<![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Tue, 21 Oct 2014 21:19:27 +0100 http://www.bruegel.org/fileadmin/images/bruegel-logo.png <![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Zend_Feed http://blogs.law.harvard.edu/tech/rss <![CDATA[Uber Economics: There is no such thing as bad publicity]]> http://www.bruegel.org/nc/blog/detail/article/1464-uber-economics-there-is-no-such-thing-as-bad-publicity/ blog1464

Last month we published a blog post examining the economics behind, and the challenges for, the Uber ridesharing company. We now want to consider how Uber might have been affected by opposition from vested interests – in Uber's case, taxi drivers – and by regulation to restrict Uber. We take into account major events involving the company, and use Germany as a case study.

Uber arrived in Germany in February 2013. In April 2014 the first regulation imposing restrictions on its activity was passed, prohibiting the company from offering its services in Berlin.

In June 2014 there was a pan-European demonstration by taxi drivers against the company, possibly contributing to its ban in Germany later in August. The ban was revoked in September.

The following graph shows the individual index of Google searches for "Uber" (orange line) and the index of searches for "Taxi" (blue line), both in Germany.

Source: Bruegel based on Google trends.

Note: The indexes are not in relative terms of each other, thus are not comparable in absolute terms.

Tue, 21 Oct 2014 09:22:12 +0100
<![CDATA[The return of market volatility]]> http://www.bruegel.org/nc/blog/detail/article/1463-the-return-of-market-volatility/ blog1463

What’s at stake: The size of the market gyrations this week took everybody by surprise. Several stories have been put forward to rationalize these movements, but the abruptness of the adjustment is puzzling and underlines that the degree of liquidity in these markets may have been overestimated.

Last week wrap-up

We are definitely back in the “risk-on-risk-off” regime again

Sober Look writes that we are definitely back in the “risk-on-risk-off” regime again. In its Global Market overview, the FT notes this morning that high volatility will likely remain the story for now especially as expectation on monetary policies shift back and forth. Luigi Speranza write that market fluctuations have reached fever pitch over the past few days, with the continued decline in equity markets accompanied by new cyclical lows in bond yields and, more recently, a sharp widening of eurozone bond spreads.

Gavyn Davies writes that on Wednesday, the US ten year treasury, perhaps the most liquid financial instrument in the world, traded at yields of 2.21 per cent and 1.86 per cent within a matter of hours. This type of volatility in the ultimate “risk free” asset has previously been seen only in 2008 and other extreme meltdowns, so it clearly cannot be swept under the carpet.

What is the market telling?

The most prominent story since the September peak seems to be a “global slowdown” with associated “deflation

Gavyn Davies writes that overall three separate factors have probably been at work:

  • a reversal of speculative positions, which has had temporary effects on asset prices;
  • a contractionary and deflationary demand shock in the euro area;
  • an oil shock that will also be deflationary, but will be expansionary for many economies.

Robert Shiller writes that the most prominent story since the September peak seems to be one of a “global slowdown” with associated “deflation.” Underlying this tale are deeper, longer-term fears. There is a name for these concerns too. It is “secular stagnation” — the idea that there is disturbing evidence that the world economy may languish for a very long time, even for generations, as the word “secular” suggests. Gavyn Davies expresses doubts about this story since this fails to show up in any recent change in consensus GDP forecasts.

Paul Krugman writes that the financial turmoil of the past few days has widened the gap between what we’re told must be done to appease the market and what markets actually seem to be asking for. We have been told repeatedly that governments must cease and desist from their efforts to mitigate economic pain, lest their excessive compassion be punished by the financial gods, but the markets themselves have never seemed to agree that these human sacrifices are actually necessary. The real message from the market seems to be that we should be running bigger deficits and printing more money. And that message has gotten a lot stronger in the past few days.

Market volatility and growth

Roger Farmer writes that that a persistent 10% drop in the real value of the stock market is followed by a persistent 3% increase in the unemployment rate. The important word here is persistent. If the market drops 10% on Tuesday and recovers again a week later, (not an unusual movement in a volatile market), there will be no impact on the real economy. For a market panic to have real effects on Main Street it must be sustained for at least three months.  And there is no sign that that is happening: Yet.

A persistent 10% drop in the real value of the stock market is followed by a persistent 3% increase in the unemployment rate

Mohamed El-Erian writes that after a period of excessive risk taking and prolonged complacency, it will probably take some time for markets to fully recalibrate – a choppy process that will be driven both by fundamentals and by technically-oriented repositionings of crowded trades. 

Liquidity, regulation and price swings

Philip Gisdakis writes in Unicredit Sunday Wrap that with some clouds on the horizon, it took only a tiny trigger to send everyone bolting for the exit. With tightened market regulation also affecting banks’ trading books, market liquidity was gone within seconds, which resulted in huge price jumps. Mohamed El-Erian writes that traders are discovering – yet again – that market liquidity is not as deep as they had hoped for, causing wild price gyrations even in the most traditional of all asset classes (for eg, witness the speed and size of Wednesday’s price movements in US equities and Treasuries).

Gillian Tett writes that the question of “liquidity” – the degree to which assets can be traded – matters hugely. What is worrying is that liquidity appears to have decreased because unorthodox monetary policy experiments have collided with financial reforms and technological upheaval in an unexpectedly pernicious way. Having lots of money in the system does not guarantee that funding will flow freely, or that traders can cut deals. Systems flooded with cash can sometimes freeze.  Sometimes this occurs because investors lose faith in each other and stop doing trades, as they did in 2008. But markets can also become illiquid because it is difficult to match buyers and sellers. In the past big investment banks often matched buyers and sellers by holding large inventories of securities. But since 2008 banks have slashed their inventories by between 30 and 80 per cent (depending on the asset class) to meet tighter rules. This reduced their ability to act as market makers, and removed shock absorbers from the system.

Mon, 20 Oct 2014 07:18:49 +0100
<![CDATA[Jean Tirole's legacy]]> http://www.bruegel.org/nc/blog/detail/article/1462-jean-tiroles-legacy/ blog1462

On October 13 the Royal Swedish Academy of Sciences awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2014 to the French economist Jean Tirole for his analysis of market power and regulation.  

1 The numerous references to Laffont in the scientific background for the prize suggest that, were he still alive, he might have shared the prize with Tirole.

Jean Tirole, along with his mentor and coauthor Jean-Jacques Laffont,1 was one of the main scholars who contributed to the systematic use of game theory and mechanism design in Industrial Organization (IO), which fundamentally changed the way economists analyze oligopolistic competition, firms’ strategic behavior and market regulation. His 1988 textbook in IO is still considered “the Bible” in the field, after more than 25 years, and his 1991 textbook in game theory (coauthored with Drew Fudenberg) is still one of the main advanced references.

His contribution, however, goes well beyond elegant modelling and the robust analytical toolkit he helped to create. Several of his seminal papers had a massive impact on the way we approach relevant and delicate policy issues in the field of competition policy and market regulation. The following is a selection of some of his fundamental contributions to IO research. In a short blog post it would be impossible to describe all of Tirole’s contributions to IO and other fields (behavioral economics, corporate finance, organizational economics, etc.); however, the interested reader may visit Tirole’s personal webpage at the Institute d’Economie Industrielle, his page on IDEAS or read the slightly technical document with the scientific background for the prize.

Anticompetitive vertical mergers and restraints

Tirole developed a model in which vertical mergers (and vertical restraints) can result in market foreclosure

In his massive 82-page 1990 article with Hart, Tirole develops a model in which vertical mergers (and vertical restraints) can result in market foreclosure. Contrary to the then-common Chicago School view, that considered foreclosure an irrational strategy and efficiency gains and synergies the only motivations behind vertical practices, Tirole points out that, if contracting takes place in secret or contracts can be secretly renegotiated, the inability of an upstream supplier to make binding commitments with a downstream retailer reduces the supplier’s market power and its ability to keep prices high.

To understand why this is the case, consider an upstream supplier facing several downstream retailers and assume that there is no demand uncertainty so that both the supplier and retailers agree on the expected profits that can be made from selling the products. The supplier could promise exclusivity to one of the retailers in exchange of the profits (or parts of them, depending on the distribution of bargaining power between the two parties) that can be made from the sale of the products. However, once the deal is made, since there is no binding commitment behind the promise, the supplier has an incentive to renege on its exclusivity promise and opportunistically make a deal with another retailer (promising this time that there will be no further deals after that) for, let’s say, half of what was paid by the first retailer.

Of course, the inability to make binding commitments means that the supplier has an incentive to renege also on this promise, and iteratively repeat this scheme with all the retailers. However, anticipating the supplier’s opportunistic behavior, retailers would not accept the offer and thus the supplier loses the market power it might potentially have. A vertical merger, a legally binding exclusive contract or a retail price maintenance agreement allow the upstream supplier to “tie its hands” and retain its market power, to the detriment of consumers that have to face higher prices.

Tirole’s many contributions (see Rey and Tirole 2007, for a relatively recent one) are crucial to understand the framework in which competition authorities like the European Commission and economists more generally analyze vertical restraints and mergers which have vertical dimensions. This can clearly be seen in the guidelines of the European Commission on the assessment of vertical restraints and non-horizontal mergers.

Multi-sided platforms

2 The fact that in two-sided platform markets anticompetitive practices may be harder to identify calls for a precise definition of what a two-sided platform is, in order to avoid the case in which firms may simply try to redress the case as “two-sided platform-related” and hope in this way to avoid fines and continue their anticompetitive practices. This, however, might be a topic for another blog post.

The contributions of Tirole to the research in competition policy do not stop to vertical practices and foreclosure. He (with his coauthor Jean-Charles Rochet) kickstarted the literature on two-sided platforms (Rochet and Tirole 2003a, 2006). Two-sided platforms (multi-sided if dealing with more than two customer groups) are intermediaries which allow interactions between different parties who value each other participation (or where at least one party values the other participation, think of the case of advertisers and newspaper readership). Examples of two-sided platforms are credit/debit cards, operating systems, videogame consoles, dating clubs.

Contrary to other types of intermediaries, such as retailers, platforms leave the parties with control over their interactions/transactions.  This results in a positive feedback loop between the demands of the two customer groups, in that a member of one group (usually) enjoys the presence on the platform of more members of the other group, representing for him potential possibilities of interactions. Think of payment cards, for example. Payment cards allow consumers to purchase from affiliated stores without the need to physically carry cash with themselves and are characterized by the positive feedback loop typical of two-sided platforms: the more are the merchants accepting card payments, the more are the consumers who value holding a payment card, which in turn implies that the more are the merchants willing to install card readers, and so forth.

The interdependence between the demands of the two customer groups usually tends to result in heavily skewed pricing structures

The interdependence between the demands of the two customer groups usually tends to result in heavily skewed pricing structures, where one side is used as a loss leader to attract the other side, on which the platform makes profits. This means that the two sides cannot be analyzed in isolation but must be considered jointly, otherwise a competition authority may end up wrongly punishing the platform for excessive pricing on one side and predatory pricing on the other (while in fact it is adopting normal pricing practices for its industry, which would be adopted in a competitive environment).2 

Tirole did not just develop the theoretical concept of two-sided platforms, but he also studied the idiosyncrasies characterizing some of them, such as interchange fees in credit/debit card markets (e.g. Rochet and Tirole 2003b), which have been the focus of recent antitrust scrutiny by the European Commission (e.g. Visa and Mastercard cases). 

3 In a recent article (Lerner and Tirole 2014), Tirole and his coauthor extend the framework developed in this paper to analyze standard essential patents and prove that price commitments prior to the selection of the standard deliver the same outcome as in the (fictitious) ex-ante competitive benchmark in which users need not match their technological choice with each other (meaning that in this fictitious environment a standard setting organization would not confer undue market power to holders of standard essential patents and would de facto not need to exist). However, such price commitments are unlikely to emerge in absence of regulation. The analysis in this paper provides useful insights to policy makers on how to address currently hot policy issues like standard setting organizations and standard essential patents. Recent decisions of the European Commission on standard essential patents involve Google-Motorola and Samsung (Rambus and IPCom are slightly older but still relevant).

Patent pools and cooperation arrangements

In a 2004 paper with Lerner, Tirole studies patent pools - agreements among patent owners to jointly license their patents - and provides simple but robust conditions that would help competition authorities screen anticompetitive patent pools. He first notices that, except for the extreme cases of perfect complements and substitutes, patent substitutability and complementarity depend on the current license fees. When license prices are high, patents tend to be substitutes since licensees may just want to use some of the patents, which thus compete with one another. An increase in the price of a license would then trigger the exclusion of the patent from the selected patent bundle. On the contrary, patents tend to be complements when the prices of licenses are low, with the potential licensee preferring to use all patents conditionally on the adoption of the technology. An increase in the price of a license would therefore not result in the exclusion of the patent from the basket of patents chosen by the licensee, but rather may result in a reduction in the demand for the whole basket. In such a case, he finds that patent pools increase welfare.

Determining whether patents are complements or substitutes may be tricky in practical terms, since usually competition authorities may have limited information on the demand for the patents in the pool. However, he notices that, if licensors are allowed to offer individual licenses in addition to jointly offer their patents in the pool, this fact could be used by competition authorities to screen patent pools that do not pose anticompetitive risks, since licensors would only be tempted to make such stand-alone offers in cases when bundling entails higher prices.

Although this paper focuses on patent pools and is therefore relevant for current discussions of this topic, the analysis is rather general and applies, mutatis mutandis, also to other cooperation arrangements like code-sharing agreements between airlines (examples of these arrangements are alliances such as Oneworld and Star Alliance, that have been subjects of recent antitrust investigations by the European Commission).3 Cooperation agreements are subject to specific European Commission’s guidelines.

Regulation of natural monopolies

One of the main contributions of Jean Tirole is to the field of regulation. Together with Jean-Jacques Laffont, he wrote a very influential paper in regulation (Laffont and Tirole 1986). In this paper he analyzes the regulation of a monopolist in a situation in which the regulator observes the firm’s production cost but the firm has private information on the determinants of its costs: the regulator cannot distinguish between a firm that is more efficient because, for example, it benefits from economies of scale and a firm that has actively invested in the past to make its production more efficient.

In such a situation, they find that a regulator cannot attain the first-best outcome because of the informational asymmetry between the firm and the regulator, but that the regulator can reach a satisfactory second-best outcome by carefully designing a menu of contracts – from which the firm then self-selects its contract by announcing its expected cost – minimizing the rents to the monopolist while still leaving incentives to the firm for cost reductions. The general form of the transfer in this menu of contracts consists of a fixed-price payment plus a linear (partial) cost overrun reimbursement. The contract designed for the most efficient type of firm involves just the fixed-price component (no cost-overrun reimbursement) in order to give the firm (might it happen to be that efficient) high-powered incentives to reduce costs. This is also the only contract of the menu that is able to replicate the first-best outcome.

4 Information rents are rents that the firm earns by exploiting the asymmetry of information existing between it and the regulator.

The contracts designed for less efficient types of firm offer a partial cost overrun reimbursement (and hence less powerful incentives for cost reductions) in order to reduce the information rents4 for the most efficient types. In fact, consider the case in which the regulator designs also the contracts intended for the less efficient types of firm as a fixed-price contract, in order to give them the most powerful incentives for cost reductions. In order for these potential types of firm to pick the contract, the fixed-payment should be larger, since they are less efficient. But then more efficient types of firm would have an incentive to announce a higher expected cost in order to receive a larger payment and earn additional information rents. The menu of contract is therefore optimally designed in order to trade-off the incentives to the firm to reduce its cost with the information rents for more efficient types.

Laffont and Tirole also extend this model to take into account that regulation is not a one-time occurrence but rather a process that changes over time (for instance, Laffont and Tirole 1988, which analyzes the ratchet effect arising when the regulator can only offer a short-term contract to the firm,  and Laffont and Tirole 1990, which analyzes how a long-term contract between the firm and the regulator gets renegotiated over time) and the possibility of regulatory capture (Laffont and Tirole 1991). Many of these contributions are summarized in their book on regulation and procurement (Laffont and Tirole 1993).

The contributions of Tirole to research in regulation are not limited to general modelling of regulatory games, but deal also directly with regulation in specific (and very important) industries like communications (Laffont and Tirole 2001)  and the financial sector (Dewatripont, Rochet and Tirole 2010). 

Thu, 16 Oct 2014 08:09:01 +0100
<![CDATA[China seeking to cash in on Europe’s crises]]> http://www.bruegel.org/nc/blog/detail/article/1461-china-seeking-to-cash-in-on-europes-crises/ blog1461

Last Tuesday, I posted about the increasing investment of China in Russia, wondering whether and to what extent it could help Russia smooth the economic impact of European sanctions. But as shown by a recent  analysis of the Financial Times, China has been increasingly investing in Europe as well, focusing recently on crisis-hit countries.

Chinese FDI to Europe has been very small until 2010. But since then it has been significantly increasing, reaching 27bn euro in 2012

China has traditionally been a receiver of European FDI, which according to Deutsche Bank, accounted for 18% of total China’s FDI stock. On the contrary, Chinese FDI to Europe has been very small until 2010. But since then it has been significantly increasing, reaching 27bn euro in 2012. Even so, Chinese FDI still represents a minimal share (0.7%) of total FDI stocks that EU countries receive from non-EU countries.

Between 2008 and mid-2014, China sealed more than 200 cross-border M&A or joint venture deals in the EU

According to Deutsche Bank, between 2008 and mid-2014, China sealed more than 200 cross-border M&A or joint venture deals in the EU.  Most M&A projects were undertaken in the industrial sector, consumer products, energy and basic materials (figure 2, right). Deutsche Bank also highlights the existence of different strategies across destination countries: in Germany, deals appear to have been focused mostly on machinery, alternative energy, automotive parts and equipment; in France, the target was mostly consumer industries; while in the UK target industries reflect a broad-based mix.

Germany attracted the largest number of deals (figure 2, left) - most notably Greenfield investments - followed by the UK and the Netherlands. Italy, Greece, Portugal and Spain, seem to have become more interesting to Chinese investors only from 2012 onwards.

Italy, Greece, Portugal and Spain seem to have become more interesting to Chinese investors only from 2012 onwards

The Financial Times published this week an analytical series (“Silk Road redux”) that looks more into this new wave of Chinese FDI in crisis-hit European countries. Sources quoted in the articles suggest that with the 2010 European crisis, China has indeed started to shift its foreign investment focus from mostly natural resources-related investments in Africa, Asia and Latin America, towards assets in European countries that, at the height of the crisis, were often faced with the need to privatize quickly and at relatively cheap price (figure 3).

In Italy, the FT reports that at the end of 2012, an estimated 195 SMEs (with combined total revenues of €6bn and 10,000 employees) had been wholly or partly taken over by Chinese or Hong Kong investors. China managed to secure stakes in big companies as well. In July this year, Chinese State Grid invested heavily in the Italian power grid, buying 35% in CDP Reti. Safe in turn invested estimated 2 billions in ENI and ENEL, two state-controlled energy groups, while the state Administration of Foreign Exchange bought 2% stakes in FIAT Chrysler Automobiles, Telecom Italia and Prysmian, for a total of 670 million.

In Greece, Chinese investors are focusing on shipping and tourism. In June, Greece and China signed shipbuilding deals worth $3.2bn that will be financed by the state-owned China Development Bank. The Chinese state shipping group Cosco Pacific had already acquired a concession to operate in the Piraeus port back in 2009, and is competing to buy the 67% stake currently held by the Greek State. Greece’s Transport ministry is also reportedly expecting China’s State Construction Engineering Corporation to participate in a tender to build and operate a new 800 million euro airport in Crete, which could offer the first direct connection between China and Greece. Chinese tourists are increasing in Greece, and (in 20 years time) they could possibly enjoy the huge luxury commercial centre that will be built on the coastal site of the former Athens airport. A long-term project worth 5 billion in which Chinese Fosun is participating together with Greece and Gulf state partners.

In Portugal, Chinese investment is reported to account for 45% of the total privatization conducted in the context of the EU/IMF programme

In Portugal, Chinese investment is reported to account for 45% of the total privatization conducted in the context of the EU/IMF programme. Chinese early investments were in power utility and infrastructure, with Three Gorges Corporation acquiring in 2011 a stake of 21% in Energias de Portugal and China State Grid acquiring 25% of REN, the national grid operator. In 2014, instead, investment was concentrated in financial services, with Fosun buying 80% of the Portuguese Caixa Seguros, the largest insurance company, and now bidding for BES assets.

On top of these investments, Chinese buyers are potentially revitalising the otherwise paralysed real estate market in crisis-hit countries. The FT reports that government of Portugal, Cyprus, Greece, Hungary, Latvia and Spain are managing to attract Chinese real estate buyers by offering residency permits to non-Europeans who buy local property of a certain amount. The practice is known under the name of “golden visas”. In Portugal, the golden visa requires buying a property for at least 500,000 euros, the same in Spain (which is at present reported to have 500 application pending) whereas in Greece and Hungary it takes a 250,000 sale. Portugal is reportedly the country where the scheme has been more successful, with 1360 visa issued (81% of which to Chinese nationals) and an associated 900 million real estate investments (forecasted to reach 2 billion by end-2015).

Despite the recent increase, Chines FDI to Europe are still in an infancy state and more data will be needed before drawing conclusion on whether this can qualify as a meaningful trend. But it looks like the euro crisis might have opened to China the doors of otherwise locked European investments.

Thu, 16 Oct 2014 07:15:41 +0100
<![CDATA[Developing Asia: challenges and opportunities in the global economy]]> http://www.bruegel.org/nc/events/event-detail/event/469-developing-asia-challenges-and-opportunities-in-the-global-economy/ even469

Developing Asia remains the fastest growing region globally. Slowing external demand has hurt some economies in the region but as a whole Asia and the Pacific is on track for firm growth in 2014 and 2015. Presenting the update of the Asian Development Outlook 2014 (ADO 2014), Dr Wei will argue that moving forward structural reform processes in China, India, and Indonesia—the region’s three biggest economies—will be critical in shaping their growth outlook.

Dr. Wei will discuss the impact of the winding down of unconventional United States monetary policy on Asian financial markets. Although US policy could still surprise markets if higher growth than expected pushed the Federal Reserve toward an early interest rate increase, the effect on developing Asia would be modest next to the shock caused in 2013 by anticipated tightening. Finally, he will maintain that demand and benign international commodity prices will keep inflation moderate in developing Asia. As many economies in Asia have grown by connecting with global value chains, he will argue that strengthening them could further stimulate expansion of
industry and services and create jobs.

The presentation will be followed by comments and an open discussion chaired by André Sapir.

The event will be live streamed on this page.


  • Dr. Shang-Jin Wei, Chief Economist, Asian Development Bank
  • Lucian Cernat, Chief Economist and Head of Unit, European Commission, DG Trade
  • Chair: André Sapir, Senior Fellow, Bruegel

About the speakers

Shang-Jin Wei is the Chief Economist of the Asian Development Bank (ADB). He is the chief spokesperson for ADB on economic and development trends, and leads the Economics and Research Department, which publishes ADB’s flagship knowledge products.

Mr. Wei, born in the People’s Republic of China and a national of the United States, has a long and distinguished career in academia and international finance and trade. Before joining ADB he was the N.T. Wang Chair and Director of the Chazen Institute of International Business at Columbia University, Director of the National Bureau of Economic Research’s working group on the Chinese economy, and a research fellow at the Center for Economic Policy Research (Europe).

Prior to Columbia University, Mr. Wei was an Assistant Director and Chief of Division at the International Monetary Fund (IMF) where he led the Fund’s policy research and advised on issues in international trade, investment, globalization, and related topics. He was IMF Chief of Mission to Myanmar in 2004.

Mr. Wei served as an advisor on anti-corruption policy and research at the World Bank from 1999 to 2000. He was an assistant and associate professor at Harvard University from 1992 to 1999.

Mr. Wei earned a PhD in Economics and a Master’s degree in Finance from the University of California, Berkeley; a Master’s degree in Economics from Pennsylvania State University; and a Bachelor’s degree in World Economy from Fudan University in the People’s Republic of China.

Practical information

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Monday, 10 November 2014, 12.45-14.30
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Wed, 15 Oct 2014 16:11:28 +0100
<![CDATA[Student mobility in Europe]]> http://www.bruegel.org/nc/blog/detail/article/1460-student-mobility-in-europe/ blog1460

The chart shows the percentage of students coming from other European countries, measured on the total university student population, who are enrolled in tertiary education, either in Erasmus programs or national degree programs of the hosting country.

Share of international students has increased over the past few years in most of the selected countries

Share of international students has increased over the past few years in most of the selected countries. The increase has been particularly relevant in countries such as Belgium, Denmark and the Netherlands, while traditionally popular destinations for international students, such as the United Kingdom, have displayed a more stable trend. Share of Erasmus students has instead remained quite constant over time.

The boom in student mobility may have been consequent to the gradual enhancement of integration in the European tertiary education system, following the implementation of the Bologna process, introduced in 1999 and aimed at standardizing curriculum in higher education, making it easier for students to move across the countries of the Union.

Tue, 14 Oct 2014 11:03:31 +0100
<![CDATA[Looking past the (West’s) end of the nose]]> http://www.bruegel.org/nc/blog/detail/article/1459-looking-past-the-wests-end-of-the-nose/ blog1459

What is being largely ignored is that the underlying growth trend of the world economy itself is actually rising

Following the recent IMF annual meetings, and the coincidental declines in global stock markets, gloom is back about the state of the world economy. While there is some evidence of a recent slowdown in the world economic cycle, what is being largely ignored is that the underlying growth trend of the world economy itself is actually rising.

The world economy grew faster in the decade 2001-10 despite the fact that there were two major global economic crises

Many observers seem to be unaware of the fact that the world economy grew faster in the decade 2001-10 despite the fact that there were two major global economic crises, the bursting of the dot-com bubble in 2000-01 and the global credit crisis in 2008-09.  According to revised IMF data (displayed in Table 1 above), which incorporates the recent new PPP estimates from the International Comparison Programme (ICP), world GDP growth in 2001-10 rose by around 4.0 percent, up from 3.7 percent based on the old weights, which was already stronger than generally appreciated. This GDP growth rate was already higher than the 3.4 and 3.2 percent growth of the previous two decades, and of course, the higher growth rate reflects the stronger weights of the rising emerging economies such as China and India, and their own stronger growth rates. What is probably even less known is that despite the various challenges around the developed and developing world so far this decade, in the years 2011-13, world GDP growth was around 3.6pct, which although down from the last decade’s heady growth, is also higher than the two previous decades.

The table 2 below shows the growth rates by decade since the 1980’s for major regions, the world in general, as well as this decade to date, and what we have been assuming the world’s potential would be for this full decade, 2011-20. 

Note: *forecasts

While all four of the BRIC economies have slowed decade to date, the MINT countries have actually accelerated as a group

What is clear is that the stronger underlying trend is due to the rising weight of the so-called BRIC countries, especially China, and to a more modest degree, the next largest group of emerging economies, that I call the MINT countries. While all four of the BRIC economies have slowed decade to date, the MINT countries have actually accelerated as a group, and seem set to have a stronger growth rate this decade than the last. While the BRIC countries will experience slower growth this decade, it is only really Brazil and Russia that have significantly disappointed, which in both cases, reflects their own significant challenges, of which at the core, is their excessive dependence on commodities and the benefit of rising prices. While India has been softer than assumed so far, there is a reasonable chance that economic growth will accelerate again under the current Indian leadership. As far as China is concerned, while it is likely to continue to show softer growth than the previous decades, for many, including myself, this growth is not anything less than assumed. In fact, as can be seen, it is the one country within the BRICs that decade to date has grown stronger than assumed, despite slowing. And the rising weight of China, now bigger than the US in PPP terms, contributes more and more to world GDP growth.

Even the IMF itself appears to refer to disappointments about the emerging world, suggesting that their over prediction of world GDP forecasts for each of the past 3 years is greatly due to excessive optimism about the larger emerging economies. That might be true for Brazil and Russia, but hardly elsewhere.

Looking at the so-called developed world, relative to their underlying trend, it is hard to express too much disappointment about either of the US or UK, nor indeed Japan. Decade to date, Japan has grown close to its assumed trend, and although each of the UK and US has currently grown by less than the decade’s assumed trend, their current 2014 is above that assumed, and another year similar to this one for both , would take them close to trend.

This decade to date is –so far- higher than both the 1980’s and 90’s despite the adjustment challenges post crisis

What is also the case, that seems to be often overlooked by those talking about the persistent disappointments, is as pointed out, this decade to date is –so far- higher than both the 1980’s and 90’s despite the adjustment challenges post crisis. If it is indeed the case that some pessimists argue, that the absence of the unconstrained credit binge of the “Noughties” is hindering growth, it is surely quite encouraging that growth although softer than that decade is, at least globally, higher than the previous two. Indeed, if the strength of the 4pct growth of the previous decade was partially due to the excesses that led to the global credit crunch, and not sustainable, seen in this light, the growth maintained from 2011-13 is quite respectable.

A further substantive point which many pessimists seem to overlook, is that each of the US and China has moved to a much more desired external balance of payments position than existing before the crisis, with the US current account deficit likely to be close to 2 percent of GDP in 2014, down from around 6.5 percent in 2008. China has seen its current account surplus drop sharply from close to 10 percent of GDP to somewhere between 2-3 percent of GDP. For both these economies to make such an adjustment and for their own growth rates to have performed in the manner they have is quite impressive.

What is more genuinely disappointing is that the Eurozone has shown such persistently weak growth this decade

What is more genuinely disappointing is that the Eurozone has shown such persistently weak growth this decade, significantly below its assumed- weak- trend, and is the main explanation as to why global GDP growth has stayed below its- rising –potential. Moreover, unlike the US or China, the Eurozone has seen its external current account surplus widen significantly, probably a partial reflection of the weakness in domestic euro area growth.

For the world as a whole to achieve its better BRIC and MINT induced potential, it can only occur if Euro Area policymakers can be more determined to pursue policies that both boost their cyclical economic performance, and perhaps do more to boost their own weak underlying trend.

Mon, 13 Oct 2014 13:39:53 +0100
<![CDATA[Infrastructure investment is a no-brainer]]> http://www.bruegel.org/nc/blog/detail/article/1457-infrastructure-investment-is-a-no-brainer/ blog1457

What’s at stake: For countries with infrastructure needs, the combination of low interest rates and mediocre growth mean that it’s time for an investment push. While Brad DeLong and Lawrence Summers already laid out the theoretical case in a 2012 Brookings paper, the empirical case was laid out this week in Chapter 3 of the latest IMF World Economic Outlook.

Lawrence Summers writes that in a time of economic shortfall and inadequate public investment, there is for once a free lunch – a way for governments to strengthen both the economy and their own financial positions. Greg Mankiw writes that the free-lunch view is certainly theoretically possible (just like self-financing tax cuts), but we should be skeptical about whether it can occur in practice (just like self-financing tax cuts). 

Disinvestment madness

In advanced economies, public investment was scaled back from about 4% of GDP in the 1980s to 3% of GDP at present

Abiad and al. write on the IMF blog that the evolution of the stock of public capital suggests rising inadequacies in infrastructure provision. Public capital has declined significantly as a share of output over the past three decades in both advanced and developing countries. In advanced economies, public investment was scaled back from about 4 percent of GDP in the 1980s to 3 percent of GDP at present (maintenance spending has also fallen, especially since the financial crisis).

This makes a very strong case for sharply increasing public investment in a depressed economy

Paul Krugman writes that this is disinvestment madness. Real interest rates are extremely low, indicating that the private sector sees very little opportunity cost in using funds for public investment. There has been a lot of slack in the labor market, so that many of the workers one would employ in public investment would otherwise have been idle — so very little opportunity cost there either. This makes a very strong case for sharply increasing public investment in a depressed economy; a case that doesn’t rely on claims that there is a large multiplier, although there’s every reason to believe that this is also true.

Methodology for identifying investment shocks

The authors of the WEO’s chapter 3 write that in contrast to the large body of literature that has focused on estimating the long term elasticity of output to public and infrastructure capital using a production function approach, the IMF analysis adopts a novel empirical strategy that allows estimation of both the short- and medium-term effects of public investment on a range of macroeconomic variables. Specifically, it isolates shocks to public investment that can plausibly be deemed exogenous by following the approach of smooth transition VARs of Auerbach and Gorodnichenko (2012, 2013), where the shocks are identified as the difference between forecast and actual investment. In the WEO chapter, the forecasts of investment spending are those reported in the fall issue of the OECD’s Economic Outlook for the same year.

The positive effects of increased public infrastructure investment are particularly strong when public investment is undertaken during periods of economic slack and monetary policy accommodation

The authors of the WEO’s chapter 3 write that a problem in the identification of public investment shocks is that they may be endogenous to output growth surprises. But the public investment innovations identified are only weakly correlated (about –0.11) with output growth surprises. Another possible problem in identifying public investment shocks is a potential systematic bias in the forecasts concerning economic variables other than public investment, with the result that the forecast errors for public investment are correlated with those for other macroeconomic variables. To address this concern, the measure of public investment shocks has been regressed on the forecast errors of other components of government spending, private investment, and private consumption.

Main results

Abiad and al. write on the IMF blog that the benefits depend on a number of factors. The authors find that the positive effects of increased public infrastructure investment are particularly strong when public investment is undertaken during periods of economic slack and monetary policy accommodation, where additional public investment spending is not wasted and is allocated to projects with high rates of return and when it is financed by issuing debt has larger output effects than when it is financed by raising taxes or cutting other spending.

Infrastructure investment in Europe

Mario Monti writes that while a simplistic stability pact may have been the right choice when the euro was in its infancy, Europe can no longer afford to stick with such a rudimentary instrument. By failing to recognize the proper role of public investment, it has pushed governments to stop building infrastructure just when they should have built more. What is needed is not the flexibility to deviate from the rules, but rules that are economically and morally rigorous. The new Commission should announce a proposal for updating the rules on fiscal discipline, to reflect the role of productive public investment. The commission would then enforce the existing stability pact while allowing for the favorable treatment of public investment within the limits set out in 2013.

Europe needs mechanisms for carrying out self-financing infrastructure projects outside existing budget caps

Lawrence Summers writes that Europe needs mechanisms for carrying out self-financing infrastructure projects outside existing budget caps. This may be possible through the expansion of the European Investment Bank or more use of capital budget concepts in implementing fiscal reviews.

Mon, 13 Oct 2014 06:11:32 +0100
<![CDATA[Crowdfunding: Broadening Europe’s capital markets]]> http://www.bruegel.org/nc/blog/detail/article/1456-crowdfunding-broadening-europes-capital-markets/ blog1456

The rising financing gap for SMEs as well as high growth firms is a serious concern for Europe battered by financial fragility. These firms, particularly young innovative firms, are the drivers of job creation and economic growth, much needed to break through the economic malaise across Europe.

Note: Figures refer to the preliminary results of the OECD DYNEMP project based on data from Austria, Belgium, Brazil, Finland, France, Hungary, Italy, Japan, Luxembourg, the Netherlands, New Zealand, Norway, Spain, Sweden and the United States.

In the U.S., the majority (70%, according to IRSG) of corporate fundraising is through the securities market while in Europe, companies have traditionally relied on bank lending.

The curtailing of bank lending over the past several years due to the financial crisis has created a huge constraint for these firms, particularly as non-bank capital is less prevalent in Europe. In the U.S., the majority (70%, according to IRSG) of corporate fundraising is through the securities market while in Europe, companies have traditionally relied on bank lending.

Note: Scale from 1 to 7 from hardest to easiest, weighted averages.

At a time when banking intermediation is under pressure, it is important for European Union policymakers to further explore alternative forms of financial intermediation. Commission President Jean-Claude Juncker recently spoke about the need to improve financing in Europe by “further developing and integrating capital markets” and reducing the dependence on bank funding. He and his new team should address regulatory fragmentation in financial markets head on in order to facilitate efficient funding and growth of innovation in Europe.

For innovative young firms, equity capital can be particularly important to fuel growth across borders, yet the European capital markets are highly fragmented making it difficult for these firms to access the necessary financing. Different rules and regulations apply to various types of financial instruments and financial intermediaries across European countries.  Financial intermediation plays a critical role for young firms as information asymmetries make it difficult for investors to identify and evaluate the potential of these firms.

Venture capital and angel investment are playing an increasingly important role in Europe but activity is still overshadowed by the U.S. where the capital markets are more developed. 

Note: Data for the United States refer to market statistics, data for Europe refer to industry statistics. Europe includes here Austria, Belgium, Bosnia-Herzegovina, Bulgaria, Croatia, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Former Yugoslav Republic of Macedonia, Montenegro, Netherlands, Norway, Poland, Portugal, Romania, Serbia, Spain, Slovak Republic, Slovenia, Sweden, Switzerland, Ukraine and United Kingdom.

Over the past decade, European venture capital investment has been approximately one-fifth to one-third the size of investment in United States but this figure has dropped further in recent years. Also, the number of venture capital deals in Europe is higher than in the United States, showing that venture capital firms in Europe are, on average, dispersing funds more broadly through smaller deals. In fact, according to the data above, deals in the United States have been on average almost double the size of European deals.

Angel investment has been playing an increasingly important role in the financing innovative young firms but remains primarily local due to the fact that the majority of angel investments are made individually to entrepreneurs within the investors’ communities. A growing number of angel investors are investing through groups, networks and syndicates but the majority of these investments also remain local or national.

As analysed in a paper just published by Bruegel, Crowdfunding is increasingly attracting attention, most recently for its potential to provide equity funding to start-ups.

Equity crowdfunding can open up additional channels for new ventures to access finance at a time when securing funding is difficult, however, policy makers should carefully assess the risks of this new financial intermediation tool. The challenges that equity crowdfunding poses are distinct and more complex than those of the other forms of crowdfunding and the risks also differ from other forms of seed and early stage equity finance, such as angel investment and venture capital. Unlike other forms of equity financing, crowdfunding is intermediated by online platforms. These platforms differ in terms of the role they play in screening and evaluating companies. Also, their role during the investment and post-investment stages can vary dramatically.

Due to exemptions in legislations, Europe has been at the forefront of equity crowdfunding globally. However, the market is highly deregulated with few legal protections provided to funders.  In response, some member states have introduced ad hoc legislations for crowdfunding, while some others will introduce new laws soon. Being internet based, equity crowdfunding has the potential to contribute to a pan-European seed and early stage financial market to support European start-ups. However, in order to maximise this benefit, policies to address equity crowdfunding models should be adopted homogeneously by all member states. This approach would maximise the benefits of equity crowdfunding and help to reduce the risks. It would also help to address some of the fragmentation in Europe’s financing markets and encourage new forms of financial intermediation. The Commission should work with Member States to address the current patch-work of national legal frameworks which constitute an obstacle to the appropriate development of this nascent model of funding across Europe as part of the work towards a Capital Market Union.

Fri, 10 Oct 2014 09:30:32 +0100
<![CDATA[Developing an underlying inflation gauge for China]]> http://www.bruegel.org/publications/publication-detail/publication/853-developing-an-underlying-inflation-gauge-for-china/ publ853

This paper develops a new underlying inflation gauge (UIG) for China which differentiates between trend and noise, is available daily and uses a broad set of variables that potentially influence inflation. Its construction follows the works at other major central banks, adopts the methodology of a dynamic factor model that extracts the lower frequency components as developed by Forni et al (2000) and draws on the experience of the People’s Bank of China in modelling inflation.

Developing an underlying inflation gauge for China (English)
Thu, 09 Oct 2014 11:45:30 +0100
<![CDATA[European banks’ business models evolving under crisis pressure]]> http://www.bruegel.org/nc/events/event-detail/event/468-european-banks-business-models-evolving-under-crisis-pressure/ even468

Bruegel would like to invite you to a Finance Focus Breakfast on “European Banks’ Business Models Evolving under Crisis Pressure.” Initial presentations by Jean-François Neuez and Simon Ainsworth will be followed by an open discussion chaired by Nicolas Véron.

The business models of European Banks are evolving under a number of interrelated factors: the crisis and corresponding deleveraging & risk repricing, regulatory initiatives that have been enacted but are at various stages of implementation, the gradual buildup of Europe’s banking union, regulatory initiatives that are under discussion and may or may not materialize, and rapid technological change, to name only a few. Policy debates about banking reform are often at least partly based on somewhat abstracted considerations. By contrast, this session will provide an opportunity to take stock on current shifts from the observation of actual developments in the banking sector.

This event will be held under the Chatham House Rule


  • Jean-François Neuez, Senior Analyst European Financial Research, Goldman Sachs
  • Simon Ainsworth, Group Credit Officer EMEA Banks, Moody's
  • Chair: Nicolas Véron, Senior Fellow, Bruegel

Practical details

  • Venue:Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time:Friday, 24 October, 8:30 - 10:00
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Wed, 08 Oct 2014 10:44:35 +0100
<![CDATA[Immigration, Intra-EU Mobility, and Sustainable economic growth]]> http://www.bruegel.org/nc/events/event-detail/event/466-immigration-intra-eu-mobility-and-sustainable-economic-growth/ even466

Recent research demonstrates that immigration into the European Union and intra-EU mobility may promote economic growth in several ways: Bilateral trade and investment with the immigrants' home countries tend to grow, probably because migrants facilitate communication across borders. Immigrants may supply complementary skills to current residents and help to increase residents' productivity and income. Immigrants may also help aging European societies to age less rapidly. Commissioner Andor will discuss the growth effects of immigration and mobility in the EU and reflect on options for immigration policies at the community and member state levels that promote sustainable growth. Greg Wright will highlight recent research findings on the impact of immigration and Melissa Siegel will focus on how migrants would be affected by immigration policies that emphasize host country welfare. Finally Vit Novotný will comment on what has been discussed and talk about the ongoing political discussion on improving immigration policies.


  • László Andor, European Commissioner for Employment, Social Affairs and Inclusion
  • Greg C. Wright, University of California at Merced
  • Melissa Siegel, United Nations University - MERIT
  • Vít Novotný, Senior Research Officer at the Wilfried Martens Centre for European Studies
  • Chair: Guntram Wolff, Director, Bruegel

About the speakers

László Andor is an economist and has been Commissioner for Employment, Social Affairs and Inclusion since 2010. He is on unpaid leave from professorial appointments at the Economics Department of Corvinus University of Budapest King Sigismund College. He was on the board of directors of the European Bank for Reconstruction and Development (EBRD) from 2005 to 2010. Before that, he was involved in several research projects in the area of labour markets and European integration and was also an economic advisor to the Hungarian Prime Minister’s Office, among other institutions.

Greg Wright is an Assistant Professor at the University of California at Merced and was previously Lecturer at the University of Essex from 2011 to 2013. His research deals with the labour market impact of globalization through trade and immigration. He was educated first in astrophysics (B.A., UC Berkeley 1998) and then obtained a master's degree and Ph.D. in economics at UC Davis. His recent publications include “Immigration, Offshoring and American Jobs”, with G. Peri and G. Ottaviano, American Economic Review 2013.

Melissa Siegel is an Associate Professor and Head of Migration Studies at the Maastricht Graduate School of Governance and UNU-MERIT. She heads the Migration and Development research group of UNU-MERIT and the Migration and Development research theme of the Maastricht Center for Citizenship, Migration and Development (MACIMIDE). She has headed research projects on migration and development in countries ranging from Surinam to Afghanistan and is also regularly involved in migration-related trainings for national governments and international organizations.

Vít Novotný is a senior research officer at the Wilfried Martens Centre for European Studies. In charge of research cooperation with the Centre's member foundations, he has edited the volumes From Reform to Growth: Managing the Economic crisis in Europe (2013) and Opening the Door? Immigration and Integration in the European Union (2012). These books create European centre-right policy narratives in their fields. Vít Novotný is also responsible for research clusters on ethics, values and religion and new societal challenges. He has previous experience working in the education, private, public and non-profit sectors in the UK (2004-10). His education includes postgraduate degrees in clinical pharmacy, European studies, public administration and politics from universities in Czechia, the US and the UK. He has published widely on politics and current issues in Czech and English-language press.

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Monday 20 October 2014, 12.30-14.30
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

This event is held in the framework of the project Europe’s Global Linkages and the Impact of the Financial Crisis. This project is led by IAW and the other partners are: Tübingen University, Institut für Weltwirtschaft, Fondazione Enrio Mattei, FEEM, Keio University, Maastricht University, University of California Davis and researchers from China. The VW foundation supports this project within its program “Europe and Global Challenges

Wed, 08 Oct 2014 10:36:19 +0100
<![CDATA[How I learned to stop worrying about TARGET2 and love the ECB]]> http://www.bruegel.org/nc/blog/detail/article/1455-how-i-learned-to-stop-worrying-about-target2-and-love-the-ecb/ blog1455

There always comes a time we have to face our past.

For economists, it often happens when updating data long left sitting in a remote corner of our desktops.

It happened to me recently. I refreshed an old chart and suddenly realized how—and why—an issue that spooked economists and financial markets alike back in 2011 and 2012 has faded so far into the background.

During the height of the European financial crisis, economists and journalists eagerly followed the latest updates on a mysterious-sounding data series known as TARGET2, which needed to be unearthed from the depths of the websites of each and every national central bank in the euro area.

TARGET2 stands for Trans-European Automated Real-time Gross settlement Express Transfer. (It is the second iteration of the system, thus the “2.”) Essentially, this a European Union payment system used by large institutions—mostly banks—to make large, cross-border euro-denominated payments throughout the course of the day. These are large amounts of money. In 2012, roughly €2.5 trillion worth of transactions were made on the TARGET2 system each day.

In practice, during the crisis the system worked more as a transfer system between countries that were seeing capital flow into or out of the country.

Here’s how it worked. Imagine a CFO at a corporation in say, Spain, back in 2011 when the crisis was intensifying. Yields on Spanish government debt were rising as markets were starting to lose confidence. There were serious doubts about the possibility that Spain might be forced to request an EU/IMF assistance program. The CFO became reasonably nervous about the safety of the bank where her company kept its money. So she decides to move the company’s account to a stronger bank in, say, Germany.

She directs her Spanish bank to transfer the company’s money, say €100 million, to the new German bank. This implies to opposite things: Deposits at the Spanish bank go down by €100 million, and deposits at the German bank go up by €100 million.

Now, like all banks, the Spanish bank doesn’t have that company’s €100 million just sitting around in a vault somewhere. (Banks make money by lending out deposits.) And the CFO of our company, most likely, is not the only one who had the brilliant idea to move money to safety. So the Spanish bank probably finds itself in a situation where its deposit base is naturally shrinking.

But still, assets and liabilities on bank balance sheets must match. That means the Spanish bank must raise the money it needs to send to the German bank, if it wants to avoid raising additional doubts about its solvency. If such doubts grow unchecked, they could trigger a full-on bank run. Now, in normal times the Spanish bank could borrow needed cash cheaply and easily from other banks. But 2011 and 2012 were not normal times.

The interbank market—where banks lend money to one another—was basically frozen. The Spanish bank might have come up with the money by selling assets, such as the bonds or other investments the bank owned. But that would have taken too long. And borrowing from depositors was not an option. Remember, this was a situation where depositors were pulling money out of the bank, not depositing more in.

So what is to be done? Luckily for the banks in the euro zone countries that ended up under highest stress, the European Central Bank had a solution. The ECB would provide cheap, long-term loans in exchange for collateral, via its Longer-Term Refinancing Operations (LTROs). The ECB launched two extraordinary version of these operations (on December 2011 and February 2012 ) offering to lend cash for three years. European banks jumped on the offer, borrowing roughly €1 trillion (paywall).

Through this program the ECB essentially acted as a conduit between countries that were experiencing constant outflows and those where capital was constantly flowing in, in search of safety.

This is reflected in the chart. Countries where banks were constantly borrowing from the ECB—the actual system through which the money was transferred in LTROs was our old friend TARGET2—such as Greece, Ireland, Portugal, Italy and Spain were net borrowers of the Central Bank’s liquidity. As a result the accumulated a TARGET2 deficit vis à vis the ECB.

On the other hand, banks in countries like Germany were receiving large flows of that safety-seeking cash. As it started to pile up, these German banks didn’t see a lot of good places to immediately invest it. (After all the European economy was in turmoil.) So they simply started to deposit their excess reserves at the ECB—again using our TARGET2 payment system—driving their account TARGET2 balance at the ECB into a giant surplus.

And that’s how things continued to develop until 2012.

Since then, things have changed dramatically. Why?

Well, the most clear development came in August 2012, when the ECB announced it was willing to buy government bonds on the secondary market, if the country asked for help, via a program known as outright monetary transactions (OMT). The possibility of a buyer like the ECB, which had theoretically bottomless pockets—although there were some constraints on the maturities of securities it said it would buy—stopped the European government bond selloff in its tracks.

Over the next few years, prices for European bonds issued by troubled countries rose sharply, dissipating some of the doubts about the immediate solvency of the banking systems in those countries. The return of confidence eased concerns of depositors and other lenders, making it easier and cheaper for those banks to raise money.

Banks that saw deposit outflow, such as our imaginary Spanish bank, were better able to raise the money they needed. They therefore returned some or all of the money they borrowed from the ECB. In other words, conditions have been normalizing. (Although this is happening very slowly and we are still far from pre-crisis balance.)

So, is that it? Problem solved?

Not exactly. While short-term issues of financial stability have improved markedly, the wild ride of TARGET2 balances in recent years highlights a new problem for the ECB. As I recently pointed out here, the ECB’s approach to unconventional monetary is ultimately outside the central bank’s control, because it is driven by banks’ demand for (and decision to reimburse) the money created by the central bank. In other words, during the worst phase of the crisis, the ECB effectively outsources the central bank’s balance sheet management to banks in the private sector.

Why is this a problem? You need only look at the recent readings of dangerously low inflation in the euro zone to understand why. If the ECB truly wants to keep the risk of falling into a Japanese-style deflationary trap at bay, it must act decisively to expand its balance sheet—as the US Federal Reserve did—on its own.

Tue, 07 Oct 2014 16:31:20 +0100
<![CDATA[Making Argentina's Debt Debacle a Rarity]]> http://www.bruegel.org/nc/blog/detail/article/1453-making-argentinas-debt-debacle-a-rarity/ blog1453

After defaulting on its debt in January 2002, the Argentine government wore down its bondholders into accepting a 75 percent reduction on their claims. Among the few who refused the deal, Elliot Management Corporation aggressively pursued its legal rights for full repayment.

United States courts—having confirmed Elliot’s claims under U.S. law—have also blocked payment to the other bondholders unless Elliot is paid. This has led Argentina back into default.

While almost no one has sympathy for the rogue Argentine government, U.S. courts have been criticized for undermining global financial stability. Elliott vs Argentina may have severely narrowed the options for reducing the debt obligations of distressed sovereigns. Official international institutions will need to provide greater financial support, stretching their resources.   

Criticism of U.S. courts is not warranted. They were only interpreting and enforcing a contract, not trying to promote international public policy. Sovereign debt contracts have an inherent contradiction. The contract creates a firm commitment to timely repayments but renegotiation requires that the contract not be so firm after all.

For this reason, sovereign debt restructuring has had inevitable legal and financial uncertainties, making the process messy and fractious. Policy makers have therefore been inclined to delay the default decision, as recently was the case in Greece. The delays have increased the eventual cost of the default and created huge inequity in the eventual arbitrary imposition of losses.

But all proposals for resolving the built-in conundrum of sovereign debt continue to fiddle on the margins. The latest by the International Capital Market Association (ICMA) involves writing a complex set of covenants, which will remain subject to interpretation and challenge.

A durable and predictable system requires that the possibility of change in repayment terms must be built into the contract rather than being the outcome of renegotiation.

The economic basis for this radical change is compelling. As many—among them Nobel Laureate, Christopher Sims—have pointed out, the phrase “sovereign debt” is a misnomer. The value of equity held in a private company falls when economic conditions deteriorate. Sovereigns need similar, contractually-transparent leeway to deal with the inevitable adversities. In such eventualities, forgiving some part of the debt makes sense even from the creditor’s perspective because that makes it more likely that the rest of the debt will be repaid. That is why bondholders eventually do renegotiate. But, because they can gain by holding out for full repayment, especially when others are likely to do so, the process is chaotic.

Here is how a more flexible sovereign debt contract may work. The debtor would have the option to defer repayment when, say, the 100-day average risk premium on its debt (the excess interest rate above US treasuries or German bunds) rises above a pre-agreed threshold. Thus repayment obligations would be automatically and predictably eased to handle contingencies, avoiding the angst associated with renegotiating the contract. Such contingent sovereign contracts (“cocos”) would be similar to those in increasing use by banks.

The built-in risk of payment standstill in the cocos would require that the sovereign debtors pay higher risk premia, which would be a prime benefit, not a flaw. The pressure would be to reduce public debt ratios and practice greater fiscal discipline. The present system generates unreasonably low premia on the sacrosanct “sovereign debt” because of the implicit but unreasonable reassurance of full repayment in those contracts. The consequence is that governments pay higher premia on their other obligations—or worse, payment obligations proliferate under the illusion of low premia, creating an unsustainable burden. When eventually all payments cannot be made, losses are imposed on such vulnerable groups as pension holders while well-heeled bondholders pay no, or a small, penalty.

The cocos would also eliminate the endemic incentives to delay restructuring. Under the current system delays occur, in part, because the threshold at which debt restructuring should occur is fuzzy. That fuzziness is compounded by prolonged and uncertain negotiations, which elevates the further risk of contagion to other sovereigns. For these reasons, international financial institutions are inclined to legitimize the delays with optimistic forecasts. The theme always is: restructuring is a good idea, but not in the midst of this crisis. The eventual restructuring imposes higher costs on all.

Sovereign cocos will prevent delays by pre-specifying the threshold at which a payments’ standstill can be initiated by the debtor. The standstill would need to be triggered well before insolvency is imminent and, hence, the likelihood of a return to normalcy is high. Economists Charles Calomiris and Richard Herring have made a similar observation for cocos issued by banks. Thus, the process would be incremental and automatic instead of arbitrary and spasmodic.

For example if a risk premium threshold of, say, 5 percent had been in place, Ireland, Portugal, and Spain could have initiated standstills and hence required less fiscal austerity, with reduced hardship on the most vulnerable and a more rapid return to growth. Creditors would have waited but would have eventually benefited by lending to more robust debtors. The sovereigns would have paid a penalty via higher risk premia for their new borrowing and, hence, would have been subject to the more reliable market vigilance rather than being guided by the illogical and fractious centralized system based in Brussels. Perhaps, the European Central Bank’s legally and politically fragile Outright Monetary Transactions would have been unnecessary.

With cocos, it would be in the sovereign’s interest to prevent the risk premium from reaching the threshold and, once reached, to restrain from exercising the option. If the threshold is reached often and standstill triggered, the terms of future access to the market will worsen. Official financial agencies called on to help if standstills persist will also have an incentive for credible monitoring rather than indulging in serially optimistic forecasts.   

Today, the elevation of the sovereign bondholder to a privileged creditor reflects a self-serving mystique fostered by financial lobbies and policy elites. As such, undoing the system will meet more than the usual resistance. However, the technical challenges of introducing sovereign cocos are no greater than that of the ICMA proposal. In fact, cocos are much simpler in design. The novelty of cocos will make the pricing initially more difficult, but will lead ultimately to greater public and private benefit.

The eurozone nations will gain much-needed flexibility in their rigid macro management apparatus by fostering a critical mass of cocos. While the existing overhang of eurozone debt cannot be so resolved, the further tendency to over accumulate debt can be curbed and a more mature future relationship with creditors can be established.

No contract is perfect. The current system, however, generates egregious outcomes. And all the so-called reform proposals retain the traditional implicit guarantees of repayment along with the contractual uncertainties and incentives to delay restructuring. In contrast, sovereign cocos would induce more realistic pricing of debt and help reduce public debt ratios. By automatically triggering a standstill, cocos would diminish the likelihood of reaching the point of no return. Paradoxically, the greater flexibility of cocos will create more predictability—and, hence, greater efficiency and equity.



Tue, 07 Oct 2014 16:15:03 +0100
<![CDATA[A compelling case for Chinese monetary easing]]> http://www.bruegel.org/nc/blog/detail/article/1452-a-compelling-case-for-chinese-monetary-easing/ blog1452

A successful Chinese economy needs both structural reforms on the supply side, and a nimble monetary policy on the demand side

Despite unmistakable signs of messy but meaningful monetary easing since last May, a puzzling debate is still raging over whether China should persist with painful but eventually rewarding economic reform or ease monetary policy to stabilise short-term growth. The puzzling question is why one should have to make a stark choice between them instead of sensibly combining the two. In my view, a successful Chinese economy needs both structural reforms on the supply side to enhance potential growth, and a nimble monetary policy to fully exploit such potential on the demand side. I discuss below six reasons why China ought to ease its monetary policy stance.

This policy debate is everywhere in the Chinese media, with the two most powerful Chinese official news agencies China Xinhau News and People’s Daily pitching two opposing views. Against a broad background of a slowing economy, low inflation and increased financial stress in China, the contrast between the two competing camps is crystal clear.

One camp believes that monetary accommodation hampers economic reforms, worsens the imbalances in the Chinese economy and simply promotes unsustainable short-term pseudo-growth at the expense of sustainable long-term development. This camp's main arguments appear to be that economic reforms and structural adjustments are necessarily painful and that the recent slowdown is mainly structural and healthy. Thus monetary easing is not only a show of no confidence in economic reform but also an attempt to sabotage economic reform — a scary accusation in China nowadays.

The opposite camp thinks that sensible monetary easing complements economic reforms, supports growth, facilitates structural adjustments and mitigates financial risks. Reform is not a sacred cow but a means to improve living standards for the majority of the Chinese population. Cyclically or structurally, there a very strong case for timely and measured monetary accommodation as risk management. The Chinese economy is unbalanced, but one doesn’t need to strangle it in order to rebalance it. Indeed, quite the contrary.

This ongoing controversy in China looks odd and even a bit funny, especially viewed through the lens of the US, the euro area and Japan, where the consensus view is that both aggressive demand support policy measures and strong structural reforms on the supply side should go hand-in-hand. And why not?

A similar case can also be made for China, in my view.

First, in the wake of the global financial crisis, the Chinese central bank (PBC) has unquestionably tightened the most relative to the big four central banks of the US Fed, European Central Bank, Bank of Japan and Bank of England. In other words, the PBC has been quite restrained, while the other big four central banks have pursued aggressive monetary accommodation. There is little doubt that the relatively tight Chinese monetary policy has considerably redistributed global demand away from domestic to foreign products. Thus to loosen its relatively tight monetary policy, China ought to ease.

Second, China’s financial conditions have also tightened the most since the global financial crisis among the big five economies of the US, euro area, Japan, the UK and. The financial condition indices here are a weighted sum of short and long-term interest rates, exchange rate and stock market indices. The tighter Chinese financial conditions could in part be policy-induced and in part relate to other institutional and fundamental changes in the Chinese economy, potentially contributing to slower economic growth. In any case, as an insurance policy, China ought to ease.

Third, the famed Taylor rule suggests that Chinese monetary policy was too tight before its latest easing. China undershoots it inflation target. Whether the economic slowdown is structural or cyclical, the equilibrium real interest rate should decline, but instead actual real rates have been rising for quite a while, as can be seen from the higher and more volatile real long-term Chinese government bond yields. Although the Taylor rule is silent on the weight attached to financial stability, the recent increased financial stress, as witnessed by increasing shares of non-performing loans and more debt defaults, intuitively calls for a more accommodative monetary policy to assist the risky deleveraging process. Sticking to a tight policy in the face of increased financial fragility makes little sense. Thus in light of growth, inflation and financial stability, China ought to ease.

Fourth, monetary policy measures need to be taken early in order to counter the headwinds that the Chinese economy faces, because it would typically take 2 to 4 quarters for a change in policy stance to have an effect on the real economy. Indeed, timely policy response is the best way to avoid excessive monetary stimulus. The market tends to underappreciate the fact that the mind-boggling credit binge in 2008, mostly related to local government borrowing, was in part a sad response to the already emerging panic partially triggered by the decisively late monetary policy actions at that time. So China ought to ease in a timely way.

Fifth, monetary policy should take the lead before fiscal policy turns more expansionary. The fiscal automatic stabilisers have already kicked in, as witnessed by a marked slowdown in Chinese tax revenues. When needed, discretionary fiscal policy actions can also affect the economy faster and more directly in China’s case. The experiences of the global financial crisis inform us that it is vital for China to preserve its capacity for future fiscal interventions, which could be much needed in times of crisis. Therefore, to maintain a strong fiscal position, China ought to ease monetary policy.

Finally, an accommodative monetary policy and neutral fiscal policy can combine to best promote fuller exchange rate flexibility of the Chinese renminbi, especially against a global background of near zero interest rates at major central banks. A standard Fleming-Mundell model would inform us that as the renminbi gains greater flexibility, a Chinese mix of tight monetary policy and expansionary fiscal policy could be tantamount to suicide. Both policy stances entice further capital inflows and/or add to currency strength in today’s global environment. To facilitate both growth and currency flexibility at the same time, China ought to ease monetary policy.

The latest monetary easing by the PBC is well justified

Conclusion: the latest monetary easing by the PBC is well justified – and still more can be done.

Of course, controversy remains. One issue is the evolving Chinese potential growth rate, which itself is unobservable and in part cyclical. Various arguments and estimates can be put forward to justify a case or no case for monetary easing. While this policy debate is mostly healthy, I also find it disturbing, as those arguing for monetary easing have often been labelled by some of their opponents as the vested interests hostile to economic reforms and resistant to structural adjustments. My best advice to those who do the labelling: come down from your high horse, please.



Tue, 07 Oct 2014 15:58:47 +0100
<![CDATA[The euro area: an unbalanced rebalancing?]]> http://www.bruegel.org/nc/events/event-detail/event/465-the-euro-area-an-unbalanced-rebalancing/ even465

This event will feature a presentation by Mahmood Pradhan and Petya Koeva Brooks based on the recently published IMF World Economic Outlook and other IMF research into Euro area external rebalancing. The presentation will be followed by comments by Philippe Weil and an open discussion chaired by Guntram Wolff.

Since the global financial crisis, external imbalances have declined, both globally and within the euro area. However, within the euro area, the rebalancing has been highly asymmetric. While most debtor countries, such as Greece, Ireland, and Spain, have seen substantial current account improvements, this partly reflects cyclical factors and stock imbalances remain large. At the same time, creditor countries, such as Germany and the Netherlands, have maintained very large and persistent surpluses, partly reflecting weak domestic demand. The presentation will analyze the factors that are holding back a more balanced recovery, and set out a policy agenda to support sustainable growth in the euro area and contribute to global rebalancing.


  • Mahmood Pradhan, Deputy Director of the IMF’s European Department,
  • Petya Koeva Brooks, Assistant Director of the IMF’s European Department
  • Philippe Weil, Professor of Economics, Université libre de Bruxelles
  • Chair: Guntram Wolff, Director of Bruegel

Event materials

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Wednesday 22 October 2014, 12.30-14.00. Lunch will be served ahead of the event at 12.30 after which the event will begin at 12.45.
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Tue, 07 Oct 2014 11:50:52 +0100
<![CDATA[Whose is Russia’s external debt?]]> http://www.bruegel.org/nc/blog/detail/article/1451-whose-is-russias-external-debt/ blog1451

Note: for Banks, “loans” includes also debt liabilities to direct investors and to direct investment enterprises

Data from the Central Bank of Russia show that, as of 1st Quarter of 2014, 90% of the country’s external debt was attributable to banks and other sectors, whereas government debt accounted for about 7.5% of the total. However, given that publicly-owned banks and companies are not singled out in this data, the actual government share is most likely higher. For both banks and other sectors’ external debt, loans and liabilities to direct investors are the biggest component.

And when is this debt coming due?

54% of Russia’s external debt has maturity of over two years (unspecified); 10% is between 1 and 2 years whereas about 23% has maturity of 1 year or less. For part of the external debt, the schedule is not available or inexistent (debt without schedule). Of that part of debt that is coming due within 1 year, the biggest redemptions will be in December 2014 - with 32 USD billions of banks and other sectors’ debt coming due - and Q5-2015, with 28 billion.

Tue, 07 Oct 2014 07:30:06 +0100
<![CDATA[Remerge: regression-based record linkage with an application to PATSTAT]]> http://www.bruegel.org/publications/publication-detail/publication/852-remerge-regression-based-record-linkage-with-an-application-to-patstat/ publ852

We further extend the information content in PATSTAT by linking it to Amadeus, a large database of companies that includes financial information. Patent microdata is now linked to financial performance data.

Source code on Github.

Download data.

Remerge: regression-based record linkage with an application to PATSTAT (English)
Tue, 07 Oct 2014 07:14:37 +0100
<![CDATA[A scaleable approach to emissions-innovation record linkage]]> http://www.bruegel.org/publications/publication-detail/publication/851-a-scaleable-approach-to-emissions-innovation-record-linkage/ publ851

PATSTAT has patent applications as its focus. This means it lacks information on the applicants and/or the inventors. In order to have more information on the applicants, we link PATSTAT to the CITL database. This way the patenting behavior can be linked to climate policy. Because of the structure of the data, we can adapt the de-duplication algorithm to use it as a matching tool, retaining all of its advantages.

Source code on Github.

Download data.

A scaleable approach to emissions-innovation record linkage (English)
Tue, 07 Oct 2014 07:12:05 +0100
<![CDATA[A flexible, scaleable approach to the international patent 'name game']]> http://www.bruegel.org/publications/publication-detail/publication/850-a-flexible-scaleable-approach-to-the-international-patent-name-game/ publ850

The inventors in PATSTAT are often duplicates: the same person or company may be split into multiple entries in PATSTAT, each associated to different patents. In this paper, we address this problem with an algorithm that efficiently de-duplicates the data. It needs minimal manual input and works well even on consumer-grade computers. Comparisons between entries are not limited to their names, and thus this algorithm is an improvement over earlier ones that required extensive manual work or overly cautious clean-up of the names.

Source code on Github.

Download data.

A flexible, scaleable approach to the international patent 'name game' (English)
Tue, 07 Oct 2014 07:08:22 +0100
<![CDATA[The Fed and the Secular Stagnation hypothesis]]> http://www.bruegel.org/nc/blog/detail/article/1450-the-fed-and-the-secular-stagnation-hypothesis/ blog1450

What’s at stake: Larry Summers made a big splash in late 2013 when he re-introduced the secular stagnation hypothesis to explain the disappointing recovery from the Great Recession. Experts have since debated whether we should worry about systemic saving-investment mismatches and what to do about them. But the extent to which monetary policymakers have already revised their views about the long-run equilibrium interest rate has remained quite unnoticed so far.

The new secular stagnation hypothesis

Barry Eichengreen writes that the idea that America and the other advanced economies might be suffering from more than the hangover from a financial crisis resonated with many observers. Coen Teulings and Richard Baldwin write that this ill-defined sense that something had changed was given a name when Larry Summers re-introduced the term ‘secular stagnation’ in late 2013.

Secular stagnation usually refers to a situation in which saving can only equal investment at a negative real interest rate

Juan F. Jimeno, Frank Smets and Jonathan Yiangou write that secular stagnation usually refers to a situation in which saving can only equal investment at a negative real interest rate – an equilibrium that cannot be achieved because of the zero lower bound (ZLB) constraint on interest rates and low inflation. Laurence Summers writes that the ‘new secular stagnation hypothesis’ responds to recent experience and the manifest inadequacy of conventional formulations by raising the possibility that it may be impossible for an economy to achieve full employment, satisfactory growth, and financial stability simultaneously simply through the operation of conventional monetary policy.

Secular stagnation and the pace of policy normalization

David Beckworth writes that the FOMC projections that are available show a pronounced downward trend in the "longer run" forecast of the federal funds rate. Alex Rosenberg writes that when it comes to what the markets ultimately care about in the short term—Fed policy—there's one thing nearly everyone can agree on: fresh concerns about secular stagnation are likely to make the Fed even more nervous about reducing accommodation too soon.

During the latest FOMC press conference, Steven Beckner pointed out that the Summary of Economic Projections assessments of appropriate funds rate levels show the funds rate getting up to that 3.75 percent normal level at the end of 2017. If you look at the SEP projections of unemployment, inflation, and so forth, they seem to get back to those mandate-consistent levels by the end of 2016, if not much sooner. So what is the justification for waiting that much longer to get back to normal?

In her response, Janet Yellen said that the story is […] not that the Fed is behind the curve in failing to return the funds rate to normal levels when the economy is recovered. It is rather that, in order to achieve such a recovery in 2016 or by the end, that it’s necessary and appropriate to have a somewhat more accommodative policy than would be normal in the absence of [several] headwinds. [A] common view on this is that there have been a variety of headwinds resulting from the crisis that have slowed growth, led to a sluggish recovery from the crisis, and that these headwinds will dissipate only slowly.

How to model secular stagnation?

Paul Krugman writes that if you look at the extensive theoretical literature on the zero lower bound since Japan became a source of concern in the 1990s, you find that just about all of it treats liquidity trap conditions as the result of a temporary shock.

Something – most obviously, a burst bubble or deleveraging after a credit boom – leads to a period of very low demand, so low that even zero interest rates aren’t enough to restore full employment

Something – most obviously, a burst bubble or deleveraging after a credit boom – leads to a period of very low demand, so low that even zero interest rates aren’t enough to restore full employment. Eventually, however, the shock will end. The idea that the liquidity trap is temporary has shaped the analysis of both monetary and fiscal policy.

Simon Wren-Lewis writes that a basic idea behind secular stagnation is that the natural real rate of interest might become negative for a prolonged period of time. A simple way to model this would be to allow the steady state real interest rate to become negative. But that cannot happen in basic representative agent models since the steady state real interest rate is pinned down by the discount factor of the representative agent.

Gauti Eggertsson and Neil Mehrotra write that in representative agent models the natural rate of interest can only temporarily deviate from this fixed state of affairs due to preference shocks or some similar alternatives. Changing the discount rate permanently (or assuming a permanent preference shock) is of no help, since this leads the intertemporal budget constraint of the representative household to ‘blow up’ and the maximization problem of the household to no longer be well defined. Moving away from a representative savers framework to one in which households transition from borrowing to saving over their lifecycle can, however, open up the possibility of secular stagnation. The key here is that households shift from borrowing to saving over their lifecycle. If a borrower takes on less debt today (due to the deleveraging shock), then tomorrow he has greater savings capacity since he has less debt to repay. This implies that deleveraging will reduce the real rate even further by increasing the supply of savings in the future.

Mon, 06 Oct 2014 07:01:03 +0100
<![CDATA[Austerity Tales: the Netherlands and Italy]]> http://www.bruegel.org/nc/blog/detail/article/1449-austerity-tales-the-netherlands-and-italy/ blog1449

In 2008 and early-2009, most euro area countries joined in an internationally-coordinated stimulus of the global economy to ward off the menacing crisis. But by late-2009, especially after the Greek fiscal hole was revealed in October, the focus shifted to reducing public debt. This shift was encouraged by the global economy’s brief display of economic strength in 2010, which lulled policymakers everywhere into believing that the crisis was largely over. Since then, the euro area countries have single-mindedly pursued the objective of debt reduction.

There was reason to be concerned about the rapid increase in euro area public debt. But the policy pursued had serious unforeseen consequences. This article documents the unusually severe and persistent austerity, which has yet to make a dent in the debt burdens but has slowed growth and created deflationary tendencies. The emerging link between frustrated debt reduction efforts and deflation in the most stressed economies is particularly worrisome. Specifically, we find:

Because austerity caused growth rates to fall, public debt ratios today are much higher than in 2010 and private debt ratios are no lower

  • Even making allowance for their high public debt-to-GDP ratios, euro area countries adopted significantly greater austerity than on average in other advanced economies.
  • The austerity response within the euro area was remarkably similar across countries: Netherlands (with a relatively low public debt ratio) and Italy (with a high ratio) responded with equal aggressiveness.
  • Because austerity caused growth rates to fall, public debt ratios today are much higher than in 2010 and private debt ratios are no lower.
  • Public debt ratios have not only increased but they have exceeded forecasts. The higher-than-projected debt ratios have gone hand-in-hand with lower-than-projected inflation, highlighting the operation of a country-specific debt-deflation cycle. As an incomplete monetary union, the eurozone has no tools to deal with such country-specific pathologies.

Even within the eurozone’s operational constraints, the outcomes could have been better. Our findings reflect the balance in the deployment of macroeconomic management tools. In the euro area, the most proactive tool for addressing the crisis was fiscal policy pursued under the framework of the Stability and Growth Pact (the SGP). The unwavering commitment to fiscal austerity—despite its adverse growth consequences—arose from a “wait-and-watch” approach in the use of other macroeconomic policy instruments. Unlike their counterparts in the United States and the United Kingdom, the euro area authorities have remained unwilling to use monetary policy aggressively to provide economic stimulus—indeed, interest rates were raised at moments of critical weakness. And there has been only token effort—restricted to the most egregious cases—in dealing with unviable banks. Moreover, the euro area does not have well-developed systems to address household and personal financial distress (Claeys, Darvas and Wolff, 2014).  Thus, despite occasional calls to make it more “flexible,” the traditional SGP emphasis on the perceived vulnerability arising from high public debt and the emphasis on deficit reduction have had long-lasting, possibly irreversible, effects.

Measuring Austerity

The crisis caused public debt ratios to rise sharply in much of the advanced world, and especially in the euro area (Figure 1). Hence, fiscal austerity to lower these ratios seemed prudent.

Because tax receipts fall and government expenditures for social safety nets rise, the fiscal balance decreases (equivalently, the fiscal deficit increases) when output falls below the economy’s potential. For this reason, the traditional measure of austerity is the increase in the structural fiscal balance, which is the improvement in the balance after making allowance for the shortfall due to the recessionary conditions.

The degree to which the primary budget surplus is increased (equivalently, the primary deficit is decreased) relative to the public debt ratio is a measure of the fiscal austerity that allows for the objective of lowering the debt-to-GDP ratio

But the change in the structural balance may also inappropriate when comparing two countries with very different debt ratios. A country with a higher debt ratio may be more concerned with the risk that the debt ratio may become unsustainable (spiral out of control). Debt sustainability requires that a rise in the public debt-to-GDP ratio be countered by an improvement in the primary budget balance (the balance that does not include interest expenses).  The degree to which the primary budget surplus is increased (equivalently, the primary deficit is decreased) relative to the public debt ratio is a measure of the fiscal austerity that allows for the objective of lowering the debt-to-GDP ratio (Bohn, 1998).

In determining the relationship between the primary balance and the public debt-to-GDP ratio, it is necessary to control for the economy’s position relative to its potential. For, as noted above, if output is below potential, revenues will be depressed and income transfer and unemployment support payments will be elevated, depressing the primary balance. This procedure leads to the following equation, so-called “solvency equation:"

Where PBi,t is the primary balance, Di,i-1 is the (lagged) gross debt over GDP, Ÿi,t is the output gap. A higher β1—the metric of austerity—implies a stronger response to the debt ratio. The term c1 controls for country characteristics that do not change over time and εi,t is error term representing unmeasured variables.

Austerity in and outside the Euro Area

Regression results are reported in Table 1. A positive β1, the coefficient on the debt-to-GDP ratio, indicates that the rise in primary surplus in response to public debt will eventually achieve debt sustainability. A larger coefficient implies greater deference to the debt reduction objective.

Notes: The dependent variable is primary fiscal balance/GDP; t-statistics in brackets; *** p<0.01, ** p<0.05, * p<0.1. The data point for primary balance in 2010 in Ireland is dropped from regression (2) (2008-13), as that country had to deal with an extraordinarily high deficit (-27.2) due to banks bailouts.

A finer view of the time variation in the responsiveness to debt, β1, is reported in Figure 2, which reports the coefficient on debt for each five-year period ending in that year.

Note: The rolling regressions are estimated as in Table 1, and the coefficient on debt-to-GDP ratio is for the year in which the five-year sample ends.

Before the crisis (2003-2007), the countries in the euro area increased their primary balance by about 0.06 percent of GDP for a 1 percent increase in their public debt ratios. There was no notable difference between the euro and non-euro countries during this period. During the years 2009 and 2010, the world was preoccupied a coordinated fiscal stimulus to stave off another Great Depression (Eichengreen and O’Rourke, 2012), and (quite rightly) the concern with public debt diminished. However, that concern reemerged soon thereafter and vigorously so in the euro area.

For the five-year period ending in 2013 (which includes the stimulus years), the rise in euro area primary balance was about 0.15 percent of GDP for a one-percent increase in the public debt-to-GDP ratio

For the five-year period ending in 2013 (which includes the stimulus years),  Table 1 and Figure 2 show that the rise in euro area primary balance was about 0.15 percent of GDP for a one-percent increase in the public debt-to-GDP ratio. As the stimulus years are left behind, the preoccupation with debt is more starkly evident, and the coefficient on debt reached 0.20 in the five-year period ending in 2014. The concern with rising debt ratios also increased in other advanced economies, but to a much lower degree and with less persistence.

The Netherlands and Italy

In Figure 3, we ask if the responsiveness of the primary balance to public debt was similar across the euro area countries. The finding is represented in a so-called “partial plot,” the relationship between the primary balance and public debt, controlling for the output gap, for the period 2008-2013, as in Table 1. The figure is normalized so that the mean debt-to-GDP ratio for each country is zero. The dots mark the different member states in the different years, and show that the countries behaved more-or-less similarly around their mean debt ratios.

Note: Based on Table 1, column 2. The axes values are deviations from the country mean and are expressed as percentage of GDP.

We focus on the Netherlands, where the public debt-to-GDP ratio in 2009 was 61 percent of GDP and Italy, where it was 116 percent of GDP.  The lines connecting the dots for Italy (blue) and the Netherlands (red) tell us that, around their respective mean debt ratios, both countries displayed the same tendency to increase their primary balances in response to their rising debt ratios. This is also true if the same picture is examined for later years.

While fiscal austerity does reduce debt over a period of time, it has an almost immediate impact on reducing growth

But while fiscal austerity does reduce debt over a period of time, it has an almost immediate impact on reducing growth. Blanchard and Leigh (2013) have proposed a method to assess the growth impact of austerity. If a country’s GDP fell “unexpectedly” below its forecast, they suggest that a likely cause was an underestimation of the “fiscal multiplier”—the extent to which austerity hurts growth. Their paper reports extensive robustness tests to test for biases due to omitted variables and influential observations (and the spirit of their findings has been confirmed by several scholarly studies). They find that in the period 2010-2012, an extra 1 percent of GDP fiscal consolidation was correlated with between a 0.6 and 1.0 percentage shortfall in growth relative to the forecast.

We do not undertake new analysis in this regard, but present a graphical version of the Blanchard-Leigh relationship in Figure 4. Over the years 2011 to 2013, the unexpected growth of a country is the actual growth minus the growth that was projected in the IMF’s April 2011 World Economic Outlook. The unexpected growth of several advanced economies is plotted against the fiscal consolidation over the same period. The negative relationship shows that greater consolidation (austerity) was associated with actual growth that was lower than projected.

Note: The average annual unexpected growth is calculated as the difference between the average annual realized growth between 2011 and 2013, as reported in the 2014 WEO data release, and the average annual expected growth projected for the same period in the April 2011 WEO data release.

The growth shortfall in Italy and the Netherlands bore about the same proportion to austerity as in Greece

Notice that in Figure 4 the Netherlands and Italy fall on the regression line, which extends to Greece. Italy and (more so) the Netherlands had lower debt-to-GDP ratios than did Greece, so they undertook less austerity. However, the growth shortfall in Italy and the Netherlands bore about the same proportion to austerity as in Greece.

Notice also that the United States and, to a lesser extent, the United Kingdom, are above the regression line, implying that austerity was less costly in terms of foregone output growth. It is likely that the more aggressive monetary policy in these two countries and the early efforts to restore banks to health created alternative avenues of growth. In the euro area, monetary policy remained stodgy (Mody, 2014) and bank restructuring and recapitalization was delayed (Reichlin, 2014).

1 Recent revisions of the Italian data have lowered the entire trajectory of the Italian debt ratio by about 5 percentage points.

Because austerity in the euro area caused growth to slow, the debt ratios continued to rise—and faster than the projected. Figure 5 reports the time paths of debt ratios for the Netherlands and Italy, as seen in April 2011 (blue line) and April 2014 (red line). As austerity was stepped up in 2011, the projection was for debt ratios to stabilize. However, the ratios continued to rise. The debt ratio for the Netherlands now appears to be stabilizing, but that for Italy is unlikely to start falling as projected.1

Note: Dashed lines refer to projections at the time.

In sum, we see a consistent pattern of fiscal austerity, slower than expected growth, and higher than expected debt ratios.

Where do we stand?     

Today, the Netherlands has to deal with a more serious public debt problem than in 2011 and with an undiminished private debt burden

For the Netherlands, the austerity was gratuitous. At its relatively low level of public debt ratio, the Netherlands could have afforded fiscal stimulus. GDP growth would have been higher and, it is possible, that the public debt ratio may have been lower. In the Netherlands, the costs of austerity were especially high because the private debt burden was substantial (since households had borrowed extensively to buy homes). In such a circumstance, a more stimulative fiscal policy is particularly desirable since the increased incomes help to pay down debt, which in turn opens the space for further spending and economic growth. Today, the Netherlands has to deal with a more serious public debt problem than in 2011 and with an undiminished private debt burden. Together, these will continue to dampen growth as the necessary deleveraging occurs over time.

The Netherlands example has a more general echo through the euro area: even as the public debt ratios rose while fiscal austerity was pursued, the private debt burdens did not fall (Figure 6a). In contrast, household debt ratios fell across virtually every state in the United States (Figure 6b) While U.S. commentators have been critical of the insufficient policy effort to alleviate mortgage-related distress (see Mian and Sufi, 2014), the extent of such efforts was substantially greater than in the euro area.

Today, the Italian debt ratio has just crossed 135 percent of GDP, and the warning applies with greater force

In Italy, with its high debt ratio, the options were more limited and more painful. In 2010, an IMF paper argued that the Italian debt ratio of over 120 percent of GDP had become unsustainable for practical purposes (Ostry et al, 2010). While the debt could, in principle, be reduced through fiscal consolidation, the authors warned that the austerity needed was so large even by Italian historical norms that it would be politically unacceptable. Today, the Italian debt ratio has just crossed 135 percent of GDP, and the warning applies with greater force.

The euro area authorities have ruled out the restructuring of public debt, except if a Greek-like situation repeats itself. Their concern is that restructuring would cause widespread contagion and damage to the European (and global) economies and financial systems. Thus, the strategy is to persevere with austerity. The projections of reduced debt ratios starting in 2015 rely overwhelmingly on the continuation of historically severe levels of austerity. The risk is that the primary surpluses will not materialize, growth will be compromised, and the debt ratios will continue to rise (see Darvas, 2013).

Debt and Deflation

Finally, we examine the relationship between debt and deflation. Figure 7 is a plot of the unexpected rise in debt-to-GDP ratio in the latest 2014 estimates versus those projected in 2011 against the unexpected fall in inflation over the same period. Notice that in virtually every country the debt ratio was higher than projected and inflation was lower. Moreover, these two errors are strongly correlated. A clear negative correlation emerges: higher levels of unexpected debt correspond to higher deflation. Once again, both Italy and The Netherlands fall along the regression line. The implication is that fiscal austerity had had far reaching unforeseen consequences: not only was growth lower (as described in Figure 4 above), but debt was higher, and the prospect of deflation was not even considered.

Note: The unexpected inflation is calculated as the difference between the realized inflation in 2014, as reported in the 2014 WEO data release, and the projected inflation for 2014, as reported in the 2011 WEO data release. The unexpected debt-to-GDP ratio is computed similarly. If Cyprus is included, the relationship is even stronger.

The importance of this finding is that the deflationary tendencies in the euro area are neither uniform nor randomly distributed. Rather, they are associated with the rise in debt: as debt has risen, the policy of austerity has thus far failed to rein in the desired increase, but it has weakened demand and, hence, reduced inflation rates. The latest data suggest that prices are actually falling in some of the high debt countries. And, since the cycle of higher debt and lower prices will not correct itself, a strong stimulatory policy with a country-specific focus will be needed.


A policy of more modest austerity everywhere in the eurozone, with active stimulus in a few countries, would have paid dividends

A policy of more modest austerity everywhere in the eurozone, with active stimulus in a few countries, would have paid dividends. Such an approach would have created a more stimulative overall fiscal policy stance throughout the euro and would have been particularly beneficial since European economies trade so much with each other (Figure 8): the boost to domestic demand would have been amplified through trade. The growth performance throughout the euro area would have been superior, which would have helped debt reduction with less austerity.

Instead, simultaneous austerity caused a drag on all countries. For the Netherlands, there was no trade-off: less austerity would have been unambiguously better. For Italy, an early effort to engineer a restructuring of public debt, while a controversial decision, would have allowed more space to lower the burden of austerity and create the conditions for stronger growth. Foregoing this choice would be particularly unfortunate if debt restructuring is eventually rendered inevitable.

Austerity might be driving the eurozone into a debt-deflation cycle, as higher debt and deflation feed off each other

The damage may not be over. Austerity might be driving the eurozone into a debt-deflation cycle, as higher debt and deflation feed off each other. Earlier this year, the ECB viewed the dip in inflation as temporary (Mody, 2014). Even now, ECB officials regard deflation to be unlikely. And the safeguards that they are glacially moving towards take a eurozone-wide view rather than differentiating across countries. Yet, the analysis in this article warns that the deflation is likely to be a country-specific phenomenon, requiring counter measures at the country level. The eurozone, by its construction, has no instruments to deal with a country debt-deflation threat.

We are very grateful to Ajai Chopra, Zsolt Darvas and Guntram Wolff for their helpful comments.



Blanchard, O.J., 2013, “Growth forecast errors and fiscal multipliers,” National Bureau of Economic Research Working Paper 18779.

Bohn, H., 1998, “The behavior of US public debt and deficits,” Quarterly journal of economics, 949-963.

Claeys, G., Darvas, Z., & Wolff, G. B., 2014, “Benefits and drawbacks of European unemployment insurance,” Bruegel Policy Brief, Bruegel.

Darvas, Z., 2013, “The Euro Area’s tightrope walk – debt and competitiveness in Italy and Spain,” Policy Contribution, Bruegel.

Eichengreen, B. and O’Rourke, K. H. (2009). A tale of two depressions.  VoxEu

Mian, A., & Sufi, A., 2014, “House of Debt,” Chicago: The University of Chicago Press.

Mody, A., 2014, “The ECB is much too stodgy.”

Ostry, J. D., et al., 2010, “Fiscal space,” International Monetary Fund, Research Department.

Reichlin, L., 2014, “Monetary policy and banks in the Euro Area: the tale of two crises,” Journal of Macroeconomics, 39, 387-400.

Fri, 03 Oct 2014 09:27:06 +0100
<![CDATA[The ECB’s ABC of ABS is missing a few letters]]> http://www.bruegel.org/nc/blog/detail/article/1448-the-ecbs-abc-of-abs-is-missing-a-few-letters/ blog1448

After the ECB last month announced a programme of private sector assets purchases, all eyes were directed at Frankfurt yesterday. As expected, the ECB unveiled further details of its new ABS and covered bond purchase programmes, revealing that important issues remain unresolved (while others may soon become thorny).

Draghi was rather vague about whether the TLTRO and ABS programme are mutually reinforcing or rather conflicting with each other in banks’ eyes

There was still no figure quoted for the programme. Draghi reiterated his September point saying that it is hard to give a figure because there are several interactions between ABS purchases, Covered Bond purchases and the TLTRO. He insisted that the overall impact should be such as to bring the ECB’s balance sheet back to the size it had at the beginning of 2012. Draghi was rather vague about whether the TLTRO and ABS programme are mutually reinforcing or rather conflicting with each other in banks’ eyes (something I previously addressed here).

Further measures are not ruled out. At the eve of the meeting, pressure had been mounting for the ECB to “do more” on the back of weak data. Perhaps in the attempt to counteract the scepticism that seemed to be growing after the disappointment of the first TLTRO auction, Draghi spelled out somewhat more clearly than usual that “despite the measures already taken, the Governing Council still stands ready to take additional measures”. This – by now, usual – statement, is hardly an indication that a full QE should be expected in a near future, considering how much reputational capital the ECB has put at stake in marketing the TLTRO and ABS programmes over the past months.

Details on the ABS and Covered bond programme (CBPP3) were unveiled. In both cases, purchases will be conducted in both primary and secondary markets, as it was the case for the two previous CBPP.

The third Covered Bond Programme (CBPP3) differs significantly from the two previous waves (2009 and 2011), and the ECB has evidently tried to make it look more open-ended. No target amount was revealed on announcement; there is no eligibility requirement related to the issue volume of a covered bond (it needed to be 300 million during the second and no less than 100 million during the first programmes); there is no maximum residual maturity on covered bonds accepted and fully retained securities are eligible. Purchases of covered bonds will start in mid October 2014 that – as we already pointed out in a paper and a post – is a tricky timing. Banks will in fact have to deal with the aftermath of the ECB’s supervisory assessment – including but not limited to possible capital needs identified. The ECB’s involvement in the business of buying banks’ bonds could put the Central Bank in an uncomfortable position and raise questions of incompatibility with the supervisory function that is carried out by the same institution – although supposedly behind Chinese walls.

The eligibility criteria for guaranteed mezzanine tranches of ABSs – has not been disclosed yet. This most likely signals that ECB has not yet found the way around the opposition it faces on this politically (highly) sensitive point

Concerning the ABS Purchase Programme (ABSPP), the programme will last for at least 2 years and both senior and guaranteed mezzanine tranches of asset-backed securities (ABSs) will be purchased. This is something that ECB’s President Draghi has been strongly fighting for in recent weeks, but the most important detail – i.e. the eligibility criteria for guaranteed mezzanine tranches of ABSs – has not been disclosed yet. This most likely signals that ECB has not yet found the way around the opposition it faces on this politically (highly) sensitive point. The purchases of ABS will however not start until the fourth quarter of 2014.

One issue on which the ECB’s official position was much awaited was the credit rating of the instrument that the programme would be targeting. Last week, the FT had reported that the ECB would announce derogations from the rating criteria set for ABS in the collateral framework, in order to broaden the pool of targeted securities. At present, in fact, the minimum grade for marketable assets to be eligible as collateral in ECB’s lending operations is BBB-. Currently, ABS rating is strictly linked to the rating of the sovereign, often constrained by country ‘ceilings’. In the case of Greece and Cyprus, a strict application of this principle would rule out purchases of ABS issued in these countries.

The ECB confirmed today that the Eurosystem’s collateral framework will be the guiding principle for deciding the eligibility of assets to be bought under the ABSPP and the CBPP3, but there will be some adjustments.

Draghi clarified that the rules governing eligibility for the asset purchase programmes are inspired by the fact that:

1 The Eurosystem will apply an issue share limit of 70% per ISIN, except in the case of ABSs with underlying claims against non-financial private sector entities resident in Greece or Cyprus and not fulfilling the CQS3 rating requirement; for those ABSs, a corresponding limit of 30% per ISIN will be applied.

  1. Outright purchases differ from lending against collateral (because in the second case the asset is only temporarily pledged on the Central Bank’s balance sheet);
  2. The asset purchase programme is focused on lending to SME, so the ECB will not buy structured ABS;
  3. The general aim is to be “as inclusive as possible, but with prudence”.

In practice, the ECB’s view of “prudence” means that assets bought should be “risk equivalent”. This has two major implications. The first one is operative: while ABSs and covered bonds from Greece and Cyprus – which are currently not eligible as collateral for monetary policy operations – will be included, the Eurosystem will buy relatively fewer of them1.

The second implication is instead more philosophical. Answering to a specific question, Draghi hinted to the fact that derogation would require the country to be under a programme to be applicable. He actually did a little bit more than hinting at it, as he even came up with a catchy phrase such as “no programme, no purchase” (and this is how e.g. Reuters also reported it). In fairness, this sounded striking, because it would be hard to see the rationale of subjecting a country to a programme before implementing a monetary policy measure that would be explicitly targeted at private sector assets.

Draghi hinted to the fact that derogation would require the country to be under a programme to be applicable

The issue is in fact considerably more vague in the two technical documents issued by the ECB after the press conference. The ABSPP one for example states that “for ABSs with underlying claims against non-financial private sector entities resident in Greece or Cyprus […], a derogation […] will be applied for as long as the Eurosystem’s minimum credit quality threshold is not applied in the collateral eligibility requirements for marketable debt instruments issued or guaranteed by the Cypriot or Greek governments”. After their sovereign ratings were slashed to the lowest levels during the crisis, the ECB decided to suspend the usual minimum rating criteria for the programme countries, so as to allow banks in these countries to pledge government bonds as collateral (which would not have been possible otherwise). This is still the case for Greece and Cyprus, and the ECB seems to be saying that the derogation in ABSPP will be applied to them “for as long as” the minimum credit quality threshold is suspended. And when is the minimum credit quality threshold is suspended? The ECB itself decided in 2012 that this will be the case for all countries “eligible for Outright Monetary Transactions or under an EU-IMF programme”.

So, putting the pieces together in a slightly more linear way, it looks like the ECB will buy Greek and Cypriot securities derogating from rating requirements, for as long as the minimum credit threshold is suspended, and the minimum credit threshold will be Suspended for as long as the countries will be under a programme. While being overly convoluted, this does look significantly less strong than Draghi’s own language. The ECB will most certainly be asked to clarify what the correct interpretation is.

What would happen to these ABS after a country like Greece were to exit the programme, if their rating were not upgraded?

But more importantly, what would happen to these ABS after a country like Greece were to exit the programme, if their rating were not upgraded. Would they be offloaded? And if so, how would that be justified? This point is definitely too important – especially for a country like Greece that is approaching the end of the second programme and is surrounded by rumours about the opportunity of a third one – to be left lost in the translation of central bank jargon.

Fri, 03 Oct 2014 08:10:07 +0100
<![CDATA[Flash Cards for European Commissioner-designate Jonathan Hill]]> http://www.bruegel.org/nc/blog/detail/article/1447-flash-cards-for-european-commissioner-designate-jonathan-hill/ blog1447

The President-designate of the European Commission, Jean-Claude Juncker, has nominated Jonathan Hill, previously a UK government minister, as Commissioner-designate for Financial Stability, Financial Services and Capital Markets Union. The European Parliament has a veto on the eventual confirmation of the whole Commission, and has used this right in the past to request and obtain the replacement of individual candidates it deemed unfit. As part of the confirmation process, the Parliament’s Economic & Monetary Affairs Committee has quizzed Mr Hill on October 1, and decided to conduct a second hearing session next week. In preparation thereof, President of the European Parliament Martin Schulz has sent a list of questions to Mr Hill on October 2. The 23 questions in that list are copied below.

1 It should be noted that unlike Mr Hill, the author has no political affiliations or commitments. Therefore, these prepared answers for Mr Hill do not necessarily reflect the personal opinions of the author.

To enable Mr Hill’s overworked staff to enjoy a rare sunny weekend in Brussels, ready-made answers are suggested here. With due regard to the European Commission’s ever-stretched finances and to avoid any possible perception of conflict of interest, they are provided free of charge.1

  1. What is your vision of a well-regulated and integrated Capital Markets Union? How do you define the concept, what are its features and what are in your opinion the three most important elements to achieve a Capital Markets Union?

Well these are meaty questions, so I will make a bit of a longish answer. The concept of the Capital Markets Union is the fulfilment of the Treaty’s promise of a single market for financial capital in the EU. The single biggest obstacle to this vision was the fragmentation of the banking supervisory framework, a crucial one given that banking intermediation represents most of the EU’s financial system. Now that this obstacle is being lifted thanks to banking union, we need to go further in creating a single market for capital. Because London is the hub of the EU’s capital markets, this needs to encompass all EU member states in a way that was not as critical for banking union, as Commission President-designate Jean-Claude Juncker helpfully reminded me in my mission letter.

As with banking union, the features of the Capital Markets Union are about regulation, supervision, and crisis management. In regulation, I will seek to fulfil the Larosière Report’s vision of a single rulebook, taking into account the principles of subsidiarity and proportionality with regard to existing national rules that affect capital markets. In supervision, I will review which non-bank financial firms need to be supervised, and for those that need to, whether the national or European level is most appropriate. For example, credit rating agencies and trade repositories are – appropriately, in my view – supervised at the European level by the European Securities and Markets Authority (ESMA). I believe it is appropriate that small audit firms be supervised by national audit regulators, even though I am less sure about firms that belong to the larger international audit networks. Financial consultancies and the like are not supervised at all. I will also review crisis management and guarantee frameworks for those non-bank financial firms that may require a special resolution regime or any other form of intervention process other than court-ordered insolvency in case of failure. I am thinking particularly of financial market infrastructures here, and specifically about central counterparties (CCPs) for which I have promised a recovery and resolution framework in the answers I sent you a few days ago.

As I wrote in these answers, the Capital Markets Union will have to be initiated quickly. But some of its components will take time to elaborate, decide and implement. I will duly consult and listen before entering into detailed proposals. That said, I can already tell you that I see the three most important elements as being:

  1. An overhaul of the policy framework for capital markets infrastructure in the EU. I said during my hearing on Wednesday that I needed to get the plumbing right, so here we go. All market practitioners know that national barriers to sharing infrastructure, aided and abetted by economic nationalism (the promotion and protection of national champions), are a major factor of unnecessary cost and market fragmentation in Europe. I want Europe to have as efficient, cost-effective and innovative market infrastructure companies as the United States.
  2. A quantum leap for consumer and investor protection. For example, it is common knowledge that while the EU has adopted common accounting standards by endorsing International Financial Reporting Standards (IFRS), these standards’ implementation and enforcement are not fully consistent across the EU because of separate national audit firms, audit regulators and enforcement authorities. I want us to do better than that.
  3. An unprecedented EU effort on national insolvency frameworks. These need to be reformed and partly harmonized to allow for better financing of fast-growth companies and securitization of Small- and Medium-sized Enterprises (SME) loans. I know this is a political minefield but I will not shy away from the endeavour. Also, to complete the banking union, I will seek the creation of a single insolvency regime for large banks, perhaps as an alternative option to existing national regimes. I believe this can be achieved without Treaty change.

There are other elements of course, such as new rules on securitization, money market funds and other financial products; a review of possible obstacles to SME and infrastructure financing that may come from our prudential rules (especially Solvency II); and perhaps some work on the taxation of savings, even though I am aware of how difficult it will be to reach any form of harmonization in this latter area.

  1. What are the main barriers to creating a Capital Markets Union? What specifically needs to be done for these barriers to be removed? Which ones will you be giving priority and why?

There are all sorts of barriers inherited from the past, and maintained by the pervasive economic nationalism that remains a key driver of our policy framework, in spite of all the lip-service given by member states to their obligations under EU treaties. To remove such barriers, I need to ceaselessly analyse and expose the costs of market fragmentation and the economic benefits of capital markets development, which require a degree of market integration. Let me stress that the objective is not integration or centralization for the sake of it, but to develop our capital markets for the benefit of all EU citizens.

  1. If securitisation is to be revived, please outline your view of how it can be made safe and how it will lead to growth and jobs.

Financial activities are based on a trade-off between risk and reward and can thus never be made perfectly safe – otherwise it is the safety of the graveyard, as they say. I believe the recent joint paper of the Bank of England and European Central Bank can be a good starting point for our reflection. I expect to be able to make more specific proposals before the end of 2014.

  1. What legislation can be adapted or introduced to support he further development and diversification of capital markets? How would this lead to SME's gaining better access to long-term funding via capital markets?

One instrument is to legislate on specific products or market segments to make sure they are properly monitored and stay within reasonable prudential limits, such as the Commission’s proposal on European Long-term Investment Funds. I will develop more proposals of this kind. However, I believe the framework conditions for capital markets development are even more important, in good Ordnungspolitik fashion as I may say in the language of Master Eckhart. (Or was it Erhard?) Thus my three priority elements as outlined under Question 1.

  1. What recommendations would you suggest with regards to digital currencies like bitcoin?

I need more in-depth analytical work on this, and more generally on how technology is rapidly changing the shape of our financial system and the very categories through which we think about finance and regulate it. It is frustrating that people make more mobile payments in Kenya than in most EU countries. I want to be much more ambitious in adapting our financial regulatory framework so that it allows EU citizens to benefit from great new technologies, while providing adequate protection for consumers and against systemic and other risks.

  1. What is your opinion on high frequency trading in general and its compatibility with the need to stimulate long term financing?

High-frequency trading is one form of technology-enabled financial innovation. I will consider it in a dispassionate way, and will also look with interest at what the US authorities are envisaging in this regard. There are both investor-protection and financial-stability concerns about HFT, which I take seriously but on which I have not drawn conclusions yet. Having said that, our financial system is vast, and it includes many different segments. I don’t see why the simultaneous existence of HFT and long-term financing should pose a problem per se.

  1. The Chair of the European Banking Authority indicated that certain banks might not pass the on-going stress tests. Should this happen, what action would you take?

We are building up the Single Resolution Board and it will be ready for the deadlines set by the Single Resolution Mechanism Regulation. That said, in the next few months the responsibility for addressing the consequences of the European Central Bank (ECB)’s Comprehensive Assessment in terms of bank restructuring and resolution remains at the national level. Of course, I will monitor such developments closely and participate actively in those discussions that have a euro-area or EU dimension in this respect.

  1. Could you provide details on how you see the distribution of responsibilities between yourself and Commissioners-designate Moscovici and Katainen in respect of issues in ECON’s field of competence, as well as the distribution of responsibilities between yourself, Commissioners-designate Moscovici and Dombrovskis, particularly with regard to the external representation of matters concerning the euro area?

I will work with Vice President Katainen under the terms set by my mission letter. Commissioner-designate Moscovici will take the lead on the Financial Transaction Tax and other issues of taxation, but I look forward to working together with him on assessing and addressing any possible impact in terms of market integration and financial stability. The teams that are transferred under my responsibility from the European Commission’s DG ECFIN will continue to play their important part in the financial sector assessment work of the so-called Troika. The external representation of matters uniquely linked to the euro area will be a task for Vice President Dombrovskis, assisted by Commissioner-designate Moscovici. Any external representation of matters concerning the banking union are for VP Katainen or (more probably) for me directly, as far as the Commission is concerned. And I will do external representation on EU financial regulation, for example in the Financial Stability Board, IFRS Foundation Monitoring Board, etc., the way my predecessor Michel Barnier did.

  1. Taking into account he previous commitments of the Commission, are you in favour of a Single EU Deposit Guarantee Scheme? Will you make a legislative proposal to that effect, and if so when?

Well, as I am sure you well know, there can be no effective deposit guarantee without a potentially unlimited backstop from a credible fiscal capacity. This capacity currently exists at the national level but not at the European level, and is clearly not in my area of responsibility to create one. As soon as such a capacity exists, I will make proposals for a federal – oops, single – deposit guarantee scheme that will be backed by it. In the meantime, there is little more I can do than help implementing and enforcing the existing DGS Directive.

  1. Can you make a clear commitment that when legislating for the EU28 you will guarantee the integrity of the single market and neither propose nor support or introduce double majority voting applicable to euro area and non-euro area Member States such as in EBA?

I do commit to the integrity of the single market. Now, as you know, I inherit some tricky issues as the Single Supervisory Mechanism (SSM) regulation and SRM regulation do not treat all member states equally. This was a necessary consequence of the political conditions under which they were adopted, not least the sometimes irrational unwillingness of my country of citizenship to participate in common-interest EU initiatives. (May I quote from the February 2014 report of the UK House of Lords here, paragraph 187: “It would be wise not to close the door on the possibility of some level of [UK] participation in Banking Union in the future, in particular as a means of further promoting and shaping the Single Market in Financial Services and the UK’s position within it”.)

As for double majority voting, it was found appropriate for the EBA last year. But in his mission letter, President Juncker asked me to “review the governance and the financing” of the European Supervisory Authorities, including the European Banking Authority. I will do this with an open mind and you will of course be closely associated with such review.

  1. How do you intend to deal with discrepancies between EU and other important jurisdictions, notably USA? Which approach do you intend to take on third-country equivalence decisions? How do you plan to involve the European Parliament in third-country related matters?

This is a very complex area, and I cannot have a one-size-fits-all approach. The current discussion on financial services in the Transatlantic Trade and Investment Partnership does not look promising. I will need to give a serious second look at our objectives and proposals in this respect. The European Parliament will of course be involved in policy decisions that correspond to a legislative level, but not in individual supervisory decisions, as is common practice in finance.

  1. Will you keep the European Parliament fully informed about the work being done in international bodies such as the FSB, Basel Committee, the IASB, and guarantee that unnecessary and unadapted rules for the EU financial sector are being avoided?

I will inform the European Parliament in these areas in line with what I will identify as best practices in other advanced democratic jurisdictions that are members of these bodies. These organizations being global, I cannot commit on their decisions. That said, I will do my best to favour decisions that are aligned with the European interest, and can be implemented in Europe in a fully compliant manner. I will also take a second look at areas in which the EU is currently not fully compliant with the global standard, such as the IAS 39 accounting standard and some aspects of Basel III.

  1. What do you think of the proposals on Eurobonds made by the Commission in the Green Paper on the feasibility of introducing Stability Bonds?

I now have a particularly informed view on the subject. I believe that Eurobonds are part of a broader debate about what could be a sustainable fiscal framework for the euro area. I also believe that the sustainability of the current euro area fiscal framework is open to question, even though this will not be in my area of primary responsibility as a Commissioner. Frankly, we know that more debate and evolution of the national consensus is needed in Germany before this issue can move significantly, so I’ll stop there and let Chancellor Angela Merkel take the lead.

  1. What do you think about payment regulation and the fact that payments in the Member States to suppliers should be done within 60 or 90 days at most?

I like the idea, but need to check whether this falls within my responsibility or is on a colleague’s turf.

  1. You agreed that the problem of “to-big-to-fail” banks is important and persists. Can you outline how you intend to address it through legislation currently on the table and, potentially, new initiatives? Can you outline what a healthy European banking system looks like?

As for the January proposal of the European Commission on banking structural reform, I will consult extensively before taking a stance. I am sure you will also soon undertake hearings of your own. I have two clear objectives for this legislation. First, it should be a genuine single rulebook, at least inside the banking union area and I believe also for the EU as a whole: some recently adopted national legislation may need to be modified as a consequence. Second, it should facilitate not impede the resolvability of banks, even though I know full well this is easier said than done. Having some convergence with the so-called Volcker Rule in the US would be nice as well, though not a must-have. For the rest, I have an open mind.

Beyond this text, I am following with particular attention the FSB work on bank resolution and still believe a globally consistent framework can be agreed upon there, in which case I will work at its compliant adoption in the EU. A healthy European banking system should be diverse, well-capitalized, well-managed and well-supervised.

  1. The IMF is warning about an uncontrolled rise of shadow banking activities. You stated a need to be vigilant of the risks such activities entail but also to distinguish economically useful activities of this kind from others. Can you outline how you propose to detect these activities, assess their utility and ensure the application of the principle of “same risks, same rules”? In this regard, what is your opinion about the key provisions regarding the Commission legislative proposal on Money Market Funds?

There is no such thing as a typical shadow banking activity. The generally accepted (though arguably incorrect) use of the term refers to all non-bank finance. This encompasses myriads of market segments, defined by what they are not (namely, banks) not by what they are. We need to be humble as regards assessing what you call their economic usefulness: economists have not yet come up with a working macroeconomic model of the financial sector, and are unlikely to do so for a while yet. That said, I will do my best. Money Market Funds are one of these segments, and I believe the Commission proposal’s key provisions are reasonable.

  1. You made several references in your written and oral answers to ECON about the possibility that we “may have got it wrong” in certain aspects of financial markets regulation and their interactions to the detriment of the real economy. Can you provide some examples of areas where this could be the case? Can you outline how you propose to detect such cases?

2 N.B. The author is an independent board member of the global trade repository arm of DTCC. More disclosures are on my profile at Bruegel

I believe the third regulation of credit rating agencies (CRA III) is a good example of politically motivated regulatory overkill. Some aspects of the European Market Infrastructure Regulation (EMIR) also appear to require review in light of the experience of their early implementation so far.2

I will ask an independent task force of highly respected luminaries to do an in-depth review of overlaps, underlaps, inconsistencies, unintended consequences, and mere bad drafting of currently applicable legislation and rules, with the aim of having a comprehensive report by early 2016. Without wanting to boast about UK experiences, I believe the Independent Commission on Banking (also known as Vickers Commission) provides a good benchmark in methodological terms. It had a temporary secretariat for a period of up to a year, formed of very capable technocrats seconded by various public authorities, and gave an extensive look at the academic and other analytical literature not just at the legal or political context. Such features could inspire me for the review task force.

  1. You mentioned in your written responses that one of the key features of this parliamentary term will be the renegotiation of the relationship between the UK and EU. As a senior member of the UK government, you will be fully aware of any contentious areas in the financial services portfolio. Could you outline what they are and what strategy you would suggest to deal with potential conflicts between UK and EU objectives?

Put simply, the City of London serves the entire EU (and to an extent as well, the global economy) but is primarily supervised, and largely regulated, by the UK government and its agencies. There is a tension there. The EU interest, the UK interest and indeed the interest of the City (though I won’t pay any attention to the latter) are aligned on many topics, but not all. Systemic risk management is a good example of misalignment, as sadly illustrated by the ongoing lawsuit by the UK against the ECB on its so-called location policy for CCPs. My strategy is simple. I will work entirely for the EU interest, within the framework of EU institutions that give a significant voice to the UK government and citizens. I believe that a strong, internationally competitive and properly supervised City of London is absolutely in the EU interest.

  1. You committed yourself to the principle of proportionality. Can you outline measures and proposals you want to put forward in order to ensure that small and low complexity financial actors will not be pushed out of the market because of regulatory burden?

This is a case-by-case question. For example, the Alternative Investment Fund Managers Directive has size thresholds under which some provisions do not apply. If I decide to propose a revision of AIFMD, I will certainly keep the principle of such thresholds.

  1. Could you provide the committee with a complete list of the financial services clients you personally, or the companies in which you held directorships or shares, worked for?

See Appendix A. [Appendix A still to be drafted.]

  1. Do you agree that financing of the three European Supervisory Authorities wholly by the sectors they supervise, as indicated in the mission letter by President-elect Juncker, is simply taxation through the back door?

Well, financing them out of the EU budget is also taxation through the back door, or maybe the front door depending on your perspective. These are public institutions, and their funding cannot be based on voluntary donations. My understanding of my mission letter is that the funding should be changed to make it more predictable, more sustainable and less prone to frequent political negotiation. Such change would be appropriate and indeed needed for independent supervisory authorities. As I said before, their governance needs to change as well, supporting their independence and mandate to serve the European public interest.

  1. Could you provide us with a specific figure/estimate on the size of the implicit funding subsidy for Too Big to Fail Banks by taxpayers in the EU and how you envisage removing that subsidy by means of banking regulation?

Economic studies suggest this implicit subsidy is evolving over time and generally decreasing of late. I do not have a more specific quantitative snapshot at this point, but will work at reducing it further. See also Question 15.

  1. In relation to the Commission proposal on Benchmarks, there is significant pressure to extend or increase the number of definitions of benchmarks. Do you take the view that it is appropriate to have different supervisory rules for different benchmarks, depending on their importance, which could give rise to regulatory arbitrage, or do you think it is better to have a simple supervisory rule that applies to all benchmarks?

I am instinctively wary of one-size-fits-all solutions to complex challenges, but your point on the risk of regulatory arbitrage strikes me as well-taken as well. I will also look at having a framework on benchmarks which is compatible with evolving requirements and practices outside the EU.

Fri, 03 Oct 2014 07:21:46 +0100
<![CDATA[The New EU Political Cycle: Addressing the Growth Agenda]]> http://www.bruegel.org/nc/events/event-detail/event/464-the-new-eu-political-cycle-addressing-the-growth-agenda/ even464

Centre for European Affairs, member of the Central European Strategy Council, Bruegel, the Ministry of Finance of SR
and Ministry of Foreign and European Affairs of SR are organizing another round of TATRA SUMMIT conferences in Bratislava.

The event will review the unfolding design of the 2014 EU political cycle, shaped by changes in the leadership posts of the EU institutions and their outlined policy goals for the next five years. The main aim of the conference is to address strategic growth agenda. Furthermore, the debate will look at the key priorities of the new political cycle in Europe. In reference to that, the panels will seek to address the following areas - the flexibility of the stability and growth pact; the state of EMU completion; the area of multispeed Europe in the context of the new EU architecture; buildup of the EU energy union and its impact on the industry competitiveness.

TATRA SUMMIT 2014 will also provide a platform for Central Europe to present its recommendations and regional priorities, and, thus, make its voice heard in the unveiling political cycle of the EU.

More information of this event will be available shortly

Practical details

  • Time: 12 November, 17:00 - 13 November 17:00
  • Location: Kempinski Hotel River Park, Bratislava

Conference partners are the Centre for European Affairs, Ministry of Finance of the Slovak Republic and Ministry of Foreign and European Affairs of the Slovak Republic

Wed, 01 Oct 2014 13:28:20 +0100
<![CDATA[The 'dos and don'ts' of a growth-friendly policy mix for the Euro area]]> http://www.bruegel.org/nc/blog/detail/article/1446-the-dos-and-donts-of-a-growth-friendly-policy-mix-for-the-euro-area/ blog1446

1 Speech by Mario Draghi, Annual central bank symposium in Jackson Hole, 22 August 2014

When looking at possible ways out of the euro area crisis, there is a growing consensus that it will require “a policy mix that combines monetary, fiscal and structural measures at the union level and at the national level”, as Mr. Draghi recently put it.1 However, stipulating the details of this policy mix is far more controversial. On the monetary side, there is a debate on the extent to which the TLTRO operations of the ECB would achieve the desired goal of reactivating the credit flow in the euro area (Claeys, 2014; Merler, 2014). Similarly, it is not clear whether the ECB should push its expansionary monetary policy into the realm of ‘non-conventional measures’ to fight the risks of deflation (Claeys et al., 2014; Altomonte and Bussoli, 2014). On the fiscal / structural side, the status of the debate is in even more dire straits. No clear consensus exists on the direction of the fiscal stance, often summarized through the ‘flexibility vs. austerity’ controversy; at the same time the implementation of the national reforms’ agenda keeps facing many internal political obstacles, especially at a time of stagnation and high unemployment.

And yet, leaving aside the (relatively more mature) monetary debate outlined above, recent results from a research line on competitiveness, based on previously unavailable micro-level data (e.g. EFIGE, available here, and the ECB CompNet), allow us to point to some clear ‘dos’ and ‘don’ts’ when looking at the fiscal/structural side of a growth-friendly policy mix for the euro area.

2 To grasp this idea, think at the 80-20 rule, in which 80 per cent of a given phenomenon (e.g. the total number of people living in cities in the world, or the total exports of a country) is explained by just 20 per cent of the concerned observational units (e.g. the top 20% largest cities or exporting firms). In a ‘normal’ distribution these figures would be 50-50.

The key starting point of this line of research is the recognition that competitiveness is essentially a firm-level phenomenon. Often, competitiveness policies are designed at sector or country level, but targeting the sector or country means targeting the “average firm” of a given sector/country. The idea is that what is good for the average firm is good for all the firms. Nevertheless, this might reveal itself to be highly problematic as the “average firm” does not exist; rather, firms are very heterogeneous in their performance. Indeed, like the length of rivers in the world, or the size of cities, where it is possible to observe a large number of relatively short rivers (or small cities), and a few very long rivers (or very large cities), firm performance across countries and industries is typically characterized by many relatively ‘bad’ firms performing below the average, but also a certain number (although less numerous) of particularly good firms. Technically, we can thus claim that firm level data on a given performance index (e.g. productivity) are typically characterized by a distribution ‘skewed to the right’, i.e. what is known as a ‘Pareto’ distribution, versus an assumed symmetric normal distribution (see Altomonte et al., 2011 for a detailed discussion, and Altomonte et al., 2012 for some evidence from EFIGE data).[2]

3 In emerging economies these within industry differences in performances are even larger, with the best firms making up to five times more than the worst firms, always controlling for the same amount of inputs (Hsieh and Klenow, 2009).

This evidence is there even for firms observed within narrowly defined (4-digit SIC) industries, i.e. firms producing essentially the same product. In the US, for example, the best firms producing a given product make twice as much output with the same amount of inputs (i.e. their total factor productivity (TFP) is twice larger) with respect to the worst firms in the same industry (Syverson, 2004).[3] Recent data now available for Europe thanks to the CompNet project (see ECB WP 1634, 2014) convey essentially a similar message, as reported in Figure 1.

Figure 1: Heterogeneity in Firm Performance Within and Across Sectors

Among the ‘don’ts’ is trying to achieve competitiveness through ‘internal devaluations’ in times of crisis

There it is shown how, for all the reported EU countries, the average difference (here summarized by dispersion of industry mean productivity) in performance across firms within the same industry (the ‘within-sector’ dispersion) is larger than the average difference in performance across industries (the ‘across-sector’ dispersion). Hence, if one considers two industries in any European country (e.g. Textiles and Bio-tech, with the first on average less productive than the other), the best Textiles firms in a country are likely to be much more productive than the ‘average’ Textile firm, with a dispersion so large that they are actually likely to dwarf also the ‘average’ Bio-tech firm in the same country in performance. This implies that the potential gains derived from a reallocation of economic activity from low to high productive firms within the same industry might be at least comparable, in terms of performance gains, to a change of the ‘average’ performance of firms across industries.

The evidence shown above suggests a number of ‘dos’ and ‘don’ts’ of a policy agenda aimed at fostering growth.

First of all, given the evidence on the role of reallocation in fostering productivity growth, among the ‘don’ts’ there is the idea of trying to achieve competitiveness through ‘internal devaluations’ in times of crisis. In fact, the latter might prove unreasonably painful and somehow relatively ineffective. Painful because, at a time of crisis, the attempt would very likely result in a demand compression that might further compress the investment opportunity of firms, and thus their restructuring as a reaction to the crisis. Ineffective because the policy, by lowering prices and wages across the board, would necessarily work on the ‘average firm’, rather than triggering the beneficial effects of resources reallocation from less to more productive firms.  Of course, this does not imply that, in a situation of escalating public (or private) debt, the necessary deleveraging through appropriate austerity policies does not have to be promptly achieved in order to restore sustainability in public finances; only, we should avoid selling this as a ‘competitiveness’ strategy.

Rather, in terms of actual growth-friendly strategies, activating policies able to foster the reallocation of resources towards the most productive firms is of paramount importance. In particular, reforming labor markets to link individual wages to the productivity of the firm more closely, coupled with additional flexibility of workers across firms, should top the list of the ‘dos’ in the policy agenda of every country in which growth is lagging behind. Together with this line of action, this micro-based line of research has also identified a further set of specific policies that would allow firms to acquire the characteristics that are associated with productivity growth:

Reforms of labor markets able to link individual wages to the productivity of the firm more closely, coupled with additional flexibility of workers across firms, should top the 'dos' list


  • Altomonte C. & Aquilante T. & Békés G. & Ottaviano G.I.P  (2013). "Internationalization and innovation of firms: evidence and policy," Economic Policy, CEPR & CES & MSH, vol. 28(76), pages 663-700, October.
  • Altomonte C. & G. Barba Navaretti & F. di Mauro & G.I.P. Ottaviano, (2011)."Assessing competitiveness: how firm-level data can help," Policy Contributions 643, Bruegel.
  • Altomonte C. & Aquilante T. & Ottaviano G.I.P. (2012). "The triggers of competitiveness: The EFIGE cross-country report," Blueprints, Bruegel, number 738, December.
  • Barba Navaretti, G., M. Bugamelli, F. Schivardi, C. Altomonte, D. Horgos and D. Maggioni, (2011) “The global operations of European firms”, Blueprint 12, Bruegel.
  • Bloom N. & J. Van Reenen (2007). "Measuring and Explaining Management Practices Across Firms and Countries," The Quarterly Journal of Economics, MIT Press, vol. 122(4), pages 1351-1408, November.
  • ECB Working Paper No. 1634.
  • http://www.efige.org/
  • Foster, L., Haltiwanger, J and C. J. Krizan, (2006): "Market Selection, Reallocation, and Restructuring in the U.S. Retail Trade Sector in the 1990s," The Review of Economics and Statistics 88(4): 748-758.
  • Hsieh, C. T. and P. J. Klenow (2009), “Misallocation and Manufacturing TFP in China and India”, The Quarterly Journal of Economics, 124(4): 1403-1448.
  • Krugman, P. (1997), “Pop Internationalism”, Cambridge MA: MIT Press.
  • Marc J. Melitz & Ottaviano G.I.P. (2008). "Market Size, Trade, and Productivity", Review of Economic Studies, Oxford University Press, vol. 75(3), pages 985-985.
  • Syverson, C. (2004), “Market Structure and Productivity: A Concrete Example”, Journal of Political Economy, 112(6): 1181-1222.

Wed, 01 Oct 2014 08:30:18 +0100
<![CDATA[The economics of Uber]]> http://www.bruegel.org/nc/blog/detail/article/1445-the-economics-of-uber/ blog1445

Effectively Uber works as a matching platform for passengers and drivers and makes money by taking a 10-20% cut from each ride

Uber, a San Francisco company founded in 2009, is currently one of the fastest growing startups worldwide. In 2014 its estimated valuation reached 17 billion USD, up from 3.5 billion USD a year earlier. The idea behind Uber is simple. Potential passengers can download a smartphone app that allows them to request the nearest available Uber car. But unlike a traditional taxi company, Uber does not operate its own cars. Instead it signs up private drivers willing to provide rides to paying passengers and passes the ride requests directly to them. Effectively Uber works as a matching platform for passengers and drivers and makes money by taking a 10-20% cut from each ride. The drivers can work in their leisure time and have to maintain a good rating, which is given by passengers after each trip.

Uber was welcomed by the urban population and widely acclaimed for low prices, short waiting times, and good service, as reflected by its rapid growth. However, despite its popularity Uber faces numerous legal challenges across the world. It was recently banned in Berlin, Hamburg and eventually across all of Germany following a court decision in Frankfurt. The Brussels court banned Uber while threatening a 10,000 Euro fine for a single ride. In Seattle, New York, London, Seoul and Toronto, the company was also threatened with litigation. In some places, including Germany, the bans were lifted, but the uncertainty about Uber’s future remains.

Over the past two years the cab use in San Francisco, Uber’s home city, declined by 65%

Most of these charges were brought against Uber by the taxi industry on the grounds of non-compliance with local regulations, operating without licenses or putting taxis at an unfair disadvantage. The motivation of the taxi industry to undertake legal action is clear. The profits of taxis in cities where Uber became active decreased significantly. For example, over the past two years the cab use in San Francisco, Uber’s home city, declined by 65% according to a recent report by the Metropolitan Transportation Agency. Appealing to regulation is one way for taxis to block Uber from market entry, and thus preserve their profits.


Banning Uber would massively disadvantage consumers who are enjoying lower prices and better quality due to the increased competition

The solution to this situation is not straightforward. Banning Uber would massively disadvantage the consumers who are enjoying lower prices and better quality due to the increased competition in taxi services. However, in many cases Uber indeed threatens not only taxis’ profits, but also their investment and assets in form of costly operating licenses. Finally, the ridesharing industry is in need of regulation that levels the playing field for it and the taxis, and protects its customers and employees.

Benefits to consumers

Ridesharing companies like Uber are strong competitors to the established taxi industry on their own, but their utilization of information technologies and innovative business model provides further benefits to consumers. For example, “surge pricing”, a temporary increase in prices during peak demand time, like Friday evening, invites a larger number of inactive drivers to offer rides. While the service comes at a higher price, this significantly increases the availability of rides and decreases waiting times. However, the companies are required to inform their customers of such practices and limit surge pricing in cases of emergency.

While elimination of information asymmetries was cited as a major motivation for taxi industry regulation, ridesharing companies’ reliance on digital technology precisely provides consumers with a better overview of quality and prices. The drivers are rated by consumers and are banned from the system if their rating falls below a certain threshold. Prices of the rides are estimated beforehand and can be easily compared across several applications, introducing greater transparency - something that taxi regulation attempted for years by requiring taxis to publish their price lists inside and outside of the cab.


The cost of a single-taxi medallion has varied between 700,000$ and 1,000,000$ in large US cities like New York and Chicago

Taxi regulation differs across countries and individual cities, varying from a deregulated market in Ireland to quotas and price controls in France. Many cities limit the number of taxis on the streets by requiring drivers to hold a license to operate a taxi. Since licenses are issued rarely, entering the market often requires buying one from a current owner at a high price. In fact, growing urban populations and stagnating supply has led to skyrocketing prices for taxi medallions in some of the large cities. For example, the cost of a single-taxi medallion has varied between 700,000$ and 1,000,000$ in the large US cities like New York and Chicago.


License holders can no longer monetize their asset as expected

Strict government quotas and regulation protected the industry from competition and allowed it to reap increasingly large profits, as reflected in the rising bidding prices for the licenses. In fact, a taxi license was treated as an asset which could later be sold for a similar or higher price. Its value was severely reduced by Uber’s entry. First, licenses no longer grant protection from competition. And second, becoming a driver no longer requires buying a license, since joining Uber can be done for free. As a result, the license holders can no longer monetize their asset as expected - increased competition dilutes profits and reselling a license also yields a lower price. As most cab drivers and companies have no financial protection against a sudden devaluation of their licenses, this situation can have detrimental effect on their welfare and generate a lot of bitterness among them.

The cities with tighter market controls like Barcelona, Paris and Berlin recently saw more intense protests by the taxi industry, as opposed to, say, Dublin which deregulated its taxi market and lifted restrictions on the number of taxis practically overnight in 2000 (the fares remain regulated). To deal with the problem at the time, Ireland set up a “hardship fund” with payments of up to 15,000 Euro to alleviate the financial hardships suffered by license holders due to the devaluation of their assets, although the general consensus was that the government was under no obligation to compensate the taxi industry. Liberalization in Ireland brought massive benefits for consumers - the number of taxis in Dublin increased threefold, waiting times were reduced to a minimum and service reportedly improved.


Unlike taxis, Uber and other ridesharing companies were indeed subjected to few rules at the start of their operations, as regulations for companies of the “sharing economy” often does not exist yet. Nevertheless, such regulation is needed to protect customers and employees, and ensure a level playing field for ridesharing companies and taxis alike. However, such regulation should also take the peculiarities of Uber’s business model into account and aim to stimulate competition between companies, rather than restrict it.

California was the pioneer in regulating the “sharing economy” when complex issues related to provision of insurance and taxation arose

As the experience of Uber and Airbnb shows, an efficient solution can be found. California was the pioneer in regulating the “sharing economy” when complex issues related to provision of insurance and taxation arose. With regards to insurance, Uber drivers initially operated under private policies, while cabs were required to purchase a more expensive commercial insurance. It was argued that passengers and drivers were at risk, as private insurance coverage could be limited or denied if the accident took place during commercial use. Although there were attempts to force Uber to provide 1 million USD blanket coverage to the drivers at all times, California legislators reached a compromise with ridesharing companies, requiring them to provide insurance of up to 200,000 USD for drivers in search of a customer and 1 million USD for drivers and passengers in the car.

Although Uber drivers are employed as independent contractors and are thus subjected to a different taxation structure than the taxi drivers, the debate around taxation of the “sharing economy” revolved mostly around Airbnb, Uber’s counterpart for sharing apartments. Airbnb’s users were criticized for not paying local hotel occupancy taxes. However, the problem was quickly resolved when Airbnb itself started to collect taxes from its users on behalf of the California government. While there still may be some disparity in requirements for background and technical checks between Uber and taxis,this can also be eliminated by closing gaps in the regulation.

However, not all regulations benefit consumers and put companies on the equal footing. The progress on regulation of “sharing economy” in California comes in stark contrast with the recent regulation passed in France, where Uber drivers were required to wait 15 minutes before picking up a passenger! This regulation was later scrapped and replaced by a prohibition for Uber drivers to share their GPS location, thus effectively disrupting Uber’s operations. While such steps indeed give the taxi industry a fighting chance, they handicap the competitor, reduce competition, deprive customers of choice and reduce service quality for passengers.

Concluding remarks

Uber’s business model is still fairly novel. Yet such new “sharing” business models use previously underutilized resources more efficiently, increase competition in the markets and provide consumers with more choice. However, as the ongoing debate shows, these innovations may strongly disrupt existing markets and their success may depend on the willingness of regulators to open markets for competition. Meanwhile, regulators will have to face several challenges, including balancing the interests of consumers and incumbents, creating efficient rules for the “sharing economy” and fostering competition.

Regulation will have to be quickly adapted to the changing realities of the market. The Internet and further developments in ICT increasingly reduce the costs of search and matching, eliminate the information asymmetries with the help of rating systems, provide greater transparency of prices via real-time auctions and enable entry by smaller entrepreneurs. These developments not only increase the competition in the markets and bring them closer to scenarios with perfect competition and information, but may also make certain regulations obsolete.

Excellent research assistance by Elena Zaurino is gratefully acknowledged.

Tue, 30 Sep 2014 13:55:48 +0100
<![CDATA[Interactive: Do it yourself European Unemployment Insurance]]> http://www.bruegel.org/nc/blog/detail/article/1444-interactive-do-it-yourself-european-unemployment-insurance/ blog1444

Following on from our previous blog post on this topic, we invite you to try out our improved European Unemployment Insurance (EUI) scheme simulator which now includes a line graph to chart the evolution of the net flows from the scheme and its situation, as well as a heat map of all European countries.

Ctrl + shift +L will generate a permanent url to share the selected combination of inputs.

Tue, 30 Sep 2014 09:55:38 +0100
<![CDATA[Russian Roulette, reloaded]]> http://www.bruegel.org/nc/blog/detail/article/1443-russian-roulette-reloaded/ blog1443

European attention will be back to Russia and Ukraine this week, as sanctions are reviewed.  In the meantime, important changes have taken place. European FDIs and loans to Russian borrowers have started to dry up, while lending from China has reached new highs, raising important questions about the effectiveness of measures supposed to restrict Moscow’s room of maneuver in seeking access to capital.

Geopolitical conflicts have one common characteristic: they catalyse attention according to cycles. The Ukraine-Russia affaire is not an exception, in this respect. On Tuesday, EU diplomats will meet to review the sanctions imposed to Russia with the aim to “amend, suspend or repeal them”. At the moment, the FT reports, there seem to be no signs that the measures would be suspended or changed.

Russia did not look particularly open to compromise last week, when president Putin demanded a reopening of the EU-Ukraine recently-ratified trade pact - which was the casus belli in the Ukraine crisis. According to the FT, Putin accompanied his demands with threats of “immediate and appropriate retaliatory measures” if Kiev were to actually implement any part of the deal. These points were not welcomed well in Europe, in particular in Germany, which is reportedly insisting that there should be no dilution of sanctions imposed on Russia.

This new stand-offs will attract Europeans' attention back to their Eastern borders. The first question to answer - before wondering what to do with the sanctions in place - is whether they have been effectively biting. It may be too early to tell, but some recently published data - which are reviewed here - show interesting signs that may support the points of those who are skeptical.

Capital has been flowing out of Russia over the last quarter of 2013 and the first quarter of 2014 and the financial account at the end of Q1 2014 reached a deficit of almost 9% of GDP

On net terms, capital has been flowing out of Russia over the last quarter of 2013 and the first quarter of 2014. The right panel of figure 1 shows that the financial account at the end of Q1 2014 reached a deficit of almost 9% of GDP, excluding the movements in reserves assets. Reserves - shown in the left panel of figure 1 - have been decreasing since a peak in 2012, and more markedly since end-2013, reaching 458 USD bn on the 19th September 2014. This amounts to a 10% decrease over the nine months since the beginning of the year. As a comparison, during the crisis of 2008-09, reserves went down in Russia by 37% over six months, and by about 13% monthly during the two worst months.

To be fair, the fact that reserves have not dropped nearly as fast as in 2008-09 does not preclude the possibility that Russia may experience another balance of payment crisis. Reserves have in fact been constantly decreasing - although slowly - and psychological factors could play as an amplificator, if external pressure were to intensify significantly (which may come from expected redemptions on external debt, especially if sanctions were to be simultaneously thoughened).

But what is behind the relatively contained drop of the Russian financial account? Understanding this may be an essential prerequisite to assess the effectiveness of sanctions. On one hand, the limited coverage of the data - which stops in the first quarter of 2014 - does not (yet) allow us to assess the impact of the second wave of sanctions. But there might be something - quite interesting - going on.

Figure 2 reports quarterly data on foreign direct investments (FDI) in Russia from 2007 till the first quarter of 2014, broken down by investing countries. Data were taken from the Central Bank of Russia’s website, and they are provided already in net terms (i.e. inflows minus outflows), meaning that a negative number in one quarter represents a net outflow in that quarter and a positive number represents a net inflow. The upper-left panel shows FDI coming from European countries, both EU and non-EU. The other three panels show FDI coming from Asian, American and Caribbean countries.

Foreign Direct Investment in the Russian Federation in 2007 - 2013, Q1 2014 (Balance of Payments Data, inflows minus outflows)

Over time (if we disregard possibly dubious flows from the Caribbeans) Europe has played a crucial role in providing FDI to Russia, with the largest share of European FDI coming from Euro area countries (in particular Ireland and the Netherlands, followed by France and Germany). Cyprus and Luxembourg are clear outliers in Europe and their abnormal flows are more similar to those from the Caribbean countries, together with which they are represented (see here for wide discussion of Cypriots FDI flows to and from Russia).

FDI flows from Europe have been shrinking significantly in the last three quarters up to March 2014, while flows from Asia - mostly China - picked up to high levels during the same period

Figure 2 shows that FDI flows from Europe have been shrinking significantly in the last three quarters up to March 2014. This occurred probably in anticipation of escalating tensions, and speeded up during the first quarter of 2014, when the first wave of sanctions was agreed.

More interestingly, FDI flows from Asia - mostly China - picked up to high levels during the same period and literally exploded in the first quarter of 2014. During the first three months of 2014, European net FDI inflows to Russia amounted to 2.9 USD billion (2 billion of which coming from the euro area), i.e. down 63% year on year. Asian net FDI flows to Russia were instead 1.2 USD billion (1 billion of which coming from China), i.e. up 560% year on year.

This is not the only sign suggesting that Russia might have been re-orienting the geography of its capital flows over the latest months (something I already looked at here). Figure 4 shows the amount of loans to Russia non-financial corporations and households from foreign lenders, over the period 2007-2014Q1. These are net loans (i.e. disbursement net of repayments) so they can be taken as a proxy of the new lending.

The data for the first quarter of 2014 is not properly comparable with the previous - annual - points, but it is nevertheless striking. It shows the expected negative net new lending by European lenders and the - less expected - positive and big net new lending by Chinese lenders. As a comparison, China net new lending to Russian NFCs and Households was 13 USD billion for the sole first quarter of 2014, compared to 7.5 USD billions for the entire 2013.

The sanctions to make access to European financial market more difficult for Russian banks and companies may prove far less effective than expected

Obviously, it is too early to draw conclusions, and assessment at this point in time needs to be cautious. But this data may be the first sign of a geographical reshuffling of capital flows to Russia, with China possibly starting to substitute outgoing European countries. Data on the past two quarters - covering the period during which sanctions were toughened on the European side - will be key to understand whether this development can be a lasting trend.

But if this were to be the case, then the sanctions that were supposed to make access to European financial market more difficult for Russian banks and companies may prove far less effective than expected.

Tue, 30 Sep 2014 07:33:26 +0100
<![CDATA[The new normal of monetary policy]]> http://www.bruegel.org/nc/blog/detail/article/1442-the-new-normal-of-monetary-policy/ blog1442

What’s at stake: Since 2008, the asset purchases made under QE have increased drastically the aggregate level of bank reserves, thereby weakening the control of the Fed's federal funds rate. On Wednesday 17 September 2014, the Federal Reserve announced a revised plan for the mechanics of how it will raise interest rates from near zero despite large excess reserves.

The primary tool for moving the fed funds rate will be the interest rate the Fed pays on the money, called excess reserves

Real Time Economics writes that as part of the so-called exit strategy, the Fed will continue to rely on its benchmark federal funds rate, an overnight interbank lending rate, as the key rate used to communicate Fed policy.  But the primary tool for moving the fed funds rate will be the interest rate the Fed pays on the money, called excess reserves, that banks deposit at the central bank. The Fed also will use an interest rate it pays on trades called reverse repurchase agreements, or reverse repos, to help ensure the fed funds rate stays in its target range.

The old way of raising rates

Michael Woodford writes that it will be an interesting experiment in monetary economics because the Fed will be attempting to control short-term interest rates in a situation where almost certainly its balance sheet is going to be unusually large. That means that there are going to be extraordinary quantities of excess reserves in existence, and this means that Fed control of short-term interest rates will not be achievable in the way that it always was in the past: through rationing the supply of reserves. The Fed would maintain a fairly small supply of reserves, small enough that there was indeed an opportunity cost of reserves, and it could adjust that opportunity cost fairly precisely through relatively small changes in the supply of reserves.

John Cochrane illustrates in the figure below the standard story for monetary policy, and one option for the Fed when it wants to raise rates. In this story, the Fed controls interest rates by rationing the amount of non-interest-paying reserves. Banks must hold reserves in proportion to their deposits. If the Fed sells bonds, taking back reserves, the banks must get along with fewer reserves. They bid up the Federal Funds rate they pay to borrow reserves from each other. Treasury rates and other rates rise by arbitrage with the Federal Funds rate. So all interest rates rise.

The new way of raising rates

Attention turned to an alternative approach to monetary policy implementation by effectively “divorcing” the quantity of reserves from the interest rate target

Todd Keister, Antoine Martin, and James McAndrews writes that recently, attention has turned to an alternative approach to monetary policy implementation by effectively “divorcing” the quantity of reserves from the interest rate target. The basic idea behind this approach is to remove the opportunity cost to commercial banks of holding reserve balances by paying interest on these balances at the prevailing target rate. Under this system, the interest rate paid on reserves forms a floor below which the market rate cannot fall. The Reserve Bank of New Zealand adopted a particular version of the “floor-system” approach in July 2006.

Todd Keister, Antoine Martin, and James McAndrews writes that the key feature of this system is immediately apparent in the exhibit: the equilibrium interest rate no longer depends on the exact quantity of reserve balances supplied. Any quantity that is large enough to fall on the flat portion of the demand curve will implement the target rate. In this way, a floor system “divorces” the quantity of money from the interest rate target and, hence, from monetary policy. This divorce gives the central bank two separate policy instruments: the interest rate target can be set according to the usual monetary policy concerns, while the quantity of reserves can be set independently.

Policy "normalization” principles and plans

In its press release, the FOMC writes that during normalization, the Federal Reserve intends to move the federal funds rate into the target range set by the FOMC primarily by adjusting the interest rate it pays on excess reserve balances. During normalization, the Federal Reserve intends to use an overnight reverse repurchase agreement facility and other supplementary tools as needed to help control the federal funds rate.

Real Time Economics writes that since the authority to pay interest on reserves does not extend to other participants in short-term rate markets, such as government-sponsored enterprises and money market funds, the central bank has developed so-called overnight reverse repurchase agreements that allow it to withdraw liquidity from the system even from non-banks.

The Fed should stop referring to "normalization” when it talks about reducing the size of its balance sheet

The FOMC writes that it intends to reduce the Federal Reserve's securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the SOMA. John Cochrane writes that the Fed should stop referring to "normalization” when it talks about reducing the size of its balance sheet. The Fed may discover that a huge balance sheet, reverse repos for everyone, and even near-zero rates and zero inflation are a permanent and healthy policy configuration. If you've called tiny reserves that don't pay interest "normal," it's going to be awfully hard to accept that the "new normal" is just fine.

Mon, 29 Sep 2014 07:27:53 +0100