Transcript Slide 1

The euro crisis so far
• Susan Senior Nello
• University of Siena
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The introduction of the euro
• Following the decision on which countries should join
the euro of May 1998, from January 1999 the euro
emerged as a virtual currency and conversion rates of
the various member currencies were irrevocably fixed.
It is perhaps a reflection of how strong the political
commitment to EMU was during this period that the
process proceeded smoothly and without strong
speculative attacks against currencies.
• In June 1998 the European Central Bank (ECB) came
into operation.
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The introduction of the euro
• From 1 January 2002 12 EU countries
replaced their national currencies with euro
notes and coins. Only three of the then EU
member states remained out of what became
known as the ‘eurozone’ or ‘euro area’: the UK,
Denmark and Sweden.
• Slovenia joined from January 2007, Cyprus
and Malta from 2008, Slovakia in 2009 and
Estonia joined in 2011.
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The theory of optimum currency areas
(Robert Mundell)
• A currency area is defined as a group of countries that
maintain their separate currencies, but fix the
exchange rates between themselves permanently.
They also maintain full convertibility among their
currencies, and flexible exchange rates towards third
countries.
• The problem then becomes determining the optimum
size of the currency area and, more specifically,
deciding whether it is to the advantage of a particular
country to enter or remain in a currency area.
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Cost/benefit analyses of
economic and monetary union
• Most theoretical assessments of whether countries
should join together to form an economic and monetary
union take the traditional optimal currency area approach
as a starting point, but attempt to assess the various
costs and benefits.
• In general it is assumed that the costs of forming an
economic and monetary union will fall, and the benefits
will rise as the level of integration increases.
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The benefits of economic and
monetary union 1:
• a saving in transaction costs;
• increased transparency in comparing prices;
• encouraging the creation of deeper and wider capital markets;
• increased trade;
• possible economies of scale in holding international reserves;
• use of the euro as an international reserve could yield
seigniorage;
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The benefits of economic and
monetary union 2:
• the introduction of a common monetary policy
which may permit countries to ‘ borrow
credibility’;
• improved location of industry;
• neo-functionalist spill-over into other integration
areas, and
• increased weight of the member countries at a
world level.
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The main costs of EMU are:
• the problem of ‘one size fits all’ arising with a single interest
rate and loss of the possibility of exchange rate changes
between the member states. The role of the exchange rate
mechanism is to compensate asymmetric shocks, i.e. shocks
that affect the countries involved in different ways. But how
effective is the exchange rate mechanism in correcting
asymmetric shocks? McKinnon (1962) argued that with more
trade openness, the cost of giving up an independent currency
is less;
• the psychological cost of losing a national currency;
• the technical costs of changeover;
• loss of seigniorage for some member states;
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Table 9.2 Price increases of food products in Italy
between November 2001 and November 2002
Source: De Grauwe (2009), Table 7.3, p.161, reproduced by permission of Oxford University
Press.
Breakfast items (bread, snack s)
Pasta, bread, rice
Beverages
Meat, eggs and fresh fish
Cold cuts
Canned food
Fruit and vegetables
Frozen food
Average
23.3%
20.1%
32.9%
22.1%
27.5%
30.9%
50.8%
23.6%
29.2%
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The Maastricht convergence
criteria:
• Successful candidates must have inflation rates no more than
1.5 per cent above the average of the three countries with the
lowest inflation rate in the Community.
• Long-term interest rates should be no more that 2 per cent
above the average of that of the three lowest inflation
countries.
• The exchange rate of the country should remain within the
‘normal’ band of the ERM without tension and without initiating
depreciation for two years.
• The public debt of the country must be no more than 60 per
cent of GDP.
• The national budget deficit must be no more than 3 per cent of
GDP.
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The 5 tests for the UK to adopt the
euro
• Convergence: Are business cycles and economic structures
compatible so that Britain can live comfortably with common
euroland interest rates on a permanent basis?
• Flexibility: If problems emerge is there sufficient flexibility to deal
with them?
• Investment: Would adopting the euro create better conditions for
firms taking long-term decisions to invest in the UK?
• The City of London: How would adopting the euro affect UK
financial services?
• Stability, growth and employment: Would adopting the euro help
to promote higher growth, stability and a lasting increase in jobs?
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Monetarists vs. Economists
Source: Figure 4.2 (p. 76 from The Economics of Monetary Union(2009) by De Grauwe, Paul. By
permission of Oxford University Press.
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The European System of Central
Banks
The European System of Central Banks (ESCB)
is composed of the European Central Bank
(ECB) and the national central banks (NCBs) of
all EU member states.
The ‘Eurosystem’ is the term used to refer
to the ECB and NCBs of the countries that have
adopted the euro. The NCBs of member states
that do not participate in the euro area are
members of the ESCB with a special status as
they do not take part in decision-making with
regard to the single monetary policy for the
euro area.
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The main tasks of the Eurosystem
(1)
• To maintain price stability. According to the
TFEU, this is to be the ‘primary objective’.
The ECB has adopted two policy guides to
carry out this task: a reference value for
monetary policy and an inflation target of 2
per cent or less over the medium term.
•
• To support general economic policies. This is
a secondary function, only to be carried out
without prejudice to price stability.
• To define and implement monetary policy for
the euro area.
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The main tasks of the Eurosystem
(2)
• To conduct foreign exchange operations.
• To hold and manage foreign reserves.
• To ensure the smooth operation of the payments system and
supervision by the relevant authorities.
• To contribute to the smooth conduct of policies pursued by the
competent authorities relating to the prudential supervision of
credit institutions, and the stability of the financial systems’ .
However, the ECB was not originally responsible for supervision
of banks and financial institutions. Article 127/6 TFEU allows
the Council acting unanimously to ‘confer specific tasks upon
the European Central Bank concerning policies relating to the
prudential supervision of credit institutions and other financial
institutions with the exception of insurance undertakings’.
September 2012: a more active role for the ECB in supervision
of banks was proposed.
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The independence of the ECB 1
The TFEU tries to ensure the independence of ECB by:
•forbidding the ECB to lend to ‘Union institutions, bodies, offices or
agencies, central governments, regional, local or other public
authorities…’ (Article 123).
•The article also prohibits monetary financing or the ‘direct purchases’
of debt instruments from these bodies by the ECB or national central
banks.
• In the second part of Article 123 it is specified that ‘Paragraph 1 shall
not apply to publically owned credit institutions which, in the context of
the supply of reserves by central banks, shall be given the same
treatment by national central banks and the European Central Bank as
private credit institutions’
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The independence of the ECB 2
•Stipulating that the ECB should not ‘seek or take
instructions from Union institutions or bodies, from
any Member State or from any other body’ (Article
130).
• Requiring that members of its Executive Board
(a President, Vice-President and four other
members) be appointed for 8-year non-renewable
terms (Article 283).
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The early years of the euro
• The celebrations for the first decade of the euro were
surprisingly positive, and the websites of the ECB and
European Commission to commemorate its first ten
years hardly make any mention of the crisis.
• In its first decade the average inflation rate in the
eurozone was 1.98 per cent, and growth was 2.1 per
cent for 1999-2008.
• But there were underlying imbalances and the one
size interest rate did not fit all.
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Growth nominal wages in the EU in 20002010
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Balance of payments end of first quarter
2012 by eurozone country
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Table 11.1 Public deficit and debt in the EU
Source: Eurostat ©European Union 2011.
Government deficit/surplus
Government debt %
Government
Government debt %
% GDP
GDP
deficit/surplus
GDP
2009
2009
% GDP
2009
2009
BE
-6.0
96.7
LU
-0.7
14.5
BG
-4.7
14.8
HU
-4.4
78.3
CZ
-5.8
35.4
MA
-3.8
69.1
DK
-2.7
41.6
NL
-5.4
60.9
DE
-3.0
73.2
AU
-3.5
66.5
EE
-1.7
7.2
PL
-7.2
51.0
IE
-14.4
64.0
PT
-9.3
76.8
EL
-15.4
115.1
RO
-8.6
23.7
ES
-11.1
53.2
SL
-5.8
35.9
FR
-7.5
77.6
SK
-7.9
35.7
IT
-5.3
115.8
FI
-2.5
44.0
CY
-6.0
56.2
SW
-0.9
42.3
LT
-10.2
36.1
UK
-11.4
68.1
LI
-9.2
29.3
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The incomplete Single Market for financial
services
• The introduction of Economic and Monetary Union (EMU) in the
EU was not matched by parallel progress in evolving a single
market for financial services. After years of light-touch regulation
and supervision of the financial sector, EU banks were highly
over-leveraged when the crisis began. The incompleteness of the
Single Market for financial services meant that instruments for
regulation and supervision of EU banks were inadequate.
• The ECB was not alone among central banks in focussing on
price stability and failing to take adequate account of interest rate
decisions on the behaviour of banks. Excessive lending led to
property bubbles in Ireland, Spain and Slovenia, and
subsequently private indebtedness lead to problems of public
deficits and debt in these countries.
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Some key dates in the
international economic crisis
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August 2007 Problems in the US mortgage market spilt over into the
interbank market
Sept. 2008 Default by Lehman Brothers.
Oct. 2008 The US Congress passed TARP (the Troubled Asset Relief
Program which authorised expenditure of up to $700 billion.
Major central banks jointly announced that they were prepared to take
measures to ease tensions in money markets.
Feb. 2009 USA presented plans for a support package including up to $1
trillion in a Public-Private Investment Program to purchase troubled
assets.
July 2010 US President Obama signed the Dodd-Frank Wall Street
Reform and Consumer Protection Act relating to the regulation and
supervision of the U.S. financial system.
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The Eurozone crisis
Figure 11.7 Monthly sovereign bond yields in 2010/11
Source: Eurostat data, © European Union, 2011.
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Monthly sovereign bond yields in 2012
(January-July)
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The epicentre of the crisis shifts
to the eurozone
• Jan. 2010 Greek sovereign debt crisis worsens: deficits are at
least double those reported.
• May 2010 Agreement on an EU/IMF package of assistance for
Greece. Bail-out fund for eurozone countries of up to €750 billion,
including a special-purpose European Financial Stability Facility
(EFSF). The ECB decided to intervene in markets to buy 10-year
government bonds (the Securities Market Programme), and to
exempt the Greek government from minimum credit requirements
on collateral.
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The Irish Crisis 1
• Following Ireland’s entry to the eurozone in 1999, low interest
rates and inflows of foreign capital allowed Irish banks to borrow
heavily to finance the Irish property boom.
• Politicians who relied on developers, builders and bankers for
electoral support helped to fuel the construction bubble with tax
breaks and failure to tighten regulation.
• In September 2009 the Irish government introduced guarantees
for the debts of six Irish banks, maintaining this was necessary to
prevent systemic collapse.
• In March 2010 the NAMA (the National Assets Management
Agency) came into operation as a ‘bad bank’ to acquire bad
property loans at a steep discount from the banks.
• The results of the stress tests published in July 2010 were
positive for all the Irish banks.
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The Irish Crisis 2
• If the bank bail-out costs are also included, the Irish
budget deficit rose to about 32 per cent of GDP in
2010, with public debt of 98.6 per cent.
• The financial turmoil precipitated a fall of government
in Ireland, and the question of loss of national
sovereignty was hotly debated in the Irish press.
• November 2010: agreement was reached on a €85
billion bail-out package for Ireland
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The bail-out funds
• At the time of the Irish bail-out, it was agreed to set up a
permanent European Stability Mechanism (ESM) for dealing with
debt crises in the eurozone with an effective lending capacity of
€500 billion.
• In March 2012 The Eurozone finance ministers agreed to allow
the temporary EFSF to continue to run for a year in parallel with
the permanent ESM. The overall ceiling for ESM/EFSF lending,
as defined in the ESM Treaty, was raised to €700 billion.
However, from mid-2013, the maximum lending volume of ESM
will be €500 billion, its initial level.
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The bail-out funds
• In April 2012 it was agreed to increase IMF resources
by $430 billion. With the lending ceiling of €700bn of
the EMS/EFSF and the amounts already committed
under the Greek Loan Facility and the EFSF, the
overall eurozone firewall amounts to €800bn
($1060bn). With the IMF financing the total sum
available amounts to some $1500bn.
• A banking license for the ESM?
• Decision of the German Constitutional Court of
September 2012.
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The summer of 2011: The Portuguese bailout and fears of contagion
• In March 2011 the Portuguese Prime Minister
Socrates resigned when the Parliament rejected the
fourth set of austerity measures in a year and in May
2011 also Portugal was granted a €78 billion bail-out
from the EU and IMF.
• There were worries of contagion to larger eurozone
countries in particular in August 2011 when the spread
on ten-year bonds Spain and Italy widened. In 2010 it
was estimated that Ireland accounted for 1.7 per cent
of eurozone GDP, Portugal for 1.9 per cent, Greece for
2.6 per cent, but Spain for 11.4 per cent and 12.7 per
cent for Italy.
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Fear of contagion
• In the face of widening spreads on long-term bonds,
the ECB extended it purchases of bonds on secondary
markets to Spain and Italy.
• Austerity packages introduced by the Berlusconi
government were considered inadequate and failed to
assuage markets and in November 2011 a
government of technocrats under Mario Monti was
formed.
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The debate about Eurobonds
• Eurobonds would entail euro area sovereign
debts being jointly guaranteed by member
states of the eurozone, and would have the
expected advantage of lowering borrowing
costs for peripheral countries.
• US experience under Hamilton.
• Different proposals to render the idea more
palatable to countries such as Germany.
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Reform of EU governance and the debate
about fiscal union
• The package of six legislative proposals (known as the ‘SixPack’) published by the European Commission in September
2010.
• At a European Council meeting of February 2011 Germany, with
the backing of France, tabled a ‘Competitiveness Pact’.
• In March 2011 agreement was reached on a Euro-Plus Pact.
Britain, the Czech Republic, Hungary and Sweden remained out
of the Pact and the European Stability Mechanism.
• At the European Council of January 2012 agreement was
reached by 25 countries on the proposed intergovernmental
Fiscal Compact treaty. British Premier David Cameron
remained isolated vis-à-vis all the other member states.
• Many of the Commission’s ‘Six-Pact’ proposals have entered into
force, in particular, with a package of December 2011.
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The package on economic
governance of December 2011
• Stronger preventive action through a reinforced Stability and
Growth Pact (SGP) and deeper fiscal coordination.
• Stronger corrective action through a reinforced Stability and
Growth Pact.
• Minimum requirements for national budgetary frameworks
• Preventing and correcting macroeconomic and
competitiveness imbalances
• Application of the new economic governance rules was to be
reinforced by ‘reverse qualified majority’ voting whereby a
Commission recommendation or proposal to the Council is
considered adopted unless a qualified majority of member states
votes against it.
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The Longer-Term Refinancing
Operations (LTRO)
• In December 2011 the Governing Council of the ECB agreed an
unprecedented measure to allow unlimited quantities of cheap 3year loans to banks.
• Under the scheme known as LTRO (longer-term refinancing
operations) in December 2011 523 banks borrowed €489 billion
roughly equivalent to 5 per cent of the GDP of the eurozone. In a
second stage of the LTRO scheme the ECB lent a further €529.5
billion to some 800 banks in February 2012.
• In order to receive the unlimited three-year loans the banks had to
provide collateral, and this created difficulties for some of the
banks most in need of liquidity. To meet this situation the ECB
also made adjustments to what could be considered as collateral.
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The ongoing Greek crisis
• The EU and IMF had long been pointing to the persistent failure
of Greece to complete the fiscal and structural reforms requested
in return for the €110 billion bail-out of May 2010.
• Greece had suffered five years of recession, and pro-cyclical
austerity measures worsened the situation.
• It was largely the high interest rates on refinancing debt that
pushed the Greek debt-to GDP ratio from 113 to 163 per cent in
three years.
• In late 2011 agreement in principle appeared to be reached on a
second bail-out for Greece, with a haircut or ‘voluntary’
restructuring of outstanding Greek bonds and implementation of
further austerity measures. The Greek Prime Minister Papandreu
announced that he would hold a referendum on the package, but
was forced to step down in favour of a crisis coalition.
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Fear of exit from the euro by Greece
or another member state
• The EU Treaty does not foresee exit from the euro, though Article
50 of the Lisbon Treaty allows for exit from the EU.
• Exit would probably involve a plethora of legal cases over
redenominated contracts, a run on banks, bank failures, and
massive capital exodus in the expectation of substantial
devaluation. Capital controls would probably be necessary to
prevent currency leaving the country.
• There would be inflationary pressures resulting from higher prices
of imports after devaluation. Printing and distributing a new
currency would also involve technical costs and would take time,
ruling out the possibility of secrecy or surprise. Debt default,
increased poverty and widening income disparities would be
difficult to avoid.
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Contagion
• With Greek exit it would be difficult to avoid bank runs
in other peripheral countries, and possibly also
elsewhere due to the still wide, though reduced
exposure of banks.
• Banks had been cutting cross-border lending since
mid-2010, but this process accelerated in the first half
of 2012, reflecting worries that euro break-up would
lead to capital controls and tighter regulation.
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The second Greek bail-out
• In March 2012 €14.5 billion of Greek debt was due for repayment
so the need to finalise agreement on a Greek deal became more
urgent.
• The Troika of European Commission, ECB and IMF offered a
€130 billion bail-out and lower interest rates on bail-out loans to
Greece provided an additional list of reforms was approved.
• The conditions for the private sector involvement (PSI) or
‘voluntary’ restructuring of Greek sovereign debt were rendered
more stringent. In February 2012 the restructuring or ‘haircut’
agreed was 53.5 per cent on €206 billion of Greek debt.
• It was hoped that this would reduce Greek debt from 160 per cent
of GDP to 120.5 per cent by 2020.
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Towards a bail-out for Spanish
banks 1
• In March 2012 the new Spanish prime minister Rajoy announced
that the target for the government deficit was to be raised from
4.4 per cent (agreed by the previous government with the EU) to
5.8 per cent of GDP for 2012.
• This was said to be necessary because the country was in
recession and the 2011 deficit had been higher than forecast. EU
partners subsequently endorsed the new target.
• Additional problems also arose from fiscal laxity and
mismanagement at the level of some autonomous regional and
municipal governments.
• The government tightened fiscal austerity, introduced labour
market reforms and required banks to set aside an extra €54
billion of bad loan provisions and capital buffers in 2012.
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Towards a bail-out for Spanish
banks 2
• There were worries about Spanish banks and their failure to
recognise the full extent of their loan losses as a result of property
investments in the decade to 2007.
• In particular, extra capital was needed for the nationalised
Bankia, which had been formed out of seven former savings
banks. As in Greece, bank deposits were shrinking as clients
moved their capital abroad in a slow-motion bank run. In the first
three months of 2012 it was estimated that almost €100 billion
had left the country There was discussion about segregating
difficult property loans into a ‘bad bank’ or asset management
agency agency similar to the Irish NAMA.
• In June 2012 Spain formally asked for a bailout of its banks and
€100 billion in assistance from eurozone funds was agreed.
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The link between banking
weaknesses and sovereign debt
• .Under then existing rules the €100 billion in eurozone assistance
had to be channelled by the Spanish government to the banks, a
step that would have added to sovereign debt and raised
borrowing costs.
• There was a dangerous link between banks and the sovereign
debt of their country.
• Domestic banks hold a large share of sovereign debt. In 2011
domestic banks held more than 60 per cent of Irish, Portuguese
and Greek bonds, and these had to pay more for funds because
of the fiscal troubles of their sovereigns.
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Towards the Pact for Growth and
Jobs
• Though restrictive fiscal measures were necessary to calm bond
markets, many felt that member states such as Germany had
pushed too far for austerity measures at a time of recession.
Simultaneous attempts to cut deficits may also spill over into
other countries and aggravate the economic slowdown.
• During 2012 there were growing calls for measures to foster
growth and employment at the national and EU levels.
• In May 2012 the Bundesbank and the finance minister Wölfgang
Schäuble suggested that German prices could be allowed to rise
faster than those of other eurozone countries (within a corridor of
2 to 3 per cent) to address imbalances.
•
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May-July 2012
• At the June 2012 European Council (see below) a ‘Pact for
Growth and Jobs’ was agreed, taking up the proposals of
additional capital for the EIB, €5 billion in EU project bonds, and
more targeted use of EU Funds to promote economic, social and
territorial cohesion.
• World Economic Outlook (WEO) Coping with High Debt and
Sluggish Growth of October 2012. The short-term fiscal
multipliers could be much higher than previously estimated (0.91.7% rather than 0.5%).
June 2012 Cypriot bail-out
• July 2012 fears of a bail-out for Slovenia
•
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June 2012 The Report of the Four Presidents (Herman
Van Rompuy, Barroso, Junker, and Draghi)
• 1. An integrated financial framework with common measures for
recapitalising or closing banks, and a European scheme to
guarantee customer deposits, provided a single supervisor for EU
financial institutions was in place. There would be conferral of the
power to supervise banks on the ECB (in line with Article 127/6
TFEU). The ESM could act as the ‘fiscal backstop’ to bank
resolution and deposit guarantees, and methods for extending its
tools for intervention should be examined. There was to be
differentiation between aspects linked to the functioning of the
monetary union and stability of the euro, and those relating to the
Single Market to assuage countries outside the eurozone such as
Britain.
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June 2012 The Report of the Four
Presidents
2. A qualitative move towards a fiscal union, which would probably
require treaty change. This would involve an integrated budgetary
framework with coordination, joint decision-making, tighter
enforcement and ‘commensurate steps towards common debt
issuance’. The mutualizing of sovereign debts was seen as a
medium-term objective and its details were not spelt out. Upper limits
on deficits and debts would be agreed in common, and EU capacity
to manage economic interdependencies would be reinforced,
possibly by introducing a eurozone fiscal body, such as a treasury
office. The role and functions of the EU budget would also be
redefined.
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June 2012 The Report of the Four
Presidents
3. An integrated economic policy framework with adequate
mechanisms to ensure growth, employment, competitiveness and
social cohesion, and to address imbalances. This should take into
account policies regarding labour markets and tax coordination and
should ensure the smooth running of EMU.
4. Measures to ensure democratic legitimacy and accountability, also
through close involvement of the European parliament and national
parliaments.
July 2012 German manifestos for and against against a banking
union
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The June 2012 European Council
• Pact for Growth and Jobs’
• Agreement to draw up a plan for common supervision of banks
involving the ECB by the end of 2012.
• It was agreed that the ESM could directly help refinance troubled
banks without having to pass through national governments once
the supervision of the ECB is in place. The aim was to ‘break the
vicious circle between banks and sovereigns.
• It was agreed to drop seniority status for eurozone loans to
recapitalize Spanish banks, but not for other loans or bond
purchases.
• The European Council agreed ESM intervention on secondary
bond markets. Monti believed that the terms for intervention had
been rendered lighter, but this was denied by Germany, Finland
and the Netherlands.
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•
Changes in the Role of the ECB
• In July 2012 the President of the ECB
Mario Draghi expressed his
determination to do ‘whatever it takes to
preserve the euro’. He considered it
‘squarely’ within the mandate of the ECB
to prevent ‘convertibility risk’ arising from
doubts that the euro would survive, and
maintained that it was ‘pointless to bet
against the euro’.
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Changes in the Role of the ECB
• The justification for unconventional measures by the ECB was
that the transmission mechanism of monetary policy was no
longer working. Draghi warned of ‘financial fragmentation’ with far
higher interest rates being paid by firms and households in
peripheral countries such as Greece, Spain and Italy than in core
countries such as Germany. The ‘singleness’ of monetary policy,
long seen as a cornerstone of financial integration, was being
undermined, and the collapse in cross-border lending by banks
exacerbated this problem. If the interdependence between banks
and sovereign debt could be reduced by the ECB buying
government bonds, the price paid by banks to access funding
could be cut, and banks might be prepared to pass these lower
costs on to firms and households.
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Changes in the Role of the ECB
• In September 2012 the agreement was reached on ECB
intervention to buy shorter-duration bonds.
• The ECB would renounce seniority on loans to address the fears
of private investors.
• Interventions would require beneficiary countries to ask for
support from eurozone bail-out programmes, and to accept ‘strict
and effective’ conditionality.
• Bundesbank president Jens Weidmann, withheld his vote on the
programme, though the other German representative, Jorg
Asmussen voted in favour.
• The Bundesbank commented publically on Weidmann’s decision,
stating that he considered bond-buying tantamount to financing
governments by printing banknotes.
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The role of the German
Constitutional Court
• In September 2012 the German Constitutional Court ruled against
delay of ratification of the ESM while they decided whether it is
compatible with the German Constitution (or Grundgesetz).
• The complaint was that the ESM undermined the budget
sovereignty of the Bundestag or German Parliament, and lacked
democratic control.
• The Court in Karlsruhe stated that any increase in the German
financial liability to the ESM above €190 billion would have to be
sanctioned by the Bundestag, and comprehensive information on
the operations of the ESM would have to be provided to the
parliamentarians.
• The Court also ruled in favour the legality of the Fiscal Compact
treaty.
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The European Commission’s
proposals for a banking union
• In September 2012 the European Commission presented
proposals for a banking union with ECB responsibility for
supervision of all Eurozone banks. The ECB would have the
power to monitor the liquidity of banks and require them to
increase capital if considered necessary.
• It could penalise and even close banks across the Eurozone by
withdrawing their licenses. A eurozone-wide deposit guarantee
and European bank resolution scheme was opposed by Germany
and was not proposed.
• A second proposal would modify the role of the European
Banking Authority, which would co-operate closely with the ECB.
Voting arrangements in the EBA would be adapted to ensure the
rights of non-eurozone countries are protected, and to preserve
the integrity of the Single Market.
© McGraw-Hill Companies, 2011
Criticisms of the proposal for a
banking union
• It had been suggested that the ECB should supervise only larger
cross-border banks (though, smaller banks may also be
dangerous as Northern Rock, Dexia and Bankia show)
• The ECB could be overstretched if it has to supervise the 6000
eurozone banks.
• The ECB will set up a supervisory board, but there could be
conflicts of interest so it will be necessary to ensure that there is a
firewall between the ECB’s activity of providing cheap loans to
banks and its supervisory role. The ECB could be subject to
political pressure and interference, jeopardising its commitment to
price stability.
• Member states are worried about the implications for their
banking sectors, and there are concerns about differential
treatment for non-eurozone countries.
© McGraw-Hill Companies, 2011
Conclusions
• After the relatively smooth first years of the euro, since late 2009
the eurozone has lurched from crisis to crisis. Many of the
peripheral member states have entered recession, and the risks
of bank runs, default and exit from the euro of one or more
countries remain. Repeatedly, the announcement of austerity
packages by national governments, agreement by the European
Council or intervention by the ECB caused markets to rally, only
to be followed shortly after by renewed widening of spreads.
© McGraw-Hill Companies, 2011
That disaster has so far been avoided in such
turbulent times is thanks to some timely policies:
• The bond-buying programme of the ECB with its relaxing of
collateral under Trichet
• The unlimited three-year loans from the ECB to banks (LTRO).
• Austerity measures in Italy, Portugal and Spain, and a second
Greek deal.
• Monitoring, supervision, and economic conditionality by the EU
have increased (even without the Fiscal Compact treaty).
• More consensus on measures to promote growth, employment
and competitiveness.
• The programme for outright monetary transactions to allow
unlimited purchase of short-run government bonds by the ECB.
• The threat of delay of the ESM and Fiscal Compact by the
German constitutional Court has been overcome for now
• Work has begun on a ©Eurozone
banking union.
McGraw-Hill Companies, 2011
Turbulence seems set to continue.
• The EU (and consequently the eurozone) has a sui
generis institutional structure and in general tries to
move forward by consensus. It takes time and
concessions to reach common positions.
Disagreements are open, and markets pick up
vulnerabilities. Again and again agreement seems to
have been reached in the European Council only to
evaporate subsequently when the details have to be
worked out.
• The EU is also constrained by its treaties, and this
also circumscribes the role of the ECB.
© McGraw-Hill Companies, 2011
Turbulence seems set to continue.
• Many banks in countries such as Spain still need to be
recapitalised.
• Recession seems likely to continue in various
peripheral countries, rendering structural reforms
difficult and knocking austerity packages off target.
Fiscal laxity by some regional authorities has been
exposed in some peripheral countries. Differences in
growth and competitiveness persist.
• The application of economic conditionality by the EU
raises issues about respect for democratic principles
and national sovereignty.
© McGraw-Hill Companies, 2011
Conclusions
• Faced with the costs and high risks of contagion of eurozone
break-up or even exit of one or more countries, the eurozone is
edging messily towards tigher integration with steps towards a
fiscal, banking and political union.
• Progress is piecemeal and the process causes tensions with noneurozone countries (such as Britain over financial regulation).
• It seems probable that the traits of a two- or multi-speed EU will
be reinforced.
• EU integration has always lurched forward in times of crisis and it
seems likely that this will again be the outcome of efforts to ‘do all
that it takes to save the euro’.
© McGraw-Hill Companies, 2011