, countries' concerns that do not have an economic nature should be put under the spotlight. This would make it difficult for opponents of tax-base harmonisation to justify retaining their murky systems in order to circumvent state aid rules.

There are good reasons why a degree of tax competition between jurisdictions can be good

[1]This is the year for Europe to put its tax house in order, Margarethe Vestager and Pierre Moscovici on The Guardian

Thu, 29 Jan 2015 09:22:01 +0000
<![CDATA[The new European research agenda]]> http://www.bruegel.org/videos/detail/video/144-the-new-european-research-agenda/ vide144

Highlights of the event of the 22 January 2015 at Bruegel with Commissioner Moedas. For the full recording of the event:  www.bruegel.org/nc/events/even...

Mon, 26 Jan 2015 15:08:04 +0000
<![CDATA[Retaking the Greek Test]]> http://www.bruegel.org/nc/blog/detail/article/1553-retaking-the-greek-test/ blog1553

For about five years now, Greece has been giving the euro area authorities a test in economics and politics. The test must be retaken until the authorities produce the right answers.

How should Europe deal with a country that has lived beyond its means and cannot repay its debts?

The economics question is simple. How should Europe deal with a country that has lived beyond its means and cannot repay its debts? The answers have evolved. Greece has no problem. Greece can manage with loans from the European authorities and the IMF. Privately-held Greek debt does, after all, need to be restructured. The repayment terms of the debt owed to European authorities need to be eased some—and a bit more.

“I will think of some way…. After all, tomorrow is another day.” This Scarlett O’Hara dictum rarely works in conditions of distress. Delays are costly and the distress deepens. The then French Finance Minister Christine Lagarde, now the IMF’s managing director, said of the delays in the original Greek bailout, "If we had been able to address it right from the start, say in February [2010], I think we would have been able to prevent it from snowballing the way that it did."

Predictably, and despite concessional terms, the Greek debt levels remain unmanageable.

Predictably, and despite concessional terms, the Greek debt levels remain unmanageable. The unending fiscal austerity caused GDP to collapse and is steadily reducing the price level, making the debt burden more onerous. The debt ratio has continued to rise faster than forecast and the current projections of a decline are not credible.

The “radical-left” party Syriza, which led the polls in the election run-up, has given voice to a sharper economic question: Is it time to make a clean break with the past and forgive Greek debt? 

And then there is the political question on the test: how should the European democratic process treat a country that does not live by the rules? The Lisbon Treaty requires that official loans be repaid, and not repaying them incurs the wrath of the German taxpayers.

European leaders have, therefore, sought to influence the Greek elections. European Commission President Jean-Claude Juncker advised Greek citizens to not vote the “wrong” way. “Extremist forces,” he said, should not “take the wheel.” The grown-ups must continue because they understand that Greece has obligations, which flow from “the necessity of the European processes.”

Could it be that honoured European processes are feeding nationalism?

As with the economics, the political strategy has backfired. The same Mr. Juncker earlier lamented: “We are increasingly sliding down the slope towards reflexive regionalism and nationalism.” But could it be that the honoured European processes are feeding the nationalism? The Greeks feel aggrieved and the Germans see unending bills.

Angry German politicians want Greece to leave the euro area. But the exit would cause global financial mayhem and the costs to Germany would be much greater than from a write down of Greek debt.

No matter who now governs the country, forgiving Greek debt would give Greece a real opportunity to restart its economy. Official debts forgiven in the aftermath of World War I led to: “higher income levels and growth, lower debt servicing burdens and lower government debt.”

Those who worry that Greece will create a new burden for Europe should use this opportunity to fundamentally change the European architecture. Official monitoring of Greece has not worked—and will not work. Instead, under a new “no bailout” regime, private creditors must unambiguously bear the burden of future defaults, ideally through contracts that require debt restructuring at pre-agreed thresholds. Making creditors and debtors beware will create greater discipline. Continued reliance on discredited European processes will cause legitimate distress to spread. Extremism will grow.

The wrong answers to the Greek test have escalated the stalemate. The dilemmas intensify, raising the stakes in resolving them. Greek debt will eventually be written down. Doing so in driblets will only drag the process out while the Greeks hurt and European political divisions deepen. Till then, the Greek test will need to be taken again—and again.

Mon, 26 Jan 2015 12:33:40 +0000
<![CDATA[Blogs review: QE and central bank solvency (continued)]]> http://www.bruegel.org/nc/blog/detail/article/1552-blogs-review-qe-and-central-bank-solvency-continued/ blog1552

What’s at stake: Our previous review suggested reasons for believing that central bank financial strength was a non-issue, even within the particular institutional set-up of the euro area. Yet central banks tend to display a strong aversion to financial weakness. And as this week ECB’s decision (that QE risks won’t be fully mutualized) illustrates, this aversion is even higher within in a currency union. In this review, we explore potential reasons for this aversion.

Central Banks aversion to negative equity

The Economist writes that under European QE each of the 19 national central banks, which together with the ECB constitute the Eurosystem, will buy the bonds of its own government and bear any risk of losses on it.

The BIS notes that up until the passage of the Dodd-Frank Act in 2010, Section 13(3) of the Federal Reserve Act provided the Federal Reserve with the authority to lend to individual non-depository financial institutions (such as AIG, but more generally also to individuals, partnerships and corporations) in “unusual and exigent circumstances”, subject to a qualified majority of Board members voting to do so. With the passage of the Dodd-Frank Act, that independent authority has been curtailed. Such lending is now required to be in a manner “consistent with sound management practices” that protects taxpayers from losses, and subject to the authorization of the Treasury Secretary. According to records of the Congressional debate, the motivation for the restriction was to limit the ability of the Federal Reserve to put taxpayer money at risk through emergency lending.

In its 2010 Convergence Report, the ECB writes that ``any situation should be avoided whereby for a prolonged period of time an NCB’s net equity is below the level of its statutory capital or is even negative, including where losses beyond the level of capital and the reserves are carried over […] the event of an NCB’s net equity becoming less than its statutory capital or even negative would require that the respective Member State provides the NCB with an appropriate amount of capital at least up to the level of the statutory capital within a reasonable period of time so as to comply with the principle of financial independence.”

Recapitalization through base money issuance, inflation and signals

Peter Stella writes that losses for a central bank become an immediate problem when they interfere with the conduct of monetary policy. As losses either lead to an injection of reserve money or portend future cash injections if they’re unrealized, they have either an immediate impact on domestic liquidity or influence expectations about future monetary growth.

Willem Buiter writes that it should be obvious that the central bank can make the nominal present discounted value of current and future seigniorage pretty much anything it wants it to be. While a central bank can always recapitalize itself through the issuance of base money, doing so may not be optimal or even acceptable, even though it is feasible: self-recapitalization through seigniorage may generate undesirably high rates of inflation. Marco Del Negro and Christopher A. Sims write that whether a can manages to recapitalize through base money issuance and respect its policy objectives depends on the policy rule, the demand for its non-interest-bearing liabilities, and the size of the initial net worth gap.

Jaime Caruana writes that the problem is that not everyone appreciates that a central bank’s accounting equity can be negative without any reason for alarm bells to ring. Markets may instead react badly in the false belief that losses imply a loss of policy effectiveness. Politicians may also object, if they leap to the conclusion that bad decisions have been made at the taxpayer’s expense, or that the central bank now depends on the government for a rescue. Such harmful self-fulfilling prophecies are in nobody’s interest.

Economists at the Czech National Bank write that the link from CB financial strength to inflation is far from straightforward. There are historical examples of countries where central bank financial weakness has led to clear problems, but there are also central banks that have successfully delivered price stability for many years irrespective of their negative equity. Economists at the Bank of Thailand write that four central banks which are commonly referred as successful central banks with weak financial status are Czech National Bank (CNB), Central Bank of Chile (CBC), Bank of Israel (BOI) and Bank of Mexico (BOM). Mojmír Hampl writes that the Czech National Bank has indeed lived for years with negative equity of up to some 5% of gross domestic product without experiencing any ill effects on its reputation or operation. The Slovak central bank adopted the euro comfortably with an uncovered loss and is still functioning happily within the euro area.

QE and fiscal transfers redux (on Paul de Grauwe)

Monetary Realism writes that the standard central bank strategy for QE includes the assumption that it is temporary – that there will be an exit sometime down the road, anticipating the prospect that central banks will be returning policy interest rates to more normal positive levels. Given that goal and expectation, QE related excess reserves (and related liability forms) will have to pay a positive rate of interest in order to support a policy rate structure above the zero bound – until the completion of QE exit. QE related liabilities must pay a positive interest rate as floor support if the central bank’s policy rate is set sufficiently above zero.

Monetary Realism writes that De Grauwe has overlooked the fiscal effect linked to the charge for any future interest expenses on the ECB liabilities that were created as the result of QE purchases of bonds that have now defaulted. This is relevant considering the real possibility that the world may return to more positive interest rates at some future point. In that case, under De Grauwe’s proposed treatment, any Eurozone country that has defaulted on bonds will have escaped its respective share of ECB liability costs for which it has been responsible by direct QE association. Such a country will have obtained perpetual free funding courtesy of the ECB and its remaining capital holders. That is an unambiguous fiscal transfer that De Grauwe has either not recognized or assumed away.

Mon, 26 Jan 2015 08:57:40 +0000
<![CDATA[Greek choices after the elections]]> http://www.bruegel.org/nc/blog/detail/article/1551-greek-choices-after-the-elections/ blog1551

In the days ahead of the Greek snap elections on 25 January 2015 a huge range of opinions has appeared on what Greece and its lenders should do. A large group of people are saying that Greek public debt is unsustainable and a significant part of it should be written off. In their view, the Troika is responsible for the deep crisis, austerity has failed, and the fiscal space gained from the debt write-off should be used to stimulate growth.

Another group says that irresponsible pre-crisis Greek policies, as well as the extremely large, 15% of GDP budget deficit in 2009, necessitated the bail-out in 2010. Implementation of the bail-out conditionality was incomplete and the Geek public sector is so inefficient and so much depends on cronyism that it is not surprising that the Greek crisis became so deep.

As always, both sides have some truths but none of these explanations is complete. One could write a lot on what happened, who is responsible for desperate social hardship and what should have been done differently. But after the elections, both Greece’s new leaders and euro-area partners should look ahead: given the status quo, what are the real choices?

Grexit would contract Greek GDP, push unemployment up, reduce budget revenues, require new fiscal austerity and would risk the stopping of almost 3% of GDP transfers from the EU-budget

Exit is not an option. Greece would enter another deep recession, which would push unemployment up further and reduce budget revenues, requiring another round of harsh fiscal consolidation: exactly what opposition parties want to avoid. (This effect is forgotten by those who argue that since Greece has a primary budget surplus, it has now the option to default and exit.) Euro-area creditors would lose a lot on their Greek claims and private claims on Greece would also suffer (see our earlier post here). Moreover, exit would also risk the stopping of EU-budget related inflows to Greece (cohesion and structural funds, agricultural subsidies): in 2013 Greece received a net payment of 2.9 % of GDP from the EU budget. This was a transfer (not a loan) and the country would receive similar transfers in the future too.

Debt write-down is extremely unlikely – and unnecessary as well. Any level of debt is sustainable if it has a very low interest rate. Japan is a prime example: gross public debt is almost 250 % of GDP, while the average interest rate is 0.9 percent per year. Despite the very high Japanese public debt, there is no talk about its restructuring.

 Any level of debt is sustainable if it has a very low interest rate

Loans from euro-area partners to Greece carry super-low interest rates and also have very long maturities. The lending rate from the European Financial Stability Facility (EFSF) is a mere 1 basis point over the average borrowing cost of the EFSF, which is around 0.2 percent per year currently. The average maturity of EFSF loans is over 30 years with the last loan expiring in 2054. Moreover, in 2012 the Eurogroup agreed on a deferral of interest payments of Greece on EFSF loans by 10 years, implying zero cash-flow interest cost on EFSF loans during this period. The interest rate charged on bilateral loans from euro-area partners is Euribor plus 50 basis points, which is currently about 0.56 % per year: another very low value (which could be lowered further, as we argued here). Bilateral loans have a long maturity too: they should be gradually repaid between 2020-2041.

One can say that yields will not remain so low forever and if ever growth and inflation will pick up in the euro area, interest rates will increase. Unfortunately, this is in the distant future and therefore the cash-flow gain for Greece from stopping interest payments to euro-area partners would be very low in the next few years.

In fact, according my calculations, one of the demands of Syriza leader Alexis Tsipras will be likely met this year, even without any change in bail-out terms: actual interest service costs of Greece will likely be below 2% of GDP in 2015. Table 1 shows the situation in 2014. Total interest expenditures of Greece amounted to 4.3 % of GDP. However, interest paid to the ECB and euro-area national central banks (NCBs) is returned to Greece (if Greece meets the conditions of the bail-out programme) and interest payments on EFSF loans are deferred. If we subtract these, interest payments were only 2.6% of GDP in 2014, well below the values of other periphery countries. Given that interest rates have fallen significantly from 2014, actual interest expenditures of Greece will be likely below 2% of GDP in 2015, if Greece will meet the conditions of the bail-out programme.

 Table 1: Interest burden on public debt in 2014

Note: end-2013 value for gross public debt, 2014 value for interest payments. ECB=European Central Bank. NCBs=national central banks. EFSF= European Financial Stability Facility. Greece receives from the ECB/NCBs both the interest it pays on their Greek bond holdings and the capital gains of the central banks from Greek bonds (most of the bonds were purchased below face value). In my calculation I only excluded the interest component. Source: the first two data columns are from the November 2014 forecast of the European Commission; the third column is my calculation.

Since the actual debt servicing cost of Greece is low, it is extremely unlikely that parliaments and governments of euro-area lending countries would decide to cancel their Greek loans and raise taxes at home to cover the losses.

Maturity extension and further cut in interest rate: yes. While euro-area loans to Greece already have extremely long maturities, further extension is possible. Whether the average maturity is 30 years or 40 years, there is not a big difference. Moreover, the 50 basis point spread over Euribor, which is charged on bilateral loans, can be abolished without leading to direct losses to euro-area partners. As was argued with Pia Hüttl, such changes would imply a 17 % of GDP net present value gain for Greece over the next 35 years. While this would not be an upfront funds that could be spent, on average the primary surplus of Greece could be about 0.5 % of GDP lower in the next 35 years, which is sizeable.

A new financial assistance programme: yes. As we argued with André Sapir and Guntram Wolff a year ago, a third programme should be put in place to take Greece out of the market until 2030. Even if the currently very high market interest rates for Greece will fall, they will likely remain too high.


Maturity extension, further cut in interest rate and new ESM lending would allow easing fiscal policy to support the poor and help growth

Easing fiscal policy: perhaps. In our paper with Sapir and Wolff we also argued that the new programme should be accompanied by enhanced budgetary commitments by Greece, whereby Greece should reach a balanced budget by 2018. Hoverer, due to the fall in interest rate and an improvement in economic activities (2014 was the first year with modest economic growth, with 2-3 percent growth expected for 2015), in November last year the Commission forecast a balanced budget already for 2015, despite a forecast decline in structural primary surplus (Figure 1). In fact, the expected decline in the structural primary surplus would imply fiscal easing and therefore the expected improvement of the actual primary balance (red line of the figure) is expected to come mainly from the improved economic situation. If the maturities of euro-area loans to Greece are lengthened and the 50 basis points spread on bilateral loans is scrapped, the primary surplus could be reduced by an additional half percent of GDP. Therefore, there would be some room for manoeuvre to ease the social pain and to help growth with some public investment.

Figure 1: Primary budget balance of Greece, % of GDP, 2003-2016

Note: the primary balance is the budget balance excluding interest payments. The structural primary balance is the estimate of the underlying position of the primary balance, by excluding the impact of the economic cycle (such as the negative impact of recession on tax revenues) and one-time revenue and expenditure measures (such as bank rescue costs). Source: European Commission forecasts: the November 2014 forecast includes data on the structural balance from 2010 onwards, for earlier years we used the May 2014 forecast.

Structural reforms: yes. Even Syriza argues that Greece needs major structural reforms. Yet it may be difficult to find an agreement between Greece and the Troika, because many of the current plans of the Greek opposition parties are in diametric opposition to reforms agreed under the financial assistance programme. But a compromise has to be found: both sides have strong incentives to agree and structural reforms have to be part of the comprehensive agreement.

A European boost to economic growth in the euro-area periphery: should be yes, but low hopes. With Sapir and Wolff we also argued for the need for European support to growth throughout the euro-periphery. While I continue to think that there would be a strong rationale for it, unfortunately I see little political reality.

Some sort of European assurance is needed for Greece to eliminate the uncertainty over Greek debt, if Greece meets loan conditions

European assurance for Greece against adverse shocks: yes. Even if Greece will cooperate with euro-area partners and will fulfil its commitments, such a high debt ratio is sensitive to adverse risks, like weaker growth, lower inflation or higher interest rates. Therefore, some sort of European assurance is needed for Greece to eliminate the uncertainty over Greek debt, if Greece meets loan conditions. Otherwise, the uncertainty may deter the investment climate, even if euro-area loans have super-long maturity and low interest rates. One option would be to index official loans to Greek GDP as I suggested in a 2012 paper. Thereby, if the economy deteriorates further, there will not be a need for new arrangements, but if growth is better than expected, official creditors will also benefit. Another option would be to commit on the part of lenders to reduce loan charges below their borrowing costs, should public debt levels prove unsustainable despite Greece meeting the loan conditions (as we argued with Sapir and Wolff).

 What are the chances for such a comprehensive agreement which could be claimed as victory by both sides? I think it is higher than many commentators think, for two main reasons.

  • First, lack of an agreement may lead to Grexit, which would be so bad for all that both the new Greek leadership and euro-area partners have very strong incentives to avoid it.
  • Second, there are some reasonable options to agree on the reduction of the debt burden and easing fiscal policy, as I outlined above. Thereby, the new Greek leadership could claim that it achieved a major reduction in the cost of debt service and got some fiscal space to ease the social pain and boost growth, while European partners could tell their people that they only extended the loan maturities and eliminated the gap between their own borrowing costs and their lending rate to Greece, thereby taxpayers should not suffer loss.


Certainly, negotiations may not work out nicely. We do not know yet if a government will be formed right after the elections, or a new election will be needed later; Greece may run out of time. When a government is formed, negotiations could be suspended, perhaps repeatedly, which would create further uncertainty. Such uncertainty would lead to deposit withdrawal from Greek banks and deteriorating economic and fiscal outlook. Some euro-area partners may say no to certain parts of the agreement even if other euro-area partners agree. Some members of the new Greek parliament may say no even if the new government and most of its parliamentary members are in support. I may have also incorrectly assumed that the responsible decision makers think rationally. Therefore, there could be many pitfalls for an agreement, yet the Grexit threat will be hanging over the negotiators like the sword of Damocles.


A version of this post appeared in ISPI Dossier.

Fri, 23 Jan 2015 08:49:20 +0000
<![CDATA[Sovereign debt restructuring: Legal frameworks and European challenges]]> http://www.bruegel.org/nc/events/event-detail/event/500-sovereign-debt-restructuring-legal-frameworks-and-european-challenges/ even500

There were several sovereign debt crises and debt restructurings during the past decades, primarily in emerging and developing countries, but during the past few years many European countries also faced major difficulties in financing their budgets. Greece went through major debt restructuring. The regular reoccurrence of such crises in emerging countries and high public debts and weak growth outlooks in some European countries suggest that debt restructuring could come back to the agenda again. However, there is no global legal framework for orderly sovereign debt restructuring, which could complicate the resolution of public debt overhangs. In Europe, there is a renewed discussion on whether Greek public debt should be restructured again, even though the bulk of Greek public debt is in the hands of official creditors and enjoys very preferential terms.

The workshop brings together a distinguished group of speakers to assess legal options for debt restructuring and European challenges.

The first session of the workshop assesses broader issues, drawing lessons from Argentina, Europe and hundreds of other debt restructuring episodes. How much does the lack of a global legal framework for debt restructuring hamper the resolution of sovereign debt crises? Can collective action clauses substitute the lack of a sovereign debt resolution mechanism? Is there a need for a European mechanism for sovereign debt crisis resolution? Would an automatic lowering of the debt burden upon the breach of contractually-specified thresholds be the right solution in the specific context of the euro area?

The second session of the workshop focuses on the current case of Greece. Is Greek public debt unsustainable? What is the rationale for offering debt relief for Greece? What are the available options to improve the sustainability of Greek public debt? Would a new Greek debt relief have implications for other EU countries which also received financial assistance during the crisis?

The panellists will offer some kick-off remarks on these and related questions, which will be followed by a general discussion.

Note that the programme for this event is still under construction. We will provide additional information shortly.

Confirmed speakers

  • Hernan Lorenzino, Ambassador of Argentina, former Minister of Finance
  • Ashoka Mody, Non-resident fellow at Bruegel and Professor at Princeton University (by video conference)
  • Moritz Kraemer, Managing Director and Chief Rating Officer, Sovereign Ratings, Standard & Poor’s
  • Zsolt Darvas, Senior Fellow, Bruegel
  • Chairs: André Sapir, Senior Fellow at Bruegel and Guntram Wolff, Director of Bruegel

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: 12 February 2015, 11.30-15.10
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Thu, 22 Jan 2015 17:09:59 +0000
<![CDATA[The ECB has fired its bazooka]]> http://www.bruegel.org/nc/blog/detail/article/1550-the-ecb-has-fired-its-bazooka/ blog1550

The ECB announced today an expansion of its asset purchases, to include securities issued by European agencies and institutions, as well as central government in the euro area. Purchases are intended to be continued until at least September 2016 and in any case until the Governing Council sees a sustained adjustment in the path of inflation that is consistent with its aim of achieving inflation rates below, but close to, 2% over the medium term. This is a positive feature of the announcement, as it leaves the operation open ended enough. 

The combined target monthly asset purchases will amount to 60 billion euro. However, this will also include the purchases already envisioned under the ABSPP and CBPP. There are no weekly targets for purchases under these two programmes, but the ECB had bought about 35bn combined as of 16 January. The CB purchases began in October and ABS purchases in November 2014, meaning the ECB bought on average around 10 billion a month. Assuming a similar pace in the future, the additional purchases would be around 50 billion (and not 60) per month, leading to a total of 900/950 billion under the scenario in which the programme were to be stopped in September 2016. This is still positively above the 500-700 billion range that had been rumoured ahead of the meeting.The maturity spectrum will also be very large, as eligible securities will range form a minimum remaining maturity of 2 years to a maximum remaining maturity of 30 years at the time of purchase.

The purchases will be pari passu with private investors, which will be achieved by imposing a 33% issuer limit and a 25% issue limit (the latter needed to help avoid that the ECB achieves a blocking stake under Collective Action Clauses (CACs)).

The most interesting point is the risk sharing arrangement of the ECB programme

The most interesting point, as largely expected, is the risk sharing arrangement of the programme. Purchases of securities of European institutions (which will account for 12% of the additional asset purchases, and which will be purchased by NCBs) will be subject to loss sharing. This is consistent with the idea that these securities are at present the closest resemblant to an Euro/EU-wide bond, as we first pointed out in May. On top of this, the ECB will hold 8% of the additional asset purchases, meaning that a total 20% of the purchases will be subject to loss sharing. The rest of the NCBs’ additional asset purchases will however not be subject to loss sharing at all. This effectively means that 80% of the risk is borne by the NCBs, and fragmented along national borders. However, if we consider only the purchases of non-EU-wide securities (i.e. if we exclude that 12% of the purchases that are likely to be safest), then only 9% of the national sovereign risk will be shared.

  • Overall, the large majority of the governing council came to the correct assessment that inflation expectations are getting disanchored and that therefore monetary policy action was needed. 
  • The programme is large. This increases its effectiveness and will have a powerful impact especially through the exchange rate channel and the portfolio rebalancing channel
  • Some Northern governing council members were concerned that such a large programme would mean that the ECB takes on board a too significant fiscal risk. The ECB therefore reduced risk sharing substantially. This may reduce the effectiveness of the programme.
  • Before this decision, nobody could have questioned whether monetary policy is "single". Now, investors can rightly ask that question. Mario Draghi addressed this several times in his comments but his answers were not convincing. This question will be an important issue in the coming months and potentially years.

Thu, 22 Jan 2015 16:13:18 +0000
<![CDATA[Oil and the dollar will complicate the U.S. revival]]> http://www.bruegel.org/nc/blog/detail/article/1549-oil-and-the-dollar-will-complicate-the-us-revival/ blog1549

At the start of 2015, two familiar features dominate the global economic outlook: continuing turbulence in financial markets and the relative strength of the US recovery. One  aspect of America's superior performance, though, has received surprisingly little attention, and that's the marked decline in the country's external deficit.

The shrinking of the current-account deficit -- from its peak of almost 6 percent of US gross domestic product in 2006 to 2.3 percent in 2013 -- ought to be a big story. Bear in mind, it happened even though the US has enjoyed stronger growth in domestic demand than either Europe or Japan, and despite the recent strength of the dollar. That took some doing.

JO acct def % gdp

In my early years of learning international economics, it was banged into my brain that the U.S. would always see its imports rise significantly when its domestic demand grew more strongly than that of other developed economies. Ten years ago many economists believed that the U.S. external deficit would persist until domestic demand gave way or the dollar collapsed (or both).

The US is a net oil importer, so the collapse in crude-oil prices has squeezed the current-account deficit

What concerns me as 2015 gets under way is that this little-noticed but highly significant adjustment could now be under threat.

One crucial variable is the price of oil. The US is a net oil importer, so the collapse in crude-oil prices has squeezed the current-account deficit. In the short term, it will continue to do so; in the longer term, however, other forces will come into play. Cheap oil will boost the real incomes of U.S. consumers, allowing them to spend more on imports. In addition, if the price of oil stays down, the recent surge of investment in the domestic production of shale oil and gas may stall or even go into reverse. The technological opportunity afforded by fracking -- and the prospect of a permanent improvement in the U.S. balance of trade in oil -- could be undone.

Another big factor is the aforementioned strength of the dollar. Over the past year, the dollar has appreciated against almost all the main currencies. Even if the connection isn't apparent yet, a stronger dollar will slow the decline of the US deficit.

Even if the connection isn't apparent yet, a stronger dollar will slow the decline of the US deficit.

On the one hand, if the dollar were to strengthen in 2015 as it did in 2014, there'd be a boost to consumer demand from higher real incomes, and this would support the recovery. On the other, the diminished competitiveness of U.S. producers in domestic and foreign markets would probably cancel out the benefit. Exports would fall and imports would rise. It's quite likely -- contrary to some short-term forecasts -- that the combination of cheap oil and a strong dollar will be more helpful to Japan and the euro area than to the United States.

If I were a U.S. policy-maker, I'd be concerned about this. If I were a governor of the Federal Reserve, I might be concerned enough to wonder whether the dollar's strength -- in effect, an unplanned tightening of U.S. monetary policy -- should make me want to postpone the first post-crash rise in short-term interest rates yet again.

True, a strong dollar will keep imported inflation in check --but inflation is not yet a concern. Meanwhile, further currency appreciation could do lasting structural harm to the economy by bringing the recent revival of US manufacturing to a premature halt. That's not all. Lately, unlike the other main currencies, China's renminbi has risen along with the dollar; at some point, policy-makers in Beijing are likely to act against the ongoing loss of competitiveness. That would add to the downside for the U.S. economy.

Many will say there's little the US can do about the fall  in oil prices or the rise of the dollar -- and I expect they're right. Even so, I see US policy-makers mobilising their diplomats and hitting the phones, urging foreign counterparts not to solve their own economic problems at the expense of the US. Since 2008, the structure of the American economy has changed and, partly for that reason, the nation has recovered much of its strength. Those gains won't be surrendered lightly.

Thu, 22 Jan 2015 08:59:07 +0000
<![CDATA[The ECB’s bond-purchase dilemma]]> http://www.bruegel.org/nc/blog/detail/article/1548-the-ecbs-bond-purchase-dilemma/ blog1548

German opposition to government-bond purchases by the European Central Bank is solidifying ahead of the programme’s likely announcement on January 22. Elections in Greece that could bring a government that will seek to negotiate the country’s debt with official creditors puts the ECB’s decision under even greater scrutiny. The fact that the ECB did not share losses in the previous round of Greek debt restructuring highlights the problem of sovereign QE, which is not feasible or will be ineffective if fiscal implications are excluded. The design of the programme is therefore crucial.

ECB is falling far short of fulfilling its mandate of keeping inflation below but close to 2%

With the euro-area inflation rate at minus 0,2% and an increasing de-anchoring of inflation expectations, the ECB is falling far short of fulfilling its mandate of keeping inflation below but close to 2%. Many German economists and politicians downplay this failure by trying to re-define price stability as an inflation rate above zero. This is wrong for a number of reasons. A third of the sectors in the euro area, including in Germany, is in deflation. Low inflation is harmful because it makes price adjustment harder, undermines investment and renders debt service more difficult.

Monetary policy alone cannot fix all the problems of low growth and low inflation as many Germans rightly point out. Significant structural reforms and investment to stimulate higher demand will pay off rather quickly. A strong commitment to such reforms is essential for exiting the crisis. Nevertheless, the ECB should not and cannot hide behind slow government progress on reform, but should instead fulfill its mandate.

The more and longer that inflation expectations remain unanchored, the harder it will become for the ECB to regain credibility

The reason for the growing German opposition to a sovereign QE programme is the fear that it could result in illicit monetary financing of governments. A QE programme would have to be combined with an implicit understanding that the ECB accepts losses on the same terms as private creditors in case of a debt restructuring. Otherwise, the purchase of low-rated government debt would be largely ineffective and could even lead to an increase in sovereign yields.The ECB has four options.

The first is to wait and hope for the best. This is the preferred strategy of many Germans, but would be dangerous and irresponsible. The more and longer that inflation expectations remain unanchored, the harder it will become for the ECB to regain credibility and achieve price stability, and the higher will be the real economic costs for the euro area and for Germany.

The second option would be to allocate the potential losses from purchases to the individual national central banks in the euro area. This might sound like an attractive option, but would be counter-productive by increasing sovereign spreads and worsening financial fragmentation within the euro area. And it would send a devastating signal that the single monetary policy would be single in name only.

The third option is to focus government bond purchases on highly rated debt only to limit the balance sheet risks to the ECB. This strategy could succeed, but the ECB would have to buy large amounts of already low-yielding, “safer” euro area sovereign debt and hope that private investors subsequently rebalance their portfolios towards riskier euro-area countries.

The fourth option– while accepting that the founding fathers of the euro might not have foreseen that monetary policy has to accept some fiscal risks – would be for the ECB to purchase sovereign debt according to the capital key of individual euro-area countries, with adjustments for those without sufficient amounts of privately held sovereign debt. The Treaty does not prohibit such purchases in secondary bond markets. The ECB’s governing council has expressed its intention to expand the balance sheet by €1 trillion. As this will hardly be possible with private sector assets only, the ECB could buy a portfolio of government debt combined with a portfolio of private debt.

The ECB needs to urgently show its uncompromising determination to fulfil its mandate and repair monetary transmission in the euro area.

The ECB needs to urgently show its uncompromising determination to fulfil its mandate and repair monetary transmission in the euro area. Accepting some fiscal risks is reasonable and unavoidable. The fourth option is the most promising strategy for the ECB to raise inflation expectations credibly and durably, avoid stagnation and help end the debt crisis. It is a risky strategy, but the other strategies are riskier.

Wed, 21 Jan 2015 11:33:57 +0000
<![CDATA[Deepening Economic and Monetary Union]]> http://www.bruegel.org/videos/detail/video/143-deepening-economic-and-monetary-union/ vide143

On Monday 19th January, Pierre Moscovici, European Commissioner for Economic and Financial Affairs, Taxation and Customs, came to Bruegel to speak about his ideas about deepening the European economic and monetary union.

Wed, 21 Jan 2015 10:28:52 +0000
<![CDATA[SIMPATIC final conference]]> http://www.bruegel.org/nc/events/event-detail/event/499-simpatic-final-conference/ even499

We are pleased to announce that the SIMPATIC Final Conference will take place on 26-27 January 2015 at HUB- Rue d’Assaut 2, Brussels.

SIMPATIC (Social Impact Policy Analysis of Technological Innovation Challenges) is a collaborative research project funded by the Socio-economic Sciences and Humanities Programme of the 7FP of the European Union, and provides a comprehensive and operational tool box, allowing for a better assessment of the impact of research and innovation policy in Europe.

The aim of the Final Conference is to present all the research work conducted in the research areas of the project (micro, macro, green and social) during the 3 years projects, which will provide new scientific insights in fundamental and applied policy evaluation research. It will also provide simulation based insights into demand-driven behavioural changes, shifts in regulation, organisation, habits and citizens’ behaviour.

More information can be found on the website (www.simpatic.eu ) which offers in-depth project results, all project publications, as well as information on the research partners.

Preliminary Programme -

Thursday 26 February

8.30 - 9.00 Registration & Coffee

9.00 - 10.00 Simona Mateut, Nottingham University Business School “Subsidies, financial constraints and firm innovative activities in developing economies”

10.00 - 11.00 Cedric Schneider, Copenhagen Business School; “Science and Productivity: Evidence from a randomized natural experiment”

11.00 - 12.00 Mark Schankerman, London School of Economics and Political Science (tbc)

12.00 -13.00 Lunch Break

13.00 - 14.00 Jacques Mairesse, ENSAE

14.00 - 15.00 Tuomas Takalo, Bank of Finland

15.00 - 16.00 Otto Toivanen, KU Leuven

16.00 -16.15 Conclusions

16.15 -18.00 Internal meeting with SIMPATIC Partners and SAC/PAC Members

19.30 Dinner (on invitation)

Friday 27 February 2015

8.30 - 9.00 Registration

9.00 - 9.15 Welcoming remarks

  • Reinhilde Veugelers, Scientific Coordinator of SIMPATIC, Bruegel
  • Domenico Rossetti, DG RTD, European Commission, SIMPATIC project officer

9.15 - 10.15 Jobs & Innovation

  • Joze Damidjan, Institute for Economic Research (Ljubljana)
  • Jordi Jaumandreau, Boston University

10.15 – 10.30 Coffee Break

10.30 - 11.30 Climate & Energy

  • Ralf Martin, Imperial College Business School
  • Georg Zachmann, Bruegel
  • Adam Jaffe, Motu Economic and Public Policy Research (tbc- videoconferencing)

11.30 - 12.00 Micro evaluation of R&D funding impact

  • Otto Toivanen, KU Leuven

12.00 - 12.30 Lunch Break

12.30 - 13.00 Policy Implications from micro-evaluations of R&D funding

  • Manuel Trajtenberg, Tel-Aviv University

13.00 - 13.30 John Van Reenen, London School of Economics and Political Science

13.30 - 14.30 Macro evaluation of R&D funding impact

  • Paul Zagamé, SEURECO
  • Philippe Aghion, Harvard University & Bruegel non resident scholar (videoconferencing)

14.30 – 14.45 Coffee Break

14.45 - 16.30 Policy Panel. Bringing it all together: the impact on growth and jobs

  • Opening address: Janez Potočnik (tbc)
  • Panel discussion: Luc Soete, Maastricht Universiy; SIMPATIC researchers and external speakers

16.30 Closing reception

Practical Details

Tue, 20 Jan 2015 14:47:07 +0000
<![CDATA[Deepening the economic and monetary union]]> http://www.bruegel.org/nc/blog/detail/article/1547-deepening-the-economic-and-monetary-union/ blog1547

Thank you for inviting me at Bruegel. I’m very happy to have the occasion to speak here for the first time since I moved to Brussels in November.

Let me begin by saying how useful high quality and truly European think tanks like Bruegel are, for the quality of policy making and democracy in Europe.

I am very much looking forward to good intellectual cooperation and exchange with think tanks over the mandate of this Commission, and in particular in the field of Economic and financial affairs.

I have been asked to give my views on how « Deepening the EMU » could take place over the coming months and years. Therefore, I will express my personal ideas, which does not necessarily reflect the views of the European Commission.

The economic and monetary union architecture was quite substantially reinforced over the last five years, in response to the crisis.

As you know, the economic and monetary union architecture was quite substantially reinforced over the last five years, in response to the crisis, and most of the time without the luxury of time to design and implement optimal solutions. The priority was to stabilize the EMU – and that was right and was largely achieved.

We are now entering a new period where the acute phase of the crisis is over. We can now take the time to take stock of our past actions, and think about how to design a permanently stable and balanced EMU.

The time of firefighters is behind us, now is the time for architects. This is not a reflection for the months to come, it is a reflection for the years to come. My conviction is that this work is absolutely necessary.

We are the Commission of the last chance – we have to deliver to secure the legitimacy of the European project. Of course, this means acting today – what we have done in the last two months is already very substantial (Juncker Plan, flexibilities, Greece…). But this means also thinking about tomorrow.

Maybe this Commission will only lay ground for future changes under future Commissions – but this Commission cannot stay idle, we have to show the way.

A mandate was given to the « four presidents » by the October Euro summit to prepare next steps on better economic governance in the euro area. The Commission’s Blueprint for a Deep and Genuine EMU, as published in November 2012, remains an important basis for the work in this regard.

But please let me share more personal views on how we should prepare the needed changes.

The first important pillar is a shared understanding of what went wrong in the crisis, and in the response to the crisis

The first important pillar is a shared understanding of what went wrong in the crisis, and in the response to the crisis. It is time, now that a new team is in charge, to have a lucid and critical look into the past.

The second step is to agree on the main broad features a balanced and sustainable EMU should possess over the medium run.

Only then, can we envisage a multistage process to move towards genuinely deepening the EMU.

Short term reactions will not lead to satisfactory outcomes.

All the ambitious and successful endeavors of the European integration have taken place over long periods of time but with a clear view to where we were heading. The initial EMU was designed and implemented this way over ten years.

Deepening the EMU will not happen overnight. The method of small steps, advocated by Monnet, might still be the right approach, but it cannot be the alibi for unclear end goals.

Over the past years the EU has been experiencing the largest crisis since the nineteen thirties. Euro area GDP saw an unprecedented drop of 4.4% in 2009 and recovery of the EU economy since the recession in 2008-09 has been slower than any other recovery in the post-World War II period, on both sides of the Atlantic.

The crisis in the euro area has seen great depths, with euro area Member States losing market access and entering into emergency assistance programs, and even fears about a euro area breakup.

Overall we are just exiting six years of average almost zero growth…

With hindsight it is now clear that the flawed setup of Economic and Monetary Union contributed to the emergence and depth of the crisis.

With hindsight it is now clear that the flawed setup of Economic and Monetary Union contributed to the emergence and depth of the crisis.

The original EMU setup – developed under the Maastricht Treaty – consisted of a common monetary policy under the European Central Bank, combined with national decision-making on fiscal issues.

The framework is the Stability and Growth pact, an open method of coordination for national economic policies, financial market supervision and regulation remaining a competence of the national level.

When launching the euro, it was generally assumed that the single currency would foster growth. While there were doubts whether the euro area was an optimum currency area, it was believed that the euro itself would increase cyclical convergence.

Also, many believed that the euro would bring further convergence in Member States’ economic structures and policies and that it would fuel cross-border integration and growth. While the euro has indeed created some positive integration effects (for instance on trade and prices), forces of divergence prevailed.

In a nutshell, the crisis exposed important deficiencies in the structure of the EMU. The EMU governance failed on two accounts: effective crisis prevention and effective crisis resolution.

Lack of effective crisis prevention

The EMU setup proved unable to incentivise the build-up of fiscal buffers in good times.

Excessive risk taking in the private sector, macroeconomic imbalances and asset prices bubbles were able to develop unchecked and spilled over through the financial sector.

While economic cycles seemed to converge in the early years of the euro, the underlying divergence was masked by the build-up of imbalances and was revealed in the presence of a common exogenous shock, the US imported financial crisis.

Structural reform implementation did not pick up – this hampered efficient resource allocation, contributed to building imbalances, which aggravated the crisis. Now it is slowing down the recovery by hampering adjustment.

Lack of effective crisis resolution

Insufficient mechanisms were in place to deal with financial instability within the single currency. Contagion between fragile sovereigns could not be prevented: no effective firewall was in place.

Insufficient mechanisms were in place to deal with financial instability within the single currency

Strong feedback loops emerged between sovereign and financial sectors, encouraging financial market fragmentation along national borders: no supranational financial resolution mechanism was in place.

Now let me turn to the response to the crisis. What has been done is known – but I believe we still miss a precise assessment of the efficiency of our response. This is normal as we may have too little distance.

In late November, the Commission published a first assessment of the Six and Two Packs – this is part of the necessary analysis of our crisis response. This is work in progress. There by the way we importantly need input from academia!

Important progress has been made so far on various fronts and has contributed to stabilising the situation, specifically in the financial sector with the establishment of a Banking Union:


  • Strengthening the integration and stability of the financial sector: a single European rule book and macro- and micro-prudential surveillance; a Single Supervisory Mechanism (entry into force November 2014) and Single Resolution Mechanism (entry into force January 2015).
  • These steps together with the parallel clean-up of bank balance sheets will alleviate the accumulation of risks in financial/banking sectors and help preventing fragmentation of the EU financial system in times of crisis.
  • Improving crisis resolution: with the European Stability Mechanism we now have a permanent tool for crisis management with sufficient financial backstop.
  • Preventing and correcting imbalances, stimulating adjustment and increasing competitiveness: the 6-pack and 2-pack legislation in principle provides better tools for macro-structural surveillance.


But the results are not there yet in terms of growth – which points to the still very imperfect organization of the EMU and the poor quality of policies within the EMU. Let me quickly point to some of the symptoms.

In 2015, the recovery enters its third year, but it has not been able to break out of the slow growth pattern that has defined it since its onset.


  • Adjustment mechanisms remain weak.
  • Deleveraging of private and public households is unfinished.
  • Very low inflation is making debt reduction and the adjustment of relative prices more difficult.
  • Employment growth that has been too weak to lower unemployment significantly.
  • Low investment has been a key reason for the euro area’s weak growth. Investment is still about 15% below its pre-crisis peak


Within this weak recovery substantial differences exist in economic performance between the Member States. They prevent the smooth functioning of the euro area by making the single monetary policy less effective.

At the end of the day it might even undermine citizens’ trust in the EMU and support for the euro as a common project.

At the same time, the crisis has exposed how demanding it is for Member States to belong to the EMU in terms of national policies:



  • The rebalancing of growth in a monetary union is possible only if structural reforms are implemented;
  • Member states find it hard to do and the Union as a whole has also found hard to encourage in a effective manner with the right sticks and carrots…

We cannot claim that the job is done with fixing the EMU.


In my view these symptoms reveal that we cannot claim that the job is done with fixing the EMU.

One of the reasons is that the response to the crisis should have implied two series of actions:


  • first: take the Eurozone out of the present crisis;
  • second: prepare the Eurozone for the « next » crisis – make it more resilient


In fact, these two agenda may be partially contradictory and what we did, is a bit of both. We have to make a clear distinction.

What are the features of a balanced and sustainable EMU?

To make the EMU stable in the short term we need to return to growth

To make the EMU stable in the short term we need to return to growth.

Structural, fiscal and monetary policies have to be combined in an integrated, approach to tackle the current challenges effectively.

We have to act both on the demand and supply sides. To me it is today absolutely evident that we have a problem of aggregate demand in the Eurozone. It is also absolutely clear that deep reforms are needed in the Member states and in the Union.

Action should be centred around three priorities:


  • A coordinated boost to investment: the Commission’s investment plan, published on 26 November, should mobilise at least EUR 315 billion of additional public and private investment over the period 2015-2017 and improve significantly the overall investment environment.
  • A renewed commitment to structural reforms focussing on progress both at national and EU level. At national level emphasis should lie for instance on labour and product market reforms and improving conditions for business to create new opportunities for jobs and growth. At EU level progress is needed in the single market for services, energy, telecoms and the digital economy.
  • Pursuing fiscal responsibility: without downplaying the achievements so far, most of the Member States still need to secure long term control over deficit and debt levels. I am convinced that Member States with more fiscal space should take measures to encourage domestic demand, with a particular emphasis on investment. Moreover, and most importantly, the quality of public finances should be raised everywhere.


The Commission has last week provided further guidance on the best possible use of the flexibility that is built into the existing rules of the Stability and Growth Pact. This shows the integrated nature of our policy advice and our pragmatism within existing rules. These rules might be imperfect. But they are a condition for trust among Member states, their stability makes economic sense – they have to be respected.

For the medium and long term, the challenges on the path towards the « genuine EMU » should not be underestimated.

For the medium and long term, the challenges on the path towards the « genuine EMU » should not be underestimated, as they include such vital question as changes in the EU Treaties or addressing the problem of the legacy debt.

To my mind, changes in secondary legislation and possibly the Treaty can be envisaged down the road.

In such an environment, important additional steps can be taken to further improve convergence and adjustment capacity within the EMU. A number of elements should notably come to the fore:


  • Streamlining and integrating economic and budgetary coordination processes


Consideration could be given to simplifying the rather complex existing surveillance structures to move away from the « silo » approach (fiscal, imbalances governed by separate processes which do not interact). More attention should also be paid to the euro-area specificities, such as spillovers and the aggregate policy stance.

I am convinced that transparency and simplicity should drive any improvement of the rules, and democratic accountability should be reinforced where there are executive discretionary powers for the Commission.


  • Strengthening the tools to incentivize structural reforms at the national level


Taking better into account structural reforms in the implementation of the SGP as suggested in the recent Commission communication on flexibility is such an example.


  • Moving towards an EMU-level adjustment mechanism, e.g. in the form of a euro area fiscal capacity, while acknowledging room for fiscal subsidiarity


A common fiscal capacity is a common feature of other monetary unions. It may serve purposes such as supporting macroeconomic stabilisation and insurance against shocks, or providing public goods (e.g. defence or internal security).

To me, setting up such a fiscal capacity, possibly with own resources and/or borrowing capacity at European area or European union level will have far reaching economic and legal implications.

In particular, I believe that they will imply a qualitative step forward in terms of democratic control of central European executive powers.


  • Improving democratic legitimacy and accountability


The democratic legitimacy and accountability for economic policy in the EU could be further enhanced in particular by ensuring the adequate involvement of the European Parliament and the national parliaments.

In the present state of distrust of citizens towards « Brussels » it is absolutely key if we need more integration, more intrusion of the « center » into somes of the policies of Member states.

This notably includes the area of crisis resolution, where in the context of programme surveillance, I think that the “troika” should be replaced with a more democratically legitimate and more accountable structure, based around European institutions with enhanced parliamentary control both at European and at national level. This is of course not a reproach to the « troika » which was very helpful. But now we must go further.


  • Preparing the Commissioner for Economic and Financial Affairs to become the Finance Minister of the Eurozone


To prepare this evolution, closer and more integrated work by the ECFIN and TAXUD DGs are a first step.

In due course the question of the integration of the Eurogroup President within the Commission will have to be on the table, bit this issue is for the long run.


  • A more efficient external representation of Economic and Monetary Union


The euro is the second most important currency in the world, but the fragmented external representation of the euro in international economic matters means that the euro area is punching below its weigh. There is a room for improvement and the Commission intends to come with a proposal in this regard still this year.


Ladies and gentlemen,

More solidarity between member states, more responsibility of member states, rules when possible, discretion of executive decisions when necessary, control by state of the art democratic bodies all the time.

I have given you the general directions I personally believe should be those of a genuine, sustainable and balanced EMU in the long run: more solidarity between member states, more responsibility of member states, rules when possible, discretion of executive decisions when necessary, control by state of the art democratic bodies all the time.

Obviously these goals are not achievable now, or even in a couple of years. But this is not a reason to renounce. Because I am truly convinced that we need a more integrated Union, in particular in the Economic and Monetary dimension, and because I am truly convinced that the role of Commissioners is also to prepare a better functioning Europe for our children.

Thank you.

Tue, 20 Jan 2015 10:08:33 +0000
<![CDATA[QE and central bank solvency]]> http://www.bruegel.org/nc/blog/detail/article/1546-qe-and-central-bank-solvency/ blog1546

What’s at stake: The European Central Bank will most likely reveal on Thursday its plans for a program of sovereign bond buying, as it steps up its efforts to stave the eurozone off deflation. In a previous review, we addressed the question of whether the expansion of the money base should be temporary or permanent to have a meaningful impact on inflation. In this review, we provide background on the exacerbated concern of what would happen to the Eurosystem’s capital resources if a country defaults and, in particular, whether this would generate a fiscal transfer between members.

Paul De Grauwe and Yuemei Ji write that the most important argument used by opponents of a government bond buying programme by the ECB is that such a program mixes monetary and fiscal policy. The argument goes as follows. When in the context of QE the ECB buys government bonds from fiscally weak countries it takes a credit risk. Some of these countries may default on their debt. This then will lead to losses for the ECB, which, in turn, means that the taxpayers of the fiscally sound member countries of the Eurozone will be forced to foot the bill. Thus, when the ECB buys government bonds, it creates a risk that future taxpayers will be liable to bear losses. Put differently, the ECB is, in fact, conducting fiscal policies in that it organizes fiscal transfers between member states. The ECB has no mandate to do so.

Hans Werner Sinn writes that buying low quality paper would increase the burden on taxpayers should default occur, since taxpayers will have to make up for the drop in the distribution of ECB profits to the respective treasury departments.

The basics of central bank accounting

Karl Whelan writes that commentaries along the lines of “the ECB is taking huge risks with its balance sheet”, “the ECB risks becoming insolvent, endangering the future of the euro” or that “Eurozone states may have to recapitalize the ECB at huge cost to taxpayers” are based on a widespread failure to understand that central banks are fundamentally different from commercial banks. Central banks do not need to have assets greater than liabilities and cannot “go bust” due to losses on asset purchases. That said, most of the international policy community seems happy to perpetuate this myth.

Paul de Grauwe and Yuemei Ji write that contrary to private companies, the liabilities of the central bank do not constitute a claim on the assets of the central bank. The latter was the case during gold standard when the central bank promised to convert its liabilities into gold at a fixed price. Similarly in a fixed exchange-rate system, the central banks promise to convert their liabilities into foreign exchange at a fixed price. The ECB and other modern central banks that are on a floating exchange-rate system make no such promise. As a result, the value of the central bank’s assets has no bearing for its solvency. The only promise made by the central bank in a floating exchange-rate regime is that the money will be convertible into a basket of goods and services at a (more or less) fixed price. In other words the central bank makes a promise of price stability.

Karl Whelan writes that if a central bank purchases assets that then decline in value, it could end up having negative capital.  When a commercial bank has negative capital, it is termed insolvent and either re-capitalized or shut down.  The “insolvent” terminology is sometimes applied to a central bank in this situation but central banks are unique organizations and this phrase isn’t particularly appropriate. Wolfgang Munchau writes that a NCB facing default could just go with negative capital. It might also claim some of the ECB’s future profits as part of its own capital. It is, after all, a shareholder in the ECB. It might also use some of its gold reserves to prop up its capital. What will happen will therefore depend on the size of the default, the size of the shareholding in the ECB and the size of any reserves.

QE and fiscal transfers

Paul de Grauwe and Yuemei Ji write that in a monetary union with no fiscal union a bond-buying programme leads to fiscal transfers among countries – but not the one common in the public perception. One often hears in the creditor countries that these would be the losers if one of the governments whose bonds are on the balance sheet of the ECB were to default. This is an erroneous conclusion.

Paul de Grauwe and Yuemei Ji write that an ECB bond-buying programme leads to a yearly transfer from the country whose bonds are bought to the countries whose bond are not bought. Take that the example of the ECB buying €1 billion of Spanish bonds with a 4% coupon. The fiscal implications are now as follows. The ECB receives €40 million interest annually from the Spanish Treasury. The ECB returns this €40 million every year to the EZ national central banks. The distribution is pro rata with national equity shares in the ECB. The national central banks transfer this to their national treasuries. For example, the ECB will transfer back 11.9% of the €40 million to the Banco de España. The rest goes to the other member central banks. The largest receiver is the German Bundesbank; with its equity share of 27.1%, it would get €10.8 million.

Paul de Grauwe and Yuemei Ji write that the ECB could implement a bond-buying programme that avoids fiscal transfers by buying national government bonds in the same proportions to the equity shares of the participating NCBs if interest rates were uniform across countries. But this would not eliminate all transfers because the interest rates on the outstanding government bonds are not the same. In fact the countries with the highest interest rates would in this weighted bond-buying programme be net payers of interest to the countries with the lowest interest rates. Thus even a bond-buying programme weighted by the equity shares would involve fiscal transfers from the weaker (debtor) countries to the stronger (creditor) countries.

Paul de Grauwe and Yuemei Ji write that in the case of default on the €1 billion of Spanish government bonds, the Spanish government would stop paying €40 million to the ECB. The ECB would stop transferring this interest revenue back to the member central banks pro rata. The German taxpayer, for example, would no longer receive the yearly windfall of €10.8 million. In no way can one conclude that German taxpayers, or any EZ taxpayer, would pay the bill of the Spanish default – except in the narrow sense that they would no longer be able to count on the yearly interest revenues.

Paul De Grauwe and Yuemei Ji write that eliminating this type of transfers can be achieved by following a somewhat different interest distribution rule. Instead of pooling the interest payments the ECB receives and then distributing them according to the equity shares, one could also use a rule of ‘juste retour’. This would mean that the ECB redistributes the exact amounts of interest payments it has received from each member government back to the same government. If this rule is applied, there would be no net interest transfer before or after the default. Complete neutrality is restored and taxpayers are shielded from movements of the value of the bonds on the ECB’s balance sheet.

Paul de Grauwe writes that suppose that for reasons of reputation the member states decide to recapitalize the ECB. Will that not inevitably involve taxpayers in Germany, France, etc? The answer is no. This will just be a bookkeeping operation without involving taxpayers. When national governments decide to recapitalize the ECB to make up for the loss of €1 billion, they transfer bonds to the ECB worth 1 billion, allowing the ECB to increase its equity by €1billion. These transfers occur using the same capital shares. Thus the ECB holds government bonds worth €1 billion. As a result, each government pays interest to the ECB in the same proportion to its capital share. But at the end of the year the ECB transfers these interest revenues back to the same governments using the same capital shares.

Tue, 20 Jan 2015 09:54:47 +0000
<![CDATA[Investment plan]]> http://www.bruegel.org/videos/detail/video/142-investment-plan/ vide142

No description available

Tue, 20 Jan 2015 09:12:32 +0000
<![CDATA[Die EZB ist verpflichtet, ihr Mandat zu erfüllen]]> http://www.bruegel.org/nc/blog/detail/article/1545-die-ezb-ist-verpflichtet-ihr-mandat-zu-erfullen/ blog1545

Die Europäische Zentralbank (EZB) wird wohl am 22. Januar ein Ankaufprogramm für Staatsanleihen ankündigen. Die Sorgen über die Auswirkungen und die Effektivität des Programms sind groß. Die EZB muss vorsichtig die Kosten und Risiken – vor allem die Umverteilung von fiskalischen Risiken – gegen die Vorteile ihrer Geldpolitik abwägen. Ein gut durchdachtes Programm kann jedoch erfolgreich sein. Der Schlüssel für seinen Erfolg liegt bei seiner glaubwürdigen Ausgestaltung.

Mit einer Inflationsrate von minus 0,2 Prozent verfehlt die EZB ihr Mandat von knapp unter zwei Prozent bei weitem. Auch die Kerninflationsrate – ohne die Preisentwicklung bei Energie und Nahrungsmitteln – bewegt sich unter einem Prozent und weist damit auf strukturelle Veränderungen hin. Deflation ist schon für viele deutsche Unternehmen die Realität, selbst ohne die Energiepreisveränderungen: Knapp ein Drittel der Sektoren erfährt bereits heute Preissenkungen.

Hintergrund dieser Entwicklung ist nicht ein Vorlauf der Angebotsseite durch massive Produktivitätszuwächse, vielmehr ist das Gegenteil zu beobachten: Die Arbeitsproduktivität stagniert seit der Krise 2009, und amaktuellen Rand sinkt der Kapitalkoeffizient. Deshalb kann nicht ausgeschlossen werden, dass die Disinflation weitergeht und in eine anhaltende Deflation mündet.

Die größte Sorge für die EZB ist die fehlende Verankerung der Inflationserwartungen. Unternehmen und Investoren trauen der EZB nicht mehr zu, ihrem Mandat gerecht zu werden. Das ist ein Problem für die EZB, denn ihre Glaubwürdigkeit ist dadurch in Gefahr und damit ihre Fähigkeit, mit ihrer Geldpolitik erfolgreich zu sein. Und dies ist ein Problem für unsere Wirtschaft: Es wirkt dann wie ein selbstverstärkender Prozess, und es macht auch die relative Preisanpassung im Euro-Raum schwieriger.

Es wäre falsch zu glauben, die EZB alleine könne mit ihrenMaßnahmen Europa aus der Krise ziehen und das Risiko einer Deflation beseitigen. Die Politik muss nun endlich ihren Beitrag leisten. Dies gilt nicht nur für die Krisenländer und Frankreich, sondern auch für Deutschland. In Deutschland würden Strukturreformen insbesondere im Ausbildungsbereich, aber auch bei der Migration helfen; der Arbeitsmarkt muss offengehalten werden, und neue Sektoren, etwa im IT-Bereich, sollten bessere Chancen bekommen. In Italien und Frankreich sind Strukturreformen – Marktöffnung und Privatisierung – dringend notwendig, um die Anpassungsprozesse zu erleichtern und das Produktivitätswachstum zu erhöhen. Neben Strukturreformen müssen schwache Banken angemessen saniert oder geschlossen werden. Ansonsten verpuffen viele Maßnahmen der EZB.

Trotzdem kann die EZB nicht untätig bleiben oder ihre Maßnahmen von dem Voranschreiten von Strukturreformen abhängig machen. Mit einer solchen Konditionierung würde die EZB ihre im vertraglichen Mandat fixierte Handlungsfreiheit selbst gefährden. Sie hat die fallende Inflation in den vergangenen Jahren zu zögerlich bekämpft. Ein weiteres Abwarten, bis die Deflation sich verfestigt, wie von mancher Stimme in Deutschland gefordert, ist die schlechteste Option. Jede Geldpolitik braucht Zeit, um ihre Wirkung zu entfalten. Und je stärker der Deflationsdruck und die fehlende Verankerung der Erwartungen, desto weniger effektiv ist die Geldpolitik. Der Preis eines Abwartens wäre um ein Vielfaches höher, ein Erfolg der Geldpolitik immer unwahrscheinlicher.

Der Ankauf von privaten und öffentlichen Schuldtiteln gehört zum normalen Instrumentenkasten von Zentralbanken. Aber in einer Währungsunion steht die EZB vor besonderen Gestaltungsproblemen. Inflation und Inflationserwartungen sollen durch ein Ankaufprogramm über eine Senkung des langfristigen Zinses, eine Abschwächung des Wechselkurses, eine Veränderung der Portfolio-Struktur von Investoren und insbesondere eine höhere Glaubwürdigkeit der Zentralbank bei der Verfolgung ihres Ziels entsprechend stabilisiert werden. 

Der EZB-Rat hat im Dezember effektiv beschlossen, die Bilanz um 1 000 Milliarden Euro zu vergrößern. Es ist klar, dass die EZB sich für ein substanzielles Programm entscheiden muss, um die gefährdete Glaubwürdigkeit bei dem Erreichen ihres Inflationsziels wiederherzustellen. Die EZB sollte mit einem Programm beginnen, welches sie innerhalb der nächsten zwei Jahre auf 1 000 Milliarden Euro oder, wenn notwendig, darüber hinaus ausweiten kann und welches private mit staatlichen Schuldtiteln kombiniert.

Eine zentrale Frage ist, inwiefern die EZB hierbei zu sehrfiskalische Aufgaben übernimmt. Leider ist eine perfekte Trennung des geldpolitischen Mandats von quasi-fiskalischen Aktionen nie möglich, da jede geldpolitische Maßnahme immer auch fiskalische Auswirkungen haben kann. Die EU-Verträge erlauben den Ankauf von Staatsanleihen in Sekundärmärkten.

Derzeit wird kontrovers diskutiert, ob die EZB bei einem Ankaufprogramm für Staatsanleihen die Risiken nicht bei den nationalen Zentralbanken belassen sollte. Ein solches Design würde aber die Erfolgschancen eines Ankaufprogramms reduzieren, da es eben nicht zu den gewünschten Effekten bei der Zinsstrukturkurve und den Erwartungen führen würde. Es ist sogar bedenklich, da die Glaubwürdigkeit der gemeinsamen Geldpolitik infrage gestellt würde. Somit wäre letztlich auch dem deutschen Steuerzahler nicht geholfen, denn ein Absinken in die Deflation und eine Verschärfung der Krise werden auch die deutsche Wirtschaft massiv belasten und die Risiken für den Steuerzahler erhöhen.

Die Geldpolitik steht vor einem Dilemma. Sie hat ein klares geldpolitisches Mandat. Um dieses zu erfüllen, muss sie im derzeitigen Umfeld ihre Bilanzsumme vergrößern, und dies geht unvermeidlich einher mit der Übernahme von begrenzten fiskalischen Risiken. Dies nicht zu tun würde allerdings das EZB-Mandat untergraben.

Ein Ankaufprogramm von Staatsanleihen enthält Risiken und kann auch negative Nebenwirkungen haben. Ungleich größer wäre jedoch der Schaden, wenn die EZB nicht entschieden handeln würde. Wir ziehen es bei allen Abwägungen vor, dass die EZB ihr geldpolitisches Mandat erfüllt und verhindert, dass der Euro-Raum in Stagnation und Deflation fällt, als dass die EZB kurzfristige fiskalische Risiken vermeidet, langfristig aber die Deflation und die damit noch tiefere Schulden- und Wirtschaftskrise zu einem Auseinanderbrechen des Euro-Raums führen.

Mon, 19 Jan 2015 16:13:27 +0000
<![CDATA[An investment plan for Europe]]> http://www.bruegel.org/videos/detail/video/141-an-investment-plan-for-europe/ vide141

Highlights of the event on 12 January 2015 were Jyrki Katainen, Vice President of the European Commission, presented the European Commission's new investment plan. 

Full recording of the event available here: http://www.freezbee.tv/webinars/126/370/4527/index.php

Mon, 19 Jan 2015 12:29:34 +0000
<![CDATA[Real exchange rates after the Swiss tsunami]]> http://www.bruegel.org/nc/blog/detail/article/1544-real-exchange-rates-after-the-swiss-tsunami/ blog1544

The surprise abolition of the 1.2 Swiss franc/euro exchange rate floor by the Swiss National Bank sent shock waves across currency markets. The instant reaction was an appreciation of the Swiss franc by more than 30 percent, which corrected somewhat later, along with changes in other currency rates. Today the franc is traded at a rate of about 1 to the euro, implying 20 percent nominal appreciation.

How have real effective exchange rates (REER) changed after such fierce currency movements? We updated our REER dataset and approximated January 2015 values for the REERs by using the nominal exchange rates of 17 January 2015 and assumed that the 12-month rate of consumer price inflation remained unchanged in January 2015.

The figures below show the REERs of six major currencies relative to their historical average over January 1970 – January 2015. While the equilibrium rate of a currency is determined by various economic factors and is not equal to its historical average, the figures below might be indicative of the currencies’ relative strength.

The Swiss franc is at record high in real effective terms: more than 40 percent above its historical average

The Swiss franc is at a record high in real effective terms: more than 40 percent above its historical average. This may help to reduce the huge current account surplus of Switzerland, but may push the country to deflation.

The US dollar has continued its recent trend of real appreciation (it is now 7 percent above its historical average), while the euro’s slide continued (6 percent below its average). There have been a couple of times in the past 45 years when the dollar was much stronger and the euro was much weaker than today, so recent trends may continue if the differences in economic strength and monetary policy persist.

Interestingly, the Pound sterling is exactly at its historical average, so its recent strengthening has just compensated for its previous weaknesses. The Aussie gave back some of its strength, yet it is still about 20 percent over its historical average, while the yen is about 15 percent below it.

See our dataset including monthly REERs for 154 countries and annual REERs for 179 countries here.

Consumer price index-based real effective exchange rates (average 1970-2015 = 100), January 1970 – January 2015

Source: Bruegel. Note: the real effective exchange rate is calculated against 41 trading partners

Mon, 19 Jan 2015 10:33:59 +0000
<![CDATA[The ECJ suggests OMT is compatible with the Treaty, but not with the Troika]]> http://www.bruegel.org/nc/blog/detail/article/1543-the-ecj-suggests-omt-is-compatible-with-the-treaty-but-not-with-the-troika/ blog1543

In September 2012, the European Central Bank announced its new Outright Monetary Transactions (OMT). The programme – very successful in easing tensions on sovereign bond markets – foresees the possibility to purchase government securities on the secondary market. It is virtually unlimited, although de facto limited by the existing outstanding stock of eligible bonds with maturities that make them eligible. Differently from a previous bond-buying programme (the SMP), the OMT specifies that the ECB will not have preferential creditor status in the occurrence of a credit event (i.e. it will be pari passu).

What is more important is that a necessary condition for OMT is explicit “strict and effective conditionality” attached to an appropriate EFSF/ESM programme

The objective of the OMT is to safeguard the monetary policy transmission mechanism in the euro area

The ECB intervention will not be automatic, but the Governing Council will decide on a case-by-case basis when and to what extent it will intervene. In particular: “the Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme. Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate”.

This conditionality is controversial. The OMT framework introduces explicit conditionality for the bond buying and it links the decision of the Governing Council to continue or suspend the OMT to the assessment of whether such conditionality is fulfilled.

As Zsolt Darvas and I pointed out earlier, this setting puts the ECB in an extremely delicate position. The objective of the OMT is to “safeguard the monetary policy transmission mechanism in all countries of the euro area. [...] to preserve the singleness of [...] monetary policy and to ensure the proper transmission”. At the same time the OMT is a monetary policy instrument, the activation and use of which is made subject to considerations that would not strictly pertain to a central bank in the exercise of its monetary policy competences. The ECB in fact explicitly commits to terminate the OMT not only – as it would be logical – in case the latter is no longer warranted from a monetary policy perspective, but also in case the beneficiary country fails to comply with the required conditionality..

And the implications of such conditionality requirement have been central to the advocate general’s opinion on whether the OMT falls within the statutory mandate of the ECB to conduct monetary policy (and thus is legitimate) or whether it actually amounts to economic policy of the kind that would fall outside the ECB’s mandate.

In his opinion, the European Court of Justice’s Advocate General observes that the framing and implementation of monetary policy are the exclusive competence of the ECB, which “must have a broad discretion”[1] when framing and implementing it. The question is therefore to establish what is monetary policy in the euro area, and then whether the OMT can be legitimately considered part of it.

The architecture of euro area monetary policy is essentially based on three articles of the Treaty. Article 119 states that the  “primary objective” of monetary policy shall be to “maintain price stability and, without prejudice to this objective, to support the general economic policies in the Union, in accordance with the principle of an open market economy with free competition”. Article 127 translates this general principle into an objective for the institution that deals with monetary policy, stating that the primary objective of the European System of Central Banks (ESCB) shall be to maintain price stability and that  - without prejudice to the objective of price stability - the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union. Article 123 draws the boundary, by prohibiting the ESCB to engage in operations that amount to monetary financing.

From this, the advocate general states that, “for a measure of the ECB actually to form part of monetary policy, it must specifically serve the primary objective of maintaining price stability and it must also take the form of one of the monetary policy instruments expressly provided for in the Treaties and not be contrary to the requirement for fiscal discipline and the principle that there is no shared financial liability”[2]. If there were to be “isolated economic-policy aspects to the measure at issue”, the latter will be compatible with the ECB’s mandate only “as long as it serves to ‘support’ economic policy measures but remains subordinate to the ECB’s primary inflation objective”[3].

Whether the OMT is legitimate therefore depends on where the line between its monetary and economic policy component lies. In the opinion of the ECJ’s advocate general, linking the OMT to compliance with financial assistance programmes blurs this line considerably, because of the role that the ECB itself is assigned in the context of financial assistance.

By buying bonds in the context of OMT, ECB becomes a creditor of governments receiving financial assistance

The ESM Treaty confers multiple responsibilities on the ECB in the course of a financial assistance programme, including participation in negotiations and monitoring. The ECB’s hybrid role in the Troika raises concerns about possible conflicts of interest that the ECB could experience in relation to the conduct of its other functions. The potential conflict of interest with the ECB’s bond-purchase programmes is especially strong. By buying bonds of vulnerable countries in the context of OMT, the ECB would become formally a creditor of the governments receiving financial assistance, and this may influence its position in the negotiations and its assessment of conditionality.

The advocate seems to recognise this risk when he points out that “the ECB, in creating and announcing the OMT programme, did not properly weigh up the impact of its involvement in those financial assistance programmes on the monetary nature of the OMT programme[4]”.

The problem is that “the ECB is involved in the elaboration of the conditionality imposed on the State requesting assistance whilst, subsequently, it also takes part in the task of monitoring compliance with conditionality”. The ECJ’s Advocate general points out that “unilaterally making the purchase of government bonds subject to compliance with conditions when those conditions have been set by a third party is not the same as doing so when the ‘third party’ is not really a third party[5]”.

If the ECB is at the same time participating in the negotiation and monitoring of financial assistance programmes and deciding on the activation of the OMT, which requires the fulfilment of those programmes’ conditionality, then “the purchase of debt securities subject to conditions may become another instrument for enforcing the conditions of the financial assistance programmes[6]”. And if the OMT purchases can be perceived as an “instrument which serves macroeconomic conditionality” then their monetary policy nature is in doubt.

if the OMT were activated ECB will need to detach from direct involvement in monitoring the financial assistance to the State concerned

The conclusion is therefore that the ECB does not necessarily need be prevented from regularly participating in financial assistance programmes, because the fact that a financial assistance programme is adopted does not mean that an OMT programme will be activate for sure in the future. However, if the OMT were to be activated, it would be “essential for the ECB to detach itself henceforth from all direct involvement in the monitoring of the financial assistance programme applied to the State concerned[7]”. Otherwise, in the view of the advocate general, the OMT programme could no longer be considered a pure monetary policy measure.

This conclusion has potentially interesting consequences. A first question, if the ECJ were to follow the opinion of the advocate general, is what changes would be needed to the legal texts that establish the ECB’s participation in the Troika, i.e. the ESM Treaty and Regulation 472/2013. According to these documents, the negotiation and monitoring of programme conditionality should be done by the Commission “in liaison” with the ECB, a wording that is blurry. The question therefore is whether the ECB’s acting “in liaison” with the European Commission in the Troika qualifies as “direct involvement” in the sense suggested by the ECJ’s advocate general. If it were, and if the ECJ were to follow the opinion of the Advocate General, then the question is whether amendments should be made to these legal text to ensure remove the “liaison”.

A second question is whether the conditionality attached to the OMT programme would still make any sense. In a view to limit the moral hazard that could be induced by ECB’s purchases, the ECB Governing Council can decide to terminate the programme – even if it were still warranted from a monetary policy perspective – if the conditionality is not met. In order for the ECB to act independently in the pursuit of its monetary policy, the OMT technical rules state that such assessment is a prerogative of the Governing Council. At present, by directly taking part in the Troika, the ECB can form its judgement on the fulfilment of programme conditionality. But if it were no longer involved in the monitoring – as the advocate general seems to require – then the ECB’s assessment of conditionality fulfilment would need to be based on information obtained from a third party, i.e. the other institutions involved in the Troika.

The question then is whether this would still qualify as an independent decision. The definition of ECB independence is given in Article 130 TFEU, which states that “when exercising the powers and carrying out the tasks and duties conferred upon them […] neither the European Central Bank, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body.”

While being true that the ECB would not be formally “instructed” by a third party to terminate OMT, the fulfilment of conditionality is a necessary requirement for the continuation of the purchases and that assessment would necessarily be outside of the ECB’s control, possibly exposing it to political capture. At that point, it would be more reasonable for the ECB to scrap the link to conditionality completely, making the OMT decision dependent only on the assessment of whether the programme is warranted from monetary policy purpose to safeguard the monetary policy transmission mechanism and to preserve the singleness of monetary policy.

monetary policy with conditionality presents significant theoretical and practical problems

In conclusion, in his opinion the ECJ advocate general pointed out the problematic multifaceted role of the ECB in the macroeconomic adjustment programmes,. This is welcome, as the ECB’s role in the Troika was ill designed since the start, and put the ECB in an uncomfortable position. On top of that, the analysis supports the claim that monetary policy with conditionality presents significant theoretical and practical problems and the logical consequence of requiring the ECB not to have any direct involvement in the programmes, if OMT is activated, makes the OMT conditionality even less meaningful and possibly tricky for the central bank’s independence. At that point, the least risky option would be to scrap the OMT’s link to conditionality completely. After all, it made little sense to put it there in the first place.


[1] See: curia.europa.eu/jcms/upload/docs/application/pdf/2015-01/cp150002en.pdf

[2] Para 132, opinion of the Advocate General

[3] Ibidem

[4] Para 147

[5] Para 145

[6] Para 145

[7] Para 150

Sat, 17 Jan 2015 19:08:20 +0000
<![CDATA[Why a Grexit is more costly for Germany than a default inside the euro area]]> http://www.bruegel.org/nc/blog/detail/article/1542-why-a-grexit-is-more-costly-for-germany-than-a-default-inside-the-euro-area/ blog1542

A few days ago the influential IFO Institute published a short paper suggesting that a Greek default inside the euro-area would cost Germany €77.1 billion, while a default combined with an exit from the euro would cost €75.8 billion. The two numbers are about the same, yet unsurprisingly, media reports emphasised that a Grexit would be cheaper for Germany by €1.3 billion (see e.g. a Focus report here).

We think that the publication of such numbers falsely suggests that direct losses can be calculated precisely. Even more importantly, we noticed that the calculation did not consider three major factors:

  • the different haircuts likely under the two scenarios,
  • private claims,
  • other second round losses.

All three factors suggest that direct losses for Germany would be much larger if Greece was to exit the euro.

we think that a Greek default and exit are neither likely nor necessary

Before assessing the details of the calculations, let us make our view clear: we think that a Greek default and exit are neither likely nor necessary. It is definitely in the interests of both Greece and its euro-area partners to find a comprehensive agreement that would avoid default and exit, which would make everyone much worse-off. Greece would enter another deep recession, which would push unemployment up further and reduce budget revenues, necessitating another round of harsh fiscal consolidation. Euro-area creditors would lose a lot on their Greek claims and private claims on Greece would also suffer. The new depreciating Greek drachma may not revive the Greek economy that much (see on this Guntram Wolff’s recent post here and our 2011 post here). Furthermore, a Grexit would have many broader implications beyond economic issues. What are the prospects for a comprehensive agreement?

  • Concerning Greek debt sustainability, there are relatively painless options, as we recently argued.
  • Agreement on fiscal policy may not be that difficult either. Greece has suffered a lot in the past few years and has implemented major fiscal adjustments. Although the outlook is not too bright, by now the trough in economic activity has perhaps been reached and some economic growth is expected. This should help fiscal accounts and it is likely that no more fiscal adjustment will be necessary. In fact, the EU Commission expects that the cyclical adjusted primary budget surplus of Greece will decline from 8% of GDP in 2014 by about 1 percentage point in both 2015-16, suggesting a fiscal easing: exactly what Greek opposition parties demand. In other words, the new Greek government will be able to reap the benefits of the adjustments made in the past few years.
  • The most difficult step may be to secure an agreement on structural policies, because many of the current plans of the Greek opposition parties are in diametrical opposition to reforms agreed under the financial assistance programme. But a compromise has to be found: both sides have strong incentives to agree and structural reforms have to be part of the comprehensive agreement.

While there are very strong incentives to cooperate and therefore a Grexit is not very likely, for the sake of intellectual exchange, we thought it useful to comment on the IFO calculations assessing the impact of default.

The IFO Institute’s calculations considered the German share of the official assistance to Greece (bilateral German loans, Germany’s share in the EFSF and IMF loans) and various European Central Bank claims. They summed-up all of these claims, assuming that all will be written off in the case of a default. While we have some questions considering central bank related claims (which explains the €1.3 billion difference in IFO’s results), there are three more important issues.

there have been many debt restructurings in recent decades, but claims have never been written off completely

The first major problem with these calculations is that they consider the complete write-off of official claims on Greece in both cases. We doubt that this will be the case: there have been many debt restructurings in recent decades, but claims have never been written off completely. See for example, Juan Cruces and Christoph Trebesch's dataset -, which summarises 187 distressed sovereign debt restructurings from 1970-2013. The average haircut was 38 percent. Moreover, among the two scenarios (default inside versus exit), the haircut would most likely be much higher if Greece was to exit the euro area, since the new Greek drachma would likely depreciate substantially and Greek GDP would contract substantially, thereby reducing Greece’s ability to honour debts, especially those that are denominated in foreign currencies (in this case, the euro would be a foreign currency). The depreciation of the exchange rate of the Argentine peso in 2002 may be indicative of a hypothetical nominal currency depreciation of the new Greek drachma in the case of a Grexit (Figure 1).

Figure 1: The exchange rate of the Argentine peso against the US dollar, January 1992 – January 2015

the financial losses of Germany and other euro-area countries would be much higher if Greece exits the euro than if Greece remains

Second, the the IFO Institute’s calculations do not consider claims by the private sector (though the IFO paper acknowledges this omission). Again, a Grexit would likely lead to much larger losses for the German private sector than a Greek default inside the euro area, since more Greek banks and non-banks would default on the back of a likely massive depreciation of the new currency and contraction of Greek GDP. The table below shows that while German private sector claims on Greece have been reduced substantially since 2009, they still amount to about €16 billion of debt-type claims (the sum of portfolio debt and banking exposure) and about €3 billion of equity-type claims (the sum of FDI ad portfolio equity).

Source: OECD International direct investment database, IMF Coordinated Portfolio investment Survey, BIS consolidated data (ultimate risk basis), and Eurostat (exchange rate data to convert US dollar figures to euros).

Third, further second round effects should be expected, such as a reduction of German exports to Greece. Moreover, other euro area countries would suffer losses too, which could negatively impact Germany as well.

Overall, we conclude that while calculating the losses in the event of a Greek default is difficult and depends on many assumptions, in all likelihood, the financial losses of Germany and other euro-area countries would be much higher if Greece exits the euro than if Greece remains.

Fri, 16 Jan 2015 09:36:43 +0000
<![CDATA[Backward guidance, Chinese style]]> http://www.bruegel.org/nc/blog/detail/article/1541-backward-guidance-chinese-style/ blog1541

Since early 2014, the People’s Bank of China (PBC), the Chinese central bank, has deployed multiple policy tools to loosen its monetary policy stance, including cutting its benchmark bank interest rates, relaxing mortgage terms, tinkering with the outdated loan-deposit ratio rule, selectively cutting some reserve requirements and injecting liquidity into the banking system via various new facilities. Such concerted actions pressed both 10-year government bond yields and short-term interbank rates lower during most of 2014 (see Chart). 

The PBC appears to have attempted to dilute what it did, by issuing confusing ‘backward guidance’, cautioning the market not to interpret its latest rate cut as monetary easing

However, in response to the November interest rate cut, the 10-year Chinese government bond yield temporarily ticked up to 3.8 percent from 3.6 percent (see Chart), while interbank rates remained volatile. More puzzlingly, soon after the rate cut last November, the PBC in statements on its website and senior PBC officials rushed to repeatedly deny this policy move as a shift in the monetary policy stance. Many central banks in the advanced economies nowadays provide ‘forward guidance’ to reinforce and amplify the impact of monetary policy on the full market yield curve, by communicating to the public about the expected future path of the policy rate. In contrast, the PBC appears to have attempted to dilute what it did, by issuing confusing ‘backward guidance’, cautioning the market not to interpret its latest rate cut as monetary easing! 

Chart: the Chinese government bond yield and stock market index

Note: SHCOMP stands for Shanghai Composite Stock Market Index

It will probably take some time to fully comprehend this baffling mix of monetary easing and tough talking. If we assume that the PBC wants to cushion the downside risks of economic growth without aggravating financial imbalances, then the best option would be to ease in a timely and measured manner while opening its big mouth to influence the longer end of the yield curve, which in the end matters most for both consumption and investment decisions. But these PBC ‘backward guidance’ statements instead appear to aim at dispelling expectations about further monetary accommodation on the horizon, potentially contributing to a higher yield curve and thus tightening Chinese financial conditions. 

One can only speculate about the motives behind such confusing PBC signals

For now, one can only speculate about the motives behind such confusing PBC signals.  Here, I put forward three possible motives, all related and not exhaustive. 

The first motive could be that the PBC wants to convey the message that monetary stimulus, if any, will be minimal and fleeting, out of fear that the rate cut could stoke asset price bubbles before benefiting the real economy. In this view, the PBC “backward guidance” is really a disguised forward guidance. I am uncertain about the precise weight the PBC attaches to financial stability, but reasonably certain that the weightings of inflation and growth dominate, and both clearly call for meaningful monetary accommodation. Also, the asset price channel is part of the normal transmission mechanism for monetary policy, especially in light of a weak housing market. The latest surge of some 50 percent in Chinese stock market prices over the past few months (see Chart) could be a valid concern for the PBC; but the average Shanghai stock market valuation of some 10-time trailing and forward P/E appears manageable, and a buoyant equity share market could assist the tricky deleveraging process.

The second motive could relate to the concerns of the PBC about the moral hazard risk associated with China’s high level of local government debt. Local government officials have strong incentives to borrow, from both banks and shadow banks, to fund their pet investment projects, but then leave messy debts to their successors. These concerns make little sense to me. First of all, this is an issue of fiscal discipline facing local governments, whether the monetary policy bias is tighter or looser. Second, harder budget constraints are already gradually being imposed on local governments. This implies a de facto, sizable fiscal contraction and thus calls for reasonable monetary relaxation to partially offset the possible contractionary effects of reduced local government borrowing.

The third motive is the challenge of properly communicating the policy stance to the market under an emerging new monetary policy framework and in a more liberalised interest rate environment. The PBC used to principally target M2 growth while also setting benchmark loan and deposit rates. More recently, the PBC has introduced a few new policy tools, such as Short-term Liquidity Operations (SLO), the Standing Lending Facility (SLF), Medium-term Lending Facility (MLF) and Pledged Supplementary Lending (PSL), in an attempt to influence market-based interest rates. Maybe the PBC prefers to nudge the market to pay greater attention to these market rates rather than those still partially-regulated benchmark loan and deposit rates. This makes some sense but still does not justify sending out conflicting signals when a more accommodative policy stance is clearly warranted and desired. 

the best course of action for the PBC now is to pursue a sensible and accommodative monetary policy in a confident fashion

In any case, the best course of action for the PBC at this juncture, in my view, is to pursue a sensible and accommodative monetary policy in a confident fashion, with the aim of a lower and steadier domestic interest rate and less-managed currency. Just as forward guidance by some major central banks at the zero lower bound can help depress their yield curves further out, a clear and firm PBC policy signal could also help flatten and stabilise the Chinese yield curve, which in turn would cushion economic growth, pre-empt deflation risk, facilitate structural adjustment and support financial liberalisation. As a minimum, the PBC should avoid diluting the signalling effect of its own new policy moves.

Wed, 14 Jan 2015 16:42:02 +0000
<![CDATA[Sovereign QE and national central banks]]> http://www.bruegel.org/nc/blog/detail/article/1540-sovereign-qe-and-national-central-banks/ blog1540

Inflation continues to fall. The first outright deflation numbers since 2009 have been recorded and inflation expectations are clearly dis-anchored. Inflation and inflation expectations are now clearly below the 1.7 to 1.9 percent range and inflation expectations are 1.5 percent for the EMU 5y5y forward inflation swap. More worryingly, wage growth in Germany is starting to fall as a result of lower inflation expectations.

It is clear that the European Central Bank will have to act

It is clear that the European Central Bank will have to act. It is true that the ECB cannot solve all of the euro area's problems: governments have a clear obligation to move ahead more quickly with structural reforms that address the deep divergences in the euro area and with more public investment to trigger growth. However, slow government progress cannot be an excuse for the ECB not to act. It looks as if the decision has already been taken to buy sovereign bonds. The policy debate is now about how to design a sovereign-bond purchase programme.

An option reportedly seriously under consideration is to leave national central banks to take on the risk of default on sovereign bonds, while the market risk will remain with the Eurosystem as a whole (see for example Reuters). This would be at best ineffective, at worst dangerous. In fact, the attempt to make national central banks shoulder hard default risks is bound to fail in the Eurosystem. The following technical points need to be considered to properly assess this matter.

1) Signalling: Buying sovereign bonds but leaving national central banks to take on the risk of default would be a strong signal that the ECB is no longer a “joint and several” institution. It would effectively be a declaration that the ECB cannot act and purchase government bonds as a euro-area institution in the interest of, and on behalf of, the entire euro area. This could severely undermine the ECB's credibility not just in the sovereign purchase programme but also more broadly as an institution.

2) Pari-passu: ECB executive board member Benoit Coeure argued recently in an interview with France24 (1) that it is illegal according to the treaty to reschedule or restructure the Greek debt that the ECB holds. He argued that the ECB bought this debt for monetary policy purposes and that any restructuring of such a portfolio would be against the treaties. (2) It seems to be clear that the ECB views voluntary participation in a restructuring as monetary financing and therefore in violation with Article 123. 

A different question is how to consider losses that the ECB would make on a forced restructuring. What would happen if a debtor country unilaterally declares that it will default on its debt, or that alternatively a majority of creditors with collective action clauses declare that they accept a restructuring of the bond? In my interpretation, the ECB could do nothing against such a restructuring and would have to accept its consequences. As this would not be voluntary and it would happen after the monetary policy decision has been taken, it would not amount to monetary financing and would therefore be legal. If this interpretation is wrong, then, de facto, the ECB would never be able to buy pari-passu, including through the OMT programme.

Overall, it is currently debated if the ECB could actually assume the risk of default of sovereign bonds it would buy. I would argue that it has that possibility according to the treaty if the restructuring is forced on the ECB, but the ECB cannot agree to a voluntary exchange leading to a loss. But the legal debate on this is ongoing. The question of whether the ECB can buy at pari-passu is one of the central points that Advocate General Pedro Cruz Villalon of the EU Court of Justice (ECJ) will discuss in his opinion on the German Constitutional Court’s challenge of the OMT, to be published tomorrow.(3)

The fear is that the ECB might violate the European treaties by accepting the risk of default of individual member states that could be distributed throughout the Eurosystem

This uncertainty is the main reason why the ECB Governing Council is currently discussing whether default risk should remain with the national central banks. The fear is that the ECB might violate the European treaties by accepting the risk of default of individual member states that could be distributed throughout the Eurosystem. The hope of those proposing a solution that would see the national central banks buying the sovereign bonds of their country is that it would be a way to avoid the redistributive effects of monetary policy across the common currency area. It is seen as a way of avoiding potential cross-border fiscal implications of monetary policy.

3) So what would happen if the national central banks were to buy the sovereign bonds of their countries only? The following discussion will show that this cannot solve the pari-passu issue in a satisfactory way. On the contrary, the construction would be very complicated and would also lead to a de-facto super-seniority of the national central bank over the private creditors. Ultimately, isolating default risk in one national central bank is impossible as long as there remains a Eurosystem. Here is why:

Take the example of a country with 25 percent of its debt in the hands of its national central bank. What would happen if the national government had to decide to impose a haircut on all of its debt in order to reduce the burden on its taxpayers? There are essentially two options in such a case: 

  • The national treasury could decides to exempt the national central bank from participating in the loss. This would mean that the remaining 75 percent of the debt would bear a greater part of the burden. The private creditors would be junior. Knowing about this possibility, they would ask ex-ante for a higher risk premium, which would render the purchase much less effective in the first place. 
  • Alternatively, the national treasury could include the national central bank in the haircut. The national central bank would incur a loss, its equity would fall or even become negative. Normally, a central bank would then go to its treasury, pass on the losses and ask for a recapitalisation. This would essentially mean that the treasury would not benefit from defaulting on this part of the debt and again, the other creditors would have to bear a greater part of the burden. They would be junior and again ask for a risk premium ex ante.  

So the purely national purchase of national sovereign debt would either leave the private creditors as junior creditors, or the national central bank has to accept negative equity. What would negative equity mean for a central bank? De facto it would mean that the national central bank, that has created euros to buy government debt, would have lost the claim on the government. It would still owe the euros it has created to the rest of the Eurosystem.(4) The Eurosystem could now either ask the national central bank to return that liability, which it is unable to do without a recapitalisation of its government. Or, the Eurosystem could decide to leave the claim standing relative to the national central bank. In that case, the loss made on the sovereign debt would de facto have been transferred to the Eurosystem. In other words, the attempt to leave default risk with the national central bank will have failed.

To sum up, either government bond purchases made by national central banks are super-senior or the potential default risk on the government bonds will be passed on to the Eurosystem as a whole. In the former case, the QE bond purchase would be rather ineffective. In the latter case, the only way to avoid losses for the Eurosystem would be to use other national central bank assets, such as gold or potentially future seignorage.

Overall, this discussion shows that monetary policy in the monetary union reaches the limits of feasibility if the principle of joint and several liability at the level of the Eurosystem is given up. Surely it was not the treaty's intention to create a central bank that is ineffective when the zero lower bound is reached and the only way to increase the money supply is bond purchases. I would therefore argue that the ECB should be able to buy sovereign bonds according to the capital key in order to fulfil its treaty-based monetary policy mandate. It could leave some constructive ambiguity about what would happen in the case of a default, which in any case is an extreme scenario. Ideally, there should be some implicit understanding that ECB would share in losses in case debt is restructured by majority decision of the creditors.

A programme for national central banks to purchase national debt would send a negative signal to markets

A programme for national central banks to purchase national debt would send a negative signal to markets, and it would also not fully and effectively address the concerns of all those that worry about the potential cross-border fiscal effects of monetary policy. For the ECB to be effective in current circumstances, policymakers will have to accept the potential fiscal implications of monetary policy.


(1) Ce portefeuille-là ne peut pas être structuré. Ce serait illégal et contraire aux traités de rééchelonner une créance de la Banque centrale sur un Etat. Je crois que les traités européens sont très clairs là-dessus. Read the full interview here.

(2) Contraintes…l’une d’entre elles – mais pas la seule – étant qu’un portefeuille de politique monétaire détenu par la BCE ne peut pas être rééchelonné. Ça, ça serait clairement contraire aux traités. Ibid.

(3) The issue of seniority of the ECB is already alluded to in sentence 132 of the ECJ's Pringle judgement when comparing article 123 with article 125 of the TFEU

(4) A similar discussion took place when national central banks gave emergency liquidity assistance (ELA). ELA is provided at the risk of the national central bank, but if the national central bank has negative equity, it can no longer honour the claim of the Eurosystem, and therefore the loss is passed on to the Eurosystem.

Tue, 13 Jan 2015 16:45:11 +0000
<![CDATA[Analysis of developments in EU capital flows in the global context]]> http://www.bruegel.org/publications/publication-detail/publication/866-analysis-of-developments-in-eu-capital-flows-in-the-global-context/ publ866

This report reviews the key theoretical foundations underlying the benefits and risks of net capital flows, in particular large, persistent inflows or outflows, and the significance of gross flows and their composition. We analyse global capital flows between country groupings. We conclude that global flow patterns changed significantly and Europe has been left behind. The magnitude of capital outflows from Russia and Ukraine due to geopolitical developments have been much smaller than during the financial crisis. In Europe, financial disintegration, which began with the financial crisis, has not been reversed when considering various indicators of financial stocks and flows. Turning to foreign assets and liabilities, we that see central and eastern European countries experienced large negative spreads on equity, and that some larger EU member states succeeded in somewhat replicating the US’s privilege on equity returns. Correlation between returns and revaluations was small, suggesting revaluation gains did not compensate low returns. Using bilateral data and panel econometric models we examine determinants of capital flows and stocks. Euro membership boosted debt flows, while EU membership increased equity flows. Global uncertainty reduces capital flows, but higher financial integration dampens this effect. We calculate financial weighted real effective exchange rates and government bond yields and spreads.

Analysis of developments in EU capital flows in the global context (English)
Tue, 13 Jan 2015 15:58:39 +0000
<![CDATA[The nod-and-wink lender of last resort]]> http://www.bruegel.org/nc/blog/detail/article/1539-the-nod-and-wink-lender-of-last-resort/ blog1539

At his press conference on December 4, 2014, the ECB President Mario Draghi was asked if the ECB would be pari passu with other creditors. Mr. Draghi replied:

“[…] we don't want to cause unintended monetary policy tightening in choosing forms of seniority which would be counter-productive. You all see this point, I believe.”

I certainly did not see the point, but not for want of trying. The issue is a simple one. If the ECB buys the bonds of a eurozone sovereign and the sovereign is unable to repay in full, then would the ECB bear the same loss as the private creditors?

It was something of a relief when the ECB Governing Council Member Benoit Coeure clarified the principle of how the ECB is required to operate: 

"It is illegal and contrary to the treaty to reschedule a debt of a state held by a central bank. The European treaties are very clear on this."

In other words, the ECB must be repaid in full.

This arcane exchange is central to the ECB’s future, not only for its proposed “quantitative easing” plans but also for its Outright Transactions (OMT) programme. Tomorrow Advocate General Pedro Cruz Villalon of the European Court of Justice (ECJ) will deliver  a much awaited opinion on the German Constitutional Court’s challenge of the OMT.  The opinion will be considered by the ECJ, which is expected to reach its judgment by May this year.

The OMT finally created the basis for the ECB to function as a lender of last resort.

The OMT brought calm to the eurozone in the midst of one its recurring existential crises and, as importantly to its supporters, it finally created the basis for the ECB to function as a lender of last resort.  The German Court, however, was not persuaded. A lender of last resort to sovereigns helps them tide over temporary payment difficulties. The OMT, the German Court said would bailout insolvent governments.

The German Court’s challenge rests on two features of the OMT: the ECB’s promise to buy unlimited quantities of the bonds and its willingness to be pari passu with private creditors—in other words, if the sovereign were to default on its repayment obligation, the ECB would bear the same loss as the private creditors.

On both these core OMT features, the ECB has adopted a “nod-and-wink” approach. On unlimited purchases, Jorg Asmussen, a former Governing Council Member, said in his submission to the German Court:

“[…] 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.” 

In other words, the OMT would be described as unlimited because otherwise markets would not be reassured, but it would be effectively limited because otherwise it would violate the European Union’s Lisbon Treaty.

A more serious disconnect applies to the pari passu provision. In its Press Release announcing the OMT, 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.

the ECB stepped beyond the traditional central banking domain of managing temporary financial disruptions into the sovereign insolvency arena. 

In emphasizing its acceptance of pari passu status, the ECB recognized that financial markets were principally interested in being relieved of the full burden of default. Thus, the ECB stepped beyond the traditional central banking domain of managing temporary financial disruptions into the sovereign insolvency arena. 

The pari passu provision is the OMT’s distinguishing feature and the key reason that made it a market favorite. The OMT’s earlier incarnation—the Securities Markets Programme (SMP)—was discredited precisely because the ECB overrode the pari passu requirement on its holdings of Greek debt. The bond contracts had specified the sharing of losses; but when those bonds were restructured in March 2012, the ECB exchanged the distressed bonds—in a side-deal with the Greek government—for new bonds that were not subject to the losses imposed on private creditors. Thus, the ECB remained whole. This, of course, meant larger losses were borne by bondholders whose securities were not purchased by the ECB. The adverse reaction that followed required that the OMT be seen to relinquish the ECB’s “seniority” claim—the claim to being repaid ahead all others. 

The German Court has concluded that such promised equal treatment in creditor status renders the OMT unconstitutional since it increases the likelihood of a “debt cut”—the risk that the ECB will not be repaid in full—and that contravenes the Treaty. That is exactly the same as Mr. Coeure’s interpretation. And, indeed, as I have argued, that is also the ECJ’s interpretation, with particularly strong strictures against the ECB taking on a sovereign’s commitments.

how unlimited are “unlimited” purchases of sovereign bonds and can the ECB legally accept losses on par with private creditors?

Of primary interest in Advocate General Pedro Cruz Villalon’s opinion will be whether and how he reinterprets the past ECJ position on no bailout of sovereigns. His answers to the two central questions will be critical: how unlimited are “unlimited” purchases of sovereign bonds and can the ECB legally accept losses on par with private creditors? Absent clear answers, the nod-and-wink strategy will continue. That, however, will be in an invitation for markets to test the ECB’s word and resolve. And the test, sovereign attorneys Lee Buchheit and Mitu Gulati predict could be merciless. 

Tue, 13 Jan 2015 10:31:51 +0000
<![CDATA[Six reasons why we should not invest too much hope in lower oil prices]]> http://www.bruegel.org/nc/blog/detail/article/1538-six-reasons-why-we-should-not-invest-too-much-hope-in-lower-oil-prices/ blog1538

The crude oil price halved from $105/barrel on 1 July 2014 to less than $50/barrel in January 2015 – an unprecedented fall that will have repercussions beyond the energy sector. In value terms, oil is the most important raw material for EU economies, and in 2013 the EU consumed about 4 billion barrels. At an average price of $100 this translated into $400 billion of EU final oil consumer spending or 2.2 percent of EU GDP. A more-or-less halving of the price therefore saves EU oil consumers an equivalent of about 1 percent of EU GDP. There are also knock-on effects on other energy costs directly or indirectly linked to oil prices, such as oil-indexed gas contracts.

All this has raised hopes of an economic dividend in the EU, an idea that might be supported by the apparent relationship in many economies over the past 60 years between the oil price change in one year and economic growth in the subsequent year. We have calculated the linear relation between the annual change in the logarithm of the real oil price in USD and the change in the logarithm of real GDP for different countries and regions – see the table. Oil exporters such as the Arab countries have tended to have a higher real GDP in the year following an oil price increase. Meanwhile, growth in the rich oil importers (such as OECD countries) has tended to be two to three percent lower when the oil price doubles, compared to years without a change in the oil price. If predictions could be made on the basis of this apparent correlation, it would mean that the EU economy might grow 2 percentage points faster when the oil price halves. However, even ignoring all the methodical issues of such a simplified regression model, the correlation between oil prices and economic growth is not universal – the rather low confidence level (a p-value of more than 5 percent is typically considered as not statistically significant) shown in the table indicates that the oil price alone is not very helpful in predicting GDP.

Table: Coincidence of oil-price changes and real GDP changes 1962-2014 for selected regions (sorted by confidence)


Coefficient (ß)

confidence level (p-value)

United States



Arab World*



High income: OECD



OECD members






Countries of EU28



Countries of the Euro Area



Colour coding: Green indicates that lower oil prices coincide with higher growth, red indicates that lower oil prices coincide with lower growth; Bold indicates significance at the 5% confidence-level
Data source: World Bank for real GDP and BP Statistical Review of World Energy 2014 for real oil price;

*Arab World only after 1975
Note to the regression:
yt = a+ß xt-1+e; with
yt :ln(real_GDPt)-ln(real_GDP t-1);
xt : ln(realoilpricet)-ln(realoilpricet-1)
-> Coefficient values can be read as the increase in GDP subsequent to a doubling in the oil price

In fact, for the EU, there are six reasons to think that the growth dividend from a low oil price might be rather limited:

1) Falling oil prices might have less of an impact than rising oil prices

2) Decreasing importance of oil prices on the macro economy

3) The current economic environment reduces further the impact of a negative price shock

4) The demand-side part of the oil price shock indicates a lesser impact on the economy

5) Deterioration of terms-of-trade limits the impact on production, investment and employment

6) The political fall-out for oil exporters carries some economic risk


Map: Coincidence of oil-price changes and real GDP changes 1962-2014


Source: Bruegel based on data from World Bank and BP Statistical Review of World Energy

  • Falling oil prices preceed rising GDP, significant
  • Falling oil prices preceed rising GDP, not significant
  • Falling oil prices preceed falling GDP, significant
  • Falling oil prices preceed falling GDP, not significant







Falling oil prices might have less of an impact than rising oil prices

According to Hamilton (2009) the 2007-08 oil price surge, when prices increased from about $50/barrel to almost $150/barrel in 18 months, contributed to the subsequent recession in the US. In contrast to 2007-08, we are currently confronted with a massive price slump. But do negative oil price shocks have impacts that are symmetrical to the much better researched positive oil price shocks? Mork (1989) shows that rising prices have a stronger impact on GDP than falling prices, a finding that is confirmed by Lardic and Mignon (2008). According to this asymmetry, the impact from the current oil-price slump should be less.

[NB: But this finding is not undisputed. A contrary argument holds that the size of the shock matters. Huang et al (2005) demonstrate that oil prices and oil price variability needs to cross a threshold for oil shocks to be significant. Kilian (2012) wonders whether asymmetries found earlier might be the result of these threshold effects. If this were the case, the current massive oil price drop might have as significant effects as a similar-sized oil price increase.]

Decreasing importance of oil prices on the macro economy

Gregorio et al (2007) find that the effects of oil shocks on inflation and output has weakened. They argue that among the factors that might help to explain this decline, the most important are a reduction in the oil-intensity of economies around the world, a reduction in the exchange rate pass-through and a more favourable inflation environment. Also, the increase in wage flexibility, introducing flexible exchange rates, opening up and liberalising global trade and augmenting the power of monetary policies in order to fight inflation might have played a role (Chen, 2009).

And indeed, when splitting the full sample (1962-2014) in the middle (1992/93) we find that after 1992 the impact substantially decreased. The average positive beta coefficient decreased from 0.038 to 0.026 and the average negative beta coefficient increased from -0.033 to -0.020. For the European Union, the coefficient after 1992 indicates that a halving of the oil price coincides with 1.1 percent higher real GDP (ß= -0.0109) but we in fact have no confidence that the impact is significant (p=0.57).

Map: Coincidence of oil-price changes and real GDP changes before and after 1992/1993

Before 1993

After 1992

 Source: Bruegel based on data from World Bank and BP Statistical Review of World Energy

  • Falling oil prices preceed rising GDP, significant
  • Falling oil prices preceed rising GDP, not significant
  • Falling oil prices preceed falling GDP, significant
  • Falling oil prices preceed falling GDP, not significant





The current economic environment reduces the impact of a negative price shock further

As Europe has introduced many of the previously mentioned economic policies that weaken the oil-growth link, such as inflation targeting, wage flexibility and trade-opening, negative oil price shocks are less likely to translate into lower inflation and higher output than in the past.

In addition, Lee et al (1995) argue that oil price changes have a bigger impact in an environment with little variability than in an already volatile environment. During periods of high price variability, oil price changes are not believed to embody important new information and seem not to trigger the same impact as changes during low variability periods. According to this, the highly volatile environment might be another reason why the current slump in oil prices might have a more limited impact on economic growth.

The demand-side part of the oil price shock indicates a lesser impact on the economy

Kilian (2008) argues that the nature of the oil shock is important: higher oil prices resulting from increased economic activity in some parts of the world (demand shock) tend to coincide with subsequent economic growth in all parts of the world. However, higher oil prices resulting from unexpectedly low production (supply shock) coincide with subsequent lower economic growth. Reversing the argument means that lower oil prices because of higher-than-expected oil production would be most effective in stimulating growth in Europe.

The current shock, however, seems to be a mixture of lower-than-expected oil demand because of sluggish growth and higher-than-expected oil production in some crisis regions (Iraq, Libya) and strong oil production growth in the US. Consequently, the positive economic stimulus arising from the current fall in oil prices can also be expected to be more modest than if it were solely due to unexpected supply hitting the market.

Deterioration of terms-of-trade limits the impact on production, investment and employment

Academic literature does not find a significant positive impact of low oil prices on general business investment. Only in mining and the oil industry itself are investments negatively affected by low prices (Edelstein and Kilian, 2007).

In terms of employment, the effect of oil prices also depends on the sector. Some jobs, such as wind turbine manufacturers or insulation producers are a substitute for oil imports. They are obviously less in demand when the oil price goes down. The productivity of other jobs increases with lower oil prices – truck drivers are an illustrative example. Thus there will be increased labour demand in this sector. The overall effect of oil prices on employment seems to be small (Keane and Prasad, 1996).

Bodenstein and Guerrieri (2007) find evidence that with imperfect financial markets, oil-importing countries have to depreciate their currencies to export more goods in order to be able to import the more expensive oil. In case of falling oil prices this would suggest that the non-oil exports of oil importers would fall, while wealth increases.

The political fall-out for oil exporters carries some economic risk

Low oil prices have an impact on the public budgets of oil-exporting countries. These countries will be faced with a trade-off between deficit-spending and austerity. In countries without vast sovereign wealth funds, the room for deficit spending is limited. But tough austerity might destabilise the political systems in these countries and in some cases even propel regional conflicts, which in turn might have negative impacts on the world economy.

In addition, most of the money of sovereign wealth funds has been parked in the financial system of oil-importing economies (such as the EU). Withdrawal of these funds to finance the state budgets of oil exporters might have repercussions for the financial systems in the oil-importing economies.


The falling oil price will have a major impact by shifting production and investment between sectors (from energy-efficient to oil-intensive, from oil industry to the rest of the economy). It will also shift substantial wealth – in the order of half of global oil export revenues in 2013: $1 trillion – from oil-exporting countries to oil-importing countries.

But the aggregate impact might be smaller than suggested by the sectoral effects, the historical data and some media fanfare, for the six reasons we have discussed.

Even if the oil price continues to hover around $50, it is unlikely to add more than one percentage point of growth to the EU economy. Given all mitigating factors, the effect is likely to be even less. Growth in the EU in 2015 will be mainly driven by factors other than the oil price.


Research Assistance by Burak Turkoglu is gratefully acknowledged. 

Mon, 12 Jan 2015 15:37:23 +0000
<![CDATA[An investment plan for Europe]]> http://www.bruegel.org/nc/blog/detail/article/1537-an-investment-plan-for-europe/ blog1537

Dear Guntram, dear participants,

Many thanks for the opportunity to debate our investment plan. As a leading Central Banker said, it is the only plan around, so that means that we need to make it a good one.

I would be happy to address your doubts and get your suggestions on how to make it better.

The Commission has delivered fast. Less than two months after announcing its ambitious strategy to boost jobs and growth, the European Commission will present tomorrow the legal proposal that will form the legal basis of the first two pillars of President Juncker's €315 billion Investment Plan for Europe.

As you know, the Plan is not designed to solve every single problem in the Euro Area and the European Union (from macroeconomic shocks to deflation to energy security to the debt problems of local authorities) but it is a step in the right direction and most importantly, it has been designed in the most flexible way so that it can grow.

There is liquidity in the system and yet investment is not happening. When doing our research, we noticed that uncertainty plays a major role (lack of risk financing, lack of certainty regarding the projects and regulatory barriers to investment).

Our plan is designed to address uncertainty over these three dimensions.

I am mostly interested in the structural features that can deliver change to the way European money is used to finance investments: there is an ample room for improvement by creating a transparent pipeline of projects and delivering on a true Single Market.

I would like to elaborate on four issues that might have attracted some misperceptions. We are moving fast so this is why it is important to take the time to explain well what we are doing. I noticed that some of the criticism to the Plan was based on rumours, incorrect interpretations and on what was done in the past. The Plan has been criticised from different corners and angles, from Hans Werner Sinn claiming it is a huge backdoor to create Eurobonds to Wolfgang Munchau claiming it is not big enough.

My five points are:

  1. Additionally of our action and type of instruments to be used
  2. Impact on the EU budget – how does our guarantee fund work
  3. Leverage effect
  4. SGP treatment (flexibility)
  5. Governance of the fund and participation of Member States

  1. Additionally of our action and type of instruments

Nobody can guarantee that EFSI will do a 100% of additional investments but by targeting higher risk and riskier instruments EFSI will go where it is more unlikely for the private sector to go.

By targeting higher risk and riskier instruments EFSI will go where it is more unlikely for the private sector to go

Tomorrow's regulation will explain that EFSI should target projects with a higher risk return profile than existing EIB and Union instruments to ensure additionality over existing operations. The EFSI should only be used where financing is not available from other source son reasonable terms'. The steering board will have the responsibility to prepare the investment guidelines.  This responsibility will include the preparation of relevant rules aiming at checking the additionality of the EFSI intervention.

Here it is very important to understand that EU budget is not providing a guarantee to the EIB and not to the private sector, but a junior tranche to what the private sector will provide in a specific investment project.

EFSI will have the flexibility to work with a wide range of different financial instruments, chosen depending on the profile of the projects, including, for example, debt financing (subordinated or senior), guarantees, equity, quasi-equity and venture capital.  It is important to bear in mind that the aim is to offer financing solutions that crowd-in private investors therefore EFSI will offer financial products that will be junior to them. The EFSI will not be there to give grants and subsidies.

The aim is to offer financing solutions that crowd-in private investors therefore EFSI will offer financial products that will be junior to them

Another misperception is to oppose EFSI to the European Investment Fund (EIF). This is the EIB subsidiary dealing with SMEs and mid-caps. In fact, EFSI's investments on SMEs will be channelled via the EIF: its size will double.

  1. Impact on the EU budget – how does our guarantee fund work

Once the EFSI regulation and the consequent budgetary adjustments will be adopted by the Council and the Parliament, the 6 billion from CEF and Horizon 2020 will constitute a provision in the EFSI guarantee fund. That money is blocked in the guarantee fund and can only be used to pay guarantee calls by the EIB.

However, thanks to the higher multiplying effect of the Investment Plan, the impact generated on investment in innovation by amounts blocked in the guarantee fund will be higher than the same amount spent by a grant programme under H2020, because of the higher risk and the riskier instruments.

Here I would like to remind you how our instrument works. Some people are mixing our Guarantee Fund in the EUB budget and the European fund for Strategic Investments:

  • The EU budget provides a guarantee of EUR 16 bn to the EIB. When there is a loss on a portfolio of instruments (e.g. junior debt), the EIB may call an amount, corresponding to that loss, from the guarantee of EUR 16 bn from the EU-budget.

  • For prudent budget-management purposes, this EUR 16 bn guarantee from the EU-budget is backed by a guarantee fund of EUR 8 bn. These EUR 8 bn act like a safety buffer for the guarantee. Given that the EFSI will finance long-term projects, that reflows will in general be kept in the guarantee fund and that losses are in general recorded over time, it is highly unlikely that the whole guarantee fund of EUR 8 bn would need to be called at one single point of time.

The EU has a very high quality signature and its budget is solid and trust-worthy. Thus, the EU does not need to provide pre-financing for a guarantee for such a guarantee to be credible for the markets and useful for the EIB. The guarantee fund of EUR 8 bn is established only to facilitate the payment of potential guarantee calls, since it avoids having to arrange sudden spending cuts or re-programming. Thus, it brings transparency and predictability to the budgetary framework but is not as such necessary for the guarantee to work.

In other words, the guarantee fund will be put in place to mitigate any potential impact on the EU budget. Its calibration (50% of the value of the guarantee) has been done in a way that will allow the EU to meet, with a safety margin, any potential risks.

Regarding the 5bn of the EIB, I do not want to speak on their behalf but this comes mainly from their extraordinary profits over the past years.

  1. Leverage effect:

I do not have pushed myself to o for conservative assumptions. I do not want to elaborate on the leverage effect but the market participants I have spoken to were not surprised.

As representatives of the EIB have said publicly on several occasions, the multiplier effect is considered to be "conservative", based on the EIB-experience. The risk-department of the EIB has a long track-record of lending activities in different sectors.

The first part of the leverage effect (times 3) is very simple: thanks to the 21bn capital of the EFSI risk-bearing capacity, the EIB will issue normal EIB triple A bonds. No mystery here.

From a financial point of view, this leverage effect is obtained by the combined effect of the EIB issuing additional bonds in the markets in order to finance projects with a higher level of risk, together with the blending with the existing deep and diversified EIB portfolio. The existence of a 21bn risk-bearing capacity means that there is a capacity of public funding to absorb significant losses. For private investors wishing to invest in a certain project, this means that they are reassured that they have a safety net against potential losses ("a first loss-protection").

I would like to remind you just that the leverage effect is the target that we will include in the investment guidelines, so we will aim at our portfolio selection to attract 4 additional euros in investment for every euro we will invest in risk-financing projects.

  1. SGP treatment  

It has to be distinguished between two matters: 

  • Eurostat accounting
  • Concrete action under the SGP in the individual case, proposed by the Commission and decided by the Council.

Irrespective of the Eurostat-accounting treatment, the Commission will take a favourable position towards such voluntary capital contributions to the EFSI for the purpose of the assessment of the debt and deficit criteria under the Stability and Growth Pact.

the Commission will take a favourable position towards such voluntary capital contributions to the EFSI for the purpose of the assessment of the debt and deficit criteria under the Stability and Growth Pac

I do not want to elaborate on this since you will have all the details tomorrow and it is under the responsibility of my fellow Commissioners: Vice President Dombrovskis and Commissioner Moscovici.

  1. Governance of the fund and participation of Member States and NPBs (via co-investment platforms)

As we explained at the end of last year, we foresee a two-tier governance structure:


  • The Steering Board where the "shareholders" of EFSI will be represented will define the risk-profile and the investment guidelines. The investment guidelines and the detailed criteria for the selection of projects will be defined by the Steering Board of the EFSI, once appointed.

  • The Investment Committee made-up of independent professionals receiving a salary for their work in EFSI will make the individual investment decisions according to the investment guidelines.

The agreement between the Commission and the EIB will be negotiated in the coming months, but for obvious reasons, cannot be finalized before the legislator comes to an agreement on the Regulation establishing the EFSI, since it only fleshes out in more technical term the legal obligations enshrined in the Regulation.

As contributor to the EFSI, the EIB will have representatives in the steering board. And since the EFSI is operating within the EIB, any project supported by the EFSI will also require the approval of the EIB Board, under the normal procedures foreseen by the Treaty.

Contributions on the first layer from sources other than Member States General government Deficit (for instance National Promotional Banks – some of them they are already in discussions) would have to come legally to co-investment platforms that will be 'pari-passu' with EFSI.

The private sector could come to these co-investment platforms if it targets high risk and high returns. In the case of infrastructure and pension funds, I could see them myself more easily participating at the level of the co-financing of projects with senior tranches (lower risk and lower returns).

My final point goes into signalling that beyond the first two pillars, the most important pillar for me of the investment initiative is the removal of barriers to investment and the creation of a true Single Market. On this, the Commission will come with further proposals on energy Union and Digital Single Market in the first quarter of this New Year.

Thank you very much for your attention and I look forward for a fruitful discussion with you.


Click here for more information on the event An investment plan for Europe

Mon, 12 Jan 2015 12:19:02 +0000
<![CDATA[The price of oil in 2015]]> http://www.bruegel.org/nc/blog/detail/article/1536-the-price-of-oil-in-2015/ blog1536

In late 1979, I began work on my PhD thesis, an empirical investigation of the OPEC surplus and its disposal. It was the end of a decade in which oil prices had undergone two dramatic increases, and most of the various geniuses of the day were confidently predicting that they would continue to soar, from under $40 per barrel – a historic high at that time – to above $100. By the time I finished my research in 1982, the price of oil had begun what would become a 20-year plunge. It would not hit $100 per barrel until January 2008.

I used to joke that the most important thing I learned from my research was never to attempt to forecast the price of oil. As 2014 comes to a close, the price of oil has just crossed the $100 threshold again – this time headed down. One of the big questions for 2015 is whether the decline will continue. Despite my earlier cynicism, I think I know the answer.

 One of the big questions for 2015 is whether the decline will continue. I think I know the answer

Over the past 33 years, I have had plenty of opportunity to study both oil prices and foreign exchange rates, including overseeing a research department of talented people trying to predict their movements. The experience has left me with a good deal of skepticism – not to mention bruises. But I do believe that it is possible to make a broad prediction as to where oil prices are headed.

Over the course of my career, I have tried to determine whether there is such a thing as an equilibrium oil price. I have spent many hours trying to guide, cajole, and beg my energy analysts to create a model that might identify it, just as we have for currencies, bond yields, and equities. I have also discussed the idea with industry experts, most of whom believe that one exists, but that it moves around a lot, because it is greatly influenced by the marginal cost of oil production – itself an unstable variable.

My conclusion is that a good indication of this moving equilibrium does exist: the five-year forward oil price, or the amount paid for guaranteed delivery of oil five years from now.

In my ongoing quest to become better at forecasting, I began, a few years ago, to pay attention to the five-year forward oil price as it compares to the Brent crude oil spot price, the price of a barrel of oil today. I suspect that the five-year forward price is much less influenced by speculation in the oil market than the spot price, and more representative of true commercial needs. So when the five-year price starts moving in a different direction than the spot price, I take notice.

The five-year forward price is less influenced by speculation in the oil market than the spot price, and more representative of true commercial needs

In 2011, after both prices had recovered from the collapse induced by the 2008 credit crisis, the five-year price started to come down gradually, while the spot price continued to surge for a while. This jibed with what I had identified as two big factors fundamentally driving the price of oil: the early days of the exploitation of shale oil and gas in the United States, and the shift in China’s economic focus from quantity to quality, which implied that the Chinese economy would no longer be consuming energy at the frenetic rate it had been.

I concluded that there was a fair chance that oil prices were peaking and that before too long spot prices would reverse and start to decline. I thought it was probably the beginning of a move back down to $80 per barrel – precisely where the price has landed at the end of 2014. The spot price has even recently slipped below that level. It was one of my better forecasts.

I no longer make predictions for a living, but I do know one thing: oil prices will either rise or fall. And I suspect that I know which way they will go. I recently read an article that suggested that, if oil prices remain at recent levels, US production of shale oil and gas next year could be 10% below recent projections. That seems plausible; and, given how important shale oil and gas has become to America’s economic recovery, it also seems like something that US policymakers would be eager to avoid.

They may very well get their wish. Oil prices may not start rising in the coming months, but, as 2014 came to a close, forces that will eventually halt their decline are beginning to appear.

Oil prices may not start rising in the coming months, but forces that will eventually halt their decline are beginning to appear

The drop in the spot price of oil has taken it significantly below the five-year forward price, which remains close to $80 per barrel. My hunch for 2015 is that oil prices may continue to drop in the short term; unlike in the past four years, however, they are likely to finish the year higher than they were when it began.

Mon, 12 Jan 2015 10:03:23 +0000