The eurozone crisis:the theory of optimum currency areas bites back Barry Eichengreen<\/p>\n
Review Essay Task
\nPart A: Summary of your OWN words of the article I have chosen to review.
\n1.\u00a0\u00a0 \u00a0DO NOT OUTSOURCE OTHER ARTICLES, STICK WITH THE ARTICLE THAT I HAVE CHOSEN ONLY
\n2.\u00a0\u00a0 \u00a0DO NOT INCLUDE YOUR OWN OPINION IN THIS PART
\n3.\u00a0\u00a0 \u00a0DO NOT USE FIGURES, GRAPHS, EQUATIONS FROM THE ARTICLES
\n4.\u00a0\u00a0 \u00a0AT LEAST 800 WORDS, BUT NOT EXCEEDING 850 WORDS<\/p>\n
Part B: Assessment and Appraisal of the article that I have chosen.
\n1.\u00a0\u00a0 \u00a0DO NOT OUTSOURCE OTHER ARTICLES, STICK WITH THE ARTICLE THAT I HAVE CHOSEN ONLY
\n2.\u00a0\u00a0 \u00a0Appraisal means you express your thoughts about the article. Eg, whether the article is full of insightful remarks, whether the article gives adequate consideration\/analysis of the main issues, or if the article covers too much or too little ground, any additional aspects should be included in the article.
\n3.\u00a0\u00a0 \u00a0AT LEAST 800 WORDS, BUT NOT EXCEEDING 850 WORDS<\/p>\n
Notenstein Academy White Paper Series<\/p>\n
The eurozone crisis:
\nthe theory of optimum
\ncurrency areas bites back
\nBarry Eichengreen<\/p>\n
1<\/p>\n
Notenstein Academy White Paper Series<\/p>\n
Contents
\nLesson 1: Asymmetric shocks are intrinsic to monetary union
\nLesson 2: Monetary union without banking union will not work
\nLesson 3: A normal monetary union needs a normal central bank
\nLesson 4: Labour mobility in monetary union is a mixed blessing
\nLesson 5: Fiscal union has distributional consequences, making it untenable
\nLesson 6: Fiscal stabilisation can be provided nationally only if debt overhangs are removed
\nLesson 7: The eurozone needs a mechanism for restructuring unsustainable debts
\nLesson 8: Monetary union is forever, more or less
\nConclusion<\/p>\n
2<\/p>\n
Notenstein Academy White Paper Series<\/p>\n
The eurozone crisis:
\nthe theory of optimum
\ncurrency areas bites back
\n2011 was Europe\u2019s annus horribilis, arguably the nadir of the
\neurozone crisis. It was the year after the crisis surfaced in
\nwhat were initially dismissed as a handful of small countries
\nwith special problems, starting with Greece, Ireland and
\n\u00adPortugal, before infecting the monetary union as a whole. It
\nwas the year preceding Mario Draghi\u2019s \u201cwhatever it takes\u201d
\nspeech which laid to rest fears of eurozone break-up and
\nended the acute stage of the crisis.
\nIronically, 2011 was also the 50th anniversary of Robert Mundell\u2019s classic article \u201cThe Theory of Optimum Currency
\n\u00adAreas,\u201d which provided the analytical framework through
\nwhich academics and policy makers think about preconditions for a smoothly functioning monetary union.1 Few other
\narticles published fully 50 years ago in the American Economic Review \u2013 much less articles running to just eight short
\npages \u2013 have had such a powerful and enduring influence.
\nIn fact, the coincidence of timing was just that, a coincidence.
\nThat said, the two events were not entirely unrelated. The
\ntheory of optimum currency areas, as developed by Mundell
\nand his followers, led by Ronald McKinnon and Peter Kenen,
\ncontained important insights, which is of course why it remained so influential for 50 years.2 But the theory was also
\nincomplete and misleading in important respects, at least as
\napplied to the circumstances of Europe at the turn of the 21st
\ncentury.
\nAs articulated by Mundell, McKinnon and Kenen, the theory
\nof optimum currency areas emphasised convergence, labour
\nmobility and fiscal integration as preconditions for a smoothly
\nfunctioning monetary union.3 Convergence means greater
\nsimilarity in the economic structures of participating member
\nstates, minimising the kind of asymmetric shocks that might
\nrequire a different monetary-policy response in different parts<\/p>\n
of the monetary union (something that would not be possible
\nfollowing the adoption of a common currency, by definition).
\nLabour mobility refers to the importance of encouraging
\nworker flows from high- to low-unemployment states as a
\nmechanism for adjusting to shocks in the absence of a national
\nmonetary policy. Fiscal integration refers to the need to create
\na system of budgetary transfers between (or budgetary coinsurance among) the participating member states, so as to aid
\ntemporarily depressed regions that no longer possessed a
\n\u00adnational currency to depreciate and therefore had limited
\nscope for exporting their way out of difficulties.
\nThese were important insights, which is why they remained as
\ninfluential as they did for 50 years. But the theory, having been
\narticulated at the middle of the 20th century, was ominously silent about important economic aspects of the 21st. And having
\nbeen developed to explain the smooth operation of monetary
\nunion within existing federations like the USA and Canada
\n(both Mundell and McKinnon, recall, were \u00adCanadian), the
\ntheory was also silent about the political prerequisites for a
\nsmoothly functioning European monetary union.
\nSpecifically, the theory of optimum currency areas and the literature that developed around it said nothing about banks as
\npropagators of asymmetric shocks or about the need for
\nbanking union to accompany monetary union, since banking
\nsystems at mid-20th century were still tightly regulated and
\nconstrained in their operation. It said nothing about the selective emigration of the most skilled workers from the members of the monetary union experiencing adverse shocks,
\nsince exceptionally deep and long-lived shocks of the sort suffered by the members of the eurozone periphery starting in
\n2010, which might lead to a serious brain drain, were not anticipated by the theory\u2019s fathers. It said nothing about the<\/p>\n
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\nneed for the central bank in the monetary union to act as a
\nlender of last resort or about the need for it to backstop the
\nbond and financial markets of the individual member states,
\nsince serious sovereign debt and banking crises like those of
\nthe 1930s were only a distant memory. It said nothing about
\nthe desirability of a mechanism for the orderly restructuring
\nof sovereign debts in an environment where participating
\nmember states inherited a debt overhang and had no recourse to the inflation tax, since the debts of existing monetary union members (US states and Canadian provinces, of
\ncourse, being everyone\u2019s favourite example) did not begin to
\napproach the levels reached in eurozone member states subsequently. It said nothing about the reversibility of monetary
\nunion, since the idea that a member of the US or Canadian
\nmonetary unions might exit was not part of 1960s discussion.
\nAnd it said nothing about how much further political integra-<\/p>\n
tion might be required for fiscal integration, or alternatively
\nwhether the limited fiscal integration that was compatible
\nwith limited political integration would be enough to support
\nthe smooth functioning of Europe\u2019s monetary union.
\nThe remainder of this paper enumerates eight lessons of the
\neurozone crisis not anticipated by the fathers of the theory of
\noptimum currency areas for the smooth operation, or otherwise, of Europe\u2019s monetary union. 4 The purpose is not simply
\nto show where the founders of optimum currency area theory
\nwent wrong. Assembling those lessons also has a positive purpose, namely to derive implications for Europe\u2019s success in
\ndrawing a line under its crisis. Those implications, and whether
\npolicy makers show resolve in addressing them, are directly
\nrelevant to investors choosing to bet for or against the monetary union and for or against the successful revival of E
\n\u00ad urope\u2019s
\neconomy.<\/p>\n
Lesson 1.
\nAsymmetric shocks are intrinsic
\nto monetary union
\nThe theory of optimum currency areas took the symmetry or
\nasymmetry of aggregate disturbances across the countries or
\nregions potentially participating in a monetary union as a
\ngiven. That is, it took the pattern of disturbances as an exogenous criterion to guide the decision of whether or not to form
\na monetary union and, if that decision was positive, as a guide
\nto what the contours of the monetary union would be. Thus, in
\nhis original article Mundell speculated that Canada\u2019s western
\nprovinces together with the western US states might constitute a natural monetary union, given similarities in their resource endowments and the sharp differences in industrial
\nstructures between the eastern and western parts of North
\nAmerica. My own work with Tamim Bayoumi (Bayoumi and
\nEichengreen 1993) estimating the symmetry of aggregate<\/p>\n
supply and demand disturbances across European countries
\nand US regions similarly took the pattern of disturbances as
\ngiven, although we also speculated about how such correlations might change in the future.
\nThere were three notable exceptions to this exogeneity rule.
\nFirst, Frankel and Rose (1998), writing on the eve of
\n\u00adEurope\u2019s monetary union, pointed out that European integration, extending to monetary integration, might lead to
\nchanges in the industrial structures that Mundell emphasised as the source of asymmetric shocks. If integration resulted in more inter-industry trade, regions might become
\neven more specialised in different industries, leading to even
\nmore asymmetric shocks (insofar as shocks are industry-\u00ad
\nspecific). If it led mainly to more intra-industry trade,<\/p>\n
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\nr\u00adegional industrial structures might overlap more than
\n\u00adbefore, leading to less asymmetric shocks. Analysing the
\nconnections between the growth of trade and the inter-\u00ad
\nregional correlation of business cycles led them to conclude
\nthat intra-industry trade and more symmetric shocks would
\ndominate. Not to worry, in other words.
\nA second exception was the literature that attributed asymmetric shocks not to different industrial structures per se but
\nto the different levels of economic development associated
\nwith those shocks and with other tensions in the monetary
\nunion. The problem was the large gap in development between Europe\u2019s core and periphery; the corresponding solution was policies of cohesion (structural fund transfers to
\n\u00adfinance infrastructure spending) and policy discipline (like
\nthat conferred by monetary union membership), which would
\npermit the economies starting out behind to catch up. Here
\nthe evidence from the 1990s suggested that cohesion was
\nworking and that the convergence process was in fact underway (see inter alia Crespo-Cuaresma and Ritzberger-\u00ad
\nGrunwald 2005, Jelnikar and Murmayer 2006). Again, the
\n\u00adreassuring conclusion was not to worry.
\nThe third, unsettling exception was Walters (1990), who
\nwarned that inflation rates were unlikely to converge quickly
\nacross the members of the monetary union. In particular, inflation would continue to be higher at Europe\u2019s periphery.
\nThis might be a fundamentally healthy phenomenon insofar
\nas the prices of nontraded goods rise faster in fast-growing
\nperipheral economies (a tendency known as the Balassa-\u00ad
\nSamuelson effect). Or it might be unhealthy insofar as the
\npoor economies of the eurozone periphery continued to
\npursue lax fiscal (and other) policies with inflationary consequences. Either way, if a single level of nominal interest
\nrates prevailed throughout the monetary union, as it should,
\nthe result would be lower real interest rates at the periphery,
\nleading to an unsustainable consumption and investment
\nboom, ultimately with destabilising consequences.
\nThis was a prescient warning. Much as Walters had forecast,
\nthe countries at the periphery of the eurozone saw booms in
\nconstruction spending (Ireland, Spain), consumption spending (Portugal) and government spending (Greece), as the
\ncost of borrowing for households, firms and governments
\ncame down. Their spending booms were financed by large
\ncapital flows from the monetary union\u2019s core to its periphery, and they were reflected in equally large current account
\ndeficits for the eurozone periphery and surpluses for the
\ncore. When doubts arose in 2009-10 about the sustainability
\nof the process, those capital flows came to a sudden stop, imparting a destabilising asymmetric shock.<\/p>\n
The clear implication, emphasised by Walters, was that this
\nasymmetric shock was intrinsic to the operation of the monetary union. It was not simply bad luck, an asymmetric draw
\nfrom the macroeconomic urn. Rather, it was fundamentally
\nconnected to the real-interest-rate effects of monetary unification. Why Walters\u2019 warning was not heeded is unclear even
\nnow. It could be that a warning coming from a strident
\n\u00adEuro-sceptical critic was easier to dismiss than warnings from
\nmore sympathetic Continental quarters.5 With hindsight it is
\nclear that this source of intrinsic asymmetric shocks to the
\nstability of the eurozone was not paid adequate attention.
\nThe policy implication is that cross-border capital flows and
\ncurrent account imbalances within the eurozone cannot be
\ntreated with benign neglect. Those capital flows enable public and private sector excesses in the countries on the receiving end. They expose the economies of the recipients and
\nthe banking and financial systems of the suppliers to disruptions when doubts arise about the sustainability of the process. These problems will be especially acute within a monetary union where there are no impediments to capital flows
\nand no exchange risk to deter cross-border borrowing and
\nlending. They will therefore require a policy response.
\nThe EU, having learned this lesson the hard way, is now moving in the requisite direction. In December 2011 it introduced
\na Macroeconomic Imbalance Procedure as part of the socalled \u201cSix Pack\u201d of reforms, portions of which are now embedded in the Fiscal Compact. That procedure consists of a
\nscoreboard of early warning indicators, of which the threeyear backward moving average of the current account balance is one, then an in-depth analysis of countries with unfavourable indicators, and finally an Excessive Imbalance
\nProcedure for countries with imbalances that jeopardise the
\nfunctioning of the eurozone.
\nAs always, the proof of the pudding is in the eating. In this
\ncase the eating depends on what steps will be taken to forcefeed distasteful portions to countries reluctant to ingest them.
\nRegulation No. 1174\/2011 on \u201cenforcement measures to correct excessive macroeconomic imbalances in the euro area\u201d
\nrelies, unfortunately, on the same weak sanctions that have
\nnot worked in the case of the Stability and Growth Pact.
\n\u00adViolators are required to make deposits of 0.1 percent of
\nGDP that convert into annual fines in the case of continued
\nnoncompliance. The decision to apply sanctions is made by
\nthe Council on a recommendation from the Commission.
\nLogic suggests that member states will be reluctant to fine
\nthemselves. There is now more than a decade of historical experience with the Stability and Growth Pact that points in the
\nsame direction.<\/p>\n
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\nMore comprehensive macroeconomic surveillance is all to
\nthe good. But recent institutional innovations bearing on
\nenforcement are not reassuring. Europe would have a
\nbrighter future if these weaknesses were addressed.
\nThe other way of attempting to limit the booms and busts<\/p>\n
caused by destabilising cross-border capital flows and current account imbalances within the eurozone is by regulating the banking systems that are the conduit for these flows.
\nThis in turn brings us to a second important lesson of the
\neurozone crisis.<\/p>\n
Lesson 2.
\nMonetary union without banking
\nunion will not work
\nThat monetary union requires banking union \u2013 a single financial rulebook, a single bank supervisor, an adequately funded
\nsingle resolution mechanism for bad banks, and harmonised
\ndeposit insurance \u2013 seems obvious in light of recent events.
\nEurope\u2019s financial system is heavily bank based. Banks play
\nan important role in cross-border capital flows in the eurozone.6 Supervision and regulation in one country that does
\nnot adequately take into account the cross-border implications of the home banks\u2019 lending policies can have destabilising implications for its neighbours.
\nSimilarly, the absence of a mechanism for the orderly resolution of insolvent banks leaves only bailouts as an alternative.
\nThis fosters moral hazard, leaves problem banks undercapitalised, threatens the solvency of the sovereigns responsible
\nfor recapitalisation, and gives rise to the spectre of zombie
\nbanks and firms. Insofar as the problem of inadequate capitalisation and resolution are neglected, confidence in the
\nbanking system as a whole can be damaged, and that damage
\nmay not be limited to the initiating country.
\nThese problems are common to a financially globalised
\nworld, but they are especially pervasive in a monetary union
\nwith a single financial market, where there is neither exchange risk nor significant statutory impediments to bank-\u00ad
\nintermediated cross-border capital flows. Early work on the
\ntheory of optimum currency areas neglected these dangers<\/p>\n
for the simple reason that banks were tightly regulated and
\ncross-border lending and borrowing was strictly limited in
\nthe 1950s and 1960s.
\nLike it or not (and not all politicians and publics like it), the
\neurozone\u2019s progress on completing its banking union is a key
\nlitmus test for whether Europe will face brighter growth
\nprospects and a superior combination of growth and stability
\ngoing forward.7 Here again, Europe talks the talk but doesn\u2019t
\nwalk the walk. There is a shared commitment to create a fullfledged banking union, but there is less than full agreement
\non the details.
\nFully analysing the challenges of creating an effective banking union would require a paper (or papers) of its own. But
\nthe key points run as follows. First, the emphasis of policy
\nmakers on, inter alia, banning proprietary trading by the
\nlargest banks risks neglecting more important issues. More
\nimportant would be regulations addressing the risks posed
\nby the excessive concentration of sovereign debts in the
\nportfolios of domestic financial institutions. Ceilings could
\nbe placed on domestic sovereign debt held by banks. More
\nflexibly, the risk weights attached to domestic sovereign debt
\ncould be conditioned on the extent of the banks\u2019 exposure.
\nSecond, the workability of a system in which the ECB supervises \u201csignificant\u201d credit institutions while national authorities remain responsible for supervising the rest remains to be<\/p>\n
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\nestablished. National supervisors and the ECB are supposed
\nto coordinate seamlessly and share information, hand in
\nglove. Time will tell.
\nThird, the decision making process envisaged in the proposed
\nSingle Resolution Mechanism is overly complex, and an adequate financial backstop will not exist for years. A decision to
\nplace a bank in resolution would involve the board of the Single Supervisory Mechanism (24 members), the ECB Governing Council (24 members), and possibly the boards of the Single Supervisory Mechanism Mediation Panel (3 members),
\nSSM Executive Board (10 members) and Single Resolution
\nMechanism Board (23 members) \u2013 after which the Council
\n(28 members) would have to give its assent, based on a proposal by the European Commission (28 members). A commitment to establish a common backstop of EUR 55 billion
\nby 2025, or even 2019, is too little, too late.8 In the meanwhile,
\nthe resolution fund will be split into national compartments;
\nthe effective resolution regime as a result will not differ significantly from the status quo. In particular, it will do nothing
\nto break the \u201cdiabolic loop\u201d connecting banking and sovereign debt problems. This is not a single resolution regime in
\nany meaningful sense of the term.9
\nComing finally to a harmonised or single deposit insurance
\nscheme, it is important to recognise that the rationales for
\nharmonised and single insurance are different. Harmonising
\nnational deposit insurance schemes is designed to prevent
\neurozone members from adopting beggar-thy-neighbour in-<\/p>\n
surance policies (as when Ireland raised its deposit insurance
\nceiling in 2008 and drained deposits from other eurozone
\nbanks). Some steps have now been taken in the direction of
\nfurther harmonisation (the EU has harmonised minimum
\nlevels of deposit insurance coverage and maximum payout
\nperiods), but the basic problem of beggar-thy-neighbour policies remains unaddressed.10
\nIn contrast, the argument for a single deposit insurance
\nscheme backed by a common fund is that the funding available at the national level may not be adequate. Efforts to
\nmove to a single scheme have foundered on German opposition, however, the fear there being that fees paid by German
\nbanks (and passed on to their customers) will be used to bail
\nout reckless banks in other countries. But it should be incumbent on those opposing a single insurance scheme to offer an
\nalternative. The alternative is to prevent bank liabilities from
\ngrowing so large that they exceed the resources of the national insurance fund and the capacity of the sovereign to
\ntop it up. But German opposition to a single scheme has not
\nresulted in pursuit of this alternative. Until one or the other
\noption is pursued, Europe\u2019s banking union will remain incomplete.
\nThe best that can be said is that Europe\u2019s banking union remains a work in progress, the implication being that faster
\nprogress is now needed. The worst that can be said is that this
\nis a pale imitation of a true banking union, which does not
\nbode well for the euro\u2019s future.<\/p>\n
Lesson 3.
\nA normal monetary union needs
\na normal central bank
\nThe fathers of the theory of optimum currency areas did not
\naddress the question of what exactly the common central
\nbank should do. In this case, at least, the sins of the fathers did<\/p>\n
not automatically translate into the sins of the children. Already in 1992, Folkerts-Landau and Garber argued that a
\n\u00adEuropean Central Bank would have to do more than follow a<\/p>\n
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\nmonetary policy rule (whether a money supply growth rule, a
\nTaylor rule, or an inflation target rule). In addition it would
\nhave to be cognisant of its role as lender and liquidity provider of last resort, of its responsibility for the stability of
\n\u00adEurope\u2019s payments system, and of its contribution toward supervising the banking system.11
\nWith hindsight, this was another prescient diagnosis and
\nwarning, right up there with that of Alan Walters, not that it
\nwas taken to heart. In its first decade, the ECB focused narrowly on its inflation target (along with, initially, the money
\nsupply target that constituted the second pillar of its monetary policy strategy) to the all but total exclusion of other considerations. Under the leadership of Jean-Claude Trichet, the
\ncentral bank famously raised its policy rate twice in the spring
\nand summer of 2011 in response to a temporary deviation of
\nheadline inflation above its 2 percent target, despite the fact
\nthat European banks, sovereigns and economies were already
\nreeling from the crisis.
\nThe central bank\u2019s stance then changed with the transition
\nfrom Trichet to Draghi, with the new central bank president\u2019s \u201cwhatever it takes\u201d remarks in the summer of 2012,
\nand the ECB\u2019s programme of Outright Monetary Transactions, in which it promised to purchase the bonds of eurozone sovereigns on the secondary market if disorderly conditions threatened the operation of the payments system,
\ninterfered with the transmission of monetary policy, and
\nraised doubts about the cohesion of the eurozone.12 The
\npreceding period had seen what looked like a self-fulfilling
\npanic, where collapsing bond prices led to doubts about sovereign finances and bank solvency, which then fed on themselves. OMT was enough to put this panic to rest. That its
\nmere announcement was sufficient to calm the markets is
\nimpressive evidence of the stabilising influence of a central
\nbank prepared to act as a lender of last resort.
\nPress reports had Bundesbank President Jens Weidmann and
\nother members of the ECB Governing Council opposing
\nOMT on the grounds that it would weaken the commitment
\nof member states to reform. This past February the German<\/p>\n
Constitutional Court then opined that the ECB had massively exceeded its competences and mandate with OMT.13
\nThis raises questions about whether the ECB will engage in
\nlender-of-last-resort type operations in the future. More fundamentally, it points to the question of whether it is properly
\nthe function of a central bank to apply pressure on governments to pursue structural reforms. That the ECB participates in the Troika, applying pressure for reform in return for
\nfinancial Helpance to troubled sovereigns, creates a conflict
\nwith its other objectives. This has led some to suggest, not
\nwithout reason, that the ECB, as a normal central bank,
\nshould not participate in future Troika-like arrangements in
\norder to focus on its core mandate.14
\nThe ECB also remains slow to react to the risk of deflation.
\nSince those mid-2011 interest-rate hikes, policy remains
\ntighter than counselled by a textbook Taylor rule. Now that
\nthe zero lower bound is binding, the ECB is reluctant to turn
\nto unconventional monetary policies. It remains disinclined
\nto embrace the Bernanke doctrine, which counsels acting
\npreemptively to prevent deflation from developing in the
\nfirst place, since once it develops it may be extremely difficult to dispatch.15 This is another notable departure from
\nwhat is now regarded in most circles as normal central banking practice.
\nIt may be that the ECB\u2019s focus on headline rather than core
\ninflation allows it to be distracted by volatile food and fuel
\nprices. It may be reluctant to antagonise important shareholders like Germany, where inflation is running above the
\neurozone average and scepticism abounds about unconventional monetary policy. A Governing Council of 24 members
\nmay be too large and unwieldy to act swiftly and preemptively. Ten years ago the ECB put forward a proposal for restructuring country representation on the Council into constituencies, but no progress has been made on that front.16
\nUntil these issues are addressed, the ECB will remain less
\nthan a normal central bank. And continuing unwillingness
\nto address them does not bode well for the future of the
\neuro and the European economy.<\/p>\n
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Lesson 4.
\nLabour mobility in monetary union
\nis a mixed blessing
\nMundell emphasised labour mobility as an alternative to
\nchanges in monetary policy and exchange rates in adjusting
\nto region-specific shocks. In 1992 Blanchard and Katz then
\ndocumented the importance of labour flows between the 50
\nUS states as a mechanism for adjusting to state-specific disturbances.17 The fact that migration within the eurozone is<\/p>\n
\u00ad oungani (2014) show that even the relatively strong migraL
\ntory response in the USA has been insufficient to prevent
\nsharp increases in unemployment and reductions in the
\n\u00adlabour force participation rate in particular regions.
\nMigration as a mechanism of adjustment has been especially
\nproblematic in the context of the Great Recession. Insofar as
\nlower than in the USA is a commonplace. Only 0.3 percent
\nthe recent shock was global rather than local, there were few
\nof the population of the EU-27 states moved across national
\nbooming regions for the residents of depressed regions to
\nborders in 2010. This compares with the 2.4 percent of the
\n\u00admigrate to. This may be part of the explanation for why the
\ntotal population of the USA that relocated across state lines,
\nmigratory response to the crisis and subsequent recession was
\nand 1.5 percent cross-territory movement in Australia.
\nnot greater.18 The same point can be made specifically about
\nMeanwhile, less than 1 percent of the total population
\nEurope, where a significant share of emigration by the resimoved across the NUTS-1 regions of Europe (the largest
\ndents of, inter alia, Spain, Portugal, Italy and Ireland has been
\nnational subregions distinguished in EU statistics) accordto extra-European destinations \u2013 Latin America in the first
\ning to the OECD.
\nthree cases, English-speaking economies in the fourth. Other
\nExplanations for the contrast with the USA point to differauthors have pointed to the weak housing market as another
\nences in language, limited access to local healthcare and benpossible culprit, since homeowners may be unable to sell their
\nefits, and uncertainties regarding the transfer of pension
\nhouses in depressed markets and be reluctant (or in the
\nrights. These observations lead in turn to recommendations
\n\u00adEuropean case, unable) to sell a home whose value is less than
\nfor streamlining regulatory requirements for vesting periods
\nits mortgage, although this conclusion has also been disputed.
\nin pension plans and eliminating barriers to access to healthBe this as it may, the kind of severe global shock experienced
\ncare and benefits for foreign workers. But the fact that migrain Europe after 2008 was not what the fathers of the theory of
\ntion is low even within EU countries, where linguistic differoptimum currency areas had in mind when they trumpeted
\nences and vesting and access problems are not obstacles,
\nthe advantages of labour mobility. Nor did they anticipate the
\nsuggests that something more is at work. Still, the implication
\ncollapse of housing prices in the crisis economies.
\nfollows that the eurozone either needs to do more to encourIn addition, structural changes, such as the role of informaage labour mobility, or else it must develop other mechanisms
\ntion technology in creating job opportunities in a variety of
\n\u2013 greater wage flexibility or compensatory fiscal transfers, for
\nlocations, dual career families, and polarisation of the labour
\nexample \u2013 to deal with concentrations of unemployment.
\nmarket may also be making for a long-run secular decline in
\nRecent experience has cast the role of labour mobility within
\nlabour mobility. Dao, Furceri and Loungani (2014) document
\nmonetary union in a less favourable light. First, it has shown
\na decline over time in both the unconditional gross migration
\nlabour mobility to be a less powerful mechanism of adjustrate and the net inter-state migration rate conditional on
\nment in the context of major shocks. Dao, Furceri and\u00ad shocks in the United States.19 They speculate that financial<\/p>\n
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\ni\u00adntegration (the relaxation of restrictions on interstate banking, for example) may have increased the correlation of regional business cycles, reducing the incentive for, and efficacy
\nof, migration (something that has obvious implications for
\n\u00adEurope, given the financial integration attendant on the euro).
\nJust as labour mobility may be a less effective mechanism of
\nadjustment in the case of major shocks, these other changes
\nmay make it less effective in the future than in the past.
\nThe selective nature of migration raises troubling issues. Outmigration from Spain, Italy and Greece is dominated by the
\nemigration of relatively high-skilled individuals, who have
\nrelatively portable credentials and more knowledge of foreign job opportunities.20 Ciccarone (2013) similarly points to
\nevidence of a rise in the share of higher-skilled emigrants
\nfrom Italy. As a result of the crisis, the higher-skilled mobile
\npopulation within the EU has become increasingly concentrated within the so-called core countries at the expense of
\nthe periphery (Holland and Paluchowski 2013).
\nThis brain drain can have a permanent negative effect on the
\nproductive potential of the sending economies. In turn, that<\/p>\n
negative productivity effect can have a reinforcing impact on
\ncompetitiveness and unemployment in the adversely affected
\nregions (Brezzi and Piancentini 2010). In addition, the outmigration of the most skilled can weaken the incentive for the
\nadversely affected regions to invest in skills and training, with
\nfurther negative implications for their competitiveness.
\nIt is relevant in this context to recall that Blanchard and
\nKatz\u2019s classic article on the role of labour mobility in the
\nUnited States was entitled \u201cRegional Evolutions,\u201d not
\n\u00ad\u201cRegional Cycles.\u201d Already in 1992, in other words, they were
\nwarning that temporary regional shocks could produce permanent regional decline through the operation of these
\nmechanisms. Permanent decline of the population and economy of a city (Detroit) or a state (Michigan) might be politically tolerable in the United States. But the hollowing out of
\na national economy through outmigration with reinforcing
\nnegative effects would not be acceptable in Europe. Measures to enhance labour mobility will not be enough to solve
\nthe eurozone\u2019s problems. On the contrary, they may only end
\nup aggravating them. Alternatives should be sought.<\/p>\n
Lesson 5.
\nFiscal union has distributional
\nconsequences, making it untenable
\nSeminal contributions to the theory of optimum currency
\nareas pointed to transfers accomplished through a federal
\nsystem of taxes and budgetary transfers as the alternative to
\nlabour mobility. A limitation of this early work was that it
\ndid not consider the redistributional impact of this kind of
\nfiscal system, simply assuming that transfers in one direction
\nin one period would be offset by transfers in the other direction in the next. Subsequent work by Bayoumi and Masson
\namong others then documented that there were large ongoing transfers associated with existing fiscal systems, with im-<\/p>\n
portant distributional implications.21 As they showed, while
\nfederal taxes and transfers have a significant stabilisation effect on US regions (they offset 31 cents of every USD 1 decline in regional income), they also have a permanent redistributional effect (of 22 cents on the dollar) from high to low
\nincome states and regions. In Canada the stabilisation effect
\n(at 17 cents) is smaller, but the redistributive effect (at 39
\ncents) is even larger. Residents of European countries will
\nbe familiar with this redistributive aspect of national fiscal
\nsystems from the ongoing transfer of resources from west-<\/p>\n
10<\/p>\n
Notenstein Academy White Paper Series
\nern to eastern Germany and from northern to southern Italy.
\nEurozone members might agree to a fiscal system that implies ongoing redistribution were it negotiated \u201cunder the
\nveil of ignorance\u201d \u2013 that is, if they had no idea whether they
\nwould be on the sending or receiving end. In practice, however, there exist strong priors, whether rightly or wrongly, in
\nGermany in particular about who the givers and getters will
\nbe in any prospective \u201ctransfer union.\u201d
\nIn theory, one could imagine designing a fiscal system for the
\neurozone in a way that provides insurance against shocks but
\nis \u201cactuarially fair\u201d \u2013 that does not entail ongoing redistribution across member states. But this is easier said than done.
\nPisani-Ferry, Vihrala and Wolff (2013) consider a number of
\nschemes, none of which turns out to be redistribution-free in
\npractice. A first scheme transfers corporate taxes (levied on
\ncorporate earnings at a rate of 12.6 percent) from the national budget to the EU budget, using the resulting revenues
\nto pay the costs of unemployment compensation in the member states. This would provide insurance against shocks to unemployment. But it would also result in large transfers from
\nstates with profitable corporations to states with high unemployment rates and generous unemployment insurance
\nschemes.
\nThe redistributive effect of such a scheme could be limited
\nby harmonising unemployment benefit systems across countries (some member states like Belgium providing much
\nmore generous benefits than others), keying the system to
\nthe change in the unemployment rate rather than its level
\n(some countries like Spain having higher recorded unemployment rates in normal times), and making payments into
\nthe common fund a function of the change in corporate
\nearnings relative to some baseline (so countries with more<\/p>\n
profitable corporations would not automatically pay more
\n\u2013 they would only pay more if their corporations became
\neven more profitable). But this approach \u2013 not compensating Spain for its higher unemployment and not taxing
\n\u00adGermany\u2019s more profitable corporations \u2013 would create political problems of its own.
\nWolff (2012) suggests instead keying transfers to the output
\ngap (the deviation of GDP from potential), limiting their
\ncost by only transferring resources when the output gap exceeds 2 percent of GDP, and avoiding moral hazard by providing only partial insurance (in the amount of 25 percent of
\nthe output gap). Such a system would provide only incomplete insurance against shocks. It would be redistribution-\u00ad
\nfree only if the output gap is calculated in such a way that its
\naverage value was the same in all countries and the frequency with which it exceeds 2 percent of GDP is similarly
\nthe same across countries. In practice, however, output is
\nbound to be more volatile in some countries than in others
\n(just as it is more volatile in some US states and Canadian
\nprovinces than others). In this scheme, states with volatile
\neconomies would be the disproportionate recipients of
\ntransfers. Such a result might be economically desirable, but
\nit would not be politically acceptable.
\nThe bottom line is that it is all but impossible in practice to
\ndetach the redistributive effect of this kind of integrated fiscal
\nsystem from its insurance effect. Given that the eurozone\u2019s
\nfiscal system would not be created under a veil of ignorance,
\nthis makes establishment of such a system unlikely in practice. Someday, when Europe has moved to deeper political
\nintegration and national identities have given way to a common European identity, things might be different. But not for
\nthe foreseeable future.<\/p>\n
11<\/p>\n
Notenstein Academy White Paper Series<\/p>\n
Lesson 6.
\nFiscal stabilisation can be provided
\nnationally only if debt overhangs are removed
\nThe obvious alternative to coinsurance through a eurozone-wide system of taxes and transfers is for members of the
\nmonetary union to self-insure. This brings us to the prickly issue of the countercyclical national fiscal policies, the idea that
\ngovernments should run surpluses in boom times and deficits
\nin slumps. The argument that governments should have more
\nfreedom to adjust national fiscal policy when all freedom to
\nadjust national monetary policy is absent (as in a monetary
\nunion) and other adjustment mechanisms (like labour mobility and fiscal integration) are lacking is straightforward in
\nprinciple. But it is not straightforward in the European context, where the argument for countercyclical (\u201cKeynesian\u201d)
\nfiscal policies is not universally accepted. It is not straightforward because there is a lack of confidence that governments
\ncan be trusted to utilise their fiscal instruments in desirable
\nways. And it is not straightforward because inherited debt
\noverhangs limit governments\u2019 fiscal room for manoeuvre.
\nThe debate over whether fiscal policy has real effects or
\ncrowds out private-sector spending one-for-one has a heavy
\nideological component and cannot be resolved here, although
\nrecent work by the IMF would seem to provide strong evidence of real effects in the European context.22 The EU has
\nattempted to address concerns about the opportunistic use of
\nfiscal policy by distinguishing automatic fiscal stabilisers,
\nwhich should be allowed to operate, from discretionary
\nchanges in fiscal policy, which it hesitates to authorise. The
\nFiscal Compact (technically, the Treaty on Stability, Coordination and Governance in Economic and Monetary Union)
\nin place since January 2013 limits the permissible \u201cstructural\u201d
\nbudget deficit (adjusted for the business cycle) to \u00bd percent
\nof GDP but allows countries to run larger deficits to the extent that these result from cyclical downturns that reduce tax
\nreceipts and raise transfer payments.<\/p>\n
The Fiscal Compact is a step in the right direction relative to
\nthe Stability and Growth Pact that preceded it. It provides
\nmore flexibility for fiscal policy over the cycle. It provides
\nmore credibility in that its budget balance rule must now be
\nembedded in the national constitutions or made a matter of
\nbinding national law in each member state. But it provides
\nneither enough flexibility nor enough credibility for the circumstances at hand. Automatic fiscal stabilisers provide only
\npartial insurance against asymmetric national shocks; studies
\nlike Bayoumi and Eichengreen (1995) and Wyplosz (2002)
\nshow that they compensate for only a third to a half of an output decline. Tax reforms that accentuate the cyclical sensitivity of revenues (by, for example, relying more on capital gains
\ntaxes, which vary strongly with the cycle) would strengthen
\nautomatic stabilisers but would be politically divisive.
\nThere are worries, moreover, that even cyclically-adjusted
\nbudget balance rules embedded in national constitutions
\nlack credibility. Governments are prone to overestimating
\nrevenues \u2013 to forecasting too small an output gap \u2013 and
\ntherefore to underestimating realised deficits. Old problems
\nof excessive deficits will therefore be quick to return, the argument goes. The solution to this problem suggested by
\nFrankel (2013) is to outsource the forecast to an independent committee or agency and require the government to formulate fiscal policy on the basis of its forecast.23 The Treaty
\nrequires member states to create independent institutions
\nto monitor compliance with the Fiscal Compact. It could
\nusefully go a step further by delegating the forecasting function to such institutions and mandating that governments
\nutilise the resulting forecasts.
\nThe other obstacle to letting automatic fiscal stabilisers operate is the inherited debt overhang. A cyclical downturn
\nthat widens the budget deficit and causes the debt-to-GDP<\/p>\n
12<\/p>\n
Notenstein Academy White Paper Series
\nratio to rise would create renewed concerns about debt sustainability given very heavy inherited debt loads in Southern European countries. Spreads on sovereign bonds would
\nrise, widening the deficit still further, and pushing up other<\/p>\n
interest rates, crowding out investment. Fiscal self-\u00adinsurance
\nremains a logical alternative to fiscal coinsurance in a
\n\u00admonetary union, but only if the existing debt overhang is
\nfirst removed.<\/p>\n
Lesson 7.
\nThe eurozone needs a mechanism for
\nrestructuring unsustainable debts
\nIt follows that the eurozone needs a mechanism for removing
\ndebt overhangs if automatic fiscal stabilisers are to be allowed to operate in stabilising ways. To this end, Hans-\u00adWerner
\nSinn has called for a one-time debt conference, in which the
\ncreditors of Southern European governments and banks will
\nforgive a significant part of the debt.24 In cases like Greece,
\nwhere the majority of sovereign debt is now in the hands of
\nofficial creditors like the ECB, such a conference might be
\nsmall and have a relatively good chance of succeeding.25 Were
\nit to also consider the debts of other Southern European
\nmember states, where the bulk of sovereign debt is still in private hands, negotiations would be messier and more difficult
\nto bring to a successful conclusion.26
\nIn these circumstances, it makes sense to rely on incentives
\nand market-based mechanisms rather than imagining that,
\nin some mythical debt conference, reasonable minds would
\nprevail. The Greek debt exchange and other market-based
\ndebt exchanges before it have shown how such incentives
\ncan be deployed. Greece provided incentives for bondholders to agree to the terms of its debt exchange by offering a
\nmenu of new bonds and an upgrade in governing law
\n(English law rather than Greek law governing the new
\n\u00ad
\nbonds). Other countries have used exit consents (new financial covenants and waivers of sovereign immunity voted by
\na qualified majority of bondholders) to achieve the same
\nend.27 More generally, the Greek debt exchange demon-<\/p>\n
strated the feasibility of market-based approaches to debt
\nrestructuring in the eurozone. Generalising the approach to
\nother countries where heavy debts are an obstacle to the use
\nof automatic fiscal stabilisers (in blunt language, proceeding
\nwith market-based sovereign debt exchanges in other countries like Portugal) would help to lay the basis for a more
\nstable eurozone going forward.
\nUntil now, there has been a reluctance to follow this market-\u00ad
\nbased approach. Some critics question the ability of sovereigns to mobilise the requisite investor participation and
\nworry about disruptive legal action by holdouts. Others warn
\nof destabilising consequences for banks, while still others caution against damaging the future ability of governments to
\nborrow. Whatever the explanation, there is a temptation to
\nturn instead to bailouts. Even when there is ultimately a recognition that restructuring is unavoidable, that recognition
\ncomes too late.28 This is a global problem, but it is especially a
\nproblem in the eurozone, where there is unusually great
\nscope for contagion, members have fewer other mechanisms
\nfor dealing with debt crises, and the existence of the E
\n\u00ad uropean
\nStability Mechanism opens the door wide to the bailout alternative. The Committee for International Economic Policy
\nand Reform (2013) therefore recommends amending the
\nESM Treaty to provide sovereign immunity from legal action
\nby holdouts if a restructuring is approved by the ESM. In addition, it suggests amending the Treaty to make debt restruc-<\/p>\n
13<\/p>\n
Notenstein Academy White Paper Series
\nturing a precondition for ESM lending when sovereign debts
\nexceed a pre-set level (say, 60 percent of GDP).
\nA sovereign debt restructuring mechanism at the global level,<\/p>\n
as proposed by Krueger (2001), remains pie in the sky. But
\nEurope already has treaties governing closely related matters
\nthat could be amended to address this important question.<\/p>\n
Lesson 8.
\nMonetary union is forever,
\nmore or less
\nSince the euro crisis erupted in 2010, there have been many
\nforecasts of exit by troubled member states, none of which
\nhas come to pass. There continue to be proposals for temporary \u201csabbaticals\u201d from the euro for countries finding it
\ndifficult to restore growth and competitiveness (Feldstein
\n2010, Sinn 2013), which similarly have not been taken up by
\npolicy makers. The fact that the eurozone has not collapsed
\nis not simply a matter of good luck, however. Similarly, the
\nreluctance of countries like Greece to take a holiday from
\nthe euro is not simply a matter of intransigence on the part
\nof policy makers. What we have learned from more than
\nthree years of crisis is that, like it or not, monetary union is
\nforever.
\nTo put the point in more nuanced form: while adjustment
\nwithin the eurozone is difficult and costly, adjustment through
\nexit would be even more difficult and costly. The idea that a
\ncountry can temporarily suspend its eurozone membership
\nand adjust by depreciating its newly reintroduced national
\ncurrency is predicated on the analogy with the classical gold<\/p>\n
standard, when countries that temporarily suspended gold
\nconvertibility committed to returning at the previous parity.29
\nIn the current context, in contrast, there would be no commitment to return at the earlier rate of conversion between the
\nnational currency and the euro; on the contrary, some proponents of the \u201choliday\u201d idea propose precisely the opposite,
\nnamely returning at a depreciated rate.
\nHence talk, much less the reality, of a euro holiday would provoke capital flight, a banking crisis and emergency resort to
\nexchange controls, which history has shown are easier to impose than to remove. This would be the mother of all crises,
\nsomething that governments would be understandably anxious to avoid. It is not a coincidence that proposals for a temporary holiday from the euro, much less scenarios of unilateral exit and wholesale eurozone break-up, have been
\navoided. Politicians can still miscalculate. But rational calculation points to the conclusion that breaking the euro up
\nwould be even more costly than holding it together. Nothing
\nis irreversible. But Europe\u2019s monetary union comes close.<\/p>\n
14<\/p>\n
Notenstein Academy White Paper Series<\/p>\n
Conclusion
\nOur eight lessons of the eurozone crisis for the theory of optimum currency areas lead to the following implications relevant to investors and policy makers. First, the initial design of
\nthe eurozone was flawed and incomplete because the analytical framework on which it was based, the theory of optimum
\ncurrency areas, was flawed and incomplete. It neglected the
\nrole of banks and capital flows in generating asymmetric
\nshocks. It overlooked the importance of banking union as a
\nconcomitant of monetary union and the need for a multilateral surveillance process focusing not just on budget deficits
\nbut also on credit booms, capital flows and current account
\nimbalances. It underplayed the need for a lender of last resort, envisaging the European Central Bank as a monetary
\nrule rather than guarantor of Europe\u2019s payments system and
\nsource of emergency liquidity. This created a tension that continues to pervade the ECB even today.
\nMoreover, the euro\u2019s architects placed too much faith in labour mobility and wage flexibility (which in the present context is referred to as \u201cinternal dAssessment\u201d) as mechanisms
\nof adjustment, because they did not foresee the kind of deep
\nand enduring slump that could create a brain-drain problem
\nfor Southern Europe and rend the social fabric on whose basis wage bargains are made. They did not pause to contemplate that Europe lacked the political preconditions for establishing a fiscal federation to complement its monetary
\nunion, and that it was similarly unprepared to empower member states to substitute fiscal stabilisation at the national level
\nfor the monetary instrument now foregone. Automatic fiscal
\nstabilisers might yet provide fuller insurance against asymmetric shocks within the monetary union, but only if the debt
\noverhangs inhibiting their operation are removed. But the
\nframers of the theory of optimum currency areas could not
\nimagine that the members of a monetary union would be bur-<\/p>\n
dened with debts as heavy as Europe\u2019s today. Hence they \u2013
\nand the European policy makers who adopted their perspective \u2013 did not propose a mechanism for restructuring
\nunsustainable debts as part of the architecture of the monetary union.
\nEuropean decision makers, having now learned the hard way
\nabout the flaws in their analytical framework and initial design, have moved some way toward rectifying these problems.
\nBut our eight lessons also point out the extent to which progress remains incomplete. The Macroeconomic Imbalance
\nand Excessive Imbalances Procedures designed to address
\nproblems associated with capital flows and current accounts
\nare a step forward, but enforcement remains questionable.
\nEurope\u2019s banking union is most charitably described as a
\nwork in progress, where the progress is less than impressive
\nand much work remains to be done. The Fiscal Compact, by
\nallowing governments to target cyclically adjusted budget
\ndeficits of no more than \u00bd percent of GDP and embedding its
\nrules in national constitutions, is similarly a step forward. But
\ngiven the ability of governments to manipulate growth and
\nrevenue forecasts, the failure to delegate the forecasting function to an independent commission and to require governments to make policy on the basis of those forecasts is troubling. Given inherited debt overhangs, allowing the automatic
\nfiscal stabilisers to operate remains problematic. And the
\n\u00adeurozone still lacks a mechanism for the orderly restructuring
\nof unsustainable debts, which could in principle be added to
\nthe ESM Treaty.
\nBreaking up the euro is not an attractive option. This leaves
\nfixing it as the only alternative. But given the slow and partial
\nprogress Europe has made in putting the relevant fixes in
\nplace, it is hard to bet on a quick resumption of rapid growth.
\nA better bet, given this slow and partial progress, is a lost dec-<\/p>\n
15<\/p>\n
Notenstein Academy White Paper Series
\nade. The good news is that Europe is already half way there.
\nThis suggests that there will come a time in the not-too\u00addistant future (perhaps five years from now or, given the
\n\u00adincentive to get in early, a bit sooner) when it will become
\n\u00adattractive to begin investing in Europe again.
\nAnd what happens if European policy makers fail to make
\nprogress in putting the relevant fixes in place What would be
\nthe implications of a breakdown in efforts to complete a
\nmeaningful banking union, to restructure debts and renationalise countercyclical stabilisation policy, and empower the
\nEuropean Central Bank to act as a true lender of last resort,
\nas needed to complete Europe\u2019s common monetary house
\nIn this case, the implications for investors are dire and, necessarily, highly uncertain. One scenario would be an even longer
\nperiod of stagnation, with Europe failing to put in place the<\/p>\n
preconditions for a sustainable resumption of growth for the
\nforeseeable future. At best, the European economy would
\n\u201cbounce along the bottom,\u201d with no to very slow growth.
\nClearly, the eurozone would not be an attractive place to invest under such circumstances. Another scenario would be
\nfor frustration to boil over and for impatient politicians, disregarding purely economic costs and benefits, to pull the plug,
\nabandoning the single currency. The important point here is
\nthat there is no such thing as the orderly dismantling of the
\neurozone. Pulling the plug \u2013 one country or a collection deciding to abandon the euro \u2013 would provoke the mother of all
\nfinancial crises. There would then be an extended period of
\nturbulence and risk of serious losses. There would be no way
\naround it. Investors should consider themselves forewarned.
\nThey should hope at all costs that this dire scenario is avoided.<\/p>\n
16<\/p>\n
Notenstein Academy White Paper Series
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\nNaumann, Reinhard. (2013), \u201cGeographical Labour Mobility in the Context of
\nthe Crisis: Portugal,\u201d Birmingham, European Employment Observatory.
\nPisani-Ferry, Jean, Erkki Vihriala and Guntram Wolff (2013), \u201cOptions for a
\n\u00adEuro-Area Fiscal Capacity,\u201d Bruegel Policy Contribution no. 2013\/01 (January).
\nSinn, Hans-Werner (2013), \u201cEuro Needs Ground-Up Reform before any United States of Europe,\u201d The Guardian (23 December), https:\/\/monkessays.com\/write-my-essay\/theguardian.
\ncom\/business\/economics-blog\/2013\/dec\/23\/euro-reform-united-stateseurope-ukraine.
\nWalters, Alan (1990), Sterling in Danger, London: Fontana.
\nWolff, Gunthram (2012), \u201cA Budget for Europe\u2019s Monetary Union,\u201d Policy
\n\u00adContribution 2012\/22, Brussels: Bruegel.
\nWyplosz, Charles (2002), \u201cEurope\u2019s Fiscal Rules Need a Serious Overhaul,\u201d
\nunpublished manuscript, Graduate Institute for International Studies,
\n\u00ad
\n\u00adGeneva (October).<\/p>\n
17<\/p>\n
Notenstein Academy White Paper Series
\nEndnotes
\n1<\/p>\n
The reference is of course to Mundell (1961).<\/p>\n
2<\/p>\n
See McKinnon (1963) and Kenen (1969).<\/p>\n
3<\/p>\n
The Anglo-Saxon literature refers to \u201cfiscal federalism\u201d rather than \u201c\u00adfiscal
\nintegration.\u201d Fiscal federalism has a somewhat different meaning in
\ncountries like Switzerland, where it refers to the high degree of autonomy that local jurisdictions possess in choosing the level and structure of
\ntheir tax and public expenditure systems. To limit confusion I refer here
\nto fiscal integration wherever possible.<\/p>\n
4<\/p>\n
And not anticipated by those of us who count ourselves among their
\nintellectual descendents, who are similarly not to be absolved of blame.<\/p>\n
5<\/p>\n
Although these were neglected as well \u2013 for an example, see Blanchard
\nand Giavazzi (2003).<\/p>\n
6<\/p>\n
As shown by Allen et al. (2011) and the Committee on International
\nEconomic Policy and Reform (2012), most cross-border capital flows are
\nchanneled through banks and are heavily procyclical.<\/p>\n
7<\/p>\n
In the short run, drawing a line under the crisis requires adequately
\nrecapitalising the banks, so that they have sufficiently strong balance
\nsheets to support renewed lending to the nonbank private sector. (The
\nrole of banking union is different; it is to prevent the behaviours that
\nbred the crisis and resulted in the current problem of inadequate capitalisation from recurring in the future.) Whether Europe successfully addresses this short-term problem will depend on the details of its Asset
\nQuality Review and Stress Tests.<\/p>\n
8<\/p>\n
9<\/p>\n
The Banking Recovery and Resolution Directive adopted at the end of
\n2013 provides for bailing in bank creditors (in the amount of 8 percent
\nof total liabilities) to help defray the costs of bank resolution, but in systemic crises this will not be enough.
\nIt is important to recognise that more often than not, bank resolution
\nin the United States occurs smoothly not because the Federal Deposit
\nInsurance Corporation is generously endowed with financial resources
\nbut because there are no restrictions on the acquisition and merger of
\nbanks across state borders. The most recent US bank failure at the time
\nof writing was that of Syringa Bank of Boise, Idaho, with USD 153 million, which was quickly acquired by Sunwest Bank of Irvine, California,
\nfollowing the injection of USD 4.5 million by the FDIC. European politicians, sensitive to the fact that banks are regarded as national champions, remain reluctant to contemplate analogous cross-border mergers.
\nClearly, it would help if Europe had a single market in bank acquisitions
\nto complement its single currency (Eichengreen, Jung, Moch and Mody
\n2013).<\/p>\n
10\u00a0\u00a0 \u00a0 A good introduction to what has and has not been done is IMF (2013).<\/p>\n
13\u00a0\u00a0 \u00a0 The Court then asked the European Court of Justice to look into the
\nconditionality aspect of OMT, whether there had to be a specific
\ngap between the primary market issue date and secondary market
\n\u00adpurchase price before securities could be purchased, and whether the
\n\u00adprogramme, in order to be consistent with European law, had to be subject to a ceiling on purchases. A ruling should be forthcoming from the
\n\u00adEuropean Court within a couple of years. In the meantime the uncertainty will linger.
\n14\u00a0\u00a0 \u00a0 See Charlemagne (2014).
\n15\u00a0\u00a0 \u00a0 The classic statement of the Bernanke doctrine is Bernanke (2002).
\n16\u00a0\u00a0 \u00a0 If Lithuania joins, as expected, the maximum size of the Board permitted
\nby the bank\u2019s statute will have been achieved, and one country \u00adafter
\n\u00adanother, in turn, will then rotate off the Board. This will prevent the
\nBoard from growing even more unwieldy without, however, solving the
\nexisting problem.
\n17\u00a0\u00a0 \u00a0 See Blanchard and Katz (1992).
\n18\u00a0\u00a0 \u00a0 See the discussion in Eichengreen, Jung, Moch and (2013) for details.
\n19\u00a0\u00a0 \u00a0 See Molloy, Smith and Wozniak (2013) and also Dao, Furceri and Loungani (2014).
\n20\u00a0\u00a0 \u00a0 See Naumann (2013).
\n21\u00a0\u00a0 \u00a0 See Bayoumi and Masson (1995).
\n22\u00a0\u00a0 \u00a0 See Blanchard and Leigh (2013).
\n23\u00a0\u00a0 \u00a0 In the manner of countries like Chile.
\n24\u00a0\u00a0 \u00a0 See Sinn (2013).
\n25\u00a0\u00a0 \u00a0 Syriza, the left-wing party that is poised to head the next Greek coalition, has already signaled its intention of calling for such a conference.
\n26\u00a0\u00a0 \u00a0 One imagines that Professor Sinn is inspired by memories of the Dawes
\nPlan Conference that restructured German debts in 1924 and the
\n\u00adLondon Conference that restructured the debts of West Germany in
\n1953; the difference, of course, is that these were purely intergovernmental debts, limiting the parties at the table.
\n27\u00a0\u00a0 \u00a0 For details see Buchheit and Gulati (2000).
\n28\u00a0\u00a0 \u00a0 The IMF made the case in an April 2013 paper (IMF 2013), as did the
\nindependent Committee on International Economic Policy and Reform (CIEPR 2013). Earlier ideas along similar lines are Giaviti, Krueger,
\nPisani-Ferry, Sapir and von Hagen (2010), who prefer a mechanism that
\nvests more discretion in the hands of the decision makers (a special
\nchamber of the European Court of Justice) but would similarly make the
\nrestructuring of unsustainable debts a precondition for the extension of
\nemergency Helpance.
\n29\u00a0\u00a0 \u00a0 See Bordo and Kydland (1995).<\/p>\n
11\u00a0\u00a0 \u00a0 See Folkerts-Landau and Garber (1992).
\n12\u00a0\u00a0 \u00a0 Officially, OMT was aimed exclusively at \u201csafeguarding an appropriate
\nmonetary policy transmission and the singleness of monetary policy,\u201d
\nbut the larger objectives are clear.<\/p>\n
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