<![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Fri, 27 Mar 2015 11:42:02 +0000 http://www.bruegel.org/fileadmin/images/bruegel-logo.png <![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Zend_Feed http://blogs.law.harvard.edu/tech/rss <![CDATA[The financial stability risks of ultra-loose monetary policy]]> http://www.bruegel.org/publications/publication-detail/publication/876-the-financial-stability-risks-of-ultra-loose-monetary-policy/ publ876

• Ultra-loose monetary policies, such as very low or even negative interest rates, large-scale asset purchases, long-maturity lending to banks and forward guidance in central bank communication, aim to increase inflation and output, to the benefit of financial stability. But at the same time, these measures pose various risks and might create challenges for financial institutions.

• By assessing the theoretical literature and developments in the United States, United Kingdom and Japan, where very expansionary monetary policies were adopted during the past six years, and by examining the euro-area situation, we conclude that the risks to financial stability of ultra-loose monetary policy in the euro area could be low. However, vigilance is needed.

• While monetary policy should focus on its primary mandate of area-wide price stability, other policies should be deployed whenever the financial cycle deviates from the economic cycle or when heterogeneous financial developments in the euro area require financial tightening in some but not all countries. These policies include micro-prudential supervision, macro-prudential oversight, fiscal policy and regulation of sectors that pose risks to financial stability, such as construction.

The financial stability risks of ultra-loose monetary policy (English)
Thu, 26 Mar 2015 09:48:52 +0000
<![CDATA[Living (dangerously) without a fiscal union]]> http://www.bruegel.org/publications/publication-detail/publication/875-living-dangerously-without-a-fiscal-union/ publ875

The euro area’s political contract requires member nations to rely principally on their own resources when confronted with severe economic distress. Since monetary policy is the same for all, national fiscal austerity is the default response to counter national fiscal stress. Moreover, the monetary policy was itself stodgy in countering the crisis, and banking-sector problems were allowed to fester. And it was considered inappropriate to impose losses on private sector creditors.

Thus, the nature of the incomplete monetary union and the self-imposed taboos led deep and persistent fiscal austerity to become the norm. As a consequence, growth was hurt, which undermined the primary objective of lowering the debt burden. To prevent a meltdown, distressed nations were given official loans to repay private creditors.

But the stress and instability continued and soon it became necessary to ease the repayment terms on official loans. When even that proved insufficient, the German-inspired fiscal austerity was combined with the deep pockets of the European Central Bank. The ECB’s safety net for insolvent or near-insolvent banks and sovereigns, in effect, substituted for the absent fiscal union and drew the central bank into the political process.

Living (dangerously) without a fiscal union (English)
Tue, 24 Mar 2015 15:58:00 +0000
<![CDATA[Potential output and private investment in a late-crisis world]]> http://www.bruegel.org/nc/events/event-detail/event/516-potential-output-and-private-investment-in-a-late-crisis-world/ even516

Falls in potential output growth and private fixed investment were among the unsurprising consequences of the global economic crisis. Despite signs of a return to growth, the economic recovery remains fragile in a number of advanced and emerging market economies. Weak private investment is both a driver and a result of low medium-term growth prospects. The analytical chapters of the IMF’s April 2015 World Economic Outlook focus on these two topics.

What emerges is a tale of diverging narratives for advanced and emerging economies. The fall in potential output growth in advanced countries started well before the crisis, and has worsened further since then. Private investment in advanced economies also contracted sharply. Meanwhile, in emerging market economies the decline in potential output growth only began after the crisis, and private investment has slowed more gradually.

  • What are the underlying causes of these developments?
  • Why are the stories of advanced and emerging economies so different?
  • What are the prospects for a possible revival of private investment and potential output growth?
  • What policy measures could be taken to encourage this?

A presentation by Roberto Garcia-Saltos and Daniel Leigh, key contributors to the IMF report, will be followed by comments from a discussant and an open debate chaired by Zsolt Darvas.


  • Roberto Garcia-Saltos, Deputy Division Chief, Economic Modeling Division of IMF Research Department
  • Daniel Leigh, Deputy Division Chief, IMF Research Department
  • Chair: Zsolt Darvas, Senior Fellow, Bruegel

Practical Details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Wednesday 29 April 2015, 13:00-14:30 (lunch at 12.30)
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Tue, 24 Mar 2015 11:21:08 +0000
<![CDATA[The dollar surge]]> http://www.bruegel.org/nc/blog/detail/article/1598-the-dollar-surge/ blog1598

What’s at stake: The US dollar has gone through a very rapid appreciation over the past 6 months. While reduced form estimates are often presented to argue that this will create a drag on the US economy, it is difficult to reason from a price change and the net effect could be positive if the price change is mostly driven by expansionary monetary policy abroad. In emerging economies, currency mismatches remain despite the recent increase in local currency sovereign debt and may create significant risks.

The dollar rally: then and now

Matt O’Brien writes that the dollar is in the middle of its biggest rally in almost 40 years. As Citibank's Steve Englander points out, the dollar, going by its trade-weighted exchange rate, has increased more in percent terms the past 175 trading days than it has in any other similar period going back to 1976. Menzie Chinn writes that the figure below makes two points clear. First, the appreciation over the past six months is very rapid. Second, the appreciation is not unprecedented. The last such episode – during the post-Lehman flight to safety – was, however, short-lived. Before that, it was in the wake of the East Asian crises. Justin Fox writes that although the recent move against the euro is dramatic, but it has merely brought us back to about where we were when the euro came into being on Jan. 1, 1999.

Source: Econbrowser. Note: Log real value (CPI deflated) of US dollar against basket of major currencies (blue), and against broad basket (red), normalized to March 1973.

The impact on US growth: understanding the reasons for the price change

Scott Sumner writes that one should never reason from a price change. The effect of the dollar increase on the US economy depends the underlying factors. There are 4 primary reasons why the dollar might get stronger:

1. Tighter money in the US.

2. Stronger economic growth in the US.

3. Weaker growth overseas.

4. Easier money overseas.

For Sumner the major factor at work today is easier money overseas. That sort of policy shift in Europe is probably expansionary for the US.

Paul Krugman writes that Sumner is right that if the euro’s fall is being driven by expansionary monetary policy, this affects the U.S. through the demand channel as well as competitiveness, so it may be a wash. But I’ve already argued that the fall in the euro is much bigger than you can explain with monetary policy; it seems to reflect the perception that Europe is going to be depressed for the long term. And if that’s what drives the weak euro/strong dollar, it will hurt US growth.

Tim Duy writes that you can't reason from a price change, but reasoning in a general equilibrium framework is very, very hard. If ECB policy - and, by extension, the falling euro - was a net positive for the US economy, shouldn't we expect higher long US interest rates? But long US rates continue to hover around 2%, which seems crazy given the Fed's stated intention to start raising rates. Consider, however, that the stronger dollar does in fact represent tighter monetary conditions, but long interest rates are falling, which acts as a counterbalance by loosening financial conditions. Essentially, markets are anticipating that the stronger dollar saps US growth, but the Fed will respond with a slower pace of policy normalization, which acts in the opposite direction. So the stronger dollar does negatively impact growth, but market participants expect a monetary offset.

Liability mismatch and the original sin (of the corporate sector)

Jeffrey Frieden writes that the recent volatility of major currencies reminds us of the close relationship between exchange rate movements and international debt dynamics. While many still think of currency values as important primarily for their impact on the relative prices of domestic and foreign goods, today arguably the principal importance of currency values is their effect on the relative prices of assets and liabilities – including their potential to cause debt crises. In as much as domestic firms, or the national government, borrow in foreign currency, large depreciations can massively raise the real cost of foreign-currency liabilities. This was true in the gold-standard era, and the experience has been repeated again and again, from the developing-country debt crisis of early 1980s and Mexico’s “tequila crisis” of 1994, through the 1997-1998 East Asian financial crisis and after.

Jeffrey Frieden writes that liability mismatches persist, but are now mostly in the private sector. While emerging-market governments owe well more than a billion dollars to foreigners, most of it in local currency, emerging-market private corporations owe over two billion dollars to foreigners – and 90 percent of this is in foreign currency. Du and Schreger (2014) document that the share of LC sovereign debt in the external portfolio increased from 15 percent to 60 percent over the past decade. However, EM sovereigns are not issuing debt in their own currency in international markets. Instead, foreign investors are buying sovereign debt issued under domestic law. While the share of FC is shrinking dramatically for sovereign external liabilities, external emerging market corporate debt remains primarily in FC. The shares of LC in corporate debt and private external bank loans have increased at a much slower pace, reaching about 10 percent in 2012.

Source: Du and Schreger (2014). Note: LC = Local Currency.

Neil Irwin writes that the biggest difference this time around compared to the Asian crisis of the late 1990s and the Argentine crisis of 2002 is is that private companies, not governments, have incurred debt in a currency not their own. Paul Krugman disagrees. This time is not different: the Asian and Argentine crises were also about private-sector debt, with Asian public debt, in particular, quite low before the crisis hit. This point matters because of the temptation to fiscalize crisis narratives – the urge to see everything that goes wrong as the result of budget deficits (there’s already been a huge effort to retroactively fiscalize the euro crisis, and we need to push back against attempts to do the same to Asia).



Mon, 23 Mar 2015 08:48:15 +0000
<![CDATA[The implications of decarbonisation for business and the financial sector]]> http://www.bruegel.org/nc/events/event-detail/event/515-the-implications-of-decarbonisation-for-business-and-the-financial-sector/ even515

In preparation for the Paris climate conference in December 2015, Bruegel hosts a closed-door event on the implications of decarbonisation for business and the financial sector.

Both decarbonisation and the effects of climate change will have a material impact on business and the financial sector. To give one example, the current value of the oil and natural gas reserves which would have to stay in the ground to meet the climate targets is more than USD 100 trillion. These reserves are a core fundamental in the valuation of oil and gas companies - and the financial companies that invested into them. On the other hand, to use these reserves could contribute to catastrophic climate change. This would have extremely negative consequences to society as a whole and therefore also the energy and finance businesses.

Workshop participants will discuss how these financial risks related to decarbonisation and climate change could be better accounted for in the financial statements of companies, and how this might affect the financing of low-carbon investments.

This is a closed-door event for invited participants only. There is another event about the path to a low-carbon economy later the same day. We will be accepting public registrations for places at this event from 13 April, and it will be live streamed on the event page.

Fri, 20 Mar 2015 10:32:12 +0000
<![CDATA[A tale of floods and dams]]> http://www.bruegel.org/nc/blog/detail/article/1597-a-tale-of-floods-and-dams/ blog1597

“Fortune can be compared to a river that floods, destroying everything in its way. But when the weather is good, people can prepare dams and dikes to control the flood. If Italy [read Greece] had such preparations, she would not have suffered so much in the present floods.”

                                                                                                                      Machiavelli – The Prince

A lot of debate has recently focused on the management of the fiscal crisis in Greece and whether or not the speed of adjustment has been too fast or too slow (see for example Anders Aslund, Simon Wren-Lewis or this VoxEu piece by the German Sachverständigenrat). In this blog I want to focus instead on the pre-crisis management before turning to the crisis period. I take the road of comparing Greece with its immediate neighbour Bulgaria. I start from their comparable current account developments, which led to crisis in one country but not in the other. The question is why this is the case. Like Machiavelli in his Prince, I would argue that once the flood is coming, it is very difficult to stop it. Once the flood has arrived, the debate really becomes one of second and third best alternatives, so ideally policy makers should build the necessary dams in advance.

Greece and Bulgaria share many similarities. Bulgaria has a fixed exchange rate with the euro thanks to a currency board which has been in place since 1997, while Greece entered the fixed exchange rate mechanism in 1999 to join the euro in 2001. Both countries are quite similar in terms of institutional quality and the structural features of their economies. In terms of the World Bank “Ease of Doing Business” indicator, Greece is ranked 61st while Bulgaria is ranked 38th (and Greece’s ranking was much worse at the beginning of the programme). Both countries are at the bottom of the European PISA education rankings, and public perceptions of corruption are at similar levels according to the World Governance Indicators. Both countries thus have a fixed exchange rate (Greece being in a monetary union) and weak institutions. Greece is in a severe crisis, while Bulgaria has not had a major crisis.

Large current account deficits

Bulgaria and Greece both ran significant current account deficits before the crisis erupted. 

Bulgaria and Greece both ran significant current account deficits before the crisis erupted. In fact, Bulgaria’s current account deficit was more significant than Greece’s right before the onset of the crisis. The deterioration in the net external liabilities of both countries was quite comparable up until this time. Since then, the Bulgarian net external liabilities decreased as a percentage of GDP while in the case of Greece net external liabilities have increased to a staggering 120% of GDP.

Source: AMECO February 2015

So looking at the external accounts superficially would suggest that both Greece and Bulgaria could have had a severe balance of payments crisis leading to a financial assistance programme combined with GDP declines and severe adjustment problems.

So are the two current account deficits comparable? In fact, they are not. In Bulgaria, foreign direct investment inflows drove the current account deficits. As an economy that had just left the communist period behind and had a low capital stock, investment opportunities were still significant despite the weak institutions. In contrast, in Greece, reckless borrowing by the government was the main driver of capital imports. FDI inflows were negligible, probably reflecting the already relatively high capital levels and the weak institutions, including in the area of property rights.

Different fiscal starting positions

Bulgaria thus exercised fiscal prudence before the crisis. In contrast, the Greek fiscal situation deteriorated throughout the good years of 1999-2008.

Bulgaria ran an average fiscal surplus of 1.3% during 2000-2008 while Greece ran a deficit of 6.1%. Bulgaria thus exercised fiscal prudence before the crisis. In contrast, the Greek fiscal situation deteriorated throughout the good years of 1999-2008. These high deficits were not put to good use, but rather gave support to a weak state suffering from corruption and bad governance.

Source: IMF World Economic Outlook October 2014, Eurostat data not available for Greece before 2006.

Both countries enacted a similar fiscal stimulus when the crisis hit, yet Greece had to do a much more significant fiscal adjustment because its starting position was so much worse.

Accordingly, the fiscal management during the crisis was different. When the crisis hit, both countries experienced a significant deterioration of their fiscal balances. In 2009, Greece increased its deficit by 5.7% while Bulgaria increased it by 3.8%, followed by another stimulus of 3.1% in 2010, so a cumulated 6.9%. Bulgaria then adjusted its fiscal deficit from 4% in 2010 to close to zero (0.5%) in 2012, while Greece had to consolidate from 15.6% in 2009 to a forecast 2.7% in 2014 to achieve a primary balance. Both countries enacted a similar fiscal stimulus when the crisis hit, yet Greece had to do a much more significant fiscal adjustment because its starting position was so much worse.

What is the counterfactual of crisis management?

Could the fiscal adjustment of 15% have been done in a less painful way? Simon Wren-Lewis replies to a VoxEU piece by the Sachverständigenrat and argues that the real issue has been that fiscal consolidation has been too quick. He does admit, however, that “In a monetary union … a period of unemployment is inevitable to restore competitiveness.” The problem with both, Wren-Lewis and the Sachverständigenrat is that they fail to specify a proper counterfactual.

Had the fiscal adjustment been lower, how much larger would the size of the financial assistance programme had to have been? Would it really have been possible to agree on a programme even larger than the current one that was already more than 100% of GDP? Would it have been possible to agree on transfers? Would it really have been possible to get a much larger contribution to the fiscal adjustment from earlier debt restructuring?

I doubt that a positive answer to any of the questions above would have been possible politically. The most realistic option would perhaps have been an earlier debt restructuring. Looking back at the debates in which I had been an advocate of earlier debt restructuring, I would argue that one could have gained some €20-30 billion, but the number just reflects a personal assessment of the politics at the time. Certainly the IMF and Germany could have countered the opposition (e.g. here) more forcefully. But the opposition to debt restructuring was - rightly or wrongly - huge. With €20-30 billion, one could have allowed delaying fiscal consolidation by perhaps 2-3 years. The Wren-Lewis piece and the Sachverständigenrat piece also fail to contemplate the impact of high interest rates and the associated confidence effects, a point that Aslund in turn greatly emphasizes. Even in a counterfactual scenario of fiscal adjustment delayed by 2 years, the collapse of GDP would probably have remained substantial due to the prohibitive funding conditions.

Credibility in financial markets

The effect of the reduced austerity may be more than offset by the interest rate hike and the worsening investment climate.

Differences in fiscal management and the substantial political turmoil, associated exit fears etc. led to a substantial difference in credibility in financial markets and Greece suffered greatly from this. Yields on Bulgarian debt have been consistently below Greek yields since the beginning of the crisis. Arguably, the higher yields driven by the lack of Greek credibility were an important factor behind the collapse of Greek GDP. Think of increased spreads like an increase in the central bank interest rate, with the corresponding negative effects on economic performance. It was therefore good news that these spreads came down substantially before the election of the new Greek government. The more recent increase in interest rates and the corresponding loss in confidence makes me pessimistic with regard to the overall economic performance of the Greek economy in 2015. The effect of the reduced austerity may be more than offset by the interest rate hike and the worsening investment climate.

Source: Benchmark Yields from Thomson Reuters

Greece’s GDP per capita is now back to where it was in 1999 after a 25% collapse since the beginning of the crisis.

Overall, differences in particular in the pre-crisis fiscal management in particular left their mark on GDP: Greece’s GDP per capita is now back to where it was in 1999 after a 25% collapse since the beginning of the crisis. In contrast, Bulgaria now stands some 8 percentage points above the 2008 level and its income per capita has doubled since 1999. Greece would have hugely benefited from better fiscal management prior to the crisis, as also argued by Martin and Philippon (2014). It is easy to postulate a better crisis management but much more difficult to propose a credible and realistic counterfactual. Containing a crisis when the flood has arrived is always difficult.

Source: AMECO February 2015

Readers will tell me that things are not great in Bulgaria and that growth is disappointing. This is true, but at least per capita growth is positive. Further policy measures could focus on investment that increases economy-wide productivity. In contrast, pet-projects driven by corrupted institutions and funded by deficits need to be avoided. This is a significant challenge, which may explain why Bulgarian citizens have been sceptical about recent government proposals to increase the deficit.


Let me draw a number of key lessons:

1) Greek fiscal imprudence prior to the crisis proved to be costly. Greece entered the crisis with a deficit that was already at an unsustainable level. The necessary adjustment was huge and had a substantial impact on unemployment and GDP. It is difficult to quantify how much a slower fiscal adjustment would have helped to restrain the decline in GDP. Arguably, to make the adjustment much slower one would have needed either politically unrealistic transfers or a debt restructuring of perhaps unrealistic size. The real issue is thus that it is difficult to build dams when the flood is coming. Prudent fiscal policy is essential in good times.

2) Large current account deficits are not a problem per se. Large net external liabilities do not necessarily lead to a sudden stop and exchange rate problems, as long as it reflects prior productive capital inflows. In contrast, if capital inflows are driven by reckless fiscal policy (or unsustainable private sector housing booms such as in Ireland and Spain) that are spent unproductively in a weak state, a balance of payments crisis can be the result. Substantial down-hill capital flows can work but only if put to a good use.

3) One can speculate as to whether the monetary union provided Greece with an incentive to run more irresponsible fiscal policy than Bulgaria, which was always aware that the currency board would only hold if the country was credible. This view would imply that Greece was of the opinion that being in the euro area removed the budget constraint and made transfers possible. This view would also imply that financial markets did not believe in the no-bail-out clause. Nevertheless, the reason for earlier fiscal irresponsibility is probably also related to the Greek political system, as Greece has a long history of high public deficits and to the failures of European fiscal surveillance. After entering the euro, the system did not realize that in a monetary union monetary financing and devaluation are not an option anymore.

4) Comparable fiscal consolidations in other countries proved to be less damaging than in Greece. The real lesson to draw is not to increase the speed of fiscal consolidation during adjustment. Instead, when institutions are weak you have to be particularly prudent in your macroeconomic management before a crisis hits you. Weak institutions mean lower potential growth and restrict the capacity to deal with crises. This is the case inside a monetary union as it is the case for a country with a currency peg like Bulgaria. It is a tale of fiscal prudence in good times.

I believe that a solution to the current impasse will be difficult to find

In conclusion, it will come as no surprise that I believe that a solution to the current impasse will be difficult to find. The Eurogroup rightly agreed to Greece running lower primary surpluses in 2015, and they should ask for lower primary surpluses than they have before for the future years as well. In my calculations, a primary surplus of 2.5% is compatible with a declining debt ratio under a moderate growth scenario. A solution also needs to be found for the debt level. While the interest burden on the debt is negligible, the high levels do undermine trust of international investors and are a constant source of political tensions. Indexing debt to future GDP developments would bring trust and stability. All of these issues are painful in any creditor-debtor relation. They are particularly painful in a monetary union as they put to the test the credibility of its rules.

Excellent research assistance by Alvaro Leandro is gratefully acknowledged as are helpful comments by Gregory Claeys, Zsolt Darvas, Ashoka Mody, Andre Sapir on earlier versions of this blog.


Thu, 19 Mar 2015 09:04:08 +0000
<![CDATA[The whys and hows of a single market for Europe]]> http://www.bruegel.org/nc/blog/detail/article/1596-the-whys-and-hows-of-a-single-market-for-europe/ blog1596

Be it sluggish growth performance, high unemployment or an incomplete monetary union, completing the single market is often offered as a silver bullet to alleviate or solve most of the current problems of the EU. However, seldom is time taken to explain what the underlying mechanics of the single market are and how the latter is supposed to deliver all these positive effects for the EU.

In a recently published Working Paper, we have aimed to bridge this gap by offering a holistic reflection on the theoretical channels of single-market-induced growth and have verified their relevance, building on existing empirical literature.

Figure 1. The single market at work

Source: Bruegel

Figure 1 sketches some of the theoretical channels through which the four freedoms (labour, capital, goods, and services) are supposed to stimulate growth and employment. However, mostly due to data limitations, verifying and quantifying these channels at micro-level is all but methodologically trivial. Furthermore, aggregating the individual (micro-level) channels to estimate the overall (macro-level) impact of the single market on GDP requires extraordinarily audacious modelling assumptions. This has resulted in a wide variety of studies yielding sharply different results (see Table 1). 

Table 1: Summary of studies and main macroeconomic effects of the single market

Source: Bruegel

All in all, however, even taking all this into account, it is safe to conclude that the impact of the single market has somewhat fallen short of initial expectations. Certainly the Single Market Programme has not succeeded in reversing the declining (though still positive) trend in EU productivity growth and its gap with the US. In our view, this is for three broad reasons:

it appears evident that the EU single market is far from complete

1. Barriers remain prevalent under several headings. Although the exact degree of integration (or lack thereof) might be difficult to assess, it appears evident that the EU single market is far from complete. Along with the economic literature, we identify problems of a) poor quality of directives’ implementation, b) insufficient mutual recognition, c) a highly fragmented public procurement and d) services market, and finally e) significant barriers to the free movement of workers.

2. Key complementary policies to the abolition of barriers were not put in place. Albeit important, the prevailing barriers in the single market tell only part of the story. In several areas, even fully abolishing barriers does not translate into the automatic engendering of a common market. For example, the mere recognition of the right of establishment failed to spark significant integration of the banking sector at European level, which rather required the creation of a single supervisor and a common resolution mechanism (see Pisani-Ferry et al, 2012). Similarly for workers, the creation of a truly integrated European labour market might require not only better recognition of professional diplomas and pension portability, but rather wide-ranging coordination of welfare policies.

3. Some national policies were not supportive of the positive effects of the single market. National regulations protecting undue rents, rigid labour market rules, industrial policy supporting national champions, prevailing public monopolies, cumbersome procedures to set up new businesses, to mention just a few, are all policies that will hamper the crucial process of ‘creative destruction’ and attenuate the benefits of the single market, even in a situation in which all barriers are removed. At the same time, an effective national welfare system is fundamental to ensure that there is not just ‘destruction’ but rather ‘creative destruction’ and that, as unproductive firms shut down, capacities are not wasted but rather re-channelled to productive sectors and firms.

one can then interpret the single market as a catalyst, rather than a motor, of growth

With this last point in mind, one can then interpret the single market as a catalyst, rather than a motor, of growth. Reforms of product and labour markets, together with policies increasing the effectiveness of welfare systems, while keeping public finances under control, will boost competitiveness and growth. A complete functioning single market will then amplify the positive effect of these reforms. However, if progress is not made under these headings, the single market cannot act as a substituting policy to bring Europe back to growth.

A key observation is that although the overwhelming prediction is for the single market to generate positive aggregate effects, specific categories might be negatively affected. A large part of the constituencies that currently show support for Eurosceptic parties are possibly to be ascribed to this category. If this were true, and given points 2 and especially 3 above, failures in national policies and welfare systems are to be partly blamed for the opposition that is currently being channelled against the EU and the single market.

Perhaps precisely because of the acknowledgment of the heterogeneous effects arising from further integration, and led by the desire to overcome distributional conflicts, the approach of the Commission in the past has been to adopt wide-ranging directives and regulations aimed at completing the single market across the board – the 1992 SMP being the most notable case. Recently however, we note a policy shift towards a more targeted approach.

The Juncker Commission has identified the main priorities for the single market as the establishment of a Capital Market Union, and the completion of the European energy and digital markets. This targeted approach might cater better to focusing on setting up the ‘complementary policies’ we have mentioned. But without comprehensive support from member states entailing not only devolution of powers but also appropriate national redistribution policies, those initiatives are likely to face increasing political resistance, significantly affecting the chances that the single market will deliver the benefits expected of it since its inception.



Wed, 18 Mar 2015 16:53:01 +0000
<![CDATA[European Monetary Union]]> http://www.bruegel.org/nc/blog/detail/article/1595-european-monetary-union/ blog1595

The European Commission President published an analytic note together with the European Council, ECB, euro area Presidents raising a number of questions on euro area governance. Europolitics asked Guntram Wolff  to provide short answers to difficult questions, which are reproduced below:

How can we ensure sound fiscal and economic positions in all euro area Member States?

The key to ensure a sound fiscal and economic position is to have the right economic policies in good times, not to run excessive deficits in good times, and to gradually adjust in bad times and implement the right productivity promoting reforms. Currently, these are national prerogatives.

How could a better implementation and enforcement of the economic and fiscal governance framework be ensured?

The current framework for economic and fiscal governance is too technocratic and too rigid in many respects, which makes implementation difficult. Ultimately, we need more centralized decision making power and political discretion – at least for exceptional times.

Is the current governance framework – if fully implemented – sufficient to make the euro area shock-resilient and prosperous in the long run?

The current governance framework is not sufficient.  We are still far from being shock resilient, as events in Greece and volatility in other countries have shown. The euro area needs a double goal for fiscal policy: debt sustainability and an appropriate fiscal stance for the area as a whole.

To what extent can the framework of EMU mainly rely on strong rules and to what extent are strong common institutions also required?

A framework based only on rules is bound to be insufficient. There is no such thing as a perfect rule that covers all eventualities.  So you need institutions that think about and assess situations and then come to clear policy conclusions. The institutions that we have so far are insufficient.

What instruments are needed in situations in which national policies continue – despite surveillance under the governance framework – to go harmfully astray?

What we are seeing at the moment is that the Euro area is stuck and doesn’t have a good answer to that question.  For extremely bad cases, we need a credible framework of no-bailout policies. So if a country really does not deliver, one has to be able to force that country to go bust and not be able to access the market any more.  In extreme cases, the policy that we have currently, where the threat of euro area exit is on the table, may continue to have to be there. A union can only function if a certain set of commitments are being followed.

Has the fiscal-financial nexus been sufficiently dealt with in order to prevent the repetition of negative feedback loops between banks and sovereign debt?

The answer is clearly no.  The banks remain highly dependent on the health of the government in the country in which they are located, and banking remains largely national.  To really address this we need integration of banks across borders, we really need European banks.  We also need to end ring-fencing across borders.

How could private risk-sharing through financial markets in the euro area be enhanced to ensure a better absorption of asymmetric shocks?

The principal idea of having more capital market integration across borders in all 3 major segments of markets  -  securities markets, equity markets, and bond markets -  is the right way forward.  To tackle that, we need to really tackle the deeper issues that prevent better integration, and that’s a long term agenda.  We’re talking about decades rather than years.

To what extent is the present sharing of sovereignty adequate to meet the economic, financial and fiscal framework requirements of the common currency?

The current sharing of sovereignty is inadequate.  Ultimately in the area of fiscal policy, sovereignty is national, so national parliaments have the final say. We need to have a framework where, at least in exceptional circumstances, a European level decision, democratically backed by the European parliament, can override national parliamentary decisions.  That means we need treaty change and national constitutional change.

Is a further risk-sharing in the fiscal realm desirable? What would be the preconditions?

Further fiscal risk sharing is desirable, but at this stage unfeasible.  Ideally, the precondition is the veil of ignorance, so you know that shocks are random shocks against which you insure and not policy induced shocks, or shocks based on policy mistakes of the past. We will live without large risk sharing for quite some time.

Under which conditions and in which form could a stronger common governance over structural reforms be envisaged? How could it foster real convergence?

I’m not quite that convinced we need real convergence.  We can have countries with different levels of economic performance in a monetary union, as long as they don’t live beyond their means. What we need, in contrast, is a framework in which wages develop in line with productivity.  On the fiscal side, we need to add to the framework the goal of a proper area wide fiscal stance, to which also the stronger countries have to contribute.

How can accountability and legitimacy be best achieved in a multilevel setup such as EMU?

The accountability and legitimacy of decisions needs to be at the level at which such decisions have to be taken.  Currently we have a problem in that policy is decided at the national level, and the legitimacy is at that level, while the need to decide on these national fiscal policies, at least in exceptional circumstances, is a European prerogative. In other words, at least for exceptional circumstances, we need to be able to shift the accountability and the legitimacy of the decisions on national fiscal policy to the European level.

Tue, 17 Mar 2015 16:20:18 +0000
<![CDATA[The effort to stabilise the financial system in Japan: an outline and the characteristics of the programme for financial revival]]> http://www.bruegel.org/publications/publication-detail/publication/874-the-effort-to-stabilise-the-financial-system-in-japan-an-outline-and-the-characteristics-of-the-programme-for-financial-revival/ publ874

This Working Paper provides an overview of the Programme for Financial Revival announced in October 2002 in Japan. The programme aimed to dramatically reduce the large amount of non-performing loans that remained until the end of the 1990s. In addition to solving the problem of bad loans, the Programme for Financial Revival aimed to build a strong financial system. For this purpose, the programme comprised three pillars:

1) creation of a new framework for the financial system,

2) creation of a new framework for corporate revitalisation,

3) creation of a new framework for financial administration.

The Japanese experience suggests that despite its delayed introduction, this programme may be considered successful in going some way to drastically reduce non-performing loans and stabilise the financial system. Japan’s financial problems and their resolution since the 1990s provide a number of lessons for other economies, particularly for Europe in relation to the difficulties over the euro.

The effort to stabilise the financial system in Japan (English)
Tue, 17 Mar 2015 13:59:20 +0000
<![CDATA[Making space for China]]> http://www.bruegel.org/nc/blog/detail/article/1594-making-space-for-china/ blog1594

When the United Kingdom announced earlier this month that it had agreed to become a founding member of the China-led Asian Infrastructure Investment Bank (AIIB), most of the headlines focused not on the news itself, but on the friction the decision had caused between the UK and the United States.

The White House issued a statement urging the British government to “use its voice to push for adoption of high standards." And one senior US administration official was quoted accusing the UK of “constant accommodation of China, which is not the best way to engage a rising power." In fact, it is the US that is advocating the wrong approach.

In the UK, the diplomatic spat served as an occasion for the British press to air criticism from those who believe that the government should adopt a stronger stance on China. For example, they say that the government should have spoken out more forcefully in support of last year's pro-democracy protests in Hong Kong, and that it should not have distanced itself from the Dalai Lama (as it seems to have done) during Prime Minister David Cameron's visit to China in 2013.

The UK does need to stand up for itself, but there is no reason for it to become confrontational about internal Chinese matters

The UK does need to stand up for itself, but there is no reason for it to become confrontational about internal Chinese matters – especially in the case of Hong Kong, where it lost its standing when it agreed to return the city to Chinese control in 1997.

The US, too, would be wise to stop resisting the fact that the world is changing. The US Congress has yet to ratify a 2010 agreement providing China and other large emerging economies greater voting power in the World Bank and the International Monetary Fund. In the meantime, the agreement has become obsolete; China's economy has nearly doubled in size since the deal was struck.

America's reluctance – and that of France, Germany, and Italy – to give the emerging powers an appropriate voice in the established international financial institutions is counterproductive. It drives the creation of new parallel institutions such as the AIIB and the New Development Bank, founded in 2014 by the BRICS countries (Brazil, Russia, India, China, and South Africa).

In the coming days, I will be visiting China in my role as Chair of the British government's Review on Antimicrobial Resistance, and also as a participant in the Boao Forum for Asia, an event similar to the annual gathering of the World Economic Forum in Davos. I hope to encourage Chinese policymakers to make the fight against antimicrobial resistance a priority when China chairs the G-20 in 2016. And though I am not the British ambassador, I will be happy to state my belief that the UK government was wise to join the AIIB, and that the US administration, in voicing its opposition, was not.

China's $10 trillion economy is bigger than those of France, Germany, and Italy combined.

China's $10 trillion economy is bigger than those of France, Germany, and Italy combined. Even if its annual output growth slows to 7%, the country will add some $700 billion to global GDP this year. Japan would have to grow at something like 14% to have that type of impact on the world.

For anyone who wants to engage in global trade, it is thus vital to identify what China wants. In the case of the UK, this obviously includes finance (as well as sports, music, fashion, and perhaps health care). The UK is simply being smart when it promotes its own interests by cooperating with China.

One of the few positive consequences of the 2008 financial crisis was the elevation of the G-20's global role; in principle, it is a far more representative forum for international leadership than the G-7 ever was. There is, however, a downside to the G-20's emergence: the large number of participants can make it difficult to reach agreements and get things done.

A new G-7 needs to be created within the G-20, thereby providing China with a degree of influence that reflects its economic weight and requires it to assume a commensurate proportion of global responsibility. Space at the table for China could be obtained if the eurozone countries, signaling their commitment to the common currency, agreed to surrender their individual seats in exchange for one representing the entire monetary union. The US, too, would finally have to accept China's heightened global role.

Later this year, the IMF will recalibrate the weights in its unit of account, the so-called Special Drawing Rights, which comprises a basket of currencies that currently includes the US dollar, the euro, the British pound, and the Japanese yen. According to almost every economic and financial criterion, the SDR basket should now include China's renminbi. The US would be wise to not oppose such a move. Otherwise, it would risk accelerating the decline of the established international financial institutions.

By founding the AIIB and the New Development Bank, China and other emerging powers have signaled that they will not wait for their voices to be better heard.

Similarly, the US Congress should ratify the agreed changes to the governance of the IMF and the World Bank. By founding the AIIB and the New Development Bank, China and other emerging powers have signaled that they will not wait for their voices to be better heard. And decisions like that of the UK – and France, Germany, and Italy – show that they are not alone.

Tue, 17 Mar 2015 11:38:04 +0000
<![CDATA[German wage negotiations]]> http://www.bruegel.org/nc/blog/detail/article/1593-german-wage-negotiations/ blog1593

In the beginning of January I wrote about the impact of persistently low inflation on collectively bargained wages in Germany. Concluded negotiations in the banking, construction, printing, and federal state and municipalities sectors at the time pointed to lower wage increases in 2015 than in 2014, as did suggestions from employers’ associations that stagnating productivity and a low inflation environment would factor into the negotiation process.

On 24 February 2015, however, IG Metall, the largest union in Germany that often paves the way for wage agreements in the other sectors, concluded their 2015 bargaining round in Baden-Württemberg with a 3.4% wage increase starting in April and a one-off payment of €150 in March for 800,000 workers. The agreement will last for 12 months, and comes after the union first requested a 5.5% increase. IG Metall then reached a subsequent and similar agreement for 115,000 Volkswagen employees, and secured the Baden-Württemberg agreement for the metal and electrical industry across all regions. As seen in the updated table below, the wage hike represents a sizeable increase over the wage agreement from the previous year, which was 2.2% for a period of 8 months.

In the chemical industry, however, wage negotiations are at a standstill after a third round of bargaining came to a close on 12 March with no agreement reached. IG BCE, the union that represents 550,000 chemical workers, is asking for a 4.8% increase over a contract of 12 months. In the latest round of negotiations, the employers’ association countered with a 1.6% increase to last 15 months. Another round of negotiations is set to commence on 26 March, and it will be interesting to see if the chemical industry can follow the metal industry’s lead in securing a sizable wage hike.

The civil service union is also in the midst of bargaining for a 5.5% wage increase with a third round of negotiations that began yesterday, 16 March.  Meanwhile, the Insurance sector, demanding a 5.5% increase as well, begins negotiations on 20 March.

If German collective bargaining agreements can resist the influences of the current low inflation environment (0.1% in February) it would be a boon for a deflation-wary Euro area.  Indeed, last July even the Bundesbank backed the idea of wage developments that would support price stability in the Eurozone, noting that Germany has “close to full employment in a number of sectors and regions, and [is] seeing more and more reports of labour shortages. It is therefore only natural, and also to be welcomed that wages and salaries are rising more strongly than in the days when the German economy was in much poorer shape.”

While higher wages may be a hindrance for Germany’s export-oriented sectors, higher wages in Germany could compliment the ECB’s new efforts to increase inflation. It is also important that German wages grow more strongly to address the imbalances plaguing the Euro area and to support ongoing adjustment in Southern Europe.

Tue, 17 Mar 2015 11:02:53 +0000
<![CDATA[The long road towards the European single market]]> http://www.bruegel.org/publications/publication-detail/publication/873-the-long-road-towards-the-european-single-market/ publ873

• The single market is often perceived as the panacea for Europe’s economic troubles. It is believed that completing the single market would boost welfare, stimulate growth and increase European competitiveness.

• However, identifying and quantifying the channels through which market integration is expected to engender growth is methodologically complex. Although the overwhelming prediction from the literature is for single market integration to generate positive and significant aggregate effects, we conclude that the impact so far has fallen short of initial expectations, because:

(1) Barriers continue to prevail in the EU, preventing the exploitation of the potential benefits of full market integration

(2) ‘Complementary policies’ to support the single market were not, or were insufficiently, put in place

(3) The single market project has not sufficiently been framed as a key part of the process of creative destruction that Europe needs to embrace to successfully modernise its economy.

• That single market integration generates positive and significant aggregate effects does not imply that its effects are positive and significant for every sector. There is therefore an important role for European Union and national distributional policies to ensure that losers are sufficiently compensated by the winners, and to overcome political resistance to completing the single market.

The long road towards the European single market (English)
Mon, 16 Mar 2015 16:43:47 +0000
<![CDATA[A fresh start for TTIP]]> http://www.bruegel.org/videos/detail/video/148-a-fresh-start-for-ttip/ vide148

TTIP negotiations: what is achievable and feasible by 2016?

Mon, 16 Mar 2015 13:05:00 +0000
<![CDATA[Greece: update on public finances]]> http://www.bruegel.org/nc/blog/detail/article/1592-greece-update-on-public-finances/ blog1592

At the end of last week the Greek Finance Ministry published the preliminary budget execution bulletin for February. The State primary budget balance has returned almost in line with the target, but mostly due to expenditure cuts. Revenues continue to underperform.

These bulletins give monthly data on a cash basis, which makes them well suited to assessing the situation of public finances from a short term financing perspective. Moreover, it shows the cumulative execution of the budget and it allows us to compare actual outcomes with expected ones.

As previously shown, the budget execution for December 2014 and January 2015 was significantly below expectations. For the 12-months period of January-December 2014 the outcome for the primary balance had been 1.9bn against an expected 4.9 billion, mainly due to the underperformance of State budget net revenues, which undershot the target by about 3.9 bn. Underperformance continued in January 2015, when the primary balance was 443 million against 1.4bn expected, with revenues still 935 million short of the target.

According to the Ministry of Finance, the underperformance in January 2015 was mainly due to the extension of a VAT payment deadline until the end of February 2015 and to the underperformance of the expected revenues from the settlement of arrears. Therefore, data for February released last week are key.

At first sight, the situation has improved. The State primary balance budget for the period January-February 2015 was 1.2bn compared to the 1.4bn expected, only 168 million short of the target. Compared to the 900 million shortfall recorded in January, this is a significant improvement.

However, a closer look at the revenues and expenditure show that the improvement in the primary balance has been achieved almost entirely by reducing expenditures. Revenues for the period January-February 2015 came in at 7.8bn compared to 8.8bn expected, 963 million still short of the target. However expenditures, which in January 2015 were almost perfectly on target, were significantly reduced in February. For the period of January-February 2015, state budget expenditures came in at 7.98bn against 8.8bn expected,  844 million below target, thus explaining the improvement in the primary balance(see Figure 2).

The reduction has come mostly from primary expenditures and this pattern is probably continuing also in March, as the General Accounting Office has reportedly blocked any state expenditure not related to salaries and pensions (this and other measures to avoid a cash crunch have been discussed here). This strategy might work for re-balancing the primary budget in the short term, but it will be difficult to sustain unless revenues revert closer to target.

Mon, 16 Mar 2015 10:36:11 +0000
<![CDATA[Negative rates and financial intermediation]]> http://www.bruegel.org/nc/blog/detail/article/1591-negative-rates-and-financial-intermediation/ blog1591

What’s at stake: While negative interest rates might be needed from a macroeconomic point of view, they create important challenges for financial intermediaries, as it is not clear how they could maintain their spread business in the below-zero lower bound environment.

Financial intermediation with negative rates

Stephen Cecchetti and Kermit Schoenholtz writes that bankers run what is called a “spread business.” They rely on receiving higher returns on their assets than they pay on their liabilities. In the simplest case, that means charging borrowers a higher rate for loans than they pay customers for their deposits. That is their spread. This spread business usually doesn’t depend on the level of interest rates. The bank’s interest margin has several parts, including the cost of screening and monitoring borrowers, the return to the bank’s owners, and the cost of providing services to depositors. 

Bill Gross writes that a serious concern might be that low interest rates globally destroy financial business models that are critical to the functioning of modern day economies. Pension funds and insurance companies are perhaps the most important examples of financial sectors that are threatened by low to negative interest rates. Both sectors have always attempted to immunize their long-term liabilities (retirement, health, morbidity) by investing at a similar duration with an attractive yield. Now that negative and in almost all cases low short term rates are expected to persist, long term bonds and similar duration assets do not offer the ability to pay claims 5, 10, 30 years into the future.

Wolfgang Munchau writes that the impact of low rates could jeopardize the life insurance sector in Europe. These companies sell insurance products and annuities with guaranteed returns. They invest the money they receive from their policyholders in government and corporate bonds. For this to work, the average return on the bonds they hold in their portfolio has to be higher than the guaranteed rate they pay out. This currently remains the case because insurers are holding bonds they bought many years ago during times of higher interest rates. But as time goes on, the weight of low-yielding bonds in their portfolio will rise. For them the biggest danger is the length of time interest rates stay low.

Are interest rates artificially low?

David Beckworth writes that negative interest rates are often considered unsettling because they’re seen as another step by central banks to artificially push down interest rates. The premise is that central banks are causing interest rates to remain low. But this premise assumes too much. It could be the case that central banks over the past six years were adjusting their interest rate targets to match where the market-clearing or 'natural' interest rate was going.

Brad DeLong writes that if interest rates are low but if planned savings at full employment exceed investment, then interest rates are not “artificially low”: they are naturally low. If they are “artificially” anything, they are artificially high. Antonio Fatás writes that to make the argument that periods of unusually low interest rates create confusion in investors and markets (what some call "search for yield"), one needs to first understand the global nature of this phenomenon that suggests that the reasons for low interest rates extend beyond the particular actions of a central bank. And then we need a theory of financial markets, their irrational behavior and how the central bank can influence this behavior.

Search for yield and flight from loss

Ben Bernanke said in his May 2013 Congressional testimony that a long period of low interest rates has costs and risks. One that we take very seriously is the possibility that very low interest rates, if maintained too long, could undermine financial stability. For example, investors or portfolio managers dissatisfied with low returns may reach for yield by taking on more credit risk, duration risk, or leverage. Martin Feldstein writes that extremely low interest rates have fueled increased risk-taking by borrowers and yield-hungry lenders. The result has been a massive mispricing of financial assets. And that has created a growing risk of serious adverse effects on the real economy when monetary policy normalizes and asset prices correct.

Gabriel Chodorow-Reich writes that low interest rates may spur risk taking by financial institutions beyond what the ultimate holders of the risk would prefer. Investment management poses a classic principle-agent problem, in which the incentives of managers may not align perfectly with the objectives of shareholders and debt holders. The definition of reaching for yield varies across authors. I use it to mean increases in risk taking for reasons other than the end-holder’s risk preferences.

Source: Gabriel Chodorow-Reich

Percival Stanion writes that the blanket search for yield will evolve into a flight from near-certain loss. It is doubtful that investors can put up with this for much longer. To avoid an almost certain loss, it is possible they will end up taking on more risk. There is a large body of evidence testifying to investors’ powerful aversion to loss. This was demonstrated more than 30 years ago by the behavioural economist and Nobel laureate Daniel Kahneman, who found individuals were prepared to take on more risk than normal if the alternative — doing nothing — meant accepting a loss. Tellingly, the pain of a $100 loss was found to be far more intense than the satisfaction from a $100 gain.

Mon, 16 Mar 2015 09:10:18 +0000
<![CDATA[Is the ECB sacrificing reforms on the altar of inflation?]]> http://www.bruegel.org/nc/blog/detail/article/1590-is-the-ecb-sacrificing-reforms-on-the-altar-of-inflation/ blog1590

Roughly one month ago, Mario Draghi announced that the European Central Bank (ECB) would activate a large programme of sovereign bonds purchases (QE), in an effort to re-anchor euro area inflation expectations to the 2% target. In the run up to that decision one of the main naysayer arguments was that, by doing so, the ECB was reducing pressure on governments to engage in painful, but necessary, structural reforms (German Council of Economic Experts, 2014). At the time, the argument was dismissed on the grounds that the ECB’s mandate is to control inflation, not foster reform efforts. The question however remains as to whether QE will slow down reform efforts in the coming months and therefore, in boosting short-term demand, risks inadvertently shrinking long-term supply.

In order to explore the determinants of reform efforts in advanced economies, and in the euro area more specifically, I analysed a highly balanced panel dataset of the OECD’s reform responsiveness rate[1], an indicator of whether wide-ranging reform packages were adopted. The data is available for all 34 OECD members, with biannual frequency, for the time span 2007-2014. The technical results are illustrated in Table 1 (at the bottom).

The main findings can be summarised as follows:

1. Countries under an IMF programme significantly step up structural reform efforts. This should come as no surprise, given the carrot-and-stick structure of IMF lending, involving frequent reviews that need to be approved in order to access the Fund’s payment tranches[2].

2. Countries with a high unemployment rate tend to implement significantly more reforms. This result is in line with what Williamson (1993) calls the “crisis hypothesis”: the public perception of a crisis is needed to create the conditions under which it is politically possible to undertake extensive policy reforms. As we see in Figure 1 (below), the relationship does not seem to be dictated by the programme countries.

Figure 1. Relationship between reform effort and unemployment rate

Source: OECD, Bruegel calculations

3.  Advanced economies tend to implement fewer reforms when under financial market pressure and the relationship becomes insignificant when zooming in on the euro area. In OECD countries, the statistical relationship between financial market pressure - proxied by the 10-year government bond yields - and reforms seems to be at best U-shaped: as financial market pressure mounts, governments are less likely to implement reforms[3]. However, above a certain threshold, this effect might be reversed. Evidence for this non-linear relationship does not seem to be highly compelling, judging from a joint reading on the two panels in Figure 2 (below). When looking at euro area countries only, any effect of financial market stress on reforms disappears. As can be seen in Figure 2 (rhs), although there seems to be a positive correlation between financial market stress and reform efforts in the euro area, this is driven by IMF programme countries, which in any case have typically lost financial market access.


Figure 2. Relationship between reform effort and market stress 

Source: OECD, Bruegel calculations

Although it is true that this analysis lends itself to clear methodological challenges, some concerns can be immediately addressed.

First, the results do not seem to be dictated by extreme outliers. Models 6 and 7 in Table 1 (below) show how financial market stress continues to be a non-significant determinant of reform efforts in the euro area even when Greece is excluded (as a country which underwent an economic collapse), or when Spain is excluded (as the other country where unemployment soared to unprecedented levels). High unemployment rates continue to be significantly associated with reform drive.

Second, and possibly more concerning, is the potential for reverse causality. The claim here would be that what the analysis above is capturing is not that high unemployment rates lead the electorate to push governments to reform, but rather that reforms have short-term negative effects on the economy and therefore lead to temporarily higher unemployment.

Although reverse causality cannot be directly tackled in this setting, I attempt to take this problem into account by controlling for GDP growth. If a problem of reverse causality was at play, then the relationship between reform implementation and GDP growth should be negative. However, Table 2 shows how in all specifications the coefficient of GDP growth remains insignificant.

Actually, when looking at non euro area countries only (model 4), the relationship is positive and significant. This is illustrated further in Figure 3 and 4 (below), which shows how GDP growth (lhs) displays no clear relationship with reform implementation, whereas unemployment (rhs) does.

Figure 3 and 4. Relationship between reform effort and GDP growth (lhs) and unemployment rate (rhs)

Source: OECD, Bruegel calculations

Note: Greece excluded as an extreme outlier. Results however are only reinforced by its inclusion.  

Two main conclusions can be drawn from this short analysis. First, the crisis mechanism put in place by the euro area, composed of the ESM + OMT, seems to be well equipped to step up reform efforts and hence boost competitiveness in crisis countries. However, as seen lately in Greece, programmes risk producing popular backlashes and can therefore not be seen as the sustainable way to foster competitiveness in the euro area on a long-term basis. As such, alternative mechanisms of euro area economic governance should be devised, as argued recently, inter alia, by Sapir and Wolff (2015).

Second, the ECB’s bond buying programme seems unlikely to lead to a disproportionate setback in reform efforts in stressed countries. In particular, economies affected by large unemployment rates are expected to continue facing pressure from the electorates to enact reforms and should do so benefiting of the temporary boost in aggregate demand offered by a weaker euro and lower oil prices (as I have argued here).

Fostering structural reforms is not only outside the ECB’s mandate, but apparently also outside its direct influence. It is for euro area governments, and EU institutions, to ensure that reforms continue progressing in the months to come, laying the foundations of sustainable long-term growth.

Table 1. Panel regression results

Source: OECD, Bruegel calculations


Technical Notes

IMF is a dummy variable taking value 1 when an IMF programme is in place, 0 otherwise.
Source: IMF

Unemployment rate (avg) is the average monthly unemployment rate over each two-year period.   
Source: OECD

GDP growth (avg) is the average yearly growth in real GDP for each country over each two-year period.
Source: OECD

Peak yield is the maximum value of the quarterly 10-year government bond yield experienced by each country over each two-year period. All regressions allow for the possibility of a non-linear relationship between the yields and reform efforts (hence the inclusion of peak yield-squared). Main results are confirmed when allowing only for a linear fit.
Source: OECD

All regressions are run using country fixed effects, to control for time-invariant country-specific characteristics like political systems, cultural characteristics, etc.

All regressions (but Model 1) include time fixed effects to control for uniform shocks affecting all countries in a given year. Results seem however to be all but weakened by their exclusion.

All specifications adopt clustered standard errors at country level, hence allowing for heteroskedasticity.

[1] The reform responsiveness rate indicator is based on a scoring system in which recommendations set in the previous year’s issue of Going for Growth take a value of one if “significant” action is taken and zero if not. An action is considered as “significant” if the associated reform addresses the underlying policy recommendation and if it is actually legislated: announced reforms are not taken into account (OECD, 2015).

[2] This result is confirmed in all specifications, except model 4 (OECD non-EA only). However, there are reasons to suppose this result is driven by the poor reform track record of Iceland, which is the only non-EA OECD country to have undergone an IMF programme over the period 2007-2014.

[3] This result can be rationalised by the fact that, as yields increase, governments are likely to be pushed to consolidate their finances. OECD (2006) finds that budget consolidation appears to retard structural reforms, possibly reflecting the corresponding call on political capital. 

Fri, 13 Mar 2015 10:24:44 +0000
<![CDATA[Mobilizing capital towards a low-carbon economy]]> http://www.bruegel.org/nc/events/event-detail/event/513-mobilizing-capital-towards-a-low-carbon-economy/ even513

Climate change data underline the urgent need to move toward a low-carbon economy: a goal echoed in ambitious emissions reduction targets. Achieving this will require a substantial transformation of infrastructures and business models. For this to succeed capital must be moved from the established high-carbon investments towards low-carbon opportunities. However, this process is fraught with uncertainties - not least political ones - and redirecting capital flows across the economy will be a massive challenge.

In this event Nick Robins and Anthony Hobley will share their experiences of these challenges and suggest possible ways to overcome them. This will be followed by comments from discussants and an open discussion with the participants. The discussion will be moderated by Georg Zachmann, Research Fellow at Bruegel.


  • Nick Robins, Co-chair, UNEP Finance Initiative Climate Working Group
  • Anthony Hobley, CEO, Carbon Tracker Initiative
  • Chair: Georg Zachmann, Research Fellow, Bruegel

Background Materials

Practical Details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Monday, 27 April 2015, 12.30-14.00
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Thu, 12 Mar 2015 14:53:01 +0000
<![CDATA[A Fresh Start for TTIP]]> http://www.bruegel.org/nc/blog/detail/article/1589-a-fresh-start-for-ttip/ blog1589

Ladies and gentlemen,

It's something of an understatement to say that I've been thinking a lot about this negotiation since last November.

And that I've been thinking specifically about the question you pose here today. 

And sometimes I'm reminded of an old joke. The one where you stop in the countryside to ask for directions and the answer comes back, "Well I wouldn't start from here."

But then I remember that it's not at all surprising that the Transatlantic Trade and Investment Partnership is a challenge.

We knew it would be long before we ever started:

· We knew our differences all too well.

· We knew that as the two largest economies in the world, our trade negotiators were not used to making many compromises.

· And we knew that there would be both great political support and, yes, some concern about such an ambitious project.

And still we took on the challenge.

We did so because we knew this agreement was worth the effort, worth it economically, worth it strategically.

We did so because we knew that for all our transatlantic differences we actually agree on most things, from first principles like human rights to their most complex implementation in the high quality regulation.

We did so because we knew that this bed of shared principles, combined with the size of the prize, would help us find our way forward when it counted.

And that's why I'm happy to say that this fresh start you are calling for is not only well on its way but is in fact already happening.

First, a key element of what I wanted to achieve when I used the term fresh start was a new beginning for the political debate within the European Union.

There is no doubt that the debate continues but our initiatives are starting to bear fruit, particularly on transparency. The steps we've taking are being acknowledged. Even our deepest critics have to admit that there is a now great deal of information in the public domain.

Do we need to do more on transparency? Possibly. I think we probably have reached the limits of what the EU can do on its own. But as the negotiations proceed we may decide, together with the US, to do more.

Do we need to do more outreach? Certainly. I will certainly continue to listen and discuss TTIP with anyone who wishes, here in Brussels and as I visit Member States. And I urge all those who believe this deal matters to do the same - especially national ministers and MEPs, but also business, think tanks and civil society. Having information online helps. But myths live on in people's heads long after they have been disproved.

Second, the fresh start is also a reality when it comes to the pace of negotiations. After we met at the end of January, Mike Froman and I gave clear instructions to negotiators to step up the work and make as much progress as possible this year.

· This already started with the eighth round of talks in Brussels last months. It was the broadest set of discussions we've had since last summer.

· We have also agreed on two more such comprehensive rounds before the summer break.

· We plan a series of dedicated meetings on specific issues between rounds, for example on some of the regulatory issues.

· And Ambassador Froman and I will keep a very close eye on the process. We meet in Brussels in just over a week. And I will travel to Washington in May.

Third, we are moving ahead, I can reassure you, on the substance too.

Take regulatory cooperation, the most important part of these talks. During the last round we reached a milestone, in that both sides now have proposals on the table for what we call the horizontal part of those talks. The US is now examining the proposal that the EU has made on all of these issues - a proposal which is already online by the way:

·  It covers good regulatory practices: ways to make sure both sides make high quality regulation like impact assessments and consultation of the public.

· And it covers ways of encouraging regulators to work together in future, including through a regulatory cooperation body. We want to do this in a way that in no way compromises our freedom to make policy in the public interest.

We will discuss it again in the next round in Washington in April.

We are also moving ahead on the sectoral parts of the regulatory cooperation work. For instance, we now have much more detailed data on the whole question of car safety. That is enriching the discussions between the regulators and helping them move forward. Talks are making headway on the other sectors, including medicines, medical devices, clothing, cosmetics, machinery and others.

These are core areas for TTIP and we are moving forward on them… finding ways to make regulation more compatible, without lowering health, safety, environment or consumer protection standards.

The same good progress applies to the rules part of the deal. Our idea here is to establish disciplines that would set gold standards…

… and for these, in many cases, to be a starting point for future negotiations on global rules.

They cover issues like trade facilitation, intellectual property, rules of origin and energy and raw materials. But let me just talk about two where we are talking very intensely:

First, sustainable development. I hope that we will soon be ready to exchange proposals. We are not quite there yet, but both sides agree that we need strong rules on both labour rights and the environment as a matter of principle. And we have already had detailed discussions on how to implement these.

Second, we are making real progress in the chapter on SMEs. We know that smaller firms - and the communities they operate in - stand to be among the biggest winners from this deal. SMEs feel many trade barriers more than large companies because they have to spread fixed costs like product approvals over smaller sales. High tariffs are also concentrated in sectors that are important for SMEs, like food, textiles and ceramics. That's why we need to think small all across the negotiations.

But we also agree that SMEs need help taking advantage of this deal. That's why we agree on the need for a dedicated chapter:

It should mandate more EU-US joint government outreach to the SME community…

… set up an SME Committee to make sure that we keep thinking small after TTIP is in place…

… and most importantly, deliver clear information to SMEs about all the rules and regulations that apply to their product. The EU wants this to be done via a comprehensive website.  

The final area I want to mention is market access for goods, services and public procurement. We spoke about all three during the round and we have a much clearer sense of our priorities and sensitivities.

We are continuing to have those discussion since then. And one thing is very clear. We know that both sides want very ambitious results. You just have to look at what we have done in other deals - like our deal with Canada for example - to see that. So I am very confident that in the end we will have a very high level outcome on all pillar of market access. It's just a matter of time.

And this brings me to the question of how we deal with differences.

Well, ladies and gentlemen, as I said at the outset: there are differences.

If there weren't there wouldn't be a negotiation.

And this certainly is a negotiation.

Which means that it's following the pattern of a negotiation.

And that pattern is that you don't solve everything at the beginning and you leave the hard things for the end.

For any diligent student that's a bit counter-intuitive. But we know it's the way things work.

And it makes our task very clear.

Let's keep moving forward on all the complex, time consuming technical work that remains. There's plenty of it.

Let's look at the political level for the compromises that we can make in the short term.

Let's prepare the ground for the final tough negotiations when the time comes. 

Let's keep talking to our citizens and stakeholders about the progress we are making and about their wishes and concerns.

And let's remember that what we are all aiming for is a good deal. A deal that meets our ambitions. And a deal that's worthy of all the effort we are making.

Losing patience is definitely not an option. Keeping our heads down and our spirits up is compulsory.

I hope that your discussions today will help us do that.

And I thank you very much for you attention.




Thu, 12 Mar 2015 11:01:13 +0000
<![CDATA[European Central Bank quantitative easing: the detailed manual]]> http://www.bruegel.org/publications/publication-detail/publication/872-european-central-bank-quantitative-easing-the-detailed-manual/ publ872

• The European quantitative easing programme, the Public Sector Purchase Programme (PSPP), started on 9 March 2015 and will last at least until September 2016. Purchases will be composed of sovereign bonds and securities from European institutions and national agencies.

• The European Central Bank Governing Council imposed limits to ensure that the Eurosystem will not breach the prohibition on monetary financing. However, these limits will constrain the size and duration of the programme, especially if it is sustained after September 2016. The possibility for national central banks to also buy national agency securities could alleviate this, but the small number of eligible agencies could limit their role as a back-up purchase.

• The Eurosystem should find other eligible agencies, especially in countries in which public debt is small, or waive the limits for countries respecting the investment grade eligibility criteria. The same issue arises with European institutions: their number and outstanding debt securities are limited. The waiver of the limits proposed for sovereigns should be applied to institutions with high ratings.

• The PSPP profits that will ultimately be repatriated to national treasuries will be small. This was to be expected, given current very low yields. Profits will also come from the major increase in reserves resulting from the implementation of QE, combined with the negative deposit rates on excess reserves at the ECB.

European Central Bank quantitative easing: the detailed manual (English)
Wed, 11 Mar 2015 09:07:14 +0000
<![CDATA[Greek payment deadlines ahead]]> http://www.bruegel.org/nc/blog/detail/article/1588-greek-payment-deadlines-ahead/ blog1588

Discussions between Greece and its creditors are due to restart tomorrow. In the meantime, the pressure on Greece is increasing.   Here we take a look at the relevant deadlines ahead for the Greek State coffers. 

Redemptions to official creditors

The path of redemptions to public creditors in 2015 is dominated by repayments to the IMF, T-Bills rollover and repayment of bonds held by the ECB

As previously discussed, the path of redemptions to public creditors in 2015 is dominated by repayments to the IMF, T-Bills rollover and, in July and August, repayment of bonds held by the ECB. In March, Greece has 1.2 billion euros left to repay to the IMF, in three tranches: 335 million will be due on the 13th of March, 558 million on the 16th of March and 335 million on the 20th. On top of this, Greece will need to roll over 1.3 billion of T-Bills expiring on March 13th and 1.6 billion on March 20th. Once the March deadlines have passed, April and May will be relatively quiet, before funding challenges resume in June, and most importantly in the summer with the big tranches due to the ECB (see here for detailed dates on all payments).

Ordinary State expenditures


Beyond repayments to official creditors, the Greek government also needs to meet its ordinary primary expenditures during the year, so it is useful to have an idea of what these are and how much they account for. According to the 2015 budget published in November 2014 (unfortunately available in Greek only) the ordinary primary expenditure at the State level is expected to be about 42 billion for the entire year. Total expenditures are expected to be 56 billion at the State level (see figures in the most recent the budget execution bulletin).

About 78% of the State ordinary primary expenditure is accounted for by payments of wages, salaries and pensions as well as of insurance, health care and social protections. An indicative monthly distribution of expenditures provided in the 2015 budget suggests that in March the government will need to pay about 1.5 billion in salaries and pensions and 1.3 billion in insurance, healthcare and social protection (with similar payments foreseen over the following months, see also Macropolis here). These are expenditure items that are not easy to avoid or reduce in the case of liquidity shortage, at least not without having a significant  social and economic impact.

it is very difficult to have an accurate impression of the exact state of the Greek State coffers.

ECB president Draghi reportedly told Greek Finance Minister Varoufakis yesterday that the Greek government’s books needed to be examined to determine its financing shortfall, and Commission, IMF and ECB staff are due to start the work in Athens on Wednesday. In the meantime, given the absence of real time data, it is very difficult to have an accurate impression of the exact state of the Greek State coffers.

According to a recent interview, finance minister Varoufakis suggested that the situation is not as rosy as previously thought:   “I can only say that we have money to pay salaries and pensions of public employees. [...] For the rest we will see”. Kathimerini reported yesterday that the General Accounting Office has blocked any state expenditure not related to salaries and pensions. The same article reports a government official as saying that the budget has 4,772 expenditure categories - not salary-related - and that a review has allegedly saved about 180 million. 

Recent analyses by Macropolis suggest that the government can rely on a number of sources in the very short term. Following two recent ministerial decisions, it could utilize cash reserves of 250 million euros from OPEKEPE, e organisation responsible for managing Common Agricultural Policy aid, and 114 million from the Hellenic Telecommunications and Post Commission (EETT). On top of that, the Bank of Greece’s financial accounts show that the profits for 2014 amount to 641 million euro which, according to Macropolis, were also transferred to the government at the end of February. Possibly, 500 million more could come from a fund in the Hellenic Financial Stability Facility which, according to recent news, could be drawn upon subject to a law amendment.

Altogether, this adds up to 1 billion, which could  be precious to Greece in the course of this month, but it does not seem to be a game changer if agreement is not struck.

The Greek budget execution data released in February will be key to watch

As previously shown, the Greek budget execution data for January showed a significant underperformance of revenues compared to the targets set.  According to the Ministry of Finance, this was mainly due to the extension of a VAT payment deadline until the end of February 2015 (Figure 2). The data presented here suggest yet another reason why this is worrying.  The budget execution data released in February will be key to watch.

Tue, 10 Mar 2015 18:03:55 +0000
<![CDATA[Realizing the Indian Dream]]> http://www.bruegel.org/nc/blog/detail/article/1587-realizing-the-indian-dream/ blog1587

It is not often that I get to wear two hats at once. But that is exactly what happened earlier this month, when I spent a few days in New Delhi.

I was in India primarily as part of my current role as Chairman of a review for the British prime minister on anti-microbial resistance (AMR). But my visit coincided with the presentation of India's 2015-2016 budget, the first under Prime Minister Narendra Modi. Given some of my other interests and experiences, I found what was presented to be very interesting.

India's economy has recently grown – in real terms – slightly faster than China's

Following recent revisions to its GDP figures, India's economy has recently grown – in real terms – slightly faster than China's. A key feature of my research into the BRIC economies (Brazil, Russia, India, and China) more than ten years ago was that at some point during this decade, India would start to grow faster than China and continue to do so for dozens of years.

The reasoning is straightforward. India's demographics are considerably better than China's, and the size and growth rate of a country's workforce is one of the two key factors that drive long-term economic performance – the other being productivity. Between now and 2030, the growth rate of India's workforce will add as much to the existing stock of labor as continental Europe's four largest economies put together. India is less urbanized than China, and it is in the early stages of benefiting from the virtuous forces that normally accompany that process.

But there is a catch. When it comes to productivity, India has been a laggard. Unless it finds a way to improve, the country's demographic profile could become a burden rather than a benefit.

In this regard, Modi's first full budget did not include anything dramatic. But if a number of initiatives are successfully implemented, the economy should receive a real boost. Indeed, the budget's main feature is its commitment to investments in public-sector infrastructure, even at the expense of raising next year's deficit from 3.6% to 3.9% of GDP.

I have argued for several years that India should emphasize investment spending, so I welcome this shift. The budget also includes a number of other helpful measures, such as the reduction of the corporate-tax rate and efforts to improve the business environment.

My visits as chairman of the AMR review also allowed me to witness some encouraging signs. In my book The Growth Map, I describe my unforgettable first visit to Gurgaon, a municipality near Delhi that serves as a regional financial and industrial hub. Gurgaon is home to a lot of high-flying technology firms, and on this trip I visited one of India's leading diagnostics companies, SRL Diagnostic, which is developing tools that could improve the use of antibiotics.

The last time I made the trip from the Oberoi hotel in New Delhi to Gurgaon, it took well over 2.5 hours to travel the 30 kilometers. Though a new freeway was under construction, the building site was full of cars and animals. As a result, traffic was in a state of chaos, and it was impossible for any roadwork to be done.

I had always promised myself that the next time I took the trip, I would somehow repeat the exact journey. I am pleased to say that the drive now takes less than an hour and the experience was much less dramatic. Moreover, the hotel car that made the journey provided free Wi-Fi – the first time I have come across this anywhere in the world.

By 2017, India could surpass Italy and Brazil to become the world's seventh largest economy

It is probably too early to say with certainty that India will soon take its place as the world's third largest economy, behind China and the United States. But, given that India's investment climate seems to be improving, that moment might not be too far away. By 2017, India could surpass Italy and Brazil to become the world's seventh largest economy; by 2020, there is a reasonable chance that it will overtake France and the United Kingdom to become the fifth largest.

Overtaking Germany and Japan, however, will require bolder steps, especially regarding education, health, and economic policy. India will need to improve its education system dramatically, both at the secondary and tertiary level, and make similarly large advances in basic sanitation (not to mention implementing my review's recommendations for combating AMR).

These developments, along with a more stable framework for monetary and fiscal policy, could lead to the type of double-digit growth that China has enjoyed for the past three decades. It is up to India's policymakers to realize this ambition.

Mon, 09 Mar 2015 10:32:31 +0000
<![CDATA[The below-zero lower bound]]> http://www.bruegel.org/nc/blog/detail/article/1586-the-below-zero-lower-bound/ blog1586

What’s at stake: The negative yields observed on some government and corporate bonds, as well as the recent move into further negative territory of monetary policy rates, are shaking our understanding of the ZLB constraint. This blogs review summarizes the recent debates on the binding nature of the zero lower bound. Next week, we’ll look at the implications of negative interest rates for financial stability.

Negative yields everywhere

Matthew Yglesias writes that something really weird is happening in Europe. Interest rates on a range of debt — mostly government bonds from countries like Denmark, Switzerland, and Germany but also corporate bonds from Nestlé and, briefly, Shell — have gone negative. And not just negative in fancy inflation-adjusted terms like US government debt. It’s just negative. As in you give the German government some euros, and over time the German government gives you back less money than you gave it.

Evan Soltas writes that economists had believed that it was effectively impossible for nominal interest rates to fall below zero. Hence the idea of the "zero lower bound." Well, so much for that theory. Interest rates are going negative all around the world. And not by small amounts, either. $1.9 trillion dollars of European debt now carries negative nominal yields, and the overnight interest rate in Swiss franc is around -1 percent annually.

Gavyn Davies writes that an unprecedented experiment in monetary policy is underway in two small countries in Europe. By pushing policy interest rates more deeply into negative territory than ever seen before, the Swiss and Danish central banks are testing where the effective lower bound on interest rates really lies. Denmark and Switzerland are clearly both special cases, because they have been subject to enormous upward pressure on their exchange rates. However, if they prove that central banks can force short term interest rates deep into negative territory, this would challenge the almost universal belief among economists that interest rates are subject to a ZLB.

Paper currency and the ZLB constraint

Miles Kimball writes that paper currency (and coins) guarantee a zero nominal rate of return, apart from storage costs, which are relatively small. It is then difficult for central banks to reduce their target interest rates below the rate of return on paper currency storage, which is not far below zero. This limitation on central bank target interest rates is called the “zero lower bound.” Because the zero lower bound is a consequence of how monetary systems handle paper currency, it is possible to eliminate the zero lower bound by alternative paper currency policies.

JP Koning writes that there are a number of carrying costs on cash holdings, including storage fees, insurance, handling, and transportation costs. This means that a central bank can safely reduce interest rates a few dozen basis points below zero before flight into cash begins. The lower bound isn't a zero bound, but a -0.5% bound (or thereabouts).

Gavyn Davies writes that in the past, economists have always assumed that the convenience yield on bank deposits is extremely small, so there would be a stampede into cash, led by the banks themselves, if the yield on deposits at the central bank went even slightly negative. But no one really knows whether that is true. In the long term, new businesses would appear, helping the private sector to handle and store cash cheaply and efficiently, but this may not happen quickly.

Reviewing the convenience yield on deposits and bonds

Evan Soltas writes that if people aren't converting deposits to currency, one explanation is that it's just expensive to carry or to store any significant amount of it. Therefore, the true lower bound is some negative number: zero minus the cost of currency storage. How much is that convenience worth? It seems like a hard question, but we have a decent proxy for that: credit card fees, counting both those to merchants and to cardholders. That's because the credit-card company is making exactly the same calculus as we are trying to make – how much can we charge before we make people indifferent between currency and credit cards? The data here suggest a conservative estimate is 2 percent annually.

Barclays (HT FT Alphaville) writes currency hidden under a mattress is useful for small transactions in your local market (the local café or store). However, it is of little use for large or distant transactions since armored trucks are neither cheap nor convenient. Internet transactions are an increasingly large share of both retail and business-to-business transactions, and bank transfers are an even larger share. Aside from the costs of transferring cash, both consumers and businesses derive utility from the convenience of book-entry (electronic) transactions.

Barclays writes that the value of that convenience likely forms the negative lower bound. Credit and debit card interchange fees, the fee card companies charge merchants for transactions, are a measure of how much that transaction utility is worth to both consumers and businesses that accept card payment. Until recent moves to regulate interchange fees, debit card interchange fees were approximately 1-3% of transaction value, depending on the card and the merchant. Credit cards, which remain unregulated, still command fees in that range. Coincidentally, the ECB has calculated that the social welfare value of transactions is 2.3%. If these rates represent an accurate measure of the value of transaction utility, they suggest that the negative lower bound for interest rates likely is considerably lower than the –75bp in Sweden and Switzerland.

Paul Krugman writes that the medium of exchange utility is irrelevant. In normal times, once interest rates on safe assets are zero or lower, liquidity has no opportunity cost; people will saturate themselves with it. That’s why we call it a liquidity trap! And what this means is that the marginal dollar of money holdings is being held solely as a store of value — the medium of exchange utility is irrelevant. Paul Krugman writes that when central banks push interest rates on government debt below zero, the effective lower bound is the return on cash held by people who would otherwise be holding that government debt — not people looking to expand their checking accounts. So the liquidity advantages of bank deposits over cash in a vault are pretty much irrelevant. It’s all about the cost of storage.

JP Koning writes that Krugman is assuming that liquidity is a homogeneous good. It could very well be that "different goods are differently liquid," as Steve Roth once eloquently said. The idea here is that the sort of conveniences provided by central bank reserves are different from those provided by other liquid fixed income products like deposits, notes, and Nestle bonds. If so, then investors can be saturated with the sort of liquidity services provided by reserves (as they are now), but not saturated by the particular liquidity services provided by Nestle bonds and other fixed income products. Assuming that Nestle bonds are differently liquid than central bank francs, say because they play a special roll as collateral, then Soltas isn't out of line. Once investors have reached the saturation point in terms of central bank deposits, the effective lower bound to the Nestle bond isn't just a function of the cost of storing Swiss paper money, but also its unique conveniences. Koning quotes Michael Woodford’s Jackson Hole paper: “one might suppose that Treasuries supply a convenience yield of a different sort than is provided by bank reserves, so that the fact that the liquidity premium for bank reserves has fallen to zero would not necessarily imply that there could not still be a positive safety premium for Treasuries”.

A bit of history of thought on negative interest rates

Brad Delong writes that the idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it.

David Kehoane writes that for those not familiar with the 19th century idea of a Gesell tax, it’s basically a stamp tax on money that acts as a negative interest rate. The idea being that in order to be legal tender notes would have to bear an annual/ monthly stamp provided by the government — and for which the government would charge a fee.

Brad Delong writes that this is not an obscure idea. Silvio Gesell is the topic of part VI of chapter 23 of Keynes’s flagship work, The General Theory of Employment, Interest and Money. And it’s not just Keynes in his flagship work. There are 55,000 google hits for “Silvio Gesell.” Patinkin (1993) reports that Irving Fisher advocated Gesell-based “velocity control” in his 1932 Booms and Depressions. Nobel prize-winning Maurice Allais was an advocate as well. Gerardo della Paolera and Alan Taylor are Gesell’s biggest boosters today in their book Straining at the Anchor: The Argentine Currency Board and the Search for Macroeconomic Stability, 1880-1935, a University of Chicago Press book that is part of the NBER’s series on “long term factors in economic development.” Willem H. Buiter and Nikolaos Panigirtzoglou writing in the Economic Journal in 2003: “Overcoming the Zero Bound on Nominal Interest Rates with Negative Interest on Currency: Gesell’s Solution.”

JP Koning writes that a central banker can safely guides rates to a much more negative rate than before, say to -2.5% rather than just -0.5%, by varying the conversion rate between low denomination notes/electronic currency and large denomination notes. Central banks currently allow free conversion between deposits, low value notes, and high value denominations. The idea here is to keep the conversion window open, but levy a fee, say three cents on the dollar, on anyone who wants to convert either deposits or low denomination notes into high denomination notes. Conversion between low value notes and deposits remains free of charge. This method is akin to Miles Kimball's crawling peg, except that the conversion penalty is set on high denomination notes only, not cash in general. 



Mon, 09 Mar 2015 08:39:08 +0000
<![CDATA[Not SIFIs but PIFIs]]> http://www.bruegel.org/nc/blog/detail/article/1585-not-sifis-but-pifis/ blog1585

The EU bank resolution framework deals in principle with risks from SIFIs, or systemically important financial institutions, but might have overlooked PIFIs -- politically important financial institutions.

Over the weekend of 28 February to 1 March, the Austrian government refused to help Heta Asset Resolution fill a capital hole discovered by the financial regulator. The refusal was an about-turn following almost 10 years and billions of euros of public assistance to Heta and to Hypo Alpe Adria – the bank that Heta was created to help restructure.

Public sector bailouts of nationally or globally systemically important financial institutions (SIFIs) can be justified. Without intervention, the financial sector of a given country might collapse and bring the whole economy down. For this reason, Basel III now requires SIFIs to meet higher capital requirements than other banks. In the United States, Dodd-Frank obliges such banks to design contingency plans in case they get into trouble. In Europe, the roughly 130 largest banks that are systemically important face supervision by the European Central Bank’s Single Supervisory Mechanism (SSM), while the Single Resolution Mechanism (SRM) prescribes when to assist a failing bank and under what terms.

But the decision on whether to let a bank fail rarely depends alone on whether it is a national or global SIFI. Politicians also care about the local effects of a bank failure. Where banking regulation is sub-national and matches electoral boundaries, a given bank might be inconsequential for the health of the overall national economy, but critical to politicians making the decision on how to proceed with a given troubled bank. In such cases, politically important financial institutions (PIFIs) might receive benefits they otherwise would not get.

The PIFI logic drove the series of bank assistance packages in Germany[1]. Despite a popular perception of Germany as an adamant opponent of bank bailouts, considerable public support was given to German banks during the euro-area crisis. In fact, only three very small banks were initially allowed to fail. The structure of German federalism and politicians’ banking sector competencies explain this apparent contradiction. German banks, such as WestLB and HSH Nordbank, that were not systemically important from a national perspective were nonetheless prevented from failing at the onset of the recent crisis because they were important to Länder-level politicians.

We are seeing the same dynamic unfolding in Austria with Hypo Alpe Adria. The Austrian state of Carinthia part-owned the lender, provided it with generous guarantees, and used it for pet projects of the party in power, namely Jörg Haider’s FPÖ. A German Landesbank, Bayern LB, bought the bank in 2007. When it got into substantial trouble during the 2008-09 financial crisis, Hypo Alpe Adria remained politically important and it received public financial support from both the state and national governments. It was ultimately nationalised in 2009.

The story, however, has a new twist. The 28 February-1 March revaluation of the remaining assets in Hypo’s bad bank Heta Asset Resolution means that the national government is theoretically on the hook for an additional €7.6 billion. This time, the national government baulked at supporting the institution, which has become a political liability. A true bail-in would mean that the Landesbank based in Munich would be expected to pay something like €2 billion. A series of lawsuits has followed.

Of course, some in other EU member states might experience schadenfreude over the banking problems in northern 'surplus' countries. But they should be careful. While this case involved Carinthian and Bavarian state governments, one can imagine a parallel with the European Union. A national government is concerned about one of its banks and takes measures to help it. The bank gets into even worse trouble, and the euro-area single supervisor orders that it be resolved. At the beginning of the process, the SRM expects a bail-in of shareholders. One can imagine a scenario in which a true bail-in would hurt significant shareholders, and hence politicians, in a neighbouring country. Would they simply pay up, or would there be the same sort of legal fights one now sees in Austria and Bavaria, with any true resolution still some years away?

Also, note that the Hypo Alpe Adria funding gap is now bigger than it should have been precisely because the bank was a domestic PIFI. This meant that its lending decisions suffered from moral hazard and it was given public support to enable it to hobble along for much longer than it should have. Once again, the parallel to the European level is clear. If a troubled bank is not part of the original 130 under the SSM, it could be that European authorities only learn about its problems after much delay and when the overall losses are much bigger precisely because it was not wound up earlier.

[1]    As we detail in: Deo, Sahil, Christian Franz, Christopher Gandrud, and Mark Hallerberg (2015) 'Preventing German Banks Failures: Federalism and decisions to save troubled banks', Politische Vierteljahresschrift 2/2015, forthcoming.

Fri, 06 Mar 2015 12:37:37 +0000
<![CDATA[Mapping competitiveness with European data ]]> http://www.bruegel.org/publications/publication-detail/publication/871-mapping-competitiveness-with-european-data/ publ871

Europe needs improved competitiveness to escape the current economic malaise, so it might seem surprising that there is no common European definition of competitiveness, and no consensus on how to consistently measure it.

To help address this situation, this Blueprint provides an inventory and an assessment of the data related to the measurement of competitiveness in Europe. It is intended as a handbook for researchers interested in measuring competiveness, and for policymakers interested in new and better measures of competitiveness.

MAPCOMPETE has been designed to provide an assessment of data opportunities and requirements for the comparative analysis of competitiveness in European countries at the macro and the micro level.

Visitwww.mapcompete.eu to find out more about the project. The project's final conference will take place in May 2015.

Mapping competitiveness with European data (English)
Thu, 05 Mar 2015 09:00:03 +0000
<![CDATA[Dynamic scoring and budget forecasting]]> http://www.bruegel.org/nc/blog/detail/article/1584-dynamic-scoring-and-budget-forecasting/ blog1584

What’s at stake: In January, House Republicans formally adopted a budgeting rule known as “dynamic scoring”, which aims to account for the macroeconomic effects of major legislations. While the move from static to dynamic scoring makes economic sense, some worry that it will invite politicized scorekeeping.

Source: Econbrowser

Gregory Mankiw writes that the new appointed CBO director, Keith Hall, will face a big challenge. Until now, conventional budget analysis has used a process called static scoring, which assumes that the path of gross domestic product remains the same when the government changes taxes or spending. This procedure has the virtues of simplicity and transparency. Yet the assumption of unchanged G.D.P. has one notable drawback: It is patently false. House Republicans have recently changed the rules: The Congressional Budget Office and Joint Committee on Taxation are now required to use “dynamic scoring” when evaluating major changes in tax and spending policy. 

Alan Auerbach writes that working together, CBO and JCT provide two types of revenue and expenditure projections for Congress: (1) forecasts of expenditures and revenues based on assumptions about what `current’ policy is, and (2) forecasts of the changes in expenditures and revenues that would result from proposed legislation. The first type of forecast is known as a baseline. The second type is called scoring. The two types of forecasts are interdependent. Projected effects of legislation depend on the starting point, so the baseline affects scoring. Updates of the baseline reflect the estimated impact of legislation, so scoring affects the baseline.

Alan Auerbach writes that in a sense, the debate over dynamic scoring may be traced to an inconsistency in the way that legislative changes are handled by the two agencies. Under standard scoring procedures, JCT scores proposed legislation taking the macroeconomic forecast underlying the CBO baseline – including nominal GDP and other aggregates – as given. Macroeconomic feedback effects are ultimately incorporated in CBO’s baseline, but are not attributed by JCT to any source when the proposals are scored.

Donald Marron writes that for more than a decade, CBO and JCT have published dynamic analyses using multiple models and a range of assumptions. The big step in dynamic scoring will be winnowing such multiple estimates into the single set of projections required for official scores. Chye-Ching Huang writes that the new rule indeed asks for an official cost estimate that reflects only a single estimate of a bill’s supposed impact on the economy and the resulting revenue impact. 

Pros and cons

Gregory Mankiw writes that the case for dynamic over static scoring is strong in theory.  Alan Auerbach writes that arguments in favor of dynamic scoring generally emphasize its consistency with the principles of economic and statistical analysis.

1. Dynamic scoring makes use of all available information.

2. The lack of dynamic scoring biases the legislative process against tax cuts.

3. Current methods impose constraints on scoring that are at odds with economic evidence.

4. Advances in technology and economics strengthen the case for dynamic scoring.

Gregory Mankiw writes that the task is difficult in practice. First, any attempt to estimate the impact of a policy change on G.D.P. requires an economic model. Because reasonable people can disagree about what model, and what parameters of that model, are best, the results from dynamic scoring will always be controversial. Second, accurate dynamic scoring requires more information than congressional proposals typically provide. The impact of the initial tax cut depends crucially on how future Congresses will deal with the revenue shortfall, but budget analysts usually have little to go on but speculation.

Ezra Klein writes that it’s not just Congress whose behavior the CBO will now have to predict. It's also the Federal Reserve. If Congress passed a massive deficit-reduction bill and, in response, the Federal Reserve decided to lower interest rates a bit, that would have a huge effect on the cost of the bill under dynamic scoring. But how is the CBO supposed to read Janet Yellen's mind three years from now?

Alan Auerbach writes that arguments against dynamic scoring point to the technical difficulties of doing it correctly and the political reality of the context in which scoring is done.

1. Dynamic scoring must rely more on assumptions and is susceptible to political pressure.

2. Dynamic scoring would require an impractical integration with the baseline process.

3. Dynamic scoring would have to account for all channels and expenditure-side changes.

4. Dynamic scoring requires assumptions about monetary and fiscal policy reactions.

CBO and JCT credibility

Ezra Klein writes that the trust the CBO and JCT have won is a rare and fragile thing. By adding complexity, it adds more opportunities for political manipulation and partisan skepticism. The CBO isn't particularly transparent in how its models work now. But in a dynamic scoring world, the assumptions built into those models become much more important — and much more contestable. Which study the CBO and JCT end up using on the elasticity of labor in the face of higher marginal tax rates can decide whether a tax hike looks like a great idea or a disaster. If you want to get really sinister about it, as the models require more assumptions, there's more opportunity for tampering. But you don't even need to go that far. More complex, assumption-dependent models increase the importance of sincere disagreements over which research to believe.

Donald Marron writes that cherry picking model assumptions to favor the majority’s policy goals runs against the DNA of both organizations. Even if it didn’t, the discipline of twice-yearly budget baselines discourages cherry picking. Neither agency wants to publish rosy dynamic scenarios that are inconsistent with how they construct their budget baselines. You don’t want to forecast higher GDP when scoring a tax bill enacted in October, and have that GDP disappear in the January baseline.

Jared Bernstein writes that CBO’s estimates should always be delivered to the public with explicit confidence intervals, to better convey to the public the uncertainty of their guesstimates. I was reminded of the need for this approach in their recent report on the impact of the Senate immigration bill on the economy. They reported the following: “CBO’s central estimates also show that average wages for the entire labor force would be 0.1 percent lower in 2023 and 0.5 percent higher in 2033 under the legislation than under current law.” Given the uncertainty of such an estimate—10 and 20 years away!–it seems inconceivable that we could measure such a small change with any degree of accuracy that would distinguish 0.1 percent from good old 0 percent.

Selective Voodoo

Paul Krugman writes that we’re not just looking at a possible mandate for using voodoo in budget estimates, we’re talking about selective voodoo, which incorporates some supposed dynamic effects while ignoring others for which there is if anything stronger evidence. Although we don’t know how CBO will embrace supply-side fantasies, one thing is fairly certain: CBO won’t be applying dynamic scoring to the positive effects of government spending, even though there’s a lot of evidence for such effects. Neither will dynamic scoring be applied to the damage to potential output caused by cutting spending in a depressed economy.

Peter Orszag (HT Econbrowser) writes that dynamically scoring tax proposals but not expenditure programs would create an even larger incentive to transform spending programs into tax incentives, even if that involves unnecessary administrative and economic costs.

Keith Hennessey writes that it’s a little hard to see how one would practically expand the new rule to apply to discretionary spending. The House rule would only apply dynamic scoring to big fiscal policy changes, those with an aggregate static budget impact bigger than 0.25% of GDP (>$45 B per year in 2015). That high de minimis threshold is a smart practical limitation so that CBO doesn’t have to worry about the growth impacts of the cars-for-crushers program or a $50M increase in spending for pet project X. But since nobody is proposing adding >$45B/year to discretionary spending, this limitation in the new rule has no practical impact. But the House rule doesn’t create a bias for tax cuts. It eliminates a pre-existing bias against very large policy changes that would expand the supply side of the economy, including but not limited to broad-based reductions in tax rates.

Tue, 03 Mar 2015 08:31:21 +0000
<![CDATA[Eurozone enlargement]]> http://www.bruegel.org/videos/detail/video/147-eurozone-enlargement/ vide147



Fri, 27 Feb 2015 10:07:57 +0000
<![CDATA[Euro-area governance: what to reform and how to do it]]> http://www.bruegel.org/publications/publication-detail/publication/870-euro-area-governance-what-to-reform-and-how-to-do-it/ publ870
  • The Issue Reform of the governance of the euro area is being held back by disagreement on what is at the root of the euro area’s woes. Pre-crisis, the euro area suffered from the built-up of financial imbalances, price and wage divergence and an insufficient focus on debt sustainability. During the crisis, the main problems were slow resolution of banking problems, an inadequate fiscal policy stance in 2011-13 for the area as a whole, insufficient domestic demand in surplus countries and slow progress with structural reforms to overcome past divergences.
  • Policy Challenge Euro-area governance needs to move beyond the improvements brought about by banking union and should establish institutions to prevent divergences of wages from productivity. We propose the creation of a European Competitiveness Council composed of national competitiveness councils, and the creation of a Eurosystem of Fiscal Policy (EFP) with two goals: fiscal debt sustainability and an adequate area-wide fiscal position. The EFP should have the right in exceptional circumstances to declare national deficits unlawful and to be able to force parliaments to borrow more so that the euro-area fiscal stance is appropriate. A euro-area chamber of the European Parliament would have to approve such decisions. No additional risk-sharing would be introduced. In the short term, domestic demand needs to be increased in surplus countries, while in deficit countries, structural reform needs to reduce past divergences.

Euro-area governance: what to reform and how to do it (English)
Fri, 27 Feb 2015 07:32:12 +0000
<![CDATA[A Greek primary issue]]> http://www.bruegel.org/nc/blog/detail/article/1583-a-greek-primary-issue/ blog1583

On the 25th February, the Greek ministry of finance published the final data for the execution of the State Budget in January 2015.

This data is available at monthly frequency and on cash basis, which makes it well suited to assess the situation of public finances from a short term financing perspective. Moreover, it allows comparing actual outcomes with expected ones.


Source: Greek Ministry of Finance - State Budget Execution Bulletins

Over the period January-September 2014, the State primary budget outperformed expectations. The actual outcome for the 9-months period was 2.5bn against. 1.6bn expected. This has remained the case up until November 2014, when the 11-months State primary balance amounted to 3.6bn against an expected 2.9bn.

Then came the elections, and the situation drastically reverted. For the 12-months period of January-December 2014, in fact, the outcome has been 1.9bn against 4.9bn expected, meaning that the State primary balance has undershot its target by 3bn.

A breakdown shows that the shortfall was due mainly to the underperformance of State budget net revenues, which came in at 51bn against about 55bn expected.

The final figures for January 2015 show that the underperformance has carried on in 2015. The primary balance was 443 millions in January against 1.4bn expected, with revenues still 935 millions short of the target. 1.4bn may look a very large value, but figure 2 shows that in 2014 a large part of the final primary surplus was built up in the first two months of the years, with January being one of the most important months for the collection of tax revenues.

Source: Greek Central Government


According to the Ministry of Finance, the underperformance in January 2015 was mainly due to the extension of a VAT payment deadline until the end of February 2015 and to the underperformance of the expected revenues from the settlement of arrears.  Therefore, data released in February will be key to watch, for two reasons.

First, it has been previously been pointed out that March is one of the heaviest months for Greece in terms of financing needs, with 4.3bn of T-bills to roll over and 1.5 bn coming due to the IMF. After last Friday’s agreement, which includes the returning of the 11bn left over in the Hellenic Financial Stability Fund (HFSF) to the EFSF, the short term funding options for the Greek government have narrowed.

Second, it might be an important indicator for the negotiations over the target primary surplus for 2015, which is still not set. According to the European Commission forecasts released this month, the primary surplus in 2014 was expected to be 1.7% on an accrual basis, although the  weaker end-2014 data suggest the actual figure might be lower. 1.7% is not far from the 1.5% target that Syriza would like the Eurogroup to agree to for 2015. Leaving aside the political considerations on this, budget data show that revenues in January 2015 were 17% lower than they were in January 2014, suggesting that if this trend does not revert, even 1.5% primary surplus may be hard to achieve.






Thu, 26 Feb 2015 15:34:53 +0000
<![CDATA[The gender pay gap]]> http://www.bruegel.org/nc/blog/detail/article/1582-the-gender-pay-gap/ blog1582

Blogs review: Actress Patricia Arquette’s plea to address wage disparity between women and men during the Oscar ceremony has lead to interesting discussions in the blogosphere about the measurement, causes and evolution of the gender pay gap.

The evolution of the gender pay gap

Claudia Goldin writes that the mantra of the women’s movement in the 1970s was “59 cents on the dollar” and a more recent crusade for pay equality has adopted “77 cents on the dollar.”

Claudia Goldin writes that of the many advances in society and the economy in the last century, the converging roles of men and women are among the grandest. A narrowing has occurred between men and women in labor force participation, paid hours of work, hours of work at home, life-time labor force experience, occupations, college majors, and education, where there has been an overtaking by females.

Sandra Black and Alexandra Spitz-Oener write that when investigating possible explanations for the narrowing of the gender wage gap, most research has focused on factors such as education and experience, for which changes have been more favorable for women than for men. Francine Blau and Lawrence Kahn write that the narrowing in the U.S. gender pay gap decelerated in the 1990s and gender-specific factors seem to be the source of this slowing convergence. It is difficult to say whether this represents merely a pause in the continued closing of the gender pay gap or a more long-term stalling of this trend.

The residual portion and discrimination

Claudia Goldin writes that the explained portion of the gender wage gap decreased over time as human capital investments between men and women converged. In consequence, the residual portion of the gap rose relative to the explained portion.

Daniel Kuehn writes that it’s very misleading and a mistake to use conditional mean differences in a regression to argue that the gap is mythical. My frustration with the empirics of the wage gap come in whenever – following something like the Arquette statement, or a mention of "77 cents on the dollar" in the State of the Union – people get up and assert that the wage gap is a "myth" or a "fallacy" simply because there are explanations for different contributions to the gap. Some people are tempted to perform the following exercise:

1. Add a bunch of controls in a wage regression.

2. Note that the difference in conditional means between men and women shrinks when you do that.

3. Call the gap a "myth" or a "fallacy".

In another post, Daniel Kuehn writes that you can't simply control for occupation and major and call it a day because people select into occupations and majors based on expected wages, and that selection process influences the observed wage distribution. If any of you are familiar with it, this is the basic point of the Roy model, and it has a variety of applications in labor economics. It is also analogous to the Lucas Critique and the need for some understanding and identification of the structural model in macroeconomics. The short point here that anyone who's gone through an econometrics class should get right away is that occupational choice is endogenous in the wage regression. Controlling for it also controls away part of the wage differential.

Some explanations for the residual portion

Claudia Goldin writes, for some, that earnings differences for the same position are due to actual discrimination. To others it is due to women’s lower ability to bargain and their lesser desire to compete. Others blame it on differential employer promotion standards due to gender differences in the probability of leaving. Wonkblog also points to research showing that women may also be more likely to accept non-monetary compensation for jobs, like healthcare.

Claudia Goldin’s preferred explanation is that the gap exists because hours of work in many occupations are worth more when given at particular moments and when the hours are more continuous. That is, in many occupations earnings have a nonlinear relationship with respect to hours. A flexible schedule often comes at a high price, particularly in the corporate, financial, and legal worlds.

The 2015 Economic Report of the President chapter on the economics of family-friendly workplace policies writes that workplaces have been slower to adapt to changing family dynamics. Two of the most important policies that firms can offer to allow workers to better balance work and family are access to paid leave and workplace flexibility. Paid leave includes access to family leave, sick leave, and other leave that allow workers to take paid time off to care for themselves or a family member. Workplace flexibility generally refers to arrangements that allow workers to shift the time or location of their work through flexible or alternative hours, telecommuting policies, or alternative work locations. It can also include partial employment options such as job sharing and phased retirement of older workers.

Jordan Weissmann writes that the US is one of three countries in the world, along with Papua New Guinea and Oman, that doesn't guarantee paid leave for new mothers. We also offer few protections for part-time workers, which makes it harder for women to keep a foot in the workforce after children. A study by economists Francine Blau and Lawrence Kahn of Cornell University found that, if U.S. family policy looked more like Europe's, employment among U.S. women would have been 7.2 percentage points higher in 2010.









Thu, 26 Feb 2015 10:00:58 +0000
<![CDATA[Welcome to the dark side: GDP revision and the non-observed economy]]> http://www.bruegel.org/nc/blog/detail/article/1581-welcome-to-the-dark-side-gdp-revision-and-the-non-observed-economy/ blog1581

Back in 2009, the United Nations Statistical Commission endorsed a revision to the System of National Accounts (SNA), which sets the international standards for the compilation of national accounts. As a consequence, Eurostat has amended the European equivalent of the SNA, the European System of Accounts (ESA) leading to a revision of GDP figures.

The changes come from the accounting treatment of some items. Research & Development (R&D) purchases and military weapon systems have been reclassified from intermediate consumption to investments, which increases value added (the difference between output and intermediate consumption), and thus GDP. Additional changes have been introduced in the accounting of pension entitlements, directly affecting the computation of compensation of employees and households’ savings rate. Other measures, such as changes in measurement of financial services, and the classification of head offices, holding companies and Special Purpose Entities, have little or no impact on the GDP numbers.


The reclassification has had a positive effect on GDP, increasing it on average by 3.5 percentage points for the EU and the Euro area as whole.

Figure 1 shows the average difference between GDP computed with the new and the old standard, retrospectively over the period 2000-2013. The reclassification has had a positive effect on GDP, increasing it on average by 3.5 percentage points for the EU and the Euro area as whole. Country variation is however significant; the impact of the reclassification ranges from 0.3 percentage points in Luxembourg to 9.3 percentage points in Cyprus. Although the revision may have had a visible impact on GDP levels, growth rates are generally less affected.

Unfortunately, Eurostat does not provide a breakdown of how the different accounting changes contribute to the final number. However, the OECD published this month a report disentangling the effect of the different factors for all OECD countries in year 2010 (Figure 2).

Having a breakdown is important because most countries have used the opportunity of the changeover in standards to also introduce a new statistical benchmark estimate, introducing new sources and methods. The OECD report shows that in some countries this has an important impact, most notably in the Netherlands and the UK (see the light red bar in Figure 2).

Other than that, R&D reclassifications tend to be the item with the largest impact on GDP recalculation, whereas reclassification of military weapon systems has very limited impact, with the exception of Greece. In Europe, the impact of R&D reclassification on 2010 GDP ranges between 0.5 percentage points and 4 percentage points, compared to an OECD average of 2.2.  The effect of the change is highest in Finland and Sweden - which have among the highest gross spending levels on R&D in EU - and lowest in Poland, the Slovak Republic, Luxembourg and Greece (Figure 3).                      


The impact of including illegal activities varies across countries. Both the new and the old standards for the compilation of national accounts stated that illegal activities should be included in GDP, but many countries did not explicitly include estimates for these activities, also because the definition of illegal activities was only streamlined by the decision in September 2014. In contrast with the previous system, EU States are now required to comply with common methodological guidelines how to account for prostitution, the production and trafficking of drugs and alcohol and tobacco

This decision was expected to have a differentiated impact across countries, and the OECD breakdown of GDP change between the old and new system make clear the extent of this divergence.

The inclusion of estimated illegal activities results in an increase in 2010 GDP by 1 percentage point in Italy and 0.9 percentage points in Spain. 

In Figure 3, Italy and Spain stand out as two special cases. The inclusion of estimated illegal activities results in an increase in 2010 GDP by 1 percentage point in Italy and 0.9 percentage points in Spain. This is about five times the average for the OECD as a whole, which was 0.2 in 2010. Perhaps even more striking is the fact that in these two countries the impact of including illegal activities is only slightly smaller than the impact of reclassifying R&D (which increased 2010 GDP by 1.3 pp in Italy and 1.2 pp in Spain).

Apart from illegal activities, GDP numbers can also be influenced by the share of countries’ ‘legal’ shadow economies, defined as all market-based legal production of goods and services which are deliberately concealed from public authorities.

A report on the shadow economy in Europe shows that its size reached a 10-year low in 2013. Several reasons might explain this development: improving economic conditions, the dramatic contraction of the construction-sector in several crisis-hit countries (which is historically a sector with a large shadow economy), a crack-down on tax evasion in recent years and generally stricter law enforcement.



Interesting to note is the comparatively small size of the shadow economy in Western Europe, with Southern and Eastern Europe exhibiting substantially higher shadow economy activities in % of GDP. The euro area is characterized by a great heterogeneity, with the size of the shadow economy in % of GDP in 2013 varying from just 7.5% in Austria to 27.6% in Estonia. In absolute numbers, the shadow economies in Italy and Germany were as large as Austrian GDP in 2013. Statistical offices make adjustments to account for shadow economy in order to arrive at exhaustive estimates of GDP and national accounts (see OECD)

A report on the shadow economy in Europe shows that its size reached a 10-year low in 2013.

The rationale for streamlining guidelines for both the inclusion of legal and illegal activities in the national accounting - which has been extensively debated in the media - is that GDP is supposed to be comparable across countries, independently of differences in national law. As recently pointed out by the OECD, international comparability has become even more important, as contributions to international organisations (including e.g. the European Union) are based on levels of Gross National Income, which is linked to GDP. 



Thu, 26 Feb 2015 08:51:29 +0000