Blog Post

Why we should listen to Tim Geithner

In this op-ed, Guntram Wolff comments on Tim Geithner’s encouragement to eurozone leaders to collaborate in order to avoid a financial melt-down and his proposal to use EFSF guarantees and capital more efficiently by leveraging it with ECB money. In his visit to Poland, Tim Geithner has urged eurozone leaders to collaborate and avoid a […]

By: Date: September 18, 2011 Topic: Macroeconomic policy

In this op-ed, Guntram Wolff comments on Tim Geithner’s encouragement to eurozone leaders to collaborate in order to avoid a financial melt-down and his proposal to use EFSF guarantees and capital more efficiently by leveraging it with ECB money.

In his visit to Poland, Tim Geithner has urged eurozone leaders to collaborate and avoid a financial melt-down. He urged to use EFSF guarantees and capital more efficiently by leveraging it with ECB money, thereby increasing the firing power of the EFSF for buying government bonds. This mechanism would immediately ease the crisis and may even be cheaper than all the other options currently followed. It also does not amount to a monetary financing of government debt. Here is how and why.

The mechanism would essentially give the EFSF access to ECB liquidity[1]. The ECB would immediately stop its bond purchasing program and transfer this task to the EFSF. This will help increase ECB independence and separate clearly monetary policy from fiscal policy. The EFSF would start buying government bonds of countries with significant spreads and would repo the bonds with the ECB. The ECB would not increase its overall liquidity provisioning as it would fully sterilize the liquidity provided by providing less liquidity to the banking system directly. The ECB would set a haircut that is in line the fundamental solvency risk of the country. By doing so, the solvency risk would remain with the EFSF. A ten percent haircut would allow the EFSF to leverage its resources by a factor of ten. Its firing power could thereby increase to up to 3500 billion euros.

In the face of such a large fund, markets would immediately stop speculating against the euro area sovereigns under stress. Indeed, investors that were speculating against peripheral bonds would quickly lose a lot of money. This outcome was recently confirmed in a simulation with real market participants organized by Bruegel and the Peterson Institute (download event summary). In fact, market participants in the simulation reacted positively to the new mechanism when it was proposed in the simulation. Spreads to Germany narrowed strongly and overall market stress was reduced. In addition, the ECB could stop its costly securities markets program.

In the discussions among participants after the simulation, market participants agreed that the new mechanism would immediately ease problems. It was argued that the mechanism would probably not be tested for quite some time. However, many players warned that even while the short-term financing and budget problems of Greece were eased, all the debtor countries needed to continue on a path of fiscal consolidation and structural reform in the years ahead. The new mechanism would leave unresolved the issue of how structural reforms could be fostered and conditionality imposed. Ultimately, it would therefore risk being tested again by the market. The proposed mechanism should therefore be seen as a way of buying time only. But the mechanism is more compatible with incentives for reform than the current mechanism that relies on the ECB stepping-in to avoid a financial meltdown. Since it relies on the EFSF where every government has a veto right, its introduction would increase the incentives for structural reforms as the countries participating in the EFSF could at any stage decide to discontinue their support in case of severe misbehavior of a country. At the same time, given the size of the fund, market speculation could be ended thereby giving the time to move forward with a new economic governance framework that would allow much stronger control of public budgets and structural reform progress.


[1] This proposal was already made by Gros and Meyer (2011).


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article Download PDF
 

Parliamentary Testimony

European ParliamentInclusive growth

Understanding the socioeconomic effects of the COVID-19 pandemic on women

Testimony before the European Parliament's Committee on Economic and Monetary Affairs (ECON) on the consequences of the pandemic on women.

By: Maria Demertzis and Mia Hoffmann Topic: European Parliament, Inclusive growth, Macroeconomic policy Date: October 27, 2021
Read about event More on this topic
 

Upcoming Event

Nov
4
14:00

European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Petra Geraats, Wolfgang Lemke and Francesco Papadia Topic: Macroeconomic policy
Read about event More on this topic
 

Upcoming Event

Nov
9
11:00

Phasing out COVID-19 emergency support programmes: effects on productivity and financial stability

How can European countries phase out the COVID-19 support measures without having a negative impact on productivity and financial stability?

Speakers: Maria Demertzis and Laurie Mayers Topic: Macroeconomic policy
Read article More by this author
 

Opinion

European governance

Can EU fiscal rules jump on the green bandwagon?

By and large, setting a new green golden rule would be a useful addition to the existing EU fiscal framework.

By: Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: October 22, 2021
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read about event
 

Past Event

Past Event

Monetary policy in the time of climate change

How does climate change influence monetary policy in the eurozone? What potential monetary policy measures should be taken up to address climate risks?

Speakers: Cornelia Holthausen, Jean Pisani-Ferry and Guntram B. Wolff Topic: Green economy, Macroeconomic policy Date: October 20, 2021
Read article More by this author
 

Podcast

Podcast

Rethinking fiscal policy

A look at the past, present and future of fiscal policy in the European Union with Chief economist of the European Stability Mechanism, Rolf Strauch.

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: October 20, 2021
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

External Publication

Global Economic Resilience: Building Forward Better

A roadmap for systemic economic reform calling for step-change in global economic governance to increase resilience and build forward better from economic shocks, prepared for the G7 Advisory Panel on Economic Resilience.

By: Thomas Wieser Topic: Global economy and trade, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Opinion

Letter: Declining investment may explain why rates are low

Perhaps an analysis of the causes of the declining investment rate would bring us closer to explaining why real interest rates are so low.

By: Marek Dabrowski Topic: Macroeconomic policy Date: October 1, 2021
Read article More by this author
 

Podcast

Podcast

A green fiscal pact

How can the European Union increase green public investment while consolidating budget deficits?

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: September 29, 2021
Read article More on this topic More by this author
 

Blog Post

Monetary arithmetic and inflation risk

Between 2007 and 2020, the balance sheets of the European Central Bank, the Bank of Japan, and the Fed have all increased about sevenfold. But inflation stayed low throughout the 2010s. This was possible due to decreasing money velocity and the money multiplier. However, a continuation of asset purchasing programs by central banks involves the risk of higher inflation and fiscal dominance.

By: Marek Dabrowski Topic: Macroeconomic policy Date: September 28, 2021
Load more posts