<![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Fri, 18 Apr 2014 23:07:32 +0100 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[The future of the EU and the euro area]]> http://www.bruegel.org/nc/events/event-detail/event/434-the-future-of-the-eu-and-the-euro-area/ even434

The goal of this joint Bruegel-PIIE workshop is to bring together a selected group of experts from the public and private sector as well as academia, to discuss the broad directions for the EU's institutional reform, vital issue of AQR and stress-testing in Europe, economic developments in the euro area - in comparison with emerging markets, and the role of sovereign credit rating before, during and after the crisis.

Draft programme

9:30-9:50 Registration and breakfast

9:50-10:10 Opening

10:00-11:20 Session 1: The EU's institutional reform agenda

  • Chair: TBA
  • Guntram Wolff, Director, Bruegel (confirmed)
  • MEP (France)
  • UK representative

11:20-12:40 Session 2: Banking Union, AQR and stress testing: Europe’s prospects and lessons from the US

  • Chair: Nicolas Véron (Senior Fellow, Bruegel and Visiting Fellow, PIIE – confirmed)


  • Ignazio Angeloni, ECB (confirmed)
  • Andrea Enria, EBA (confirmed)
  • Lucio Vinhas de Souza, Managing Director, Sovereign Chief Economist, Moody's (confirmed)

12:40-13:40 Lunch

13:40-15:00 Session 3: Stabilization in the euro area, stresses in emerging markets

  • Chair: Peter Spiegel, FT (invited)


  • Madhavi Bokil, Associate Vice-President, Moody's, (confirmed)
  • Marco Buti, European Commission (invited)
  • Jacob Funk Kirkegaard, Senior Fellow, PIIE (confirmed)

15:00-15:45 Session 4: Ratings and the euro-area sovereign crisis

  • Chair: Guntram Wolff, Director, Bruegel (confirmed)
  • Presenter: Dietmar Hornung, Associate Managing Director, Moody’s: EA Sovereign ratings, before, during and after the crisis
  • Discussant: Zsolt Darvas, Senior Fellow, Bruegel (confirmed)

15:45-15:50 Close

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Wednesday 28 May 2014, 9:30-15:50
  • Contact: Matilda Sevón, Events Manager - matilda.sevon[at]bruegel.org

Organised jointly with the Peterson Institute for Inernational Economics

Fri, 18 Apr 2014 14:23:23 +0100
<![CDATA[The threat of low inflation in the eurozone]]> http://www.bruegel.org/videos/detail/video/128-the-threat-of-low-inflation-in-the-eurozone/ vide128

No description available

Thu, 17 Apr 2014 18:08:12 +0100
<![CDATA[Minimum wage and pension reform in Germany: A headwind for growth?]]> http://www.bruegel.org/nc/blog/detail/article/1306-minimum-wage-and-pension-reform-in-germany-a-headwind-for-growth/ blog1306

Key components of the coalition agreement between Merkel’s CDU and the Social Democrats are the adoption of a nationwide minimum wage and the introduction of new pension benefits, in particular early retirement at 63. The introduction of the minimum wage follows a heated debate which gained importance ahead of coalition talks last September. The grand coalition is now governing since December and the two legislative projects advance quickly. We want to summarize the development of both projects and to review the ongoing public debate over potential consequences on the German economy, particularly in light of a report published on 9th April by four leading economic Institutes.

On 15th January, the German government presents its pension reform plan, hammered out under the leadership of SPD Labour Minister Andrea Nahles, which would allow some employees to retire on a full pension at 63, provided they have worked for 45 years without claiming jobless benefits for more than a short time. The reform also includes higher pension benefits for mothers which had been demanded by the CSU. With extra costs rising to EUR 160 billion in 2030, the reform is likely be the most expensive single measure of the legislative period. The Bundestag is due to pass the law in May so that the new rules apply by July.

On 2nd April, the cabinet of Ministers adopts a draft bill which would introduce Germany’s first national minimum wage of EUR 8.50. It would be phased in from January 2015 and be fully in place from 2017, taking into account currently valid collective wage bargaining agreements in some sectors. Negotiators agree only on a few exceptions such as for minors, apprentices, interns, voluntary workers or long-term unemployed in the first six months after finding a new job. The first reading of the bill in the Bundestag is due in June, with the draft bill to be voted through in July.

On 9th April, four leading German economic Institutes published their bi-annual report “Joint Economic Forecast Spring 2014” on the German economy. They raise their German growth outlook for 2014 to 1.9 percent from last October’s prediction of 1.8 percent, and predict a further pick-up to 2 percent in 2015. The joint statement is, however, critical of key policy initiatives of the grand coalition. In particular, early retirement at 63 and the introduction of a minimum wage would create a headwind for growth.

“The entitlement to a full pension as of 63 years is a step in the wrong direction” in view of Germany’s ageing population. The pension at 63 jeopardizes the sustainability of fiscal policy and is questionable with regard to inter-generation fairness. It “counteracts efforts to adapt pension entitlements to rising life expectance and will instead serve to curb production potential.”

The minimum wage “will tend to reduce the employment prospects of low-skilled workers overall and – since transfers are reduced – it will hardly help to reduce poverty at all.” The Institutes estimate that some 4 million people would be affected and that around 200 000 jobs would be lost. Those jobs, however, “have comparably low productivity levels”, and, therefore, only a tenth of a percentage point will be shaved off Germany’s annual GDP. Despite the jobs lost, the Institutes predict that the overall jobless rate in 2015 will remain steady at 6.7 percent. The authors, however, acknowledge that the economic implications of a minimum wage are difficult to assess. “Such state intervention in the German labour market is unprecedented to date. “ Plus, drawing on experiences of other countries is of little use, since the German institutional framework has specificities that do not exist in other countries, such as the mini-job.

One of the Institutes does not share some assessments, particularly regarding the implications of the minimum wage. The German Institute for Economic Research (DIW) Berlin believes that the significance of the uncertainty related to the estimation of the impacts of the minimum wage is higher than assumed by the other Institutes. Therefore, by no means the introduction of the minimum wage will necessarily lead to negative long-term effects on the economy.

The report has to be seen in the context of an ongoing public debate over the consequences of the minimum wage and pension reform. In an interview to the FAZ on 13th April Labour Minister Nahles says she doesn’t believe in important job losses after the introduction of the minimum wage by referring to positive experiences with minimum wages already in place in some sectors in Germany and to other European countries. Nahles defends the introduction of pension benefits at 63 by saying that the reform doesn’t withdraw the pension at 67. Not only young generations, but also pensioners will pay for the reform.

Business organisations regularly voice concerns about the minimum wage deal. For instance, the President of the German Chambers of Commerce and Industry (DIHK), Eric Schweitzer, expects hundred thousands of additional unemployed because of the minimum wage. He says it looks like the grand coalition wants to “give a hard time to German companies” and, therefore, asks to stop the pension reform: “The pension project is completely wrong.”

Stefan von Borstel writes in Die Welt that the government has abstained from any economic expertise when concluding the minimum wage deal – which may lead to “catastrophic consequences”. The age limit of 18 years is set too low and the fact that companies will be able to pay wages below the minimum wage when employing long-term unemployed during the first six months will provide them with incentives to substitute them for other long-term unemployed. Furthermore, he criticises the nationwide dimension of the minimum wage which ignores regional productivity differences and the level of EUR 8.50, which is too high for many sectors and regions. Moreover, the first evaluation is foreseen in 2020 – too late according to Von Borstel. By then, already hundreds of thousands of jobs may be destroyed.

Stefan Bielmeier writes in the Wirtschaftswoche that the “new generosity of the government will cost a lot of money and will destroy many jobs. The minimum wage as share of median wage would be around 62 percent in Germany in 2015, the highest in Europe. As a consequence, Germany might await the same scenario as France, where the high minimum wage (60 percent) and the strong dismissal protection are main causes for high youth unemployment according to Bielmeier. Furthermore, higher wages will lead to higher costs for businesses which may eventually deteriorate their competitiveness.

The Hamburg Institute of International Economics writes in a report that the current plan of the grand coalition to allow employees to retire at 63 is a “fatal signal”. “In Germany, the various early retirement options and generous pension schemes of the 70s and 80s have created a society that, at the age of 50, is already mentally prepared to receive a pension.”

Klaus Zimmermann, Director of the Institute for the Study of Labour (IZA) believes that this reform will put further pressure on younger generations, which will have to pay on the long run. Michael Hüther, head of the Cologne Institute for Economic Research, says firms had so far countered the skilled labour shortage by keeping older employees on for longer and that lowering the pension age sent out “completely the wrong signal”. He says that “A longer working life and a higher retirement age are the best tools we have to counter the demographic change and a skilled labour shortage”.

In an article on the FAZ on 13th April, Christoph Schmidt, Anabell Kohlmeier and Lars Feld write that the coalition parties follow with the pension reform a clientele policy at the expense of Germany’s competitiveness. Moreover, the reform will put at stake the sustainability of the German pension fund ensured by previous reforms as the extra costs cannot be solely paid by reserves of the pension fund.

Rainer Dulger, head of metal and electrical employer’s association Gesamtmetall says that “Pension contributions and taxes will inevitably rise at the expense of ever fewer contributors, so young people will have to pay for these presents knowing full well that they will never get as much as themselves”.

Former SPD chancellor Gerhard Schröder says“It’s absolutely the wrong signal, especially in view of our European partners, from whom we’ve rightly been demanding structural reforms”, Schröder writes in a new book, an excerpt of which was published in Bild on 29th January. The extra costs to the pension system will mean employee and employer pension contributions will have to be raised in a few years, he says, adding: “There are simply not enough workers who can finance the growing group of pensioners”.

Die Welt writes that the pension reform has the advantage that its costs will be paid by those who currently don’t vote, namely the future contributors. Those responsible for this reform do either not understand the demographic challenge Germany is facing or act cynically according to the motto “After us, the deluge!” Both SPD and CDU have to watch out not to lose sight of young generations in the contest over the favour of pensioners according to the Welt.

Wolfgang Weimer writes that the reform is a revenge Nahles’ for the 2005 Agendapolitik and one needs to look back to understand: In 2005, there was a “brutal power struggle” between SPD-Chairman Franz Müntefering and Nahles which “declares war” to Müntefering by running for secretary general of the SPD. She wins and Müntefering throws in the towel. Since 2005, the SPD is traumatized. Since then, Nahles states that the misery of the SPD comes from Schröder’s reforms and the increase of pension age to 67. Weimer writes that the current pension reform bears the markings of personal coping with a trauma, which will cost billions. Nahles wants to reverse Agendapolitik of Schröder and Müntefering. The introduction of the minimum wage will break-up the second cornerstone of the Agendapolitik. Nahles doesn’t worry about the low-qualified who will lose their job chances, or about the thousands of jobs that will be destroyed in Eastern Germany. Neither Müntefering nor the entire republic merits that a campaign of vengeance becomes a governmental policy.

Wed, 16 Apr 2014 09:33:58 +0100
<![CDATA[Unanswered FAQs on Research and Innovation]]> http://www.bruegel.org/nc/blog/detail/article/1305-unanswered-faqs-on-research-and-innovation/ blog1305

What is the impact of research and innovation policies in Europe? Which policies better address the EU2020 challenges? The SIMPATIC Collaborative Research Project tries to answer these questions by providing policy makers with a comprehensive and operational toolbox for analysis. The 2nd annual conference held in The Hague on April 2-4 brought together several top class economists and experts on evidence-based policy analysis and impact assessment of research and innovation policies. SIMPATIC scholars, leading keynote speakers, discussants, and panel members got together to examine some of the key issues in the field of innovation policy. Here is an overview of the answers provided.

Why support Research & Innovation (R&I)?

Economic literature already provides a theoretical justification for government support to R&D. Whenever the social rate of return of a project is higher than the private rate of return, the government should intervene to prevent the firm from investing below what is socially optimal.

Nevertheless, public funds should attract private investments rather than substitute them, and this is a subject of empirical scrutiny. Most of the answers given at the Conference provided evidence of complementarity between public and private investments. For example, Jacques Mairesse, of the UNU – MERIT and CREST/ENSAE, presented a study evaluating the 2008 reform of R&D tax credits in France. The models showed that the reform had a positive and significant effect on R&D capital and investment, which are higher in the long run by about 13% than they would have been without it.

John Lester, Executive Fellow at the School of Public Policy of the University of Calgary, also warned that some countries are at risk of excessive subsidization. For instance, subsidy rates can be as high as 30% or 40% in different OECD countries, while simulation results suggest that for rates higher than 25% or 35%, the net economic benefits are likely to become negative.

From a macroeconomic perspective, Reinhilde Veugelers, Senior Fellow at Bruegel, pointed out that additionality effects can also occur at the country level. Indeed, the EU budget for R&I (both Framework Programme (FP) funds and parts of the Structural Funds) can complement national budgets. Since this holds especially for innovation lagging countries with lower public R&D budgets and high fiscal consolidation pressure, the EU budget can serve as a mechanism to ease the public R&D divide in Europe.

EU funds and Innovation Union score. Figure presented by R. Veugelers. Source: Bruegel calculations on the basis of EUROSTAT.

Another central question concerns the relationship between R&D, growth, and employment: what are the effects of public investment in R&D on GDP and employment? Answering this question requires the adoption of sophisticated models. SIMPATIC’s researchers performed this exercise to assess the impact of the European Commission’s FP7 2013 budget allocation of €8bn. Using the NEMESIS model, they estimated that the total cumulative extra GDP amounts to €75bn after 15 years, and €86bn after 20 years, while the extra jobs created amount to 38,000 after 15 years.

A more specific question concerns the opportunity to heavily invest in renewables. Can the EU economy get a first-mover advantage from pioneering strong climate action? Leonidas Parousos, Senior Researcher at ICCS-NTUA, presented simulation results up to 2050 using the GEM-E3-RD model. The analysis showed that the first-mover advantage can develop if three conditions are met:

  • the European internal market is sufficiently large and unified to allow for achieving a large part of learning by doing potential for clean energy technologies;
  • ambitious greenhouse gas emission reduction targets are eventually adopted by other regions of the world, thus allowing the development of a large market for such technologies;
  • spillovers are sufficiently small or at least delayed to enable the retention of competitive edge for a period of time.

An additional contribution on this debate was provided by Georg Zachmann, Research Fellow at Bruegel, who questioned the current policy on renewable technologies, which seems to favour rapid deployment over R&D. The author contended that a more balanced mix between deployment and R&D could be more economically efficient.

When is the support to R&I critical?

There are two reasons that make research and innovation policies increasingly relevant today. The first is contingent to the crisis. The second is related to the structural changes of our economy.

First, in times of crisis there is a need to assess the value of each euro of public money invested. Therefore, the opportunity to invest in research and innovation is under scrutiny. EU countries reacted quite differently to the crisis. Veugelers noted that, overall, innovation leaders tended to increase their expenditure in R&D, while innovation laggards cut their budgets during the crisis, thus contributing to increase the divide between the two groups.

As Luc Soete, Rector Magnificus of Maastricht University, pointed out, countries under the strongest budgetary pressures appear to have consolidated their public spending most in areas where cuts in public spending raised the least immediate opposition but affected growth primarily in the long term. The euro-crisis has brought about a research and innovation divide within the EU likely to perpetuate itself. Therefore, we are witnessing the emergence of “submerging” economies (Paul Collier) within the EU, with the crisis affecting their long term capacity to invest in human resources and R&I and, as a result, causing a brain drain of their most talented youngsters to the rest of Europe or abroad.

GBOARD trends (base 2007) – aggregates. Figure presented by R. Veugelers. Source: Bruegel calculations on the basis of EUROSTAT.

Second, the fundamental characteristics of our economy are rapidly changing and this evolution requires new policy tools. Knowledge is becoming the main asset of firms and industries, surpassing physical capital. As Dirk Pilat, Head of the Science and Technology Policy Division of the OECD, highlighted, investment in knowledge-based capital (KBC) is growing in importance and accounts for over half of all business investment in several OECD countries.

Business investment in KBC and tangible assets in the United States (% GDP, 1972-2011). Source: Corrado et al. (2012).

Such investments are often key to creating value and enabling differentiation. However, the development of investments in KBC needs policies that acknowledge the peculiarities of this type of assets. Policies to strengthen framework conditions are often essential. Indeed, well-functioning product, labour, and capital markets, as well as bankruptcy laws that do not overly penalise failure, can raise the expected returns to investing in KBC. Other policy improvements are required in areas such as the intellectual property rights system. Moreover, strategies to develop skills that match the new knowledge-based environment are also needed.

How to support R&I?

Government support to R&D occurs in three main sectors: higher education, government, and business enterprise and private non-profit. In 2011 the latter accounted for 14% of the total EU intervention in R&D.

Government financed gross expenditure in R&D by sector of performance: EU-27 and US. Figure presented by R. Veugelers. Source: Bruegel calculations on the basis of EUROSTAT.

Direct government funding of business R&D and tax incentives for R&D, 2011. Figure presented by R. Veugelers. Source: OECD (2013).

There is great heterogeneity among countries about how business R&D is supported. Some countries use only direct subsidies (e.g. Germany), while others resort mostly to tax incentives (e.g. France). Which instrument works better?

The advantage of direct subsidies is that they allow governments to target projects with the highest social returns. However, government’s ability to select these kinds of projects is questionable and should be constantly assessed.

Concerning tax credits, Pierre Mohnen, Professor at Maastricht University and UNU MERIT, highlighted that these are simple to claim and allow firms to choose their own R&D projects. The disadvantages are that firms must be able to finance R&D projects up-front, and must obtain positive taxable income in order to benefit from the credits. These two problems may be particularly severe for SMEs. Moreover, Pilat argued that higher R&D tax incentives tend to benefit incumbent firms, leading to a less dynamic distribution of firm growth. Therefore, R&D tax incentives might be primarily subsiding incremental innovations amongst incumbents, as opposed to new to the market innovations associated with young entrepreneurial firms. This problem can be particularly severe given the critical role that young firms play in net job creation. It follows that tax credit policies should be designed in order to provide more favourable tax incentives for young firms.

Moreover, as Bronwyn Hall, Professor at Maastricht University and University of California, Berkeley, explained, R&D is only one of the many inputs that contribute to generating innovation: the determinants of innovation can be found in the supply and demand sides, as well as in the institutional environment. A successful innovation policy should therefore consider the whole innovation ecosystem and provide the best framework conditions.

Finally, the panel chaired by Otto Toivanen, Professor at K.U.Leuven and CEPR, with Vincent Verouden, Deputy Chief Economist in the competition directorate of the European Commission; Jeroen Heijs, Dutch Ministry of Economic Affairs; and Petri Lehto, Ministry of Employment and the Economy of Finland, highlighted how innovation policies should be subject to systematic ex post evaluations in order to ensure that economic efficiency is maintained. For this purpose, state of the art evaluation methodologies should be applied in order to deal with the ever increasing complexities of innovation policies.

Where to support R&I?

Given the increasing integration of European economies and the correlated increasing relevance of international spillovers, many of the benefits from an improved innovation policy will be reaped at the EU level. It follows that the EU should continue to coordinate the efforts towards the 2020 targets.

However, a smart innovation policy has to consider the industrial peculiarities of individual countries. For example, Frederique Sachwald, Head of the Business R&D Unit at the French Ministry of Higher Education and Research, showed that the ranking of EU countries according to R&D intensity can vary considerably by correcting the estimates for the sectorial compositions of the countries. This variation is due to the different optimal R&D intensities across sectors.

R&D intensities correcting for sectorial composition. Figure presented by F. Sachwald. Source: OECD.

Therefore, as Soete noted, the heterogeneity of Europe’s regions requires local smart specialization strategies that reflect their absorptive capacity and regional characteristics.

Contribution by Michele Peruzzi is gratefully acknowledged.

Tue, 15 Apr 2014 15:40:49 +0100
<![CDATA[Germany relishes role of hegemon, but is not able to play the part]]> http://www.bruegel.org/nc/blog/detail/article/1304-germany-relishes-role-of-hegemon-but-is-not-able-to-play-the-part/ blog1304

This article first appeared on Project Syndicate, 14 April 2014.

German Finance Minister Wolfgang Schäuble recently declared that the European Union has “moved sovereignty to the European level” – a startling claim, given that European governments seem to be pursuing their national interests more aggressively than at any time since World War II. Was Schäuble’s statement supposed to serve as a rallying cry for greater European solidarity? Or was it just a ploy to deflect calls for a larger German contribution to the eurozone’s recovery?

Schäuble is at the forefront of Germany’s efforts to lead Europe without having to pay its bills. To this end, he has called for EU treaty changes to establish a European “budget commissioner” with authority to spend shared European funds and reject member countries’ fiscal strategies when they do not comply with established rules. According to Schäuble, negotiations for such reforms should begin immediately after the European Parliament election in May.

While Schäuble’s strategy may sound appealing, it is, at best, the symbolic garb of progress. For starters, the common funds are meager, with no prospect of being increased – not least because of Germany’s unrelenting opposition. Likewise, so long as member countries maintain fiscal sovereignty, a new mechanism to facilitate finger-wagging at countries that defy European budget rules will change nothing. Over the last two decades, every effort to discipline the EU’s fiscal delinquents has failed, owing to the lack of enforcement authority.

Of course, when a country has run out of options, it will play along to gain access to official bailout funds. But, as Greece’s experience has demonstrated, this does not always work out as planned. Indeed, the Greek bailout – jointly funded by the EU and the International Monetary Fund – began disastrously as it delayed a much-needed debt-restructuring and demanded strict austerity. As a result, the influence of extremist political forces has grown, and a public-health tragedy is brewing. Yet Schäuble, in a seemingly interminable quest for more austerity, views Greece as a model for an even more hapless Ukraine.

Europe is in a muddle. With debt restructuring essentially ruled out and without a sizeable, politically-sanctioned central budget to relieve countries in distress, Europeans have anointed Germany as their presumptive hegemon. Germany relishes that role, but is not able to play the part.

Simply put, Germany is unwilling to spend its taxpayers’ euros to bolster Europe. The robust German economy is little more than a memory at this point. Annual GDP grew by more than 3% in 2010 and 2011, because a still-booming Chinese economy was sustaining high demand for German machines and cars; but, as China’s GDP growth has slowed, so has Germany’s, to an annual rate of less than 1%. This is likely to improve slightly, but Germany’s aging population means that its economy faces low potential growth in the long term.

With Germany lacking the economic dynamism to support Europe financially, its leaders have been unwilling to take political risks. The country’s two major political parties – the Christian Democrats and the Social Democrats – sidestepped a public dialogue on Europe in the September 2013 election that produced their governing coalition.

More revealing is Schäuble’s defense of the European Central Bank’s “outright monetary transactions” scheme (which would permit the ECB to purchase unlimited amounts of weaker eurozone countries’ government bonds). Even as Germany’s Bundesbank fiercely (and rightly) opposed the OMT program for its focus on countries’ solvency, rather than liquidity risk – thus creating a backdoor fiscal union – the government was relieved that the German Constitutional Court, assessing the scheme’s legality, ultimately passed the buck to the European Court of Justice. After all, establishing a genuine fiscal union would require strong political commitment – and considerable legwork.

The EU is an inspiring political structure that seeks to break the mold of the nineteenth-century nation-state. But progress toward that idealistic vision cannot continue to depend on shopworn symbolism. The euro was the most audacious of those symbols – a construct of dubious economic value, with well-documented fragilities. Its adoption was an act of economic hubris that has imposed costs well beyond Europe’s borders.

Today, European leaders are indulging in triumphalism, viewing the current economic reprieve as a validation of failed transnational governance structures. But the depth and persistence of the ongoing crisis have exposed the euro’s fundamental fragilities, and should serve as a warning that today’s technocratic Band-Aids may not hold in the face of another shock.

Unfortunately, bold action to address these fragilities seems more distant than ever. Relinquishing some control over national budgets to achieve fiscal integration appears politically impossible, and talk of treaty changes – even if it comes from the German finance minister – amounts to little more than empty rhetorical finery.

Adopting the euro was a mistake. But the damage is done, and precipitously abandoning the common currency would only make a bad situation worse. With countries unwilling to cede sovereignty, Europe’s only option is to dump the pretense of centralized coordination, leaving countries and banks to deal with – and be disciplined by – their creditors. A step back to this more stable arrangement may offer the only way forward.

Tue, 15 Apr 2014 07:02:42 +0100
<![CDATA[Recovery at risk? Central and Eastern Europe remains vulnerable to external funding threats]]> http://www.bruegel.org/nc/events/event-detail/event/433-recovery-at-risk-central-and-eastern-europe-remains-vulnerable-to-external-funding-threats/ even433

Growth in most Central, Eastern and Southeastern European (CESEE) countries is recovering, but the region is facing an unusual constellation of external risks—potential escalation of geopolitical risks, possibility of protracted weak growth in the euro area, and further bouts of financial volatility along the path towards monetary policy normalization in advanced economies. At this event representatives from the IMF will present their report: Central, Eastern, and Southeastern Europe: External Funding Patterns and Risks. This report addresses three questions: (1) What countries/sectors are most reliant on external funding, especially less stable forms of funding or relatively few sources of funding? (2) What makes countries more vulnerable to external financial shocks? (3) How would tighter external financial conditions affect growth and debt dynamics in CESEE countries? The report also outlines related policy implications.


  • James Roaf, Senior Regional Representative for Central and Eastern Europe, IMF
  • Chair: Zsolt Darvas, Senior Fellow, Bruegel

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Wednesday 5 May, 2014, 12:45-14:30
  • Contact: Matilda Sevón, Events Manager - matilda.sevon[at]bruegel.org

Mon, 14 Apr 2014 14:29:07 +0100
<![CDATA[Appreciate the yuan depreciation]]> http://www.bruegel.org/nc/blog/detail/article/1303-appreciate-the-yuan-depreciation/ blog1303

This article was published in China Daily on 8 April 2014.

Since the beginning of this year, the renminbi has been depreciating against the US dollar. That marked a departure from the earlier trend of the Chinese currency appreciating against the US greenback since the exchange rate reform in 2005.

On Jan 15, the People's Bank of China's midpoint rate was 6.04 yuan for one US dollar. But by March 14, the same had fallen to 6.14 yuan. The bank announced that, effective March 17, the exchange rate would be allowed to rise or fall 2 percent from a daily midpoint rate set each morning by the central bank.

Since then the yuan has been on a downward spiral.

On March 21 the rate plummeted to 6.22 yuan. Compared with the exchange rate in mid-January, the yuan has depreciated more than 3 percent since then. However, the recent devaluation of the yuan is a rare phenomenon and there are several reasons for it.

Due to the US Federal Reserve's quantitative easing policy, short-term capital has been flowing out of emerging economies since the second half of last year, and currencies of emerging economies have been facing devaluation pressures.

Changes in the international environment have also weakened the expectations for yuan appreciation. Since January, the appreciation trend has slowed, or even moved onto a plateau. It is obvious that these changes have played a major role in the current round of devaluation.

Recent macroeconomic indicators have also triggered fears about the Chinese economy in the mid-term. In February, the growth rate of China's exports was minus 18.1 percent year-on-year. Even taking into account the effect of the Spring Festival, the numbers are still in the red. This is a major deviation from the earlier optimistic predictions.

In addition, during January and February, year-on-year growth in fixed asset investment was 17.9 percent, down 3.3 percentage points for the same period last year. More importantly, the added value of industrial enterprises' year -on-year growth in February fell to 8.8 percent, the lowest growth since April 2009.

At the same time, risks of a partial financial crisis are gradually emerging in China. Following the late payment crisis of China Credit Trust, the first corporate bond default of Chaori Solar, and the debt repayment crisis of a real estate company in Ningbo, downside macroeconomic indicators have promoted rising financial market risk factors.

International capital invested in China with a high leverage faces the prospect of a decline in yields and rising investment risks. These factors also hampered short-term capital inflows.

China's international payment imbalances are also further approaching equilibrium. In recent years, international net capital inflows and net outflows appear staggered, and the current account surplus has narrowed.

Among them, the current account surplus accounted for only 2.1 percent of last year's GDP. In February, China's trade deficit was $23 billion. However, due to the Chinese New Year effect, and a false trade base period last year, the volume of exports in the current account balance in 2014 is likely to be underestimated.

Taking into account all of these factors, it is clear that February's exports and the current account balance are still weak. From the perspective of the fundamentals of international payments, the yuan exchange rate has been relatively close to equilibrium.

For these reasons, it is unlikely that yuan will continue to lose its value over time. Moreover, after the People's Bank of China announced the expansion of yuan exchange rate volatility on March 15, the depreciation rate was expected to soar. However, the current rate is still modest, and a sharp depreciation of the currency exchange rate will not happen in China, as in some other emerging economies, because it is still within controllable means.

This is also because since the 2008 global financial crisis, short-term international capital inflows into China have been limited, while in countries such as Turkey, Mexico, and South Africa, net short-term capital inflows since the crisis have accounted for almost all of its foreign exchange reserves. In others countries such as India and Brazil it was nearly 50 percent. Though China's capital account has limited access, it has a huge pile of foreign exchange reserves. This mitigates the possibility of sharp exchange rate depreciation in China. Devaluation of the yuan will also help alleviate pressure on China's exports.

Since the second half of last year, most of the currencies in the emerging nations have depreciated against the US dollar. The yuan's depreciation against the dollar by 3 percent does not provide a strong impetus to fuel further growth in exports. Therefore, enhancing the competitiveness of enterprises should be the main focus at this stage.

However, the depreciation of the yuan is an important change since the exchange rate reform of 2005. Some analysts believe the central bank pulled the trigger. Although it is controversial, it is undeniable that unilateral yuan appreciation is expected to smooth into a two-way volatility change over the years.

For the central bank, its monetary policy independence will garner more space. In this case, in order to maintain the stability of the yuan against the dollar (1 percent in the volatility range), it needs to intervene more actively in the foreign exchange market.

Specifically, it should release more yuan and absorb more dollars in the foreign exchange market. Although the central bank has been carrying out effective hedging operations, its costs are also rising rapidly. After further liberalization of yuan exchange rate, the monetary policy can be relaxed further.

As for foreign trade enterprises, the exchange rate risks will not necessarily increase in the long term. The reason is simple: because 70 percent of China's exports cater to economies outside the United States. In the past, in order to maintain the stability of the yuan against the US dollar, there was always a compromise on the yuan's stability vis -a-vis the euro, Japanese yen, South Korean won and other currencies. In the next few years, the quantitative easing in the US will further weaken the yuan's dependence on the dollar and help stabilize the yuan's effective exchange rate.

In the international financial markets the yuan will have several new opportunities.

Countries that have close economic and trade relations with China will soon take into consideration the yuan fluctuations in their exchange rate formulation mechanism.

The currency appreciation will also promote the offshore, onshore yuan exchange rate forward market, and the development of derivatives markets.

Mon, 14 Apr 2014 12:47:06 +0100
<![CDATA[Blogs review: The wonk bubble]]> http://www.bruegel.org/nc/blog/detail/article/1302-blogs-review-the-wonk-bubble/ blog1302

What’s at stake: There’s been an interesting development phase in the news industry with fresh money being poured into ventures that want to become the next big thing in how America consumes content. As the supply for serious, empirical, and quantitative analysis of (so-far mostly US) policy grows, we’ll learn whether the demand for wonkery is big enough to make these ventures profitable and sustainable.

The rise of the wonk

Henning Meyer writes that the digital niche media market has entered another very interesting development phase, at least in the US. More and more well-known authors who made their names in the emerging digital age have left their mainstream publications to start smaller and more targeted publications with an edge.  Whether it was Nate Silver, who left The New York Times to build up his blog FiveThirtyEight, Glenn Greenwald, who left The Guardian to found The Intercept, or most recently Ezra Klein and Matt Yglesias who started Vox.com, there is a clear trend in this direction.

Felix Salmon writes that if you’re in the market for serious, empirical, quantitative analysis of national policy, the East Coast Media Elite has you covered like never before. Tess VandenDolder writes that the success of FiveThirtyEight and then Ezra Klein's Wonkblog on The Washington Post, has inspired many other major publications to try to build their own internal homes for data journalism. The New York Times is launching The Upshot, to focus heavily on visualizations, while The New Republic and the New Yorker are building special verticals within their respective sites to focus on the wonkish aspects of policy.

Michael Wolff calls this the auteur school – in which the business shifts from being organized by institutions to being organized around individual journalists with discrete followings. Andrew Sullivan, a blogger first at the Atlantic and then at the Daily Beast, may be the grandfather of the auteur school, leaving the Daily Beast a year ago to set up his own subscription site.

Technology and the development of explanatory journalism

Ezra Klein writes that the constraint of newness was crucial when the dominant technology was newsprint: limited space forces hard choices. You can't print a newspaper telling readers everything they need to know about the world, day after day. But you can print a newspaper telling them what they need to know about what happened on Monday. The web has no such limits. There's space to tell people both what happened today and what happened that led to today. But the software newsrooms have adopted in the digital age has too often reinforced a workflow built around the old medium. We've made the news faster, more beautiful, and more accessible. But in doing we've carried the constraints of an old technology over to a new one. In an interview, Ezra Klein explains that they want to be able to take the reader from not knowing anything about a subject to having a working understanding of it.

Joshua Gans writes that journalism has tended to be reactive rather than preparatory. That is, a news story breaks, there are some quick reports but no one really knows what is going on and the expert journalists don’t have time to explain it at the time. Then it evolves, more features get done and we reach some state of knowledge a few days later. Vox seems to be evolving towards a different model. Its ‘explaining cards’ are a form of preparation. They are things the journalists make and manage to keep up to date so that when a story or development breaks, they can easily refer to them. That means that when a reader becomes interested, the background information that is trusted is at hand. The cards themselves are pretty dry but, in the right place, at the right time can potentially help people understand what is going on a little better. Gaps in knowledge are filled and we can be brought up to speed.

Profitability and the wonk niche

John Gapper writes that suddenly, after a prolonged drought, fresh money is pouring into US digital news. The strange thing is where it is going. Instead of mass-market publications – the online equivalent of newspapers or network television – it is being directed to elite start-ups whose editors prefer hard-nosed analysis of data to splashy headlines. Felix Salmon writes that all of these ventures claim to be in it for the money: They’re for-profit entities that see real financial value in providing accessible wonkery to the online masses. But is that really credible? Is there any realistic hope that the tens of millions of dollars being poured into these sites will ever pay real dividends for the media companies hiring all these eggheads? Or is the Wonk Bubble just the latest bandwagon, an act of desperation from fearful executives who don’t want to seem behind the curve and who have no real idea what they’re doing?

Michael Wolff writes that the flight from journalist institutions has much to do, obviously, with what everyone assumes to be bleak futures within them. But, curiously, the escape is to an even more difficult economic landscape. At a cost per thousand advertising rate on the web or in mobile of $1 or $2 – pretty standard – Ezra Klein will make, optimistically, $8,000 a month, before expenses, if he has a million readers (assuming four page view per unique visitor). Klein apparently has the idea to build out his brand to encompass much more policy coverage, perhaps attracting more visitors and offering more pages to view. Still, it's hard to think how the 8-figure investment he is reportedly seeking, could ever, in a million years, pay off.

Tess VandenDolder summarizes Felix Salmon’s argument that the move toward data journalism is a sign of a media renaissance.


  1. News websites are built to provide "fast, accurate explanation and analysis of current policy debates."
  2. Advertisers crave the educated and affluent audience that reads wonkish content.
  3. Journalists are free to present their own opinions and analysis without worrying about objective reporting.
  4. There is a low cost to data journalism, since most information is parsed from other news sources.
  5. The wonk bubble is still small.

Felix Salmon writes that the Wonk Bubble might be inflating pretty fast right now, but it’s still tiny in comparison to the news business as a whole, which means it could potentially keep on growing at this pace for quite a while. The wonk niche is getting lots of headlines right now, mainly because so many high-profile pundits are changing employers or starting new projects. But it is still a niche, and a pretty small one at that. The same thing is likely to happen with the wonks. As the Wonk Bubble continues to grow, and online news organizations become more comfortable with this new form of journalism, you’ll increasingly find that the wonks’ journalistic techniques—the explainers, the charts, the accessible-yet-informed voice—will appear all over the news file. Eventually, a separate wonk site will feel as quaint as a separate blog site feels today. 

Felix Salmon writes that the more wonkery there is, the more valuable it becomes. Wonkery is like the diamond stores on New York’s 47th Street: Each one makes money not despite the nearby competition, but because of it. Back when wonkery was confined to the early-2000s blogosphere, it took real effort to seek it out, and the audience was primarily other bloggers. In the era of the social web, the potential audience for such material has grown by orders of magnitude.

John Gapper writes that one notable aspect of this trend is that it is confined to the US. Only the US has a big enough market, and sufficient venture and philanthropic capital to fund such experiments. The French-language market, for example, is having trouble supporting mass media, let alone intriguing niches.

Mon, 14 Apr 2014 07:58:15 +0100
<![CDATA[European external energy policy – re-orientation in times of crisis]]> http://www.bruegel.org/nc/events/event-detail/event/432-european-external-energy-policy-re-orientation-in-times-of-crisis/ even432

On EU external energy policy there has been a certain mismatch between ambition and instruments. On the one hand, there is a long-standing argument that the EU needs to develop ‘one voice’ towards foreign suppliers to improve its negotiation position and improve supply security (e.g., the proposal by Jaques Delors and Jerzy Buzek). On the other hand, the most tangible results of EU external energy policy were achieved by European initiatives such as the ‘Energy Charter’ and the ‘Energy Community’ that helped to gradually transform energy sectors in the European neighbourhood so as to make them more compatible with the EU energy market.With recent events in Ukraine, the discussion on re-orienting European external energy policy gained new momentum.

At this event we will discuss European external energy policy from three perspectives: (1) Małgorzata Kałużyńska (Director EU Economic Department at the Polish Ministry of Foreign Affairs) will address the issue from the perspective of a member state, (2) Dirk Buschle (Deputy Director Energy Community) will give a view from his international organisation and (3) Vsveolod Chentzov (Director at the Foreign Ministry of Ukraine) will the provide the perspective of a partner country. The three short presentations will be commented by Frank Umbach (EUCERS) before the floor is opened for discussion.


  • Małgorzata Kałużyńska, Director, EU Economic Department, Polish Ministry of Foreign Affairs
  • Dirk Buschle,Deputy Director, Energy Community
  • Vsveolod Chentzov, Director, Foreign Ministry of Ukraine
  • Discussant - Frank Umbach, Associate Director at the European Centre for Energy and Resource Security (EUCERS), King's College, London
  • Chair - Sami Andoura, Chair of European Energy Policy at the College of Europe

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Wednesday 14 May, 2014, 12:00-14:00
  • Contact: Matilda Sevón, Events Manager - matilda.sevon[at]bruegel.org

Fri, 11 Apr 2014 16:19:10 +0100
<![CDATA[Highlights from the IMF, World Bank Spring Meetings]]> http://www.bruegel.org/videos/detail/video/127-highlights-from-the-imf-world-bank-spring-meetings/ vide127

Nicolas Véron discusses the IMF, World Bank semi-annual meetings held this week in Washington. In this interview, he explains the IMF’s main focus on the US’s tightening of monetary conditions on emerging markets: “Investors are very concerned about this, but the IMF insists that emerging markets are very diverse. The fund is pushing investors to look at the fundamentals, to differentiate between countries. The question however is: will investors in capital markets reason that way or will they have herd behaviour, as it has happened in the past?”

Fri, 11 Apr 2014 10:32:58 +0100
<![CDATA[Why China’s haste to internationalise the renminbi?]]> http://www.bruegel.org/nc/blog/detail/article/1301-why-chinas-haste-to-internationalise-the-renminbi/ blog1301

Last week, the People’s Bank of China (PBC), the Chinese central bank, signed agreements with the Bundesbank and Bank of England, respectively, over the clearing and settlement of renminbi (RMB) payments in Frankfurt and London, marking an expansion of RMB payment facilities into the Europe trading zone. These moves come in the wake of similar PBC agreements with the monetary authorities in Hong Kong, Singapore and Taipei over the past few years. In this context, this blog raises two questions. The first is puzzling: why is Beijing in such a hurry to internationalise its inconvertible currency? The second is bigger: can the RMB acquire the status of an international currency?

The latest PBC agreements with Frankfurt and London signal that the external use of the RMB is gaining global momentum, expanding well beyond Hong Kong where a little noticed offshore RMB market first started a decade ago in 2004 when local residents were allowed to convert their Hong Kong dollars into RMB subject to a daily limit of twenty thousand RMB. This tiny offshore RMB market remained obscure and boring for five sleepy years until the global financial crisis. Then Beijing policymakers in 2009 suddenly got serious about promoting the wider international use of the Chinese currency.

A host of policy measures have since been put in place to expand the offshore RMB markets, initially in Hong Kong and now across major global and regional financial centres. First, the Chinese government in 2009 unveiled a pilot scheme of RMB settlement in cross-border trade and issued the first ever RMB-denominated treasury bonds in Hong Kong, aiming to establish an offshore benchmark RMB yield curve. Then, in 2010, all banks and corporations in Hong Kong were allowed to open RMB accounts and conduct RMB business. In addition, some central banks and commercial banks participating in RMB trade settlement and clearance were invited to participate in the onshore interbank bond market in China. In 2011, the first RMB-denominated corporate bond was issued in Hong Kong, and an experiment was launched to allow RMB-denominated outward and inward direct investment from and into China and to allow offshore RMB funds to be invested in onshore debt and stock markets under a quota. By 2012, any non-resident could open an RMB account and trade RMB products in Hong Kong. Over the past five years, the PBC has signed bilateral local currency swap agreements with more than twenty central banks, including the ECB and Bank of England, to provide backstops for RMB liquidity in case needed.

The Chinese government has been following a three-pronged approach to promoting the external use of the RMB. The first move was to encourage cross-border trade settlement in the RMB, even while China’s capital account was still heavily managed. This has facilitated cross-border RMB outflows from China to build up the initial offshore RMB liquidity pool in Hong Kong. The second has been selective and incremental capital account opening. The two-way cross-border financial RMB flows now also take place through the direct investment channel and via managed schemes of portfolio investment and bank loans. The third step has been the creation of offshore RMB markets where RMB products trade freely among non-residents. Once offshore, the RMB is now fully convertible, with most RMB products being traded freely. However, cross-border RMB flows are still managed.

The offshore RMB market has been moving along impressively after embarking on the active internationalisation path in only five years (Graph 1). Cross-border RMB trade settlement has expanded from nil before 2009 to a current level of some 15% of China’s total exports and imports. RMB deposits rose tenfold between 2008 and 2013 in Hong Kong, exceeding 10% of Hong Kong’s total bank deposits, although still below 1% of China’s total domestic bank deposits. RMB-denominated bonds outstanding in Hong Kong have also risen ten times to RMB350 billion (US$55bn). There is a wider range of RMB products now available offshore, including spot, FX derivatives, interest rate derivatives, certificates of deposit, loans, bonds and equity-linked products. The RMB was the ninth most traded currency in 2013, up from 29th in 2004, according to the BIS Triennial Central Bank Surveys (Table 4). Geographically, offshore RMB markets have spread from Hong Kong to Taipei, Singapore, London and now Paris and Frankfurt. Some 20 central banks have reportedly invested part of their reserves in China’s onshore interbank bond market, and more have gained RMB exposure via Hong Kong.

So a puzzling question begs why there has been such haste since 2009 for Beijing policymakers to promote the international use of the Chinese currency that at least then was still far from convertible, heavily managed and according to some, misaligned or outright undervalued. Even today, the RMB arguably remains so to some extent. This is not to mention that China’s domestic financial market still has a long way to go to match its international peers (McCauley (2011)). Is the RMB internationalisation a bit precocious? Some media commentators also speculated about Beijing’s intention to seize the moment of crisis to challenge the US dollar as a dominant reserve currency. On the other hand, some Chinese academic sceptics have expressed reservations about a strategy to rush the RMB internationalisation, arguing that this is risky and no more than a stealth two-track capital account opening that permits cross-border arbitrage between onshore and offshore RMB exchange rates and interest rates.

On the other hand, one can argue that Beijing could leverage its strength on other fronts to facilitate the external use of the RMB. Globally, China is the top trader, the second largest economy and second biggest international net creditor, with a strong record of economic growth and inflation. Also, some existing impediments are neither insurmountable nor as serious as often assumed. For example, a fully internationalised currency does eventually require capital account convertibility. Yet the offshore RMB market could still expand meaningfully for some time, while the Chinese capital account remains regulated. Moreover, the PBC is currently preparing new capital account liberalisation measures. Also, while a heavily managed RMB may not appeal to reserve managers who seek currency diversification, neither does an extremely volatile RMB. The recent policy moves by the PBC to instil some two-sided market volatilities and to widen the daily RMB trading band are steps in the right direction if done in a measured manner. Finally, as to possible exchange rate misalignments, I am not fully convinced that the RMB today remains meaningfully undervalued, as it has appreciated 40% in real effective terms since the 2005 de-pegging and perhaps more than 50% if measured in relative unit labour cost (Ma et al, 2012).

In my view, there are at least three possible and complementary reasons why Chinese policymakers have proactively encouraged the internationalisation of the RMB since the global financial crisis. First, the wider external use of the RMB would allow China to better share currency risk with the rest of the world, mitigating the country’s huge long-dollar and short-RMB position (Cheung et al (2011); and Ma and McCauley (2013)). China’s net long dollar (and euro) exposure could potentially reach 50% of its GDP. A more widely used RMB may help denominate more of China’s external claims and lessen the currency mismatch. Second, a more internationalised RMB may spur further domestic financial liberalisation, a parallel being China’s preparation for WTO accession in 2001, which helped remove many impediments to domestic market liberalisation. This argument has been controversial in China. And third, China may aim to one day have the RMB become one of the important reserve currencies, such as those that make up the SDR, and thus join the group of countries forming the core of the international monetary system. In all, Beijing appears to have no ambition to challenge the current international monetary system and instead wants to become a serious stakeholder.

So, while the puzzling question regarding Beijing’s possible motives would remain debated for some time, the bigger question is whether and how quickly the RMB can achieve the status of an international currency. There are three pivotal factors here. First, China still faces with the challenging task of achieving a deep and liquid domestic financial market and open capital account, in addition to containing the domestic financial imbalances that have built up in recent years. Second, the prospect of a greater global role for the Chinese currency also in part depends on the evolving fundamentals of the incumbent global reserve currencies. Third, potential slots for major international currencies are likely limited. While a global portfolio with additional currencies may yield greater diversification benefits, managing its currency risks could also become more costly, given the externalities of the network effects in the currency market. Presumably, there would be only a small, optimal number of currencies in a typical global portfolio.



Cheung, YW, G Ma and R McCauley (2011): “Renminbising China’s Foreign Assets”, Pacific Economic Review, Vol 16, No 1, pp 1-17.  

Ma, G and R MCauley (2013): “Global and euro imbalances: China and Germany”, in M Balling and E Gnan (ed), SUERF 50 Years of Money and Finance: Lessons and Challenges, pp 43-72.

Ma, G, R McCauley and L Lam (2012): “Narrowing China’s current account surplus: the roles of saving, investment and the renminbi”, in H McKay and L Song (ed), Rebalancing and Sustaining Growth in China, The Australian National University Press.

McCauley, R (2011): “Renminbi internationalisation and China's financial development”, BIS Quarterly Review, December, pp 41-56. 

Fri, 11 Apr 2014 09:22:33 +0100
<![CDATA[Chart of the week: IMF forecasts euro area inflation to stay well below 2% target for years to come]]> http://www.bruegel.org/nc/blog/detail/article/1300-chart-of-the-week-imf-forecasts-euro-area-inflation-to-stay-well-below-2-percent-target-for-years-to-come/ blog1300

In the April 2014 update of the World Economic Outlook (WEO) released this week, the International Monetary Fund (IMF) forecasts a fall in the average inflation for the euro area to 0.9% in 2014, down from 1.3% in 2013. For 2015 and 2016, inflation is expected to remain well below the 2% policy rate, at approximately 1.2% and 1.3%. While the fall in inflation for 2014 was largely anticipated in recent estimates released by Eurostat, the IMF forecasts might be taken as further support for the claim that inflation will be lower than 2% in the medium term. Indeed, the IMF forecasts usually display a strong mean-reverting behaviour, i.e. a speedy convergence to the long term inflation rate, which in case of the euro area is anchored at below but close to 2%. This trend is quite apparent when we check the realized inflation against each year’s April forecasts from the IMF. This time however, the IMF recognizes that given the bleak outlook for the euro area real economy, if the ECB continues with its relatively hawkish monetary policy approach it will take 5 years for inflation to converge to just 1.5%.

Average euro area Inflation percent change in different vintages of IMF WEO

Source: IMF WEOs

Thu, 10 Apr 2014 10:35:31 +0100
<![CDATA[Could Russia's troubles affect the world economy?]]> http://www.bruegel.org/nc/blog/detail/article/1299-could-russias-troubles-affect-the-world-economy/ blog1299

Read also comments 'Can Europe survive without Russian gas?' and 'The cost of escalating sanctions on Russia over Ukraine and Crimea'

The sanctions applied by the European Union and the United States against Russia in retaliation for its annexation of Crimea might seem relatively mild, but they are a sign of deteriorating confidence in Russia as an economic partner, which in the longer term could progressively undermine the Russian economy. This in turn raises the question of a global spillover from a potential Russian crisis through real-economy channels.

But although Russia is the world's eighth largest economy, ranked between Brazil and Italy in GDP terms (IMF, 2013, in US$), there are limited grounds to fear a global spillover, for five reasons:

First: Despite Russia's economic rank, it generates slightly less than 3 percent of global economic output, at approximately US$ 2000 billion. Russia thus poses a limited systemic threat.

Second: Russia is relatively well integrated into international trade flows. Imports and exports of goods correspond to slightly more than 40 percent of GDP (compared to trade-intensity in Germany: 75 percent, and in the US: 25 percent). However, Russia plays the smallest role of all WTO/OECD countries in global value chains. While in Germany the value of exported goods is up to 30 percent of imported intermediate products, in Russia it is less than 10 percent. Only in Russia's automotive industry is this ratio up to 20 percent. Hence, an economic crisis in Russia would have little impact on foreign suppliers – there are hardly any.

Figure: Domestic value added content of gross exports, %

Source: OECD

Third: An economic crisis in Russia would have little impact on the country's exports. Russian foreign trade is heavily biased towards energy, raw materials and agricultural commodities . In terms of value, the greatest share of Russia's exported goods is indistinguishable from corresponding foreign products. Other countries could step into any breach created by a decline in Russian exports. Depending on the depth of the decline, however, there would be an impact on world market prices (see my blogpost on replacing natural gas exports). Nevertheless, a major decline in energy and commodity exports in particular is not expected because continued use of the existing and very profitable plants is likely even in the case of a severe economic crisis. Only in arms exports might the main importers, such as Venezuela, Syria and Algeria, find it hard to replace Russian goods.

Table: Top ten export categories 2012

Export category

% of total exports

In million US$


Mineral fuels, mineral oils and products of their distillation




Iron and steel




Natural or cultured pearls, precious or semi-precious stones, precious metals, metals clad with precious metal, and articles thereof








Inorganic chemicals




Nuclear reactors, boilers, machinery and mechanical appliances




Aluminium and articles thereof




Wood and articles of wood








Copper and articles thereof




Fourth: Russia's huge revenues from energy exports allow it to act as a major buyer on global markets. In 2012, Russia imported goods amounting to US$ 300 billion – the GDP of Denmark. But Russia is a pick-and-mix purchaser. Few countries sell more than one-twentieth of their exports to Russia. These are – in addition to nine former Soviet republics – Poland, Serbia, Finland, Uruguay and Paraguay.

In addition to these countries that would be directly affected by reduced exports to Russia, there could be second-round effects – countries selling goods to the countries that export more than 5 percent to Russia might also be affected.

Table: Countries that sell more than 5 percent of their exports to Russia, 2012

























Rep. of Moldova




Source: UN Conmtrade

Fifth and finally, foreign firms in Russia might lose (a part of) their business there. There are many prominent and visible examples of foreign investors ranging from the Carlsberg brewery to Volkswagen (see stories in the FT and the Spiegel). But one has to put these exposures into context. Russia has been much less able to attract foreign direct investment than other countries of its size. For 2012 the OECD reported that the stock of foreign direct investment to Russia amounted to US$ 137 billion. This is about a third of what Brazil was able to attract (US$ 354 billion) and about the same level as Poland (US$ 118 billion).

A post-Crimea Russian economic crisis is hardly desirable, not least because of the internal instability that it might provoke. But it would be unlikely to have substantial direct spillovers onto trading partners. Shock-transmission through the financial sector is another concern discussed by Silvia Merler in a previous blogpost.

Assistance by Olga Tschekassin is gratefully acknowledged.

Tue, 08 Apr 2014 08:59:37 +0100
<![CDATA[Japan and the EU in the global economy]]> http://www.bruegel.org/publications/publication-detail/publication/824-japan-and-the-eu-in-the-global-economy/ publ824

Why is Japan a good case study to help Europe overcome the economic and financial crisis that started more than five years ago? What can Japan learn from Europe's experience?

Japan and the EU are both open economies with significant trade and financial links; both face in many respects similar challenges. Both economies are affected by the rise of emerging market economies, which represent a huge opportunity but also imply the need to continuously adapt the production structure to the new competition. Both economies also face comparable internal economic adjustments.

This report sets out to address these issues, and to identify some of the channels through which Europe can learn from Japan, and viceversa. It is the final output of a strategic European Union-Japan research partnership, involving Kobe University and Bruegel with selected outside contributors from Japanese and European government and policy institutions.

This publication compiles a collection of papers presented at Bruegel's event Japan and the EU in the global economy - challenges and opportunities

Japan and the EU in the global economy (English)
Tue, 08 Apr 2014 07:12:50 +0100
<![CDATA[Ukraine's currency crash]]> http://www.bruegel.org/nc/blog/detail/article/1297-ukraines-currency-crash/ blog1297

Ukraine’s crisis of politics and territorial integrity has left its mark on the exchange rate of Ukraine’s currency, the Hryvnia. From 2009 until the protests on Maidan square intensified towards the end of 2013, the Hryvnia had a quite stable rate against the US dollar of around 8, but over the past three months, about one-third of its value relative to the dollar has been lost (Figure 1), reaching a rate of 11.6 Hryvnia to 1 USD on April 4th. The exchange rate continued to fall during recent days, suggesting the bottom has not been reached yet.

How has the value of Hryvnia changed against the basket of its trading partners’ currencies? We used the recently updated Bruegel database on real effective exchange rates (REER) to answer this question. This database includes data up to March 2014. 

In order to get a first impression on developments in the first days of April, we approximated an April 2014 REER by using the average exchange rate from the 1st to the 4th of April (see further details in the notes to Figure 2). Figure 2 shows a dramatic depreciation of the Hryvnia: its real value against the basket of 138 trading partners’ currencies fell by 27 percent from December 2013 to April 2014 and the April 2014 value is the lowest since January 1995. The currencies of some other former Soviet Union countries have also fallen in the same period, such as in Russia, Kazakhstan and Kyrgyzstan, though the Russian Rouble recovered somewhat at the beginning of April. Not all the currencies of former Soviet countries have fallen however, as indicated by Panel B of Figure 2.

The major currency fall that Ukraine has experienced will reduce imports by making them more expensive in Hryvnia. It could stimulate exports, if exporters are able to respond by producing more and lowering their export prices quoted in foreign currency units. But there is a significant danger that the major collapse of Ukraine’s currency will wreak havoc to Ukraine's financial system, its economy and its people (see also David Saha's blogs review on the Ukrainian economy). 

According to the EBRD’s vulnerability indicators, Ukraine’s external debt amounted to 77 percent of GDP in 2012 – a relatively large figure –, a ratio that has most likely increased due to the collapse of the currency (external borrowing is typically made in foreign currencies, while the foreign currency value of GDP falls with the collapse of the exchange rate). This makes it more difficult to service external debt. 

While the share of domestic bank loans to the private sector is not that high, 21 percent of GDP, 38 percent of these loans were granted in foreign currencies and thereby borrowers (ie households and companies) will find it much more difficult to service their debt as well. The share of non-performing loans, which was already at a very high level at 21 percent of total loans, will likely increase further and thereby undermine the stability of the banking sector. A weaker banking sector could in turn have a negative impact on the economy, lower output, employment and thereby could culminate in a banking crisis. 

Inflation is also likely to accelerate after such a major currency fall, with adverse impacts on the investment climate and poorer people, who used to consume a larger share of their income. It's therefore fair to say that Ukraine’s economic challenges are mounting, yet as Ricardo Giucci and Georg Zachmann argue, the current critical situation of the country also provides a great opportunity for sweeping reforms.

Figure 1: Daily nominal exchange rates against the US Dollar, 1 January 2013 – 4 April 2014 (1 January 2013 = 100)

Source: Datastream. Note: a decline in the index indicates depreciation of the home currency against the US dollar.

Figure 2: Monthly consumer price index based real effective exchange rates, January 1995-April 2014 (December 2007 = 100)

Source: Bruegel. Note: the real effective exchange rate was calculated against 138 trading partners. The March 2014 REER is based on the actual March 2014 nominal exchange (average of all business days of the month) and a projected March price consumer level, for which we assumed that the 12-month inflation rate was the same in March 2014 as in February 2013. Therefore, the March 2014 REER will be revised when the March 2014 inflation figures will be published (this revision may not be large). The April 2014 REER is based on the average exchange rates of 1-4 April 2014 and a projected priced level for April. Therefore, the April 2014 REER will also be also subject to revision if nominal exchanger rates will change after the 4th of April. A decline in the index indicates real depreciation of the home currency against the basket of trading partners’ currencies.

Mon, 07 Apr 2014 16:26:40 +0100
<![CDATA[Blogs review: High frequency trading]]> http://www.bruegel.org/nc/blog/detail/article/1296-blogs-review-high-frequency-trading/ blog1296

What’s at stake: Michael Lewis’ new book “Flash Boys: A Wall Street Revolt” has unleashed a huge controversy about the economic benefits and costs of high frequency trading (HFT). For the author, this new breed of traders use sophisticated algorithms and fast computers to effectively front-run trades, a practice that is illegal if performed by humans but which remains legal if performed by computers.

The emergence of HFTs

Justin Fox writes that while the rest of the stock market world was still operating in terms of minutes and seconds, the HFTers (led by two Chicago-based firms, hedge-fund giant Citadel and upstart GETCO, now called KCG) found a whole new world of profit in the milliseconds and microseconds between when orders were placed and filled. Thanks to their early success, and the regulatory push that had broken the NYSE/Nasdaq duopoly into a scrum of competing exchanges, the HFTers were then able to get exchanges and brokers to craft all sorts of new ways for them to make money. Eric Hunsader explains that Regulation NMS issued in 2007 by the SEC took x amount of available stock at one place, and made it one tenth of that x at ten different places.

Wonkblog writes that sophisticated and expensive computers allow high-frequency traders to take advantage of minuscule differences in price among the many exchanges where securities are bought and sold. Some firms pay to place their computers on the site of a stock exchange to be sure their access to price data is as fast as possible, a practice known as colocation; others will use technology to obscure their trading intentions for a few crucial thousandths of a second.

Felix Salmon writes that the scale of the HFT problem — and the amount of money being made by the HFT industry — is in sharp decline: there was big money to be made once upon a time, but nowadays it’s not really there anymore. Lewis’ book appears to be an exposé not of high-frequency trading as it exists today, but rather of high-frequency trading as it existed during its brief heyday circa 2008.

Front running and dark pools

Dean Baker writes that Michael Lewis' basic story is that a new breed of traders can use sophisticated algorithms and super fast computers to effectively front-run trades. This allows them to make large amounts of money by essentially skimming off the margins. By selling ahead of a big trade, they will push down the price that trader receives for their stock by a fraction of a percent. Similarly, by buying ahead of a big trade, they will also raise the price paid for that trade by a fraction of a percent. Since these trades are essentially a sure bet (they know that a big sell order or a big buy order is coming), the profits can be enormous.

Michael Lewis writes that it used to be that when trading screens showed 10,000 shares of Intel offered at $22 a share, it meant that one could buy 10,000 shares of Intel for $22 a share by only pushing a button. By the spring of 2007, however, when one pushed the button to complete a trade, the offerings would all disappear, and the stock would pop higher. What happened was that HFTs were taking advantage of the different time it took orders to travel a trading desk in the World Financial Center to the various exchanges.

The Economist writes that the HFTs’ trading edge comes from two different sources. When an investor presses the button to deal, that signal is sent to a broker or bank, who in turn is supposed to search the many different stock exchanges for the best price. But because of the time taken for trading signals to be sent down the wire, those orders arrive at different stock exchanges at separate times. The HFTs were sitting in wait, and used their advantage to exploit the time differences. The second edge comes from the existence of “dark pools” — trading venues set up, usually by banks, which were designed to give investors anonymity. But banks, says Mr Lewis, have been allowing HFTs access to those pools in return for a fee, allowing them to prey on unsuspecting investors.

Who ends up being harmed by HFTs?

Craig Pirrong writes that although this has been framed as evil computer geniuses taking money from small investors, this isn’t at all the case. If anyone benefits from the tightening of spreads, especially for small trade sizes, it is small investors. Instead, the battle is mainly part of the struggle between large institutional investors and HFT. Large traders want to conceal their trading intentions to avoid price impact. Other traders from time immemorial have attempted to determine those trading intentions, and profit by trading before and against the institutional traders.  Nowadays, some HFT traders attempt to sniff out institutional orders, and profit from that information.  Information about order flow is the lifeblood of those who make markets.

Matthew Philips writes that the idea that retail investors are losing out to sophisticated speed traders is an old claim in the debate over HFT, and it’s pretty much been discredited. Speed traders aren’t competing against the ETrade guy, they’re competing with each other to fill the ETrade guy’s order. Felix Salmon writes that small investors are helped by HFT: they get filled immediately, at NBBO. (NBBO is National Best Bid/Offer: basically, the very best price in the market.) It’s big investors who get hurt by HFT: because they need more stock than is immediately available, the algobots can try to front-run their trades.

The distinction between non-public information and inside information

Craig Pirrong writes that the FBI is investigating whether HFT trades on “non-public information”.  Well, “non-public information” is not necessarily “inside information” which is illegal to trade on:  inside information typically relates to that obtained from someone with a fiduciary duty to shareholders. Indeed, ferreting out non-public information contributes to price discovery: raising the risk of prosecution for trading on information obtained through research or other means, but which is not obtained from someone with a fiduciary relationship to a company, is a dangerous slippery slope that could severely interfere with the operation of the market. If firms trade on the basis of such information that can be obtained for a price that not everyone is willing to pay, and that is deemed illegal, how would trading on the basis of what’s on a Bloomberg terminal be any different?

Dean Baker writes that, like insider trading, HFTs is rewarding people for doing nothing productive. Many analysts may carefully study weather patterns to get an estimate of the size of the wheat crop and then either buy or sell wheat based on what they have learned about the about this year's crop relative to the generally held view. In principle, we can view the rewards for this activity as being warranted since they are effectively providing information to the market with the their trades. If they recognize an abundant wheat crop will lead to lower prices, their sales of wheat will cause the price to fall before it would otherwise, thereby allowing the markets to adjust more quickly. The gains to the economy may not in all cases be equal to the private gains to these traders, but at least they are providing some service. By contrast, the front-running high speed trader, like the inside trader, is providing no information to the market. They are causing the price of stocks to adjust milliseconds more quickly than would otherwise be the case. It is implausible that this can provide any benefit to the economy.

Transaction costs and systemic risk

Charles Jones writes that the key question is whether HFT improves liquidity and reduces transaction costs, and economic theory identifies several ways that HFT could affect liquidity. The main positive is that HFT can intermediate trades at lower cost. Those lower costs from automation can be passed on to investors in the form of narrower bid-ask spreads and smaller commissions. The potential negative is that the speed of HFT could put other market participants at a disadvantage. The resulting adverse selection could reduce market quality. There is also the potential for an unproductive arms race among HFT firms racing to be fastest.

Tom Lin writes that the emergence of cyborg finance has borne two new systemic risks: one related to connectivity, “too linked to fail”, and the other related to speed, “too fast to save.”

Mon, 07 Apr 2014 08:31:09 +0100
<![CDATA[Discussion: Can border carbon taxes fit into the global trade regime?]]> http://www.bruegel.org/nc/blog/detail/article/1295-discussion-can-border-carbon-taxes-fit-into-the-global-trade-regime/ blog1295

Reinhard Quick – Director Brussels Office of the German Chemical Industry Association, as well as a well-known trade specialist in Brussels and Honorary Professor for international economic law, Saarland University – discusses the policy brief “Can border carbon taxes fit into the global trade regime?” authored by Henrik Horn, Non Resident Scholar at Bruegel, and André Sapir, Senior Fellow at Bruegel. Quick has authored several papers on the topic including “The Debate Continues: Are Border Adjustments of Emission Trading Schemes a Means to Protect the Climate or are they ‘Naked’ Protectionism?” published in Trade and Competition Law in the EU and Beyond (2011).

I have read with great interest the Bruegel Policy Brief “Can border carbon taxes fit into the global trade regime?” It is a remarkable document showing the difficulties countries face when implementing such measures. I am however quite astonished that after rightly and intensively criticising border carbon taxes, you come to the conclusion that such instruments could nevertheless be put in place. I would have preferred a clear statement recommending that border carbon adjustments (BCAs) not be pursued, since politicians could use or abuse your analysis to justify protectionist measures.

- Reinhard Quick

Many thanks for your careful comments on our Policy Brief. Given our training as trade economists, and experience from actual policy making and from working at the WTO, we are of course very sympathetic to your concern that BCAs will be used for protectionism. Indeed, this concern was the reason why we started working on the issue. At the same time, there is obviously a looming climate problem, which implies that the standard prescription concerning the optimality of free trade might not necessarily hold any more. This does not lead to the immediate conclusion that trade restrictions should be imposed in practice.

Regarding the use politicians could make of our analysis, we disagree. Politicians would not draw on our Brief to defend protectionist measures, but they would find in it arguments to show that although BCAs can be designed in a non-protectionist manner, it would be difficult to do so in practice. There is a vast amount of literature on BCAs in environmental economics - we are aware of at least 200 papers, but there are many, many more - that purports to demonstrate the various benefits (and much more rarely the drawbacks) of using BCAs. These analyses are methodologically as solid as those in the trade field, and therefore cannot be dismissed off-hand.

- Henrik Horn and André Sapir

I have my doubts whether such a system could be construed in a way that is compatible with the World Trade Organization’s (WTO) framework. I tackle this in my article [mentioned above] about the proposal made by some officials in the Commission during the revision of the Emissions Trading System (ETS) scheme, the so-called ‘FAIR’ scheme. I come to the conclusion that ‘FAIR’ would have been an unjustifiable violation of the European Union’s WTO obligation.

- Quick

As economists, our intention was not to argue about the legality of BCAs. We are aware of the fact that some prominent trade lawyers are skeptical about BCAs, but other equally prominent ones hold the opposite view.

- Horn and Sapir

Notwithstanding my job as a lobbyist for an energy-intensive industry, which allegedly could benefit from BCAs, as a trade lawyer I fundamentally disagree with introducing them. You are certainly aware that the Kiel Policy Brief - published by the Kiel Institute for World Economy - argues that border carbon adjustments should not be considered an instrument of choice in international climate policy.

- Quick

We completely agree.

- Horn and Sapir

Your first point, the extraterritorial feature of the system, is a valid one. However, as the WTO’s Appellate Body has stated, as long as the country taking the measure can demonstrate a “sufficient nexus” the argument of an extra-jurisdictional limitation of the Article XX of the General Agreement on Tariff and Trade (GATT) can hardly be made. Would any CO2-emission be enough to establish a sufficient nexus? Or would it be necessary to determine a benchmark for the amount of CO2 considered “sufficient”?

- Quick

We agree of course on the sufficient nexus / USShrimps parallel. But our point is that the arguments for BCAs do not point to any nexus at all. In fact, such arguments typically seem oblivious altogether to the legal requirement for this nexus. It seems to us that the existence of climate externalities creates such a nexus, however. Additionally, we assume that the Appellate Body would be uncomfortable with striking down a BCA, if it is clearly motivated by a climate concern, and that it would instead do something creative to avoid it.

- Horn and Sapir

I find it more challenging to answer the question of whether the measure is ‘necessary’ under GATT Article XX (b) or ‘related’ under GATT Article XX (g). If in spite of implementing a European BCA, the world continues to emit as much or even more CO2 than without the measure, one could probably question whether the basic requirements of Article XX (b) and (g) are met.

- Quick

A strong version of the leakage argument holds that domestic climate policy might worsen the climate, if the leakage problem is severe enough. But it is harder to see how the BCA itself could worsen the problem, economically speaking. With this, we are not trying to deny the problem of defining the limits of the term “necessary” in Art. XX. For instance, does it include the case where a BCA is “necessary” in order to coerce other countries to pursue stricter climate policies?

- Horn and Sapir

It is not likely that the world would accept a multilateral agreement on how border carbon measures could be implemented. Without such an agreement, BCAs will be considered unilateral trade measures and those measures can and will probably be challenged under WTO.

- Quick

Yes, it is of course highly unlikely that there will be sufficient support for such an agreement. But it might not be more utopic than a multilateral climate agreement with some bite.

- Horn and Sapir

I agree with your second point on ‘leakage’. Where in legal terms do we find an environmental justification that we should avoid ‘leakage’? Where is the international reference that a country can take measures to avoid leakage?

According to my understanding, the United Nations Framework Convention on Climate Change (UNFCCC) explicitly accepts leakage because of the notion of common but differentiated responsibilities. The industrialised world has to do more against climate change than the developing world. Again, the fundamental argument against leakage is that it will have no effect on CO2 reduction, unless BCAs are used by a large number of countries.

Given that emerging countries, in particular, have new and old production facilities, a BCA taken only by the EU would just lead to trade diversion. The products fabricated at the high-tech installations would be exported to the EU notwithstanding BCA, and those from dirtier facilities would be exported to the rest of the world. The BCA would, therefore, have no effect on reducing CO2-emissions.

- Quick

We would guess that in the scenario you discuss, the trade diversion would not completely undo the gains in terms of reduced emissions: an EU tax on dirty production would effectively constitute a reduction of global demand for such products, and in turn reduce global production, as long as the supply of this product is not completely inelastic.

- Horn and Sapir

The fundamental issue is not leakage, but who should bear the cost of a domestic regulation. It is internationally understood that the cost of environmental media legislation should be borne by domestic producers and not by importers. There is no convincing environmental argument for allowing adjustments for climate change purposes, when they are still considered illegal for air, water, soil, waste, and installations.

- Quick

We do not believe that “adjustments” are motivated for any policy. It is a different matter, however, to regulate activities with negative externalities. This clearly should be done, if the externalities are large enough, and the policy tools available are sufficiently sharp.

- Horn and Sapir

I disagree with your tariffs analysis. Should tariffs reflect climate externalities and other societal goals? I do not think so. From my understanding of the WTO law, the only purpose of a tariff is the protection of a domestic industry. The WTO does not envisage tariffs to promote societal goals. If that were the case, the WTO would recognise tariff increases for societal purposes. Yet the WTO wants tariffs to be reduced and eventually eliminated.

- Quick

In our view, there is nothing in the WTO that implies that tariffs be imposed for any particular reason - in contrast to some domestic policy instruments. Members negotiate tariff levels without having to defend their political preferences in this regard. The WTO is based on the notion that gradual trade liberalisation is desirable, but it does not require or imply total elimination of tariffs on all products. And from an economic point of view, tariffs can be desirable to promote global efficiency, provided there are distortions that can be at least partly remedied through trade restrictions. Almost all economists agree that in practice the situations where trade barriers would have such effects are rare, especially when taking into consideration that such barriers are likely to be in the interest of protectionism.

- Horn and Sapir

The resolution to an environmental issue can and should not imply tariff increases. How would you then define ‘most polluting products’? Tariffs are applied on a Most Favoured Nation (MFN) basis on products, not taking production processes into account. As far as climate mitigation measures are concerned, they need to be applied as part of the production process and not on products per se.

- Quick

Trade measures are obviously not the best way of tackling climate problems. The only attractive aspect of the “adjustment” notion in BCAs is that they are seen as complements to domestic measures. With regard to how they are levied, the fact that they are production process measures implies they are not taxes on specific products, but on emissions sent out during production.

- Horn and Sapir

Let me give you several examples from the chemical industry – an energy intensive industry. Many of our products are needed for so-called environmental goods, yet the input is probably not as environmentally sound as the end product. You cannot build a wind-turbine, a solar panel, a fuel efficient car, or even a fully electrical car without chemicals. However, the production of these chemicals might be quite energy intensive and therefore negative from a climate change mitigation view.

So what would your choice be? Increasing tariffs on input products needed to produce those goods you want to promote? This idea would go against the promotion of global value chains which both the OECD and the WTO vigorously defend.

- Quick

This is a very telling example of the practical difficulties of designing any type of border measure in a way that it hits where it should. It would have fitted nicely into our Brief!

- Horn and Sapir

If the EU is the only one that applies BCAs and if they work properly, they will benefit domestic industries solely. These measures will therefore be nothing but naked protectionism.

- Quick

A large part of the aforementioned vast literature on BCAs seeks to quantify the effects of BCAs for the EU, for instance. The results are far from conclusive. Some (perhaps most) studies suggest moderate positive effects for the climate. Whether BCAs in practice would be implemented to reap such benefits, or for protectionist motives, is a different issue. If implemented, this would most likely result from interplay between various political interests.

- Horn and Sapir

Fri, 04 Apr 2014 07:12:25 +0100
<![CDATA[Europe's social problems]]> http://www.bruegel.org/videos/detail/video/126-europes-social-problems/ vide126

What was the impact of the crisis in Europe's social problems? Bruegel Director Guntram Wolff and Senior Fellow Zsolt Darvas discuss a study that was presented to the Finance Ministers gathered at Greece's Informal Ecofin.

Thu, 03 Apr 2014 12:32:38 +0100
<![CDATA[Is there a risk of deflation in the euro area?]]> http://www.bruegel.org/nc/blog/detail/article/1293-is-there-a-risk-of-deflation-in-the-euro-area/ blog1293

This is a policy question of high relevance as low inflation rates can undermine the sustainability of public and private debt, make relative price adjustment in the euro area more difficult, and eventually risk creating negative economic dynamics. We review some of the recent evidence and focus in particular on the heterogeneity of inflation developments in the euro area, the expectations of inflation measures and a measure recently used by Mario Draghi, namely the number of items in the HICP basket that are in deflation. We draw a parallel to Japan, where this measure was a useful indicator of deflation.

Inflation developments in the euro area

Panel A of Figure 1 shows that headline inflation has been on a downward trend in the euro area since late 2011. Core inflation – which excludes more volatile components of HICP, namely unprocessed food and energy – shows the same tendency (Panel C).

Figure 1: Inflationary developments in the euro area, January 1999 – February 2014 (percent change from the same month of previous year)


Panel A: Headline inflation

Panel B: Constant tax inflation

Panel C: Core inflation


Source: Eurostat. Note: core inflation is defined as the ‘Overall index excluding energy and unprocessed food’. Data for core inflation in Slovakia is not available for the full period and therefore this country is not included in the second group. The constant-tax inflation rate is not available for Ireland and Finish data starts only in 2006.

Figure 1 also indicates the existence of major differences across euro-area countries. Countries in the so-called euro area periphery (defined here as Cyprus, Greece, Ireland, Italy, Spain and Portugal) recorded higher inflation rates than the other euro-counties before the crisis and most of them have been experiencing lower inflation rates since 2012. Panel B of Figure 1 shows inflation at constant tax rates, i.e. excluding the potential impact of the increase in consumption taxes (value added taxes and other duties). Correcting for tax-hikes points to more marked deflationary tendencies in the most vulnerable countries since 2012.

Country-level inflation data (figure 2) indicates that some countries are already experiencing outright deflation. Greece and Cyprus entered deflation in March 2013 and October 2013 respectively, and stayed in negative territory thereafter. In February 2014, the Spanish and Irish HICP rates dropped to 0.1%, while Portugal and Slovakia (not shown in the graph) entered negative territory (-0.1% respectively). And the first estimate for the Spanish inflation in March indicates that the country may have also entered deflation, with the HICP rate estimated to fall to -0.3% (INE, March 2014) . Overall, a downward trend in inflation rates is clearly visible, even in the core countries.

Figure 2 – Inflation developments in selected countries, Jan 2012 – Feb 2014 (percent change from the same month of previous year)

Source: Eurostat

During the February 2014 monthly press conference, ECB’s President Draghi pointed out that the ECB does not see “much of a similarity with the situation in Japan in the 1990s and early 2000s” as “during the period of deflation in Japan, over 60% of all commodities experienced a decline in prices” while “the percentage for the euro are much lower”. The data show that the number of items considered for the calculation of the harmonised index of consumer price index (HICP) that are in deflation has increased significantly in recent months to about 20%. This share is much lower than the Japanese share of about 50-60% between 2000 and 2004 and between 2009 and 2012. Interestingly, in 2004-2005 also approximately 20% of the items were in deflation in the euro area, at a time when the headline inflation was about 2%. From this perspective, the euro area seems to be still far away from a Japanese scenario, where deflation was broad-based, as Mario Draghi pointed out.

Figure 3, HICP basket, items count

Source: Bruegel calculations based on Statistics Bureau of Japan, Eurostat, OECD

Inflation expectations

Over the recent months, the ECB has continually stressed that inflation expectations remain well anchored at 2%, and that more forceful action is therefore not needed. Indeed, Figure 4 shows that inflation expectations for the long-term fell only slightly, but this is less true for the shorter term. Professional forecasters have been revising their forecasts downward, reflecting negative surprises in the behaviour of inflation.

Figure 4, Survey of Professional forecasters, 2 year and long-term inflation expectations

Source: ECB

Market-based measures of inflation expectations built from inflation swaps (Panel A of Figure 5) confirm that inflation expectations are well below 2% in the short- and medium term and do not point to a revival in inflation for the near and medium term. More importantly, the fact that long-term inflation expectations have remained anchored around 2%, until now, should not be taken as a fully reassuring. In Japan, long-term inflation expectations(see figure 7 in Antolin-Diaz, 2014) remained around 1% on average between 1999 and 2013, despite actual inflation being negative (-0.2%).

Moreover, Panel B of figure 5 suggests that inflation expectations could have a backward-looking component (i.e. economic agents could use past data to form their expectations on future inflation, especially for the long term). The recent drop in headline inflation could therefore explain why inflation expectations at a ten-year horizon have been falling from 2.5% in 2012 to 1.75% in April 2014. This could be dangerous as a prolonged period of low inflation could dis-anchor inflation expectations, which might become a problem for the ECB in the long run.

Figure 5

Panel A: Market expectations on inflation

Panel B: OIS Inflation linked swaps

Source: Datastream

Today, Eurozone inflation is at 0.5%, i.e. its lowest level since November 2009. Inflation expectations and inflation forecasts, including the ECB staff projections, do not suggest a quick return to an overall euro-area inflation rate that can be regarded to being close to two percent in the next few years. Despite this, the ECB has not announced any new measure since last November’s monthly press conference. Even though the euro area as a whole has not yet entered into deflation, this picture is worrying. Low inflation rates will make the relative price adjustment in the euro area more difficult, complicate debt deleveraging and put the sustainability of debt at risk.

A more difficult question is which monetary and/or structural measures would be best suited to increase inflation rates. We address this question in a forthcoming paper that we write together with Zsolt Darvas and Guntram Wolff.

Thu, 03 Apr 2014 07:21:26 +0100
<![CDATA[Taylor-rule interest rates for euro area countries: diversity remains]]> http://www.bruegel.org/nc/blog/detail/article/1292-taylor-rule-interest-rates-for-euro-area-countries-diversity-remains/ blog1292

Last September we wrote a blog post with Silvia Merler on Taylor-rule interest rate recommendations for euro area countries (see this post for explanation and interpretation of the results). Here is the update.

Not much has changed for the euro area as a whole (Figure 1, Panel A). The recommendation for the euro area is slightly lower in 2014Q1 than it was in 2013Q3. However, despite the very low headline (0.5%) and core (0.8%) inflation figures for March 2014, the Taylor-rule recommendation for the euro area has in fact slightly increased from the last quarter of 2013 to the first quarter of 2014. The reason is that average core inflation during the quarter was slight higher in 2014Q1 (0.87%) than in 2013Q4 (0.80%) and the gap between actual unemployment and the NAIRU (non-accelerating rate of unemployment) slightly narrowed, because unemployment remained the same (11.9% on a seasonally adjusted basis between October 2013 – February 2014), while the NAIRU increased a bit.

But diversity among the first 12 members of the euro area remained (Panels B, C and D of Figure 1). In Italy and the Netherlands there was a major decline in the Taylor-rule recommendation, due to a drop in core inflation and an increase in unemployment (Figure 2). In 2014Q1, the Taylor-rule suggests negative interest rates for five of the first twelve members of the euro area. Such a huge diversity makes the job of the European Central Bank extremely complicated, as we discussed in our blog post with Silvia last year.

Figure 1: Taylor-rule recommendations for the central bank interest rate (percent per year), 1999Q1-2014Q1

Notes: Taylor-rule target = 1 + 1.5 x Inflation – 1 x Unemployment gap. Similarly to Mechio (2011), we use core inflation (all items HICP excluding volatile food and energy prices; change relative to the same quarter of the previous year) and the deviation of the actual unemployment rate from the estimated non-accelerating inflation rate of unemployment (NAIRU), as estimated by the OECD. MRO = Main refinancing operations. The 2014Q1 recommendations are based on January-March 2013 core inflation rate for the euro area. For the 12 countries the March core inflation is not available: we assumed that it declined from February to March by as much as in the euro area aggregate (ie by 0.2 percentage points) and then calculated the average for January-March. The unemployment rate is available for January and February for most countries and we used their average for 2014Q1.

Figure 2: Core inflation, the unemployment rate and the estimated NAIRU (non-accelerating inflation rate of unemployment), percent

Note: the OECD’s NAIRU (non-accelerating inflation rate of unemployment) estimate is available at the annual frequency. We converted it to quarterly frequency by using the Hodrick-Prescott filter, which assumes smooth changes for the filtered series. For this filter, we used a rather low smoothing parameter, ie 10, in order to filter out only the impact of frequency conversion, but to keep tendencies. See, for example, the results of this smoothing for the euro area in Figure 3.

Figure 3: OECD’s annual estimate for the NAIRU and our approximation for the quarterly frequency, 1998-2015

Note: see the notes to Figure 2. The annual data is indicated by the blue line, which has the same value in each quarter of the year. The red line is our “quarterlised” estimate.

Wed, 02 Apr 2014 20:47:31 +0100
<![CDATA[Blogs Review: Capital in the twenty-first century]]> http://www.bruegel.org/nc/blog/detail/article/1291-blogs-review-capital-in-the-twenty-first-century/ blog1291

What’s at stake: Thomas Piketty, probably the leading researcher on inequality, has recently published his magnum opus “Capital in the twenty-first century”. The book, which is the culmination of years of research, paints a rather bleak picture of the future of capitalism: Analysing huge volumes of data, Piketty sides with Karl Marx rather than Simon Kuznets on the future of capitalism: Absent strong policy measures such as a global tax on capital returns, inequality will be ever-increasing. The economic community has welcomed this book, which aims to (re-)establish inequality as the most pressing economic issue of our time, as a monumental contribution with scores of reviews (twelve of them collected here by Brad deLong) and comments.

Ryan Avent summarizes Piketty’s key arguments in a series of posts on Free Exchange (see the discussion of the intellectual context of the book and of the key theories underlying the analysis as well as those of chapter 1, chapter 2, 3&4 – the remaining 12 chapters will be covered in the coming weeks). The middle of the 20th century was characterized by period of relative equity due to the economic and political effects of two World Wars and the Great Depression (destruction of capital, higher taxation and nationalisation of industries). Since the 1970s, however, income inequality is rising again and levels of wealth concentration are again approaching those of the pre-war era. The Kuznets-Curve idea that, as economies mature, they become more equal, is fallacious: What we witness now is a return to historic normality. The return of inequality is driven by the the soaring inequality in labour income, especially in the USA, and, most importantly, the return of wealth, the central topic of the book.

Daron Acemoglu (through Thomas B. Edsall) is not convinced that the data proves that we now return to the “natural tendency” of capitalist economies to generate inequality. The data is consistent with what Piketty says, but it is also consistent with certain technological changes and discontinuities (or globalization) having created a surge in inequality which will then stabilize or even reverse in the next several decades. It is also consistent with the dynamics of political power changing and this being a major contributor to the rise in inequality in advanced economies. We may be seeing parts of several different trends underpinned by several different major shocks rather than the mean-reverting dynamics following the shocks that Piketty singles out.

Branko Milanovic writes that Piketty dismisses Kuznets‘ inverted U curve for income inequality over an economy’s development on several grounds: First, he does not see any spontaneous forces in capitalism that would drive inequality of incomes down; rather, the only spontaneous forces will push concentration of incomes up. Second, he thinks that Kuznets misinterpreted a temporary slackening in inequality after World War II as a sign of a more benign nature of capitalism, while it was really due to the unique and unrepeatable circumstances. Third, he thinks that Kuznets’ theory owes its success in part to the optimistic message that it conveyed during the Cold War, namely that poorer capitalist economies were not forever condemned to high inequality. And finally, the data available to Kuznets in the 1950s was minimal and almost derisory.

Capital returns: the prime cause for divergence

Probably the most crucial dynamic in the book is the difference between the return rate on capital r and economic growth g. When r>g, wealth – which in Piketty’s analysis equals capital as anything other than labour that generates income – can grow faster than output and the capital income share keeps increasing.

Source: Free Exchange

Paul Krugman investigates how r-g can attain a positive value, thus allowing inequality to increase. In terms of the steady-state of a Solow growth model, in which the capital-output ratio is equal to the ratio of the savings rate over n (technological progress plus population growth), the impact of a reduction in n (reflecting decreasing global population growth and per capita growth rates) on r and g depends on the elasticity of substitution between capital and labor. If, as Piketty asserts, the elasticity of substitution is more than 1 (i.e. capital and labour are substitutes), the capital share rises, and r falls less than g. A growth slowdown would thus be causing inequality to increase. A question that remains open is how much of the decline in r relative to g in the 20th century reflected fast growth, and how much reflected policies that either taxed or in effect confiscated inherited wealth?

Edward Lambert thinks that Krugman leaves out one aspect in his last question: What about the impact of monetary policy? Loose monetary policy is also a policy that pushes up r relative to g. The rate of return on assets is increased when the cost of capital is lowered. Thus loose monetary policy is adding to the wealth inequality that is bringing down the US and other advanced economies. The US must protect its middle class. The solution is to raise the cost of capital through a combination of tightening monetary policy, raising taxes on capital & higher incomes and strengthening once again the transmission mechanisms of wealth to labor, namely unions, living wages and investing in locally owned businesses.

Branko Milanovic finds Piketty’s arguments why r may remain high interesting (for example, he sees today’s processes of expanding financial sophistication and international competition for capital as intended to help keep r high), but in arguing that the elasticity of substitution between capital and labour is likely to remain high, and that an increase in capital will not drive r down, he is running against one of the fundamentals of economic theory: decreasing returns to an abundant factor of production. Although Piketty is indeed critical of a blind belief that marginal returns always set the price for labour and capital, he does not develop these arguments.

Ryan Avent writes that sustained rates of return to capital above the rate of growth g may sound unrealistic - we would expect diminishing marginal returns to capital to cause r to reduce as capital is piled up. But Piketty shows that the rate of return on capital is remarkably constant over long periods, partly due to technology improvements. Innovation, and growth in output per person, creates investment opportunities even when shrinking populations reduce GDP growth to near zero. New technology can also make it easier to substitute machines for human workers, causing the capital share of income to rise. Amid a new burst of automation, wealth concentrations and inequality could reach unprecedented heights.

Drivers of convergence: growth and technology spread

Ryan Avent summarizes Piketty’s arguments on the inequality-lessening effect of growth: in the long run and under the right circumstances, the capital stock to GDP ratio should approach the ratio of the national savings rate to the national growth rate. This implies that rapid (absolute) economic growth is a force for economic convergence. It limits the relative importance of accumulated wealth. It comes in two components: population growth and per capita growth, both of which were roughly equally responsible for growth in the last 300 years. Population growth has peaked at 1.9% p.a. in the middle of last century and is now falling. And the rate of per capita growth also appears to be near what is likely to be a peak at above 2%, due to the present rapid catching-up of emerging markets. Taking these rates together, absolute growth has been around 4% p.a. in the past and may decline to 1.2% by the end of the century. This rate is more similar to the pre-industrial era of the past and will generate a longer shadow of accumulated wealth.

John Cassidy believes there is a chance that innovations may spur productivity growth, shifting it to a permanently higher rate and thus strengthening the forces of convergence. Also, he finds that Piketty pays slightly insufficient attention to decreasing inequality on a global scale, where millions of people have seen their lives improve in the recent pass. He also thinks Piketty doesn’t seriously consider the argument that globalization—and the rise of nations like China and India—is at once holding down wages and pushing up the profitability of capital, boosting inequality at both ends.

Ryan Avent writes that for Piketty, the principal force for convergence at present is the spread of new technologies from rich areas to poor ones. Countries that have been successful in the economic catch-up process have typically been economies that self-financed industrialisation on the back of high domestic savings rates. On the other hand, where a large share of capital is foreign-owned, it may create a strong incentive for governments to expropriate foreign capital, thus perpetuating institutional weakness. The gains from openness are therefore almost entirely down to the transfer of knowledge, rather than the efficiency benefits of free trade and capital flows. Avent finds this view excessively pessimistic: even if openness mostly entails foreign ownership and thus institutional weakness, cutting the poor off from goods markets has historically been a good way to keep them poorer than they need to be and to reinforce cronyist regimes.

Dean Baker does not share Piketty’s pessimism on profits exceeding growth rates: a very large share, perhaps a majority, of corporate profit hinges on rules and regulations that could in principle be altered. Examples are drug patents (allowing Indian low-cost generics to enter the market could severely limit the profits and value of corporate stock in that industry) or regulating the telecommunications sector, preventing monopolies and thus curtailing capital returns. And financial transaction taxes can be implemented, curtailing returns from financial capital. In the past, progressive change advanced by getting some segment of capitalists to side with progressives against retrograde sectors. In the current context this likely means getting large segments of the business community to beat up on financial capital.

Policy recommendation: A global tax on capital?

Thomas Piketty himself writes in the FT that many of the relatively egalitarian and inclusive institutions set up in Europe after World War II drew inspiration from the US. Very high, confiscatory tax rates for top incomes were an American invention of the inter-war years when the country was determined to avoid the disfiguring inequalities of class-ridden Europe. That experiment did not hurt the US. The main force driving inequality at present are, however, the strong returns to capital. What is required now, therefore, is a tax on vast fortunes, which is preferable over alternatives such as inflation (a soft expropriation of creditors to government) or a Russian approach to dealing with excessively ambitious oligarchs.

Branko Milanovic agrees that lowering r by implementing a global taxation of capital is key to limiting inequality. Sure, this may seem unrealistic, but ne would be wrong to dismiss the proposal out of hand. Nobody believes that it could be implemented hic et nunc, and neither does Piketty. It is based on several strong points: It is the most direct instrument attacking the key issue, capital returns. And capital taxes have a long history. Their technical requirements are not overwhelming: housing is already taxed; the market value of different financial instruments is easily ascertainable and the identities of owners known. The key problem is that capital taxation needs international coordination to eliminate the drawback of causing capital outflows from the countries implementing it. Although it will probably be impossible to bring all countries on board, a modest proposal built around the OECD countries or the US and EU seems feasible.

Lawrence Mishel (through Thomas B. Edsall) believes that the real problem is the suppression of wage growth, thus arguing that a strengthened labour movement is needed to counteract the development, rather than the capital tax proposed by Piketty.

Richard Freeman (also through Thomas B. Edsall) finds himself in full agreement with Piketty’s analysis – but has a different proposal: Let’s turn everyone into a capitalist. Much of labour inequality comes because high earners got paid through stock options and capital ownership. Therefore, “The way forward is to reform the structure of American business so that workers can supplement their wages with significant capital ownership stakes and meaningful capital income and profit shares.”

Wed, 02 Apr 2014 11:40:10 +0100
<![CDATA[Interactive map: Europe’s social polarisation and the generational struggle]]> http://www.bruegel.org/nc/blog/detail/article/1290-interactive-map-europes-social-polarisation-and-the-generational-struggle/ blog1290

See also policy brief 'Europe's social problem and its implications for economic growth'

According to the latest Eurobarometer survey on the social impact of the crisis, 80% of respondents believe that poverty has increased in their country over the past 12 months. Over 30% of respondents in Greece, Latvia, Lithuania, Bulgaria, Romania and Hungary reported that their household ran out of money to pay for ordinary bills, food and other daily consumer items at some point during the previous 12 months. These alarming numbers are reflecting the perception of European citizens. But what do indicators measuring different dimensions of poverty and inequality actually show?

The best publically available indicator to assess poverty is the ”Severe Material Deprivation Rate” (SMDR). It is an absolute measure of poverty and represents the proportion of people who cannot afford at least four out of nine basic needs, like utilities, regular hot meals or heating to keep the home adequately warm. As you can see in the interactive map below, there is a strong dispersion across Europe. While Bulgaria has the highest rate (44.1%), in Luxembourg only 1.3% of people are severely affected by a lack of resources. The average rate in EU27 countries increased from 9% percent in 2007 to 9.9% in 2012. Even though this increase does not seem to be as dramatic as the survey implies, it is worth highlighting that a share of almost 10% is unacceptable and against the objective of promoting the well-being of EU citizens.

Tue, 01 Apr 2014 15:23:48 +0100
<![CDATA[Europe's social problem and its implications for economic growth]]> http://www.bruegel.org/publications/publication-detail/publication/823-europes-social-problem-and-its-implications-for-economic-growth/ publ823

See also comment 'Interactive map: Europe’s social polarisation and the generational struggle'

The European Union faces major social problems. More than six million jobs were lost from 2008-13 and poverty has increased. Fiscal consolidation has generally attempted to spare social protection from spending cuts, but the distribution of adjustment costs between the young and old has been uneven; a growing generational divide is evident, disadvantaging the young. The efficiency of the social security systems of EU countries varies widely. Countries with greater inequality tended to have higher household borrowing prior to the crisis resulting in more subdued consumption growth during the crisis. The resulting high private debt, high unemployment, poverty and more limited access to education undermine long-term growth and social and political stability.

Policymakers face three main challenges. First, addressing unemployment and poverty should remain a high priority not only for its own sake, but because these problems undermine public debt sustainability and growth. Second, bold policies in various areas are required. Most labour, social and fiscal policies are the responsibility of member states, requiring national reforms. But better coordination of demand management at European level is also necessary in order to create jobs. Third, tax/benefit systems should be reviewed for improved efficiency, inter- generational equity and fair burden sharing between the wealthy and poor.

Europe's social problem and its implications for economic growth (English)
Tue, 01 Apr 2014 13:18:34 +0100
<![CDATA[Inflation persistence in central and eastern European countries]]> http://www.bruegel.org/publications/publication-detail/publication/822-inflation-persistence-in-central-and-eastern-european-countries/ publ822

This article studies inflation persistence with time-varying coefficient autoregressions for 12 central European countries in comparison with the United States and the euro area. We find that inflation persistence tends to be higher in times of high inflation.

Since the oil price shocks, inflation persistence has declined both in the United States and the euro area. In most central and eastern European countries, for which our study covers 1993–2012, inflation persistence has also declined, with the main exceptions of the Czech Republic, Slovakia and Slovenia, where persistence seems to be rather stable. Our findings have implications for the conduct of monetary policy and for a possible membership in the euro area.

Among the two time-varying coefficient methods we use, our results favour the flexible least squares smoother over the Kalman smoother. We also conclude that the OLS estimate of an autoregression is likely upward biased relative to the time-average of time-varying parameters, when the parameters change.

This external publication is available though Taylor & Francis online (paywall).

Mon, 31 Mar 2014 10:35:05 +0100
<![CDATA[Who's paying for bank bailouts?]]> http://www.bruegel.org/videos/detail/video/125-whos-paying-for-bank-bailouts/ vide125

Who has paid for bank bailouts? Nicolas Véron, Senior Fellow at Bruegel, interviews Hans-Joachim Dübel, prominent economist and founder of Finpolconsult, on the details surrounding bailout programmes.

Fri, 28 Mar 2014 12:05:58 +0000
<![CDATA[The calm after the storm: developments in Cyprus’ banking sector]]> http://www.bruegel.org/nc/blog/detail/article/1289-the-calm-after-the-storm-developments-in-cyprus-banking-sector/ blog1289

On March 24th, the Central Bank of Cyprus (CBC) released new data on key aggregate financial stability indicators, including provisional data for the fourth quarter of 2013. Our preliminary figures show some improvement in the profitability and capital adequacy ratios of the Cypriot banking system, reflecting the progress made on restructuring last year.

The facts

Although the banking system as a whole is still not generating profits, losses were much more moderate during 2013 than the year before; the total losses before tax from continuing operations (not taking into account the parts of the business that have been disincorporated due to restructuring or other reasons) stood at less than 1% of total assets for the last quarter of 2013, while the ratio for return on assets (after tax profit/losses on a discontinued operations basis as a share of total assets) was shrinking continuously since the bail-in of depositors in March 2013.

Cyprus banking sector profitability


Note: The difference between the two lines reflects the one off costs of the ongoing restructuring process.

Source: Central Bank of Cyprus

Thanks to the recapitalization of the two largest banks, the Tier 1 capital ratio stood at its highest level of the last five years at 12.9% and the overall solvency ratio at 14%. Both of them close the euro area average at 13% and 15.4 (during the first half of 2013).

Cyprus banking sector capitalization

Source: Central Bank of Cyprus

The most worrisome financial concern in Cyprus is the high and increasing level of non-performing loans. According the CBC’s new definition (see legal framework), the percentage non-performing credit facilities soared to 44.9% at the end of January, showing a slow but continuous increase since September 2013 when it stood at 40.3%. For the cooperative credit sector the number was almost equally high at the end of January at 40.4% and also increasing.

There is an undergoing discussion about the creation of a bad bank that would buy troubled assets, including NPLs, to clean the banking system like in the cases of Spain and Ireland, which was also mentioned in a Reuters interview with Bank of Cyprus Chief  Executive John Hourican. 

The restructuring process of the cooperative banking sector was somewhat slower than expected last year, but its recapitalization is expected to be completed shortly according to the latest Troika Statement on the Third Review Mission. The restructuring plan of the cooperative sector includes the merging of 93 cooperative credit institutions into 18 monetary institutions under the supervision of the recently created Central Cooperative Bank.

The total amount of deposits in the Cypriot banking system has basically stabilized since October around a total of 46-47 billion euros, decreasing at a monthly rate just 0.3% in the last quarter of 2013. Despite the imposition of capital controls, the cumulative shrinkage of total deposits since December 2012 still amounts to all of 33.9% (17.3 billion euro), of which 27.2% were withdrawn since the end of March when the capital controls were imposed. Discounting the effect of the 5.8 billion bailed in deposits (of which 2.8 billion were accounted for in April statistics and 3 billion distributed between the months of June and August, see chronology in the Monetary and Financial Statistics of the Central Bank of Cyprus), the reduction on total deposits still amounts to 18.1% or 11.5 billion euro since the end of March 2013.

Cyprus total deposits by residence

Source: Central Bank of Cyprus

From the 17.3 billion reduction in the total outstanding amount of deposits in Cyprus after the establishment of the capital controls: 9 billion euro (or 52% of the total decline) came from domestic deposits, 1.2 billion euro (7%) from other euro area residents and 7.1 billion euro (41%) from residents of the rest of the world. Presumably, the bail-in of depositors hit depositors from the rest of the world harder, but lacking sufficient evidence, the amount of deposit flight by residence discounting the effect of the bail in cannot be estimated.

What can we conclude?

In absence of counterfactual, assessing how effective the restrictive measurements on capital movements in Cyprus have been at containing the deposit flight from the island is a very difficult task.  And more so as Cypriot authorities have been progressively relaxing the controls as the banking sector becomes more financially stable. All we can say is that at present there is calm after the storm; despite having less stringent restrictive measures than almost a year ago, the banking system remains stable. Though dealing with mounting non-performing loans remains the biggest financial challenge.

As we stated before, so far so good, but it is yet to be seen whether Cyprus will be able to lift the capital controls by the end of the year as expected by the Governor of the Central Bank of Cyprus, Panicos Demetriades

This post was written on request following discussions with @Alexapostolides.

Fri, 28 Mar 2014 07:12:46 +0000
<![CDATA[Eastern promises: The IMF-Ukraine bailout]]> http://www.bruegel.org/nc/blog/detail/article/1288-eastern-promises-the-imf-ukraine-bailout/ blog1288

Read our comments on Ukraine and Russia 'Eastern promises: The IMF-Ukraine bailout', 'Interactive chart: How Europe can replace Russian gas', 'Can Europe survive without Russian gas?', 'The cost of escalating sanctions on Russia over Ukraine and Crimea', 'Russian roulette' and 'Gas imports: Ukraine's expensive addiction'

The International Monetary Fund has announced a $14-18 billion rescue package for Ukraine. The country has considerable economic potential. It possesses the second-largest area of fertile soils in Europe after Russia, important natural gas resources, and has a significant industrial backbone, important transit routes and a well-educated population of 45 million. Nevertheless, Ukraine is in a dire economic situation. In 2013, its twin deficits – which have persisted for several years – reached a new record. The budget deficit increased to about 8 percent of GDP and the current account deficit reached almost 9 percent of GDP. Economic growth has been practically zero in the last two years. Access to foreign capital markets is closed. And the hryvnia devalued by about 20 percent in the first two months of this year.

But how did Ukraine get there? When Yanukovich became president in 2010, his administration envisaged a project of fiscal consolidation and structural reform. The budget deficit halved between 2009 and 2011 and a progressive tax-code reform was adopted. Access to financial markets allowed his administration to issue Eurobonds. But ahead of the 2012 parliamentary elections, the government moved from long-term economic stabilisation to short-term populism. Even before the elections, from 2010 to 2012, the administration shied away from the main steps needed to tackle macro-economic imbalances: adjusting domestic energy prices and allowing for more exchange rate flexibility. In an attempt to demonstrate strength and stability, the hryvnia was fixed at 8 hryvnia per dollar by a non-independent National Bank. As a consequence, the hryvnia appreciated strongly between 2011 and 2014 compared to other currencies in the region, for example by 10 percent compared to the Polish zloty or 20 percent compared to the Turkish lira. As a result of unfavourable agreements with Russia, gas import prices increased from about $250 per thousand cubic meters in 2010 to about $400 in 2013, but gas and heat tariffs for the population were not adjusted accordingly. This tariff deficit was ultimately financed from the state budget and amounted to about 6 percent of GDP per year.

The clearly unsustainable macro-economic policy of the Yanukovich administration implied first, that Ukraine was unable to issue fresh debt on the international financial market from May 2013. Cut off from financial markets, Ukraine tried to secure an IMF programme. But as the government was unwilling to tackle the exchange rate and energy price issues, the talks stalled. By that stage, in late 2013, Russia was the only creditor that proposed financing for Ukraine without requiring unpopular measures until the regular presidential elections in 2015. But the 30 percent gas price discount and the $15 billion credit offered by Russia would have only increased the adjustment need after the elections. Furthermore, the population was highly suspicious that there was a political price for this ‘gift’ that was supposed to assist Yanukovich's re-election. Since then, of course, the deal with Russia has fallen apart and the macroeconomic crisis is acute again.

The National Bank of Ukraine has been forced to allow the hryvnia to devalue substantially and introduce capital controls. The banking sector is under severe stress. The devaluation, deposit withdrawals and an expected increase in non-performing loans have caused a blow to the balance sheets of several banks, which might have to be recapitalised. But worse is to come. The government has to service $9.7 billion in foreign-currency debt in 2014. If Russia returns from the preferential gas price of $268 granted in December last year to the more than $400 it demanded in 2013, it will imply a 2 percent of GDP hike in the current account deficit. If Russia imposes trade restrictions, the short-term impacts on Ukraine could be severe. Switching from the current free trade regime to most-favoured-nation tariffs would imply a loss of 1.7 percent of GDP. Non-tariff measures, as applied in August last year, could further deteriorate the situation.

However, it is not impossible for Ukraine to overcome its macroeconomic crisis. In the context of an IMF programme, the country could significantly reduce the twin deficits in the medium term, accompanied by the necessary funds to finance the deficits in the short term. Additional funds from the EU and the USA are certainly welcome. A key issue in this respect is the price of energy for the population, which in some cases covers only 16% of the import and distribution costs. A gradual but decisive increase in energy prices is a necessary condition for fiscal consolidation in the short term, but also for current account sustainability in the medium term. Such a move would also reduce dependence on Russia and decrease the widespread corruption in the energy sector. But stabilisation of the banking sector is also crucial, including liquidity support and recapitalisation for systemic banks. A strong push for institutional reform should also be initiated, including the strengthening of key institutions such as the National Bank and the energy regulator, in order to avoid the mistakes of the recent past. Finally, decisive structural reforms are needed to reinstall the rule of law, improve tax administration, reduce bureaucracy and fight corruption.

One might wonder if it is realistic to achieve these multiple tasks in the short- and medium terms. In fact, while the current situation is very critical, it also provides a great opportunity for sweeping reform. First, it became evident to large parts of the population that the “old ways” according to which the country has been managed no longer work. The country needs a new economic management approach. Second, members of the new government have put aside personal interests and decided to take over responsibility, despite risking becoming unpopular. They are ready to change the country and create a better future for the Ukrainian people. Third, the EU and the USA are ready to support the country in this difficult situation, both in technical and financial terms. Seen from this angle, Ukraine might have a unique opportunity for decisive reform. 

The German Advisory Group in Ukraine, of which the two authors are members, just published its 'Government Reform Agenda'

Thu, 27 Mar 2014 11:35:06 +0000
<![CDATA[Cross-country insurance mechanisms in currency unions]]> http://www.bruegel.org/publications/publication-detail/publication/821-cross-country-insurance-mechanisms-in-currency-unions/ publ821

Countries in a monetary union can adjust to shocks either through internal or external mechanisms. We quantitatively assess for the European Union a number of relevant mechanisms suggested by Mundell’s optimal currency area theory, and compare them to the United States.

For this purpose, we update a number of empirical analyses in the economic literature that identify (1) the size of asymmetries across countries and (2) the magnitude of insurance mechanisms relative to similar mechanisms and compare results for the European Monetary Union (EMU) with those obtained for the US.

To study the level of synchronization between EMU countries we follow Alesina et al. (2002) and Barro and Tenreyro (2007). To measure the effect of an employment shock on employment levels, unemployment rates and participation rates we perform an analysis based on Blanchard and Katz (1992) and Decressin and Fatas (1995). We measure consumption smoothing through capital markets, fiscal transfers and savings, using the approach by Asdrubali et al. (1996) and Afonso and Furceri (2007). To analyze risk sharing through a common safety net for banks we perform a rudimentary simulation analysis.

Cross-country insurance mechanisms in currency unions (English)
Wed, 26 Mar 2014 13:20:20 +0000
<![CDATA[Reforming the structure of banks: The UK approach in its EU context]]> http://www.bruegel.org/nc/events/event-detail/event/431-reforming-the-structure-of-banks-the-uk-approach-in-its-eu-context/ even431

The European Commission’s proposal on banking structure reform, published in January, has framed what is likely to become an animated policy debate about banking structures and business models in the next European legislature. The UK has been a pioneered regulatory changes and bank structural reform with the Independent Commission on Banking and the Vickers Report in 2011, and subsequently the Financial Services Act 2012, the Banking Reform Act 2013 as well as and the Parliamentary Commission on Banking Standards following the uproar about LIBOR and other bank malpractice. The Volcker Rule in the US, the Liikanen Report of October 2012, and national legislation recently passed in France and Germany may also contribute to shaping the forthcoming EU discussion. Sajid Javid MP, who has been Financial Secretary to the UK Treasury since October 2013, will present the current UK approach, after which the moderated conversation will turn to reform prospects at the EU level.

18.45-19.00 Registration
19.00-19.05 Introduction by Gregory Claeys, Research Fellow at Bruegel
19.05-19.30 Presentation by Sajid Javid MP, Financial Secretary to the UK Treasury (on the record)
19.30-20.00 Q&A session (under the Chatham House Rule)


  • Sajid Javid MP, Financial Secretary to the Treasury
  • Chair: Gregory Claeys, Research Fellow at Bruegel

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Bruxelles
  • Time: 1 April 2014. 19.00-20.00
  • Contact: Matilda Sevón, Events Coordinator - matilda.sevon[at]bruegel.org

Wed, 26 Mar 2014 11:29:11 +0000
<![CDATA[Transatlantic trade, butterflies and earthquakes]]> http://www.bruegel.org/nc/blog/detail/article/1287-transatlantic-trade-butterflies-and-earthquakes/ blog1287

European Union and United States heads’ of state are meeting this week to reinforce among other things the political will to conclude the transatlantic trade talks termed the Transatlantic Trade and Investment Partnership (TTIP). The agreement is meant to bring down the remaining tariffs on goods and unnecessary regulatory barriers that undermine the transatlantic trade and investment potential. According to an independent study, an ambitious deal could boost overall EU exports by 6% (or €220 billion) and overall US exports by 8% (or €240 billion). The sectors that are expected to benefit the most are largely in manufacturing, namely metal products (+12% in EU exports), processed food (+9%), chemicals (+9%), other manufactured goods (+6%), and other transport equipment (+6%). The study’s estimates incorporate trade creation and trade diversion, as well as dynamic effects in third countries.

Yet TTIP negotiators need not to forget that in an integrated world economy a multitude of unpredictable factors can alter the intended consequences of the agreement. To contextualise the ongoing TTIP negotiations in the larger global trade scenario and show its relevance for TTIP's prospects, in this blog I illustrate how world trade patterns have changed in the past two decades and highlight current trends. If TTIP negotiators cannot predict whether the flap of a butterfly in Chinese factories will provoke a hurricane in transatlantic trade, they can look at how an earthquake in China has shaped trade to date and try to think how future earthquakes could be accounted for. I focus on merchandise trade, as this is the area that TTIP’s impact would be most apparent.

Changing trade patterns: the world upside down.


The past twenty years witnessed dramatic changes in global trade shares. The first one of them is the increased relevance of merchandise trade. According to World Bank data, the percentage of imports plus exports over GDP increased from 46% to 66% for the EU and from 18% to 24% in the US over the 1995-2008 period (Figure 1). Noticeably, intra-EU trade increased less than extra-EU trade did. The crisis produced a major shock: world trade to GDP fell by 10 points in one year, but then reversed in 2010 and 2011. However, the data does not allow predicting if we are entering a phase of slow or negative trade to GDP growth.

Source: The World Bank

Relevant intra-regional trade patterns also radically changed in the 1995-2012 period, albeit in the opposite direction, and underlying trends were not hugely affected by the crisis. The year 1995 is an interesting reference as it marked a transition point for world trade, with the completion of both the Uruguay Round and NAFTA.  According to UNCTAD data, the EU-US share of world merchandise trade (excluding intra-EU trade) almost halved from 8.5% in 2001 to 4.4% in 2012 (Figure 2). Noticeably, bilateral EU-US trade also became less significant for the two partners, falling sharply to 15% of total extra-EU trade and 17% of US trade in 2012 (Figure 2) as both partners diversified their export and import destinations.

Source: UNCTAD, Bruegel computations

But trade patterns were affected everywhere: by way of comparison, we consider intra-group trade between partners in two other supra-regional agreements currently under negotiation, i.e. the Trans-Pacific Partnership (TPP) and the Regional Comprehensive Economic Partnership, also known as ASEAN + 6 (Figure 3). The observed change is startling: trade between the TPP partners – comprising the US, Canada, Mexico, Japan, and other eight countries in the Pacific area – fell from 25% of world trade in 2000 to 13.6% in 2012, while trade between ASEAN + 6 countries – comprising China, India, Japan, Australia, New Zealand, South Korea and ten countries in the South-East Asian region – increased from 9.3% in 1998 to 15% in 2010. These figures suggest that the dominating trade groups in the Nineties saw their influence on the global scene declining to make way for the rise of the Asia-Pacific region. The prospects of continued high growth in Asian countries suggest that the trade relations could further strengthen in their influence: the global trade landscape seems to have suddenly turned on its head. While the economic balance between the Western World and Asia might be reassuming the pre-industrial revolution trends, the speed of this adjustment so far has undoubtedly been extraordinary.

Source: UNCTAD, Bruegel computations

How do changing trade patterns affect TTIP?


Despite its declining relevance for the two partners and for the world, transatlantic trade still amounted to $648 bn in 2012, or 4.4% of extra-EU global trade, which as a base level is likely to result in far-reaching impact of the negotiations. Yet shifting trade patterns worldwide indicate a change in the composition of the goods bilaterally traded between the EU and the US, which must be reflected in the TTIP negotiations. Indeed the past fifteen years also witnessed a critical shift: China's accession to the WTO twinned with increased possibilities of slicing up the manufacturing production processes boosted the relocation of the low-value added intermediate goods production from the EU and the US to lower-cost Asia, in particular China. Figure 4 shows the steady rise in bilateral trade of the TTIP partner’s vis-à-vis China.

Source: UNCTAD, Bruegel computations

In turn, European and American companies refocused their domestic industrial capacities to high-value high-tech products and activities like product design and R&D. Arguably, today's transatlantic trade in final goods incorporates inputs from many other countries. To grasp the relevance of these shifts for the ongoing bilateral trade negotiations, one can imagine that had the two partners agreed to tear down regulatory barriers in the year 2000, as was being attempted, the savings from the costs of multiple regulations would have partly offset for the huge labour cost savings from relocating to China. Thus, benefits would have been a lower drop in the bilateral trade share relative to extra-EU global trade, and retaining of more manufacturing employment at home. Perhaps in the past political capital has been expended in favour of the owners of capital and technology as opposed to interests of labour. Nonetheless, the fall in manufacturing employment in the EU and the US could not have been avoided. Today, cutting unnecessary regulatory costs through TTIP can be seen as a competitiveness-boosting measure that benefits business while also protecting labour’s interests.

Ultimately, to deliver a deal that is more welfare-improving, TTIP negotiators will need to focus on means to enhance long-term competitiveness of the two partners rather than bargain concessions that will be bear little fruit in the global trade arena.

Special thanks to Suparna Karmakar for her useful comments.

Tue, 25 Mar 2014 11:35:26 +0000