<![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Mon, 24 Nov 2014 18:15:58 +0000 http://www.bruegel.org/fileadmin/images/bruegel-logo.png <![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Zend_Feed http://blogs.law.harvard.edu/tech/rss <![CDATA[The Euro trap: on bursting bubbles, budgets and beliefs]]> http://www.bruegel.org/nc/events/event-detail/event/479-the-euro-trap-on-bursting-bubbles-budgets-and-beliefs/ even479

On 4 Decembe we welcome Professor Hans-Werner Sinn at Bruegel to present his latest book, ‘The Euro Trap’, in which he provides a critical assessment of the Eurozone crisis and details the policy failures in trying to solve it. Sinn highlights the mistakes in creating a currency union without a full political union – flaws exposed by the financial crisis to devastating effect. 

At a time when concerns around the Eurozone’s economic malaise are growing once again, Sinn argues that the peripheral Eurozone countries are trapped in a flawed currency system and plagued by a fundamental lack of competitiveness. Contrary to the current approach of liquidity injection by the ECB and bailouts, Prof Sinn advocates a radical approach – limit the role of the ECB, exit the regime of soft budget constraints and write off public and bank debt to allow the struggling countries to breathe again. Furthermore, he suggests the euro should allow countries to exit in order to make it easier for them to restore their competitiveness before re-joining the currency union. 

To discuss all this and more around Europe’s economic future we have Philippe Weil, Professor at ULB and President of the Observatoire français des conjonctures économiques.


  • Hans-Werner Sinn, Professor of Economics and Public Finance, University of Munich; President, Ifo Institute; President, CESifo Group, Member of the Advisory Council of the German Ministry of Economics
  • Philippe Weil, Professor at ULB and President of the Observatoire français des conjonctures économiques

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Thursday 4 December 2014, 12:45-14:30. Lunch will be served at 12:45 after which the event will begin at 13:00.
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Mon, 24 Nov 2014 17:05:27 +0000
<![CDATA[The Euro trap: on bursting bubbles, budgets and beliefs]]> http://www.bruegel.org/nc/events/event-detail/event/478-the-euro-trap-on-bursting-bubbles-budgets-and-beliefs/ even478

On 4 Decembe we welcome Professor Hans-Werner Sinn at Bruegel to present his latest book, ‘The Euro Trap’, in which he provides a critical assessment of the Eurozone crisis and details the policy failures in trying to solve it. Sinn highlights the mistakes in creating a currency union without a full political union – flaws exposed by the financial crisis to devastating effect. 

At a time when concerns around the Eurozone’s economic malaise are growing once again, Sinn argues that the peripheral Eurozone countries are trapped in a flawed currency system and plagued by a fundamental lack of competitiveness. Contrary to the current approach of liquidity injection by the ECB and bailouts, Prof Sinn advocates a radical approach – limit the role of the ECB, exit the regime of soft budget constraints and write off public and bank debt to allow the struggling countries to breathe again. Furthermore, he suggests the euro should allow countries to exit in order to make it easier for them to restore their competitiveness before re-joining the currency union. 

To discuss all this and more around Europe’s economic future we have Philippe Weil, Professor at ULB and President of the Observatoire français des conjonctures économiques.



  • Hans-Werner Sinn, Professor of Economics and Public Finance, University of Munich; President, Ifo Institute; President, CESifo Group, Member of the Advisory Council of the German Ministry of Economics
  • Philippe Weil, Professor at ULB and President of the Observatoire français des conjonctures économiques


Practical details


  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Thursday 4 December 2014, 12:45-14:30. Lunch will be served at 12:45 after which the event will begin at 13:00.
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Mon, 24 Nov 2014 17:05:23 +0000
<![CDATA[Measuring Europe’s investment problem]]> http://www.bruegel.org/nc/blog/detail/article/1486-measuring-europes-investment-problem/ blog1486

The President of the European Commission is worried about the investment situation in Europe and has taken the initiative to propose a €300 billion investment plan to the December European Council meeting.

The hope is that the EU investment package will be significant to boost growth 

Under the leadership of Vice President Katainen, the Commission has designed a plan which will be announced this week. The announcement of the investment plan is scheduled to coincide with the announcement by the Commission of its assessment of national budgetary plans for 2015. The hope is that the investment package will be significant enough to boost growth and make it possible for EU countries to comply with EU fiscal rules in the years to come. As we argued some time ago “without growth, it will become impossible to respect the spirit of the fiscal rules”.

Before evaluating whether the investment plan is sufficient to boost growth, there is a need to evaluate the extent of Europe’s investment problem, which is what this blog post does.

Substantial shortfall in investment in the EU: €260 billion below the expected linear trend between 1970 and 2014  

Our starting point is a long-term view of investment growth in Europe. Chart 1 shows the development of investment measured in 2014 prices in the “old” EU15 (for which data is available for a much longer period that for the current EU28) from 1970 to 2014. We compute a simple linear trend from 1970 to 2005, in order to take out the years of the construction boom that affected some EU countries in 2006 and 2007 and document the deviation of investment from this trend. A linear trend captures the overall development of investment quite well as the graph shows. Investment is currently €260 billion below this trend suggesting that the EU suffers indeed from a substantial shortfall in investment.




Chart 2 shows the comparable graph for investment excluding construction (i.e. dwellings, non-residential construction and civil engineering projects). The investment gap for non-construction investment is still substantial at €160 billion.

Turning to the Member states that have joined the EU since 2004, the data is only available since 1995 therefore we compute a linear trend for the shorter period of 1995-2005. Obviously, one can hardly compare the EU15 with these countries since the latter grouping experienced significant catching-up growth and very substantial capital inflows from Western Europe even before they joined the EU. As shown in Charts 3 and 4, the gap is €20 billion for total investment and €10 billion for non-construction investment.



Another important question is to what extent public investment has played a role in mitigating the fall in total investment.

public investment is not playing its role in mitigating Europe’s investment problem

Chart 5 shows the development of public investment during 1970-2014 and the deviation from trend. We find that in the EA12, public investment rose substantially above the 1970-2005 trend in 2009 but then fell sharply, giving rise to current shortage of €25 billion. There is currently no shortfall for the EU15 but a similar sharp decline in public investment occurred after the 2009 stimulus. Obviously simply being on the same trend as during the relatively mild 1970-2005 implies that public investment is not playing its role in mitigating Europe’s investment problem.



We next turn to the five largest EU countries, Germany, France, UK, Italy and Spain and zoom in on how investment developed in construction and non-construction during the crisis period from 2007 to 2014. A number of substantial differences emerge in the 5 countries with trends in some of them being particularly worrisome. Chart 6 shows indeed different patterns across the five countries:

The total investment free fall observed in Spain since the beginning of the crisis has been mainly driven by the correction of overinvestment and misallocation of capital in the construction sector that characterized the pre-crisis period. A look at the non-construction investment reveals however that it has rebounded strongly since the low point of 2009.

The decline in investment in France has been relatively modest initially and has recovered relatively quickly from the 2009 recession, but has been basically stagnating ever since and is now around the level of 2010.

Germany exhibited a stronger drop in investment in 2009 and a quicker recovery in 2010, followed by an overall modest growth (which was fueled, in contrast to the other countries, by strong growth in the construction sector).

Investment in the UK has been sluggish since it reached a low point of 2009-10 and has stayed around this level thanks to investment in construction.

Finally, Italy offers the most worrying picture with a continuous and broad-based decline in investment since the beginning of the crisis.



In this post, we have documented a substantial decline in investment, both private and public as well as construction and non-construction throughout the EU.

The numbers show that the EU is substantially below long-term trends. Given the central importance of investment for growth in the short but also in the long term, this is a very worrying development.

We urge the European Commission to present an ambitious plan to re-invigorate growth and jobs in the EU.

We urge the European Commission to present an ambitious plan to re-invigorate growth and jobs in the EU. Failure to do so would result in continued stagnation of the EU economy in the years to come.




Mon, 24 Nov 2014 08:51:19 +0000
<![CDATA[Internationalisation of the Renminbi: Developments in Offshore Business]]> http://www.bruegel.org/nc/events/event-detail/event/477-internationalisation-of-the-renminbi-developments-in-offshore-business/ even477

The renminbi (RMB) – the official currency of China – is poised to join the US dollar and the euro as one of the world’s top three global trading currencies. China is now the world’s second largest economy, its largest exporter and the single greatest destination for global direct investment.

The Chinese government is actively seeking to internationalise the renminbi to match China’s global economic status. The Chinese government policy is to promote international use of the renminbi in three stages through trade, investment and as a reserve currency. This represents new opportunities for companies, financial institutions and personal investors. As the renminbi is not yet fully convertible, the Chinese government has promoted an ‘offshore’ market where renminbi can be used outside the Chinese mainland, separate from the ‘onshore’ market used by domestic companies, Chinese residents and foreign companies with a Chinese presence.

Offshore renminbi markets are developing rapidly in Hong Kong, Singapore, Taiwan and London. Offshore borrowing and lending are market-driven and not subject to the regulations that set interest rates on the Chinese mainland. Offshore renminbi is now actively used for cross-border trade, finance and direct investment while rapid and successive waves of liberalisation are opening onshore markets to trade, financing and investment.

Secretary Chan will discuss the Renminbi market and the Shanghai-Hong Kong Stock Connect.


  • Professor K C Chan, Secretary for Financial Services and the Treasury, Hong Kong
  • Discussant: Sheila Nicoll, Head of Public Policy, Schroders
  • Discussant: Rupert Willis, Desk Officer for China, Directorate General, Economic and Financial Affairs, European Commission
  • Chair: Karen Wilson, Senior Fellow, Bruegel

About the speakers

Professor K C Chan is Secretary for Financial Services and the Treasury in Hong Kong. Professor Chan was Dean of Business and Management in the Hong Kong University of Science and Technology (HKUST) before he was appointed Secretary for Financial Services and the Treasury in July 2007. Prior to joining the HKUST Business School in 1993, Professor Chan had spent nine years teaching at Ohio State University in the United States. Professor Chan received his bachelor's degree in economics from Wesleyan University and his M.B.A. and Ph.D. in finance from the University of Chicago. He specialised in assets pricing, evaluation of trading strategies and market efficiency and has published numerous articles on these topics. Before joining the Government, Professor Chan held a number of public service positions including Chairman of the Consumer Council, Director of the Hong Kong Futures Exchange, and Member of the Commission on Strategic Development, Commission on Poverty, the Exchange Fund Advisory Committee, the Hang Seng Index Advisory Committee, and the Hong Kong Council for Academic Accreditation. He was former President of the Asian Finance Association and President of Association of Asia Pacific Business Schools.

Sheila Nicoll is the Head of Public Policy at Schroders. She joined Schroders in September 2014 although her financial services regulatory career began in 1982.Sheila was a Senior Advisor at EY in 2013/14, focused on the asset management sector having been Director of Conduct Policy at the Financial Services Authority (FSA) between 2009 and 2013, and joined the FSA as Director of Retail Firms Division in 2007. Previously she was Deputy Chief Executive of the Investment Management Association and held several policy roles at the London Stock Exchange. She is a modern Language graduate and holds a non-executive role as the Secretary of the Churches’ Mutual Credit Union.

Rupert Willis is the Desk Officer for China in the Directorate General, Economic and Financial Affairs at the European Commission. He is responsible day to day for DG ECFIN’s assessment of developments in the Chinese economy, as well as preparing forecasts and related materials, and preparations for annual macroeconomic dialogues with China. He has worked in various roles for the British government (1993 – 1997) and (since 1997) for the European Commission, across a range of policy areas (including environmental policy, the EU budget, and (more recently) on macroeconomic issues in DG ECFIN). He is an economist by training, with higher degrees in both Economics and Chinese studies.

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Wednesday 3 December 2014, 8:15-10:00 (Breakfast will be served at 8:15 after which the event begins at 10:00)
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Thu, 20 Nov 2014 09:11:17 +0000
<![CDATA[Vicious circle(s) 2.0]]> http://www.bruegel.org/nc/blog/detail/article/1484-vicious-circles-20/ blog1484

Since the beginning of the crisis – and more so since 2010 – Europeans have been looking at the sovereign-banking “vicious circle”, tying the dismal fates of States and banks together. This has emerged as a characteristic disease during the euro crisis, and one of the stated objective of the European Banking Union project was precisely to remedy it.

The idea was basically to achieve this goal in a twofold way, ex ante and ex post. On one hand, by imposing stronger and harmonised supervisory requirements (e.g. on capital) and by empowering a third-party, independent and hopefully high-quality, supervisor to oversee their fulfillment, thus rebuilding trust in supervision and in the financial sector’s health. On the other hand, if a crisis turned out to be unavoidable, the second principle consisted in limiting recourse to taxpayers’ money as much as possible therefore preventing doubts about the damage that bank rescue would inflict to the state of public finances.

The first principle was translated into practice by the creation of a Single Supervisory Mechanism (SSM) under which, on the 4th of November, the ECB took over supervisory responsibility for banks in the euro area. The second principle concretized by the introduction of the Bank Recovery and Resolution Directive (BRRD) which gives a framework for resolution of troubled banks, and by the creation of a Single Resolution Mechanism (SRM), who should ensure consistent and homogeneous application of it. Among the other provision, the BRRD contains a set of rules for the application of bail-in in bank resolution, strengthening the involvement of private creditor that de facto is already introduced by the amended State Aid framework.

Hence, there has been a remarkable shift in the European mindset about banking crisis, from a first phase in which bail-in was a taboo, to a second one in which it is considered as a new normal and welcome practice. And there is in principle nothing bad about this idea, but the question is whether in rapidly overturning the approach, European policymakers have not overlooked important weaknesses that still exists in the system and could have important consequences in the perspective of applying these new rules.

One such point of weakness could be the fact that banks are actually very substantial creditors to other banks, via cross-holdings of share as well as bank bonds. In its latest Financial Stability and Integration Report (April 2014), the European Commission reported that between 2008 and June 2013, out of the €630 bn of banks’ capital increase in aggregate terms, €400 bn correspond to increases in interbank positions and only €230 bn represent fresh capital injected from outside the banking system. Despite declining since the pre-crisis peaks, interconnectedness across banks remains high, and as of December 2013 “the counterparty for 24 percent of Euro area banking assets (or €7,400 bn) is another Euro area bank”.

Figure 1 - originally published in this Bruegel post - shows how serious the situation is in the case of Italian banks, who appear to be strongly tied together in a network of cross-holdings. Figure 2 - compiled by the Financial Times back in 2013 - shows that the Spanish system was not immune to the problem either, although less striking. In the case of Italian banks, I pointed out that strong cross holding structure (with political interference) could impede the post-stress test needed reform, but that is not the only problem it raises. As a matter of fact, we could already witness an example of possible implications at the time when the Portuguese Banco Espirito Santo was resolved, last August. The second largest shareholder of BES was in fact another bank, i.e. Credit Agricole, which on the occasion of BES restructuring ended up taking a 708 mn euro hit from its stake in BES, nearly wiping out its second-quarter net profit, which fell 97.5 percent to 17 million euros.

Banks’ bond holdings also represent a possible risk in view of resolution. Almost 40% of securities other than shares issued by banks in the euro area are held by other banks in the euro area at the aggregate level, according to ECB data, and holdings are also affected by home bias.

The charts below show Italian and Portuguese banks’ holdings of bonds issued respectively by domestic government, other domestic banks and other domestic sectors. As a comparison, holdings of bonds issued by the corresponding sectors in other euro area countries (i.e. cross border rather than domestic holdings) are also reported. it is clear (and not new) that holdings by banks of bonds issued by the domestic government have increased a lot during the crisis, in same cases reaching back to the level of the 1990s. But what is even more noteworthy is the strong increase of holdings of bonds issued by other fellow domestic banks, which seem to have been traditionally very low but are now between 7 and 9% of total assets in these two countries.

Figure 4 shows that this is not the case for French and German banks, which not only reduced (or at least did not increase significantly) their exposure to the domestic government, but which also decreased their holdings of bonds issued by other domestic banks as percentage of total assets.

It should therefore be clear that this strong interconnectedness makes the European financial system vulnerable in the context of bank resolution and rises concerns for the application of bail-in, which would become very difficult due to the possible systemic implications. In fact, as in the BES case, the creditors targeted by bail in would include to a large extent other banks, which would as a consequence fall in trouble as well. It follows naturally as a conclusion that one of the first priority for the ECB in its brand new role as supervisor should be to weigh possible measures to mitigate these problems. The ECB in its prudential exercise is including a capital add-on of 1 percent to take into account the systemic relevance of banks. This is in line with CRD IV rules, which include mandatory systemic risk buffer of between 1 and 3.5 percent CET 1 of RWAs for banks that are identified by the relevant authority as globally systemically important and also gives the supervisor an option to set a buffer on 'other' systemically important institutions, including domestically important institutions and EU-important institutions.

On top of imposing a capital buffer to limit the effect of interconnectedness once it has built up, one possible way to go would be to act on its underlying drivers to foster more diversification ex ante. There has been a lot of talk over the last years about the need to change the framework for the risk-weighting of government bonds in banks’ assets, in order to better reflect their actual degree of risk (which certainly was way above zero, during the crisis). Reports suggest that stricter rules on banks’ exposure to single counterparties could trigger a sovereign debt portfolio rebalancing in the order of €1tn across the region. The data presented here suggest that weakening the drivers of bank-bank national interconnectedness (e.g. by means of risk weights) and fostering portfolio diversification should also rank high on the priorities, in order to foster financial stability in Europe. Otherwise, we might sooner or later discover that by trying to fix the sovereign-bank vicious cycle we have instead fuelled a bank-bank one, no less dangerous.

Thu, 20 Nov 2014 07:36:01 +0000
<![CDATA[Brain drain, gain, or circulation?]]> http://www.bruegel.org/nc/blog/detail/article/1483-brain-drain-gain-or-circulation/ blog1483

For each author and mobility profile, the median across the relevant journals’ Source-Normalized Impact per Paper (SNIP) over the entire period is calculated. A SNIP impact value that is higher than one means that the median attributed SNIP for authors of that country/category is above average.

International mobility of scientific researchers is inferred from authors listed in the Scopus Custom database of peer-reviewed scientific publications, with at least two documents during the reference period, based on changes in the location of their institutional affiliation. Outflows are defined on the basis of their first affiliation. Inflows are defined on the basis of the final affiliation and exclude individual authors who "return" to their original country of affiliation.

This chart benchmarks the median quality1 of scientists leaving or moving (for the first time) to a country between 1996-2011. The size of the bubble corresponds to total flows (inflows plus outflows). Countries in red are net contributors to the international market for scientists, those in blue net recipients2.

Ideally, a country should want to be below or on the 45-degree line, indicating that the quality of the newcomers is just as high (or higher) as that of the leavers. Conditional on this, a country should also prefer a larger rather than smaller bubble, representing a sizeable flow of scientists and indicating a full exploitation of synergies gained from international cooperation. Finally, countries should aim to land in the top-right quadrant, indicating higher quality of both incoming and outgoing researchers. 

Over the long-term (pre-crisis) period analysed, Spain and the UK seemed the best placed at attracting high-quality scientists. France and Germany were broadly breaking even in terms of quality, although we note that they were facing significant net outflows of scientists, as was the UK.

All in all, in the sample here presented, while the US (unsurprisingly) comes out as the top performer in terms of net inflow of quality researchers, Italy ranks quite poorly. Not only the country is a net contributor of scientists, it also trades high quality researchers for lower quality ones. Time for a reform of the university system?

Wed, 19 Nov 2014 11:43:58 +0000
<![CDATA[Lessons from the Bank of Japan for the euro area]]> http://www.bruegel.org/nc/blog/detail/article/1482-lessons-from-the-bank-of-japan-for-the-euro-area/ blog1482

It was feared that after the consumption tax hike, the inflation expectations would be dampened too much and the Bank of Japan would miss its target

The decision of the Bank of Japan end of October 2014 to significantly expand its asset-buying programme came as a surprise. The yen weakened and stock markets rallied. The decision taken with only a small majority by the board of the Bank of Japan was taken to show the resolve of the BoJ to increase inflation expectations so that inflation eventually moves to two percent. It was feared that after the consumption tax hike, the inflation expectations would be dampened too much and the Bank of Japan would miss its target. The just released Q3 data seem to confirm that fear. Governor Kuroda was explicit on the aim to change the mindset of the public arguing that “… we could face a delay in eradicating the public's deflation mindset”.

Which lessons can the euro area and the European Central Bank draw from this recent episode of Japan’s monetary policy? I would emphasize three central lessons. The first lesson is that it is very difficult to change inflation expectations and get the public move from a deflation to an inflation mindset. This is a very important lesson for the ECB. Inflation expectations in the euro area have fallen already significantly. Five-year ahead inflation swaps signal a rate of about 1% instead of the official target of the ECB of close but below two percent. The ECB needs to avoid that markets lose even more confidence in the ECB to achieve its target. The more inflation expectations get disanchored, the more difficult it will become for the ECB to change them again. The BoJ had to step up an already very large quantitative easing programme. If the ECB wants to prevent such a scenario, it should be bolder with its policies now to ensure that inflation expectations revert quickly back to the target. 

The euro area should not neglect the role of fiscal policy. In Japan, an increase in taxes is unavoidable to achieve fiscal policy credibility

Second, the euro area should not neglect the role of fiscal policy. In Japan, an increase in taxes is unavoidable to achieve fiscal policy credibility. However, the timing of the last increase weakened the economic dynamics too early. One can also question whether the consumption tax is really the best tax to raise in those circumstances. Fiscal consolidation is also necessary in a number of euro area countries. Weaker countries are particularly fragile in a monetary union due to the absence of a central bank lender of last resort and therefore have to re-gain fiscal credibility. However, the simultaneous consolidations across the euro area until 2013 was a heavy burden on growth and contributed to the disinflationary momentum. Euro zone policy makers have now reduced the speed of consolidation. It would be useful if the new European Commission was successful in its plans to create a stimulus with Eurozone-level investment funded by common fiscal resources.

Finally, the Bank of Japan teaches us how controversial monetary policy measures can become. The narrow majority in the BoJ governing council still allows the BoJ to take bold decisions. In the euro area, a narrow majority is more difficult to sustain. This is particularly the case, if the opposing camps in the ECB governing council cut across countries of the North and of the South of the euro area. While this does not necessarily make the ECB non-operational, the resulting political pressure would certainly be higher. The risk is that the ECB would not be able to ever take decisions as bold as the BoJ is taking currently. In other words, once the Eurozone gets stuck in deflation, it may become even more difficult than in Japan to get out of it.

Important lesson to the euro area that monetary policy should act decisively while the euro area investment programme planned ought to be implemented

Overall, the recent episode in Japan provides the important lesson to the euro area that monetary policy should act decisively while the euro area investment programme planned ought to be implemented. The lesson from Japan’s experience of the 1990s should be taken on board: bold and early policies on banking reform and productivity enhancing structural reforms should be part of the policy package.

Tue, 18 Nov 2014 09:34:28 +0000
<![CDATA[The spillovers of fiscal and monetary policies]]> http://www.bruegel.org/nc/blog/detail/article/1481-the-spillovers-of-fiscal-and-monetary-policies/ blog1481

What’s at stake: Policymakers in emerging economies have repeatedly complained over the spillover effects of advanced economies’ policies in the Great Recession. As the Federal Reserve normalizes its policy, while the Bank of Japan and the ECB contemplate further easing, it remains unclear whether emerging economies possess the tools to limit undue fluctuations associated with these adjustments.

Spillovers and coordination

Olivier Blanchard, Luc Laeven and Esteban Vesperoni write that the understanding of transmission channels of spillovers has become essential, not only from an academic perspective, but also policymaking.

In a globally integrated economy, national economic policies generate international spillover effects

Anton Korinek writes that in a globally integrated economy, national economic policies generate international spillover effects. In a theoretical paper, Korinek finds that the first theorem of welfare applies and that spillovers are efficient if three conditions are met: (i) national policymakers act as price-takers in the international market, (ii) national policymakers possess a sufficient set of policy instruments, and (iii) there are no imperfections in international markets. If any of the three conditions is violated, spillover effects generally lead to inefficiency, and global cooperation among national policymakers can generally improve welfare.

David Wessel writes that if the central bank is pursuing policies that are demand-augmenting, it’s kosher. If these policies are demand-diverting, it is not. Although it’s an easy question conceptually, it’s a tougher question in practice. And it’s not only about looking at whether a government is intervening in the currency markets. When fiscal authorities are excessively tight fisted, there’s a temptation to cheer a depreciating currency and perhaps see it as a substitute for expansionary domestic policies. One might describe the recent behavior for ECB, unable to move fiscal policy and unable to move quickly on QE, as relying heavily on rhetoric to push down the euro.

Spillovers from asynchronous exit strategies

In its 2014 Spillover report, the IMF writes that normalization proceeding at different times in different advanced economies can have wider implications for interest and exchange rate movements. More-synchronized tightening cycles in the past were characterized by higher global interest rates and risk aversion, as well as modestly higher stress in sovereign bond and stock markets in emerging market economies. A less-synchronized tightening cycle this time would partly counteract the impact of higher interest rates from normalization elsewhere. Asynchronous adjustment may result in larger swings in exchange rates of major currencies that could cause problems for some economies with balance sheet vulnerabilities and foreign exchange exposures.

Normalization proceeding at different times in different advanced economies can have wider implications

Barry Eichengreen and Poonam Gupta write that the ‘tapering talk’, which started in May 2013, had a sharp negative impact on economic and financial conditions in emerging markets. Based on a cross-country empirical exercise, the authors find that there is little evidence that countries with stronger macroeconomic fundamentals (smaller budget deficits, lower debts, more reserves, and stronger growth rates in the immediately prior period) were rewarded with smaller falls in exchange rates, foreign reserves, and stock prices starting in May.

Variant perception writes that the BOJ is putting pressure on other Asian central banks. Their trade openness coupled with a strong appreciation of their currency is going to drag heavily on their growth prospects.  Other Asian countries may soon start intervening more aggressively in managing their own exchange rates as a response.

The macroprudential view of capital controls

Julien Bengui and Javier Bianchi write that central banks in emerging markets have responded to the recent surge in capital inflows by pursuing active capital flow management policies. The hope is that current efforts to curb capital in flows will reduce the vulnerability of the economy to sudden reversals in capital flows. While this macroprudential view of capital controls has gained considerable ground in academic and policy circles, the debate about their effectiveness remains unsettled. In fact, a growing empirical literature argues that there are important leakages in the implementation of capital controls, casting doubt on the effectiveness of such policies in fostering macroeconomic and financial stability. Their analysis indicates that while leakages create risk-shifting in the unregulated sphere, a planner may, nonetheless, find it optimal to tighten regulation on the regulated sphere in order to achieve higher stabilization effects.

The magnitude of fiscal spillovers is likely to depend heavily on how exchange rates respond to fiscal shocks

Barry Eichengreen and Andrew Rose write that we have little empirical knowledge of how the economy will operate if capital controls are adjusted at high frequency, since controls have historically been adjusted infrequently. Governments have rarely imposed or removed capital controls in response to short-term fluctuations in output, the terms of trade, or financial-stability considerations. Once imposed, controls stay in place for long periods. Once removed, they are rarely restored. Rather than fluctuating at a business cycle frequency, the intensity of controls tends to evolve over long periods in line with variables like domestic financial depth and development, the strength of democratic checks and balances, and the quality of regulatory institutions, which similarly evolve slowly over time.

The exchange rate response to fiscal shocks

Alan J. Auerbach and Yuriy Gorodnichenko write that the magnitude of fiscal spillovers is likely to depend heavily on how exchange rates respond to fiscal shocks. Using daily data on U.S. government military spending, they find hat unanticipated shocks to announced military spending, rather than actual outlays on military programs, lead to an immediate and tangible appreciation of the U.S. dollar. This finding is broadly consistent with a variety of workhorse models in international economics and it suggests that fiscal shocks can have considerable spillovers into foreign economies. At the same time, this finding contrasts sharply with the results reported in previous studies. Specifically, the earlier work routinely documented that the domestic currency depreciates in response to government spending shocks, which is hard to square with the predictions of classic and modern open-economy models. We argue that this difference in results is likely to arise from the mis-timing of shocks in previous papers and their use of actual spending rather than news about spending.

Tue, 18 Nov 2014 07:22:02 +0000
<![CDATA[Financing long-term investment to stimulate growth in the EU]]> http://www.bruegel.org/nc/events/event-detail/event/476-financing-long-term-investment-to-stimulate-growth-in-the-eu/ even476

New European Commission President Jean-Claude Juncker has just launched a three-year €300 billion investment plan with the aim of reviving economic growth and creating jobs primarily through infrastructure investment. One major question mark that still hangs over the initiative is how it will be financed. It would appear a significant amount of the €300 billion will have to come from leveraging existing sources of finance and tapping into private long-term capital. However many countries are concerned by the lack of willingness of the private sector to commit to long-term investments following the increased uncertainty created by the financial crisis. A number of high-level international initiatives have been launched and the G20 also has it on their agenda.

Institutional investors, such as pension funds, insurance companies and sovereign wealth funds, can play an important role in as can multi-lateral finance institutions. In this event, institutional investors will share their views on long-term investment globally and highlight some of the challenges and opportunities for long-term investment in Europe. The role that the policy can play in providing the appropriate conditions and/or incentives for long-term investment will also be discussed.


  • Michael Wilkins, Managing Director, Infrastructure Finance Ratings, Standard and Poor’s, U.K.
  • Other speakers (TBC)

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Tuesday, 9 December 2014, 12:00-14:00. Lunch will be served after the event at 13:30.
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Mon, 17 Nov 2014 13:33:37 +0000
<![CDATA[Eurosystem collateral policy and framework: Was it unduly changed?]]> http://www.bruegel.org/publications/publication-detail/publication/857-eurosystem-collateral-policy-and-framework-was-it-unduly-changed/ publ857

This Policy Contribution was prepared for the European Parliament Committee on Economic and Monetary Affairs.

All Eurosystem credit operations, including the important open market operations, need to be based on adequate collateral. Liquidity is provided to banks against collateral at market prices subject to a haircut. The Eurosystem adapted its collateral framework during the crisis to accept lower-rated assets as collateral. Higher haircuts are applied to insure against liquidity risk as well as the greater volatility of prices of lower-rated assets.

The adaptation of the collateral framework was necessary to provide sufficient liquidity to banks in the euro area periphery in particular. In crisis countries, special emergency liquidity assistance was provided. More than 80 percent of the European Central Bank’s liquidity (Main Refinancing Operations and Long Term Refinancing Operations) is provided to banks in five countries (Greece, Ireland, Italy, Portugal and Spain). The changes in the collateral framework were necessary for the ECB to fulfil its treaty-based mandate of providing liquidity to solvent banks and safeguarding financial stability. The ECB did not take on board excessive risks.

Alvaro Leandro provided excellent research assistance.

Eurosystem collateral policy and framework: Was it unduly changed? (English)
Mon, 17 Nov 2014 09:54:10 +0000
<![CDATA[The twenty-first century needs a better G20 and a new G7+]]> http://www.bruegel.org/publications/publication-detail/publication/856-the-twenty-first-century-needs-a-better-g20-and-a-new-g7-plus/ publ856

Read also Jim O'Neill and Alessio Terzi's survey of the G20 sherpas 'The world is ready for a global economic governance reform, are world leaders?'

During the 2008 financial crisis, the G20 was hastily elevated to ‘global economic steering committee’. In the early stages of the crisis, the G20 was an effective forum for crisis containment. As the crisis has eased, however, the G20 has lost both direction and momentum. Governments and policymakers have felt less need to act in unison and have rather refocused on their national agendas, as is their duty and primary function. However, effective global governance is needed permanently, not just in crisis times. It is desirable to have more representative and effective global governance that, among other things, is equipped to prevent crises rather than just react to them.

In an environment of rapid change in global patterns of trade and wealth creation, a new revamped (but highly representative) grouping should be created within the G20, to provide leadership on key economic policy matters. Euro-area members should give up their individual seats in this G7+, allowing room for China and other large emerging economies. Without euro-area countries taking such a step, it would be impossible to reconcile effectiveness and representation in this new G7+, which would take charge of decision making on global economic imbalances, financial and monetary issues. All existing G20 countries, including individual euro-area countries, would however remain in the G20, which could potentially expand and would remain the prime forum for discussion on all remaining matters at global level.

The twenty-first century needs a better G20 and a new G7+ (English)
Fri, 14 Nov 2014 17:13:41 +0000
<![CDATA[Europe’s Capital Markets Union]]> http://www.bruegel.org/nc/events/event-detail/event/475-europes-capital-markets-union/ even475

The development of a Capital Markets Union has been heralded as a key project by the new European Commission and its President Jean-Claude Juncker. In liaison with the European Commission, Bruegel will contribute to the effort to define its specific policy content. In this context, we are organising a brainstorming workshop on Monday 24 November 2014, at Bruegel in Brussels.

This event will not be public and will bring together policy officials from the European Commission and other EU and national institutions, capital markets participants, and independent experts. The agenda will be devoted, first, to taking stock on past initiatives in Europe and abroad and the current status of capital markets development in Europe, including in comparison with the United States; and second, to outlining, discussing and (to the extent possible) prioritizing the various possible components of a five-year Capital Markets Union strategy, e.g. securities and prudential regulation, accounting and auditing, the policy framework for financial infrastructure, insolvency and debt restructuring, and selected tax issues. Most of the time will be spent in a moderated conversation involving all participants.

This is a closed-door off-the-record brainstorming workshop, accessible on invitation only.

Thu, 13 Nov 2014 16:57:13 +0000
<![CDATA[From De-industrialization to the future of industries]]> http://www.bruegel.org/nc/events/event-detail/event/474-from-de-industrialization-to-the-future-of-industries/ even474

Deindustrialization is a major issue for all industrialized countries, in Europe and in America. This is also the case for Japan and Korea, two countries that have experienced an economic development based on the growth of manufacturing industries and that are particularly concerned by the rise of China in the international division of labor.

The purpose of this workshop is twofold. First, it revisits the link between deindustrialization and globalization, which is often blamed as a cause of deindustrialization, without much empirical evidence. Second, it investigates the emergence of new industries as a mean to stabilize the above trend or event to reverse it. The issues are then how to promote it and how governments can help the process.

The originality of this event is that papers that will be presented are dealing with German, French but also Japanese and Korean cases that are not well not known in Europe.

This event concludes a 3-year research program on the issues of industries coordinated by the Fondation France-Japon de EHESS (Ecole des hautes études en sciences sociales, Paris) that gave birth to various publications and debates.

Programme -

Part I: Globalization and labor market outcomes: de-industrialization, job security, and wage inequalities

9:00 Welcome Address and general introduction by Guntram Wolff (Bruegel)

  • Chair: Guntram Wolff (Bruegel)

09:15 - 09:35 Sébastien Lechevalier (EHESS): Presentation of the special issue of Review of World Economics (Volume 151, issue 2, 2015), “Globalization and labor market outcomes: de-industrialization, job security, and wage inequalities”

9:35-9:55 Sébastien Miroudot (OECD): “Is Labor the fall guy of a financial-led globalization? Offshoring and its Relations to Wage-share, Employment and Skills in France, Germany, Korea and Japan since 1995” (joint with Cédric Durand (University Paris 13))

  • Discussant: Benedicta Marzinotto (Bruegel)

9:55 Discussion and Coffee Break

10:25-10:45 El Mouhoub Mouhoud (University Paris Dauphine): “Which are the risky jobs in the globalization? The French case” (joint with Catherine Laffineur (University Paris Dauphine))

  • Discussant: Cédric Durand (University Paris 13)

10:55-11:15 Ryo Kambayashi (Hitotsubashi University): “Expansion Abroad and Jobs at Home, Revisited” (joint with Kozo Kiyota (Keio University))

  • Discussant: Kazuyuki Motohashi (The University of Tokyo)

11:25-12:25 Policy panel “The impact of globalization on national labor markets. Policy implications and recommendations“

Participants: Cédric Durand (University Paris 13), Ryo Kambayashi (Hitotsubashi University), Sebastien Lechevalier (EHESS), Mouhoub El Mouhoud (University Paris Dauphine), Guntram Wolff (Bruegel)

12:25-13:30 Lunch

Part II: Emergence and evolution of new industries: from the analysis of industrial dynamics to a political economy approach

  • Chair: El Mouhoub Mouhoud (University Paris Dauphine)

13:30-13:50 Presentation of “The path¬dependent dynamics of emergence and evolution of new industries”, special section of Research Policy (Volume 43, Issue 10, 2014, co-edited by J. Krafft, S. Lechevalier, F. Quatraro & C. Storz) by Sébastien Lechevalier (EHESS)

  • Discussant: Reinhilde Veugelers (Bruegel)

13:50–14:10 Kazuyuki Motohashi (The University of Tokyo)

  • Discussant: Lionel Nesta (OFCE)

14:20-14:40 Rinaldo Evangelista (University of Camerino): “The impact of Business services on the economic performances of manufacturing industries“

  • Discussant: Antonio Andreoni (SOAS)

14.50 Coffee Break

15:20-15:40 Lionel Nesta (OFCE): “Competition and innovation: a new challenge for economic policy in the European Union“

  • Discussant: Kazuyuki Motohashi (The University of Tokyo)

15:50-17:00 Policy panel 2: “Emergence of new industries: what can industrial and innovation policies do?”

Participants: Antonio Andreoni (SOAS), Sebastien Lechevalier (EHESS), Kazuyuki Motohashi (The University of Tokyo), Lionel Nesta (OFCE), Reinhilde Veugelers (Bruegel)

17:00 Conclusion by Reinhilde Veugelers (Bruegel) and Sebastien Lechevalier (EHESS)

Practical details

The event is jointly organised by Bruegel and The Fondation France Japon de l’EHESS.

The Fondation France Japon de l’EHESS is beneficiating from the support of the following organizations for this event: Air Liquide, EDF, EHESS, The Japan Foundation

Thu, 13 Nov 2014 13:31:39 +0000
<![CDATA[25 Years of transition in post-communist Europe - successes and disappointments]]> http://www.bruegel.org/nc/events/event-detail/event/473-25-years-of-transition-in-post-communist-europe-successes-and-disappointments/ even473

The past 25 years have seen a dramatic transformation in Europe’s former socialist economies. Most have seen major improvements in living standards. But the task of building full market economies has been harder than many expected at the start. Market-based reforms have been critical to countries’ success: those that took more front-loaded and bold reforms were rewarded with faster growth and income convergence. Analysis shows some now have more in common with advanced European countries than with other former communist economies. But for others, transition is still far from complete, and reform momentum has slowed across the board. This threatens the further convergence to Western European income levels, and risks stagnation and renewed crisis for some countries. The authors of a new IMF report examine the transition experience of the past 25 years and draw lessons for the future.


  • James Roaf, Senior Resident Representative, Regional Office for Central and Eastern Europe, IMF, Warsaw
  • Bikas Joshi Head of the Resident Representative Office of the International Monetary Fund, Moscow
  • Discussant: Zsolt Darvas, Senior Fellow, Bruegel
  • Chair: André Sapir, Senior Fellow, Bruegel

About the Speakers

James Roaf is the Senior Resident Representative heading the IMF’s Regional Office for Central and Eastern Europe, in Warsaw. Previously he was Assistant Director in the Strategy, Policy and Review Department, leading the Emerging Markets division which oversees IMF lending policy and operations, as well as covering broader EM issues. His earlier assignments in the IMF include Resident Representative in Bulgaria and the country teams handling the aftermaths of the Russia and Argentina crises. He started his career as an economist in the UK Treasury.

Bikas Joshi is the head of the Resident Representative Office of the International Monetary Fund in Moscow. Before taking up his current position in July 2013, he was the Assistant to Director in the IMF’s Strategy, Policy, and Review Department, where his responsibilities included coordinating IMF activities with international groupings such as the G20. He has had a wide-ranging career at the IMF, from working on crisis cases in Hungary and Portugal to covering countries as diverse as Mexico, Bulgaria, and Cambodia. He was part of the team that helped introduce reforms in the IMF’s lending facilities, to facilitate IMF support immediately after the global financial crisis. He holds a Bachelors degree in Economics, magna cum laude, from Harvard University, and a Ph.D. in Economics from Columbia University.

Event materials

IMF Report: “25 Years of Transition: Post-Communist Europe and the IMF” by James Roaf, Ruben Atoyan, Bikas Joshi, Krzysztof Krogulski and an IMF Staff Team

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Thursday 20 November 2014, 12:45-14:30. Lunch will be served at 12:45 after which the event will begin at 13:00.
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Wed, 12 Nov 2014 14:30:39 +0000
<![CDATA[Defining Europe's Capital Markets Union]]> http://www.bruegel.org/publications/publication-detail/publication/855-defining-europes-capital-markets-union/ publ855

The new European Commission has signalled that it will work to create a ‘capital markets union’. This is understood as an agenda to expand the non-bank part of Europe’s financial system, which is currently underdeveloped. The aim in the short term is to unlock credit provision as banks are deleveraging, and in the longer term, to favour a more diverse, competitive and resilient financial system.

Direct regulation of individual non-bank market segments (such as securitisation, private placements or private equity) might be useful at the margin, but will not per se lead to significant capital markets development or the rebalancing of Europe’s financial system away from the current dominance by banks. To reach these goals, the capital markets union agenda must be broadened to address the framework conditions for the development of individual market segments.

Six possible areas for policy initiative are, in increasing order of potential impact and political difficulty:

  1. regulation of securities and specific forms of intermediation;
  2. prudential regulation, especially of insurance companies and pension funds;
  3. regulation of accounting, auditing and financial transparency requirements that apply to companies that seek external finance;
  4. a supervisory framework for financial infrastructure firms, such as central counterparties, that supports market integration;
  5. partial harmonisation and improvement of insolvency and corporate restructuring frameworks;and
  6. partial harmonisation or convergence of tax policies that specifically affect financial investment.

Defining Europe's Capital Markets Union (English)
Wed, 12 Nov 2014 13:50:32 +0000
<![CDATA[How can Europe avoid secular stagnation?]]> http://www.bruegel.org/nc/blog/detail/article/1480-how-can-europe-avoid-secular-stagnation/ blog1480

Larry Summers crystallized an important question in a recent speech: Has the world economy entered a period of “secular stagnation”? The slow recovery in the United States since the financial crisis is his starting point and he argues that secular stagnation could also retrospectively explain features of previous decades, such as low inflation. Professor Summers had picked up an old term first coined by Alvin Hanson (1939), in his Presidential Address of the American Economic Association in 1938. Back then, Hanson focussed on the importance of (public) investment expenditure to achieve full employment. His argument was that for such investment to happen, the economy needs new inventions, the discovery of new territory and new resources, and finally, population growth.

Summers’ argument is centered on the fact that inflation rates have been falling for the past two decades and have often been lower than expected. Is a permanent fall in the equilibrium real interest rates needed to achieve full employment? Olivier Blanchard (2013) argued that it is advisable to have higher inflation rates in normal times as this makes it possible to drive down nominal interest rates more substantially so that real interest rates fall even further in crisis times. Krugman (2013) goes one step further, and even argues that the new normal may be a permanent liquidity trap, so it would therefore not be advisable to have low inflation rates in the eurozone2 and the inflation rate should be increased.

So how can we summarize the situation today in the eurozone and what policy measures can be envisaged to improve the situation? I would identify three fundamental issues facing the eurozone currently.

The first issue is a lack of aggregate demand and a corresponding fall in inflation rates. The economic recovery in the eurozone has been weak and recent data show that it may slide back into a full recession again. Correspondingly, unemployment remains very high, in particular for the young. In addition, inflation rates have been falling since late 2011, and forward-looking indicators now suggest that inflation expectations have become disanchored from the close-but-below 2 percent goal.

The second important issue is the combination of significant divergences in unit labor cost with the build-up of large levels of debt, in both the private and public sector in the eurozone periphery. The gap in unit labor costs that has opened between Italy and Germany since the beginning of the euro amounts to more than 20 percent, while the gap between France and Germany is similarly around 20 percent. At the same time, debt to GPD ratios have increased prior to the crisis mostly in the private sector while since the beginning of the crisis, high deficits have added to a substantial increase in public debt to GDP ratios, for example by more than 60 percent of GDP in Spain.

The third problem is the remaining uncertainty around the state of the banking system as well as doubts about the profitability of the system. While the European Central Bank’s (ECB) asset quality review (AQR) and stress test should remove uncertainty, the assessment by the IMF is quite clear that more restructuring may be pending.3 Non-performing loans remain high in a number of countries.

It is against these three central issues that any policy response for the eurozone has to be formulated.

Partial proposals aimed at addressing only some of the above problems are unlikely to deliver results that will satisfactorily create stable and robust growth and new employment opportunities. The solution must be found in the current context of a monetary union operating without a fiscal union, and thus there are limits on what monetary policy is allowed to do. Dealing with the problems of the eurozone therefore goes beyond the risk of secular stagnation. In fact, some of the fundamental issues may not be solvable without further steps towards fiscal union.

Three central policy measures to deal with stagnation in the euro area

First, policies need to be designed to address the demand shortage. U.S.-based Keynesians typically suggest that eurozone periphery countries should increase their deficits in response to the recession. However, this argument fails to acknowledge that debt levels have already increased substantially due to high deficits and that in a monetary union, sub-federal debt is inherently less stable. In fact, the eurozone has already used substantial fiscal resources to lessen the impact of the shock. Unless one is willing to accept the ECB as an unconditional lender of last resort, a policy recommendation to increase periphery deficits could quickly lead to renewed market stress with very harmful consequences for financial stability, which would in turn deteriorate the economic situation substantially. While one can argue that the ECB should automatically act as a lender of last resort to governments and buy governments bonds without conditions even in countries under stress, the legality of this arrangement is heatedly debated. While I would argue that the Outright Monetary Transactions (OMT) program is economically justified and legal, it certainly cannot be misread as an automatic policy to buy debt under all conditions. In fact, only a clear political consensus on the sustainability of debt in the context of a European Stability Mechanism (ESM) program would allow the activation of bond purchases from distressed countries.

4 Claeys et al (2014)

Consequently, the best way to increase eurozone demand will be by a combination of more fiscal measures in countries with strong fiscal positions and a build-up of a eurozone fiscal capacity, together with more aggressive monetary policy. Germany in particular could use its fiscal space to increase borrowing to fund public investment as well as reduce taxes on low-income households. A eurozone fiscal capacity could be built up by using existing instruments, such as the European Investment Bank (EIB), much more forcefully, for example by increasing the EIB’s leverage. Such European funds could be used to fund European investment projects as well as to support national budgets where public investment has been cut substantially recently. Monetary policy could be more aggressive by buying more bonds issued by the EIB, asset-backed securities, covered bonds as well as corporate bonds.4

5 Ruscher and Wolff (2012)

6 www.imf.org/external/mmedia/view.aspx

Second, bold measures are needed to address the substantial unit labor cost divergence and substantial debt overhang. The empirical literature is clear that countries with high unit labor costs will find it difficult to attract new and productive industry, especially if their tax levels are high.The debt overhang in the private sector in some periphery countries is holding back new investments and can lead to a negative feedback-loop between corporate debt and a weak banking system, as has been seen in Japan.5 At the same time, it needs to be made clear that unit labor costs require an adjustment in both the deficit and the surplus countries in order to be politically feasible and economically effective. I would therefore advocate for bold structural reforms such as increases in annual working hours and increases in retirement ages to address the unit labor cost problem in the deficit countries. In the surplus countries, reforms that open up professions and lead to the creation of new industries are paramount in order to achieve adjustment. The introduction of minimum wages is a riskier policy measure, but the public sector and its wage-setting can be part of the answer to support rebalancing. To deal with the high private debt levels, restructuring and reorganization in the banking system are important. One should also consider reviewing insolvency regimes and restructuring frameworks for the corporate and household sector, as has recently been argued by the IMF’s legal counsel Sean Hagan.6 Policies such as non-recourse loans for mortgages have greatly helped to reduce the debt overhang in the household sector of the U.S.

Third, the remaining banking sector problems need to be addressed. It is obvious that the ECB needs to be ambitious in its stress tests and AQR. The way the exercise has been designed largely prevents the deleveraging pressure to result in a reduction in lending. Rather, the logic of the exercise should lead to deleveraging through strengthening the capital base, and there is some evidence of such an increase having happened in the euro-zone banking system. An important question is about the right interplay between monetary policies and the ongoing bank restructuring process. Some of the ECB’s recent measures, such as the TLTRO (targeted longer-term refinancing operations) measure may delay some bank restructuring while adding little to ease monetary conditions. It would be useful to reconsider the balance between active management of the balance sheet of the ECB through unconventional measures and the policies directly aimed at supporting liquidity in the banking system.

This overall mix of policies should deliver results in terms of addressing the underlying weaknesses of the eurozone and revitalizing growth. While a lot can be done within the framework of the current institutions, this policy mix also points to the need to upgrade the European policy framework and move towards the creation of a eurozone fiscal capacity.

Some have argued that the eurozone needs a change in its inflation target to overcome the crisis and to be better equipped to deal with secular stagnation. However, I fail to see how an increase in the inflation target can be achieved in normal times without generating significant risks to the economy. One of the important features of the pre-crisis global economy was that inflation rates were falling despite loose monetary policy and arguably overly optimistic asset markets. In fact, more demand generated by monetary policy prior to the crisis would have led to even more substantial distortions in the asset markets and in the real economy. This could have triggered an even more substantial crisis than the one we are seeing currently. Perhaps more important than this rather theoretical consideration of normal times is an assessment of a potential change in the inflation target within the current situation. A change in the inflation target by the ECB from 2 to 4 percent, for example, would undermine the credibility of the ECB in many respects. On the one hand, it would undermine trust in the institution by all those who have relied on the ECB to keep inflation at close but below 2 percent. On the other hand, even now the ECB’s credibility is endangered by the fall of inflation expectations below 2 percent. Market participants fear that the ECB will not be able to push inflation up to the target level with its existing policy instruments. Instead of changing the target, the ECB would therefore be well advised to deliver bolder policies to convince markets that it is serious about achieving its current target.

To summarize, like Hansen, I believe in the importance of the structural factors that actually provide the conditions for new investment opportunities. Fundamentally, we need to know why the equilibrium interest rate has been falling globally and why the global economy has entered “secular stagnation”. Is it global demographics? Is it the lack of good investment opportunities? Certainly, these challenges need to be addressed. Also the eurozone needs to see more substantial structural policy actions to increase its long-term growth potential and to tackle the very substantial divergences between the different member states of the eurozone.

But macroeconomic policies will also have to play a larger role. One of the big problems in the eurozone has been the weakness in public investment in the last few years, in contrast to the U.S., where public investment actually increased. More European level investment in European public goods such as new and better energy and digital networks should also be undertaken. But the EU will also need a boost in domestic investment at the member state level. Monetary policy needs to be bolder and arguably the ECB has the instruments available. Overall, President Draghi’s Jackson Hole speech points the way in the right direction.7 The euro area needs bolder fiscal and structural policies, and the ECB must also play its part.

Wed, 12 Nov 2014 09:33:07 +0000
<![CDATA[“Unanimous” is the new black]]> http://www.bruegel.org/nc/blog/detail/article/1479-unanimous-is-the-new-black/ blog1479

One month has passed since the announcement of the asset purchase programmes, but pressure for action has not eased at all, for the ECB. Besides witnessing weak figures for the economic and inflation outlook, Frankfurt now finds itself in between two forces pulling in opposite directions: on one hand the FED – which is ending its stimulus – and on the other hand the Bank of Japan – which unexpectedly decided to expand its QE programme, pledging to grow the monetary base by ¥80tn ($700bn) a year.

But before taking any additional steps, the ECB needs first to assess the effectiveness of recently agreed measures, on which it has pledged quite a big reputational stake. Therefore, things are moving slowly in Frankfurt. €3.1bn in new purchases were settled last week under the third Covered bond Purchase Programme (CBPP3) and the ECB announced the appointment of executing managers for the ABS programme, which is expected to start later in November. But no additional details were revealed on the latter, most notably on whether the political opposition to purchases of ABS mezzanine tranches can realistically be overcome.

ECB watchers were however not denied their monthly dose of satisfaction. Expectations this month were high for a sparkling Q&A session, after a Reuters’ article reported the existence of strong disagreement within the Governing Council and suggested some members intended to raise openly their concerns with Draghi’s “management style”, on the occasion of an informal working dinner on Wednesday.

According to Reuters, one of the points that had caused more discontent within the Governing Council was Draghi’s statement, during the past press conferences, that the ECB’s new measures would be expected to stir the Central Bank’s balance sheet back to the level it had in 2012. Such announcement, which allegedly had not been agreed beforehand, was welcomed very well by the markets and it goes without saying that the ECB’s backtracking on it could have been disastrous.

But Mr. Draghi was not caught off guard and during the press conference he clearly showed to have internal dissent under control. He not only repeated the point about balance sheet expansion, but he did so during his introductory remarks, rather than the Q&A session. This might look like an irrelevant detail, but in Central Bank’s jargon – where every single words matters – it actually makes a substantial difference. The introductory statement is signed off by the whole Governing Council, as the ECB president himself stressed a number of times Thursday. Therefore, the inclusion of the controversial point in the introductory statement is clearly meant to show that the ECB’s latest measures are fully endorsed.

Draghi also dispelled any remaining ambiguity about the size of the balance sheet increase, clarifying that the 2012 reference is to the level reached after the second LTRO, when the ECB balance sheet was at its highest. This clarification implies a €1 trillion increase to be achieved, and it is quite important from a communication perspective, because it acts as a commitment device. On Thursday, the central bank implicitly tied its credibility to a specific target: markets know that now, and their expectations will need to be fulfilled.

Unless it wants to put its credibility at stake, the ECB will then be forced to do more, if the currently agreed measures were to prove inefficient to reach the target or the inflation outlook were to worsen. Draghi reinforced his dovish message on Thursday by saying the Governing Council unanimously acknowledges it, and by suggesting that preparatory work for this eventuality is already underway at that ECB. No hint was given about the timing, but all eyes will obviously be pointed at December Eurosystem projections. Concerning what could be done, the door was left completely open.

Despite apparent lack of action, the ECB meeting was not an irrelevant one. Draghi clearly showed that divergences of views within the Governing Council will not be allowed to put the credibility of the ECB at stake. The message delivered on Thursday was overall extremely dovish and clarified that, no matter how we got here, we should from now on consider the target of €1trillion balance sheet increase as set in stone. Such explicit commitment reinforces the credibility of the additional claim that further measures would be introduced if the target could not be reached. But it also raises the pressure on the ECB. As the bar of expectation as never been higher, divergences are likely to re-surface in the politically complex environment the ECB has to navigate through, promising much more interesting developments for the months ahead. 

Mon, 10 Nov 2014 08:49:39 +0000
<![CDATA[Monetary vs. fiscal credibility in Japan]]> http://www.bruegel.org/nc/blog/detail/article/1478-monetary-vs-fiscal-credibility-in-japan/ blog1478

What’s at stake: The damage inflicted by the introduction in April of the first major tax increase in 17 years has led to calls for postponing the next scheduled raise in the consumption tax for fear that it would, otherwise, affect the credibility of the monetary regime change. But with a debt load that exceeds 240% of GDP, several commentators believe that backtracking on the consumption tax could cause a fatal loss in Japan’s fiscal credibility.

The funny thing is that both sides of this debate believe that it’s about credibility; but they differ on what kind of credibility

Paul Krugman writes that the funny thing is that both sides of this debate believe that it’s about credibility; but they differ on what kind of credibility is crucial at this moment. Right now, Japan is struggling to escape from a deflationary trap; it desperately needs to convince the private sector that from here on out prices will rise, so that sitting on cash is a bad idea and debt won’t be so much of a burden. The pro-tax-hike side worries that if Japan doesn’t go through with the increase, it will lose fiscal credibility and that this will endanger the economy right now.

The credibility of the monetary regime change

Jacob Schlesinger writes that the anti-deflation quest would be easier if the government focused solely on that goal. It isn’t. The Finance Ministry’s top priority is curbing Japan’s outsize sovereign debt, prompting it to push through a sales-tax increase this past spring and seek another next year—even though the first set back the anti-deflation drive by depressing growth.

Paul Krugman writes that Japan should be very, very afraid of losing momentum in the fight against deflation. Suppose that a second tax hike causes another downturn in real GDP, and that all the progress made against inflation so far evaporates. How likely is it that the Bank of Japan could come back after that, saying “Trust us — this time we really will get inflation up to 2 percent in two years, no, really” — and be believed? Stalling the current drive would cause a fatal loss of credibility on the deflation front. Jay Shambaugh believes the value-added tax is problematic because it makes the inflation data difficult to read.

Kevin Drum writes that all three of the biggest central banks on the planet apparently are having trouble hitting even the modest target of 2% inflation. Are they unwilling or unable? Either way, the longer this goes on, the more their credibility gets shredded. In the past it's been mostly taken for granted that "credibility" for central banks was related to their ability to keep inflation low. Today, though, we have the opposite problem.

Fiscal credibility: then and now

There is more art than science in determining what is fiscally sustainable for a large economy with its own currency

Adam Posen writes that there is more art than science in determining what is fiscally sustainable for a large economy with its own currency. Takatoshi Ito has argued that a major reason there has not been a breakdown in or market attack on JGB trading up till now is because everybody knows you could eventually raise taxes. There is this room to raise taxes, in terms of the limited share of tax revenue in national GDP for Japan. But we are reaching the point where it is no longer a question of the Japanese government could do that when needed, but that the government should do that starting now. I do think that there is now a true market risk - not so much in the JGB market but in the Japanese equities market and in the yen exchange rate. Were the Abe government to hesitate too much or fail to commit this fall to raising the tax in 2015 as scheduled, much of the asset price gains seen in Japan since December 2012 would disappear, and credit would be disrupted.

Adam Posen writes that Japan was able to get away with such unremittingly high deficits without an overt crisis for four reasons. First, Japan's banks were induced to buy huge amounts of government bonds on a recurrent basis. Second, Japan's households accepted the persistently low returns on their savings caused by such bank purchases. Third, market pressures were limited by the combination of few foreign holders of JGBs (less than 8 percent of the total) and the threat that the Bank of Japan (BoJ) could purchase unwanted bonds. Fourth, the share of taxation and government spending in total Japanese income was low.

An experiment in fiscal consolidation with full monetary offset

Brad DeLong understands the argument if what is being advocated is not just an increase in taxes but an increase in taxes coupled with full monetary offset in the form of additional monetary goosing. Gavyn Davies writes that under such a scenario the devaluation and monetary easing would compensate for the second leg of the sales tax increase from 8 to 10 per cent due next autumn, so nominal GDP would grow at least at a 3 per cent rate and the public debt to GDP ratio would start to decline.

Mr Abe should instead announce legislation for the tax to go up by one percentage point a year, for 12 years

The Economist writes that Kuroda’s stimulus was intended to make it easier for the prime minister both to carry out structural reforms and also to raise the consumption tax. But private consumption is too weak for the economy to bear a tax rise right now. So Mr Abe should instead announce legislation for the tax to go up by one percentage point a year, for 12 years. The increases should start when the economy can bear it. That will not be next year.

Gavyn Davies writes that following its most recent announcements the BoJ will now increase its balance sheet by 15 percent of GDP per annum, and will extend the average duration of its bond purchases from 7 years to 10 years. This is an open-ended programme of bond purchases that in dollar terms is about 70 percent as large as the peak rate of bond purchases under QE3 in the US.

Mon, 10 Nov 2014 08:14:39 +0000
<![CDATA[Money matters in the euro area]]> http://www.bruegel.org/nc/blog/detail/article/1477-money-matters-in-the-euro-area/ blog1477

Would you be indifferent between holding cash in your wallet and holding a two-year maturity bond of a bank? If not, you should be interested in Divisia money calculations.

Would you be indifferent between holding cash in your wallet and holding a two-year maturity bond of a bank?

Standard simple-sum monetary aggregates, like M3 published by the ECB and other central banks, sum up monetary assets that are imperfect substitutes and provide different transaction and investment services. It is therefore difficult to interpret such aggregates.

More than three decades ago William A. Barnett from the University of Kansas initiated a theoretically better way to measure the stock of money, which is called Divisia money. Divisia monetary aggregates are available for the United States (from the Center of Financial Stability and the Federal Reserve Bank of St. Louis), for the United Kingdom (form the Bank of England) and many other countries, but not for the euro area. Using mostly US and UK data a growing academic literature found that Divisia aggregates are useful in assessing the impacts of monetary policy and they work better in econometric models than simple-sum measures of money.

No Divisa monetary aggregates are published for the euro area. In a working paper published today I calculated Divisia money indicators for the euro area. The dataset is downloadable from here. The good news is that I found that Divisia money aggregates work quite well in econometric models of the euro area and they lead to better results than simple-sum money indicators.

Divisa money works well in econometric models with better results than simple-sum money indicators.

The theoretical derivation of a Divisia indicator is demanding, but the intuition is straightforward: it is calculated by weighting the changes in different money components (like cash, demand deposits, time deposits, etc.) with their usefulness in making transactions. In practice, the weight of an asset in Divisia aggregate is influenced by the difference between two yields: the yield on an asset which does not provide transaction service but only helps to transfer wealth from one period to the next, and the yield of the asset in question. For example, the yield on cash is zero so cash has a relatively high weight, while the yield on a two-year maturity bank bond is high, so it has a relatively lower weight in Divisia calculations.

The following chart compares the 12-month percent changes in euro area M3, as published by the ECB and as calculated by us using the Divisia formula. There are some notable differences. For example, there was an acceleration of money growth in late 2006 and 2007 according to the simple sum measure, but our Divisia measure suggests that there was no major increase in money growth that time. This indicates that while the standard monetary aggregate used by the ECB suggested that inflationary pressures were increasing, this was not the case with our Divisia measure. In 2009, the growth rate of simple sum M3 fell below zero, but our Divisia indicator suggested that money growth remained positive. And in recent months the growth rate suggested by Divisia money is somewhat higher than the growth rate of the simple sum M3, which is good news as Divisia money growth used to predict nominal GDP growth. However, even the most recent money growth rate (September 2014) is well below the growth rates observed in the first half of the 2000s so the outlook is not rosy yet.

Figure 1: 12-month percent change in M3 monetary aggregates

And finally let me share one of the results of my econometric calculations. The Figure below shows the estimated response of euro-area GDP to a shock in monetary aggregates. The response of output to a Divisia shock is positive and statistically significant about 5-7 quarters after the shock. This approximately 1.5 year horizon coincides perfectly with the horizon at which monetary policy it thought to have an effect on the economy. The output level response is temporary as the impulse-response function returns to zero, which is quite sensible because we would not expect a monetary shock to have a permanent impact on the level of output. While the shape of the responses to shocks to simple-sum monetary aggregates is similar, the impulse response function is never significant.

Figure 2: Response of euro-area GDP to a shock in monetary aggregate

Note: The solid blue line indicates the point estimate of the impulse response function of real GDP to a shock in the monetary aggregate, while the dashed red lines indicate the boundaries of the 95 percent confidence band. The horizontal axis indicates the number of quarters after the shock (with the shock occurring in quarter 1).

The unmistakable conclusion is that Divisia money indicators should complement the analysis of monetary developments. I encourage the ECB to calculate and publish Divisia indices too.

Thu, 06 Nov 2014 14:11:43 +0000
<![CDATA[Does Money Matter in the Euro area? Evidence from a new Divisia Index]]> http://www.bruegel.org/publications/publication-detail/publication/854-does-money-matter-in-the-euro-area-evidence-from-a-new-divisia-index/ publ854

The purpose of this paper is to examine the possible role of money shocks on output and prices in the euro area.

Since no Divisia monetary aggregates are available for the euro area, we first create and make available a database on euro-area Divisia monetary aggregates.

We plan to update the dataset in the future and keep it publicly available.

Using different SVAR models, we find sensible and statistically significant responses to Divisia money shocks, while the responses to simple-sum measures of money and interest rates are not statistically significant, and sometimes even the point estimates are not sensible.

Does Money Matter in the Euro area? Evidence from a new Divisia Index (English)
Thu, 06 Nov 2014 12:04:21 +0000
<![CDATA[France and Germany: a moment of truth]]> http://www.bruegel.org/nc/blog/detail/article/1476-france-and-germany-a-moment-of-truth/ blog1476

France and Germany, which together account for half of euro-area GDP, are rightly considered the key to the euro area’s exit from the current impasse of low growth, falling inflation and increasingly dangerous debt trajectories. But more importantly, the German-French couple is a clear example of the need for a coordinated strategy. Their unit labour costs have diverged by some 20% since the introduction of the single currency. This would not necessarily be worrying, but the world market share of French exports has fallen by more than twice that of Germany, and the current account gap has increased by more than 8% of GDP. France has not compensated for its rising costs by higher non-price competitiveness, while the German low-cost strategy has made the country more and more dependent on foreign markets. 


The German-French couple is a clear example of the need for a coordinated strategy

The steady decline in inflation and the increase in the euro area’s current-account surplus are an indication that aggregate demand is too low in the euro area and in France and Germany. The stagnation of total factor productivity since the mid-2000s in several euro-area countries (including France) is an indication that deep reforms are needed for long-term growth to restart, and therefore for the sustainability of social systems.

To break out of the current economic impasse, a bold, coordinated Franco-German strategy is needed. It requires simultaneous implementation of measures in both countries.

Currently, there is no political consensus in France for far-reaching reforms that would encompass structural spending cuts and changes to some services market regulations, and would also improving the functioning of the labour market. This could be done, for example, by reconsidering the labour contract in order to incentivise long-term hiring, or averaging working time across the year, rather than week by week, which would be a smooth way of reducing unit labour costs. There is also, so far, no consensus in France on the need for education system reform. Such reforms would boost French productivity growth, stimulate innovation and also help to narrow the unit labour cost gap with Germany.

Before the full gain from productivity can be reaped, wages and other costs such as housing will need to grow more slowly in France than in Germany, so that the former can regain competitiveness and the latter can alleviate its excess dependence on external demand.

Germany should gear its efforts to boosting its own economic activity. Boosting domestic demand is part of the answer and could be quickly achieved through lower taxes on low-income households and a credible strategy for public investment. For this, accepting that the “black-zero” balanced budget must be given up is essential. But structural reform to develop the non-traded goods sectors, for example IT services, is also essential. The introduction of a minimum wage next year increases the need to focus on such high value-added sectors. The education system should support a shift to the new growth sectors of the 21st century, where Germany is lagging behind. This renewed economic dynamism needs eventually to lead to an inflation rate of above 2 percent, which is required to support the rebalancing.

With the prospect of an increase in demand and inflation in Germany, the French government would have more leeway to cut social contributions and social spending, and to implement far-reaching structural reforms. The French government’s recent announcements of reforms to protected sectors, although going in the right direction, will not be sufficient. Aggregate demand is not only a question of fiscal stance. France needs to reduce the uncertainty surrounding future policies, which is currently a powerful drag on private investment. Clarifying the future path of tax rates and energy and carbon prices is one issue. Agreeing on a number of medium-term fundamental objectives covering issues such as vocational training, tertiary education, lifetime working hours, the health system and housing subsidies, are needed to anchor expectations. Credibility, through political agreement on medium-term objectives is needed to trigger private investments.

The success of such a joint strategy will of course depend on what happens at euro-area level

The success of such a joint strategy will of course depend on what happens at euro-area level: on the ability to finance European Commission president Jean-Claude Juncker's €300 billion investment project with fresh money, on the willingness of the European Central Bank to do what it considers necessary to meet its target of an inflation rate “below but close to 2 percent”, and on the ability of the European Commission and the European Council to enforce the fiscal rules without suffocating the economy. France and Germany have a major responsibility as shareholders in the European Investment Bank and as direct participants in the European Council. But, equally importantly, they have a responsibility to reduce the structural divergence between them by introducing coordinated deep economic reforms at national level. 

Wed, 05 Nov 2014 16:43:11 +0000
<![CDATA[A crazy idea about Italy]]> http://www.bruegel.org/nc/blog/detail/article/1475-a-crazy-idea-about-italy/ blog1475

I've spent a good deal of my 35 years as an economic and financial analyst puzzling over Italy. Studying its economy was my first assignment in this business -- as a matter of fact, Italy was the first foreign country I ever flew to. I'm just back from a vacation in Puglia and Basilicata. Over the decades, the question has never really changed: How can such a wonderful country find it such a perpetual struggle to succeed?

Over the decades, the question of Italy has never really changed: How can such a wonderful country find it such a perpetual struggle to succeed?

All the while, Italy has pitted weak government against a remarkably adaptable private sector and a particular prowess in small-scale manufacturing. An optimist by nature, I've generally believed these strengths would prevail and Italy would prosper regardless. In the days before Europe's economic and monetary union, though, it had one kind of flexibility it now lacks: a currency, which it could occasionally devalue. These periodic injections of stronger competitiveness were a great help to Fiat and other big exporters, and to smaller companies too.

The rest of Europe had mixed feelings about this readiness to restore competitiveness through devaluation -- meaning at their expense. When discussions began about locking Europe's exchange rates and moving to a single currency, opinions divided among the other partners, notably Germany and France, on what would be in their own best interests. Many German conservatives, including some at the Bundesbank, doubted Italy's commitment to low inflation, which they wanted to enshrine as Europe's chief monetary goal. On the other hand, leaving Italy outside the euro would leave their own competitiveness vulnerable to occasional lira devaluations.

In the end, of course, the decision was made to bring Italy in. The fiscal rules that were adopted at the same time -- including the promise to keep the budget deficit below 3 percent of gross domestic product -- can be seen as an effort to force Italy to behave itself. Now and then I wondered if some saw them as a way to make it impossible for Italy to join at all. In any event, Italy found itself doubly hemmed in, with no currency to adjust and severely limited fiscal room for maneuver.

Between 2007 and 2014 Italy has done better than most in keeping its cyclically adjusted deficit under control, yet its debt-to-GDP ratio has risen sharply

The results haven't been good. It's ironic that between 2007 and 2014 Italy has done better than most in keeping its cyclically adjusted deficit under control -- yet its debt-to-GDP ratio has risen sharply. The reason is persistent lack of growth in nominal GDP, itself partly due to an overvalued currency and tight budgetary restraint.

Italy is the euro area’s third-largest economy and its third-most populous country. Given this, the scale of its debts and everything we've learned about Europe's priorities during the creation of the euro and since, I've always presumed that, in the end, Germany would do whatever was necessary to protect Italy from the kind of financial blow-up that hit Greece in 2010. Now I am starting to wonder.

Italy needs growth in nominal GDP to stop its debt burden from rising any further. Yes, it also needs to reform its economy, raise its productivity and boost its labour force to do this in a lasting way. But as long as it remains a member of the euro system, there'll be no aid from a devalued currency.

This means it needs Germany's help -- not just through greater fiscal flexibility, which is essential, but also through a rise in euro-area inflation back to the European Central Bank's target of "below, but close to, 2 percent." It will be almost impossible for the euro area to do this unless Germany itself sees consumer-price inflation rise to that rate or higher.

Come to think of it, perhaps Italy could impose a punitive tax on German tourists? I know. That would be crazy

As I travelled around Italy on this latest trip, I imagined a different kind of Germanic rigidity. How about a zero-tolerance approach to inflation that falls below target? Perhaps German citizens should pay an extra tax each year the country experiences inflation that is below but not close to 2 percent -- with the penalty increasing in proportion to the shortfall? The proceeds could be distributed to countries with a cyclically adjusted fiscal deficit of less than 3 percent and less-than-trend GDP growth. Come to think of it, perhaps Italy could impose a punitive tax on German tourists?

I know. That would be crazy. But would it be any crazier than insisting on an arbitrary fiscal-deficit rule, unadjusted for the economic cycle -- or letting demand fall so low that Europe misses its inflation target by a mile, and in a way that condemns Italy and others to endless recession? I'd say it's a close call.

Wed, 05 Nov 2014 08:56:15 +0000
<![CDATA[Assessing the European Fiscal Framework]]> http://www.bruegel.org/nc/events/event-detail/event/472-assessing-the-european-fiscal-framework/ even472

Bruegel is organizing a closed-doors off-the-record brainstorming workshop in order to assess the current European fiscal framework. The event will take place on November 17 and will consist of two sessions. The first one will focus on the technical details of the current framework and will try to determine if the methodology used to review national budget and based on the estimation of structural budget deficits needs to be reformed. The second one will be more policy-oriented and will try to assess the economic justification of the rules and their adequacy given the current situation of the Eurozone. This workshop will bring together academics, policy makers from EU institutions and national authorities, and more generally experts on this issue.


9.15-9:30 Registration

9.30 Word of welcome by Guntram Wolff, Director, Bruegel

9.35-10.45 First panel: Fiscal rules based on structural budget deficits. Can the methodology be improved?

  • Lucio Pench, Director, Fiscal Policy, European Commission, DG Economic and Financial Affairs
  • Lorenzo Codogno, Director General, Italian Ministry of the Economy and Finance, Department of the Treasury
  • Igor Lebrun, Chairman, Output Gap Working Group, and Belgian Bureau Federal du Plan
  • Wim Suyker, Programme Leader, Public Finances, CPB Netherlands Bureau for Economic Policy Analysis
  • John McCarthy, Chief Economist, Department of Finance, Ireland
  • Chair: Zsolt Darvas, Senior Fellow, Bruegel

10.45-11.00 Coffee break

11.00-12.45 Second panel: The Fiscal framework confronted to the current Eurozone situation. Is the framework adequate and economically justified?

  • Pervenche Berès, Member of the Committee on Economic and Monetary Affairs of the European Parliament
  • Thomas Westphal, Director General, European Policy, German Federal Ministry of Finance
  • Renaud Lassus, Head of Macroeconomic Policy and European Affairs, Treasury, French Economic and Finance Ministry
  • Paolo Manasse, Professor, Economics Department, University of Bologna
  • Rodolphe Blavy, Deputy Director of the Europe Office, International Monetary Fund
  • Chair: Gregory Claeys, Research Fellow, Bruegel

12.45 Lunch

Tue, 04 Nov 2014 14:34:28 +0000
<![CDATA[Young and under pressure]]> http://www.bruegel.org/nc/blog/detail/article/1474-young-and-under-pressure/ blog1474

Since the beginning of the global financial crisis, social conditions have deteriorated in many European countries. The youth in particular have been affected by soaring unemployment rates that created an outcry for changes in labour market policies for the young in Europe.

Almost 5.6 million young people were unemployed in 2013 in the European Union

Following this development, the Council of Europe signed a resolution in 2012 acknowledging the importance of this issue and asking for implementation of youth friendly policies in the Member States. Yet, almost 5.6 million young people were unemployed in 2013 in the European Union (EU) - in nine EU countries the youth unemployment rate more than doubled since the beginning of the crisis. 

In this post we draw your attention to two more indicators reflecting the social situation of the young generation: the percentage of children living in jobless households and the percentage of young people that are neither in employment nor education nor training.

Children in jobless households 

Country groups: 10 other EU15: Austria, Belgium, Denmark, Finland, France, Germany, Luxembourg, Netherlands, Sweden and United Kingdom; Baltics 3: Latvia, Lithuania, Estonia; 10 other CEE refers to the 10 member states that joined in the last decade, excluding the Baltics: Bulgaria Czech Republic, Croatia, Hungary, Poland, Romania, Slovenia, Slovakia, Cyprus and Malta; Sweden: data for 2007 and 2008 is not available, the indicator is therefore assumed to evolve in line with the other 9 EU15 countries. Such approximation has only a marginal impact on the aggregate of the other EU15 countries, because children in jobless HHs in Sweden represented only 3% of the country group in 2009. Countries in groupings are weighted by population. 

The indicator Children in jobless households measures the share of 0-17 year olds as a share of the total population in this age group, who are living in a household where no member is in employment, i.e. all members are either unemployed or inactive (Figure 1). 

In the EU28 countries this share rose only slightly over the past years to 11.2%. It is striking, however, that the ratio of children living in households where no one works more than doubled in the euro-area programme countries (Greece, Ireland, Portugal) as well as in Italy and Spain to 13% and 12%, respectively. And even more shocking - while the share stabilized in the programme countries, in Italy and Spain it is still sharply increasing. In Ireland in 2013 more than one in every six children lived in a household where no one worked. This is indeed an alarming development. Only the Baltics, which experienced a very deep recession among the first countries hit by the crisis, are reporting a sizable turning point in the statistic in 2010 and the share is presently continuing to decline. The numbers are, however, still well above pre-crisis levels. 

In Ireland in 2013 more than one in every six children lived in a household where no one worked.

A high share of children living in jobless households is not only problematic at the moment but can also have negative consequences for the young people’s future since it often means that a child may not only have a precarious income situation in a certain time period, but also that the household cannot make an adequate investment in quality education and training (see a paper on this issue written for the ECOFIN Council by Darvas and Wolff). Therefore a child’s opportunities to participate in the labour market in the future are likely to be adversely affected. Moreover, as I discussed in a blog post earlier this year, children under 18 years are more affected by absolute poverty than any other group in the EU and the generational divide is widening further.

Not in Education, Employment or Training (NEET)

The financial situation of young people between 18 and 24 years old who finished their education is less dependent on their parents income because they usually enter the labour market and generate their own income. Therefore we are going to have a closer look on their work situation, i.e. how many young people have difficulties participating in the labour market.

The NEET indicator measures the proportion of young people aged 18-24 years which are not in employment, education or training as a percentage of total population in the respective age group. We can see in Figure 2 that the situation among EU28 countries stabilized over the last four years.

The good news is that for the first time since 2007 we see a decline in the rate in the euro-area programme countries in 2013. This decline is, however, mostly driven by Ireland with an unchanged situation in Greece and Portugal. Also, in the Baltics the ratio is on a downward trend. More worrying, however, is the situation in Italy and Spain.

Among all EU28 countries, the young generation in Italy is disproportionately hit

Among all EU28 countries, the young generation in Italy with 22.2% of all young people being without any employment, education or training, is disproportionately hit by the deterioration in the labour market. Every fifth young person between 18 and 24 is struggling to escape the exclusion trap. Europe and especially Italy is risking a lost generation more than ever. 

Labour market policies for young people should therefore stand very high on the national agendas of Member States. The regulations introduced in summer 2013 into the Italian labour market reform which are setting economic incentives for employers to hire young people build an important step towards more labour market integration of the youth in Europe. Their effects are yet to be observed in the employment statistics in the coming years in Italy. More action on the national and European level is needed to improve the situation of the young.

Tue, 04 Nov 2014 13:13:59 +0000
<![CDATA[The decline of U.S. labor under-utilization]]> http://www.bruegel.org/nc/blog/detail/article/1472-the-decline-of-us-labor-under-utilization/ blog1472

What’s at stake: Slack in the American labor market is being absorbed quickly, but the actual size of the gap remains an open question. While most FOMC participants consider that the decline in the unemployment rate overstates the improvement in labor market conditions, the FOMC chose this week to no longer characterize the degree of labor underutilization as “significant”.

The FOMC’s upgraded language on slack

Business Insider write that Fed-watchers noticed that a word was missing from the most recent characterization of the labor market. Back in September, the FOMC wrote in its statement that “a range of labor market indicators suggests that there remains significant underutilization of labor resources”. On Wednesday, the FOMC upgraded its language to “underutilization of labor resources is gradually diminishing”. The exclusion of the word "significant" was no accident, and for monetary policy experts it was a signal that the labor market has improved so much that an initial interest rate hike would come sooner than later.

Brad DeLong writes that the Federal Reserve policy right now is reasonable only if the unemployment rate is taken as a sufficient statistic for the state of the labor market. Jan Hatzius writes that the explicit phrase in the FOMC statement that 'underutilization of labor resources is gradually diminishing' is factually correct, but the implicit notion that underutilization is no longer 'significant' — the term used in the July and September statement — looks inconsistent with the employment and wage data. Specifically, the focus on the drop in the unemployment rate below 6% ignores two important aspects of labor market slack—labor force participation and involuntary part-time employment. Looking at the July 2013 – September 2014 trend of the unemployment rate U6 and the total employment gap, Goldman economists find that these measures are only on track to normalize by early/mid-2016.

Gavyn Davies writes that until recently the focus for was mainly on the falling participation rate as the chief reservoir of under-utilized labor, but the center of gravity of Fed thinking on this now seems to have changed towards the more hawkish view that most of this decline is structural. However, this shift is more than compensated by increasing conviction that another reservoir of under-utilized labor exists, in the form of people who are forced to work part time when they would prefer to work full time.

Mark Zandi writes that the perspective that the amount of slack is still considerable because we don’t see wage growth is challenged by recent data collected from payroll processing records for about one-fifth of all US workers, which show a definitive, broad acceleration in wage growth. The hourly wage rate for jobholders is the most telling. It is up 4.5% from a year ago in the third quarter, a strong and steady acceleration from its low two years ago.

Tim Duy writes that the upgraded language of the Fed on underutilization and the fact that the 2% inflation target looks more and more like a ceiling rather than a symmetric target raises the possibility that labor data will trump inflation data in policy considerations.

The uncertainty in slack measures

Cleveland Fed economists write that Estimates of labor market slack can diverge a great deal depending on how slack is defined. There are different ways to measure slack, and they don’t always give the same answer. Indeed, some of these differences are reflected in the minutes of that same FOMC meeting: “Participants generally agreed that … labor market conditions had moved noticeably closer to those viewed as normal in the longer run. Participants differed, however, in their assessments of the remaining degree of labor market slack and how to measure it.”

Cleveland Fed economists write that the seemingly simple question of how much slack is in the labor market is not so easy to answer. Even when we focus exclusively on the unemployment rate as the sole measure of the state of the labor market, slack estimates can differ greatly depending on the way the natural/long-run unemployment rate is estimated. One method calculates it as a function of long-run trends market flows both into and out of unemployment. Another method follows Gali, Smets and Wouters (2012) to calculate the “flexible wage counterfactual”. A third approach follows Stella and Stock (2012) to decompose the unemployment series into a trend part, a cyclical part, a seasonal part, and a random noise part. A fourth approach involves forecasting as in Beauchemin and Zaman (2011). A fifth approach relies on the connection between inflation and labor slack. The figure below illustrates these different methods give different answers.

The Labor Market Conditions Index

Business Insider writes that the index was first "made famous" by Fed Chair Janet Yellen in her speech at Jackson Hole, when she said, "This broadly based metric supports the conclusion that the labor market has improved significantly over the past year, but it also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions."

Tim Duy writes that Yellen's claim that it provides information above and beyond the unemployment rate is questionable with a simple look at the cumulative change of the index compared to that of unemployment. And her halfhearted claims are even more telling given that she was the impetus for the research. If it was policy relevant, you would think she would be a little more enthusiastic (think optimal control). Moreover, the faster pace of recovery of the index compared to previous recessions - as clearly indicated by the Fed - seems completely at odds with the story it is supposed to support. Simply put, the press and financial market participants should be pushing the Fed much harder to explain exactly why this measure is important.

Mon, 03 Nov 2014 08:58:23 +0000
<![CDATA[Pulling the eurozone back from the brink]]> http://www.bruegel.org/nc/blog/detail/article/1471-pulling-the-eurozone-back-from-the-brink/ blog1471

On October 14, as yet another financial storm gathered over Europe, the European Court of Justice convened in Luxembourg. In the coming months, the ECJ will assess the German Constitutional Court’s ruling that the European Central Bank’s “outright monetary transactions” (OMT) scheme – which allows the ECB to purchase weaker eurozone countries’ government bonds, in exchange for compliance with the rules of the European Stability Mechanism (ESM) – is illegal.

The mere announcement of OMT – the eurozone’s most potent crisis-management tool – immediately calmed panicked markets in the summer of 2012, prompting ECB President Mario Draghi to describe it as “the most successful monetary-policy measure undertaken in recent time[s].” That is why the German court’s ruling earlier this year that OMT oversteps the ECB’s authority under the Lisbon Treaty was met with consternation.

The German court did, however, pause to ask the “Europe-friendly” ECJ – the ultimate arbiter of European law – for its opinion. And, once the 2012 financial-market panic subsided, it seemed possible that OMT may have served its purpose, without ever having to be called to duty.

Europe may be facing another moment of reckoning, and the scenarios are bleak. Suddenly, the ECJ’s deliberations have become much more important

Then, earlier this month, amid slowing global growth, German economic indicators swooned, the risk premium on Greek sovereign bonds spiked, and ECB statistics showed that investors were pulling out of Italy. Europe may be facing another moment of reckoning, and the scenarios are bleak. Suddenly, the ECJ’s deliberations have become much more important.

Of course, this storm may blow over. But others will undoubtedly arise. The eurozone economy faces a grimmer outlook than at any time since the start of the global financial crisis in 2008. Growth prospects have been steadily downgraded; public debt/GDP ratios have risen dramatically, despite – or, some might argue, because of – unrelenting fiscal austerity; household debt burdens are not falling; and Italy’s vicious circle of rising debt and falling prices will soon be the fate of other stressed eurozone economies.

Moreover, all feasible policy options to jump-start growth – including a bold, eurozone-wide (not just German) fiscal stimulus and substantial, internationally coordinated euro depreciation – have been ruled out. Simply put, the eurozone is fragile, and it lacks a reliable safety net.

The OMT scheme could provide that safety net. But the German court’s case against it is strong. Indeed, it is based on the ECB’s own judgment validating the ESM (the eurozone’s existing effort to create a firewall against financial crises).

The German Constitutional Court and the ECJ agree that the Lisbon Treaty prohibits the ECB from taking action to support a sovereign on the verge of insolvency; that is a fiscal and political issue. Central-bank best practice follows the same view. The ECB’s argument that the OMT program’s primary purpose is to prevent a eurozone breakup is unconvincing to the German court, for only a nearly insolvent sovereign would risk breaking up the union.

The ECJ may ask the ECB to dilute its OMT promise

The ECJ may ask the ECB to dilute its OMT promise. Even Jörg Asmussen, former member of the ECB Governing Council, conceded to the German court that the “unlimited” purchases pledge contravened the treaty and would thus have to be limited. After all, once such purchases are initiated, the market will likely test the ECB to find out where it will draw the line.

Worse, the ECB has made an ambiguous promise to share losses with private creditors if a distressed sovereign does not eventually repay its debts. If the ECJ reverses this provision, OMT is unlikely to survive.

If, instead, the ECJ finds a legal argument to validate the scheme – and the German court, sensitive to current financial uncertainties, acquiesces – the ambiguities will be pushed aside, to be addressed later. A loss incurred by the ECB on an OMT operation would create a fiscal liability for Germany (and others), with far-reaching political consequences. (The recently leaked minutes of the ECB’s Governing Council meetings highlight the differences between Draghi and Bundesbank President Jens Weidmann’s views, adding to operational concerns about OMT.)

The problem is that none of these discussions addresses the fundamental flaw in the eurozone’s structure: It is an incomplete monetary union. Eurozone countries surrendered monetary sovereignty, but remain loath to pay for one another’s fiscal mistakes.

Unwilling to confront that issue, the eurozone authorities are consumed with tweaking trivialities like the degree of “flexibility” in the fiscal rules and the ECB’s dubious plan to purchase asset-backed securities. All the while, they are relying on Scarlett O’Hara’s credo: “Tomorrow is another day.”

A financial guarantee like OMT can work wonders to dampen market fears and ease pressure, but only if it is credible. If it is not, it is likely to fail spectacularly.

The authorities have pulled the eurozone back from the brink before. Is it too late to do so again?

To avoid such an outcome, Europe’s leaders should agree to share, with full transparency, whatever losses the ECB incurs from its OMT operations, thereby giving OMT the political legitimacy it needs to serve as an effective safeguard for the eurozone. Such an agreement could, however, prompt a public referendum in Germany, at which point all bets would be off.

Whatever its flaws, OMT is the closest thing to a safety net the eurozone has. The authorities have pulled the eurozone back from the brink before. Is it too late to do so again?

Sun, 02 Nov 2014 11:15:40 +0000
<![CDATA[Held og lykke, Commissioner Vestager]]> http://www.bruegel.org/nc/blog/detail/article/1470-held-og-lykke-commissioner-vestager/ blog1470

Tomorrow, new European Commissioner Margrethe Vestager will take control of the Commission’s most powerful tool: the enforcement of European Union competition law. She will have the power to block mergers or require the sale of companies’ assets for deals go through. She will be able to fine companies that breach antitrust rules up to 10 percent of their global turnover. She can oblige EU member states to take back subsidies granted to firms if the money gives an unfair advantage.

The power of the European Commissioner for Competition needs to be exercised with care

Such power needs to be exercised with care. Vestager inherits a number of high profile and sensitive cases: Google's alleged self-bias in internet search, Gazprom’s alleged excessive gas prices, the tax-sweetener cases involving Apple, Starbucks and Fiat. In addition, there are new possible merger waves and industrial restructuring and ongoing high profile cartel cases in the financial sector. Although enforcement is strictly governed by law, the Commission retains a margin of discretion in assessment; appeals are rare (more than two-thirds of antitrust abuse cases are resolved without ending up in court), meaning there is often no independent check on the Commission's analysis. Vestager’s discretionary power will therefore play a crucial role – especially in the major pending cases, in which the Commission's decisions will potentially have a huge impact on firms and markets.

But the apparent advantage of discretion can quickly turn into a burden for competition commissioners.  Given the high stakes, it exposes them to pressure to take bad decisions. For example, the Commission might be asked to act against successful foreign companies, because domestic industry fears their competition or because their prices are regarded as excessive and should thus be curbed to reduce input costs. Member states might fight hard to promote their own industries. For instance, they could claim that mergers that imply higher prices for European consumers are the only solution that allows European businesses to invest and regain prominence in global markets.

The new commissioner will only be able to negotiate the political swamp and shield her services from unsubstantiated criticism if she sends a clear, credible signal that her assessments will be guided by economics and that any decision taken will ultimately benefit consumers.

A company should be deemed guilty not merely by holding significant market power

An example is abuse of dominance cases. A company should be deemed guilty not merely by holding significant market power; it should be proved that such power is misused to penalise competitors and that ultimately consumers would suffer from it. An antitrust case against Google in the United States was cleared by the Federal Trade Commission because it found that even if Google’s algorithm penalises competitors, it might nevertheless improve American users’ experience by swiftly addressing their search queries.

Likewise, mergers that result in savings that compensate for reductions in competition should be cleared, and the existence of such efficiency gains should be duly acknowledged. At the same time the causal link between a merger and its benefits should be carefully and transparently substantiated, because higher investment levels are never obvious when market competition is reduced. For example, for more than a decade, US telecoms companies have been allowed to enjoy a significant degree of market power. In the 2003 Organisation for Economic Cooperation and Development country ranking for fixed broadband penetration, the US ranked tenth. In 2013, the US had dropped to sixteenth. Countries that implemented a pro-competition policy demonstrated a better investment performance. Vestager can reconcile business and consumer interests if operators can trust that future antitrust decisions will correctly capture the interplay between short-term effects (such as potential price increases) and dynamic/long-term effects (such as a potential supply of new or better products). Antitrust empowers consumers, who can threaten to switch suppliers, forcing companies to perform and innovate. But it also guarantees that innovative companies are fully rewarded for their efforts. Antitrust enforcement can be a resource for business, not a problem.

Antitrust enforcement can be a resource for business, not a problem

As the father of capitalism Adam Smith wrote: “consumption is the sole end and purpose of all production; the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of consumer”. By heeding Smith’s wisdom, Ms Vestager will get the most out of her new job in the interest of the European economy.

Fri, 31 Oct 2014 09:20:47 +0000
<![CDATA[Building Entrepreneurial Ecosystems in Europe]]> http://www.bruegel.org/nc/events/event-detail/event/471-building-entrepreneurial-ecosystems-in-europe/ even471

Policy makers in Europe are seeking ways to create jobs and spur economic growth. Entrepreneurship, particularly the creation of innovative young firms, is needed yet many challenges to the creation and growth of firms remain. This event will highlight some of the barriers and how to address them as well as help identify steps that policy makers can take to facilitate the development of entrepreneurial ecosystems in Europe as well as models for collaborative innovation, which in turn can spur more high growth entrepreneurship.


10.30-10.35 Welcome: Guntram B. Wolff, Director, Bruegel (TBC)

10:35-11:15 Keynote: Elżbieta Bieńkowska, European Commissioner for Internal Market, Industry, Entrepreneurship and SMEs (TBC)

11.15-12.30: Session 1 - Drivers of entrepreneurial ecosystems

Entrepreneurship flourishes in areas which have a vibrant entrepreneurial ecosystem consisting of a collaborative mix of start-ups, large firms, universities, funders and others. There has been a growing interest in the “phenomenon” of ecosystems from policy makers, researchers and practitioners, particularly as a number of countries have attempted to create Silicon Valley clones. In Europe, as well as in other parts of the world, an increasing number of entrepreneurial ecosystems have developed (Cambridge, Berlin, etc.).

Some recent research will be presented, followed by an interactive discussion.

Discussion questions:

  • What are the drivers behind the creation and growth of entrepreneurial ecosystems?
  • Who are the key players in the ecosystems that have evolved in Europe?
  • How do the models different from the U.S. and other regions?
  • Are top-down or bottom-up approaches more successful?

Chair: Karen Wilson, Senior Fellow, Bruegel

Introduction by Chair and presentation of initial Bruegel research findings

Speakers (TBC)

Q&A and Roundtable discussion

12:30-13:00 Lunch

13.00-14.15: Session 2 – Collaborative Innovation: Facilitating links between large and small firms

Collaborative innovation, particularly when established and young, dynamic firms work with established firms to commercialize new ideas, can promote long-term growth and enhance competiveness. Such collaborations are critical in helping young, entrepreneurial firms to scale up, while enable established firms to address innovation challenges. However, companies collaborating in this way must overcome a number of challenges, including searching and finding the right partner in networks, designing the most effective capital and governance structure, applying mechanisms to share and benefit from IP, building a positive business case and being organizationally and culturally ready to engage.

Recent research by the World Economic Forum will be presented, followed by an interactive discussion.

Discussion questions:

  • What determines whether a firm will face one or more of these challenges?
  • Which of these challenges are firms likely to face when they pursue disruptive innovation as opposed to efficiency driven innovation?
  • What kinds of strategies do or should firms employ to overcome these challenges?
  • How do these strategies differ among established and young firms?
  • How could a shifting context in technology or business context influence the strategies?

Chair: Nicholas Davis, Director, Head of Europe, World Economic Forum

Introduction by Chair and brief overview of preliminary insights of the World Economic Forum project “Collaborative Innovation, Transforming Business, Driving Growth”

Speaker (TBC):

Q&A and Roundtable discussion

14.15-15.30: Session 3 – Policies to promote entrepreneurial ecosystems

Chair: Karen Wilson, Senior Fellow, Bruegel

Policies can play a role in helping to facilitate an entrepreneurial ecosystem that fosters collaborative innovation. However, more evidence is needed regarding which approaches and policies are most effective. In this session, those involved in efforts to support the development of entrepreneurial ecosystems and collaborative innovation will present their perspectives and experiences. This will be followed by a discussion with workshop participants to identify potential policy recommendations to be given to the new European Commission as well as national governments.

Discussion questions:

  • What is the most appropriate role of policy in fostering entrepreneurial ecosystems?
  • What are some examples of policies which have or haven’t worked?
  • Which policies might be adopted by the new Commission and how can these policies be implemented most effectively?
  • What policies or incentives might be most effective in fostering collaboration between start-up entrepreneurs and large companies?

Speakers (TBC)

Q&A and Roundtable discussion

15.30 Concluding remarks by Pierre Moscovici, European Commissioner for Economic and Financial Affairs.

16.00 Close

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Tuesday 2 December 2014, 10.30-16.00
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Thu, 30 Oct 2014 13:25:33 +0000
<![CDATA[Mapping Competitiveness with European Data]]> http://www.bruegel.org/nc/events/event-detail/event/470-mapping-competitiveness-with-european-data/ even470

Competitiveness is at the heart of policy making at the Union level and specifically within the Eurogroup. Definition of new country–level competitiveness indicators is an essential task.

This half-day workshop will discuss how to map competitiveness with European data, specifically the future potential of matching data in Europe within and across countries.


9.00- 9.30 Registration and Breakfast

9.30-12.30 Session I- Mapping Competitiveness with European Data

Technical Workshop with experts on future potentials of matching data in Europe within and across countries. Final input for Blueprint 1

9.30 – 9.45 Introduction: László Halpern (Project Coordinator)

9.45 – 10.30 Presentation of main findings and policy recommendations of Blueprint 1

  • Davide Castellani (LdA) and Andreas Koch (IAW)

10.30 – 11.00 Coffee Break

11.00 – 11.30 Discussants

  • Lauro Panella, European Commission
  • Jan Hagemejer, Central Bank of Poland

11:30-12:30 General discussion

12.30- 13.30 Lunch

13.30-16.30 Session II: Private workshop for project partners

This workshop will be held in the framework of the MAPCOMPETE Project. The aim of this project is to provide a thorough assessment of data opportunities and requirements for the analysis of comparative competitiveness in European countries.

Read more about the project.

Download MAPCOMPETE flyer -

Practical details

Partners of the project are Brussels based think tank Bruegel, Budapest based research center CERS–HAS (coordinator), Milan research centre LdA, Paris School of Economics and Sciences–Po in Paris, and Tübingen research institute IAW. Associate partners are the OECD, the ECB and several central banks in Europe.

Wed, 29 Oct 2014 11:13:43 +0000
<![CDATA[Monday blues for Italian banks]]> http://www.bruegel.org/nc/blog/detail/article/1469-monday-blues-for-italian-banks/ blog1469

On Sunday, the ECB and EBA published the results of their comprehensive assessment of banks balance sheets, and Italian banks where the worst performers. The stress tests singled out 25 banks that would be falling short of the 5.5% minimum CET1 threshold, based on data as of end 2013. But once the measures already enacted in 2014 are taken into consideration, the number of banks failing the test is reduced to 13. Of these, 4 are Italian.

Banca Monte dei Paschi di Siena, Banca Carige, Banca Popolare di Vicenza and Banca Popolare di Milano will need to raise respectively 2.1bn, 0.81bn, 0.22bn and 0.17bn, for a total of 3.31bn. It is the largest share of the total net (of capital raised in 2014) shortfall of 9.5bn identified from the test.

13 banks are found to effectively fail the ECB stress tests. 4 of them are Italian

Markets gave Italy a very rude awakening on Monday morning. Milan stock exchange closed on Monday at -2.4%. By the end of the trading session MPS had lost 21.5% and was valued at 0.79 euros, whereas Carige ended the trading day down by 17% at a value of just under 0.08 euros per share.

But leaving the market reaction aside, the truth is that beyond capital some long-lived problems of the Italian banking sector have by now been known for a while but not addressed. In this respect, the comparison with a country like Spain - where the banking system has been subject to a deeper monitoring and restructuring during the financial assistance programme of 2012-13 - may yield striking insights.

First, the Italian banking system is still keeping in place a strong liason dangereuse with the (huge) government debt. This is not at all a special feature of Italian banks (as Figure 1 shows) but with almost 80% of their sovereign long direct gross exposures concentrated on Italy, Italian banks are found in this supervisory exercise to be among the most exposed to the sovereign debt issued by the domestic sovereign. Actually, if one excludes the countries that have been or are under a EU/IMF macroeconomic adjustment programme, Italian banks are the most exposed in the Eurozone (Figure1 and Figure 2 left).

Note: Long Direct Gross Exposure

Sovereign debt accounts for 10% of Italian banks asset on average and the home bias in debt portfolio seems to have increased since the last EBA test

More interestingly, the exercise shows that this “home bias”, which is deeply at the root of the sovereign-banking vicious circle that characterised the euro crisis, has even worsened over the last three years. Domestic exposure has grown (rather than decreased) as a percentage of total sovereign exposure on the books of all those banks that were already tested in 2011 with the exception of UniCredit (Figure 2).

Note: Long Direct Gross Exposure

Sovereign debt accounts by now for around 10% of total assets of Italian banks, on average. The carry trade on these holdings might have kept banks afloat over the last 3 years, but these gains are actually concealing deeper structural issues that Italian banks have - until now - never been forced to facein full.

One such long-known problem of the Italian banking system is profitability, which is (and has been for quite a while now) very low. According to ECB data, average return on equity has been negative over the period 2010-2013 and the comparison with Spanish banks is especially striking. After the huge drop in return on equity during 2012, Spanish banks recovered, whereas Italian banks seemed to have never done it (Figure 2).

After the huge drop in return on equity during 2012, Spanish banks recovered, whereas Italian banks seemed to have never done so

Differences between Italy and Spain are evident also in the reliance on Eurosystem liquidity and the pace of reimbursement, which until very recently has been significantly slower in Italy than in Spain (Figure 3 right). Italian banks have borrowed less - in absolute terms - from the ECB facilities, but have been sticking to the central bank liquidity for longer, accelerating reimbursements only in recent months. This may be explained by the fact that their alternative funding is relatively more expensive than it is for Spanish banks. Interest rates paid by Italian banks on retail (households’) deposits is in fact still significantly above those paid by their Spanish equivalents, not to mention German banks. More interestingly (and worryingly) deposit interest rates in Italy have only very recently started to drift downwards, contrary to Spain, where convergence has started earlier and moved faster.

These few elements depicts a gloomy Italian banking system which has been spared - until now - from the deeper monitoring and restructuring that have been undergoing in Spain and other programme countries, but at the cost of finding itself stuck in a limbo where lack of capital (in some cases), low profitability (in general) and rising bad loans are hindering credit and therefore further harming the potential recovery.

Even if the economic cycle were to improve and bad loans to subside, the low profitability will stick due to structurally high costs and inefficiencies

As pointed out, among others, by RBS’ Alberto Gallo, this is not a sustainable situation. Even if the economic cycle were to improve and bad loans to subside, the low profitability will stick due to structurally high costs and inefficiencies (such as Italy’s very high concentration of bank branches and length of the judicial process, for example).

One possible answer to these issues could be consolidation, which has been important in Spain but basically absent in Italy. This is partly due to specific features of the Italian banking structure, which make such reform very difficult. In particular, as shown in figure 4, banks are closely bound together by equity cross holdings in which bank foundations play often a significant role. And bank foundations are often dominated by local politics (see for example this summary account of professional politicians presence in Italian banks’ foundation boards), which may hinder consolidation on the bases of various (not necessarily economic) interests. This suggests that a meaningful reform process in the Italian banking system can hardly go separate from a deep restructuring of this governance structure.

Needed consolidation is made difficult by a corporate governance structure that is strongly tied with local politics

All these problems are long known, but have not yet been addressed. In our (Italian) language, there exists a fascinatingly peculiar expression: La Bella Figura. While it is impossible to appropriately convey all the nuances of its meaning, it could be broadly translated with “nice appearance” and it fits well also to the attitude that has until now been kept about the Italian banking system’s need for reform. Hopefully the stress test results will act as a wake up call, forcing some to finally acknowledge the importance of  substance over form.

Tue, 28 Oct 2014 14:10:10 +0000