Blog Post

The Weekender

Dear All, I’m writing these lines from Paris after a few days in Naples where I participated in a conference on the future of the Arab Spring.   There are important debates to follow both in the world economy and on the geopolitical front. On this note, the meeting between PM Netanyahu and a suddenly […]

By: Date: March 5, 2012 Topic: Macroeconomic policy

Dear All,

I’m writing these lines from Paris after a few days in Naples where I participated in a conference on the future of the Arab Spring.
There are important debates to follow both in the world economy and on the geopolitical front. On this note, the meeting between PM Netanyahu and a suddenly more Hawkish President Obama on Monday is important to follow. It could, somewhat paradoxically, reduce the risks of a unilateral Israeli strike and therefore take away some risk premium from energy markets.
I will focus on:
1.    The Target 2 debate and the Bundesbank
2.    The aftermath of the Arab Spring

1. Target 2 debate and the Bundesbank
Until recently, the debate about balances between National Central Banks (NCBs) in the eurosystem was limited to experts and central banking geeks. Jeremie Cohen-Setton and myself had covered it this summer in one blog review that is still a good background document on the matter (as well as this post by Silvia Merler).

But as Jean Pisani-Ferry explained, the debate has profoundly changed last week with the suggestion that the Bundesbank had written a letter to the ECB asking a return to stricter collateral rules and expressing concerns over the rise of Target 2 balances.

I previously questioned the willingness of the ECB to do any and everything necessary to preserve the integrity of the euro area. Limitations of target 2 balances would inevitably precipitate a discussion about euro exit or at least about a dual currency regime as Harold James and others seem to consider as the smoothest way to organize a devaluation within a monetary union.

That being said, this target 2 debate raises important questions.

i. First, it is true that these balances help to limit real sudden stops by effectively allowing the NCB of a country in difficulty to continue to refinance its banking sector by drawing on the eurosystem and increasingly so with ELA and the LTRO’s softer collateral rules. This allows slower current account adjustments.

ii. The implicit transfer associated with the financing of the external imbalance (Current Account or capital account) is de facto larger in a set up that limits fiscal transfers. In the eyes of the Bundesbank, the target 2 system in fact allows to hide some form of fiscal transfers from political and democratic oversight, a clear case of fiscal dominance.

iii. Finally and related to point (ii), this system (along with softening of the collateral requirement) also forces the ECB to take on more credit risk albeit fairly contingent (on EMU break up) but credit risk still.

One has to interpret Weidmann’s letter along all these three dimensions because the Bundesbank knows very well that Target 2 balances are economically natural in a monetary union (see the Bundesbank’s own Monthly Bulletin on the matter). Hence, the intent of this letter is not to debate the technical aspects but it is eminently political.

On point (i) the Bundesbank clearly wants to flag how much transfers a monetary union require. By deciding to raise its hand on the target 2 balances, the Bundesbank will inevitably start a debate about all the underlying transfers involved with a monetary union. This is an important debate to have indeed and it is probably right for the eurosystem to flag to the public and to policymakers that monetary unions do involve large transfers. But this debate cuts both ways: it can either precipitate a rejection of the monetary union or accelerate the creation of a framework at the European level that facilitates fiscal transfers and therefore reduces monetary transfers.

This leads to point (ii) and (iii) and the fact that the Bundesbank is also realizing that although it is only taking “contingent” risk, it is taking a growing amount of credit risk. As it steps further into “fiscal dominance”, Weidmann’s letter should also be read as a warning shot to governments that there is only so far the ECB can go. This is basically another of these calls upon governments to live up to their responsibilities.

Finally, (and this is a point I’m borrowing from Bernard Connolly), Weidmann is very (partly because of his time at the Chancellery) aware of the possible future legal and constitutional challenges to the current financial assistance framework. Indeed, in the context of a future ESM challenges before the Courts, hypothetical plaintiffs (Hans-Werner Sinn for instance) could be raising the point that there were hidden transfers that create a risk to German tax-payers without the explicit consent of the Bundestag.

In essence, the Weidmann letter is consciously and publicly trying to convince in advance the Karlsruhe Constitutional Court that the ELA, the LTRO and the resulting target 2 balances are really limited in scope, time and that they are not permanent mechanisms that would require substantially more political oversight.

This leads me to a final point, which I think is the most important take away of last week’s eurogroup meeting. Draghi would have confirmed to the eurogroup that there wouldn’t be no more such LTRO. A gesture that should pacify the governing council and respond favorably to the Bundesbank’s letter.
2. Arab Spring
I took part in a very interesting conference organized by the German Marshall Fund last week attended by a few senior representatives of international financial institutions, former diplomats and politicians from a few countries in North Africa. I came back more concerned than I was in the first place.

There is a growing diplomatic and political vacuum surrounding key aspects of the political and economic transition in this region.

On one hand, Europe seems completely self-absorbed by its own crisis and therefore largely ignores what is happening on the other side of the Mediterranean sea while it could open a new area of cooperation, address some of its long term challenges (ageing…) and help launch a future important trading partner.

On the other hand, the US adopts a more distant policy of leading from behind and is unlikely to do anything bold before the elections next year. In addition, and maybe more fundamentally, one shouldn’t underestimate the degree to which US energy dependency is changing. Better production in the Gulf of Mexico, in Alaska and more important natural gas in South Dakota contribute to bring the US on track to energy self sufficiency in the next 5 to 10 years. The US’ interest in the region could therefore decline meaningfully.

All in all, this international context is such that there is a total absence of political and economic anchor following the Arab Spring and that these transitions are largely left adrift following the tumultuous current of their idiosyncratic political dynamics. This is a dangerous state of affairs and in this context, the well meaning international financial institutions that want to provide financing will most probably under-deliver and fail to address the economic frustrations that are at least partially at the root of these uprisings.

It is urgent that Europe wakes up to the urgency of the situation and that it lays out a vision for its relations with this region in the next 20 years. It is likely to be left alone without the US to formulate this. It is unlikely to be anything close to EU membership but there are a number of other important pillars that could contribute to regional stability and advancement.

All Mediterranean countries could for instance, over time, become full members of the Council of Europe. This would set in motion important political changes, democratization and enshrine a new relation with the rule of law. One shouldn’t underestimate the degree to which Turkey’s membership has contributed to open its society. From the economic standpoint, it is paradoxically what would be the most useful for the region’s development that seems the hardest for Europeans. A customs union for agricultural goods could be very beneficial to the region. Eventually, after economic, social and environmental reforms, the region should be granted a form of access to the single market. The combination of these two objectives (political and economic) could be very powerful to ground the transition process in the region.

Short of that, local politics and a difficult economic climate could leave the region in chaotic and endless political transition. There is unfortunately no more time to be taking time, in the next few months, in the absence of determined action, Tunisia and Egypt will most likely experience a proper Balance of Payment of crisis. An IMF program, as much as it might be necessary is not an intelligent transitional device. The EU owes something better to this region, and to itself.
I will be looking at the fiscal compact in more details next week. I think we should start to live with the idea that this fiscal compact could face serious ratification challenges (in Ireland, but also maybe in France…). This could be an opportunity to negotiate a better treaty but it could also be a very disruptive political moment for Europe.

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 about event More on this topic

Upcoming Event

May - Jun


Improving understanding of productivity, its drivers and the way we measure it.

Speakers: Carlo Altomonte, Eric Bartelsman, Marta Bisztray, Peter Bøegh Nielsen, Italo Colantone, Maria Demertzis, Wolfhard Kaus, Javier Miranda, Steffen Müller, Hannu Piekkola, Verena Plümpe, Niclas Poitiers, Andrea Roventini, Gianluca Santoni, Valerie Smeets, Nicola Viegi and Markus Zimmermann Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author



Taming inflation?

What are the implications of prolonged inflation?

By: The Sound of Economics Topic: Macroeconomic policy Date: May 25, 2022
Read about event More on this topic

Past Event

Past Event

How can we support and restructure firms hit by the COVID-19 crisis?

What are the vulnerabilities and risks in the enterprise sector and how prepared are countries to handle a large-scale restructuring of businesses?

Speakers: Ceyla Pazarbasioglu and Guntram B. Wolff Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 25, 2022
Read about event

Past Event

Past Event

[Cancelled] Shifting taxes in order to achieve green goals

[This event is cancelled until further notice] How could shifting the tax burden from labour to pollution and resources help the EU reach its climate goals?

Speakers: Niclas Poitiers and Femke Groothuis Topic: Green economy, Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 12, 2022
Read about event More on this topic

Past Event

Past Event

How are crises changing central bank doctrines?

How is monetary policy evolving in the face of recent crises? With central banks taking on new roles, how accountable are they to democratic institutions?

Speakers: Maria Demertzis, Benoît Coeuré, Pervenche Berès, Hans-Helmut Kotz and Athanasios Orphanides Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 11, 2022
Read article Download PDF More by this author

Book/Special report

European governanceInclusive growth

Bruegel annual report 2021

The Bruegel annual report provides a broad overview of the organisation's work in the previous year.

By: Bruegel Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: May 6, 2022
Read article Download PDF

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article Download PDF More on this topic

Working Paper

The low productivity of European firms: how can policies enhance the allocation of resources?

A summary of the most important policy lessons from research undertaken in the MICROPROD project work package 4, related to the allocation of the factors of production, with a special focus on the weak dynamism of European small and medium-sized enterprises (SMEs).

By: Grégory Claeys, Marie Le Mouel and Giovanni Sgaravatti Topic: Macroeconomic policy Date: April 25, 2022
Read article More on this topic

External Publication

What drives implementation of the European Union’s policy recommendations to its member countries?

Article published in the Journal of Economic Policy Reform.

By: Konstantinos Efstathiou and Guntram B. Wolff Topic: Macroeconomic policy Date: April 13, 2022
Read article Download PDF More on this topic More by this author

Working Paper

Measuring the intangible economy to address policy challenges

The purpose of the first work package of the MICROPROD project was to improve the firm-level data infrastructure, expand the measurement of intangible assets and enable cross-country analyses of these productivity trends.

By: Marie Le Mouel Topic: Macroeconomic policy Date: April 11, 2022
Read about event More on this topic

Past Event

Past Event

Macroeconomic and financial stability in changing times: conversation with Andrew Bailey

Guntram Wolff will be joined in conversation by Andrew Bailey, Governor of the Bank of England.

Speakers: Andrew Bailey and Guntram B. Wolff Topic: Macroeconomic policy Date: March 28, 2022
Read article


European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Load more posts