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Número 102.2 ANEXO VI

Alvaro Espina 17 Septiembre de 2014 Entre el 1 y el 21 de julio

World Affairs

Daniel Gros Daniel Gros is Director of the Brussels-based Center for European Policy Studies. He has worked for the International Monetary Fund, and served as an economic adviser to the European Commission, the European Parliament, and the French prime minister and finance minister. He is the editor of Economie Internationale and International Finance. JUL 21, 2014 The Transatlantic Growth Gap BRUSSELS – The global financial crisis that erupted in full force in 2008 affected Europe and the United States in a very similar way – at least at the start. On both sides of the Atlantic, economic performance tanked in 2009 and started to recover in 2010. But, as the financial crisis mutated into the euro crisis, an economic gulf opened between the US and the eurozone. Over the last three years (2011-2013), the US economy grew by about six percentage points more. Even taking into account the increasing demographic differential, which now amounts to about half a percentage point per year, the US economy has grown by about 4.5 percentage points more over these three years on a per capita basis. The main reason for the gap is the difference in private consumption, which grew in the US, but fell in the eurozone, especially in its periphery. A retrenchment of public consumption actually subtracted more demand in the US (0.8 percentage points) than in the European Union (0.1 points). This might appear to be somewhat surprising in light of all of the talk about Brussels imposed austerity. In fact, public consumption in the eurozone has de facto remained fairly constant over the last three years, whereas it has declined substantially in the US. (The same is true of public investment, though this constitutes such a small proportion of GDP that transatlantic differences could not have had a large impact on growth over a three-year horizon.) The contraction of private investment in Europe accounts for only a small part (one- third) of the growth gap. Though the financial-market tensions that accompanied the euro crisis had a strong negative impact on investment in the eurozone periphery, investment demand has also remained weak in the US, minimizing the overall difference. The resilience of private consumption in the US, the key to the growth gap, is not surprising, given that American households have reduced their debt burden considerably from the peak of more than 90% of GDP reached just before the crisis. The lower debt burden is also a key reason why consumption is expected to continue to grow much faster in the US than in the eurozone this year and next. But the crucial question – and one that is rarely asked – is how US households were able to reduce their debt burden during a period of high unemployment and almost no wage gains while sustaining consumption growth. The answer lies in a combination of “no recourse” mortgages and fast bankruptcy procedures. Millions of American homes that were purchased with subprime mortgages have been foreclosed in recent years, forcing their owners, unable to service their debt, to leave. But, as a result of no-recourse mortgages in many US states, the entire mortgage debt was then extinguished, even if the value of the home was too low to cover the balance still due. Moreover, even in those states where there is full recourse, so that the homeowner remains liable for the full amount of the mortgage loan (that is, the difference between the balance due and the value recovered by selling the home), America’s procedures for personal bankruptcy offer a relatively quick solution. Millions of Americans have filed for personal bankruptcy since 2008 , thereby extinguishing their personal debt. The same applies to hundreds of thousands of small businesses. Of course, there has also been a surge of bankruptcies in the eurozone’s periphery. But in countries like Italy, Spain, and Greece, the length of a bankruptcy proceeding is measured in years, not months or weeks, as in the US. Moreover, in most of continental Europe a person can be discharged of his or her debt only after a lengthy period, often 5-7 years, during which almost all income must be devoted to debt service. In the US, by contrast, the corresponding period lasts less than one year in most cases. Moreover, the terms of discharge tend to be much stricter in Europe. An extreme case is Spain, where mortgage debt is never extinguished, not even after a personal bankruptcy. This key difference between the US and (continental) Europe explains the resilience of the US economy to the collapse of its credit boom. The excessive debt accumulated by households has been worked off much more rapidly; and, once losses have been recognized, people can start again. The cause of the transatlantic growth gap thus should not be sought in excessive eurozone austerity or the excessive prudence of the European Central Bank. There are structural reasons for the eurozone economy’s slow recovery from the financial meltdown in its periphery. Most important, compared to the US, the excess debt created during the boom years has been much more difficult to work off. European officials are right to promote structural reforms of EU countries’ labor and product markets. But they should also focus on overhauling and accelerating bankruptcy procedures, so that losses can be recognized more quickly and over- indebted households can start afresh, rather than being shackled for years. http://www.project-syndicate.org/commentary/daniel-gros-attributes-america-s-edge- over-europe-to-its-faster-bankruptcy-procedures

Economía OPINIÓN El tamaño y la informalidad Ángel Ubide 27 JUL 2014 - 00:00 CEST2 Ahora que el periodo agudo de la crisis ha remitido, los mercados se han empezado a normalizar, a pesar de los sustos, y no hay que tomar decisiones cada fin de semana, es un buen momento para reflexionar sobre problemas estructurales. La evolución a largo plazo de una economía depende de su capacidad de crecimiento potencial, que a su vez depende de la demografía, la capacidad del mercado laboral de emplear a la población, el crecimiento del stock de capital y, sobre todo, la tasa de crecimiento de la productividad. Cuando los economistas o los políticos o los banqueros centrales hablan de reformas —ese término tan usado y a su vez tan vacío de contenido, ya que hay muchos tipos de reformas, con impactos y objetivos diferentes, y es un término que se acaba usando como instrumento para negar la necesidad de estimular la demanda a corto plazo— se refieren a medidas para aumentar el crecimiento potencial y, sobre todo, la productividad. Lo interesante es que no sabemos muy bien lo que determina la productividad. Por un lado, a nivel macro la profesión económica pasó años debatiendo las causas de la ralentización del crecimiento de la productividad en los años setenta, sin llegar a ninguna conclusión definitiva (la hipótesis más probable es que fue el impacto del shock petrolífero). La intuición sugiere que la revolución tecnológica de los años noventa debería aumentar la productividad, pero tardó más de una década en notarse en los datos y, tras la crisis, la productividad se ha vuelto a desacelerar a pesar de estar inmersos en una nueva ronda de innovación. Por otro lado, a nivel micro sí que hay acuerdo en la importancia del tamaño de las empresas y de la economía informal para el crecimiento de la productividad. El caso de México ilustra de manera muy interesante este aspecto micro. El McKinsey Global Institute publicó hace poco un informe sobre la economía mexicana. Durante 1950-1980 México disfrutó de un periodo de rápido crecimiento de la productividad — definida como productividad por hora trabajada—, con tasas de crecimiento promedio superiores al 3%. Pero, de repente, el crecimiento de la productividad se estancó —pasó a ser negativo durante la década perdida de los años ochenta, y creció a tasas inferiores al 1% durante 1990-2000, a pesar del proceso de integración comercial con EE UU—. El resultado es que, desde inicios de los ochenta, el output por hora trabajada, medido en dólares constantes y a paridad de poder de compra, no ha crecido. El crecimiento del PIB desde 1990 se ha debido, sobre todo, al crecimiento del empleo. ¿Les suena la historia? El caso español es muy similar, con un crecimiento de la productividad durante el largo ciclo alcista cercano a cero. Lo interesante del caso mexicano es que la clave del estancamiento de la productividad es la dicotomía entre empresas grandes y pequeñas, entre economía formal e informal: la tasa de crecimiento de la productividad en las empresas grandes (de más de 500 trabajadores) se ha acelerado, mientras que la tasa de crecimiento de la productividad de las empresas pequeñas (de menos de 10 trabajadores) ha declinado. Y el porcentaje de trabajadores empleados en empresas pequeñas ha aumentado durante este periodo. Es decir, no solo las empresas pequeñas han perdido productividad, sino que han aumentado el número. Esta es la clave del deterioro del crecimiento potencial en México, el auge de las empresas pequeñas, muchas de ellas en el sector informal.

Hay muchas cosas que podemos hacer para mejorar el bienestar de los españoles ¿Por qué se ha producido este fenómeno? Por varias razones, que se pueden resumir en una simple frase: hay un sistema de incentivos que incita a las empresas a no crecer y a quedarse en la economía informal. El coste, de organización, fiscal, laboral, legal, de crecer a partir de un cierto tamaño, y de entrar en la economía formal, es muy alto, y la penalización por permanecer en el sector informal demasiado baja. Y esto conlleva costes para la economía en su conjunto, ya que muchos de estos pequeños emprendedores serían más productivos si trabajaran para una empresa de tamaño superior. Esta dualidad no es exclusiva de México, se observa en muchos países. Hay estudios que sugieren que la mitad del diferencial de productividad entre EE UU y Canadá, y casi la totalidad del diferencial entre Alemania y España, se debe a la diferencia en el tamaño de las empresas (mayores en EE UU y en Alemania). Hay estudios que muestran que aspectos de la legislación laboral, que imponen condiciones adicionales a las empresas a partir de un cierto número de trabajadores empleados, genera una aglomeración de empresas por debajo de ese límite (el artículo 18 del estatuto de los trabajadores italiano, que se aplica a empresas de más de 15 trabajadores, es uno de los ejemplos más estudiados). Hay otros estudios que muestran un fenómeno similar debido a cambios en el tratamiento fiscal a partir de cierto volumen de facturación. El resultado es que los países menos productivos, en general, tienen demasiadas empresas pequeñas. No, esto no es una contradicción. Es verdad que las empresas pequeñas son fundamentales para la creación de empleo y para la innovación. Pero la innovación se genera sobre todo a través de la creación y destrucción de empresas, mucho más que de manera planificada dentro de una misma empresa (una gran parte de la innovación en multinacionales punteras se produce a base de comprar start-ups innovadoras, no en los departamentos internos de I+D). Las empresas pequeñas que no crecen dejan de contribuir, ya que carecen de la escala suficiente para dar el siguiente paso. El tamaño de la firma es una variable fundamental para determinar el éxito exportador —mucho más importante que el nivel de salarios, ya que la productividad y el ascenso en la escala de valor son más importantes que la competitividad salarial—. Por tanto, la clave para tener una economía productiva y competitiva es generar los incentivos necesarios para que las empresas pequeñas exitosas puedan crecer rápidamente —las llamadas “gacelas”— y las que fracasen puedan cerrar de manera transparente y rápida y volver a empezar (de hecho, el FMI recrimina a España en su último informe la dureza con que el régimen legal español trata a las empresas que fracasan). Si una empresa fracasa y el empresario está condenado a la informalidad, nunca crecerá. La clave son cambios en la legislación laboral, fiscal y financiera que eliminen el subsidio implícito para las pequeñas empresas; cambios legales (y de mentalidad) que eliminen ese concepto tan extendido en España de que cuanto más se facture en negro, mejor; cambios que faciliten el acceso al crédito y a los mercados de capitales para las empresas de menor tamaño, donde el fracaso esté contemplado (y esté incluido en el coste del capital, por supuesto). ¿Por qué les cuento esto? Porque hay muchas cosas que podemos hacer para mejorar el bienestar de los españoles, tanto a corto como a largo plazo, sin necesidad de una revolución, ni política, ni geográfica, ni institucional. Claro, todo esto es aburrido, y no genera titulares. Pero es lo que podemos, y debemos, hacer.//Ángel Ubide es senior fellow, Peterson Institute for International Economics, Washington DC. http://economia.elpais.com/economia/2014/07/25/actualidad/1406312476_238462.html 4

Daily Morning Newsbriefing July 25, 2014 On the WEO: Forget the forecast – it’s hard enough to predict where we are right now Even the IMF downplayed the significance of this latest World Economic Outlook revision, which gives us a world economic growth project of 3.4%, after 3.7% in the April version. Oliver Blanchard says this is not really significant because much of that has already happened –mostly in terms of weak US first quarter growth. The most interesting bits of the report are not the global headlines – nor the entirely useless predictions for 2015 –but the numbers for dispersion. There is no change to the IMF’s 1.1% GDP growth projection for the eurozone as a whole, but big differences for member states. An upward revision of German annual growth by 0.2pp and of Spanish growth by 0.3pp, and downward revision for Italy and France by 0.3pp. These are big numbers, since they relate to the April forecast. The revision is telling us two things. The first is that it is hazard to forecast an economy after a financial crisis. Like driving in the dog, you can only a see short distance ahead. It would already be an achievement if the forecasters were able to give us a good “nowcast” – which few of them do. For example, we are very doubtful about the forecast for Russia. While the IMF has revised the 2014 projections by 1.1pp to a growth rate of 0.2%, we feel this is still way too optimistic, given what we know is happening in the Russian economy right now – and since the official data on financial outflows do not capture adequately what is happening. The second interesting aspect is the extraordinary disappointment of Italy. There is clearly no Renzi effect in the numbers. The IMF now expects Italy to growth by 0.3% this year, having contracted by 2.4% and 1.9% in the previous two years respectively. While the overall growth rates for the eurozone have not moved, the cross-country gaps are getting wider. The IMF puts German growth at 1.9% (we recall that the Ifo Institute made that forecast in December, having since revised it upwards again to 2%). Federico Fubini has a comment in La Repubblica in which he looks at financial flows inside the eurozone, and says we should not be surprised to see a liquidity trap. Germany has a current surplus of €280bn with the world each year. Unlike in China, this money is not showing up in central bank reserves. Before the crisis, German banks invested the surpluses in securities issued by other countries – with holdings of some €4.6tr, according to BIS data. By the spring of this year, they have reduced their exposure by €2tr. It is the largest repatriation of money in history. The countries most affected are Italy, Portugal and the UK. German banks have

instead increased their exposures to China, Finland and Poland, an of low yielding German government paper. On Fubini’s math, the stock of excess savings in Germany are some €5tr. It would only take a small part of that to yield higher growth in the eurozone. A current account surplus of some €240bn per year still means that Germany is exporting capital abroad – but the money goes mostly into low-risk/low yield securities. If you want to increase investment spending in Germany itself but also elsewhere, the private money will not do it. It would require that the public sector at least starts the process, or gives the private sector strong incentives. We fear that it would take more than a loosening of co-financing rules. More signs of a slowdown in France French manufacturing contracted in July at the fastest pace this year suggesting that the French recovery is struggling to gather pace, writes Bloomberg. A Purchasing Managers Index for the manufacturing industry fell to 47.6 from 48.2 in June according to Markit Economics. That’s the lowest since December 2013 and the third straight reading below 50, the mark that signals contraction. A gauge of services activity rose to 50.4 from 48.2 in June, indicating growth for the first time in three months. A composite index of both services and manufacturing rose to 49.4 from 48.1. Outrage over guillotine It seemed to be the perfect strategy to frustrate the Senate reforms – 8000 amendments, 1000 secret votes. Yesterday, the Senate majority imposed a guillotine on the process, with a final vote deadline of August 8, 135 hours of total Senate time for discussions, and 80 hours for the votes. The opposition (mainly Grillo’s Five Star Movement and the SEL, a leftist party) was so outraged by this decision that they staged a walk-out. Constitutionally, the imposition of a guillotine seems to be possible, as there is no fundamental difference in procedure between constitutional and ordinary legislation. The Constitutional Affairs Minister Elana Boschi said yesterday that the final world would be with the people – thus confirming that the Italian government will call a constitutional referendum. Under Italian constitutional law, such a referendum is affirmative – a simple majority of those who are taking part in the vote would be sufficient. Towards financial sanctions EU ambassadors met yesterday, and inched towards an eventual agreement on financial sanctions against Russia. The actual decisions taken yesterday were minor. The list of people and institutionss was increased by another 15 and 18 respectively, but the really important development – as Frankfurter Allgemeine reports – is that the list of sanctions to be agreed next week will be similar to those imposed by the US by focusing on financial transactions. This will affect in particular state-owned Russian companies and banks. As the paper writes, one of the reasons for the delay is the need for unanimity. It is not clear whether the ambassadors could simply take the decision themselves, or whether there is a need for a foreign affairs council, or a European Council. In a separate article the paper writes that the discussions are to be continued next Tuesday. The Commission’s proposal focuses mostly on banks in which the Russian

state as a share of more than 50%. The sanctions could make it illegal for EU citizens to buy shares or bonds in such banks. As in the case of the US sanctions, the EU sanctions, too, would kick in for maturities of 90 days or over. There are no plans to extend the ban to Russian sovereign debt. The article points out that Russia could withstand financial sanctions for a while, given is $470bn in foreign reserves. Another important development is the announcement by Norway’s Government Pension Fund Global, one of the world’s largest sovereign wealth funds, that it will reconsider its investments in Russia. Spiegel Online remarks that if there was an agreement next week, it would be more far reaching than what the US has done so far. The other interesting piece of news was a remarkable interview by Reuters of Alexander Khodakovsky, commander of the Vostok Battalion, who acknowledged that the rebels did possess a BUK missile system. Khodakovsky said Kiev had launched air strikes in the area fully aware that the missiles were in place. He said that the only situation in which he would use a BUK was as a direct response to an air strike. Spain’s unemployment crisis improves after touching bottom Spain’s national statistics institute INE released its quarterly active population survey. The government can celebrate that the unemployment figure, around 5.8m, is now lower than it was when it took office in the last quarter of 2011. The survey shows: the largest Q2 qoq occupation increase since 2005, over 400,000 people; the first yoy employment increase in 6 years, with 192,000 net jobs; the largest qoq unemployment reduction since 2006 and the best yoy unemployment reduction since 1999 at 425,000 fewer unemployed; and a 232,000 yoy reduction of the active population. On a yoy basis private sector occupation is up by 208,000 and public sector occupation is down by 15,600. Overall this indicates that Spain’s unemployment crisis has touched bottom, but the picture is spoiled by the continuing reduction in the active population. In their commentary on the survey, Economistas Frente a la Crisis note that the yoy rate of occupation growth is about the same as the GDP growth rate just estimated by the Bank of Spain. This indicates that the productivity of the workforce is not improving. Greek coalition leaders defuse tension over evaluation scheme Greek coalition leaders sought yesterday to defuse tension that has built up between New Democracy and Pasok over the assessment of public servants’ performance, Kathimerini reports. Both sides let it be known that the two leaders are determined to overcome this rift and to meet Greece’s commitments to the troika. The conciliatory mood was helped by Deputy Administrative Reform Minister Evi Christofilopoulou indicating that it is willing to make compromises over the evaluation scheme. The point of friction between the two governing parties has been the Administrative Reform Minister’s insistence that 15% of employees in each department deemed below standard would be automatically placed into the mobility scheme. Christofilopoulou indicated that the ministry is now willing to commit in writing that civil servants who fail the grade will not be fired, transferred or have their wages cut. Instead, the government will seek ways to increase their productivity, such as extra training. Share on facebookShare on twitterShare on emailShare on printMore Sharing ServicesShare

Ireland seeks early repayment of IMF loan The Irish government is seeking to repay the IMF bailout loan earlier and Is currently in discussions with EU countries about such a move, the Irish Times reports. Under the original bailout agreement struck in December 2010, any move by Ireland to repay its loans early must apply to both the IMF and European portions of the package. While Ireland’s EU lenders could revise this clause, such a change would need the agreement of all member states. Currently, Ireland is paying about €1bn a year in interest on its IMF loans. The cost of servicing the IMF loans is about 5%– more than twice the interest rate charged for the European loans. With Irish 10-year debt currently attracting a yield of just over 2% in the market, Ireland is effectively is also paying more than twice the market rate for its IMF loans. While there will be no decision in time for the October budget, the government hopes to reduce its interest servicing costs over the coming years. However, sources in Brussels said some euro zone members may resist any move to allow Ireland to repay its IMF loans early, as the EU would then take on the full risk of holding the outstanding loans. Share on facebookShare on twitterShare on emailShare on printMore Sharing ServicesShare Former BES chief Salgado suspect in tax evasion investigation Former BES chief Ricardo Salgado is named a suspect in a long-running money- laundering and tax evasion investigation, Reuters reports. Salgado was released on bail of €3m after being detained and questioned. Under Portuguese law the status of "arguido", or formal suspect, differs from the suspect status in other legal systems as it gives the person certain legal advantages in being questioned and does not per se involve a formal accusation. There is no suggestion that the three-year-long money- laundering investigation is related to the family's recent financial problems. BES shares have rebounded from near record lows in the past two days after two major investors bought into the bank, as traders now say they see the bank as mostly isolated from the family problems. Papadia on the costs of the sanctions Francesco Papadia has done some back-of-the-envelope calculation on the basis of financial market data to estimate the effects of economic sanctions. “…while it is impossible to estimate the absolute size of the damage that the Ukrainian events are causing to the Russian, European and American economy, and it is thus also impossible to exclude that this damage could be very serious and even catastrophic, the reaction of the stock exchange market so far would indicate that indeed Russia suffers more than twice as much than the US, followed by Europe, with a loss two third higher than the US. This can explain to some extent the different political attitudes of the three actors.” He said what is more difficult to measure is the ability to bear economic pain. Russia’s pain threshold is clearly higher than that of western democracies.

Eurozone Financial Data

10y spreads Previous This Yesterday day Morning France 0.293 0.294 0.292 Italy 1.600 1.553 1.555 Spain 1.416 1.386 1.388 Portugal 2.572 2.538 2.546 Greece 5.150 5.001 4.99 Ireland 1.113 1.095 1.093 Belgium 0.394 0.393 0.390 Bund Yield 1.147 1.178 1.176 exchange rates This Previous morning Dollar 1.348 1.347 Yen 136.880 137.03 Pound 0.792 0.7929 Swiss Franc 1.215 1.215

ZC Inflation Swaps previous last close 1 yr 0.71 0.71 2 yr 0.74 0.74 5 yr 1.19 1.19 10 yr 1.64 1.64

Eonia 23-Jul-14 0.05 22-Jul-14 0.04 21-Jul-14 0.05 18-Jul-14 0.04

OIS yield curve 1W 0.080 15M 0.068 2W 0.074 18M 0.070 9

3W 0.076 21M 0.078 1M 0.099 2Y 0.086 2M 0.110 3Y 0.138 3M 0.103 4Y 0.237 4M 0.092 5Y 0.360 5M 0.100 6Y 0.504 6M 0.101 7Y 0.657 7M 0.100 8Y 0.810 8M 0.098 9Y 0.955 9M 0.089 10Y 1.087 10M 0.072 15Y 1.557 11M 0.084 20Y 1.775 1Y 0.090 30Y 1.872

Euribor-OIS Spread previous last close 1 Week -4.414 -3.214 1 Month 1.243 -0.757 3 Months 9.857 9.657 1 Year 35.257 35.357

Source: Reuters http://dev.eurointelligence.com/professional/briefings/2014-07- 25.html?cHash=12ea5685f265ca7d55c6b2910b0917a1

The Slow Recovery Continues Posted on July 24, 2014 by iMFdirect By Olivier Blanchard

The recovery continues, but it remains weak, indeed a bit weaker than we forecast in April. We have revised our forecast for world growth in 2014 from 3.7 percent in April to 3.4 percent today. This headline number makes things look worse than they really are. To a large extent, it reflects something that has already happened, namely the large negative US growth rate in the first quarter. But it is not all due to that. It also reflects a number of small downward revisions, both in advanced and in emerging economies.

The overall story remains largely the same as before: Advanced economies are still confronted with high levels of public and private debt, which act as brakes on the recovery. These brakes are coming off, but at different rates across countries. Emerging markets are slowing down from pre-crisis growth rates. They have to address some of their underlying structural problems, and take on structural reforms. At the same time, they have to deal with the implications of monetary policy normalization in the US. Let me take you on the usual tour of the world. Advanced economies The United States First quarter growth in the US, as currently reported (I would not be surprised if the numbers were revised), was far worse than anybody had anticipated. In retrospect, it seems to be largely due to one-off factors, ranging from an inventory correction to unusually bad weather. Looking forward, US growth for the rest of the year is still forecast to be 3.25 percent and 3 percent in 2015. The main policy issue, at this juncture, is the appropriate speed of monetary policy normalization. Given the unusual behavior of labor participation, and uncertainty about the equilibrium rate of unemployment, assessing the amount of slack in the US is difficult. The current plans, namely the end of tapering later this year and increases in the policy rate from the middle of next year, are appropriate. But the timing of the increase in the policy rate may have to be adjusted, as a function of developments on the inflation and unemployment fronts. A recent report by the BIS has drawn attention to the potential for excessive risk taking in financial markets coming from an extended period of low rates. We agree that, in some financial markets, valuations appear perhaps optimistic. But, overall, we do not see a systemic threat to financial stability, mainly because of lower leverage in both banks and, to the extent we can measure it, in non banks as well. Were the risks to increase however, macro prudential tools should be the right first line of defense. Getting ready to use them should be a policy priority. The Euro area The recovery in the Euro area remains weak, and inflation remains too low. Our forecasts for the Euro area remain roughly unchanged, 1.1 percent for 2014, and 1.5 percent for 2015. These numbers hide, however, differences across countries. In the core, we have revised our forecasts up for Germany, and down for France. In the periphery, we have revised our forecasts up for Spain, down for Italy. To strengthen the recovery, the Euro area clearly still needs strong action on both the demand and the supply side: In most Euro countries, unemployment rates far exceed their equilibrium value, and Euro wide inflation is too low. Thus, demand side policies are still of the essence. As fiscal space is tight, monetary policy must continue to support activity. The recent

measures taken by the ECB are welcome. It is too early to assess their effects, and if inflation continued to remain stubbornly low, more measures should be considered. Monetary policy cannot do the job alone however. The asset quality review currently under way in European banks is critical to reestablishing confidence in banks, and improving intermediation. And looking beyond the demand constraints, structural measures must be taken to increase very low potential growth rates. These measures differ across countries, ranging from reforms to re-enfranchise the unemployed youth, to measures that increase competition in non-tradable sectors, to infrastructure spending. Japan We have revised upwards our forecasts for Japan, to 1.6 percent in 2014. This reflects the effects of Abenomics, and stronger domestic demand, including investment. The fundamental challenge of Japan remains, how to decrease public debt and increase growth both in the short and the long run. Our forecast for 2015 gives a glimpse of the difficulty. Growth is forecast to be only 1.1 percent, reflecting in part the adverse effects on demand of the planned increase in consumption taxes later in the year. Emerging market and developing economies We forecast growth in emerging market and developing economies to run at 4.6 percent for 2014 (a revision down of 0.2 percent), and 5.2 percent for 2015 (a revision down of 0.1). Our largest downward revision, relative to our WEO April forecast, is for Russia, where we have revised growth for 2014 from 1.3 percent to 0.2 percent, and for 2015 from 2.3 percent to 1 percent. This reflects mainly a deterioration of business confidence, which has been aggravated by geopolitical tensions. The result has led to large capital outflows, and a near freeze in investment decisions. Housing investment has slowed down in China, and we expect this slowdown to continue. The government has counteracted this through a series of targeted stimulus measures directed at priority areas such as railway investment and social housing. Recent months have also seen higher credit flows and increasing infrastructure spending, as well as improving exports. Thus our forecast for this year is broadly unchanged at around 7½ percent growth. The main challenge for China remains however to achieve a more balanced growth, with less investment and more consumption. Looking forward, emerging and developing economies face two challenges. The first is to implement reforms to rebalance their economies and strengthen their growth. Some of these countries, Mexico notably, but others as well, are indeed embarking on ambitious reforms, which should help lift investment and growth. The second is to adapt to a changing world environment. This change has already started. The recovery in advanced economies implies increased demand for their exports. The normalization of monetary policy in the United States, however, implies that some of the capital flows that went to emerging markets in search of higher returns will eventually return home. This in turn implies tighter financial conditions and a tougher financial environment. Foreign investors are less forgiving,

macroeconomic weaknesses are more costly. And financial bumps, such as those we saw in May 2013, may well happen again. In short, the recovery continues. But it remains weak, and is still in need of strong policy support, to strengthen both demand and supply.

http://blog-imfdirect.imf.org/2014/07/24/the-slow-recovery-continues/

Economistas Frente a la Crisis El pensamiento económico al servicio de los ciudadanos

Menú principal/ Navegador de artículos ← Anterior El análisis de la EPA de ECONOMISTAS FRENTE A LA CRISIS (2º trimestre 2014) Publicado en 24/07/2014 por Economistas Frente a la Crisis EL EMPLEO SE REACTIVA CON FUERZA… AUNQUE MUESTRA CON CLARIDAD LOS DESEQUILIBRIOS DE FUTURO El empleo se reactiva por fin con fuerza (incluso con los datos desestacionalizados), lo cual constituye una excelente noticia que Economistas Frente a la Crisis (EFC) quiere celebrar. El número de ocupados en el trimestre ha crecido en 402.400 personas, y el de desempleados se ha reducido en 310.400. Consecuencia de ello, la tasa de paro ha descendido en casi un punto y medio, hasta el 24,47%. El empleo crece en términos interanuales por primera vez desde el segundo trimestre de 2008 (1,1%).

El empleo se reactiva como consecuencia de que, al fin, en el último año se han suavizado considerablemente las irracionales restricciones económicas impuestas por las políticas de austeridad. Por otro lado, esta reactivación, además de por el inicio de la temporada veraniega, se produce por la bondad del clima de este año y por el efecto de la Semana Santa al coincidir este año en abril y en el anterior en marzo. La prueba de la importancia de la suavización de los ajustes la facilitan los datos de la Estadística de Flujos de la EPA, al poner de manifiesto que la fortaleza de la recuperación del empleo, registrada por primera vez este trimestre, no se debe tanto a un aumento de las personas que consiguen un empleo (“entran en la ocupación”, según los términos del INE), que en realidad era mayor en años como 2009, 2010 y sobre todo 2011, sino a la considerable caída trimestral de aquellos que lo pierden (“salen de la ocupación”). Es la atenuación de los ajustes la que, en mayor grado, explica la recuperación del empleo.

Lo cual, a juicio de EFC, viene a sancionar: . tanto el error cometido durante años por la política económica europea y española, que profundizó y agravó la crisis, . como los costes sociales, en términos de brutal incremento del paro y de la pobreza y privación material de tantas familias, y destrucción de tejido productivo, que ocasionaron esas equivocadas políticas económicas de forma injustificada e innecesaria. El empleo se reactiva lo cual implica la recuperación de la población activa, lo que constituye otra buena noticia, aunque todavía parcial porque el incremento de activos se concentra en los hombres españoles, sin alcanzar prácticamente el efecto positivo a las mujeres nacionales, ni a la población inmigrante que aún continúa saliendo de nuestro país debido a la imposibilidad de soportar las terribles condiciones que han presidido durante años el mercado de trabajo español. La reactivación del empleo es tan fuerte que, a pesar del incremento de activos, se ha producido una significativa y prácticamente generalizada reducción del desempleo, lo que supone la mejor de las noticias tras tantos años de dolorosos incrementos.

Aunque todos seamos conscientes de que aún hay 5,6 millones de personas desempleadas, que la tasa de paro todavía asciende al 24,5%, y de que 1,8 millones de hogares tienen a todos sus miembros en paro, lo cierto es que hay que destacar que se ha iniciado el difícil y largo camino para superar esta situación. ——– Sin embargo, junto a todos los aspectos positivos que, sin duda alguna, los tiene esta EPA del 2º trimestre de 2014, y que hemos ya destacado, es preciso señalar un conjunto de sombras relevantes que, según están confirmando indubitablemente los datos, va a tener la recuperación del empleo debido a las políticas laborales adoptadas:

1- El empleo se está creando sin aumento de la productividad. La práctica identidad entre las tasas de crecimiento del empleo y las estimadas del PIB pone en evidencia que el empleo creado es de muy baja productividad. Luego el modelo productivo no mejora, lo cual es una obviedad puesto que no se ha adoptado política alguna para hacerlo. 2- Las reformas laborales, y muy en especial la de 2012, con sus radicales medidas desreguladoras y de recorte de derechos laborales y salarios, aumentan claro está la elasticidad de la creación de empleo, pero eso es a costa de la calidad del mismo, y de incrementar aún más la volatilidad e inestabilidad del empleo (dado que el crecimiento de la elasticidad actúa también en la dirección de los ajustes). Lo cual significa que, si se debilita el crecimiento económico, sufriremos incrementos aún más fuertes del paro que en el pasado. 3- El empleo creado, fruto asimismo de las medidas adoptadas en materia de contratación en el seno de esas reformas, es en una proporción elevada temporal. Incluso mayor de la que en apariencia refleja la EPA ya que ahora existen modalidades contractuales que se denominan indefinidas, pero que en realidad son tan inestables o más que los contratos temporales. 4- Y finalmente, aunque de tanta o mayor importancia y trascendencia que los anteriores, la creación de empleo se concentra en puestos de trabajo a tiempo parcial (a menudo a tiempo parcial y temporales), lo que ocasiona dos efectos altamente negativos: 16

A. Aumenta el número de personas que trabaja, pero estas lo hacen crecientemente con salarios muy bajos, como muestran los datos más recientes de la Encuesta Trimestral de Coste Laboral. B. Las horas efectivamente trabajadas, que es la variable que en realidad importa desde el punto de vista económico, lo cierto es que crecen mucho menos que el empleo, como pone de manifiesto el hecho de que las horas medias efectivamente trabajadas por los ocupados están cayendo intensamente en los últimos trimestres.

—————– En suma, EFC destaca y se felicita por la recuperación de la creación de empleo, y quiere al mismo tiempo señalar los desequilibrios y efectos negativos que tendrán los tipos de empleos que se están creando.// 24.07.2014 http://economistasfrentealacrisis.wordpress.com/2014/07/24/el-analisis-de-la-epa- 2o-trimestre-2014-de-economistas-frentea-la-crisis/

Daily Morning Newsbriefing July 24, 2014 EU edges towards tier-3 sanctions According to a report in Spiegel Online, Angela Merkel is now ready to support immediate tier-3 level sanctions against Russia. Unnamed German government sources were quoted as saying that Merkel would welcome proposals by the EU Commission today in relation to sanctions in respect of capital market access, defence, dual-use goods, and sensitive technologies, including the energy sector. The ambassadors should not only discuss the proposals, but actually agree a list of sanctions. Earlier yesterday, Merkel’s spokesman said yesterday that Russia had shown no interest in getting to the truth about the shooting down of MH17, nor was Russia trying to use calm down tensions in eastern Ukraine. Spiegel Online quotes a foreign ministry spokeswoman as saying that Russia has made many promises, but not delivered any. “We have had it”, she is quoted as saying. The shooting down of the two Ukrainian military aircraft yesterday – possibly from Russian soil – leave no doubt that Vladimir Putin is not about to change course, thus edging the EU further towards sanctions. The Wall Street Journal reports that the European Bank for Reconstruction and Development yesterday suspended lending to Russia, with only its sole Russian director opposed. In the first half of this year, the EBRD made new investments of €3.6bn, with Russia accounting for 19% of that figure. It is the first time ever that the EBRD has stopped making an investment in a country of its operations. As of end March, the EBRD's portfolio of investments in Russia stood at €8.7bn. Writing in the FT, Francois Heisbourg says that France could be helped to give up on the Mistral deal if Britain, imposed capital sanctions. One of the problems for the French government is that abandoning the sale at this stage would be extremely costly. The ships are built with Russian and French components, so that the ship cannot be simply sold to a third party. But Heisbourg says it is imperative that this deal does not go through. He writes the French government does not fully understand how seriously other eastern European countries would react to the delivery of the Mistrals. Poland will be spending €20bn for the modernisation of its military, and French companies are competing for contracts there. Heisbourg is sceptical on the effectiveness of sanctions, because they harm the sanctioner just as much, and because they are political divisive. It would be a lot more effective to support Ukraine economically. We agree with Heisbourg on the importance that the Mistral deal does not go ahead, but disagree with his general comment on sanctions. Financial sanctions can be very effective, and could cripple the Russian economy relatively quickly. We do, however, agree that they won’t impress Putin, at least not initially. The German news reports

suggest that Merkel seems now more determined than previously to accept sanctions, but we will withhold judgement until we see the list of sanctions. What is really important is that Russian firms no longer receive access to EU capital markets. The best deal would indeed be a combination of financial, energy and defence sanctions – which would also triangulate between the interests of Germany, France and the UK. A not so good outcome would be that you get a little bit of each. ERC’s Junqueras threatens Spain with bond vigilantes In an interview quoted by Bloomberg, left wing Catalan independentist party ERC ‘s leader Oriol Junqueras suggested the bond vigilantes would punish Spain, which “owes a trillion”, if an independence vote did not go ahead in November as planned, causing political instability. Bloomberg points out that the Catalan region’s 6y bonds yield about 1% higher than Spanish bonds, down from a peak spread of 744bp in the Summer of 2012, when Spain was in the throes of its own sovereign debt crisis and Catalonia and other regions were on the brink of insolvency in the eyes of bond markets. What Bloomberg does not say is that the Spanish government bailed out its regions (in exchange for austerity) by instituting a regional liquidity fund (FLA) which disbursed €16.6bn in 2012, €22.9bn in 2013 and €9.3bn to date in 2014, of which about 40% has gone to Catalonia. Austerity policies by Catalan premier Artur Mas had led to protests already 2011 and were a major contributor to popular discontent in 2012. This crystalised in massive pro- independence demonstrations after which Mas embarked on the independence course and called early elections in November 2012. Electorally, Junqueras’ ERC has benefitted more than Mas’ CiU from the independence process and now leads in the polls, also because ERC is not in the regional government but provides outside support in the regional parliament. Spain’s securities regulator warns against structured products as deposits Spain’s securities market regulator CNMV has issued a circular letter tightening the information requirements on retail banking “structured products” to prevent them being marketed as deposits, reports El Confidencial. These products were very popular in the run-up to the financial crisis, and are making a comeback because of the demand for higher yields for savings and the limitations imposed by the Bank of Spain on the remuneration of time deposits to avoid a price war among banks as was observed before the Spanish banking crisis. The generalised sale of preferred shares as deposits on which savers later incurred heavy losses is a precedent the CNMV wants to avoid. Bank of Spain improves its GDP outlook as quarterly GDP growth accelerates Much is being made in the Spanish press of the acceleration of GDP growth to 0.5% qoq, up from 0.4% a quarter earlier, estimated by the Bank of Spain in its quarterly economic report just issued as part of the July-August economic bulletin. 2014Q2 was the fourth consecutive quarter of positive GDP growth, for a GDP growth rate of 1.1% yoy. The Bank of Spain is raising its growth extimates by a few tenths of a pp, to 1.3% for 2014 and 2% for 2015. 19

According to the Bank of Spain’s estimates, investment (gross capital formation) grew by 1.3% qoq in the second quarter, though this is after a 0.6% qoq drop the previous quarter so seasonal effects might be at play. Eurozone consumer confidence plunges We do not think that confidence indicators tell us much we do not already know in the current phase of the post-crisis economic cycle. The European Commission’s consumer confidence indicator – one of the indicators watched closely by the ECB and investors, fell by 0.9 points to a reading of -8.4, a second successive dip. The fall in confidence is almost surely a reflection of the news from the Ukraine, and is consistent with hard data showing that the eurozone economy has been weakening again. With more sanctions on the way, the recovery is likely to remain very weak. Lithuania to join the Euro area next January Lithuania will become the 19th member of the eurozone, with the currency entering circulation there on Jan. 1, European leaders announced yesterday. The conversion rate of Lithuania's currency, the litas, was set at the central rate of 3.4528 to the euro, according to Reuters. The entry also means a change in the voting process of the ECB. Up to now, all members of the central bank's policy-setting Governing Council have had a vote on policy. This will change with the 19th member. Voting rights will then be divided according to the size of countries: The largest five countries will share four votes, while the smaller 14 countries will share 11 votes. “Catch tax dodgers if you want to reduce taxes” Greece achieved major progress in its absorption of European subsidies as well as in restructuring its tax administration but still lags behind when it comes to bank credit to enterprises and containing tax evasion, according to the seventh TFGR report of the European Commission’s Task Force for Greece. The TFGR was launched in July 2011 with the mandate to identify and coordinate the technical assistance requested by Greece in delivering the reform commitments. The report says Greece is now ranked fifth among EU countries in the absorption of EU structural and cohesion funds compared to eighteenth place at the end of 2011 and reached an absorption rate of 81.3% in June 2014 compared to the EU average of 69.2%, according to Macropolis. The tax administration was attested good progress. Assistance was been stepped up for VAT tax collection and work is expected to progress in the area of auditing high-wealth individuals and high-income self-employed. “You need to catch tax dodgers if you want to reduce your taxes,” a top Commission official said at the presentation of the report in Athens. Kathimerini quotes a senior Commission official noting that lack of cash flow remains one of the key obstacles hindering the growth of the economy, as do bad loans, for which Greece has not asked the Task Force for any help. He added that there is a huge stock of international experience on this front that can be used.

One of the latest measures of the Greek government is to block real estate transactions for owners who have not paid their property taxes in the last five years, according to this article in Kathimerini. HFSF chief: Greece likely to recover €30bn of €50bn of its funds Greece is likely to recover more than €30bn of the €50bn it has borrowed to rescue its banks, Hellenic Financial Stability Fund (HFSF) CEO Anastasia Sakellariou told Kathimerini newspaper in an interview published on Sunday (hat tip Macropolis). The HFSF’s original paid-up capital stands at €49.7bn and Sakellariou said that its recovery value would potentially exceed €30bn, nearly double of the €16bn, the IMF put it in 2012. Sakellariou’s estimation adds up from the current value of HFSF shareholdings in core Greek banks of €18bn, €2bn that could be recovered from resolved banks and HFSF capital buffer of €11.5bn. Most of the €14.5bn spent on resolving non-core banks are lost though. Irish bank inquiry should look back 20 years In Ireland, the banking inquiry’s advisory group recommended the investigation should look back over the past 20 years to discover the origins of Ireland’s economic crash, in a report cited by the Irish Times. There has been disagreement on the cross-party committee chaired by Labour’s Ciarán Lynch about the scope and time frame of the inquiry. The advisory group report said the inquiry should look back to the mid-1990s to discover the origins of the crash, issues relating to the “build-up and night of the bank guarantee” along with the “role and influence of international organisations”. It also recommended splitting the investigation into three modules with public hearings beginning on April 13th, 2015 and continuing until at least July 17th. A final report would be published in November 2015. Under the first “banking system” module, issues relating to the role of external auditors in communicating risks to management and to the Financial Regulator could be explored. The second module, looking at regulatory and supervisory systems, would analyse the role of the Department of Finance and the Oireachtas, plus the “property- state nexus” and its impact on the property market. The final module, on crisis management systems and policy responses, would examine the role of international agencies such as the ECB “including payments to bondholders”. Renzi’s reforms face delays We have seen the glitzy campaigns and the tax cuts, but the hard work has yet to happen. Matteo Renzi’s political reforms are in trouble. There are now nearly 8000 amendments on the table – three amendments each two hours – and almost 1000 requests for secret votes. By comparison, the Senate only voted on three amendments yesterday. The amendments and secret votes are obviously a filibuster operation, designed to scupper the legislation. La Repubblica writes that government sources were no longer treating a postponement of the reforms as a taboo as they did until recently. The problem for Renzi is not only the opposition Five Star Movement, but also Senators from his own party who oppose the reforms, and are seeking to slow them down. It is also possible for the Senate leadership to guillotine the process, but this is more likely to happen after the summer break, with a first reading to be completed by end-September (instead of mid-August, as under the current plan). 21

In another article, La Republicca quotes a senator as saying that Renzi’s threat to call new elections was hollow. Even a child recognises a water pistol. The reason the treat is hollow is because in the absence of electoral reforms, any elections would have to be held under a system of pure proportional representation in line with a recent Constitutional Court ruling. There is no way that Renzi could repeat his performance of over 40% share of the vote in such an election, given that an election would only arise if the unity of his own party crumbled. For that reason, we are certain Renzi will accept a slowdown of the reforms, and compromises. And that will also be the case for any subsequent economic reforms. Moscovici unlikely to become economics commissioner Frankfurter Allgemeine writes this morning that there has been so much opposition to Pierre Moscovici from inside the European Parliament that his chances of becoming economics commissioner were now dwindling. German EPP members argue, in line with Wolfgang Schauble, that it would be wrong to appoint someone who has broken EU budget rules. The head of the French UMP says Moscovici would be rejected by MEPs. The paper writes that President Francois Hollande, who met with Jean-Claude Juncker last night, is now pondering two options. Either propose Moscovici for a less contentious office, like energy or competition, or propose Elisabeth Guigou for the role of High Representative. Les Echos though claims that Guigou is not a real alternative but a false rumour put into circulation by German newspapers.

Eurozone Financial Data

10y spreads Previous This Yesterday day Morning France 0.299 0.293 0.290 Italy 1.612 1.593 1.591 Spain 1.414 1.416 1.413 Portugal 2.567 2.572 2.569 Greece 5.102 5.150 5.15 Ireland 1.116 1.113 1.108 Belgium 0.400 0.394 0.392 Bund Yield 1.169 1.147 1.149 exchange rates This Previous morning Dollar 1.347 1.3444 Yen 136.510 136.4 Pound 0.789 0.7893 Swiss Franc 1.215 1.2143 ZC Inflation Swaps 22

previous last close 1 yr 0.71 0.71 2 yr 0.75 0.75 5 yr 1.2 1.19 10 yr 1.64 1.64

Eonia 22-Jul-14 0.04 21-Jul-14 0.05 18-Jul-14 0.04 17-Jul-14 0.04

OIS yield curve 1W 0.093 15M 0.066 2W 0.099 18M 0.067 3W 0.083 21M 0.076 1M 0.098 2Y 0.079 2M 0.109 3Y 0.150 3M 0.083 4Y 0.225 4M 0.082 5Y 0.345 5M 0.087 6Y 0.483 6M 0.078 7Y 0.633 7M 0.099 8Y 0.783 8M 0.083 9Y 0.925 9M 0.080 10Y 1.055 10M 0.086 15Y 1.526 11M 0.071 20Y 1.745 1Y 0.082 30Y 1.871

Euribor-OIS Spread previous last close 1 Week -5.014 -4.814 1 Month -0.071 1.029 3 Months 6.829 9.029 1 Year 34.829 35.729

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 24.html?cHash=1c69968f7be881cdd443b4950e5ac41c

THE IRISH TIMES Group advises 20-year scope for banking inquiry Mary Minihan Last Updated: Thursday, July 24, 2014, 07:55 The banking inquiry’s advisory group has recommended the investigation should look back over the past 20 years to discover the origins of Ireland’s economic crash. Economist Colm McCarthy is among the members of the expert group that presented an initial report suggesting a framework for a 14-month investigation into the €64 billion bailout to the Oireachtas Banking Inquiry committee yesterday. The report said the inquiry should look back to the mid-1990s to discover the origins of the crash, issues relating to the “build-up and night of the bank guarantee” along with the “role and influence of international organisations”. There has been disagreement on the cross-party committee chaired by Labour’s Ciarán Lynch about the scope and time frame of the inquiry. “The group has discussed a broad scope for the inquiry, for example reflecting the fact that a number of issues arising in the banking system go back to before the early 2000s and in fact it may be necessary to look back to the mid-1990s to uncover answers to some of the questions,” the report said. The report recommended splitting the investigation into three modules with public hearings beginning on April 13th, 2015 and continuing until at least July 17th. A final report would be published in November 2015. Communicating risks Under the first “banking system” module, issues relating to the role of external auditors in communicating risks to management and to the Financial Regulator could be explored. The second module, looking at regulatory and supervisory systems, would analyse the role of the Department of Finance and the Oireachtas, plus the “property-state nexus” and its impact on the property market. The final module, on crisis management systems and policy responses, would examine the role of international agencies such as the ECB “including payments to bondholders”. The advisory group report suggested the inquiry would need to distinguish itself from other reports into Ireland’s financial crisis, including those popularly known as Nyberg, Regling-Watson and Honohan. “A guiding principle will be the need to identify gaps in existing knowledge (including public knowledge) and to prioritise issues which have not been covered by previous reports.” The group has met four times and will meet again on September 9th. http://www.irishtimes.com/news/politics/group-advises-20-year-scope-for-banking-inquiry-1.1876223

July 23, 2014 5:45 pm Luxembourg tax regime: Under siege By Vanessa Houlder The low-tax system that has brought great prosperity to the Grand Duchy now threatens to become a liability

©Alamy Finance stronghold: Luxembourg receives more than a 10th of the world’s foreign direct investment Amid the rolling, wooded farmland of the Ardennes, the highway from Brussels briefly hugs the Luxembourg frontier at Martelange, a small town famous for the border that runs down the middle of its busy main street. On one side – in low-tax Luxembourg – is a profusion of petrol stations offering some of the most lightly taxed fuel in Europe. It is a striking example of the “gas pump tourism” that boosts Luxembourg’s exchequer at the expense of its neighbours. More ON THIS STORY// US Senate ire at $6bn tax ‘fiction’/ Global crackdown on tax secrecy nets €37bn/ In depth Great tax race/ ‘Golden age’ of tax planning under threat/ Switzerland to lift veil on tax secrecy IN ANALYSIS// US railways Back on track/ Asean Long on optimism/ US jobs Slim pickings/ Technology Wear your medicine This is one face of Luxembourg: a tiny country at the crossroads of Europe that built a significant part of its wealth on its appeal to other countries’ taxpayers. Its low fuel duties are just one facet of a distinctive tax system that has helped make its society one of the richest in the world. 25

There is another face to Luxembourg. Its agility and financial expertise has built the world’s second-largest fund administration industry. It has a reputation for stability and professionalism, demonstrated by the resilience of its huge banking sector in the financial crisis. But the rumbling discontent over Luxembourg’s tax practices is now threatening its prosperity. The world’s last Grand Duchy has already bowed to pressure over accusations it helped other countries’ citizens hide from the taxman. Xavier Bettel, its prime minister, is “fed up with being accused of being a defender of a tax haven and a hotbed of sin”. Luxembourg is also under suspicion of offering “sweetheart” deals to big companies, in breach of EU rules on state aid. Nerves are on edge in the Grand Duchy after the European Commission launched an investigation last month into tax “rulings”, embroiling Fiat, the car company, and potentially others. The commission is also suing Luxembourg for “serious distortions of competition” over the 3 per cent rate of value added tax it charges Amazon and other ebook retailers. Its low VAT rates have made the Grand Duchy an ecommerce hub but it stands to lose €800m of revenues – 1.5 per cent of its gross domestic product – next year under a long-awaited shake-up of European tax rules. Another threat is posed by a looming crackdown on corporate tax planning proposed by the Organisation for Economic Cooperation and Development in the wake of a public outcry over tax avoidance by companies such as Amazon and Apple.

The OECD aims to stamp out “treaty shopping” – routing income through “brass-plate” companies in countries with attractive tax treaties – which will affect many of the Grand Duchy’s finance and holding companies that own more than $2tn of assets. It could spell the end of an era in which a country of 1,000 square miles receives more than a 10th of the world’s foreign direct investment, as calculated by the International Monetary Fund. Consumption taxes are already set to rise as Luxembourg grapples with the loss of “significant” revenues from these changes, the IMF said in May. “Luxembourg’s public finances are at a turning point.” 26

In Luxembourg City, a glass and steel metropolis grafted on to a medieval fortress town, the impending changes are viewed with trepidation, tempered by a belief the Grand Duchy can both adapt and defend its interests. Much depends on whether the government is “being seen to fight” the OECD proposals, according to PwC, the professional services firm, in a May bulletin. The appointment of Jean-Claude Juncker, Luxembourg’s former prime minister, as president-designate of the European Commission, has sparked speculation that the Grand Duchy has won a powerful protector. Chris Lenon, former global head of tax at Rio Tinto, the mining group, says: “This isn’t a poacher turned gamekeeper, it looks more like the poacher in charge of the gamekeepers.” The allegation made by French Socialists that I actively promoted tax evasion is an outrageous attack on my country and my person - Jean-Claude Juncker Mr Juncker has angrily rejected claims that Luxembourg is a tax haven. In a March interview with Der Spiegel, the German news magazine, he said: “It is a fairy tale to say that Luxembourg has special rules with regard to company taxation. The allegation made by French Socialists that I actively promoted tax evasion is an outrageous attack on my country and my person.” But Luxembourg has been battling with its neighbours on tax matters for decades. As long ago as 1973, France and Germany demanded a crackdown on its “letter box” subsidiaries – structures governed by a 1929 tax law that were often used to avoid tax. It was not until 2006 that the regime was outlawed under the commission’s state aid rules. For companies, as well as individuals, Luxembourg’s emphasis on discretion added to its appeal. Foreign tax inspectors trying to understand their multinationals’ tax planning struggled to make sense of the sparse details in the companies’ Luxembourg accounts and/or get hold of legal documents, entrusted to lawyers. “Luxembourg was phenomenally secret,” says one such official. “Secrecy was more important to Luxembourg than anywhere else.”

There was often a big gap between the letter of the law and how it was applied, with informal rulings playing an important role, he says. “I would normally see rates of around 9-10 per cent in Luxembourg but they could be as low as 1 per cent.” Luxembourg is not overtly a low-tax country for businesses; more than two-thirds of OECD countries have rates lower than its 29.2 per cent. But there are numerous deductions and exemptions that lower the rate by creating profits – known as “white” income – that escape tax altogether. Some exemptions are straightforward. Since 2008, companies have been exempt from tax for up to 80 per cent of income from copyrights, patents, trademarks and other intellectual property. Finance companies can be set up so the overwhelming majority of the interest income they receive is booked in an untaxed or low-tax foreign branch. Falls in the value of foreign assets can be deducted against income in Luxembourg under an unusual rule that it once shared with Germany. But others are far more complex. Sprawling structures, often involving companies and branches in business-friendly countries such as the Netherlands, allow companies to arbitrage the difference between countries’ tax rules. Exotic “hybrid” instruments, treated as loans in Luxembourg but equity elsewhere – or vice versa – give multinationals a tax-efficient way of taking profits home, or routing them to havens such as Bermuda. Luxembourg’s popularity with US multinationals, including Amazon, Caterpillar and Microsoft, has increased dramatically in recent years. Their profits in the Grand Duchy rose from the equivalent of just 19 per cent of its GDP in 1999 to 141 per cent by 2011, according to the US Bureau of Economic Analysis. It looks more political than anything else. I would be very surprised if they found anything. The truth on the ground is far more boring than people make out. - Keith O’Donnell of Atoz In Europe too, Luxembourg has played an important role in the tax affairs of multinationals, thanks to its flexibility, its network of tax treaties and the benefits of its EU membership. The freedoms enshrined in Europe’s 1957 founding treaty meant other tax authorities could not penalise multinationals for using Luxembourg, giving it a big advantage over many other offshore finance centres. Even so, the scrutiny of Luxembourg structures intensified as cash-strapped tax authorities stepped up their attack on tax planning in the wake of the financial crisis. In Italy, Domenico Dolce and Stefano Gabbana, the fashion designers, were prosecuted by the tax authority over the transfer of their brands to a Luxembourg company. Only Britain bucked the trend by making it easier for companies to go offshore as it sought to increase the competitiveness of its tax system. This undercurrent of hostility grounds Brussels’ state aid challenge to Luxembourg, in the view of some of the country’s tax professionals. Keith O’Donnell of Atoz, an advisory firm, says: “It looks more political than anything else. I would be very surprised if they found anything.”

The fabled secrecy and informality of Luxembourg’s system of rulings – confirming how intra-company deals are taxed – is a misconception, he says. “The truth on the ground is far more boring than people make out.”

The system traditionally revolved around meetings with an important official, now retired, who was responsible for most of the rulings – although, even then, a technical analysis was required to justify the tax treatment. But since 2011 the rules have tightened significantly. The government has said it is “pretty confident” about its handling of tax issues but even so there is anxiety in Luxembourg over the commission’s actions. “It is creating nervousness among VPs [vice presidents] of taxes,” says a Luxembourg adviser. “They want certainty and that is being jeopardised.” Brussels’ move has put off some companies. Neil Todd, a partner of Berwin Leighton Paisner, a law firm, says: “Clients have picked up on it and think it is another marker against going offshore.” The international push against brass-plate companies is another worry, particularly for private equity firms. Yet some companies are responding to the new climate by broadening their Luxembourg operations. Once profits have to be earned where they are reported, Luxembourg has the infrastructure and workforce to compete for some activities, while small tax havens do not. Even so, Luxembourg is likely to need to overhaul its tax system if it is to preserve its appeal to companies, once the international rules have been reformed. The “base erosion and profit shifting” project of the OECD is intent on closing loopholes such as hybrid loans and low-tax branches. In June, Europe’s finance ministers also took action against hybrids. “It is not our fault if other countries tax their people more than ours. Maybe they are out of line with us - Nicolas Mackel, head of Luxembourg for Finance

Luxembourg’s government has promised to reform the system by 2017. Richard Collier, a tax partner at PwC, says: “I would be very surprised if Luxembourg doesn’t reduce its rate and revamp its system.” Luxembourg’s tax system is likely to end up more like that of its neighbours, potentially paving the way for harmonisation across the eurozone. The fallout from the financial crisis is putting pressure on European governments to pull together and stamp out harmful tax competition. The paradox of a country at the heart of the single market that undermines its neighbours through the design of its tax system looks increasingly untenable. But tax sovereignty will not be relinquished without a fight – in Luxembourg and elsewhere. Michael Probst, a partner at BA tax accountants in the Grand Duchy, says: “Tax harmonisation will never happen: national differences are too big.” Nicolas Mackel, who heads Luxembourg for Finance, an inward investment agency, insists the country is ready to co-operate and change. But how it taxes its people is a matter of “political or societal choice”. Nowhere is this more visible than in the queues of drivers from outside Luxembourg taking advantage of its low fuel duties, who the OECD says are responsible for an “extraordinary” 70 per cent of its fuel sales. High fuel taxes are seen by Luxembourg as socially unjust, says Mr Mackel. “It is not our fault if other countries tax their people more than ours. Maybe they are out of line with us,” he adds. Banking secrecy: How a duchy became a financial hub The meteoric growth of Luxembourg’s financial sector since the 1970s owes much to a tradition of banking secrecy. Its popularity as a banking centre with Belgians is rooted in 1922 monetary union with Belgium, which did not extend to taxes. So many investors flocked to the Grand Duchy to exchange bond coupons for interest payments that the train from Brussels became known as the “Coupon Express”. From the late 1960s, Luxembourg also became an offshore centre for dozens of German banks. After 1993, when Berlin imposed a 30 per cent withholding tax, its citizens began to shift billions of D-marks. The outflow sparked talks on withholding taxes or information exchange on bank accounts across the EU. The move was blocked by Luxembourg. “We shall only support an EC withholding tax when it covers all of western Europe, including Austria, Switzerland and such exotic tax havens as the British Channel Islands,” said Jean-Claude Juncker, then finance minister.

©EPA Jean-Claude Juncker resisted withholding tax proposals

Luxembourg’s obduracy paid off. A pan-European agreement signed in 2003 on savings taxation included Switzerland and Britain’s offshore islands. This made it somewhat harder to evade tax while allowing Luxembourg and others to maintain their secrecy. The Grand Duchy’s resistance to transparency took a toll on relations with its neighbours. The nadir was a diplomatic row with Germany in 2009. It was a threat of being virtually cut off from the US financial system that forced it to bow to pressure last year and agree to exchange tax information with other countries. Even so, some criticism continued: last November, the OECD said it had not lived up to global standards on transparency. The financial sector expects to lose 5 per cent of its assets from abandoning secrecy but it has not been the catastrophe that many feared. Last year, the number of banks in Luxembourg stopped shrinking and started expanding, with several Chinese banks setting up shop. The IMF describes the impact of information exchange as “benign”, in a sign that the importance of bank secrecy has already diminished. http://www.ft.com/intl/cms/s/0/b429f2c4-124f-11e4-a581- 00144feabdc0.html#axzz38N1TGC5h

Daily Morning Newsbriefing July 23, 2014 The return of the narrow commercial interest After the outrage over MH17, a whiff of business-as-usual returned yesterday. France is pressing ahead with the delivery of the first of the two Mistral helicopter carriers – on which work is nearly complete – but according to Bloomberg Francois Hollande is ready to cancel the second order. The FT said the meeting of foreign ministers ended with the agreement that the European Commission should draw up options for tier-three economic sanctions, including blocking Russian access to European capital markets, and limits on access to sensitive technologies, as well as energy import caps. Catherine Ashton said one of the options would be for an emergency EU summit to debate tier-three sanctions. But the FT notes that this will only happen if Putin fails to co-operate by ending the flow of weapons to the separatists. In the meantime, there is more evidence that the sanctions already passed have significant economic effects. The German English news portal The Local has a useful collection of reaction by German industry, quoted Eckhard Cordes, the head of Germany’s notorious Ostausschuss, a pro-eastern business lobby group, as saying that 25,000 jobs were already in danger due to the existing sanction. There were similar protests from other business lobby groups. The article noted that of the 6300 German companies active in Russia, most were small-to-medium sized businesses. In Russia, economic tensions are building up. Spiegel Online reports on the bankruptcy of Newa, one of the largest tourist groups in Russia, with close links to Putin. Newa was not itself targeted for sanctions, but got entangled with an insurance, which was targeted by sanctions. The article says the US sanctions will have to be followed by European banks simply because they would otherwise flout US-law. German companies, which used to be welcomed in Russia with open arms, are met with more scepticism these days, as further sanctions are looming. Die Welt reports that the fall in the rouble has led to an increase in Russian inflation to 7%, which in turn is likely to prompt the Russian central bank to raise interest rates further. The FT quotes Alexei Kudrin, a former finance minister, as warning that Russia managed to become the west’s adversary again. He says business wants to invest and create jobs, and they are getting by what they are hearing on Russian television. The article also makes the point that the much trumpeted programme of de- dollarisation is not progressing well.

One of the things we noted when we perused this morning’s European media that the story was virtually non-existent in Italian newspapers. The absence of Italian victims on MH17 is possibly one factor. But the Italian political elites also do not seem to share the same outrage against Putin. We noted a comment in Huffington Post about Federica Mogherini, Italian foreign minister, and Renzi’s candidate for the job of EU High Representative. They online paper said Mogherini acted prudently – in view of her candidacy for the High Rep job - by not confronting Moscow. On Mogherini: We are not sure that the Huffington Post is right on this. We do not think that the EU will, or should, go for all out sanctions against Moscow. A calibrated approach would be far more intelligent. But Italy’s role is suspicious. We also do not see why Renzi is wasting so much political capital on this particular job. Does he perhaps see the role as a lobbying function for inward investment to Italy? On the sanctions: as the reports from Moscow already make clear, the financial sanctions are beginning to bite. This is what the EU should focus on – rather than quarrel about helicopter-carriers or mindboggling complex energy embargos. The EU should needs a policy to become more self-sufficient in energy, but it does not require an end of all energy imports. Unlike some of the media reports, we are not quite as pessimistic about the diplomatic efforts. We welcome that the EU is now beginning a more strategic approach to sanctions, which has been absent so far. 8000 amendments against Renzi While the Italian media were largely silent on Putin, they are preoccupied with their own internal affairs as Matteo Renzi’s political reforms once again hit a hurdle. After the Sentate’s constitutional committee voted to bring the legislation to the entire Senate, the legislation is now stuck there, with almost 8000 (!) amendments – a process that is extremely accident prone. La Repubblica spoke of yesterday as a “day of total madness”, with Renzi threatening new elections unless the Senate passes the reforms. The timetable deadline now is August 15, and a timetable that forces Senators to work Monday-Sunday, 9am until midnight, to pass the legislation. The newspaper points out that the process would be very risky. The majority must be present in all the votes. The PD must keep a check on all of its members at all times – “even on those on the toilets”. One voting accident, the reform falls to pieces. PD Senators are already talking about Renzi’s Vietnam. Michele Ainis writes in a comment Corriere della Sera that the situation resembles that of a Titanic bumping into a double-iceberg. One consists of proposals, rejected by the government, to revert to an elected Senate. The second consists of secondary preference votes to elect ordinary MPs as part of the electoral reforms. Ainis goes into some technical detail of the subterranean interact between the two. The bottom line is that the outcome cannot be taken for granted. Greek debt falls 1pp to 174.1% Greece’s general government debt fell by €3.9bn qoq to €314.8bn, or 174.1% of GDP, at the end of the first quarter in 2014 from €318.7bn, or 175.1%, at the end of 2013, according to Eurostat data. Recent Finance Ministry figures put central government debt at €320.42bn in Q1, implying a smaller drop of €1.06bn in the quarter, writes 33

Macropolis. The difference between the Eurostat and ministry figures relate to intra- government debt holdings, which increased to €5.62bn in Q1 from €2.77bn in Q4 2013. Pasok voices opposition to civil servant evaluation scheme As we reported previously, Pasok’s need to raise its profile ahead of the next election is already resulting in tension inside the government. Yesterday this conflict came out in the open on the subject of public sector reform. Administrative reform minister Kyriakos Mitsotakis was hitting out at fellow cabinet members and at Pasok in particular for questioning the evaluation of civil servants and plans to sack another 6,500 by the end of the year, writes Kathimerini. “Each minister has to leave behind the paradise of their own ministry and see the bigger picture,” Mitsotakis told Skai. “We have to all realize that the evaluation will proceed and that it has been approved by Parliament.” Pasok has voiced opposition to Mitsotakis’s plans for the civil service evaluation scheme. “The evaluation should happen but using the same method as in the past,” said Pasok spokesman Dimitris Karydis. The Socialists argue that Mitsotakis’s system will lead to departments or services which are already short-staffed being deprived of more employees. Speaking to Skai TV, Mitsotakis said the government could not risk going back on commitments it had made to its lenders. Hollande says France will not cut spending if economy slows down France will not accelerate cuts in public spending even though disappointing growth could make it difficult to meet EU fiscal targets, Reuters quotes Francois Hollande that he would not cut spending if the economy were to slow down, “which is not impossible”. In that case, he said, he would use the flexibility margins of the EU’s fiscal rules. Pro-cyclical austerity would make everything worse, he said. "We will do things the intelligent way." He confirmed said the government would not change its plans and go beyond €50bn of savings on public spending planned for 2015-2017. France has based its plan to reach the 3% deficit target next year - after using a two-year reprieve granted by its EU peers - on forecasts of 1% growth this year and 1.7% in 2015. If the growth forecast of the government turns out to be too optimistic, France will not be in a position to use the additional flexibility for countries that have already brought their deficit below 3% of GDP. However, EU rules also allow giving member states some leeway on the 3% deficit rule in the case of an unexpected deterioration in growth, which France has already benefited from. IMF warns about costly external rebalancing in bailed out countries An IMF study on “adjustment in euro area deficit countries" finds external rebalancing in bailed out Eurozone countries come at a price of internal imbalances: “The large current account deficits in Greece, Ireland, Portugal, and Spain have shrunk drastically or turned into surpluses largely because imports and potential growth have slowed down drastically relative to pre-crisis trends. Their net foreign liabilities remain very high (implying higher net income payments), and the progress with external rebalancing has come at the expense of internal balance, notably sharply higher unemployment rates. Relatively weak demand from euro area partner countries, including these surplus economies, is slowing down the adjustment.”

The paper argues that once the output gap starts to close, external imbalances will again emerge, unless more capacity is transferred to the tradable sector. The paper also claims that the fall in unit labour costs was due to job destruction, as there is no evidence of declines in wages in Portugal and Spain, writes Jornal de Negocios. On Brexit Tim Oliver has an interesting contribution in the LSE Blog, in which he goes into the five Brexit scenarios – how it might actually happen. They are: 1. The big bang: a referendum supporting withdrawal triggers Article 50 TEU; 2. The big leap: a unilateral decision by a British government to withdraw; 3. The big kick: the EU expels Britain; 4. The big freeze: a passive expulsion from the EU; 5. The big divide: the rest of the EU leaves Britain behind. In conclusion, he writes, a referendum will not settle the issue at all. Britain will remain a large European power. Brussels and London will have to work together in many areas. “This all begs the question then of what ‘out’ means. As noted at the start, a Brexit is a means to an end and not an end in itself. For each of the above scenarios, ‘out’ is a difficult concept. A referendum or unilateral declaration of withdrawal cannot compel the EU to give the UK what it wants beyond an official withdrawal. What ‘out’ the UK then secures will be shaped by what the rest of the EU and other powers such as the United States are willing to grant it in terms of new or recalibrated political and economic relations. Similarly, expulsion or exclusion would not solve the longer-term problem for the EU of how to deal with Britain.” Eurozone Financial Data 10y spreads Previous This Yesterday day Morning France 0.310 0.299 0.299 Italy 1.629 1.610 1.616 Spain 1.427 1.414 1.420 Portugal 2.551 2.567 2.598 Greece 5.099 5.102 5.09 Ireland 1.115 1.116 1.117 Belgium 0.410 0.400 0.400 Bund Yield 1.148 1.169 1.163 exchange rates This Previous morning Dollar 1.349 1.3463 Yen 136.890 136.54 Pound 0.790 0.7892

Swiss Franc 1.215 1.2149 ZC Inflation Swaps previous last close 1 yr 0.71 0.71 2 yr 0.75 0.75 5 yr 1.2 1.2 10 yr 1.64 1.64

Eonia 21-Jul-14 0.05 18-Jul-14 0.04 17-Jul-14 0.04 16-Jul-14 0.04 OIS yield curve 1W 0.087 15M 0.067 2W 0.103 18M 0.068 3W 0.090 21M 0.076 1M 0.099 2Y 0.089 2M 0.093 3Y 0.156 3M 0.087 4Y 0.229 4M 0.086 5Y 0.345 5M 0.091 6Y 0.492 6M 0.090 7Y 0.642 7M 0.091 8Y 0.791 8M 0.101 9Y 0.933 9M 0.089 10Y 1.062 10M 0.086 15Y 1.538 11M 0.084 20Y 1.755 1Y 0.082 30Y 1.846 Euribor-OIS Spread previous last close 1 Week -5.929 -6.029 1 Month 0.171 0.771 3 Months 6.529 8.929 1 Year 34.557 35.457

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 23.html?cHash=ee29a91f552879393dda67b53b818ebe 36

07/23/2014 05:30 PM A Tour of France What Is Wrong with the Grand Nation? By Alexander Smoltczyk The TV images of the Tour de France show an idyllic country, but behind the gloss is a nation where fears of decline are prompting people to vote for the far right. A trip along the route of the world's most famous cycling race reveals the deep uncertainty ailing the French. There is a new word in the French language: La mannschaft. It's the term used to define everything that is enviable on the opposite bank of the Rhine River -- in other words, Germany's success. It's a success that is the product of the collective and is free of any of the egocentrics, self-deluded, bling-bling divas and "general director presidents," as the heads of French companies are called, that can make France so stuffy. A week ago Monday, on Bastille Day, newspapers across France sighed that it wouldn't hurt if the country were a bit more like la mannschaft. Instead, unemployment is twice as high as it is in Germany, growth and investments have fallen far and former President Nicolas Sarkozy was recently detained for questioning by police at dawn. La mannschaft is the polar opposite of the other word currently in fashion in France: le malaise. A deep gloom appears to have taken hold in France. A recent survey showed that two-thirds of the French are "pessimistic" about their country's future. "Viewed from the outside, France under François Hollande is like Cuba, only without the sun but with the extreme right," the newsweekly Le Point recently wrote. The country is "impoverished, over-indebted, divided, humbled and humiliated and finds itself in a pre-revolutionary situation in which anything seems possible." The only thing missing, it seems is the travel warning, because right at this moment, large numbers of vacationers from the rest of Europe are traveling in the country. Are these vacationers all francophone lemmings on their way to the cliff, blind to anything that doesn't involve a game of boule or finding a camping spot? Something is adrift in France. Rarely has the public mood been this miserable and the sullenness as omnipresent as it has been this summer. A president currently resides in Elysée Palace who was mercilessly booed during the July 14th military parade. It doesn't seem possible for Hollande to get any less popular, and yet his popularity continues to fall from one low to the next. But at least the country still has the Tour de France, the grand race that circles the country and serves as a prelude to the summer holiday season. Each year, it provides a long beloved view of a different, rural and idealized France -- one where local firehouses still host annual dances, where there's a memorial to those lost in the wars in front of every city hall and where the people know where they belong. But do they really? This reporter recently traveled across France to take the country's pulse with the people on the ground. The route followed stayed true to the course of the 2014 Tour de France, 37

taking in cities, towns and villages, and sought to observe signs of the crisis, decline, collective depression and other specters that are haunting Germany's most important neighbor. Lille (km 710) The first stage of the tour to take place in France (the first three are in Britain this year) ends at the periphery of Lille in Pierre Mauroy Stadium, a sparkling arena of glass, steel and concrete. The only person in sight is a guard. Lille is one of the few success stories in a French Socialism that is otherwise in a state of crisis. Local Mayor Martine Aubry even managed to get re-elected recently. The politician is the anchor of the Socialist Party's left wing. In contrast to the president, she is cherished by the party base. Aubry also happens to be the daughter of former European Commission President Jacques Delors, the father of currency union. Although Lille has profited from Europe, Joël Leclerc has not. "Lille is for the rich," he says, noting that he doesn't even buy his coffee here. Leclerc is the sole security guard standing in front of Pierre Mauroy Stadium. He's the son of a miner and has a crew cut, as is common among members of the French Foreign Legion. He says he raised his children with a "good kick in the ass." Unlike Lille, he says the village of Avion where he lives isn't home to any "vermin," the highly disparaging term used by Sarkozy to describe the children of immigrants who rampaged through the streets of Paris' suburbs in 2005. "We still have values here in the village," Leclerc says. He's the archetypical supporter of Marine Le Pen, leader of the far-right Front National party. Leclerc says he once had aspirations to become a member of the police force, but that he wasn't able to. "My father threw lumps of coal during the 1968 strikes at the CRS, the special police," he explains. "That's what people here in the village do. Avion has been communist for 200 years. People call it Little Russia. Me? Of course I'm a communist. A simple worker." Leclerc remains loyal to the communists for the same reason that most of his colleagues have since begun voting for Front National -- out of tradition, patriotism and the desire for order. He says his father once lived in Poland, somewhere near Katowice, but, no, he didn't work in the mines there. The place had a different name. He had to stay there for three years. Then, without any special emphasis, he says the name: "Auschwitz." Arras (km 865.5) Back when the Tour de France was created, French unity was anything but a given. It was a time when Bretonnians, Occitans and Alsatians, but also monarchists and Catholics all seemed to have problems with the words that are today posted on every town hall: "Liberté, Egalité, Fraternité," liberty, equality and fraternity. The race was intended to be a celebration of the country's beauty. People used the landscape as a stage to celebrate their country. It was a chance for "La France profonde" -- deep France, the real France far away from Paris -- to shine. It was all about the periphery of the country, the Café du Commerce that seemed to be located in every town or faded posters advertising aperitifs like Dubonnet. Essentially, it is this France where much of the current discontent is coming from. "Revolution is stewing at the edge of France, away from the major cities," French social

geographer Christophe Guilluy recently wrote. These areas are home to 60 percent of the French population and 80 percent of those who might be described as the "little man": laborers, pensioners, the middle class -- people who in general harbor the strongest fears of decline. It is here that voter turnout was poor during the communal elections in March. And it is here where Le Pen did particularly well. Somme is a countryside filled with former mines and battlefields. There are flat fields and sugar beets for as far as the eye can see. The French revolutionary Maximilien Robespierre was born and raised here before going to Paris to help the virtuous rise to power, using the guillotine where necessary. Raffi Ashkar holds a pair of scissors in his right hand. He runs a shoe repair and key making shop in Rue Robespierre across the street from the former Jacobin's home. Ashkar says every era needs a revolution. The question is what kind of revolution? Ashkar, who is of Lebanese origin, is every bit a member of the middle class, or Third Estate as the French called it during the revolution of the late 1700s. "I understand the French," he says. "There are no values any more. Family and friendship? Each is out for his or her self. Everyone is egotistical. That's why many vote for Le Pen -- out of sheer hopelessness. As long as you behave, the people here are likeable. Unfortunately, there are a lot of foreigners who don't understand that. They have no respect. Let's just take the example of football. Why don't all the players (on the French national team) sing the national anthem? That bothers me. I work here, I earn my money here, and this is my country. Voilà, that's all." Valmy (km 1,160) Stacks of books at a local bookstore in Valmy are dedicated to a new genre in French literature: the downfall. It includes titles like "Reinventing France," "France, a Peculiar Bankruptcy," "If We Only Wanted To, "When France Wakes Up," "A Dangerous Game in the Elysée," "Fellow French, Are You Ready for the Next Revolution?" "France, A Challenge, " and many, many more. Around two dozen such titles were published last month alone. They always seem to have the same central message as well -- that things can't continue as they are and that France is in decline. It seems like the term "déclinisme" has already emerged as its own school of thought. The Tour de France detours here around the industrial wastelands and decommissioned blast furnaces of northern Lorraine. Instead, on the route between Reims and Verdun, you see a windmill set on a hill surrounded by canons and heroic statues. This is the site of the birth of the nation. The fact that the cannons placed are emblazoned with "Made in Manchester" -- and that it was German writer and poet Johann Wolfgang von Goethe who retroactively identified the Battle of Valmy as an historical turning point -- doesn't detract from the place's symbolism. During the Cannonade of Valmy in September 1792, the Revolutionary Army halted a Prussian army that had rushed to the aid of the French monarchy. It marked the first time that the French chanted "Vive la nation!" The notion of the nation, as the central point of reference for all French, had replaced that of God and the king. They persevered as well, using team spirit akin to that of la mannschaft.

The term "nation" has been invoked here incessantly ever since -- mostly, unfortunately, to animate the people to charge into bayonettes, grenades, mustard gas and all manner of projectiles. After leaving Valmy, the Tour de France route passes through the battlefields of the last century, those of World War I and II. 'An Excessively Glorified Past that Won't Go Away' Flirey/Pont-à-Mousson (km 1,271) The name Pont-à-Mousson can be found everywhere you go in France, be it French Guiana, Martinique or any of the overseas departments. The name of the city appears on French-made manhole covers. The city's main industry is iron casting. Going by the dense smoke billowing out of the blast furnace on Rue nationale, it might come as a surprise to some that the country is in the midst of a crisis. The stockpile behind the plant is filled with pipes -- "for the time being," says Gérard Rothermel, sitting beneath a chestnut tree on a cast-iron bench that, ironically, was made in Spain. Rothermel then starts to rant. "The six-meter pipes are now being made in Germany. They do what they want." He's spent his entire career pouring iron covers. "Earlier, we used to whistle on our way to the factory. The only thing people think about today is the competition. Leftist politicians lied to us and the right did as well." Rothermel rails against taxes, but also says he thinks retirement at the age of 56 should be perfectly normal. He says he doesn't like people who just hang around doing nothing or those who take advantage of the welfare state, even though he himself is reliant on the system, receiving government-subsidized social housing and also health care benefits. "French sociologists have a term for people unable to cope with the changes that have been wrought on France: "Petit blanc," or "little whites". Words that were once closely associated with the country -- like education, president, army, nation or labor -- have become empty. Mulhouse (km 1,622) Liberal intellectual Guy Sorman says France is the sick man of Europe these days. "The state is sick, the economy is sick, its education is sick and it is sick from an excessively glorified past that won't go away," he says. Nation, Verdun, Valmy, the Tour de France and the national football team -- none of it seems strong enough anymore to hold the French together. Many are no longer able to identify with the requisite rituals, dogmas, hymns, creeds and even street names. Still, the country has some great principles, ones that are universal and known to everyone. And what could be wrong with a country that has so many streets with the word "freedom" in their names? The problem is that these terms no longer seem to have much meaning for many people, who no longer feel at home in their own country. So what terms could be used instead? The final stretch of the stage passes through the Rue de la Marseillaise and goes by a spot where Samir Ayed spends a good deal of his time, the Paradise café and bar, a lively meeting place that seems to be a magnet for the very Arab and African immigrant children who populate the nightmares of many in France. "Liberté, egalité and fraternité?" he asks. "That has never been my experience. Listen to what I have to say to you." He goes on to claim that the only freedom is that of financial 40

flows, the only equality are EU standards and norms and the sole sense of brotherhood is unbridled globalism. That's not exactly what Samir said, but it's a distillation of the phrases, theories, truths and false truths one hears when he speaks. "The French are pansies," he says. "They're allowing their country to be taken away from them -- by the EU, by the Chinese and by those who are really pulling the strings. Do you understand?" Samir and his buddies, who come from Morocco, Algeria and Turkey, are angry because France doesn't accept them and because they feel the country is going to the dogs. Yzeron (km 2,104.5) Here in the countryside, no suffering is visible. Instead, a disquieting quiet becomes noticeable. Many houses have their shutters closed up tight and there are lots of "For Sale" signs. At 6 p.m. on a recent evening, the only person to be seen was a pensioner trimming her hedge. In the local paper, the list of recent deaths is three times as long as the birth register. France's relatively high birth rate is invisible here. The Tour has managed to make its way through the Alps and now balances on the Massif Central above the Rhône River and Lyon, flying past Au Petit Rapporteur, where Josiane and Jean-Pierre Lambert have been cooking for locals for 19 years. The daily special costs €12 and is produced using local ingredients, such as veal, goat cheese, Andouillette sausage and berries. An estimated 70 percent of all restaurants in France use frozen ingredients, the New York Times recently reported -- a sign that the country's cuisine is also in freefall. Jean- Pierre Lambert says: "The main thing is that it tastes good." And perhaps, he adds, the Americans also share some of the blame for what is served up in Paris. Josiane is afraid of flying, but Jean-Pierre recently flew to Cuba with the local volunteer fire department. Neither of them have much use for the word "crisis". "There are still farmers here who make a profit. We survive." The Lamberts are a like a phenomenon of Quantum physics, only there when you look - - for the brief moment when the peloton speeds past. Afterwards, it disappears back into its parallel universe. A quarter of all French live in one of the 31,590 communities that have a population of less than 2,000. To a greater degree than in Germany, these people are dependent on what they refer to as "terroir," the specifics of the place where they live. And they are noticing that something is threatening that existence. The digital revolution is "a new space," a non-space that has eliminated distance, Michel Serres, the French philosopher, at the Sorbonne in late January. This revolution is not a French one, the British columnist Roger Cohen added, continuing the thought. "It is, in fact, an anti-French revolution. It challenges fundamental French values, the French sense of self and the French attachment to the state." Perhaps that is what is causing the grumbling and complaining along the route of the Tour. People are living next to each other, but not with one-another, they are eying each other with mistrust yet complaining about the coldness between people at the same time. "We used to whistle on the way to work." And throw chunks of coal at the CRS. 41

Saint-Rémy-de Provence (km 3,038) Stéphane Paillard trades in vineyards like others do in wine. Bordeaux, Rhône, Burgundy, Provence: He has châteauxs for all tastes and proclivities, starting at €3 million. If you want to spent your retirement walled off from the present in a 17th century property with olive orchards and grape-bedecked hillsides, Paillard is your man. Elderly Americans stroll past the shop windows, marveling at the Van Gogh-esque colors, the soft light and the sycamores. Saint-Rémy is vintage France, some might call it hardcore. "Some of the largest fortunes on the planet can be found here in the Alpilles," Paillard says, referring to the range of low mountains cutting through the Provence. Americans, in particular, are enamored of the region. Paillard's trade in vineyards is doing well as a result. But, he says, "in recent years I have noticed a certain reserve among international clients when it comes to investments in France. The government. You know." Luckily, wine is an exception, he says. "The euro might not last, but wine will." Still, Paillard has also noticed change even in the paradise of Provence, small things mostly. Large stone blocks, for example, have been placed in front of an electronics shop to prevent thieves from driving through the show window. At a bakery, customers are asked to pay using a machine due to security concerns. And fear. "It is the most insecurity I've seen here in the last 20 or 30 years," Paillard says. "Even in my line of work, you see copycats, tricksters and cheapskates." He blames the Internet in addition to the government. Beaucaire (km 3,056) By the time the town's new mayor took office in March, the route of the Tour had already been determined. It would have been difficult to drop Beaucaire from the course. It is one of the towns with over 10,000 residents where the Front National won in spring municipal elections. Seven file folders are stacked on a chair in the new mayor's office. "Inside, are 200 applications for a job in city hall," says Julien Sanchez. Thirty years old, Sanchez had been Marine Le Pen's spokesperson before winning the Beaucaire vote in March. He says the old system of cronyism and unshakable faith in the state is being thrown out. He is a gentle radical; the picture of President Hollande has been allowed to remain. "I'm not from here, I come from Paris. I said that there wouldn't be any more subsidies for bullfighting," he says, referring to the town's summer bullfighting festivals. "Going by standard criteria, I never should have been elected. But it turned out to be an advantage not to be a part of the sleaze here." The old Socialist mayor, Sanchez says, left the town with millions in debt. But one key reason for the Front National's victory in the town was the fact that mainstream parties split the vote, allowing the radicals to come out on top. It was a tedious election, with very little passion. In contrast to previous votes, inflammatory Front National signs were not plastered onto every tree in southern France and there were fewer complaints about them cluttering up the landscape.

Beaucaire is a town of limestone and sharp shadows. A dike protects it when the Rhône periodically bursts its banks while the walls and citadel shield it from the mistral, the cold winter wind. The town is largely segregated, with immigrants in the city center and those born in France on the outskirts. "Yeah, yeah, yeah, the poor, rejected people from Maghreb. And the native-born French in their single-family homes. The same old story. But that's rubbish," says Sylvestre Balit. Balit says that he should know; his own father is from Algeria. The French who lived in Algeria in colonial times and then lost their homes once the country was granted independence were among the first to vote for the Front National. Today, by contrast, the party is an option for everybody who is angry and afraid. "This country is a toilet and the Socialists have shoved my arm into it up to here," Balit says, tapping on his shoulder. "They hand out jobs to Arabs and to other Socialists. That isn't racism, my friend. That is EX-PER-I-ENCE. Humanism is a great idea and all, but it needs rules. Otherwise, you get the jungle." Sylvestre Balit, 54, is a former paratrooper. His girlfriend gets up at 4 a.m., six days a week, for her job in a supermarket. She is a real French "heroine," he says. He spends much of his time in the café waiting for better times. "I spoke with two former comrades of mine," he says, lowering his voice. "In two regiments, they are currently talking about a putsch. C'est fini la France." France is finished. An Open Wound that Never Healed Col du Tourmalet (km 3,213.5) At an altitude of 2,215 meters (7,270 feet), the Col du Tourmalet is the second highest point on the Tour de France, yet by far the most legendary. And surprisingly, there is no Tricolore flying at its peak. There is, however, a herd of sheep grazing just above the road as it crosses the pass. The fur of some of the animals has been sprayed blue, others red, while still others have been left white. Quite a few of them are black and a large portion of the herd bears a circle A on their haunches. The only thing missing is a shepherd to say: "That is France." No, the A doesn't stand for anarchy. Rather, it is a reference to his last name, says Eric Abadie, whose sheep they are. Abadie is actually wearing a beret. "Why a French flag isn't flying here? I'll tell you. No garbage service, no Tricolore. They have forgotten about us up here." Perhaps it is the pure mountain air, but otherwise Abadie has a pleasingly laid-back attitude to the world and, in particular, to his country. "I have seen all of them ride by here: Armstrong, Ullrich, Pantani, Jalabert. First they were kings, and then frauds. That's how it is everywhere. I can understand why everyone is now attacking our politicians. But we don't have any others." Eymet (km 3,433) The landscape of southwestern France, leading up to the Pyrenees foothills, is peacefully empty, the population so sparse that it feels like one is traveling through northern Canada. One can see expensively renovated farmhouses and sprawling retirement homes -- along with decaying walls covered in vegetation with cars up on

blocks out front. Many of the villages seem to survive only on people trying to get away from it all. "It's less stressful here," says Tracey Griffin. She is from Warwickshire and works behind the bar of the Café de Paris. With several flights a day to the British Midlands, starting at €40 one-way, tourism from the UK is substantial and, with many permanent residents as well, Eymet has come to distantly resemble Stratford-upon-Avon. Without the British, the town would be dead. There is an English newspaper, called The Bugle, and a cricket team, known as the Dorking Dads. Tracey Griffin likes it here, citing the food and the people, and has improved her French. "No, the main square isn't British," she says. "That's where the New Zealanders are." The town of Eymet is symptomatic. Peugeot is partly owned by Chinese investors, Renault is almost more Romanian and Japanese than it is French, the cement concern Lafarge is moving to Switzerland and Alstom's energy division was just sold to General Electric. In the last 20 years, French industry has lost more than a million jobs and soon, tourism will contribute half as much to the country's economy as the entire manufacturing sector. An economic paper recently asked: "And what if France becomes the world's amusement park?" It perhaps isn't that far off: Last year, some 90 million tourists made their way to France, the Sick Man of Europe. In his novel "The Map and the Territory," Michel Houellebecq describes a France of the future, one which is more dependent on agriculture and tourism than industry and is thus largely immune to crises. Old handicrafts flourish, as do romantic hotels, vineyard tours and discrete sex tourism. Many were horrified by the vision laid out by Houellebecq when his book was published and saw it as a warning. Not as a travel brochure. Evry (km 3,523) In the final stage, riders don't pass each other anymore; it is considered bad manners in the cycling world. But that is not true in politics. Manuel Valls was the mayor of Evry for 11 years, but now has his sights set on moving into the Elysée Palace, the presidential residence not far from the Champs-Elysées -- where the Tour de France finishes. That, at least, is the gossip. In March, François Hollande had to promote his rival from the Interior Ministry, where he gained a reputation for steeliness, to his current position as prime minister. Valls wants to lead France out of its depression with decisive reforms. Evry was his training ground. Evry was one of the new cities of the future surrounding Paris, a model of statist urbanism. There are no smoldering cars here, the trash cans are emptied regularly and there are signs everywhere: "Human Rights Square," "Citizens' Street," "Transport Assistance for the Elderly," and even one kindly noting that "You Are Entering a Zone Under Video Surveillance." It is as though the city is constantly whispering in your ear.

Evry has an ice-skating rink, schools, psychiatric services and a military recruitment office -- "We actually have everything we need." And yet Nelle Basse is missing something nonetheless. She is 33-years-old and works as a hair stylist in the mega- shopping center that serves as Evry's downtown. Her husband speaks six languages, but has been unable to find a better job than as an Air France steward. Both want to move to Senegal, where they are originally from. "The concierge in my building doesn't like blacks. Yet she isn't French either," Basse says. "When we go visit my husband's family in the countryside, they all want to touch my skin. That's how it is." In France, every immigrant can become a citizen if he or she accepts the values and culture of the République Français. But that means little to Basse. "Republic? That is just a word, totally empty," she says. "In the 15 years I have been living here, I haven't made any friends. I greet the neighbors, but that's it. Everyone keeps to themselves in the housing complex -- the Congolese, the Arabs, those from Mali, everyone. People are so stressed out. Everyone feels safe, but so alone." Champs-Elysées, Paris (km 3,660.5) At 1 a.m., a conspicuously elegant man is rifling through newly published non-fiction at Publicis Drugstore, the 24-hour mecca of luxury retail. "What a great country, where you can write about what a complete idiot the president is," the man says, holding up the book he is referring to. Born in Belgium, Philippe Jean Crijns knows the Sarkozys and works in the cosmetics industry. His address is Avenue des Champs-Elysées 25, a palace that once belonged to the Marquise de Païva, the 19th century courtesan who married a relative of Otto von Bismarck. "In France, you don't get elected president because the people want you, but because they want to get rid of someone else," Crijns says. Crijns points to a book that predicts a new revolution; the boulevard outside is packed with tourists. "Everyone loves France," he says, "except the French." The next morning, a national holiday, Crijns stands on the balcony of the Païva Palace and watches the parade passing by below. Standing in one car, the president looks small, sandwiched as he is between military leaders, and he is followed by boos and whistling as he drives past. He wanted to be a "normal president," but the people didn't want normality. They want an exceptional president that is worthy of the populace. They want everything to get better and to stay the same. "There are no crises," says Crijns, "only changes. Nowhere else is there as much history as there is in France. Every step is painful. C'est évident." It's obvious. The Tour de France may seek to celebrate the true and original France. And it ends where everything else leads -- and where one suspects the cause of the malaise can be found. On July 27, the Tour, as usual, will end with several laps around the Arc de Triomphe after passing by the Elysée Palace and the Place de la Concorde, home to a statue of a woman in front of which a king was beheaded in the winter of 1793. The event opened a wound that the country has never quite recovered from. Otherwise, it wouldn't be so passionate in its scorn of the normal citizen at the helm. 45

Translated from the German by Charles Hawley and Daryl Lindsey URL:  http://www.spiegel.de/international/europe/taking-stock-of-a-france-that-has- fallen-sick-a-982106.html Related SPIEGEL ONLINE links:  Interview with Marine Le Pen: 'I Don't Want this European Soviet Union' (06/03/2014) http://www.spiegel.de/international/europe/interview-with-french-front-national- leader-marine-le-pen-a-972925.html  Slipping Out of the Corset: Can New Prime Minister Deliver 'Changement'? (04/10/2014) http://www.spiegel.de/international/europe/french-prime-minister-manuel-valls-faces- tough-job-in-shadow-of-president-a-963271.html  Right-Wing Makeover: The Spindoctor Behind the New Front National (02/14/2014) http://www.spiegel.de/international/europe/success-of-front-national-in-france-partly- thanks-to-florian-philippot-a-952945.html  French Economics Minister: 'There Is No German Model for France' (01/28/2014) http://www.spiegel.de/international/europe/spiegel-interview-with-french-economics- minister-pierre-moscovici-a-945845.html  Romance and Reform: Does Hollande Mean Business This Time? (01/22/2014) http://www.spiegel.de/international/europe/hollande-affair-overshadowed-his-reform- announcement-a-944939.html

Daily Morning Newsbriefing July 22, 2014 More signs of an economic slowdown This morning, our main story is the latest evidence in the economic slowdown in the eurozone. The Ukrainian civil war has been – in our view – the main factor behind this, and the most recent escalation of the crisis will be a factor that will exert downward pressure on the economy. We have an in-depth summary of the relevant aspects of that story below. The economic weakness is especially notable in Italy. The Renzi effect is clearly visible in the media. Not in the economy. Istat reported yesterday that In May, new orders were down 2.1% mom. What is interesting is the composition. The domestic market was almost stable. The crunch came from demand from outside Italy, which collapsed 4.5%. This is a reversal of the previous months’ trend where non-domestic orders drove the average. Industrial production declined by 1.0% mom (and by 1.9% form exports). Corriere della Sera writes that these data may simply be a technical correction – and that’s also what the Italian government says just be patient, hoping that the effects of the reforms will come through eventually. But the report notes that the Bundesbank, too, has become more pessimistic on the economic outlook, now expecting a flattening of economic growth in Q2 after the strong performance in Q1, during which Germany expanded by 0.8% qoq. The main reason for the slowdown in Germany – according to the Bundesbank – have been geopolitical shocks – in the Ukraine, and more recently in the Middle East (both of which became worse this month, in other words the trend accelerates in Q3). With no compensation from public or private investment, the only part of the German economy tasked to do the heavy lifting to counter this trend is domestic consumption. It is no wonder that the Bundesbank is verbally encouraging higher wages. Claus Hulverscheidt noted in a commentary in Suddeutsche Zeitung that it was logical for the Bundesbank to interfere in the current wage round, given that its goal to stabilise inflation is in danger. He says the goal should not be to compensate workers for losses incurred in the past, but to allow them to participate in the rise in productivity to a greater extent in the future. We do not believe that the Bundesbank will be very effective in its attempt to talk up wages. Twenty years ago the Bundesbank had a much greater influence, when unionisation was larger than today, and when industry was less international. With the recent dent in industrial production, companies will be careful to agree wage increases just because they are verbally encouraged by central bankers, who are

otherwise unwilling to act. If the Bundesbank really wanted to raise the level of inflation (which we doubt), it would agree to QE. Towards sanctions There have been several reports yesterday that the EU was preparing the next round of sanctions against Russia. Peter Spiegel (@SpiegelPeter) tweeted that EU ambassadors had been summoned to an emergency meeting on Ukraine yesterday afternoon. EU foreign ministers are due to meet in Brussels this morning. Frankfurter Allgemeine reports that German support for economic sanctions against Russia was increasing quoting German economics minister Sigmar Gabriel as saying that the economic concern – important as they may be – should not be decisive. He said another round of sanctions against Russia would now be likely. But the paper says the EU would still not agree to target entire sectors. But it is possible that Gazprom might be targeted in the next round. The paper quotes the chairman of the Bundestag’s foreign affairs committee, Norbert Rottgen, CDU, as saying that the EU was late in its response and had allowed a vacuum to arise. The purpose of sanctions is to be forward looking, not to be punitive. Handelsblatt reports that another senior CDU MP expressed outrage at a recent defence deal by France to sell Mistral helicopters to Russia. In another article Frankfurter Allgemeine notes a disconnect between the Russian fear of sanctions, which is high, and the Western expectation that sanctions will actually happen. The Russian equity market has not collapsed but has been trending steadily downwards, having lost 6% over the last week. The article quotes a former Putin adviser as saying that if the EU passed financial sanctions against Russia, the economy would collapse within six weeks. There has naturally been a lot of commentary on this story. Wolfgang Munchau writes in his Spiegel column that the first thing the German should do is to ask Gerhard Schroder to resign from the Nord Stream pipeline project in response to the atrocities that have resulted from Vladimir Putin’s policies. He writes that eastward orientation of the German economy has gone too far, and that it was now in the country’s strategic interest to correct that imbalance quickly. He says Germany should support further sanctions against Russia, notably in the area of energy and finance. Clifford G. Gaddy and Barry W. Ickes from the Brookings Institute doubt that sanctions will be effective in influencing the action of Putin and the Russian elites in general. “It is a fallacy to assume that Russia will respond to sanctions the same way that we would. We cannot simply project our own preferences onto Russians. (After all, if Russians had our preference structure, they would not have annexed Crimea in the first place.) Whether it is the idea that Vladimir Putin cares more about his personal wealth than Russia’s national security, or that ordinary Russians who see their living standards decline as a result of sanctions will mechanistically direct their anger against Putin rather than the West — many of the assumptions underlying the West’s sanctions policy are flawed, to say the least.” The authors say that sanctions will damage the Russian economy. But our assumption is that the economic costs would lead to a change in political preference by Russian voters is mistaken.

“…if the motivation is defense of vital national interests and survival, Russia — like any state — will resort to import substitution and even more radical sorts of interventions to defend itself, no matter what the cost.” Third time’s a charm for Catalunya Banc Spain’s bank restructuring FROB auctioned off Catalunya Banc to BBVA on Monday for some €1.1bn, El País reports, thus avoiding the prospect of liquidating the institution after two previously unsuccessful attempts at selling it. As the FROB owns two thirds of Catalunya Banc, the total loss to the state from the rescue of Catalunya Caixa will be €11.8bn as it contributed a total of €12.6bn in various forms of aid. The purchase price includes a payout of up to €320m to insurer Mapfre for breaking an existing agreement to sell its insurance products. With the purchase BBVA increases its market share in Catalonia and solidifies its position as the second bank in the region after CaixaBank. In addition, the deal will improve BBVA’s balance as the purchase price is substantially below the €2.6bn book value of Catalunya Caixa which in addition carries over €3bn in deferred tax assets. Spain bad bank update Belén Romana, president of Spain’s bad bank Sareb, outlined the future plans of the institution in an interview with El Periódico de Aragón. According to Romana, the bad bank intends to sell entire apartment blocks for residential rental, hoping to attract “different kinds of investors” such as pension funds. This is a market that’s relatively underdeveloped in Spain relative to other European countries. In addition, the Sareb intends to complete construction on some 100 property developments to be able to sell them. A separate story by El Periódico describes a deal whereby the Sareb transfers the management of 600 homes to the Catalan regional government for “social rental” for a period of 4 years. The Sareb will receive money to pay taxes and fees on the homes and the Catalan government will manage the properties. The transfer includes empty homes as well as others covered by nonperforming loans which the government will turn into affordable rentals. The Platform of Mortgage Victims (PAH) takes credit for the “social pressure” leading to this and previous agreements of individual banks with the Catalan government which will now manage a total of 1230 homes. El Economista writes that the Sareb is planning to consolidate the servicing of all its assets into three or four portfolios and auction their management. Up to now, banking institutions retained the servicing of the assets they had transferred to the bad bank when it was created. According to Expansión Sareb employees are sought after by the private sector due to their knowledge of the real estate and financial portfolios transferred by the financial institutions participating in the banking rescue, which has led Belén Romana to design an economic incentives plan to retain its staff, which has grown to some 250 people in about 18 months. France and Germany at odds over Moscovici

After Wolfgang Schauble’s comment on Pierre Moscovici, when he suggested that a Frenchman would lack credibility for the job of economic and finance commissioner, the Elysee showed its bewilderment over such a direct criticism. Ancritic in comments to Le Monde, where an adviser of Francois Hollande is quoted by Le Monde as saying France would never comment on Guenther Oettinger although everyone knows that Oettinger will present German energy interests. With both countries at loggerheads over the nomination of Moscovici there are several ways forward, as outlined in Le Monde: One is that France drops the ambition for the post or its candidate. In this case, Elisabeth Guigou would be in a strong position to be a French candidate for the Commission. Some believe Berlin might compromise over the candidate provided the Austrian Thomas Wieser is placed at the head of DG ECFIN. Another option is to split the influential DG ECFIN in two, one for budget surveillance and one for finance and merge the latter with another DG. French social spending explains 80% of the gap to OECD mean France Strategie, the “think tank” of the French prime minister led by Jean Pisani-Ferry, compared public expenditures with other OECD countries to find out where and why France spends so much more than its neighbours. The results as presented in Les Echos show that 80% of the difference is explained by social expenditures and identified three areas - education, health and pensions - where money could be spend more effectively. Secondary schools spending is 21% above the OECD average, while spending on primary schooling is 17% below the OECD average, while studies showed that if a state wanted to make a difference, it should focus on the early years. In line with this argument the study highlights one cost problem in secondary schools, that of students having to repeat years if they fail the grade. The second issue is health with France having the highest consumption of medicine. The third are pensions. France spends 13.8% of its GDP on pensions, 5pp more than the UK and 4.5pp more than Germany. One reason is that the effective retirement age in France is among the lowest in the OECD. The study compared other OECD countries’ experiences with significantly reducing their public expenditures over the last 20 years. A Greek summer The Greek government is caught between the need to comply with a long list of actions prior to the next troika evaluation in the autumn and not upsetting voters ahead of potential snap elections in March next year, writes Macropolis. The troika will return in mid-September, and by then, the Greek government is expected to have completed six “prior actions” and 600 other actions. This is a lot for a summer programme. Finance minister Gikas Hardouvelis wants to break it down into two parts: measures focussing on fiscal targets and structural reforms, and those concentrating on the fiscal gap. The reason for this is timing, as the government will only know the size of the gap once the ECB’s stress test come out. But the Greek government does not want the troika’s review to be held up by the funding gap issue because this would also mean a delay in starting official talks on further debt relief. Hardouvelis, therefore, is proposing that the talks begin as soon as it has been established that fiscal and reform targets have been met. The other problem is that Pasok has become increasingly reluctant participate in the implementation of Greece’s adjustment programme. “Now is the time for us to say that 50

we are not going to implement directives that have been imposed on us and which create unnecessary insecurity in the public administration,” said Venizelos on Friday in a particularly outspoken criticism of the Greek programme. Pasok is also pushing for individuals and companies who owe taxes or social security contributions to be given more time to repay their debts. There are also more outspoken critics in Samaras camp. There is concern within the coalition that Greece will head to early elections in March next year, if it does not get enough votes to elect a new president and that the government should not rock the boat in the meantime. On the sustainability of Italian debt Barry Eichengreen and Ugo Panizza are asking the most important question affecting the future of the eurozone. Is Italy’s debt sustainable? Their answer is: probably not. In Italy’s specific case, debt reduction would require the country to run a primary surplus of 5% of GDP for at least 10 years. The authors have sampled a large number of high and middle income countries, and found only 3 episodes where countries managed to do that. An analysis of a less restrictive version – a primary surplus of 3% over 5 years – suggests that countries are more likely to fall into that group when growth is strong, the current account is in surplus, the debt-to-GDP ratio is high, and when the governing party controls all houses of parliament. The estimates “do not provide much encouragement for the view that a country like Italy will be able to run a primary budget surplus as large and persistent as officially projected.” Eurozone Financial Data 10y spreads Previous This Yesterday day Morning France 0.318 0.310 0.307 Italy 1.635 1.633 1.624 Spain 1.455 1.427 1.425 Portugal 2.538 2.551 2.577 Greece 5.094 5.099 5.13 Ireland 1.121 1.115 1.100 Belgium 0.422 0.410 0.406 Bund Yield 1.157 1.148 1.157

exchange rates This Previous morning Dollar 1.353 1.3521 Yen 136.920 137.27 Pound 0.792 0.7916 Swiss Franc 1.215 1.2149

ZC Inflation Swaps previous last close 1 yr 0.71 0.71 2 yr 0.75 0.75 5 yr 1.2 1.2 10 yr 1.64 1.64

Eonia 18-Jul-14 0.04 17-Jul-14 0.04 16-Jul-14 0.04 15-Jul-14 0.03

OIS yield curve 1W 0.000 15M 0.000 2W 0.000 18M 0.000 3W 0.000 21M 0.000 1M 0.000 2Y 0.000 2M 0.000 3Y 0.000 3M 0.000 4Y 0.000 4M 0.000 5Y 0.000 5M 0.000 6Y 0.000 6M 0.000 7Y 0.000 7M 0.000 8Y 0.000 8M 0.000 9Y 0.000 9M 0.000 10Y 0.000 10M 0.000 15Y 0.000 11M 0.000 20Y 0.000 1Y 0.000 30Y 0.000

Euribor-OIS Spread previous last close 1 Week -5.429 -4.729 1 Month 1.100 -0.9 3 Months 7.243 7.343 1 Year 36.557 35.057

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 22.html?cHash=b37d3229b2dbee15562699b2ba979b50

Blogs review: The Taylor Rule legislation debate - should Congress make the Fed adopt a policy rule? by Jérémie Cohen-Setton on 21st July 2014 74640 What’s at stake: A draft legislation was introduced on July 7 by two Republican members of the House, which would require the Fed to adopt a policy rule. The “Federal Reserve Accountability and Transparency Act of 2014″ (FRAT, HR 5018) was not well received by Federal Reserve’s chairwoman, Janet L. Yellen, who said on Wednesday that it would be a “grave mistake” for Congress to adopt such legislation. Alan Blinder writes that while the House can't manage to engage on important issues like tax reform, immigration reform and the minimum wage, it's more than willing to propose radical "reform" of one of the few national policies that is working well. As the title of Section 2 puts it, FRAT would impose "Requirements for Policy Rules of the Federal Open Market Committee." In the debate over such rules, two have attracted the most attention. More than 50 years ago, Milton Friedman famously urged the Fed to keep the money supply growing at a constant rate—say, 4% or 5% per year—rather than varying money growth to influence inflation or unemployment. About two decades ago, Stanford economist John Taylor began plumping for a different sort of rule, one which forces monetary policy to respond to changes in the economy—but mechanically, in ways that can be programmed into a computer. Nick Rowe writes that we need to distinguish between "instrument rules" and "target rules". The Bank of Canada, for example, sets a nominal interest rate instrument to target 2% inflation. The Bank of Canada follows a very simple target rule: "set (future) inflation at 2%". But it does not follow any instrument rule like the Taylor Rule. Instead it uses its discretion. John Taylor writes in his Testimony to Congress that there is precedent for the type of Congressional oversight in the proposed legislation. Previous legislative language, which appeared in the Federal Reserve Act until it was removed in 2000, required reporting of the ranges of the monetary aggregates. The legislation did not specify exactly what the numerical settings of these ranges should be, but the greater focus on the money and credit ranges were helpful in the disinflation efforts of the 1980s. When the requirements for reporting ranges for the monetary aggregates were removed from the law in 2000, nothing was put in its place. Tony Yates writes that we should remember that John Taylor sees the performance of the US post-crisis as resulting from the deleterious effects of uncertainty about policy that come with a departure from rules-based policy (for the king of evidence used to 53

make this case, see this post). Nick Rowe writes that it is hardly surprising that structural breaks in an estimated central bank's reaction function should be associated with worse economic outcomes. Suppose a central bank is targeting 2% inflation. Then a big shock hits, that causes a permanent fall in the (unobserved) natural rate of interest. That shock may itself cause worse economic performance. Plus, if the central bank is not immediately aware of that shock, or its magnitude, and fails to adjust its reaction function quickly enough, that will also cause worse economic performance. An econometrician who estimated the central bank's reaction function would notice a structural break in that reaction function, and that structural break being associated with worse economic performance. The two rules in FRAT Alex Nikolsko-Rzhevskyy, David Papell and Ruxandra Prodan write that FRAT actually specifies two rules. The “Directive Policy Rule” would be chosen by the Fed, and would describe how the Fed’s policy instrument, such as the federal funds rate, would respond to a change in the intermediate policy inputs. In addition, the report must include a statement as to whether the Directive Policy Rule substantially conforms to the “Reference Policy Rule,” with an explanation or justification if it does not. The Reference Policy Rule is specified as the sum of (a) the rate of inflation over the previous four quarters, (b) one-half of the percentage deviation of real GDP from an estimate of potential GDP, (c) one-half of the difference between the rate of inflation over the previous four quarters and two, and (d) two. This is the Taylor rule, and is obviously not chosen by the Fed. Alan Blinder writes that while hundreds of "Taylor rules" have been considered over the years, FRAT would inscribe Mr. Taylor's original 1993 version into law as the "Reference Policy Rule." The law would require the Fed to pick a rule, and if their choice differed substantially from the Reference Policy Rule, it would have to explain why. All this would be subject to audit by the Government Accountability Office (GAO), with prompt reporting to Congress. John Taylor writes that to provide some flexibility the legislation allows for the Fed to change the rule or deviate from it if the Fed thought it was necessary. Gavyn Davies writes that in 2012 Janet Yellen argued that Taylor’s original 1993 Rule was no longer her preferred interpretation of the Rule. She suggested a “balanced approach” alternative, in which the importance given to the unemployment/GDP objective was increased, relative to the importance given to inflation. She also suggested an optimal control approach, under which interest rates would stay even lower than under the balanced approach, because policy needed to compensate for a prolonged period in which the stance had been too tight as a result of the zero lower bound on rates. Policy rules in extraordinary times Alan Blinder writes that the deeper problem is that the Fed has not used the fed-funds rate as its principal monetary policy instrument since it hit (almost) zero in December 2008. Instead, its two main policy instruments have been "quantitative easing," which is now ending, and "forward guidance," which means guiding markets by using words to describe future policy intentions.Gavyn Davies writes that the Rule does not say how and when to reduce the size of the Fed’s balance sheet, and how that decision should 54

relate to the appropriate level of short rates. The Rule is also largely silent on another of the Fed’s main headaches right now, which is whether to treat the official unemployment rate as a good indicator of the amount of slack in the labor market. Simon Wren-Lewis writes that the current natural real rate of interest is likely to be a lot lower than the constant in any Taylor rule. At low levels of inflation, inflation also appears to be less responsive to excess demand. On its own this means that the coefficients on excess inflation in a horse for all courses Taylor rule will be too low when inflation is below 2%. John Cochrane writes that what is most interesting about a rule is what it leaves out. Notably absent here is "macroprudential" policy, "financial stability" goals, i.e. raising rates to prick perceived asset price "bubbles" and so forth. Of course, the Fed could always add it as a "temporary" need to deviate from the rule. Still, many people might think that should be part of the rule not part of the exception. It also leaves out housing, exchange rates, and all the other things that central banks like to pay attention to. | Read more at Bruegel http://www.bruegel.org/nc/blog/detail/article/1398-blogs-review- the-taylor-rule-legislation-debate/

BizShifts-Trends Business Change: Art of Creative Business Story Telling and Transformative Business Change Great Gatsby Curve- Trumps- Horatio Alger’s Rags-to-Riches: Society– More Unequal, Less Mobile– Income Disparity… February 23, 2014 Joe DePaola The Great Gatsby: A novel by F. Scott Fitzgerald highlights the inequality and class distinctions in U.S. during Roaring 20s… whereas, the Great Gatsby Curve illustrates the connection between inequality of wealth in one generation and the ability of those in the next generation to move up the economic ladder, compared to their parents… Some economist and policy makers use the Great Gatsby Curve to make rough forecasts of mobility across generations by the projected rise of inequality… The Gatsby curve was introduced in a 2012 speech by Alan Krueger using data from economist Miles Corak; the curve plots inter-generational income elasticity, i.e., the likelihood that someone will inherit their parents’ relative position of income level and inequality… By contrast Harvard economist Greg Mankiw noted– this correlation is not particularly surprising, the curve is an artifact of diversity… According to Alan Krueger; because of rising inequality the happenstance of having been born to poor parents makes it harder to climb the ladder of economic success… According to Timothy Noah; you can’t really experience ever-growing income inequality without experiencing a decline in Horatio Alger-style of upward mobility because (to use a frequently employed metaphor) it’s harder to climb a ladder when the rungs are farther apart… Horatio Alger’s ‘rags-to- riches’ narrative is about impoverished boys that rise from humble backgrounds to lives of middle-class security and comfort through– hard work, determination, courage, honesty… According to Miles Corak; Great Gatsby Curve is the outcome of a whole series of gradients between socioeconomic circumstances and the outcomes of young people as they make the transition from infancy to school readiness and ultimately from school to the job market… The stronger and more enriching the family environment, the more equal life chances, the more equal the labor market, the more equal life chances, and the more progressive public policies in place, the more equal the life chances… According to Jonathan Hopkin; U.S. has long had higher inequality than other advanced democracies, although many Americans see this as part and parcel of the ‘American Dream’ of rising living standards and social mobility. But recent research established that social mobility between generations has in fact remained quite stable in U.S. over recent decades… This means that ‘young people’ entering the labor market today have the same chances of moving up in the income distribution (relative to

parents) as those born in the 1970s. So what exactly does this study show, and how reliable is it? It depends on how you define ‘mobility’… If you think it’s about relative positions in a stratified society, it has stayed roughly the same, but if you think it’s about relative incomes, it has gotten worse… So what’s to be done about it?

In the article New Research Finds No Evidence of a Great Gatsby Curve by William McBride writes: New research indicates that there is no Great Gatsby Curve, at least not in the U.S. over the last several decades… Raj Chetty of Harvard and others use previously unavailable data from tax returns and elsewhere to show that economic mobility remains remarkably constant since 1971, while income inequality appears to have increased during the 1980s– they find children born to parents in the lowest quintile of income earners (bottom 20%) have about a 9% chance of eventually making it into the top quintile of income earners (top 20%) and that has essentially not changed since 1971… According to researchers; high mobility areas have, for example; (1) less residential segregation, (2) less income inequality, (3) better primary schools, (4) greater social capital, (5) greater family stability… All of this makes sense, except income inequality stands out as a function of other factors, indicating that the way to address economic mobility at its core is to fix underlying problems, i.e. failures of primary schooling, breakdown of family structures, prejudice… This is not complicated stuff its been well-known for decades by experts and non-experts alike. We appear to have simply gone off the rails of late in attributing all sorts of ills to tax policy… In the article Why Gatsby Curve is Poor Measure of Income Mobility by Philip Cross and Ian Lee write: Great Gatsby Curve asserts that more income inequality in one

generation leads to less income mobility for the next generation… Every generation expects to achieve more than the one that came before it and for many years those expectations came true; but a disquieting trend has emerged over the past two decades, as the gap between the richest and the rest has grown in the U.S… The question is whether more inequality, by itself, triggers a mechanism that reduces mobility for the next generation, and why this mechanism would exist across societies with different institutions and demographics… But if we carefully examine the Gatsby curve it exists with a wide range of mobility outcomes… That is to say, the importance of other factors is why reducing inequality in the U.S. and other nations would not change mobility significantly without changes to institutional such as; health care, education, criminal justice system, family structure… Without taking these factors into account, the Gatsby curve begins to look more like convenient narrative stringing together unrelated facts, posing as a meaningful insight into income and class dynamics… A further limitation of the Gatsby curve is that it measures inter- generational mobility only between fathers and sons. Doing so, however, exaggerates the importance of the long-run deterioration of incomes for young men while ignoring the gains made by women… While restricting data to men is technically appropriate to preserve sanctity of assumptions underlying the equations, it means sacrificing any relevance to policy… Policy makers must live in the real world: If labor market outcomes for sons are deteriorating, but daughters are doing better, is there really a problem of inter-generational mobility?

In the article U.S. Social Mobility Is Not Decreasing by Rebecca Strauss writes: There is no question that income inequality has been increasing since the 1970s in most of the world. And it has been the general assumption that as inequality went up, class mobility between generations would go down. This relationship cleverly named– the Great Gatsby’s Equality of Opportunity Project, finds that the chance of going from the bottom quintile to the top quintile has in fact remained relatively constant at about 8 to 9% for everyone born in the second half of the 20th century. If you dig further into the details and count decimal points, social mobility on average may have improved (slightly) for Americans born in the early 1990s. We can likely trust these results more 58

than any other social mobility study to date; its datasets are more precise and claim a larger sample size… The findings do not mean the picture is all rosy– even if Americans are no more stuck in their economic class than they used to be, rising inequality means that the ‘birth lottery’ of– who your parents are– matters more now than before…

In the article The Great Gatsby by Maura Pennington writes: So, how did Gatsby become great? Where did he get his money? To figure out how exactly Gatsby became rich, you have to actually read the end of Fitzgerald’s book. It’s revealed that a businessman of dubious means took him under his wing, saying: I raised him up out of nothing, right out of the gutter… I saw right away that he was a fine appearing gentlemanly young man… It was quite an act James Gatz (Gatsby) was playing, but it paid off: He was able to execute his new polished, Oxford-educated, but entirely false identity because he put work into it… He filled his days with exercise, sports, study, hygiene, financial saving. Most importantly, he sought to– practice elocution, poise and how to attain it and read one improving book or magazine per week… It wasn’t a lack of inequality that gave Gatsby his lucky break in business; it was his daily schedule and resolve to keep it. It had nothing to do with how much money his father had or how much of an improvement that was on his grandfather’s situation. Jay Gatsby was, in essence, the truest kind of American. One who made himself; and not just his fortune, out of nothing… Given that some pundits think– Great Gatsby is a tale of social mobility and not one of a self-created hero, these pundits seem to think that inequality is the root of all evil, that no one can move in society because the rungs of the ladder are too far apart, so to speak. That’s not to say there isn’t anything to remedy in this country; it’s just not what some pundit suggest… Gatsby had a personal benefactor and it was not the government… He earned good-will by being an upstanding person, by proving the quality of his character. When it’s government administering equalizing funds, there’s no test of character. Gatsby worked every day of his life to be the person he created… The trouble with social ladders is that no matter how high the first person gets who climbs it, there will never stop being a person at the bottom who has not or cannot climb it. We are human beings, a competitive species: It’s a race to get to the top… That’s how Gatsby bought his mansion. That’s how inner city drug lords buy their Escalades. This only goes to show that social equalization is a policy minefield… Jay Gatsby was socially mobile in a world vastly different from ours. The essence of how he was able to do it is universal, though. He was his own person and he made opportunities… There’s no chart that can show how to do that…

The Gatsby Curve illustrates an important point and one that over time is likely to produce profound consequences; there is a negative relationship between how unequal a country is, and how difficult it is to change the social status… According to Thomas Mucha; one of the major themes of The Great Gatsby, loosely defined, is the ‘American Dream’– but more broadly it’s the idea that it’s possible to transcend your current economic and social circumstances if you dream big enough and work hard enough.

That profound notion has fueled dreams of millions in U.S. and around the world… But as The Great Gatsby Curve warns, this dream is much harder to achieve in a country with high inequality… According to Will Wilkinson; the issue is not so much income disparity as economic well-being… no one doubts that income inequality is a fact and that it may be growing; but few have explained exactly why it’s a problem… According to David F. Ruccio; clearly inequality has increased in U.S. since mid-1980s but income mobility hasn’t much changed… However, what is not considered for example; (a) income inequality did in fact increase over time (which means the consequences of the ‘birth lottery’ are larger today than in the past), (b) major source of inequality over the course of the past three decades is the growing gap between the top 1% and everyone else (which is not, in fact, correlated with intergenerational immobility among quintiles). Inequality of opportunity is bigger problem than income inequality because the latter should be discounted due to individual choices, individual effort… Unfortunately, equality of opportunity is a highly problematic concept… The bottom line: Society is more unequal but not more mobile, so the fact that only 8-9% of bottom fifth make it to top fifth is now far more important than it was when inequality was lower. The stakes are getting higher but chances of winning haven’t budged… We must think about– more important understand; ‘how’ inequality and ‘what kind’ of inequality– influences opportunity… http://bizshifts-trends.com/2014/02/23/great-gatsby-curve-trumps-horatio-algers-rags- riches-theme-society-unequal-less-mobile-skewed-opportunity/

Daily Morning Newsbriefing July 21, 2014 Towards the next stage of sanctions Our bold assertion on Friday that pro-Russian rebels were responsible for the attack on Malaysian Airways Flight 17 is not yet fully proven, but more and more evidence came out over the weekend pointing in this direction. Given the impact of the unfolding conflicting on the eurozone economy, we will continue to treat this story as very much “inside out reservation”. Suddeutsche Zeitung writes that US intelligence sources confirmed the assessment of Ukrainian intelligence, according to which the remnants of the used anti-air missile, and two further BUKs, were transported out of the Ukraine back into Russia on Friday morning. The Pentagon said it was doubtful that the separatists were able to use the system without Russian help. The Wall Street Journal report that US intelligence established that Russia had given the rebels two Buk systems at the beginning of July, but the Americans had believed the systems were not operational. Suddeutsche writes that it not clear why the American did not insist on the closure of Ukraine air space after the rebels shot down a Ukrainian military airplane on Monday. The Wall Street Journal reports that the EU governments were weighing a dramatic increase in sanctions against Russia. The paper quotes an unnamed EU diplomat as saying that there would be “major consequences” if it emerged that the pro-Russian rebels had shot down the plane. President Barack Obama talked about "a wake-up call for Europe." The paper noted that there was some reticence from Italy, probably the most pro-Russian EU member state. The indications from Berlin were that this may have been the turning point, and Angela Merkel was quoted as saying that the next level of sanctions – presumably level 3 – would give the EU significant flexibility. Still, the WSJ noted it would be unlikely that the Europeans would be able to agree on sanctions against entire sectors. In his FT column Wolfgang Munchau argues that the EU should launch financial sanctions against Russia – just as the US did the week before –because this is by far the most effective way to hurt the Russian economy. The dollar and the euro are the world’s leading currencies – it would be hard for Russian companies to fund themselves without access to the financial infrastructure of the US and the EU. Munchau says the effect of financial sanctions far outweighs the nominal sums incurred. He says the sanctions will also have a notable macroeconomic effect, on Russia naturally, but also on the eurozone. It may well be the shock that separates the eurozone from deflation, unless policymakers act forcefully. But this is exactly what’s now needed. A forceful response against Vladimir Putin, and a forceful response to protect our own economy from the consequences of our forceful response.

Catalans still favour reformist “third way” over independence El País reports on a survey by Metroscopia according to which 38% of Catalans would prefer the negotiation of greater self-government within Spain to outright independence, a position so-called “the third way”, though support for independence has grown to 31% against 19% for keeping the current arrangement. According to the poll, Podemos would also be the third political party in a Catalan election after ruling coalition CiU, while left independentists ERC would retain the first place they attained in the recent European elections. The poll shows that both Catalan premier Artur Mas and Mariano Rajoy have low public approval, and the new King is seen as a possible mediator. The new PSOE secretary-general-elect Pedro Sánchez advocates a constitutional reform to pre-empt the independence referendum. Rajoy, who is due to meet Mas in the coming days, will call Sánchez as soon as the latter is confirmed as PSOE leader to discuss the scope of his constitutional reform proposal, writes El País. In a further development, Josep Antoni Duran i Lleida will resign as secretary general of Catalan ruling coalition CiU, though he will remain the group’s spokesman in the Spanish parliament, reports El Periódico. Duran is the leader of Unió, junior partner in CiU coalition. Duran and Artur Mas have disagreed on the handling of the Catalan independence question. Xavier Vidal Folch: Catalonia is not a microstate In his El País column, Xavier Vidal-Folch criticises the Catalan government’s advisors who proposed an independent Catalonia could operate with the Euro like some European microstates. Andorra is not a suitable model because its agreement with the EU only allows it to use the Target 2 for payment clearing but involves no access to ECB liquidity. In the case of Monaco, access to liquidity is a consequence of it being previously integrated in the French Franc monetary system and the agreement with the EU treats the principality as a dependency of France. He also attacks another document arguing Catalonia could be in a Swiss-like relationship to the EU, by pointing out first, that any agreement extending beyond trade requires the unanimity of all EU member states; and second, that the Swiss agreements are subject to a “guillotine clause” making each of a large number of bilateral agreements depend for their validity on every one of them being in force, which is causing Switzerland no small measure of trouble as a result of the recent referendum against free movement of workers. BES gives assurances amid bankrupt parent holding Portugal’s Banco Espírito Santo (BES) said will reimburse all its retail clients who invested in commercial paper, €255m in debt from its holding company Espírito Santo International (ESI), after it filed for creditor protection in a Luxembourg court on Friday. BES has a €342m exposure to the main unit, Rioforte Investments, which is also considering filing for creditor protection, Wall Street Journal reports. The bank is also exposed to Espírito Santo International and entities through €1.2bn in loans. It has said it had a €2.1bn capital buffer to cover for any defaults. Markit data shows that hedge funds renewed their bets that Banco Espírito Santo's stock would fall, known as short positions, after a ban on short selling of the bank's shares ended last Wednesday.

Bank of Portugal governor Carlos Costa said Friday that the central bank is taking all the necessary measures to guarantee that Banco Espírito Santo is separated from the troubles at its parent. "Even if everything went wrong, the [bank's] solvency would be guaranteed and depositors would be safeguarded," Costa told policy makers in Parliament, according to this WSJ article. Costa said private investors have shown interest in injecting capital at Banco Espírito Santo, although the uncertain situation prevents that from happening immediately. “A private solution to reinforce capital is possible," he said. "In terms of liquidity, Bank of Portugal stands ready to help in case of need." Coppola on the opaque Espirito Santo ownership structure Frances Coppola uses three charts on the ownership structure of Banco Espirito Santo to show its complexity and to point out that the bank’s owners are not Portuguese after all. This poses all sorts of problems for the regulators: “The regulated entity is BES's direct parent, ESFG - not its owners further up the chain. The Portuguese central bank is powerless to regulate financial dealings between BES and those owners, not least because they are not Portuguese. Banks embedded in multinational structures like this really cannot be effectively regulated by domestic regulators. They must be regulated by a supra-national regulatory body. Step forward, ECB....” Another issue is that a bank is owned by a conglomerate with significant non-financial interests, which means moral hazard is inevitable. How to reduce the moral hazard should be part of the consideration: “Regulators should have the power to enforce disclosure of corporate structures that incorporate banks, and rip them apart if they are unnecessarily complex and opaque. But to achieve this in a multinational world requires coordination and cooperation of regulators in different jurisdictions.” Schäuble opposes fiscal flexibility for France Wolfgang Schäuble said on Deutschlandfunk that he would oppose more fiscal flexibility for France, arguing that extra time would not help it overcome the crisis of confidence. He said France would need to save and reduce the costs for business at the same time. Schäuble also made clear that he had no objections to Pierre Moscovici as the next economics commissioner though he said that those who will make the decisions (Juncker) will have to take into account whether such a decision would be helpful. Merkel pushes for Oettinger as trade commissioner The German magazine Wirtschaftswoche has the story that Angela Merkel wants Günther Oettinger as the EU’s trade commissioner, quoting unnamed EU sources. That would put him in the negotiating chair for TTIP. The magazine writes that there are apparently nine countries that are seeking this particular position. It says that Germany’s chances are good because there are no German candidates for the Council presidency or for the High Representative.

The quintessential man-bites-dog story When the Bundesbank asks for higher wages, you know they are in trouble. Spiegel Online quotes Jens Ulrich, the Buba’s chief economist, as saying that the current wage increases were moderate considering the cyclical position, the low rate of unemployment and the positive economic outlook. The article also quotes Marcel Fratzscher from the DIW institute as saying that there was a case for wages to rise above the rate of productivity growth for a couple of years. Golding on globalisation Ian Golding has a thoughtful Project Syndicate column about our failure to manage globalisation properly: “… the crisis should have served as a wake-up call, spurring the financial sector, policymakers, and multilateral organizations to take action to enhance systemic stability. But, despite employing tens of thousands of highly educated economists whose primary job is to determine how best to protect the financial system from globalization’s destabilizing effects, these institutions seem to be even less willing to act now than they were before the crisis. This is particularly true in the advanced economies, where depleted financial reserves and political paralysis are preventing constructive investments in areas like infrastructure and education, which can enable citizens to take advantage of globalization’s benefits. Making matters worse, some of these countries have reduced their contributions and commitment to the reform of regional and global institutions, which are essential to managing systemic risks.” He concluded that it was no surprise that ordinary citizens feel frustrated with their governments. The answer is not re-nationalisation, which would be catastrophic, but to make globalisation safe. Share on printShare on facebookShare on twitterShare on emailMore Sharing ServicesShare How to put the macroprudential into a model Anil K Kashyap, Dimitri Tsomocos, and Alexandros Vardoulakis weigh in on the important debate on how to integration macrofinancial and macroprudential information into an economic model. They agree with a recent IMF study (Benes et al) that the present DSGE models are completely useless in this respect, and propose a new modelling approach that tries to integrate various important facts about finance. Previous economic work in this area focused on three channels through which financial intermediate can contribute to welfare – extending credit to certain types of borrowers, improving risk sharing; and in maturity transformation – but so far this has not been unified into a single model. In their model, savers can buy equity in a banking sector, and save through deposits. The banks can choose to lend, or invest in safe assets. The banks and entrepreneurs have limited liability. There is also a possibly of a Diamond/Dybvig style bank run. One of the results of their model is that there is a subtle interaction between the various strands, so that the neat separation of monetary policy and macroprudential policies is 64

not optimal. The authors are modest enough to suggest that this model is not the answer to our prayers. It is not sufficiently general. They also make the point that it is intrinsically hard to come “with regulations that simultaneously eliminate runs and shrink total lending (and risk-taking)”. Eurozone Financial Data

10y spreads Previous This Yesterday day Morning France 0.321 0.318 0.322 Italy 1.637 1.639 1.644 Spain 1.482 1.455 1.464 Portugal 2.566 2.538 2.565 Greece 5.096 5.094 5.22 Ireland 1.124 1.121 1.119 Belgium 0.428 0.422 0.423 Bund Yield 1.156 1.157 1.152 exchange rates This Previous morning Dollar 1.350 1.3538 Yen 136.860 137.04 Pound 0.792 0.7921 Swiss Franc 1.215 1.2153

ZC Inflation Swaps previous last close 1 yr 0.73 0.73 2 yr 0.76 0.76 5 yr 1.2 1.2 10 yr 1.64 1.64

Eonia 18-Jul-14 0.04 17-Jul-14 0.04 16-Jul-14 0.04 15-Jul-14 0.03

OIS yield curve 1W 0.073 15M 0.054 2W 0.081 18M 0.054 3W 0.074 21M 0.079 1M 0.082 2Y 0.066 2M 0.087 3Y 0.128 3M 0.081 4Y 0.218 4M 0.071 5Y 0.337 5M 0.068 6Y 0.481 6M 0.076 7Y 0.632 7M 0.074 8Y 0.784 8M 0.077 9Y 0.928 9M 0.076 10Y 1.057 10M 0.068 15Y 1.531 11M 0.081 20Y 1.749 1Y 0.079 30Y 1.839

Euribor-OIS Spread previous last close 1 Week -5.571 -5.571 1 Month 1.329 0.129 3 Months 7.371 8.571 1 Year 35.286 36.186

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 21.html?cHash=3d7046ac2d8044f1b94a115378617d60

ft.com/global economy EU Economy July 21, 2014 6:05 pm Bundesbank shifts stance and backs unions’ push for big pay rises By Claire Jones in Frankfurt The Bundesbank has backed the push by Germany’s trade unions for inflation-busting wage settlements, in a remarkable shift in stance from a central bank famed for its tough approach to keeping prices in check. Jens Ulbrich, the Bundesbank’s chief economist, told Spiegel, a German weekly, that recently agreed pay rises of more than 3 per cent were welcome, despite being above the European Central Bank’s inflation target of below but close to 2 per cent. More ON THIS TOPIC//Bundesbank president attacks Merkel/ Bundesbank lifts German growth outlook/ Bundesbank warns of property bubble/ Bundesbank doubles risk provisions IN EU ECONOMY// Factory go-slow increases pressure on ECB/ UK hits at transatlantic trade critics/ German business attacks ‘complacent’ Berlin/ Eurozone slips a step closer to deflation In an article published on Sunday, Mr Ulbrich said that recent wage trends were “moderate” given Germany’s relative economic strength and low levels of unemployment. His comments echo the views of Jens Weidmann, Bundesbank president, according to a senior central bank official. The push for higher pay underlines the heightened concern among even the most hawkish members of the ECB’s governing council over the eurozone’s low inflation and signs that the region’s fledgling recovery is stalling. On Monday, the Bundesbank acknowledged the German economy was unlikely to have grown at all over the three months to June. The calls for higher wages by Germany’s central bank highlight one of the most puzzling conundrums to befall the eurozone’s economic powerhouse: why, despite record low unemployment, the average German worker’s wage has hardly risen over the past decade. The problem is important for the region as a whole, as economists view a pick-up in spending by Germans as a prerequisite of the eurozone’s economy returning to full strength. Ursula Engelen-Kefer, a lecturer at Hochschule der Bundesagentur für Arbeit university and former deputy chair of DGB, Germany’s confederation of trade unions, said she was “flabbergasted” by Mr Ulbrich’s remarks. “It goes to prove that even the central bank recognises that we can’t improve internal economic growth without wages,” she added.

Stefan Körzell, a member of the DGB’s board said, while the confederation was “pleased” by the Bundesbank’s move, trade unions had done well without the central bank’s advice in the past and would continue to do so in the future. While German wage settlements this year were encouragingly strong, the central bank signalled the trend must continue if consumers in the eurozone’s largest economy are to provide the lift to demand that is so desperately needed. Until now, the German central bank has backed only the most modest rises in pay, and has often objected to measures to improve workers’ rights, including the planned introduction of a minimum wage and proposals to lower the retirement age for employees with more than 45 years in the labour market.

The Bundesbank’s support for faster wage growth in Germany is also the latest in a series of moves towards the mainstream of ECB thinking. Mr Weidmann has in the past found himself in a minority of one on the governing council, including when the ECB pledged to buy government bonds of troubled countries. In June, however, the

Bundesbank president backed the package of exceptional measures which the ECB unveiled to stave off the threat of deflation. At 0.5 per cent, inflation remains little more than a quarter of the ECB’s target. The weakness in price pressures in the eurozone is partly a positive development: it reflects an improvement in the competitiveness of workers in the bloc’s periphery, where productivity has traditionally lagged behind levels seen in economies such as Germany’s. However, even in the region’s strongest economies inflation is below target, with German prices rising by just 1 per cent in the year to June. Guntram Wolff, director of Bruegel, a Brussels-based think-tank and a former Bundesbank economist, said: “It’s a very good, very important sign from the Bundesbank. Not just of pragmatism, but of understanding that they are setting monetary policy for the entire eurozone. With that, comes the recognition that German wages have to rise at a faster pace.” ------Letter in response to this report: The whole world needs a pay rise / From Mr Philip Jennings http://www.ft.com/intl/cms/s/0/656ff1f6-10ec-11e4-94f3- 00144feabdc0.html#axzz3C3BWuJwo

ft.com Comment Letters

Sir, With reference to your report “Bundesbank shifts stance to support pay rises” (July 22): the Bundesbank has joined a growing list of the great and the good calling for a pay rise for workers.

All these institutions and leaders from the Pope to President Obama, to the CBI and now the Bundesbank, recognise that if employees’ pockets are empty they are not in a position to spend to pick up the economy. It is time for the Federal Reserve, the Bank of England and the European Central Bank to heed this message.

The world needs a pay rise if we want to see our way out of the shadow of the crisis and into the light of global growth. After all, the CEOs can take care of themselves, with their pay rises topping 15 per cent.

Philip Jennings, General Secretary, UNI Global Union, Nyon, Switzerland http://www.ft.com/intl/cms/s/0/67b244a6-11c7-11e4-8279- 00144feabdc0.html#axzz3C3BWuJwo

wsj World News EU Weighs Dramatically Raising Sanctions Against Russia Downing of MH17 With Hundreds of Europeans Aboard Intensifies Desire to Act More Forcefully in Ukraine Conflict By Naftali Bendavid in Brussels and Anton Troianovski in Berlin Updated July 18, 2014 3:12 p.m. ET European governments, jolted by the downing of a passenger plane over eastern Ukraine that killed nearly 300 people, are contemplating a major expansion of sanctions on Russia as early as next week. Related Video In the wake of the Malaysia Airlines Flight 17 disaster, President Obama criticized Russia for failing to take steps to help de-escalate the situation in eastern Ukraine. Photo: AP European Union leaders decided in recent days to expand the penalties to a broad new category of people and companies. But the apparent shooting down of a plane carrying more than 200 EU citizens has intensified a desire to act quickly and forcefully, including sanctions against oligarchs with ties to the Kremlin. In Brussels, some diplomats described the incident as a game-changer. "It would have major consequences if it was certain it came from the rebels— major consequences," said one official. President Barack Obama, at the White House, called the tragedy "a wake-up call for Europe."

German Chancellor Angela Merkel speaks during a news conference in Berlin Friday. Zuma Press 70

How far the bloc will go, however, will depend in whether the 28 countries can agree on a position. The EU, whose sanctions have generally fallen short of the tougher measures imposed by the U.S., has been hampered in part by a disagreement among members. Some southern European nations, led by Italy, and others including Hungary and Bulgaria that depend on Russian energy, have resisted harsher sanctions. One official said the potential for retaliatory actions by Russia "are weighing quite heavily on member states." Some of that caution was evident Friday. A spokesman for the Italian foreign ministry said only that Italy "supports EU unity" on crafting a response. The French foreign ministry declined to discuss whether Paris would push for tougher sanctions when EU foreign ministers meet in Brussels next week. Paris opposes any measures that would hinder its plans to deliver the first of two Mistral-class carriers— capable of launching amphibious attacks and helicopters—to Russia in October. But Gérard Araud, France's ambassador to the United Nations, tweeted, "Russia shouldn't be surprised the thugs it arms are acting like... thugs." Perhaps most important is the response of Germany, and officials in Berlin said the disaster could augur a turning point in the crisis. Related Articles//LIVE UPDATES: Latest Developments /Crash of Malaysia Airlines Plane Escalates International Tensions Over Ukraine /Sophisticated Surface-to-Air System Needed to Shoot Down High-Flying Jets /Ukraine Expands Flight Bans /Think Tank: In the Wake of MH17, the Case for Europe Standing Up to Russia /U.S. Lawmakers Call for Action /Passengers' Families Seek Answers /New Blow to Malaysia Airlines /Obama: U.S. Will Assist Investigation /Height of Ukraine No-Fly Zone Faces Scrutiny /Hillary Clinton: Time for Europe to Step Up /Five Things to Know on Flight 17 EU leaders agreed last week to expand sanctions to those who have supported Moscow's decision makers. But that gives the bloc wide latitude, and the crash could prompt the EU to penalize a larger number of people and organizations than they otherwise would have. "This is a platform that gives us a lot of leeway to act on a new level," German Chancellor Angela Merkel said in a news conference. Sanctions against entire sectors of the Russian economy still don't appear imminent. But adding prominent Russian companies to the EU sanctions list could send as strong a message as targeting specific sectors, German officials have said. The large number of victims from the Netherlands, a core EU country and one that has so far been relatively cautious about sanctions, could also help change dynamics inside the 28-member bloc. EU officials said that while they need clear evidence of the culprits before acting, that may not mean waiting until a comprehensive investigation is complete. When the foreign ministers gather Tuesday, they are expected to discuss new names that will be added to the sanctions list, probably by week's end. 71

"The first test is, can international investigators get access?" said one EU official. "Will the bodies be returned to loved ones? Will the black box be provided?" Some diplomats suggested the tragedy could even provide a political opening for the sides to move closer. Western leaders had been trying to arrange a conference call with the separatists for some time, for example, but the call only came together Thursday after the crash, a senior EU official said. In the call, members of the "Trilateral Contact Group"—which includes the Organization for Security and Cooperation in Europe, as well as Ukraine and Russia— spoke by video with separatist groups in Donetsk. The separatists agreed to secure the crash site and provide access to international investigators, the OSCE said. In Germany, arguably Europe's most influential country, extensive media coverage of the disaster, and the widespread suspicion that the separatists are responsible, could influence the debate. Polls have shown that most Germans oppose sanctions against Russia. But Manfred Güllner, one of Germany's top pollsters, cautioned that many Germans might continue to oppose sanctions because they believe the Kiev government, the EU and the U.S. are as culpable as Russia for stirring up tensions. The disaster may also influence the sanctions debate within the German government, which has been divided. Some key advisers to Ms. Merkel have been pushing for harder sanctions while the Foreign Ministry has sought to proceed more cautiously, people familiar with the matter say. "If in the course of the investigations it should become clear that one of the parties in the conflict has the lives of hundreds of completely innocent victims on its conscience," said Foreign Minister Frank-Walter Steinmeier, "this would be a crime outside of all imagination." —Matthew Dalton in Brussels, Stacy Meichtry in Paris, Laurence Norman in Vienna, and Deborah Ball in Rome contributed to this article. Write to Naftali Bendavid at [email protected] and Anton Troianovski at [email protected] http://online.wsj.com/articles/eu-weighs-dramatically-raising-sanctions-against-russia- 1405705981

Press release 256 / 2014-07-21: Producer prices in June 2014: –0.7% on June 2013 WIESBADEN – In June 2014 the index of producer prices for industrial products fell by 0.7% compared with the corresponding month of the preceding year. While prices of consumer non-durable goods increased by 0.9% compared with June 2013 prices of intermediate goods decreased by 1.1% and energy by 2.4%. In May 2014 the annual rate of change all over had been –0.8%. The overall index disregarding energy fell by 0.1% compared with June 2013. Compared with the preceding month the overall index remained unchanged in June 2014 (–0.1% in April 2014 and –0.2% in May 2014).

Press release 222 / 2014-06-24: Real earnings up 1.3% in 1st quarter of 2014 on same quarter a year earlier

WIESBADEN – According to the results of the quarterly survey of earnings, real earnings in Germany rose 1.3% from the first quarter of 2013 to the first quarter of 2014. This has been the largest increase in real earnings since the second quarter of 2011. The Federal Statistical Office (Destatis) also reports that nominal earnings in the 1st quarter of 2014 were up 2.6% on wagesa year earlier, while consumer prices increased by 1.2%. Both the earnings components paid regularly and extra payments contributed to the high growth in earnings.

In 2013 full-time and part-time employees (excluding marginally employed persons) in Germany earned 19.65 euros per hour. Extra payments are not included in this average figure. https://www.destatis.de/EN/PressServices/Press/pr/2014/06/PE14_222_623.html

20 de julio 2014, 08:21 reloj Inflación Bundesbank pide aumento salarial significativo La economía está en auge, ahora prevé aumentar los salarios: El economista jefe del Bundesbank llama SPIEGEL asentamientos salarios más altos. Otros expertos están de acuerdo. El Banco Federal ve margen para los acuerdos salariales más altos. Durante años, los interlocutores sociales tienen "contención salarial muy responsable" ejercido, dijo Jens Ulbrich, Economista Jefe del Banco Federal, el espejo. Evolución de los salarios en Alemania fue "en el contexto de la situación económica positiva, bajo desempleo y escasas perspectivas muy moderadas", dijo Ulbrich. (Lea el artículo completo aquí en la corriente Spiegel ). Acuerdos salariales más altos deberían impedir la tasa de inflación real se reduce aún más por debajo de la meta de inflación del Banco Central Europeo, de casi el dos por ciento. "Nuestra escala de evaluación como un banco central es el único la estabilidad de precios", dijo Ulbrich. "Nuestro argumento es simétrica y consistente." El director del Instituto Alemán de Investigación Económica, Marcel Fratzscher, se declaró Spiegel a favor de aumentar los salarios vigorosamente. "Si uno toma una perspectiva a más largo plazo", dice Fratzscher, "podrá ser superior al crecimiento de los salarios durante un año o dos acerca de las posibilidades de distribución." El economista explicó que los salarios reales de más de la mitad de los trabajadores alemanes habían sido asesinados en los últimos 15 años. En el primer trimestre de 2014, que mostró en los datos de junio de la Oficina Federal de Estadística, son los salarios reales aumentaron tanto como en casi tres años ya no (véase el gráfico). Por el crecimiento, sino que tenga algo igualmente no todos los trabajadores: en primer lugar los asalariados en los beneficios. URL:  http://www.spiegel.de/wirtschaft/soziales/inflation-bundesbank-und-diw- plaedieren-fuer-hoehere-lohnabschluesse-a-981962.html Más en Spiegel Online:  A pesar de salario mínimo: 1.5 millones de personas de bajos ingresos podrían obtener menos de 8,50 € (16.07.2014) http://www.spiegel.de/wirtschaft/soziales/mindestlohn-1-5-millionen-koennten- weniger-als-8-50-euro-bekommen-a-981337.html  Convenio colectivo: Los trabajadores del acero reciben aumento salarial del cuatro por ciento (08.07.2014) http://www.spiegel.de/wirtschaft/unternehmen/tarifvertrag-in-der-stahlindustrie- lohnerhoehung-von-vier-prozent-a-979799.html

 Jens Weidmann: jefe del Bundesbank advierte de las consecuencias del salario mínimo (03.07.2014) http://www.spiegel.de/politik/deutschland/mindestlohn-rente-bundesbankchef-jens- weidmann-uebt-kritik-a-979116.html  Consejos del Entrenador salario: "siempre he ganado un 30 por ciento más que el otro" (26.06.2014) http://www.spiegel.de/karriere/berufsleben/verhandeln-ums-gehalt-coach-claudia- kimich-gibt-tipps-fuer-mehr-geld-a-966547.html  El poder adquisitivo en Alemania: los salarios reales tan fuerte como en años no se elevan (24.06.2014) http://www.spiegel.de/wirtschaft/soziales/mini-inflation-realloehne-fuer-arbeitnehmer- in-deutschland-steigen-a-977060.html  Artículo Spiegel sobre el salario requerido y además: "Fin de la modestia" (30/2014) https://magazin.spiegel.de/digital/index_SP.html # SP/2014/30/128239323 24 de junio 2014, 10:02 reloj El poder adquisitivo en Alemania Los salarios reales tan fuerte como en años no se elevan Los alemanes pueden permitirse otra vez: Después de ajustar por la inflación, los salarios han aumentado en un 1,3 por ciento en el primer trimestre de 2014. Especialmente beneficiarse con salarios altos en el signo más contenido. Wiesbaden - Los salarios reales en Alemania se encuentran en el primer trimestre de 2014 aumentó tanto que no se veía desde hace casi tres años. La Oficina Federal de Estadísticas anunció que los salarios establecidos neta entre enero y marzo de la inflación al 1,3 por ciento en comparación con el mismo período del año pasado. Este es el mayor incremento desde el segundo trimestre de 2011. Los salarios nominales fueron, según los estadísticos 2,6 por ciento más que el año anterior. Los precios al consumidor presentaron sólo un 1,2 por ciento. Entre el alto crecimiento de las ganancias contribuido de este modo tanto los componentes regulares pagados de ganancias, así como bonificaciones en. De las ganancias, pero no se benefician por igual a todos los trabajadores: los trabajadores de un puesto de dirección pueden tener un incremento salarial promedio de 4.1 por ciento feliz, incluso los profesionales consiguen con 2.3 por ciento de aumento de los salarios bastante decentes. Contrario, los trabajadores no calificados ganan sólo el 1,3 por ciento más que hace un año - así que consiguen apenas compensan la inflación. Por hora ganado empleados de tiempo completo y de tiempo parcial en Alemania en 2013, un promedio de € 19.65 bruto. No se consideraron los pagos especiales. La brecha entre Occidente y Oriente está todavía muy abierto: en el antiguo territorio del salario

bruto por hora promedio es de € 20,42 en los nuevos estados federados sólo 15,30 EUR . La comparación de los estados de más alto salario bruto por hora era en Hamburgo con pagado € 22,12, en el segundo lugar seguido de Hesse , con 21,65 euros. Última en las provincias occidentales era Schleswig-Holstein , con un salario medio bruto de € 18,17, en los estados orientales de Mecklemburgo-Pomerania Occidental y Turingia , cada uno con 15,02 euros. La mayoría de los trabajadores ganan en un cargo directivo en Hesse, en promedio, es decir, 38,94 euros por hora. Por lo menos ganaron los trabajadores no calificados en Mecklemburgo-Pomerania Occidental, con un promedio de € 9,07. Para los estadísticos de encuestas ganancias trimestrales analizaron los datos de 40.500 empresas en la industria manufacturera y el sector de servicios. ade / AFP URL:  http://www.spiegel.de/wirtschaft/soziales/mini-inflation-realloehne-fuer- arbeitnehmer-in-deutschland-steigen-a-977060.html Más en Spiegel Online:  Seguridad básica: vejez cuello costos de pobreza cada vez más dinero (24.06.2014) http://www.spiegel.de/wirtschaft/soziales/altersarmut-grundsicherung-fuer-rentner- teurer-fuer-bundesregierung-a-977029.html  Decisión en el Bundesrat: pensiones suben significativamente en julio (13.06.2014) http://www.spiegel.de/wirtschaft/soziales/bundesrat-renten-steigen-ab-juli-deutlich-a- 975001.html  Precios de la energía baja: la inflación cae a cuatro años de baja (13.06.2014) http://www.spiegel.de/wirtschaft/soziales/niedrige-energiepreise-inflation-faellt-auf- vier-jahres-tief-a-974907.html

Daily Morning Newsbriefing July 18, 2014 Our next Lehman moment There are moments when unstable situations get out control. It is hard to image a more serious escalation in the Russian/Ukrainian war as pro-Russian separatists shooting down a plane with Dutch and other European travellers on board, killing almost 300 people. The story is firmly inside our reservation, since the Russian/Ukraine is now on the verge of turning into a first-order economic shock – for Russia, but also for the eurozone. Corriere della Sera has an interesting account of the telephone conversation between Barack Obama and Vladimir Putin, in which Putin made that there was no evidence that Russia supplied the separatists with guns. Just as they talked, the news of the strike against the Malaysia Airlines came in. While there is no absolute clarity at this early stage, the known evidence is that the only the Separatists would have been likely to shoot down a passenger airliner – as they were the only ones in the conflict to have used a BUK surface-to-air missile, but without information over air traffic control. The Ukrainian forces have the same technology, but they are in a position to distinguish between military and civilian aircraft while the Separatists are not. As more evidence emergence that the death of 300 passengers was the direct result of Putin’s decision to support armed rebels, the response of the West is likely to be significant. Obama was already considering the next stage of economic sanctions before yesterday’s action. As the FT reports, Senator John McCain talked about profound repercussions if it became clear that Russia or pro-Russian separatists were behind the attack. As we wrote yesterday, the sanctions imposed by the US and the EU are very serious indeed. Even the moderate sanctions during the first phase of the conflict had profound effects. As Die Zeit reports, the eurozone’s trade with Russia has fallen by 13% during the first quarter. Speaking in the Italian parliament, Italy’s finance minister Pier Carlo Padoan acknowledged that the hoped-for recovery has not happened yet. The financial sanctions announced earlier this week are likely to have a very serious impact on Rozneft, whose ambitious global expansion plans are now being frustrated. Before the terror attack against the plane, Rozneft shares were down 4.3%. Rozneft has a big joint venture with ExxonMobil to explore oil in the artic sea. The FT quotes Putin as saying: “We gave this major American company the opportunity to work on the shelf…So, what, the United States does not want it to work there now?” BP holds a 19.75% stake in Rozneft, and apart from Exxon, Statoil and Eni also have joint venture. Rozneft is also the largest shareholder in Pirelli, and is considering the purchase of Morgan Stanley’s oil-trading business.

Most of the economic impact of these sanctions are indirect, as western investors and exporters are becoming more cautious in dealing with Russia. This is already reflected in the Q1 statistics, and will become significantly more important. As the West steps up the sanctions, the Russian response is getting stronger in response. One of the possible response could be the expulsion of US banks from Russia or legislation to nationalise US companies assets in Russia. Spain’s stagnant exports In an op-ed in El País, economist José Carlos Díez notes that Spain’s exports have started declining on a year-on-year basis, attributable mostly to causes external to the Spanish economy: stagnant world trade, the emerging market slowdown, and the appreciation of the Euro relative to emerging market currencies. The Spanish government, Díez writes, had a window of opportunity to make meaningful reforms to Spain’s economic structure but didn’t use it, preferring to ride the export boom caused by external causes which are now reversing. Spain’s domestic demand is not recovering and with it the current account is returning to deficit after a brief foray into surplus territory. Díez concludes that Spain is in a classic balance of payments crisis, confirming that the diagnosis by Spanish and European authorities of the causes of Spain’s crisis was wrong. Díez doesn’t hold Spain’s economy minister Luis de Guindos in high regard, and finds it “incredible” that he’s a candidate to preside the Eurogroup, that the current Eurogroup president Jeroen Dijsselbloem is angling for the post of Economic Affairs Commissioner, and that his predecessor Jean Claude Juncker has been rewarded for his performance with the presidency of the Commission. De Guindos’ Dijsselbloem problem In his Expansión column, Miquel Roig writes that the only obstacle to de Guindos’ ambitions to chair the Eurogroup is the current holder Jeroen Dijsselbloem, whose term expires in June next year. The difficulty at Wednesday’s European Council was that, with the deadlock in the appointments of the Council President and the High Representative, there was no chance to “find an informal solution” for the Dutch economy minister. The Dutch government is not going to “accept a switcheroo” and demands a position of responsibility for Dijsselbloem. With the top jobs undecided, that is off the table. One option is the post of Economic affairs Commissioner, which Juncker has conceded should go to a Socialist, but the problem here is that Dijsselbloem called Juncker an “inveterate drinker” on prime TV during the recent European Parliament campaign. Will Juncker hold a grudge? Will the Netherlands nominate Dijsselbloem to the Commission? Will Juncker’s female Commissioner quota get in the way? A second option, writes Roig, is to appoint Dijsselbloem to head the Single Resolution Mechanism, and Guindos might land that job as a plan B. But if the Netherlands wants a weighty Commissioner in addition, that would mean overrepresentation in the top jobs. The third and final option is for Dijsselbloem to serve his term, but the Eurogroup chairman has to be a finance minister and Spain is holding general elections at the latest in November next year. If Guindos did not keep his minister portfolio after the election, he would only serve at the Eurogroup for a few months. This would not be a problem if

the Eurogroup chair were made a full-time position, but Wolfgang Schäuble has recently indicated Germany doesn’t want that. BES crisis no impact on bond rating for now The rating agencies S&P and Moody's told Jornal de Negocios that Banco Espírito Santo difficulties originating from the Espirito Santo Group, has no direct impact on the "rating" of public debt. But S&P says there will be an impact if this "highly systemic bank for the economy of Portugal continues struggling." Both rating agencies say that instability in the BES will not penalize the "rating" of Portuguese public debt even if recapitalization funds from the €6.4bn available under the adjustment program are necessary. What happened at BES? The Wall Street Journal says there were signs as early as 2012 of a struggle within the Espirito Santo group, raising concerns about the oversight of regulators. In 2012 reports were warning already that the conglomerate was becoming heavily reliant on issuing debt using its affiliates, including the fund and its bank. Some investors said the regulators should have acted faster to break the link between the conglomerate and its financial units. In November 2013, Portuguese regulator CMVM imposed a limit of 20% on investments that funds can make in companies affiliated with their owners and says it had intensified talks with the funds since 2012. A spokesman for the Bank of Portugal said then that the central bank doesn't oversee funds even if they are marketed by banks though it was monitoring connections between banks and affiliates, and there were rules in place imposing restrictions on loans from banks to those affiliates. Analysts are also concerned about the fact that the troika institutions also didn't raise concerns about possible problems with Espírito Santo International or the bank and have questioned how regulators have reacted to the problem since May. The Bank of Portugal has ordered Espírito Santo Financial Group SA, an entity of the holding company that owns 20% of Banco Espírito Santo, to set aside €700m to cover potential losses. In less than six months later, the main unit of the holding is filing for bankruptcy raising some serious questions about the quality of supervision, the article quotes Merrion Stockbrokers analyst Ciaran Callaghan. Afonso on why austerity destroyed parties in Greece and not in Portugal On the LSE blog Alexandre Afonso looks at why austerity killed the support for the traditional political parties in Greece and not in Portugal. He argues that Greece has much more a culture of pork-barrel politics as a way to ensure electoral support, and their electoral success was more closely tied to public spending while in Portugal austerity already started well before the crisis so voters had lower expectations before the bailout programme even started. Also it was politically easier in Greece to blame austerity measures on a single party, Pasok, than it was in Portugal, where Socrates with his minority government relied on the conservative party to adopt austerity measures. Alfonso argues that grand coalitions, technocratic governments or the all-party embracing “national salvation” agreements promoted by the Portuguese president avoid costly blame games and may be the only options available for parties to survive in the current situation, even if those are unlikely to last long. 79

Atkins says capital markets still not safe for Greece Ralph Atkins in the FT argues that capital markets are not yet safe for Greece and that there is a strong case for remaining in protective custody. In the current climate where revelations about BES in Portugal shake the markets making investors wonder about other ‚surprises‘, the appetite for eurozone periphery countries’ might be saturated. Last week’s Greek bond issue was almost shelved, though Athens decided to go ahead as cancelling the deal would have sent a worse signal to international investors. But it was a close-run that could easily have turned into a more embarrassing flop. Several large initial orders appear to have been withdrawn at the last minute. The next big test could be the outcome of the European Central Bank’s comprehensive review of the financial strength of the region’s banking industry, due by November. Atkins warns that a bumpy second half of the year in eurozone financial markets could throw into doubt Athens’s hopes of raising €8bn in global capital markets in 2015. It could also shape the debate about when Greece will finally escape international supervision. ECB confirms it will publish leverage ratio This is a tough list. The ECB yesterday published its Note on the Comprehensive Assessment, which contains the details of the template the ECB will be using to publish the data. The template will consist of an overview, the AQR results, and the stress test results. The ratios to be displayed are the Common Equity Tier 1, the Tier 1 capital ratio, and the core Tier 1 capital ratio, as defined by the Capital Requirement Directive IV (CRD IV). The ratios are shows for the baseline and the stress scenarios. The spreadsheet will also contain information on the capital measures taken by the banks, including the issuance of CET1 capital. The AQR parts includes risk-based evaluation of selected portfolios, and will be disclosed broken down by asset class. It will also include a standardised measure of non-performing loans, and importantly the leverage ratio. The latter was opposed by a number of banks. The stress test templates had earlier been released by the EBA. On the time scale, the join-up between AQR and stress tests will take place in September. The results will be discussed in a joint meetings with the banks during September/October. The results will be endorsed by the ECB before publication. The publication of the results will take place late October. In November, the banks will submit their capital plans to the ECB – which will also be based on a specific template. Juncker’s old-fashioned views of industrial policy Guntram Wolff does a great job debunking Jean-Claude Juncker’s extraordinary naïve statement during his confirmation speech in the EP where he pledged to bring up the share of manufacturing in GDP from 16% to 20%. Wolff says this goal will not be achieved, and indeed should not be set in the first place, because it represents a fundamental misunderstanding of the inter-linkages between manufacturing, services and finance. Wolff makes the point that the relative decline in the manufacturing share in GDP was the result of productivity increases. It would be mad trying to reverse that. What one needs to understand about manufacturing are global value chains work.

“Participation in global value chains within Europe is strongly EU-oriented with a central position for the EU15 and in particular Germany in EU manufacturing. This internationalisation of production has resulted in deeper integration of EU manufacturing, with member states specialising in sectors according to their comparative advantage. It has therefore helped to raise productivity and growth. As a result, the foreign content of countries’ exports has increased.” Wolff argues that the best strategy to help manufacturing would be to improve the functioning of capital markets, especially the creation of a venture capital market. And the EU Commission could also contribute by get rid of the dividing lines between industrial policy, single market policy, ICT and service sector policy. Papadia on ABS Frencesco Papadia talks a lot of sense in his article on ABS purchases, which he rightly says should not be conflated with the debate on quantitative easing – simply because of the scales involved. He said an ABS programme should be similar to the ECB’s covered bond purchases programme (done under his watch at the ECB), where the goal was to repair dysfunctional markets. Here is a list of parameters he proposes for the programme:  The overall size of the programme should be small – less than a €100bn;  it should be time-limited to 18-24 months;  it should kick off with legacy assets, but should over time concentrate on new issuances;  there should be a cap of the portion to be bought for each issue;  it should be subject to precise and clearly stated rules;  and importantly, it should include equity and mezzanine tiers. A German proposal for state insolvency Here is a default regime proposal by a group of senior German economists. Clemens Fuest, Friedrich Heinemann und Christoph Schröder, from the University of Mannheim, have set out a long manifesto in Frankfurter Allgemeine, in which they propose a system to link the ESM to an orderly insolvency process for member states. They start out with the observation that the lack of a state debt resolution process remains the biggest hole in the eurozone rescue strategy. What they essentially want is a rule that restricts the ESM to a role of short-term liquidity finance for a limited period, say three years. After that fixed period, the state either returns to the capital markets, or enters an insolvency procedure. In order to avoid a market panic, they are introducing a market clause. Insolvency can only happen in a market-friendly environment – for example a situation in which the eurozone’s average debt level were 80% of GDP or below. The idea is to prevent a de-stabilisation of the system. With the current average debt-to-GDP at 93%, it would take several years until this procedure will kick in. The authors are also demanding obligatory reforms; a hardening in the current collective action clauses, and changes in financial regulation to withdraw the risk-free rating of ESM loans.

Eurozone Financial Data 10y spreads Previous This Yesterday day Morning France 0.319 0.321 0.324 Italy 1.625 1.645 1.644 Spain 1.470 1.482 1.490 Portugal 2.559 2.566 2.574 Greece 5.064 5.096 5.09 Ireland 1.095 1.124 1.115 Belgium 0.427 0.428 0.432 Bund Yield 1.196 1.156 1.157 exchange rates This Previous morning Dollar 1.353 1.352 Yen 137.300 137.02 Pound 0.791 0.7906 Swiss Franc 1.214 1.214

ZC Inflation Swaps previous last close 1 yr 0.73 0.73 2 yr 0.76 0.76 5 yr 1.21 1.2 10 yr 1.64 1.64

Eonia 16-Jul-14 0.04 15-Jul-14 0.03 14-Jul-14 0.05 11-Jul-14 0.05

OIS yield curve 1W 0.063 15M 0.052 2W 0.068 18M 0.052 3W 0.065 21M 0.062 82

1M 0.060 2Y 0.073 2M 0.077 3Y 0.142 3M 0.075 4Y 0.218 4M 0.073 5Y 0.341 5M 0.072 6Y 0.484 6M 0.074 7Y 0.640 7M 0.062 8Y 0.791 8M 0.061 9Y 0.934 9M 0.070 10Y 1.065 10M 0.058 15Y 1.541 11M 0.067 20Y 1.764 1Y 0.076 30Y 1.890

Euribor-OIS Spread previous last close 1 Week -3.871 -3.771 1 Month 1.829 3.029 3 Months 8.714 10.314 1 Year 35.886 37.386

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 18.html?cHash=d959102ed15dafd47d2572c371f4bbae

Manufacturing Europe’s future by Koen De Backer, Francesca Barbiero, Michael Blanga-Gubbay, Valeria Cipollone, Alexandros Ragoussis, André Sapir, Sébastien Miroudot, Reinhilde Veugelers, Erkki Vihriälä, Guntram B. Wolff and Georg Zachmann 2nd October 2013 | edited by Reinhilde Veugelers Publication Launch 'Manufacturing Europe's Future'' Industrial policy is back!’ This is the message given in the European Commission’s October 2012 communication on industrial policy (COM(2012) 582 final), which seeks to reverse the declining role of the manufacturing industry, and increase its share of European Union GDP from about 16 percent currently to above 20 percent. Historical evidence suggests that the goal is unlikely to be achieved. Manufacturing’s share of GDP has decreased around the world over the last 30 years. Paradoxically, this relative decline has been a reflection of manufacturing’s strength. Higher productivity growth in manufacturing than in the economy overall resulted in relative decline. A strategy to reverse this trend and move to an industrial share of above 20 percent might therefore risk undermining the original strength of industry – higher productivity growth. This Blueprint therefore takes a different approach. It starts by looking in depth into the manufacturing sector and how it is developing. It emphasises the extent to which European industry has become integrated with other parts of the economy, in particular with the increasingly specialised services sector, and how both sectors depend on each other. It convincingly argues that industrial activity is increasingly spread through global value chains. As a result, employment in the sector has increasingly become highly skilled, while those parts of production for which high skill levels are not needed have been shifted to regions with lower labour costs. But this splitting up of production is not driving the apparent manufacturing decline. Participation in global value chains within Europe is strongly EU-oriented with a central position for the EU15 and in particular Germany in EU manufacturing. This internationalisationof production has resulted in deeper integration of EU manufacturing,withmember states specialising in sectors according to their comparative advantage. It has therefore helped to raise productivity and growth. As a result, the foreign content of countries’ exports has increased. Germany, in particular, has been able to benefit from the greater possibilities to outsource parts of production to central and eastern Europe and to emerging markets, and is in fact one of the countries with the smallest manufacturing share declines in the last 15 years. The

Blueprint also highlights the importance of energy for the structure and specialisation of manufacturing. Capital-intensive manufacturing faces both urgent challenges and medium-term challenges. In the short-term, one of the most pressing problems is the fragmentation of financial markets in Europe,which undermines access to finance. This affects small to medium-sized firms in particular because they are the most dependent on bank credit. In some southern European countries, even the financing of working capital is endangered. It should therefore be a high priority for policymakers to fix Europe’s banking problems and create better functioning capital markets, including for venture capital. A second important conclusion is that, given the strong links between innovation, internationalisation and firm productivity, it is important to erase the dividing lines between industrial policy, single market policy, ICT policy and service sector policy. A highly integrated economic system needs a coherent set of policies that aim at improving business conditions everywhere. Attempts to promote one sector at the expense of another one are likely to result in significant inefficiencies and weaker overall growth. Governments are notoriously bad at picking winners. Instead, Europe needs policies that are conducive to a better business climate, less-burdensome regulations and the right framework conditions. Third, public policies need to be more supportive of industry and other parts of the economy. For example, the education system is of central importance for the economy and needs to be adapted to the needs of modern economies. The single market is important for both manufacturing and services and progress is needed to unleash its potential for growth. Reducing trade barriers is particularly important for industrial firms that increasingly rely in global value chains. Distortions in energy prices are also detrimental to industrial activity and should be avoided. ‘Manufacturing Europe’s future’ therefore means getting the policies right for firms to grow and prosper. It is not about picking one sector over another, but primarily about setting the right framework conditions for growth, innovation and jobs. Guntram Wolff, Director of Bruegel Brussels, September 2013 | Read more at Bruegel http://www.bruegel.org/publications/publication-detail/view/795-manufacturing- europes-future/

07/16/2014 02:42 PM The Buzz in Berlin Is Merkel Thinking of Stepping Down? By Nikolaus Blome Angela Merkel turns 60 this week and is celebrating the pinnacle of her political career, highly popular and uncontested in office. Still, many in her cabinet and party believe she will step down as chancellor before her current term ends.

DPA//Angela Merkel turns 60 this week and has been at the helm of German politics for almost 10 years. But how much longer is she planning on staying in power. Many close to her believe that she might step down before her current term comes to an end. Several days ago, a young boy asked Angela Merkel a profound question. The chancellor was on a trip to China and found herself in the central city of Chengdu, where she was visiting a social project that provides assistance to migrant worker families. The German leader had already asked a few questions herself, but it was the children's turn. The boy, in shorts and a T-shirt, wanted to know: "Ms. Chancellor, do you have a happy life?" One person in attendance said that Merkel smiled for a moment, paused for a second and then said, "Yes, I live a happy life."

On July 17, Merkel will turn 60. There will be a party and a speech, both taking place at the Berlin headquarters of her conservative Christian Democratic Union party. Merkel will take pains to ensure that the celebrations aren't too extravagant. She would like the event to seem inconsequential and prefers sparkling wine over Champagne. Regardless, it will still be a momentous day, one likely to draw attention to the fact that Merkel has joined Konrad Adenauer and Helmut Kohl as the most influential chancellors in Germany's postwar history. But the event will also be accompanied by a question just as profound as that asked by the boy in China: How much longer will she remain in office? Neither Adenauer nor Kohl left the Chancellery voluntarily; one was forced out by his party, the other was voted out by the electorate. They left under a cloud of defeat, one which, at least for a time, overshadowed their achievements. With no term limits in Germany, it is, of course, how all other German chancellors have left office as well. But for Kohl and Adenauer, it is a problem they might well have avoided. The circumstances for either of the two to step down voluntarily would have been far more accommodating given that they had already been re-elected multiple times, they had viable successors and they had historical milestones closely affiliated with their names. And yet neither seemed able to take the step. Angela Merkel would prefer to do things differently. The chancellor, nicknamed "Mutti," or mom, remains largely uncontested both within her own party and in her coalition government. She is almost disturbingly popular among German voters (with a popularity rating of 77 percent) and is one of the clear leaders of Europe; she is on equal political footing with the presidents of Russia, the United States and China. Despite this, almost all of those closest to her professionally -- be it in her party or her cabinet -- are convinced that she will eventually step down. They are certain in their belief that she intends to become the first postwar German leader to decide on her own when she should leave office. "The idea really appeals to her," says one person on her government team, echoing the feelings of many. Merkel, though, said during the election campaign that she intends to remain in office for the full term. Expectations, in other words, are not consistent with Merkel's statements. But it is not difficult in Berlin to find people willing to talk about the paradox, be they members of Merkel's own Christian Democrats or of its junior coalition partner, the center-left Social Democrats. But no one is willing to speak on the record. The question as to whether the chancellor is considering stepping down voluntarily is one that Merkel's spokesman, Steffen Seibert, doesn't really care to hear. Officially, he replies with one word: "No." He then points to Merkel's own statements in the 2013 election campaign. But it's implausible that she's not at least thinking about it. After a cross-country skiing injury at the beginning of the year, Merkel spent several weeks half working and half bedridden. One source close to Merkel says that the chancellor used some of the time thinking about her future and life after the Chancellery. Recent months, the source said, have been more intense, for reasons including the crisis in Crimea and elsewhere in Ukraine, leaving little time to focus on other things. But the questions about her future intentions remain. 87

Plausible Denial? A short time ago, a person close to the chancellor pulled her aside to tell her that many in Berlin were already discussing the possibility that she might step down voluntarily and that the gossip wasn't just limited to journalists. "And how did you answer them?" the chancellor asked. "That it's not true," the person said. "Rightly so," the chancellor answered. That's not an unequivocal reply. "Rightly so," could mean "That's right, no resignation." Then again, it could also mean: Well done, good job blocking the stupid questions. Stepping down voluntarily is quite possibly the toughest decision a top politician can make. Those who step down can quickly be accused of being weak and become vulnerable to questions about their health. They even run the risk of being viewed as failures. Besides, there are always objective reasons to continue in office. Even absent such reasons, most of Merkel's predecessors came to believe that they were truly irreplacable. That's an idea alien to Merkel. But she also knows that, no matter how much she wants to be the architect of her own departure, the fuss surrounding it will be intense. And she too feels the call of duty. Case Study Few top politicians in Germany have succeeded in stepping down in this way. One of the few is Roland Koch, the former governor of the state of Hesse who was once a Merkel rival for the leadership of the CDU. Good luck, strong nerves and the political impotency of his SPD opponent Andrea Ypsilanti ensured Koch re-election at the beginning of 2009, after which he succeeded in building a government in Hesse together with the business-friendly Free Democratic Party. "At the end of 2009, we began considering the idea of a voluntary exit," Koch's longtime political confidant Dirk Metz said after the politician's resignation. "Koch had been saying for years -- even if no one believed him or wanted to hear it -- that he one day wanted to return to the business world. Being in his early fifties, he still had very good prospects for landing a job." The decision also involved other considerations. "After 15 years in government, the fact that the next election wasn't going to be any easier for him was also a factor," he said. Those close to Koch say he also wanted to escape the fate faced by many other politicians -- that of being forced out under pressure from their own people. At the time, Koch only discussed his future with his wife and Metz, thus managing to retain the element of surprise. In May 2010, the politician first announced his plans to step down to his party's stunned leadership before going public with the news a few days later. Afterwards, he said it had given him "perverse delight" that he had outwitted journalists. Merkel's Husband Would Be Vital in Decision Almost everyone close to Merkel agrees she would do things similarly. She would speak about it with one or two political confidants as well as with her husband Joachim Sauer, a professor of physical and theoretical chemistry at Berlin's Humboldt

University. The influence he has on Merkel is often dramatically underestimated. This is partly due to the fact that Sauer makes very few public appearances, gives virtually no interviews and often travels abroad. Some friends of Merkel in Berlin say it will be his word and their plans together that will be the determining factors. They say he's the most important point of reference in her life. But Roland Koch did more than just talk to his wife. He also took a sober look at himself and his prospects -- an ability absent in most politicians at the top. It became clear to him that his political career was unlikely to have a trajectory taking him higher than the office of governor of Hesse. For years, his name had been dropped as a potential CDU chancellor candidate. Although he had the ambition for the office, it had been clear for years that he no longer had the support or power to attain it. It was also becoming increasingly apparent that his time as governor was also limited and that he faced the prospect of getting voted out of office one or two elections down the road. Given that he had little chance of higher office and that he had already served for more than a decade as governor, he abandoned politics for a high-profile job at German engineering company Bilfinger, where he is currently CEO. He was supported by Merkel at the time. She had reacted with mystification or even mockery to other resignations, but not to Koch's departure. "He simply asked the right questions," she said at the time. "And then he acted." So when will she follow in his footsteps? That's the mother of all questions in Berlin right now. Even at a time when the capital is in the midst of unprecedented political calm, a political thriller is taking shape -- one that includes all the necessary ingredients: motives, means and a perfect opportunity. Searching for a Motive One motive could be fatigue. Merkel has said several times in the past that 10 years would be the limit for her term in office in the Chancellery, adding that the wear and tear of 16-hour days and six-and-a-half day work weeks wouldn't be sustainable beyond that. Besides, much of what Merkel experiences these days must feel like déjà vu. She has more than three dozen European Union summits behind her, eight G-7 and G-8 summits in the bag and 48 governmental addresses. She has won three general elections. Her next trip to the United States will be her 16th. One senior CDU member says that Merkel has made all of the necessary reforms to her party. Be it the image of the family, same-sex marriage, abandoning military conscription, implementing a national minimum wage or education reform -- regardless what one thinks about the CDU's policy shifts, it would be hard for the party to move any closer to the political center that Angela Merkel has steered it. Indeed, the party is a key Merkel achievement, transforming it into the perfect reflection of a zeitgeist that lacks much edge. The changes have muted the conservative and business-friendly wings of the party, but they also brought in 41.5 percent of the vote in last September's general election. With no major moves left to make, it seems inevitable that that number is destined to fall the next time voters make their way to the polls. It's a line of thinking that must have been shared by quite a number of ministers. At a December meeting, just as the new government was beginning its work, everyone began

looking for signs, one minister said. Signs of what? "That it is likely her last term in office," the minister said. "Or at least many believe that." The minister says that a presentation at the meeting by Environment Minister Barbara Hendricks provided a case in point. She was outlining her ministry's plans, one of which extended to the year 2020. "Oh, then," Merkel said, making a vague hand gesture. The minister says he wasn't alone in thinking her reaction might be a hint and wondering how far into the future the chancellor was still thinking. Many party acolytes were also baffled as to why the SPD was granted almost every economic or socio-politically relevant ministry in the current government. The center- left party controls the economics, family and labor portfolios, with conservatives left wondering: "Why is she doing that? And what's left for us?" Merkel has countered this feeling of impotence within her own party with a shrug of her shoulders and terse responses like the one she gave last Thursday at CDU's Council of Economic Advisors in Berlin. "A stable government is a value in and of itself," she said. There was very little applause from the hundreds of businesspeople gathered in the packed hall. "Is she even interested in domestic policy anymore?" one board member from a major German company wondered afterwards. Merkel 'Very, Very Relaxed' The chancellor's weight has dropped several kilos since the beginning of the year and she appears to be in much better shape physically than she was when she first entered the Chancellery in 2009. Many perceive her to be "very, very relaxed" as a head of government in her third term who has nothing left to prove. Domestically, that means that she makes governmental statements and gives speeches to parliament in an unanimated manner, at times coming across as downright disinterested. She seems not to be putting much heart into the issues on her to-do list. When it comes to dealing with international crises, by contrast, she gets her hands dirty, engaging in long telephone discussions about Ukraine, Russia or EU leadership positions. She travels abroad, most recently to China, where she was curious enough to ask a seemingly endless array of questions -- to the provincial governor, to a female employee at a VW factory, to a chef teaching her how to make kung pao chicken or to an engineering student. Her eyes lit up when she compared the Chinese system with Western democracy, just as she did when she conducted joint talks with Beijing leaders, discussions balancing advantages and disadvantages, limitations and dangers and the individual and the collective. Even late nights in a windowless conference room, you could listen in and get the sense that Merkel was still in top form. And yet, she doesn't appear to have a goal. There is no political point that she wants to achieve at all costs -- one that she can later look back on with satisfaction. Politics for Merkel seems all process and no projects. The consumation of a political vision is foreign to Merkel's nature -- which is one reason that the idea of her quitting at any time doesn't seem out of the question. Contrasting Merkel with Kohl Helmut Kohl was different. In 1994, he announced that that year's election campaign would be his last, a vote that he won by a narrow margin. Then, on his 67th birthday in

early 1997, he surprised friend and foe alike by announcing that he would run once again. Kohl felt that he was the only one who could complete his most important project, the single European currency. In 1997, the idea of the euro was the focus of serious controversy and Germany's central bank, the Bundesbank, was only one of a number of parties demanding that the plans be delayed. At the time it appeared that France and Italy, both founding members of the EU, might fail to meet the criteria for joining the euro. Serious decisions had to be made in the spring of 1998, and Kohl didn't trust anyone other than himself to make them. "Why do you think I am even still in office?" Kohl allegedly said at a 1996 summit held in preparation for the euro, according to an account by Kohl's biographer Hans-Peter Schwarz. "I'm still here because of Europe. Without me, no one will push this through in Germany." In the end, Kohl got the euro. But he lost the election. Merkel's equivalent to the euro could be a newly written EU Treaty, perhaps even a constitution. But she hasn't made any attempts to achieve that because she doesn't think she will be able to win over all 28 member states. In fact, one of her most important maxims seems to be never to promise anything that she isn't certain of being able to deliver. For almost nine years, that maxim has prevented this German chancellor from suffering from any major defeats. At the same time, it has also prevented her from achieving any great deeds. "Helmut Kohl has now become ... the most respected sitting statesman in the world as we know it," SPIEGEL founder Rudolf Augstein wrote in 1996, just as Kohl's time in office surpassed that served by Konrad Adenauer. Oxford historian Timothy Garton Ash has used similar language to describe the current chancellor. During the euro crisis, he wrote that "world history" depended on Merkel. More recently, that didn't appear to be the case, with Merkel miscalculating badly during the process to name the next European Commission president. More than one German cabinet member warned her against underestimating the political impact of adopting the leading candidate system for European elections. And sure enough, following the vote, Merkel could do little to prevent the European Parliament from taking the initiative and installing Juncker at the head of the EU's executive body. Goals for Europe It is only during crises that Germany's position as Europe's leader is clear -- when conditions call for it or suffering euro-zone member states demand it. But in quieter times, Merkel would have to actively claim a leadership role. "But she wouldn't dare to do so," says one of Germany's most important bankers who meets with Merkel now and then. Nevertheless, there are issues that are important to the chancellor in her third term in office. She intends to adjust euro-zone rules to make the common currency more crisis resistant; she hopes to ensure that members get back on track economically and she hopes to renew the trans-Atlantic relationship with the US, despite the NSA espionage affair. In addition, there is the question as to how Western societies can exert more control over the process of global digitalization. To address the latter issue, Merkel invited Mathias Döpfner, head of the powerful German publishing house Axel Springer, for a meeting on May 5. They spoke about Google and how the American company's influence is changing competition and society

for the worse. Merkel also spoke of Ludwig Erhard, the former German chancellor who was a major proponent of the kind of social market economy that defines Germany. She said the system holds that the power of individual companies must be limited both by free competition and by state regulation. The maxims of the social market economy must also retain validity in the digital age, she told Döpfner. That would be a sizeable project, implying that policymakers would like to exert the kind of control over global digital capitalism that they do over world financial markets. But it is also the kind of enormous undertaking to which Merkel has historically had an aversion -- and unsurprisingly her public comments have been more reserved. Still, she did recently utter a sentence that made greater waves than normal. "The grand coalition government intends to make the fountain of the good life available to all," she said at the beginning of the legislative period. Perhaps more than anything, the comment was reflective of her all-encompassing approach to society and politics. Furthermore, it was delivered in the tone of a mother reading a comforting goodnight story to her children -- and not just because she delivered it sitting down, the product of a cross-country skiing accident. But it nevertheless raises the question as to whether she has specific steps in mind to make progress toward that stated goal. Thus far, a satisfactory answer has not been forthcoming. Merkel Is in a Position To Control Her Own Departure The lack of specifics is symptomatic. Having established no great goals by which she can be measured, Merkel has maneuvered herself into a difficult corner: There is a danger that her period at Germany's helm will lack a clear endpoint. Many who know her say that she doesn't want to be pushed out like Helmut Kohl and Gerhard Schröder were before her. But her leadership style has made such an end a distinct possibility. Among the obligations felt by Merkel is that of not wanting to leave the Chancellery and her Christian Democrats rudderless when she departs. Because her party and her governing coalition has thus far avoided scandal and squabble, she currently enjoys significant trust from the German electorate, says one cabinet member. Germans, who tend to view politics with a certain degree of mistrust, love the calm. And in order to preserve it, Merkel would like to hand over both of her offices -- as chancellor and as head of the CDU -- to a single heir. As things stand now, that person is Ursula von der Leyen, though asking her about it won't get one very far. "Every generation has a chancellor. In my generation, that chancellor is Angela Merkel," says von der Leyen, who currently heads up the Defense Ministry. She refuses to elaborate beyond that. Even the many von der Leyen detractors among Merkel's conservatives admit that they would support her should it become necessary. Von der Leyen, they say, is the "accident chancellor" -- the one that would take over should something happen to Merkel. She has made it clear that she is willing, having done little to hide her desire to become defense minister. But what many forget is that it was Merkel who granted her the portfolio, a clear indication that she wanted to give von der Leyen a crash course in foreign policy to prepare her for the top job.

Of course any such move to install a Merkel successor during the current legislature period would require the support of the chancellor's junior coalition partner, the SPD. But at last one top conservative says that "Sigmar Gabriel wouldn't have the gumption" to jump ship. The SPD head's plan to take back the Chancellery, after all, is focused on the 2017 elections. Backing out of the current coalition would be difficult to explain to the electorate without a clear rationale. Gabriel also knows that he still needs a few years to maneuver the SPD back to the political center, which is where elections are won in Germany. Still, public opinion polls will play a crucial role in the decision. Should the SPD enjoy over 30 percent support when Merkel steps down, the party could be tempted to try its luck in a shortened campaign against a Merkel-less CDU. But if polls show lower support -- and it currently appears as though they will -- the party would likely avoid taking such a risk. The bottom line is that Merkel is in a position to control her own departure. "I have always been able to find a coalition partner who wants to govern with me," she once said. The same can no doubt be said of the search for her successor in the Chancellery and in her party. What Comes after the Chancellery? Merkel, though, is famous for thinking things through from the endpoint she envisions. What, then, might be in store for her after the Chancellery? Growing potatoes at her dacha north of Berlin? Traveling around the world with her husband? There are plenty in Berlin's government quarter who believe that such a quiet retirement is a distinct possibility. But there are many more who think that she will remain in politics. Merkel, they say, can't live without politics. There are two international posts that could come into question: president of the European Council, the powerful body representing the leaders of the 28 EU member states, or United Nations general secretary. The first comes with a term of two-and-a- half years and will be available again at the beginning of 2017. Furthermore, Merkel loves maneuvering in the complex political environment of Brussels and also possesses more experience in European politics than any other sitting European head of state or government. "There are many in Brussels who could imagine Angela Merkel making her experience and energy available to Europe," says Elmar Brok, the CDU European parliamentarian. "She would enjoy broad support." The position as head of the UN in New York will also be open as of January 2017, with Ban Ki-moon's successor being determined in mid-2016. Just recently, the Luxemburger Wort, Luxembourg's leading daily paper, wrote extensively about the possibility that Merkel might aspire to the position, though it was quickly denied by the chancellor's spokesman. The speculation, however, has continued. "It is a European's turn," said one senior CDU member at a recent evening event. An additional voice from German parliament noted: "On Jan. 1, 2017, Ban Ki-moon's successor will take over. That fits perfectly, early enough before the next general elections in Germany." It is difficult to imagine Merkel experiencing much opposition in Europe or the world were she to express interest in one or the other of the posts. Indeed, it looks as though 93

her own pledge is the only thing standing in the way. Prior to last year's election, she insisted that she intended to remain in office for an entire third term were she re-elected. Should she wish to control her departure, she would have to break her word. That, perhaps, isn't such a high hurdle. It is, after all, a fundamental rule of politics that candidates cannot say they are only interested in staying in office for part of a term. Doing so would turn them into an immediate lame duck -- and Merkel is fully aware of that. Thus, if motivation, means and opportunity must come together for a significant move, speculation over Merkel's departure at some point during the current term does not seem that far-fetched. There are many impossible-to-predict events that could forestall her farewell to German politics: a deadly attack in the country, a return of the euro crisis or a military escalation in Eastern Europe, to name but a few. Merkel could even become so enamored of her position that she refuses to go. The latter, though, hardly seems possible; there has been little indication in her almost nine years at the top that she is addicted to power. Much more likely is that Germany, in the not too distant future, will be blindsided by the news that Merkel has arranged for a successor and that she is only planning to stay in office for a few more weeks. With such a move, she would show up her male predecessors, who considered themselves indispensable in the Chancellery. With such a move, she would also, once again, get what she wants. Translated from the German by Charles Hawley and Daryl Lindsey URL:http://www.spiegel.de/international/germany/party-insiders-say-angela-merkel- may-leave-office-early-a-980987.html Related SPIEGEL ONLINE links:  Photo Gallery: Merkel's Approaching End? http://www.spiegel.de/fotostrecke/photo-gallery-merkel-s-approaching-end- fotostrecke-116995.html  Germany's Choice: Will It Be America or Russia? (07/10/2014) http://www.spiegel.de/international/germany/as-us-scandals-grow-germans-seek- greater-political-independence-a-979695.html  Queen's Quandary: Chancellor Merkel's Power Erodes in Europe (06/24/2014) http://www.spiegel.de/international/germany/european-center-left-challenging- merkel-leadership-in-eu-a-976918.html  The Democratic Deficit: Europeans Vote, Merkel Decides (06/02/2014) http://www.spiegel.de/international/germany/power-struggle-europts-between- european-parliament-and-eu-leaders-a-972870.html  Trans-Atlantic Supplicant: Merkel Chooses Unity over NSA Truth (05/05/2014) http://www.spiegel.de/international/germany/chancellor-merkel-sacrifices-nsa- investigation-for-unity-on-ukraine-a-967596.html  Biography Speculates Merkel May Quit in 2015 (04/15/2013) http://www.spiegel.de/international/germany/a-894372.html

The American economy America’s lost oomph The country’s potential growth rate is barely half what it was two decades ago. Here’s how to raise it Jul 19th 2014 | From the print edition

BACK in the mid-1990s, America’s economic prospects suddenly brightened. Productivity soared. Immigrants and foreign capital flocked to take advantage of what was quickly dubbed the “New Economy”. The jobless rate fell to 4%, yet inflation remained low. All this led economists to conclude that America’s potential rate of growth—the speed at which the economy can expand while keeping unemployment steady and inflation stable—had risen sharply from its decades-long average of 3%, to 3.5% or even higher. Sadly, the New Economy is no more. The recovery from the recession of 2008-09 has been the weakest of the post-war era, and evidence is mounting that America’s potential growth rate has plummeted. Its two big determinants, the supply of workers and the rise in their productivity, have both fallen short. Performance in the past year has been particularly feeble: America’s labour force has not grown at all and output per hour worked has fallen. The IMF recently cut its estimate of the country’s potential rate of growth to 2%. Other economists put it as low as 1.75% (see article). In this section// America’s lost oomph/ A useful crisis/ Another fine mess/ No panderers, please: this issue’s black and white/ Easeful death

So far, the slide in potential has had little practical impact. Because the recession was so deep and the recovery so weak, the economy is still operating below its capacity. But in the long term a halving of the economic speed limit would have grim consequences. Living standards would rise more slowly, tax revenues would be lower and the burden of paying today’s debts heavier. Solving the short-term problem means boosting demand, so the Federal Reserve should keep interest rates low. But to pep up long-term growth, America also needs to address the supply side. In particular, it needs more workers and faster increases in productivity. The not-so-mysterious case of the disappearing worker The number of working-age Americans rose by an average of 1.2% a year in the 1990s, and by a mere 0.4% in 2013. The proportion of them actually in the workforce has fallen from over 67% to less than 63%. The recession is partly to blame, because after years of joblessness some people have given up looking for work. That is one reason why boosting the recovery is important. The ageing of the baby-boomers is another reason. The number of people in their late 50s (when participation in the workforce starts to drop) and older is rising fast. Both these vulnerabilities are exacerbated by a self-inflicted problem: policies that depress the supply of workers. Most damaging is America’s broken immigration system. Getting into the country has become much more difficult. The number of visas issued today for highly skilled people is a fraction of what it was in the 1990s, even as the number of unfilled vacancies for skilled workers soars. Deportations have surged and the southern border has become far harder to cross. Obamacare, though good in other respects, tends to shrink the labour force because it helps people get health care without working. There is less to be said for the outdated social safety net, which manages both to be stingy and to discourage work. America spends a smaller proportion of its GDP than other rich countries on retraining the jobless and helping them find work. It has not raised the retirement age and it has allowed its disability-insurance system to become an ersatz welfare scheme. The number of workers on disability, hardly any of whom will work again, has doubled since 1997 to 9m. For once, Europe could teach America some labour-market lessons: thanks to welfare reforms, the proportion of Europeans in the workforce is now rising. The mystery of the slump in productivity In the long run, the most powerful way to boost growth is for workers to become more productive, as they did in the 1990s. But raising productivity is hard, and the recent slump puzzling. Innovation drives productivity growth, and a dizzying array of new developments, from “big data” to the “internet of things”, suggests that innovation is speeding up. Yet the growth in the average worker’s output per hour was slowing before the 2007 crisis and has fallen further since. That may change, because it takes a while for firms to react to disruptive technologies. Computers started to spread in the 1980s but their impact did not show up in the data for more than a decade. The latest surge in innovation will also take a few years to translate into higher output per hour. The slow recovery from the recession may have lengthened this delay, by deterring many firms from investing in information technology. But here, too, politicians have made matters worse. 96

There is much America’s government could do to boost investment. It could, for instance, increase public spending on infrastructure. It could reduce the sky-high corporate tax rate which encourages firms—such as AbbVie, which is proposing to shift its base to Britain by buying Shire (see article)—to move abroad rather than invest at home. And it could start cutting the endless sprawl of job-destroying regulations that companies say is a worse problem even than taxes. It is doing none of these things. The impact of a supply-side revolution, with immigration reform, an overhaul of disability and training schemes, infrastructure investment, deregulation and corporate- tax reform all high on the agenda would be gradual. But even the prospect would strengthen the recovery, by encouraging investment and deterring the Fed from raising interest rates too soon. Thoughtful politicians have produced schemes for radical change in almost all of these areas, but their plans—like so much else—have fallen victim to America’s polarised politics. The Republicans stand in the way of loosening immigration rules, while Democrats fear that supply-side reforms are a plot to hurt the average Joe. Both sides hoover up cash from special interests keen to keep anticompetitive regulations in place. Barack Obama, the least business-friendly president for decades, has devoted far too little attention to the problem. So the odds rise that America’s economy will continue to lumber along at an underwhelming pace, and Americans will have no one to blame but their leaders. From the print edition: Leaders http://www.economist.com/news/leaders/21607809-countrys-potential-growth- rate-barely-half-what-it-was-two-decades-ago-heres-how-raise

Immigration They can’t imagine not working Evidence that a stingy welfare state helps America absorb immigrants Jul 12th 2014 | ATLANTA | From the print edition FERNANDO ESCALANTE gives stark advice to job-seeking immigrants at Atlanta’s Latin American Association: don’t put your address on your résumé. Not only do employers prefer to communicate by e-mail, but they might use it against you. How? By assuming that those who live far away will not make it to work on time. Life can be tough for immigrants in America. As a Romanian bank clerk in Atlanta puts it, to find a good job “you have to be like a wolf in the forest...able to smell out the best meat.” And if you can’t find work, don’t expect the taxpayer to bail you out. Unlike in some European countries, it is extremely hard for an able-bodied immigrant to live off

the state. A law passed in 1996 explicitly bars most immigrants, even those with legal status, from receiving almost any federal benefits. In this section// The great pot experiment/ Digging dirt, digitally/ Why Democrats flip- flop on guns/ They can’t imagine not working/ Matches made in heaven—and hell/ Marco Rubio and the safety net That is one reason why America absorbs immigrants better than many other rich countries, according to a new study by Giovanni Peri of the University of California, Davis, and Michele Battisti, Gabriel Felbermayr and Panu Poutvaara, all from Germany’s Ifo Institute. These economists sought to measure the effect of immigration on the native-born in 20 rich countries, taking into account differences in skills between immigrants and natives, imperfect labour markets and the size of the welfare state in each country. Their results offer ammunition for fans of more open borders. In 19 out of 20 countries, the authors calculated that shutting the doors entirely to foreign workers would make the native-born worse off. (Never mind what it would do to the immigrants themselves, who benefit far more than anyone else from being allowed to cross borders to find work.) The study also suggests that most countries could handle more immigration than they currently allow. In America, a one-percentage point increase in the proportion of immigrants in the population made the native-born 0.05% better off. The opposite was true in some countries with generous or ill-designed welfare states, however. A one-point rise in immigration made the native-born slightly worse off in Austria, Belgium, Germany, Luxembourg, the Netherlands, Sweden and Switzerland. In Belgium, immigrants who lose jobs can receive almost two-thirds of their most recent wage in state benefits, which must make the hunt for a new job less urgent. None of these effects was large, but the study undermines the claim that immigrants steal jobs from natives or drag down their wages. Many immigrants take jobs that Americans do not want, says Mr Peri. This “smooths” the labour market and ultimately creates more jobs for locals. Native-owned grocery stores do better business because there are immigrants to pick the fruit they sell. Indian boffins help American software firms expand. A previous study by Mr Peri found that because immigrants typically earn less than locals with similar skills, they boost corporate profits, prompting companies to grow and hire more locals. On July 4th Barack Obama announced his intention to fix a “broken immigration system”; on July 8th he asked Congress for another $3.7 billion to deal with a recent influx of child migrants. Also on Independence Day, Abdul Rahim Saboor, who came to America from Afghanistan in 2002, was hard at work taking revellers to and from firework displays. Three days a week he offers lifts via Uber, a taxi app. The other four Mr Saboor spends at his family’s corporate upholstery firm in Atlanta. He can’t imagine not working, he says. From the print edition: United States http://www.economist.com/news/united-states/21606860-evidence-stingy-welfare- state-helps-america-absorb-immigrants-they-cant-imagine-not

America’s economy Jobs are not enough New figures show that the speed at which America’s economy can grow without stoking inflation has fallen Jul 19th 2014 | WASHINGTON, DC | From the print edition

AMERICAN workers have had no news this good for years. In June employers added 288,000 jobs, bringing the total for the year to 1.4m, the best six-month stretch since 2006. Unemployment has sunk to 6.1%, the lowest rate in almost six years. It could hit levels long regarded as “full employment” within a year. Help-wanted signs are proliferating, with vacancies up by 20% since January. Such an ebullient labour market is usually the token of a booming economy. Not now. In the first quarter gross domestic product fell by 2.9% at an annual rate, the worst showing since the recession. This was a result in part of bad weather. Yet the second quarter will only be strong enough to make up the ground lost in the first. Economists had thought 2014 would be the best year since the recession; with growth in the first half of around zero, it is shaping up to be the worst. Related topics// Recessions and depressions/ United States/ Economies/ Central banking Economic crisis Economic growth over the business cycle is driven mostly by swings in demand, and in recent years demand has been held back: households have been repaying their debts; the government has restrained its spending and raised taxes; and interest rates, having reached zero, are unable to fall further. Over the long run, however, a country’s potential growth depends on supply: how many workers it has and how productive they are. The recent divergence between America’s employment and output suggests the country faces not just deficient demand but also enfeebled supply, as more people working without more output means lower productivity. That is bad news for all Americans since their standard of living depends on productivity. It is also a headache for the Federal Reserve, since inflation emerges more quickly when economic capacity is expanding more slowly. Thus it could mean interest rates rising sooner than might 99

otherwise be expected. If so, though, it would also mean they might not rise that high; in a slower-growing economy, there is less demand for capital.

In the 1990s America boasted one of the rich world’s highest potential growth rates, of more than 3%, thanks to a labour force that was expanding by more than 1% a year and productivity, fuelled by the spread of information technology, growing at around 3% a year (see chart 1). By 2007 the Congressional Budget Office (CBO) had trimmed its estimate of potential growth to a still respectable 2.6%. It now thinks it may be just 2.1% (see chart 2). The Fed has lowered its projections of long-term growth by almost as much. Even that may be optimistic. The recent spell of strong jobs growth and feeble output means that productivity declined by 0.4% over the past year, JPMorgan calculates. The labour force did not grow at all. Economic theory holds that unemployment declines when the economy grows faster than its potential on the upswing of the business cycle. If the slow growth of the past year was above the long-term potential, as the rapid drop in unemployment suggests, it would seem to imply that the long-term potential was actually negative. Things are almost certainly not that bad. Still, JPMorgan reckons America’s potential growth is just 1.75%—about half the rate it enjoyed from 1947 to 2007. Measuring potential growth is notoriously difficult. Productivity is volatile, making underlying trends hard to discern. Disentangling short-term demand from long-term supply is complicated by the fact that the former has a direct effect on the latter. When the economy is booming, businesses invest and innovate more, which raises productivity, and people who might have stayed at home, retired or remained in school join the labour force. That is what happened in the 1990s: as the economic boom continued with no uptick in inflation, economists concluded that potential growth had risen. The great reversion The optimistic way to read the current situation is as the same thing happening in reverse: potential growth may be being depressed by the hangover of weak demand

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from the Great Recession, rather than by underlying structural forces. For example, the labour force has grown by just 0.3% per year so far this decade, compared with 0.8% in the previous decade, and the participation rate—the share of the working-age population either working or looking for work—has fallen from 65.9% at the end of 2007 to 62.8%. Some of that is structural: of particular note is the fact that the first baby boomers qualified for Social Security (the public pension) in 2008. Some is cyclical: those who have not found work since the recession are quitting the jobs market. But which effect is bigger? A new report by Barack Obama’s Council of Economic Advisers reckons 1.6 percentage points of the 3.1-point decline in participation can be explained by ageing alone. It reckons another half point is clearly cyclical. That leaves a gap of roughly one percentage point requiring explanation. One factor is that 16- to 24-year-olds are staying in education longer, and are less likely to work while learning. But participation among those aged from 25 and 54, the biggest and most active portion of the workforce, has also fallen—and it was doing so before the recession hit. This fall has been most striking for those with less education: participation has dropped by four percentage points for those with only a high-school diploma, according to Judd Cramer, a doctoral student at Princeton University. These are the workers most likely to be displaced by technology or foreign competition. But this long-standing trend was made worse by the recession; participation in states hit harder by the recession fell more than it did in those less afflicted, according to Christopher Erceg and Andrew Levin of the International Monetary Fund. In theory, a hotter economy should draw some of these workers back into the labour market. In practice, the impact is likely to be small. Many dropouts have retired or begun collecting disability benefits, a decision that is “more or less permanent”, according to Shigeru Fujita of the Federal Reserve Bank of Philadelphia. And the structural problem will get worse; the baby-boomers will continue to retire, even as the supply of new workers shrivels. The Census Bureau reckons America’s working-age population will grow by just 0.3% a year from 2010 to 2030, less than a third of the rate of the past two decades. Ageing is not the only reason: falling fertility rates and declining immigration also play a role. Like labour, productivity is growing more slowly, averaging a little over 1% since the recovery began, about half the average of 2.3% from 1947 to 2007. This might be partly cyclical: weak sales and financial crises have discouraged investment in recent years. But productivity growth had begun to slow even before the recession, from around 2005. John Fernald of the Federal Reserve Bank of San Francisco attributes this to the waning of the IT revolution. Led by the likes of Walmart, a fiercely efficient retailer, businesses began using IT in the late 1990s to better manage supply chains, deploy workers and design products. By 2005 they had reaped most of the benefits, the theory runs, and the pace of innovation in semiconductors had slowed. The spread of social media which allow new forms of working, of automation which increases an individual’s output and of many other technological innovations which, like those of the previous wave, are taking their time to show up in the productivity figures may yet improve the outlook. But such a pay-off could be many years away. As Michael Feroli of JPMorgan notes, the share of GDP devoted to investments in IT 101

plunged during the recession and has continued to fall, even as investment of other sorts has recovered. The Bank Credit Analyst, an investment journal, notes that lower potential growth means business needs less capital to meet future sales. That would explain why investment, at 12% of GDP, remains below its pre-recession peak.

Even if potential growth picks up a bit, America will increasingly resemble the ageing slow-growth economies on which it used to look down. To improve potential growth policymakers can take various steps, such as raising the age at which the elderly receive government benefits, lowering the top corporate-tax rate and reforming support for the disabled. But such steps would take years to bear fruit. In the meantime the Fed has held interest rates at zero out of a belief that the economy is loaded with spare capacity which is holding down inflation. Recent data have prompted a reappraisal. Not only has unemployment fallen rapidly, broader measures of underemployment which include the unemployed who have given up looking for work have fallen even further. Yet participation has not risen. Meanwhile, employers are having more trouble filling jobs: in May 3.2% of all jobs went vacant, close to a seven-year high, suggesting the jobless lack the skills that employers are looking for. All this indicates that the economy is closer to full employment than the Fed had expected just a year ago. Given how quiescent wages and prices remain, rate rises seem still at least a year away. But as Janet Yellen, the Fed chair, noted on July 15th, that date will come sooner if unemployment keeps falling so quickly. From the print edition: Briefing http://www.economist.com/news/briefing/21607810-new-figures-show-speed- which-americas-economy-can-grow-without-stoking-inflation-has

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Daily Morning Newsbriefing July 17, 2014 Sanctions against Russia are getting serious – beware of the economic consequences The biggest surprise to us this year was the apparent susceptibility of the German economy to even the mildest sanctions on Russia. The economy has been in a (so far temporary) significant economic downturn, as evidenced by the fall in industrial orders and industrial production. Yesterday’s big news is the decision by the US – very likely to be followed by the EU – to impose a further round of sanctions. They are getting progressively painful. As the FT reports this morning from Washington, the US imposed sanctions on Russian banks and energy companies, which will from now on be blocked from long-term US financing. The banks are Gazprombank and VEB, the companies involved include Novatek, a gas producer, and Rosneft. In addition, Russian defence companies will have their assets blocked. The targeted companies will be effectively shut out of the US debt and equity markets for all maturities of larger than 90 days, while short-term transactions would be permitted. The FT noted that the difference from earlier sanctions is that these companies were intertwined with western capital markets, and with industrial peers in the West. The decision by the US might precipitate EU sanctions – one of the discussion topics at yesterday’s special EU Summit. EU leaders have asked their ministers to come up with a new list by the end of the month. They also said they would block EIB and EBRD investments in Russia and re-examine up to €450m in direct EU aid to Russia, though some of that aid is to civil society groups and will be continued. The Wall Street Journal reports that the EU has once again delayed a decision to allow Gazprom to access spare capacity on the Opal Pipeline, a pipeline which transports gas from the Baltic Sea NordStream pipeline through Germany into the Czech Republic. They gave “technical reasons” for the decisions, without any further explanation. It is the second time this year that the decision has been delayed. The EU also decided to put on ice talks about the South Stream pipeline project to bring gas to Southern Europe. The Opal Pipeline has spare capacity which Gazprom wants to use. But it requires an exemption from a rule that restricts Russia’s use of the pipeline to 50% of the capacity. The main reason we are interested in this story is the wider macroeconomic impact. The Russian sanctions, in combination with a slowdown in demand from China, have had a disproportionately large effect on the German economy. As the sanctions become more intense, and as they persist, their impact will become progressively stronger. Moreover, there is no sign that these sanctions will be reversed soon. Even if the conflict is eventually resolved, this constitutes enough of an economic shock to weaken an already

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fragile recovery further. We have previously warned not to underestimate the effect of what appeared to be relatively modest sanctions. The experience is that especially the financial sanctions are likely to prove significant – more potent than an old-fashioned trade embargo. It is the combination of measures that matters. A southern European Socialist? Or a central European conservative? The European Council is gridlocked on the nomination of Herman van Rompuy’s and Cathy Ashton’s successors – and the result may well have implications for the job of the eurogroup chief – for which Luiz de Guindos remains the front-runner. But nothing was decided at last night’s special EU summit, and won’t be until late August. Corriere della Sera and the other Italian papers are doing a good job this morning focusing on Matteo Renzi’s diplomacy, who now invokes the argument that as a founding member Italy deserves respect. Given that he is the big election winner among the centrist parties, it would be hard to see how Italy cannot get one of the top three jobs – though probably not the eurogroup chief given Mario Draghi’s role at the ECB. About ten countries seem to have reservations on Federica Mogherini as High Rep, either on grounds that she is too inexperienced or that she is too soft on Putin. Angela Merkel yesterday conceded that the High Rep should go to a Socialist (which would favour Mogherini who is supported by all the Socialist leaders), but Merkel insists that the presidency of the Council should be reserved for the EPP. The Italians also report that there is some pressure to solve the impasse by proposing Enrico Letta as president of the European Council, which would throw the field wide open for the High Rep. Virtually all the rest – and some of the above probably as well – is speculation. A potentially further complicating factor arises from repeated reports in Der Spiegel, according to which Merkel plans to be the first German leader ever to give up the job voluntarily before being forced out by an election, a scandal, or an internal coup. It is our own understanding that these reports are credible. She is reported to eye two international jobs – security general of the UN and the European Council presidency – the latter not for now but in two and half years. This would suggests that she could resign in late 2016, which would give her successor another year until the next elections. Our point is this: if Merkel were to concede the job to a Socialist as a matter of principle – that concession would still stand in 2016, given the five-year term of the European Parliament. That might block her own ambitions. One solution would be an agreement that a Socialist takes over now, to be followed by an EPP candidate in 2016. Juncker’s continuity programme In his El País blog, José Ignacio Torreblanca reviews Juncker’s “political guidelines for the next European Commission”, and concludes it is an “ambitious” “continuity” programme which will face member state reluctance or even attempts to continue to renationalise the workings of the EU, and will thus depend on Juncker’s choice between compromising and diluting hs programme or “refusing to be given the cold shoulder by his former colleagues and speaking for Europe”. Torreblanca takes the headline €300bn investment programme at face value but expects Member State reluctance and Commission bureaucracy to delay its implementation. On

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energy, he criticises the “unjustifiable” foot-dragging on a common energy market both to reduce dependence on Russian gas and to develop renewable energy sources. Juncker puts “reindustrialization” within “internal market” alongside a “capital market union”, and Torreblanca criticises Juncker’s track record on tax harmonization as PM of Luxembourg. In an ouverture to the left, Juncker promises to replace the ‘Troika’ with a more “democratically legitimate” process involving the European Parliament, pushing EU minimum wage legislation, and evaluating adjustment programmes for their social impact, but Torreblanca has doubts that this will lead to “durable change”. For the TTIP negotiations Juncker draws red lines on European standards on “food safety, data protection or cultural diversity”, which Torreblanca considers another concession to the Socialists and Greens whose support will be needed in the Parliament to approve any agreement. Juncker also proposes a common asylum policy, and Torreblanca douts that the member states will allow this under pressure from growing xenophobic movements in domestic politics. Torreblanca applauds that Juncker at least acknowledges that the common foreign policy is not working as that’s “the first step towards fixing it”. And finally, Torreblanca is disappointed by the “careless” and “practically empty” section on making the EU structures more democratic which would require much more ambitious measures. Debt relief for reform efforts European creditors want to make debt-relief steps, in particular the extension of its debt- repayment schedule, conditional on Greece meeting reform milestones, Wall Street Journal reports after talking to several officials involved in the talks. The debt talks are expected to resume in earnest in the fall but preparatory work is already under way. The conditionality would ensure the troika’s influence beyond the end of the bailout programme this year, so the officials, though given that the Greek government only managed to implement a fraction of the reforms under the bailout programme, it is not clear what this means. European creditors are only prepared to make adjustments to the repayment terms. Interest rates on the first bailout of €53bn could be lowered by half a percentage point. The reduction would lower Greece's debt only modestly over time, officials noted, but lowering the rate any more would mean that countries facing steeper borrowing costs themselves would start losing money on their assistance to Greece. For the second bailout of some €140bn from the EFSF there is no possibility to cut interest rates but to extend the maturity of the loan, now standing at just over 30 years with a grace period until 2022, which could be extended by 10 to 20 years to spread out the instalments. Private debt on the agenda for August Unpaid private debt in Greece is estimated to have reached around €160bn, which corresponds to 88% of GDP, but was largely ignored until the last few days, when it became a key issue in the discussion between the government and the troika, Macropolis reports. Non-performing loans, so-called NPLs, clearly showed an upward trend (see yesterday’s newsbriefing). The Greek government and troika yesterday agreed that Greek authorities will present a comprehensive solution for the total outstanding unpaid private debt by the middle of August. News reports suggest that the solution will be initially applied to corporates and at a later stage to households. The potential solution mainly involves an out-of-court mechanism where all creditors will 105

decide on the most appropriate package of debt settlement and payment, ruling out a debt haircut. Debt settlement for viable companies could include extension of instalments, lower interest rates, removal of fines and creditor’s participation in the company’s share capital. In addition, creditors may also require a restructuring business plan that could involve cost cutting, personnel reduction and management change.The plan would have to be approved by one third of creditors. When implemented, this will inevitably lead to a massive restructuring of indebted corporates. Press reports indicate that the implementation of upcoming decisions on total private debt settlement may be delayed for six months, i.e. after the completion of the next troika review and publication of EU-wide bank stress test results. Knock-on effects of Espirito Santo difficulties Fitch Ratings downgraded Brazil’s Oi and Portugal Telecom to junk after Rioforte Investments, a unit of Espirito Santo International defaulted on debt payments to Portual Telecom, impacting the plans to merge with the South American company. Rioforte Investments failed to repay €847m of short-term debt to Portugal’s Telecom this week and is due to pay an additional €50m today. The merger is to go on, but the price increased. In exchange for unpaid debt owed to Portugal Telecom by Rioforte, the Portuguese carrier will transfer voting and non-voting shares to its Brazilian partner, the companies said in statements. That would leave Portugal Telecom with a 25.6% stake in the combined entity, down from an earlier plan for a holding of as much as 39.6%, Bloomberg reports. EP gives go-ahead for Lithuania to join the euro The European Parliament gives its go-ahead for Lithuania to join the Eurozone in January 2015, according to a statement from the EP. Parliament's recommendation was passed by 545 votes to 116, with 34 abstentions. Recent 12-monthly average inflation 0.6 % (well below the reference value of 1.7%); a general government deficit in 2013 of 2.1% of GDP and a gross debt ratio of 39.4% of GDP. Lithuania is to become the 19th member of the Eurozone. German union-negotiated real wages are rising It is hard to imagine deflation at a time when nominal wages in an economy are rising fast. So the news of an increase in union-negotiated wages – as reported by Frankfurter Allgemeine – is important, and positive. According to Hans-Boeckler Foundation, the German trade unions have achieved nominal wage increases of 3.1% this year, the biggest nominal increase in 15 years. With inflation at 1%, this translates in an increase in real wages of 2% - which is also the fastest in that period. The wages reflected the positive economic outlook (until recently at least). But FAZ makes a number of qualifying points. The agreed wages do always fully trickle through to actual wages in the economy. Last year, there was a negative wage drift of 0.5pp, due to a fall in overtime work and non-negotiated bonus payments. The second more important issue is the increasing number of employees not covered by collective wage agreements. Negotiated wages rose 7% in real terms over the last 10 years. The paper quotes a leading unionist as saying that the trend for this year was more positive, but had to be put in the context of falling real wages in previous years. The article also quotes the Bundesbank’s forecast, which expects a slowdown in wage increase in 2015.

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The low level of German wage increase was due to wage moderation, but also an increase in low productivity service jobs in the economy. The factors suggest that this offsetting trend is likely to weaker in the future. One is the base level effect – the change has taken place. The second is the statutory minimum wage. German wages are not rising near enough to levels necessary for the ECB to reach its inflation target – and for other EZ countries to adjust at the same time. But they are probably rising fast enough to avoid outright deflation. Though note that the German economy is now susceptible to relatively mild shocks – witness the most recent downturn due to geopolitical tensions. Euro continues to lose ground as global reserve currency The euro’s share in global reserves fell by 0.9% to 24.4%, according to the ECB’s latest report on the international role of the euro, due to the still lingering effects of the crisis and structural shifts in the global monetary system, including a shift towards the renminbi and other emerging market currencies. The ECB itself put a positive spin on the data, focusing on the signs of a turnaround (which is probably correct). What already went up in 2013 was foreign demand for eurozone portfolio investment, which reached its strongest level since the onset of the financial crisis in 2007, of 3.7% of GDP. The sustained levels of capital inflows were mirrored by a rise in the exchange rate of 7% - the second largest since 1999. The ECB said the fall in the euro’s share of global reserves may have been the result of structural shifts in the global monetary system as well as due to the lingering effects of the debt crisis. The long-term consequences of the Verfassungsgericht Ashoka Mody has a long article on the impact of the BvG’s verdict on the OMT – impossible to summerise. His essential point is that the BvG might have actually helped the eurozone by forcing it to reconsider the quasi-fiscal union alternative the OMT presented. The article produced a very detailed discussion of the legal aspects of the case. This is our summary of his three scenarios. 1. The OMT becomes the de facto fiscal union by the back door, as the political will for a proper fiscal union recedes; 2. The BvG and the ECJ effectively kill the OMT by imposing restrictions, thus force the eurozone onto a path of proper fiscal union. 3. Or, there is agreement the OMT is temporally necessary, but would ask leaders to put OMT on a sound legal footing to provide the ECB with a loss guarantee. Eurozone Financial Data 10y spreads Previous This Yesterday day Morning France 0.328 0.319 0.318 Italy 1.642 1.616 1.630 Spain 1.511 1.470 1.475 Portugal 2.630 2.559 2.580 Greece 5.093 5.064 5.06

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Ireland 1.110 1.095 1.109 Belgium 0.439 0.427 0.425 Bund Yield 1.208 1.196 1.182 exchange rates This Previous morning Dollar 1.354 1.3524 Yen 137.690 137.26 Pound 0.791 0.7894 Swiss Franc 1.215 1.2145

ZC Inflation Swaps previous last close 1 yr 0.73 0.73 2 yr 0.75 0.76 5 yr 1.2 1.21 10 yr 1.64 1.64

Eonia 15-Jul-14 0.03 14-Jul-14 0.05 11-Jul-14 0.05 10-Jul-14 0.04

OIS yield curve 1W 0.057 15M 0.047 2W 0.063 18M 0.067 3W 0.054 21M 0.071 1M 0.060 2Y 0.058 2M 0.072 3Y 0.122 3M 0.062 4Y 0.229 4M 0.084 5Y 0.339 5M 0.065 6Y 0.488 6M 0.061 7Y 0.647 7M 0.066 8Y 0.802 8M 0.065 9Y 0.948 9M 0.059 10Y 1.082 108

10M 0.055 15Y 1.560 11M 0.074 20Y 1.776 1Y 0.071 30Y 1.900

Euribor-OIS Spread previous last close 1 Week -4.071 -3.871 1 Month 1.657 2.957 3 Months 8.643 10.943 1 Year 38.529 37.829

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 17.html?cHash=1573df673e6861eef3c38ad8323d1162

Wages, Employment, Distribution and Growth Hein, Eckhard / Heise, Arne / Truger, Achim International Perspectives. New York: Palgrave Macmillan 2006, ISBN: 1-4039-4962-X. 275 Seiten Preis: 112,90 EUR Im Buchhandel Abstract: This volume challenges the view that unemployment is exclusively determined by structural characteristics of the labour market and the social benefit system. Macroeconomic policies and investment in capital stock are included into the analysis and it is shown that they have a major role to play. Wage setting in the labour market has no direct impact on employment but nominal wages set in this market affect the price level. Following mainstream recommendations with respect to labour market reforms in an environment of low growth and serious effective demand problems, may contribute to deflationary risks. Unemployment and 'structural reforms' also cause falling labour income shares and more unequal personal income distribution. These developments contribute to slow growth and rising unemployment. This is shown in applying growth models, which rely on the principle of effective demand and which also incorporate the effects of distribution struggle. Kurzbeschreibung: Internationale Studien stellen die gängige Auffassung in Frage, dass die Strukturmerkmale des Arbeitsmarktes die Höhe der Arbeitslosigkeit bestimmen. Vielmehr zeigt sich, dass die makroökonomische Politik und die Investitionen in den Kapitalstock eine wesentliche Rolle spielen. http://www.boeckler.de/imk_6456.htm?produkt=HBS-003581&chunk=1

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Contents List of Tables and Figures vii

Notes on the Contributors x

Introduction 1 Eckhard Hein, Arne Heise and Achim Truger

1 Labour-Market Flexibility and Economic Expansion (99) Amit Bhaduri

2 The Causes of High Unemployment: Labour-Market Sclerosis v. Macroeconomic Policy (20) Thomas I. Palley

3 Is Capital Stock a Determinant of Unemployment? (49) Philip Arestis, Michelle Baddeley and Malcolm Sawyer

4 Deflation Risks in Germany and the EMU: The Role of Wages and Wage Bargaining (67) Eckhard Hein, Thorsten Schulten and Achim Truger

5 The Influence of Unemployment, Productivity and Institutions on Real Wage Trends: The Case of Italy 1970–2000 (93) Enrico Sergio Levrero and Antonella Stirati

6 Unequal Fortunes, Unstable Households: Has Rising Inequality Contributed to Economic Troubles for Households in the USA? (117) Heather Boushey and Christian E. Weller

7 The Effects of Economic Liberalization on Income Distribution: A Panel-Data Analysis (151) Gerardo Angeles-Castro

8 Pensions and Distribution in an Ageing Society: A Non-Conventional View (181) Sergio Cesaratto

9 Do Profits Affect Investment and Employment? An Empirical Test Based on the Bhaduri–Marglin Model (206) Özlem Onaran and Engelbert Stockhammer

10 Class Conflict and the Cambridge Theory of Income Distribution (223) Thomas I. Palley

11 The Dynamics of Profit- and Wage-led Expansion: A Note (247) Amit Bhaduri

Index (255) http://www.boeckler.de/pdf/p_imk_wages_2006.pdf

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Labour cost trends and international competitiveness in Europe Labour costs and unit labour costs in 2012 and the first half of 2013

Alexander Herzog-Stein, Heike Joebges1, Ulrike Stein, Rudolf Zwiener http://www.boeckler.de/pdf/p_imk_report_88e_2013.pdf At a glance

The development of German labour costs in the private sector, which had been far below European average for a long time, normalised further in the

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course of 2012 and the first half of 2013, with respective growth rates of 2.8 % in each timespan.

Because of a strong sectoral wage differential in Germany, the industry receives cheap inputs from the service sector, leading to effective labour cost cuts of 8 % to 10 %. Taking the progress in productivity into account, the German price competitiveness is extremely high compared to the rest of Europe.

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Wages in Germany would have to rise temporarily by more than 3 % to help crisis-affected countries through the generation of more imports. The price competitiveness of the crisis countries with regard to exports on the other hand is widely restored.

Spain, Portugal and lately even Greece registered stronger export growth than Germany. And that, without passing on their declines in unit labour cost to the export prices but generating higher profit margins instead. 113

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http://www.boeckler.de/pdf/p_imk_report_88e_2013.pdf

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Comunicados de prensa 2014 | 2013 | 2012 | 2011 | 2010 | 2009 | 2008 | 2007 | 2006 | 2005 | 2004 | 2003 | 07/16/2014 WSI archivo convenio colectivo hace balance Aumentar las tarifas en un promedio del 3,1 por ciento el año base Los convenios colectivos en el primer semestre de 2014 son superiores a las del año anterior y que el precio pagado por los empleados públicos después de deducir aumento de precios el crecimiento del ingreso apreciable. En la mayoría de las industrias, los aumentos salariales 2-4 por ciento se han acordado para este año. En la industria química, la IG BCE se sentó a través de un incremento de las tarifas del 3,7 por ciento y un plazo de 14 meses. En el sector público (federal y local), la tasa de terminación para el 2014 un promedio de 3,4 por ciento. Los grupos salariales más bajos fueron significativamente más elevada (al menos € 90). En promedio, para toda la duración de los estados financieros era ligeramente más corto en torno a 22,6 meses que en el año anterior, con alrededor de 22,8 meses. Esto resulta del balance semestral actual que presenta los archivos colectivos del Instituto de Investigaciones Económicas y Sociales (WSI) de la Fundación Hans Boeckler. Teniendo en cuenta las declaraciones de larga duración desde el año anterior, con aumentos de tarifas para este año, se calcula entonces para el año 2014 por 16,5 millones de empleados un aumento arancel nominal salario básico promedio de 3,1 por ciento. "Este balance colectiva provisional muestra que el desarrollo de los ingresos de los asalariados es positivo, dice el Dr. Reinhard Bispinck, jefe del archivo colectivo WSI. "El margen de distribución neutral está agotado y los salarios sindicales son aumento real en la cara de un aumento de precios de alrededor de 1,1 por ciento este año, en promedio, alrededor de un 2 por ciento." Información adicional: R. Bispinck: informe semestral política colectiva 2014 (pdf) , WSI- Tarifarchiv/Informationen a la negociación colectiva, julio de 2014. Declaración del vídeo por el Dr. Reinhard Bispinck

http://www.boeckler.de/14_50620.htm

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Economía Internacional Café Steiner Un nuevo comienzo para Europa Por: José Ignacio Torreblanca| 17 de julio de 2014

En la edición impresa de este Diario de ayer publicaba un análisis sobre cómo Jean- Claude Juncker había logrado el apoyo de liberales, socialistas y verdes para su investidura como Presidente de la Comisión Europea (Jean-Claude habla italiano). Los compromisos que ha adquirido Juncker para los próximos cinco años han quedado plasmados en un documento titulado “Un nuevo comienzo para Europa: mi agenda para el empleo, el crecimiento, la equidad y el cambio democrático”. Ese documento ( Descargar New Start for Europe) es lo que quería discutir con los lectores de este blog. En mi opinión, ese documento tiene que ser interrogado bajo una doble perspectiva. La primera sería la de si de verdad estamos hablando de una “nueva Europa”, de un “reset” o “renicialización” como gusta decirse ahora o, por el contrario, las prioridades marcadas por Juncker son continuistas. Paralelamente, tiene sentido discutir si Juncker, un hombre que representa como nadie el establishment europeísta (primer ministro de Luxemburgo durante los últimos 18 años y, a la par, presidente del Eurogrupo en lo álgido de la crisis del euro), es un hombre capaz de liderar esa nueva agenda. Respecto a la primera pregunta, las diez prioridades de Juncker son las siguientes: La primera es el crecimiento y empleo, vía un paquete de inversión de 300.000 millones de euros apadrinado por la Comisión Europea y el Banco Europeo de Inversiones. Esta es la medida estrella del programa y con razón debe situarse en primer lugar. Esas inversiones, de tener lugar, tendrán un importante efecto, aunque falta un cuadro macroeconómico que sea capaz de cuantificar su impacto sobre el crecimiento y el empleo. No cabe duda de que Europa necesita esas inversiones (en infraestructuras físicas o redes informáticas, interconexiones energéticas o ciencia e innovación). Sin embargo, también sabemos que en el pasado, iniciativas parecidas han naufragado o perdido fuelle dada la escasa voluntad de algunos estados miembros y, también, debido a la burocracia de la Comisión Europea, lenta a la hora de poner en marcha estos

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proyectos. Por tanto, existen dudas legítimas sobre si Juncker podrá cumplir esta promesa de forma que tenga suficiente impacto. La segunda promesa estrella se refiere al mercado digital. Ese mercado es una asignatura pendiente, y si lográramos integrarlo, dice Juncker, podríamos generar 250.000 millones adicionales de crecimiento. Para ello se propone, en los primeros seis meses, introducir en el Parlamento Europeo un “ambicioso” programa legislativo. De nuevo aquí tenemos que aplaudir la iniciativa, pues sin duda que el mercado digital es una de las nuevas fuentes de crecimiento y empleo, pero también sabemos cómo de lento y farragoso tiende a ser el proceso legislativo europeo. Por tanto, la propuesta puede prepararse en seis meses, pero su aprobación puede llevar hasta dos años, dependiendo de los estados y las empresas. Por tanto, aquí también, un aplauso y una interrogación. La tercera promesa estrella es la “Europa de la energía”. Aquí también nos encontramos con algo no sólo indiscutible, sino injustificable: el retraso europeo en crear un verdadero mercado interior de la energía, con las consecuencias de dependencia energética y geopolíticas (léase Rusia) por todos conocidas así como la necesidad de explorar el potencial completo de las energías renovables, algo que requiere cuantiosas inversiones en infraestructuras e investigación. ¿Podrá Juncker vencer las resistencias de algunos socios, léase Alemania, que no quieren mandar el mensaje erróneo a Moscú (al revés, lo que han hecho en los últimos años es incluir a Rusia en el mercado energético europeo y aspirar a la fusión de intereses empresariales: piensen en Gazprom, Gerhard Schröder y el gasoducto Nord Stream). Lo mismo con Francia: ¿aceptará por fin que España deje de ser una isla energética? Estén atentos a la nacionalidad del próximo Comisario de Energía para saber cuál es el compromiso real de Juncker con esta agenda. La cuarta prioridad es la profundización del mercado interior, lo que Juncker pretende conseguir, primero, mediante un ambicioso programa de reindustrialización que de aquí al 2020 lleve el peso de la industria al 20% del PIB europeo (algo necesario pero seguramente irrealizable sin un apoyo político muy intenso por parte de los estados), una mayor integración de los mercados financieros (lo que Juncker llama una “Unión de Mercados de Capitales”), mejoras en las circulación de trabajadores y, punto importante siendo Juncker quien es y el papel tan negativo desempeñado por Juncker durante tantos años, una mejor cooperación entre administraciones públicas a la hora de combatir el fraude y la evasión fiscal. En quinto lugar, Juncker ha prometido completar la agenda dejada por Van Rompuy respecto a la gobernanza del euro pero, de forma más importante, ha prometido sustituir la Troika por “una estructura más legítima democráticamente” y que responda mejor ante el Parlamento Europeo. Aquí hay un gran guiño de Juncker a la izquierda, al que añade su propuesta de introducir el salario mínimo en la UE y someter los programas de austeridad a una evaluación de “impacto social”. Juncker ha dicho que cree en una “economía social”, ha reconocido que el ajuste presupuestario no ha sido equitativo y ha lamentado que “los especuladores se hayan enriquecido mientras los pensionistas se han empobrecido”. El guiño está hecho, ahora resta comprobar si refleja un cambio duradero.

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En la sexta prioridad de Juncker, el acuerdo comercial con Estados Unidos también hay un guiño a Socialistas y a Verdes. “No sacrificaré los estándares europeos de seguridad alimentaria, privacidad de los datos o nuestra diversidad cultural en el altar del libre comercio”. Consciente de que la izquierda tiene desenterrada el hacha de guerra contra Estados Unidos en torno al próximo acuerdo comercial con EEUU, Juncker ha querido anticiparse. Y hace bien, porque sin los socialistas no conseguirá que el Parlamento Europeo ratifique ese acuerdo. Séptima y octava prioridades de Juncker tienen que ver con los derechos fundamentales y con la inmigración, donde Juncker propone una política de asilo común y una política inmigratoria más atractiva y más funcional desde el punto de vista económico, es decir, evitando centrarse exclusivamente en la dimensión del control de fronteras. De nuevo, la pregunta es si, siendo este tema tan delicado en estos momentos y precisamente ante el auge de los movimientos xenófobos, si los Estados van a dejar a la Comisión hablar en nombre de Europa o van a preferir aplicando políticas nacionales que aunque ineficientes transmitan el mensaje al electorado de que todavía están al mando de la inmigración y de que pueden controlarla o regularla. En su novena prioridad (la Unión en el mundo) Juncker hace una confesión: “no sentirse satisfecho con el funcionamiento actual de nuestra política exterior”. El debate sobre quién tiene la responsabilidad de esta carencia excede el espacio de esta entrada. Sin embargo, reconocer que se tiene un problema es sin duda el primer paso para solucionarlo. Queda todavía por ver a quién nombrarán los Estados Miembros para el puesto de alto representante: el perfil dirá mucho (vean este artículo recientemente publicado sobre el tema titulado “Oferta de empleo”). Termino, aquí sí, decepcionado, con la mala tarea de aliño, casi parece que despachada con fastidio, con la que Juncker trata la cuestión de la profundización de la democracia en la UE. Un título ambicioso “Una Unión para el cambio democrático” detrás de cual no hay prácticamente nada. Decir a estas alturas que “los parlamentos nacionales son importantes”, que cree en la transparencia, o que pretende enviar representantes políticos, no técnicos, a los triálogos (como se conocen las negociaciones a tres bandas entre Comisión, Parlamento y Consejo) suena muy desenfocado. Juncker había dicho al comienzo de su intervención que la ciudadanía estaba dando la espalda a la Unión Europea. Y es cierto que una Unión que crezca y cree empleo ayudará enormemente a legitimarla ante los ciudadanos. Sin embargo, el volver a conectar con los ciudadanos requiere medidas mucho más ambiciosas. Mi conclusión es que el programa de Juncker es ambicioso pero incremental. Representa un europeísmo sólido y convencido pero probablemente es ahí donde chocará con los Estados. Muchas capitales no quieren progreso, quieren mayor control e incluso retroceso. Querrán diluir o retrasar esas propuestas. Y ahí es donde conoceremos por fin quién es Juncker: el hombre que se comprometerá y aceptará diluir su programa y descafeinar su presidencia o el hombre que se resistirá a ser ninguneado por sus antiguos colegas y querrá hablar en nombre de Europa. ¿Qué piensan ustedes? http://blogs.elpais.com/cafe-steiner/2014/07/un-nuevo-comienzo-para-europa.html

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Daily Morning Newsbriefing July 16, 2014 €300bn in new investments? Are you trying to fool us Mr Juncker? It was, of course, the day of Jean-Claude Juncker’s election as president of the European Commission from November, with a majority of 422 against 250. There is no shortage in the media coverage of this important event itself. What is of interest to us is what he wants to do, and what he is likely to be up against. In his address to the European Parliament he made two promises – on investment and fiscal flexibility. On the first, he promises €300bn in new public and private sector investments over 3 years – roughly 0.7% of GDP. If this is genuine new investment, it would be a significant economic stimulus. While Juncker was careful not give too many details, it appears that the €300bn is nothing of the kind, but a fictitious headline number designed to impress. La Repubblica is the only paper we have read this morning, which has done the math on this. Of the €300bn, €80bn comes from structural funds that have not yet been disbursed, and which are, technically, still available. About €180bn in funding could be unleashed by the European Investment Bank. The European Council raised the EIB’s capital during the crisis by some €10bn, which in turn allowed the EIB to co-lend some €60bn – which is what it is doing already. With a rule-of-thumb ratio of EIB lending/total investment of 1:3, this would translate to €180bn. Which is great, but most of it should not be classified as additional lending. The remaining €40bn could come from Jose Manuel Barroso’s project bond. Big deal. La Repubblica makes the point that Juncker is facing similar constraints as his predecessor. His goal is not to frighten the Germans, while doing the most he can. On the fiscal rules, he sticks to the line that if member states made a particularly great effort at economic reform, then “we have to reflect on financial incentives which could then accompany that process of great effort”. What he did not say is that the existing fiscal rules offer that flexibility; that this flexibility is small, time-limited and only affects the path of deficit reduction, and that it only applies to countries with deficits of below 3%. This is less about economics, than about a political symbol – the official end of austerity. The vote was secret, but it appears that Spanish Socialist MEPs voted against him on orders of the party’s new secretary-general elect, Pedro Sánchez. El Mundo writes that several of the PSOE’s 14 MEPs were unhappy about voting with Eurosceptics, and that Martin Schulz rebuffed the Spanish Socialist contingent in private. El Economista notes that British Labour and Swedish Social Democrats also voted against Juncker while French Socialist MEPs abstained.

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On the substance of policy we see no game changer here. The investment programme is mostly rhetorical. The best thing the Commission can do is to relax some of the co- funding rules – but the impact is not going to be large. The fundamental problem is that when private and public sectors deleverage, they do not invest – even if the incentives are there. Juncker is up against a balance sheet recession, and that requires policy choices, such as very large fiscal stimulus through eurobonds, which are politically not possible. The best he can do is to forge a consensus in favour of a common eurozone budget. On the vote: We note that membership of the eurozone shapes EU attitudes and voting behaviour. It is not accidental that the British and Swedish Labour MEPs voted against Juncker. The Spanish MEPs were unhappy to cast the vote against him, but this is due to the new party leadership positioning itself as firmly anti-austerity. This is the new fight. Britain’s exit from the EU’s mainstream took another giant leap forward with the appointment of Philip Hammond, a noted Eurosceptic, as Britain’s new foreign secretary, and the nomination of Jonathan Hill, a former lobbyist and Leader of the House of Lords, for the European Commission. We noted with some interest that David Cameron will today try to place Lord Hill in one of the top economic jobs – internal market, competition, or trade. Will there be an early Spanish election in the autumn? El Economista writes of increasing chatter about the possibility of Spanish PM calling a general election this coming November, a year early. The paper writes political appointees are beginning to move out of ministries. Other rumours include Rajoy’s intention to leave politics and the possibility that Galician regional PP leader Alberto Núñez Feijóo might move to national politics. Holding the general election a year early would bring them before the local and regional elections scheduled for next May, upsetting the political calculus of many regional leaders such as for instance the Andalusian PSOE leader Susana Díez. Most importantly, Catalan premier Artur Mas has set November 9 as the date of an independence consultation or, failing that, early regional elections which would be considered a “plebiscite” on independence. Mariano Rajoy could steal the media limelight from the Catalan elections by holding a national election simultaneously. Another political event that could be upset by early elections is the planned PSOE primary. The party had an internal understanding that an open primary would be held in November but the replacement of Alfredo Pérez Rubalcaba after the European election debacle was an unexpected development. Now Europa Press reports Sánchez is defending the ability of the new party executive to set the date of the primaries, with Público writing the preferred date might be after the regional and municipal elections in May next year. Not only might the PSOE not be ready for an election this Autumn but Sánchez as candidate might be hurt by frustration on the part of party members and sympathisers denied the promised open primary for PM candidate. Finally, the rise of Podemos in the polls continues. El Confidencial writes that the post- election survey by Spain’s sociological research institute CIS conducted in the first half of June shows Podemos solidly in third place with nearly 15% of the vote. In the “Agenda Pública” blog of El Diario, Pau Marí-Klose looks at the profile of Podemos voters: represented in all social classes, young, educated, urban, precariously employed, politically informed, internet savvy, and unhappier than average. El País for its part

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highlights that over 30% of those polled valued Podemos’ campaign favourably, and the proportion of people who recall having voted for Podemos is twice its actual vote share in the European elections. However, Podemos is counting on a year’s worth of organizing for the local elections to build a base to contest the general at the end of next year and probably needs all the time it can have for this process. If the general election were move forward to this Autumn the growth prospects of Podemos would be truncated as well. Manos Giakoumis on Greek NPLs On Macropolis Manos Giakoumis compares the non-performing loans (NPLs) ratios for Greece from Greek and international institutions. The emerging picture is confusing, warranting a closer look at definitions and methods. There are first the figures published by the Greek central bank, recording a rise of 31.9% in NLPs at the end of December 2013, led by consumer credit NLPs with 47.3%, corporate to follow with 31.8% and housing loans 26.1%. Then there are the figures from the fourth review report of the European Commission, which puts the NLP ratio at 33.1%, consumer NPLs at only 16% in 2013, housing loans at 27% and corporate lending NLPs leading at 60%. The IMF’s definition finds the NLP ratio for 2013 to be at 40%. Calculating the NPL ratio for the top-4 banks which control 95% of the loan market, results in an NPL ratio of 32.6%. For Q1 in 2014, there are also discrepancies in the same speech given by Yannis Stournaras in his first speech as governor of the central bank. Stournaras mentions that the NLP ratio is 33.5%, which would correspond to NPL figure of €72.3bn over the outstanding loans balances of €215.9bn at the end of March. Later in that speech though he mentions €77bn, with more than half from the corporate sector (€42bn), followed by the household sector (€26bn) and housing loan (€10bn). The latter can be explained by a wider loan base, including external loans from Greek bank branches. Portugal’s bond yields volatile over BES Portuguese bond yields see-sawed on Tuesday as concern persisted over the exposure of Banco Espirito Santo, Reuters reports. Portuguese 10-year yields were last 1 basis point higher at 3.84%, having fluctuated within a 3.80%-3.95% range, though Portuguese and Greek bonds underperformed other low-rated euro zone debt. Market action suggested investors were differentiating between junk-rated Portuguese and Greek bonds and the more liquid and investment-grade Italian, Spanish and Irish debt. Spanish 10-year yields were down 6 bps at 2.72%. Italian equivalents were 3 bps lower at 2.86%. Some traders told Reuters, though, that they remained concerned over other potential holes in the finances of the banking family that have so far remained undiscovered and whether such opacity in the ownership structure was a more dominant feature of the euro zone banking system than previously thought. Jornal de Negocios this morning is explaining in details that the state is coming in last after shareholders and subordinated debt holders lost their money. Banco Espirito Santo’s subordinated bonds, meanwhile, fell to a record low after Espirito Santo Financial Group said it had to sell 4.99% of BES shares to meet debt commitments, Bloomberg reports. Bulgaria seeks to join the European bank supervision system

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Bulgaria's central bank has begun talks with the ECB about joining the European Single Supervisory Mechanism (SSM). After the runs on two lenders in June the central bank seized control of Corpbank and announced it would nationalize its subsidiary Credit Agricole Bulgaria citing illicit banking practices as a reason for the move, according to Novinite. The government has said it will let Corpbank collapse, transfer the good assets and liabilities of Corpbank to the recently acquired subsidiary, and initiate bankruptcy proceedings against the rest of Corpbank Reuters reports. The plan requires a special law in parliament to be passed. The ECB declined to comment, but a source familiar with the process told Reuters that any application would take several months and could not be processed in time for Bulgaria's banks to undergo the landmark review of euro zone lenders that the ECB is carrying out this year. If the application proceeds, Bulgaria's banks would go through a similarly robust analysis before the ECB takes over their supervision. It remains unclear what the size of the bailout required to prop up the subsidiary will be. The government may issue new debt, which could swell the fiscal deficit to 3% of GDP, against a planned 1.8% for 2014. The inexorable rise of Italian debt The Bank of Italy’s latest debt statistics shows a big rise in Italian sovereign debt to €2.166tr in June. On the assumption that this level stays roughly the same until the end of the year, and that nominal GDP rises by 1.5% this year (quite optimistic given the recent data), this would imply a rise in the Italian-debt-to-GDP ratio to 137% by year- end. Gross debt data are somewhat volatile – so one should be careful not to extrapolate monthly data. For all we know the treasury might have loaded up with debt to exploit favourable market conditions. The breakdown of the data suggests that €5bn of the €20bn monthly increase stems from a higher borrowing requirement, the rest was due to treasury operations. One of the striking facts of national accounting in Europe is that the sum of deficits does not add to current debt. To assess a country’s fiscal sustainability, one needs to look at both the recorded deficit, and the total debt. We would expect Italy, for example, to manage to fulfil EU fiscal rules on paper, while the debt stock will continue to rise. The question should not be: how can we get around the fiscal rules? But, how can we make our debt sustainable? A blip? A pause? Or has the recovery ended? The volatile ZEW index of German economic sentiment has registered a drop by about 10% in July, which the ZEW institute interprets as a slight dent in recent economic activity, notably retail sales, industrial production, and incoming orders. The institute said the medium-term outlook remained favourable. Ian Campbell of Reuters Breakingviews makes the point that the latest slowdown in economic activity in the eurozone had surprised many. We are looking at another quarter of anaemic economic growth in the eurozone. He writes it would unwise to treat the slowdown as a blip, which is what current market valuations imply. Avent on the sustainability of global monetary system

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Ryan Avent has a thoughtful piece on what makes monetary regimes sustainable. Fixed- rate system are sustainable while domestic politics supports prioritisation of exchange rate stability. That was true for the gold standard and Bretton Woods. But it was not true in the inter-war years, nor was it true in the 1970s. The following is the core of his argument. "The most important question may be whether rigidities in the system are constraining enough to make another big crisis likely. I worry the answer is yes. Countercyclical policy has been dampened by the zero lower bound, fiscal-policy constraints, and central bank unwillingness to break with 2% inflation targets. Normally, exchange rates might help facilitate more of an adjustment, but the stabilising function of depreciation is explicitly off the table within the euro zone and muted, in America, by exchange-rate management against the dollar. It seems difficult to believe that domestic constituencies across the rich world will continue to tolerate a "secular stagnation" environment indefinitely: with low growth, low interest rates, and low inflation. It seems particularly easy to believe that another major shock would break some part of the system. Economies might intervene in foreign-exchange markets, to provide emergency monetary stimulus, or might shut them down altogether. There could be intense pressure to restrict trade if some economies use depreciation as a stimulus tactic while others do not. During the global financial crisis, there was an impressive global commitment to keep global goods markets open. But that commitment may not persist, and other parts of the system are less beloved. It seems crazy to court disaster when such attractive alternatives exist.” Krueger on Argentina Anne Krueger argues that the US Supreme Court ruling on Argentinian bonds will have important long-term repercussions on the market for sovereign debt. She writes that even collective action clauses do not necessarily make it easier for governments to organise a default. Well organised investors might achieve a hold-out position by buying up the blocking percentage of a small issue – since each thresholds need to be achieved for each issue. It is also possible that future bond issues will contain language that replaces the pari passu clause, but that still provides assurance to bondholders that the market would function as it did until the recent ruling. She calls the court ruling “a new wrinkle, and may well further increase the risk attached to holding sovereign debt – and this to the cost of issuing it.” Eurozone Financial Data 10y spreads Previous This Yesterday day Morning France 0.334 0.328 0.322 Italy 1.671 1.625 1.634 Spain 1.569 1.511 1.507 Portugal 2.627 2.630 2.586 Greece 5.039 5.093 5.09 Ireland 1.098 1.110 1.104 127

Belgium 0.444 0.439 0.432 Bund Yield 1.21 1.208 1.199 exchange rates This Previous morning Dollar 1.360 1.3558 Yen 138.130 137.82 Pound 0.794 0.7911 Swiss Franc 1.214 1.2154 ZC Inflation Swaps previous last close 1 yr 0.73 0.73 2 yr 0.76 0.75 5 yr 1.21 1.2 10 yr 1.65 1.64

Eonia 14-Jul-14 0.05 11-Jul-14 0.05 10-Jul-14 0.04 9-Jul-14 0.03

OIS yield curve 1W 0.060 15M 0.049 2W 0.080 18M 0.050 3W 0.066 21M 0.072 1M 0.072 2Y 0.071 2M 0.085 3Y 0.138 3M 0.085 4Y 0.231 4M 0.082 5Y 0.342 5M 0.060 6Y 0.497 6M 0.086 7Y 0.659 7M 0.085 8Y 0.820 8M 0.070 9Y 0.969 9M 0.092 10Y 1.103 10M 0.058 15Y 1.594 11M 0.067 20Y 1.814 1Y 0.075 30Y 1.905 Euribor-OIS Spread 128

previous last close 1 Week -3.671 -3.571 1 Month 2.686 1.486 3 Months 8.343 9.443 1 Year 35.729 38.329

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 16.html?cHash=ec025986b5da4ebdec80d3163628476a

Free exchange From the archive Bretton Woods

Jul 4th 2014, 14:37by The Economist

On July 22nd 1944, finance experts who had spent the past three weeks gathered at a hotel in New Hampshire, produced two documents setting out their plan for the post-war monetary system. In response, The Economist published this leader article on July 29th, paying particular attention to whether the British government should ratify the Bretton Woods Agreements. THE Monetary Conference at Bretton Woods closed its session at the end of last week with the unanimous agreement of all the participants to the text of two documents, one of them setting up an International Monetary Fund, the other setting up an International Bank for Reconstruction and Development (The terminology is confusing, since the 129

Fund will conduct a banking business—that is, will deal in currencies—while the Bank is, in the main, a guarantee fund.) The Agreements now go to the governments for ratification, and it has been made clear that no government is committed by the vote of its delegation at Bretton Woods. These two documents represent a very substantial achievement. What has been decided is the form that these two institutions will assume when (or if) they come to birth. These two documents represent a very substantial achievement The subject matter was technical and contentious, but 44 delegations have agreed. It is true that the conference presented the unedifying spectacle of a technical gathering being jockeyed by purely political considerations, and the determination of the quotas resembled the process of political chaffering more than an objective attempt to achieve equity. Populous and powerful though the Soviet Union is, and immense as its services to the common wartime cause are, it is fantastic to suppose that its part in the financial transactions of the world either is, or for a very long time will be, at all comparable with that of the United Kingdom—yet the Russian quota is $1,200 million against the British $1,300 million. Or again, nothing save the fashionable political myths of the moment could justify a quota for China larger than that for France or double that for Holland—both of which presumably cover those countries' colonial possessions. The management of the Fund and the Bank will have to rise above this sort of petty huckstering. On the whole, however, these can be accepted as surface blemishes and they are offset by many reasons for solid satisfaction with the results of the conference. Not the least of these has been the harmonious co-operation of the American and British delegations. In the main, of course, this was due to the ironing-out of differences beforehand. But it has been demonstrated that solutions worked out in advance by the American and British Governments will be accepted by the United Nations as a whole with a minimum of amendment and—so far as can be judged—an absence of resentment or of charges of dictation. This is an omen of great promise. So far as can be judged from the summaries so far available the two schemes have; in fact, been very little altered from the form in which they emerged from the American- British negotiations. There are, nevertheless, some alterations in the Fund that should be noticed, and it must be said, in candour, that they are not improvements. The item in the joint proposal of last April which was most generally applauded in this country was that which provided for the rationing of a scarce currency and allowed for the possibility of discrimination against a country which persistently failed to make its currency available in sufficient volume. In British eyes, this proposal provided a way out of a dilemma which is greatly feared in this country—the dilemma of being limited in our purchases from sterling countries because we are short of dollars. In the final version, it would appear that this proposal has been dropped. All that is now provided for is that, when a currency is in short supply, the Fund may issue a report "setting forth the cause of the scarcity and containing recommendations designed to bring it to an end." Furthermore, in addition to the omission of this proposal for putting pressure on the chronic surplus country, there are some new provisions for putting increased pressure on the chronic deficit country by taxing it upon the use that it makes of the Fund, in excess of its quota. These two pro-creditor and anti-debtor shifts have altered the balance of the Fund since the April proposals—not by any means fatally, but to an extent of which notice will have to be taken 130

It is not possible from the summaries to determine exactly how far the Fund would interfere with the working of the sterling area. British opinion will want to know whether the conference agreed with the view expressed by Lord Keynes in the House of Lords last May, that this did not exclude voluntary agreements between, say the United Kingdom and New Zealand to stabilise the expenditure of each in the other's country. It appears that "discriminatory currency practices" are to be eschewed, but this might mean almost anything. Another matter which needs scrutinising with great care is the time-table proposed. It appears to be contemplated that the Fund shall be in operation within eighteen months from now; but there is also to be an interim period during which exchange controls are still to be permitted.What is not quite clear is whether exchange rates have to be fixed before the end of 1945. If this is the proposal, it is hardly practicable. El esquema para un Banco para la Reconstrucción y el Desarrollo ha tenido menos discusión pública, pero parece plantear cuestiones menos controvertidas. De su capital total de $ 10 millones de dólares (de los cuales $ 9,1 mil millones se han asignado), sólo una quinta parte ha de ser llamado a filas en el primer lugar y se utiliza como un fondo para operaciones de préstamos propios del Banco. El resto es un fondo de garantía de los contingentes, por el cual el Banco puede garantizar las emisiones realizadas en el mercado público, ya sea por sí mismo o por otros organismos públicos o privados. Como Lord Keynes indicó francamente en su discurso inaugural de la Segunda Comisión, que será el mercado de América (o el gobierno estadounidense) que tendrá que encontrar el dinero; los demás países tendrán su parte en el riesgo. Dado que las garantías se referirán únicamente al interés y servicio, muy grandes sumas podrían ser garantizados de esta manera, a un costo para el prestatario de tan sólo 1 a 1 ½ por ciento por encima del costo de mercado. Esto es, en esencia, una extensión del método de la Liga de Préstamos de la década de 1920. Y la memoria evoca el gran desconocido en las perspectivas-how del Banco Cuántos préstamos hay probabilidades de ser lo que no son lo suficientemente seguros para cumplir con las normas del Banco y sin embargo lo suficientemente seguro como para flotar en sus propios méritos? Pero si la escala de sus operaciones resulta ser grande o pequeño, el Banco con claridad, pro tanto, estar prestando un servicio. Va a ser un complemento muy útil a largo plazo para las funciones a corto plazo del Fondo. Los acuerdos de ahora vienen de nuevo a los gobiernos para su consideración, entre otros, para el gobierno británico. En caso de que sean ratificados? Antes de que la pregunta se puede responder, es así que hacer una distinción entre el contenido de los acuerdos y los supuestos en que se basan. Desde el punto de vista técnico, aunque tienen manchas, los acuerdos deben ser aceptables. Es decir, si el tipo de mundo para el que están diseñados llega a pasar, a continuación, los arreglos son probablemente mejor, en general, de cualesquiera otros a los que 44 naciones podrían ser llevados a un acuerdo. Pero los supuestos necesitan el examen más cuidadoso. Toda la estructura se basa en la suposición de que el mundo posterior a la guerra será un lugar en el que las naciones serán capaces de equilibrar sus entradas y salidas dentro de un pequeño margen, sin controles de cambio sobre las transacciones corrientes, sin "prácticas monetarias discriminatorias" y sin más que un poder muy limitado para cambiar los valores de oro de sus monedas. El margen es menor de lo que podría pensarse a primera vista, ya que, 131

en la práctica, será la cantidad disponible de dólares y el oro que establecer el límite. La cuota de Estados Unidos es de $ 2.750 millones, la de Canadá (la otra moneda probable "duro" es de $ 300 millones, y el Fondo probablemente comenzará con cerca de $ 1.000 millones, a lo sumo, de oro (que no sea el suscrito por los Estados Unidos y Canadá ). El total de oro y dólares puede ser de aproximadamente $ 4.000 millones. Además, no se trata de cifras anuales, pero los totales. Había originalmente una sugerencia (aparte de los mencionados en los resúmenes) que ningún país debería elaborar más de un cuarto de su cuota en un año. Si esta disposición se ha incorporado, el supuesto básico es que las balanzas de pagos del mundo estarán, cada año, estar dentro de 1.000 millones de dólares-o £ 250 millones-de equilibrio. Si el suministro no se ha incorporado, la condición no se puede afirmar con tal precisión, pero no será sustancialmente diferente. The whole structure is based on the assumption that the post-war world will be a place in which the nations will be able to balance their incomings and outgoings within a small margin, without exchange controls on current transactions, without "discriminatory currency practices" and without more than a very limited power to change the gold values of their currencies. The margin is smaller than might be thought at first sight, for, in practice, it will be the available amount of dollars and gold that will set the limit. The United States quota is $2,750 million, that of Canada (the other probable "hard” currency is $300 million; and the Fund will probably start with about $1,000 million, at most, of gold (other than that subscribed by the United States and Canada). The total of gold and dollars may be about $4,000 million. Moreover, these are not annual figures, but totals. There was originally a suggestion (not referred to in the summaries) that no country should draw more than a quarter of its quota in any one year. If this provision has been incorporated, the basic assumption is that the balances of payments of the world will, every year, be within $1,000 million—or £250 million—of balance. If the provision has not been incorporated, the condition cannot be stated with such precision, but will not be substantially different. Ahora bien, esto es una gran suposición. No es imposible. Pero antes de que pueda decirse que es un uno probable, todo tipo de otras condiciones tendrán que ser establecido. Esto, por supuesto, ha reconocido desde el principio. El tipo de mundo en el que el Fondo trabajaría sería aquella en la que al menos los principales países tuvieron éxito en evitar la crisis de desempleo, en el que había una reducción sustancial de los aranceles y otras barreras comerciales, en los que los acreedores se comportaron como acreedores debe, en que deudores no por defecto, en una palabra, en el que las balanzas de pagos fueron llevados naturalmente en equilibrio por la expansión, no obligado a hacerlo por la contracción. Hacer la pregunta de si estos acuerdos deben ser ratificados, en realidad, para preguntar qué posibilidades hay de un enfoque razonablemente cerca de tales condiciones. ….The sort of world in which the Fund would work would be one in which at least the major countries were successful in avoiding unemployment crises, in which there was a substantial lowering of tariffs and other trade barriers, in which creditors behaved as creditors should, in which debtors did not default—in short, in which balances of payments were naturally brought into equilibrium by expansion, not forced into it by contraction. To ask the question whether these 132

agreements should be ratified is in reality, to ask what prospect there is of a reasonably close approach to such conditions. La respuesta hay que buscarla principalmente en los Estados Unidos. No sólo es América ahora, por lejos, el país más poderoso del mundo, ejerciendo una influencia dominante en la economía mundial, pero Estados Unidos es también el país que es el menos persuadido de la necesidad de tomar medidas positivas para controlar el entorno económico de las actividades humanas. El destino de los Acuerdos de Bretton Woods cuando se someten a la aprobación del Congreso, por sí mismo, ser una indicación de lo que se puede esperar-y no hace falta decir que la ratificación británica debería, en todo caso, esperar la acción del Congreso. Pero incluso si los acuerdos de sobrevivir a la prueba del Congreso, todavía habrá muchas otras cuestiones sobre las que necesitará el gobierno británico para aventurar una respuesta. ¿Cuáles son las perspectivas de una política de empleo eficaz en los Estados Unidos? ¿Cuáles son las perspectivas de América por lo que aumenta considerablemente sus compras a, o la concesión de préstamos a otros países, para que su balanza de pagos en equilibrio? Para hacer estas preguntas no es sugerir las respuestas a ellos, y menos aún sugerir que las respuestas serán necesariamente desfavorable. Sin embargo, tendrán que responder antes de que el gobierno británico puede darse el lujo de correr el riesgo de la ratificación de los Acuerdos de Bretton Woods. But they will need to be answered before the British government can afford to take the risk of ratifying the Bretton Woods Agreements. "El riesgo de la ratificación"-por la diferencia esencial entre las posiciones estadounidenses y británicos es que no hay prácticamente ningún riesgo para los Estados Unidos en la ratificación. Supongamos que sucede lo peor, y que el mundo posterior a la guerra no es el equilibrio y la expansión, sino de la distorsión y la depresión. Latina corre el riesgo, de hecho, la pérdida de una suma en dólares y oro igual al costo de llevar a cabo la guerra durante diez días-y los medios "pérdida", por supuesto, que esta suma se habrá gastado en los Estados Unidos por otros países . Pero todas las otras disposiciones del Fondo sería, en tales circunstancias, estar más en el interés de Estados Unidos que en cualquier otro país de. Al igual que en la depresión de la década de 1930 el interés estadounidense sería la de evitar que otros países impongan controles de cambio (que la fortaleza del dólar no requeriría), a partir de la depreciación de sus monedas, y la discriminación en contra de la compra de productos estadounidenses, ya que eran más cortas de dólares que de otras monedas. Cuanto más cerca de la aproximación a la norma-que el oro, en estos días, es un dólar se sirven: los estándares de mejores intereses estadounidenses, en la prosperidad y la depresión. "The risk of ratifying"—for the essential difference between the American and British positions is that there is virtually no risk for the United States in ratification. Let us suppose that the worst happens, and that the post-war world is not one of balance and expansion, but of distortion and depression. America risks, indeed, the loss of a sum in dollars and gold equal to the cost of carrying on the war for ten days—and "loss" means, of course, that this sum will have been spent in the United States by other countries. But all the other provisions of the Fund would, in such circumstances, be more in America's interest than in any other country's. As in the depression of the 1930's the American interest would be to prevent other countries from imposing exchange controls (which the strong dollar would not require), from depreciating 133

their currencies, and from discriminating against the purchase of American goods because they were shorter of dollars than of other currencies. The closer the approach to the gold standard—which, in these days, is a dollar standard—the better American interests are served, in prosperity and depression. Pero Gran Bretaña se encuentra en un caso diferente. Incluso en la crisis más profunda, Schachtism nunca pagará de este país. Pero es en el interés británico en tener la libertad de hacer lo mejor de un mal trabajo si un mal trabajo es lo que tiene que hacer frente. Y las circunstancias del Reino Unido exigen otros métodos de hacer lo mejor de un mal trabajo de los estadounidenses. Si las circunstancias de 1931 fueron a repetirse, el Reino Unido desearía ser capaz de permitir que la libra esterlina para encontrar su nivel y concertar medidas para estabilizar el comercio dentro de un grupo al que todos los países que cumplas las reglas deben tener acceso. Un sistema de Bretton Woods no estaría en el interés británico en tiempos de crisis. But Britain is in a different case. Even in deepest crisis, Schachtism will never pay this country. But it is in the British interest to be free to make the best of a bad job if a bad job is what has to be faced.And the circumstances of the United Kingdom dictate other methods of making the best of a bad job from the AmericansIf the circumstances of 1931 were to recur, Britain would wish to be able to allow the pound sterling to find its level and to concert measures for stabilising trade within a group to which all countries that would abide by the rules should have access. A Bretton Woods system would not be in the British interest in times of crisis. La política británica se ve ante un dilema. Estas son las propuestas que conferirán ventajas en el mundo si se cumplen determinados supuestos optimistas, pero que pueden ser un peligro de atar las manos si las esperanzas no se realizan. Por otro lado, para rechazarlos es rendirse una vez por todas la oportunidad de hacer realidad las esperanzas en que se basan. Es el mismo dilema que se enfrenta, aunque menos conscientemente, por el regreso al patrón oro-Hace veinte años las nuevas propuestas son, si no una versión del patrón oro, por lo menos sobre la base de las mismas concepciones fundamentales. Sería más fácil tener fe en que la fe sola es suficiente si no hubiera tan reciente una prueba en contrario. British policy is thus faced with a dilema. Here are proposals which will confer benefits on the world if certain optimistic assumptions are fulfilled, but which may be a dangerous tying of hands if the hopes are not realised. It is the same dilemma that was faced, though less consciously, over the return to the gold standard twenty years ago— for the new proposals are, if not a version of the gold standard, at least based on the same fundamental conceptions. It would be easier to have faith that faith alone will suffice if there were not so recent a proof to the contrary. He is a fortunate man who can reach a definite conclusion in so difficult a dilemma. Two things should, however, be reasonably clear. The first is that every effort should be made, as speedily as possible, to fit together the other parts of the jigsaw—particularly the important sections labelled "commercial policy" and "employment policy" in order to build up the assurance of a reasonable world economy. The second is that, pending this effort, there can be no question of rejecting the Bretton Woods Agreements. But whether they should be unconditionally accepted, for immediate application, is a matter which must necessarily await further evidence of the trends that are to be expected. That 134

evidence will have to be sought, above all, in the results of the American election and in the temper of the American public and Congress in the months that are to come. Él es un hombre afortunado que puede llegar a una conclusión definitiva en tan difícil dilema. Dos cosas deben, no obstante, ser suficientemente claro. La primera es que debe hacerse todo lo posible, con la mayor celeridad posible, para encajar las otras partes de los rompecabezas-en particular las secciones importantes con la etiqueta "política comercial" y "política de empleo" con el fin de construir la seguridad de un mundo razonable economía. La segunda es que, en espera de este esfuerzo, no puede haber ninguna duda de rechazar los acuerdos de Bretton Woods. Pero si deben ser aceptadas sin condiciones, para su aplicación inmediata, es una cuestión que habrá que esperar necesariamente una prueba más de las tendencias que son de esperar. Esas pruebas tendrá que ser buscado, sobre todo, en los resultados de las elecciones estadounidenses y en el ánimo de la opinión pública estadounidense y el Congreso en los meses que están por venir. http://www.economist.com/blogs/freeexchange/2014/07/archive

Free exchange From the archive Bretton Woods Jul 4th 2014, 14:37by The Economist

John Maynard Keynes addresses the delegation at Bretton Woods On July 22nd 1944, finance experts who had spent the past three weeks gathered at a hotel in New Hampshire, produced two documents setting out their plan for the post- war monetary system. In response, The Economist published this leader article on July 29th, paying particular attention to whether the British government should ratify the Bretton Woods Agreements. THE Monetary Conference at Bretton Woods closed its session at the end of last week with the unanimous agreement of all the participants to the text of two documents, one 135

of them setting up an International Monetary Fund, the other setting up an International Bank for Reconstruction and Development. (The terminology is confusing, since the Fund will conduct a banking business—that is, will deal in currencies—while the Bank is, in the main, a guarantee fund.) The Agreements now go to the governments for ratification, and it has been made clear that no government is committed by the vote of its delegation at Bretton Woods. What has been decided is the form that these two institutions will assume when (or if) they come to birth. These two documents represent a very substantial achievement. The subject matter was technical and contentious, but 44 delegations have agreed. It is true that the conference presented the unedifying spectacle of a technical gathering being jockeyed by purely political considerations, and the determination of the quotas resembled the process of political chaffering more than an objective attempt to achieve equity. Some of the results are ludicrous. Populous and powerful though the Soviet Union is, and immense as its services to the common wartime cause are, it is fantastic to suppose that its part in the financial transactions of the world either is, or for a very long time will be, at all comparable with that of the United Kingdom—yet the Russian quota is $1,200 million against the British $1,300 million. Or again, nothing save the fashionable political myths of the moment could justify a quota for China larger than that for France or double that for Holland—both of which presumably cover those countries' colonial possessions. The management of the Fund and the Bank will have to rise above this sort of petty huckstering. On the whole, however, these can be accepted as surface blemishes and they are offset by many reasons for solid satisfaction with the results of the conference. Not the least of these has been the harmonious co-operation of the American and British delegations. In the main, of course, this was due to the ironing-out of differences beforehand. But it has been demonstrated that solutions worked out in advance by the American and British Governments will be accepted by the United Nations as a whole with a minimum of amendment and—so far as can be judged—an absence of resentment or of charges of dictation. This is an omen of great promise. So far as can be judged from the summaries so far available the two schemes have; in fact, been very little altered from the form in which they emerged from the American- British negotiations. There are, nevertheless, some alterations in the Fund that should be noticed, and it must be said, in candour, that they are not improvements. The item in the joint proposal of last April which was most generally applauded in this country was that which provided for the rationing of a scarce currency and allowed for the possibility of discrimination against a country which persistently failed to make its currency available in sufficient volume. In British eyes, this proposal provided a way out of a dilemma which is greatly feared in this country—the dilemma of being limited in our purchases from sterling countries because we are short of dollars. In the final version, it would appear that this proposal has been dropped. All that is now provided for is that, when a currency is in short supply, the Fund may issue a report "setting forth the cause of the scarcity and containing recommendations designed to bring it to an end." Furthermore, in addition to the omission of this proposal for putting pressure on the chronic surplus country, there are some new provisions for putting increased pressure on the chronic deficit country by taxing it upon the use that it makes of the Fund, in excess of its quota. These two pro-creditor and anti-debtor shifts have altered the balance of the Fund since 136

the April proposals—not by any means fatally, but to an extent of which notice will have to be taken. It is not possible from the summaries to determine exactly how far the Fund would interfere with the working of the sterling area. It appears that "discriminatory currency practices" are to be eschewed, but this might mean almost anything. British opinion will want to know whether the conference agreed with the view expressed by Lord Keynes in the House of Lords last May, that this did not exclude voluntary agreements between, say the United Kingdom and New Zealand to stabilise the expenditure of each in the other's country. Another matter which needs scrutinising with great care is the timetable proposed. It appears to be contemplated that the Fund shall be in operation within eighteen months from now; but there is also to be an interim period during which exchange controls are still to be permitted. What is not quite clear is whether exchange rates have to be fixed before the end of 1945. If this is the proposal, it is hardly practicable. The scheme for a Bank for Reconstruction and Development has had less public discussion, but it would appear to raise less contentious issues. Of its total capital of $10 billion (of which $9,100 million has been allotted), only one-fifth is to be called up in the first place and used as a fund for the Bank's own lending operations. The rest is a contingent guarantee fund, by which the Bank can guarantee issues made on the public market either by itself or by other public or private bodies. As Lord Keynes frankly indicated in his inaugural speech to the Second Commission, it will be the American market (or the American government) which will have to find the money; the other countries will bear their share of the risk. Since the guarantees will relate only to interest and service, very large sums could be guaranteed in this way, at a cost to the borrower of only 1 to 1½ per cent above the market cost. This is, in substance, an extension of the League Loan method of the 1920s. And the memory calls up the one great unknown in the Bank's prospects—how many loans are there likely to be which are safe enough to meet the Bank's standards and yet not safe enough to float on their own merits? But whether the scale of its operations proves to be large or small, the Bank will clearly, pro tanto, be rendering a service. It will be a most useful long-term adjunct to the short-term functions of the Fund. The agreements now come back to the governments for consideration—among others, to the British government. Should they be ratified? Before the question can be answered, it is as well to make a distinction between the content of the agreements and the assumptions on which they are based. From the technical point of view, though they have blemishes, the agreements should be acceptable. That is to say, if the sort of world for which they are designed comes to pass, then those arrangements are probably better, on the whole, than any others to which 44 nations could be brought to agree. But the assumptions need the most careful examination. The whole structure is based on the assumption that the post-war world will be a place in which the nations will be able to balance their incomings and outgoings within a small margin, without exchange controls on current transactions, without "discriminatory currency practices" and without more than a very limited power to change the gold values of their currencies. The margin is smaller than might be thought at first sight, for, in practice, it will be the available amount of dollars and gold that will set the limit. The United States quota is $2,750 million, that of Canada (the other probable "hard” currency is $300 million; and 137

the Fund will probably start with about $1,000 million, at most, of gold (other than that subscribed by the United States and Canada). The total of gold and dollars may be about $4,000 million. Moreover, these are not annual figures, but totals. There was originally a suggestion (not referred to in the summaries) that no country should draw more than a quarter of its quota in any one year. If this provision has been incorporated, the basic assumption is that the balances of payments of the world will, every year, be within $1,000 million—or £250 million—of balance. If the provision has not been incorporated, the condition cannot be stated with such precision, but will not be substantially different. Now this is a very large assumption. It is not an impossible one. But before it can be said to be a probable one, all sorts of other conditions will have to be established. This has, of course, been recognised from the start. The sort of world in which the Fund would work would be one in which at least the major countries were successful in avoiding unemployment crises, in which there was a substantial lowering of tariffs and other trade barriers, in which creditors behaved as creditors should, in which debtors did not default—in short, in which balances of payments were naturally brought into equilibrium by expansion, not forced into it by contraction. To ask the question whether these agreements should be ratified is in reality, to ask what prospect there is of a reasonably close approach to such conditions. The answer must be largely sought in the United States. Not only is America now by far and away the most powerful country in the world, exercising a dominant influence on the world's economy, but America is also the country that is the least persuaded of the necessity of taking positive action to control the economic environment of human activities. The fate of the Bretton Woods Agreements when they are submitted for Congressional approval will, in itself, be one indication of what can be expected—and it goes without saying that British ratification should, in any case, await the action of Congress. But even if the agreements survive the Congressional test, there will still be many other matters on which the British government will need to hazard a guess. What are the prospects of an effective employment policy in the United States? What are the prospects of America so greatly increasing its purchases from, or lendings to, other countries as to bring its balance of payments into equilibrium? To ask these questions is not to suggest the answers to them, still less to suggest that the answers will necessarily be unfavourable. But they will need to be answered before the British government can afford to take the risk of ratifying the Bretton Woods Agreements. "The risk of ratifying"—for the essential difference between the American and British positions is that there is virtually no risk for the United States in ratification. Let us suppose that the worst happens, and that the post-war world is not one of balance and expansion, but of distortion and depression. America risks, indeed, the loss of a sum in dollars and gold equal to the cost of carrying on the war for ten days—and "loss" means, of course, that this sum will have been spent in the United States by other countries. But all the other provisions of the Fund would, in such circumstances, be more in America's interest than in any other country's. As in the depression of the 1930's the American interest would be to prevent other countries from imposing exchange controls (which the strong dollar would not require), from depreciating their currencies, and from discriminating against the purchase of American goods because they were shorter of dollars than of other currencies. The closer the approach to the gold 138

standard—which, in these days, is a dollar standard—the better American interests are served, in prosperity and depression. But Britain is in a different case. Even in deepest crisis, Schachtism will never pay this country. But it is in the British interest to be free to make the best of a bad job if a bad job is what has to be faced. And the circumstances of the United Kingdom dictate other methods of making the best of a bad job from the Americans. If the circumstances of 1931 were to recur, Britain would wish to be able to allow the pound sterling to find its level and to concert measures for stabilising trade within a group to which all countries that would abide by the rules should have access. A Bretton Woods system would not be in the British interest in times of crisis. British policy is thus faced with a dilemma. Here are proposals which will confer benefits on the world if certain optimistic assumptions are fulfilled, but which may be a dangerous tying of hands if the hopes are not realised. On the other hand, to reject them is to surrender once and for all the chance of realising the hopes on which they are founded. It is the same dilemma that was faced, though less consciously, over the return to the gold standard twenty years ago—for the new proposals are, if not a version of the gold standard, at least based on the same fundamental conceptions. It would be easier to have faith that faith alone will suffice if there were not so recent a proof to the contrary. He is a fortunate man who can reach a definite conclusion in so difficult a dilemma. Two things should, however, be reasonably clear. The first is that every effort should be made, as speedily as possible, to fit together the other parts of the jigsaw—particularly the important sections labelled "commercial policy" and "employment policy" in order to build up the assurance of a reasonable world economy. The second is that, pending this effort, there can be no question of rejecting the Bretton Woods Agreements. But whether they should be unconditionally accepted, for immediate application, is a matter which must necessarily await further evidence of the trends that are to be expected. That evidence will have to be sought, above all, in the results of the American election and in the temper of the American public and Congress in the months that are to come. http://www.economist.com/blogs/freeexchange/2014/07/archive

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Free exchange Education and industrialisation The importance of a skilled 1% Jul 8th 2014, 10:30by S.H. | LONDON FEW would challenge the proposition that human capital is fundamental to economic growth. Yet much evidence suggests that during what is arguably the most important era of growth—the Industrial Revolution—human capital had little bearing on economic development. Primary school enrolment in Britain, the cradle of industrialisation, was a mere 11% as late as 1850. Scandinavia, in contrast, lagged behind economically for a long time in spite of having achieved close to full literacy at the beginning of the 19th century. In a new paper, Mara Squicciarini of Katholieke Universiteit Leuven and Nico Voigtländer of the University of California, Los Angeles, attempt to resolve this conundrum by dividing human capital into two categories, one that had an impact on the Industrial Revolution and one that did not. The authors reckon that “upper-tail knowledge” rather than “average human capital” is what drives industrialisation. This matters presumably because while worker skills, such as literacy and primary education, boost productivity by utilising existing technologies, it is the skills held by top engineers and entrepreneurs that enables a society to innovate and foster the type of rapid technological progress that characterised the industrial revolution. Since education and literacy are two of the most common measures used in the academic literature this distinction would, if true, help explain why most previous studies have tried but failed to find a strong link between growth and human capital during the transition to the new manufacturing processes of the 18th and 19th centuries. To test their theory, the two researchers used city-level subscription rates to “Encyclopédie, ou dictionnaire raisonné des sciences, des arts et des metiers” (English: "Encyclopaedia, or a Systematic Dictionary of the Sciences, Arts, and Crafts") in France around 1750. “Encyclopédie” was an attempt to collect scientific and cultural knowledge and was at the heart of the Enlightenment. In the analysis, subscription rates are therefore used as a measure of "upper-tail human capital" to contrast with literacy rates, which indicates "average human capital". In addition, the authors used a set of outcomes to capture economic development, including urbanisation, soldier height, wage rates and industrial productivity. As expected, wide-spread literacy did not predict growth. Subscriptions to “Encyclopédie” per capita, on the other hand, were strongly associated with growth in each of the four measures after 1750. The results do not imply that subscribing to “Encyclopédie” caused economic growth or that reading it made people highly innovative. Instead, Ms Squicciarini and Mr Voigtländer argue that the subscription rate is a local indicator of the presence of highly educated elites who possess mathematical knowledge, scientific skills and

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entrepreneurial ability. Needless to say “Encyclopédie” was not a blockbuster; it had some 8,000 subscribers in total and those were likely highly concentrated in certain population segments. Their findings therefore support the hypothesis mentioned in the paper that "the Industrial Revolution was carried not by the skills of the average or modal worker, but by the ingenuity and technical ability of a minority." This is not to say that literacy rates and primary school enrolment are unimportant, but rather that they may not be sufficient to foster a transition to a new economic system. http://www.economist.com/blogs/freeexchange/2014/07/education-and- industrialisation

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Daily Morning Newsbriefing July 15, 2014 IMF says eurozone must do more to support aggregate demand The IMF’s Article IV consultations on the eurozone essentially makes the point – cautiously and politely – and the ECB and member states are not doing enough to support aggregate demand in the eurozone. We are not going to summarise all of it. Our focus here is on areas where the IMF sees things differently than the European authorities. The clearest areas of divergence is the assessment of inflation risks. The IMF says excessively low inflation makes price adjustment more difficult, increases the risk of outright deflation, and undermines central bank credibility. What struck us was the statement that inflation expectations have become unanchored over the short and medium term – which is the framework of the ECB’s policy target (until it was recently redefined by the GC as the medium-to-long term). Here is the graph on inflation expectations that shows the deanchoring of the medium-term target, the dark blue line, based on 2y-2y swap rates).

In a separate box, the IMF staff address the question of why investment has been so low? The answer is that most, but not all, of the fall can be explained by weak GDP, a high real interest rate, the credit crunch, and high leverage. While investment should improve as the economy recovers, it would in addition require that the authorities are dealing with the corporate debt overhang and the financial fragmentation. 142

The IMF attempts an interest shift in the discussion on structural reforms. It focuses on the structural reforms to reduce imbalances. The combination of more demand from creditor economies and structural reforms across the eurozone, i.e. including the credit countries, but the others as well, would “help reduce excessively high net external liabilities in some debtor economies (such as Greece) and temper the net external assets of some creditor economies (such as the Netherlands). More importantly, potential growth and productivity would improve across the board, with growth dividends ranging from ½–¾ percentage points of real GDP over the medium term. This would be accompanied by faster closing of the output gaps and higher inflation.” Separate from the report, Reza Moghadam and Ranjit Teja of the IMF, have published some additional details in the IMF blog to support their view of the positive effects of QE on inflation. They write that the ECB should buy assets across the board, not just in periphery countries, since the problem of low inflation is not confined to them. The channels through which QE would work are household and corporate sector balance sheets, the supply of, and demand for, bank credit. The authors make the useful point that QE is also effective in economies in which bank lending dominates capital market activity, such as the eurozone and Japan. So why has the ECB not done QE? The authors make the point that QE is either done properly, or not at all. They note the premature end of the BOJ’s programme in the early 2000s. Catalonia aims to keep Euro even outside the EU The “Advisory Council for the National Transition”, which advises Catalan premier Artur Mas on the independence project has just presented four new reports on: the sharing of assets and liabilities between Spain and Catalonia; Catalan monetary policy; the constituent process; and water and energy policy, reports La Vanguardia. On monetary policy, writes La Vanguardia, the report advocates keeping the Euro even if Catalonia found itself outside the EU, because of the “hardly bearable costs of switching currencies”. The report mentions the agreements reached between the EU and several European microstates such as Andorra, Monaco, San Marino or the Vatican allowing them to use the Euro and even granting them limited rights to mint Euro coins. At the presentation of the reports, it was claimed that it might be possible to arrange access to ECB liquidity for Catalan banks, contradicting remarks by Bank of Spain governor Luis Maria Linde earlier this year. Some commentators point out that Kosovo and Montenegro also use the Euro unilaterally. The report on sharing of the national debt argues that Catalonia could do this in exchange for commensurate assets of the Spanish state, be it local to Catalonia, financial, or extraterritorial, writes EL Periódico. The advisory council also advocates the elaboration of a protocol between Spain and Catalonia to handle the situation after a hypothetical declaration of independence, a referendum, or “plebiscitary” elections where a clear majority of the regional parliament were elected with an independence mandate. There seems to be no appetite to take the first step to initiate talks on the part of either Spanish PM Mariano Rajoy or Catalan premier Artur Mas, who are due to meet in a few days. In this context, a civic association called simply “Catalan Civil Society” was received by Mariano Rajoy in 143

Madrid, El Periodico reports. The association asked the PM to “get over” the debate on an independence consultation by means of a rapprochement on issues such as regional financing or linguistic policy. Hollande promises tax cuts for middle class and reforms In his Bastille day address Francois Hollande promised “supplementary” efforts next year to reduce taxes for several hundreds of middle class voters, without going into further details but in line with similar hints from Manuel Valls and Arnaud Montebourg earlier, Le Monde reports. The PM promised last week "a fall in income taxes for the middle class," while Montebourg talked about restoring €6bn in purchasing power to the French with a law on growth and purchasing power, to be announced in September. Hollande said the recovery is there, only that it is too weak to recognise it and that it should not be killed off by austerity. He reiterated that if the dialogue between the government, employers and trade unions did not lead to agreement on moves to ease labour market regulation in contentious areas such as employee representation and Sunday working, the government would step in to legislate, according to the FT. Wolff on BES and banking union With respect to the BES in Portugal Guntram Wolff from Bruegel says there are several key aspects that will be crucial for the Europe’s banking union: The first is whether BES is an isolated case? It may also foreshadow the pending change in supervisory regime as supervisors are acting earlier than they might have done otherwise. The second question is how much will the BES case affect economic growth of Portugal? Some hope that that de-zombification improves growth prospects, but negative market reactions and spreading contagion could undermine growth instead, at least in the short run. The third question is whether the relatively tough bail-in rules be implemented. If yes, will the system prove robust enough to withstand the shock or will financial nervousness increase? If not, will the Portuguese government eventually have to step in with state aid and how much will this undermine debt sustainability increasing market nervousness instead? Answers to the questions above will be crucial for Europe's banking union, Wolff concludes. Greek government decided not to privatise water companies The Greek government decided that Greece’s public water companies will remain under state control, in line with a recent decision by the Council of State, Kathimerini reports. The decision was announced late on Monday by Venizelos as he left the meeting and was subsequently confirmed by officials close to Samaras. The court ruling relates to the Athens Water and Sewage Company (EYDAP) but will also apply to Thessaloniki’s water board (EYATH). It was unclear how troika envoys, who are in Athens until Thursday on an informal inspection, would respond to the decision. Greece has primary surplus €712m Greece’s budget execution showed a primary surplus of €712m in the first half of the year from a primary deficit of €1.51bn in the corresponding period last year, according to Macropolis. The over-performance is primarily attributed to lower expenditure (by €1.24bn) and – to a lesser extent - higher revenues (by €166m) and Public Investment Budget (PIB) balance (by €132m). However, the latest data provided by the General

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Secretariat of Information Systems in late June showed that unpaid tax obligations from both households and corporate rose by €5.2bn in the 5-month period. Including legacy debt, the outstanding cumulative tax debt stood at €66.37bn at the end of May. Eurozone industrial output falls in May After the German figures, this should not come as a surprise. Eurostat reports that eurozone industrial production dropped by 1.1% mom in May, after rising 0.7% in April. Much of that fall was due to a sharp decline in the prices of intermediate goods. The following chart shows the latest data in some perspective. This is a recovery that is going nowhere.

Eurostat also reported that house prices were down 0.3% during Q1 yoy. Not quite a housing bubble. Renzi’s economic shadow cabinet Corriere della Sera had an interesting article this morning on how Renzi is bypassing the established machinery of Italian politics – including the finance ministry - by relying on his own group of advisers. One of the most influential task forces is the one that influences Renzi’s thinking on economic issues, and is headed by Yoram Gutgeld, a former McKinsey executive, who is also watching over the spending review. Other members of the team are Nannicini Thomas, a political economy professor at Bocconi, and Filippo Taddei, a professor at Johns Hopkins. Will the eurozone gang up on Britain? John Springford offers a very thorough analysis on the policy issues on which the eurozone might, and might not gang up on Britain. One of the arguments in the UK

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(including by us) is that the interests of the eurozone and the UK (as a permanent EZ non-member) are fundamentally misaligned that this would lead to eventual friction. Springford makes the point that this is true in some areas, but argues that the economic interests of the two are more aligned more than they are opposed. He then goes on list the policy areas where Britain has negotiated a protection of its interests, in the EBA notable, and where the fault line in the EU is not between Britain and the EZ but inside the EZ, trade agreements, even the financial transactions tax. His main point is that for as long as these interests are managed with care, there is no reason why Britain should leave the EU. He says the most important areas of EZ integration are a common market for capital and labour, and risk sharing – fiscal union, a backstop for the banks. If that were to happen, it would also benefit Britain as it would make the EZ more stable. He also specifically addresses the ECJ hearings on the ECB’s request that clearing houses relocate to the EZ. He expresses some sympathies with the ECB’s position, but adds that it would not impede the wider role of the City of London as the eurozone’s main financial centre. We agree with almost all of that. But as he writes himself, the interests of the EZ and the UK would only be compatible if are properly managed. We do not believe the current mismanagement can be blamed on David Cameron alone. It is, in part, structural. EZ membership has forced governments, but also the media and the academics, to think much more broadly in EZ-wide terms. That process produces a convergence in attitudes and ultimately in policies, a convergence process of which the British elites are not a part of. A good example has been the Juncker nomination. This was not just a disagreement between Cameron and Angela Merkel, but between virtually everybody in Britain and everybody elsewhere. Our point is not that it is impossible for Britain and EZ to align their interests in theory, but that they might find it hard to do so in practice. Eurozone Financial Data 10y spreads Previous This Yesterday day Morning France 0.333 0.334 0.329 Italy 1.688 1.662 1.670 Spain 1.572 1.569 1.568 Portugal 2.684 2.627 2.643 Greece 5.081 5.039 5.03 Ireland 1.115 1.098 1.102 Belgium 0.439 0.444 0.442 Bund Yield 1.205 1.21 1.202 exchange rates This Previous morning 146

Dollar 1.363 1.3609 Yen 138.260 138.23 Pound 0.796 0.7973 Swiss Franc 1.214 1.2145

ZC Inflation Swaps previous last close 1 yr 0.72 0.73 2 yr 0.75 0.76 5 yr 1.2 1.21 10 yr 1.64 1.65

Eonia 11-Jul-14 0.05 10-Jul-14 0.04 9-Jul-14 0.03 8-Jul-14 0.03

OIS yield curve 1W 0.070 15M 0.052 2W 0.072 18M 0.053 3W 0.073 21M 0.062 1M 0.072 2Y 0.075 2M 0.079 3Y 0.141 3M 0.079 4Y 0.217 4M 0.076 5Y 0.347 5M 0.076 6Y 0.502 6M 0.085 7Y 0.665 7M 0.076 8Y 0.828 8M 0.082 9Y 0.976 9M 0.073 10Y 1.112 10M 0.079 15Y 1.607 11M 0.078 20Y 1.830 1Y 0.069 30Y 1.924

Euribor-OIS Spread previous last close 1 Week -3.929 -4.429 1 Month 1.429 1.229 147

3 Months 8.543 9.243 1 Year 35.829 36.529

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 15.html?cHash=7d8a885b6921361aba446088c9e537f4

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Euro Area – Q&A on QE

Posted on July 14, 2014 by iMFdirect By Reza Moghadam and Ranjit Teja As inflation has sunk in the euro area, talk of quantitative easing (QE)—and misgivings about it—have soared. Some think QE is not needed; others that it would not work; and yet others that it only creates asset bubbles and may even be “illegal.” In its latest report on the euro area, the IMF assesses recent policy action positively but adds that “… if inflation remains too low, the ECB should consider a substantial balance sheet expansion, including through asset purchases.” Given all the reservations, would the juice be worth the squeeze?

Q1. What is QE and how would it differ from other ECB balance sheet expansions? A1. QE at heart is a sustained expansion of a central bank’s balance sheet—something all major central banks have done since the onset of the crisis. Against a backdrop of reduced wholesale funding, the European Central Bank (ECB) launched 3-year Long Term Refinancing Operations (LTROs) in 2012, which significantly expanded reserve money as the ECB offered funding to banks against eligible collateral. The hope was that stable multi-year funding would encourage banks to restart lending and support activity. While they did not vanish, concerns about stable funding and liquidity did ease—enough to prompt banks, eager to signal financial health, to start pre-paying LTROs. This undid much of

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the initial expansion in reserve money. Overall, LTROs prevented worse outcomes but did not actually lift private credit and broad money.

QE would differ from LTRO-type expansions in that the ECB would: (1) make outright purchases of longer-term assets (longer than 3 years), which have wider and larger effects on interest rates, asset prices and spending; (2) expand its balance sheet at its own discretion (not that of banks or others); and (3) sustain those purchases until inflation goals are met. Q2. What assets would the ECB buy—public or private, core or periphery? A2. For now, there are too few liquid private assets to sustain QE. The market for securitized bank assets is small, as is the one for corporate bonds. Bank bonds are plentiful and liquid but concentrated. Central banks rarely venture into equities. That leaves sovereign bonds the only viable option. (It would be desirable to further develop markets for securitized assets like mortgages and loans to small and medium-size enterprises; the mere fact of QE can give the needed impetus.)

ECB purchases should be across the board, not just core or periphery, because the problem of low inflation is across the board. So long as the ECB buys sovereign bonds in pursuit of its mandate and in a way that has nothing to do with fiscal outcomes (e.g., neutrally buying the bonds of all countries according to their share in ECB capital), it can rebut the oft-heard charge that QE violates the prohibition against “monetary financing of fiscal deficits.” Q3. How would QE work?

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A3. QE is not a panacea or substitute for reforms. But it can push up inflation by raising consumption and investment across the euro area, and support that trend by reviving the supply and demand for bank credit. How? For starters, growth and inflation expectations would rise as the ECB signals resolve to achieve its inflation objective. The ECB’s Outright Monetary Transaction announcement has demonstrated the potency of whatever-it-takes signaling. Current demand and asset prices also would be lifted by the prospect of lower real interest rates (as QE reduces nominal interest rates and raises inflation expectations). QE would also trigger important valuation effects. ECB sovereign bond purchases directly raise their prices. The sellers of sovereign bonds—banks, pension funds, asset managers—would need to reconstitute their portfolios with other long-term assets, over time raising asset prices more widely. European equity prices, for one, remain well below pre-crisis levels.

The significance of higher asset valuations would extend beyond the usual wealth effects:  Household and corporate balance sheets. Before the crisis, additional debt was used to buy housing and other assets whose values subsequently crashed. Ever since, households and firms have been cutting back consumption and investment in order to pay down debt. This balance sheet recession is illustrated in the charts below, which relate pre-crisis balance sheet stress (an index of the level and growth of debt) to post- crisis demand contraction. Higher asset values from QE, and a lower real carrying cost of debt, can reverse this dynamic.

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 Supply of bank credit. Banks are major holders of sovereign bonds. Higher sovereign bond prices mean higher bank valuations—i.e., higher bank capital. (A back-of-the- envelope calculation: a 50 basis point fall in long-term yields could raise the banking system’s core tier 1 capital ratio by 1½ percentage points). Further, higher private asset prices mean higher values of household and firm collateral. Together, these increase the willingness and ability of banks to supply credit.  Demand for bank credit. The increase in aggregate demand from higher asset values and growth expectations would increase credit demand. Unlike other ECB measures to date, QE also works to restore the demand for bank credit.

Q4. Can QE be effective if interest rates are already low and the system bank-based? A4. As noted above, QE works via banks too. It worked in Japan even though Japanese finance is almost as bank-based as in Europe (83% and 89% respectively). And Japan had even lower interest rates when the Bank of Japan (BOJ) launched its successful qualitative and quantitative monetary easing (QQE) program last year. There is much more space for the yield curve to fall in Europe than there was in Japan. A decline in European yields of 50 basis points at mid- maturities, and more at the longer end, is entirely plausible.

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Q5. So why did the ECB stop short of QE? A5. The ECB has been clear that it is open to unconventional measures but also that circumstances do not as yet justify QE. And indeed it would not help if the ECB went for QE with anything less than full conviction. The BOJ’s QE program in the early 2000s ended prematurely (before inflation and inflation expectations were durably raised), while that in 2010-12 was too guardedly implemented (in small steps and no clear link to the inflation goal). By contrast, its QQE since 2013 has been whatever-it-takes on size, pointed on goals and timeframe, and has yielded a strong response in inflation expectations.

Q6. What about side effects—asset bubbles and currency depreciation? A6. QE will push banks and others out of safe government bonds to lending to the rest of the economy. That is riskier but it is also the point. While risk-taking and credit growth may grow excessive, this is not an immediate risk, certainly not next to that of too low inflation. So far, credit is still contracting in the euro area (barely positive even in Germany) and there is no evidence of housing/asset bubbles (not even in Germany). If bubbles are blown, targeted macroprudential measures, which need further development, can be deployed. On the currency, QE would likely weaken the euro. Insofar as this raises demand and traded goods prices, it helps tackle the threat from low inflation. This could be an important channel. But depreciation is not inevitable: rising asset prices/economic prospects due to QE may draw capital and appreciate the euro. With thanks to Petya Koeva Brooks, Pelin Berkmen and Ali Al-Eyd for their contribution to this blog post. http://blog-imfdirect.imf.org/2014/07/14/euro-area-qa-on-qe/ 153

Daily Morning Newsbriefing July 14, 2014 Japanese investors pile into EZ betting on deflation The really big news this weekend was definitely outside our reservation. Among the rest, what surprised us the most was a Reuters story from Japan this morning, according to which Japanese investors had been buying most of the newly issued stock of French sovereign debt for two months running – because they are convinced that the eurozone would fall into a Japanese-style deflation. According to the article, they bought around €14bn worth of French bonds in May, equal to 60% of the French government’s issuance that month, citing data from the Japanese finance ministry. In June, the activity has picked up further, according to market sources, but no official data are as yet available. The paper quotes one source as saying Japanese investors had bought three quarter of France’ new issuance. Why French bonds? The yield more than German bonds, but are considered as valuable. And they also betting on similar deflation-funding trends as occurred in Japan in the 1990s – consumers hoarded money in bank accounts, forcing banks to invest in government securities. Gerald Braunberger has a comment in Frankfurter Allgemeine, in which he said that the economic forecasts for the eurozone have been too optimistic. The problems with Espirito Santo may have triggered last week’s rout on equity markets, but there are deeper problems in the eurozone economy – even in Germany. He recalled that in 2012 and 2013 the forecasters had expected much higher growth rates, but the results were disappointing. He doubts the explanation that the weakness in 2014 was due to external factors only – like Russa/Ukraine. So far, the equity markets were sustained by the ECB, but that cannot continue either, as the limits of monetary policy are becoming increasingly evident. Pedro Sánchez Castejón to lead Spain’s PSOE Pedro Sánchez Castejón won Sunday’s contest for the post of Secretary General of Spain’s leading opposition party PSOE, reports Europa Press. 2/3 of the party’s members voted, of which Sánchez got over 48% of the vote buoyed by massive support from the Andalusian federation of the party though he also won in the rest of the country. Eduardo Madina obtained 36% of the vote and José Antonio Pérez Tapias 15%. Sánchez had said that in case he became Secretary General he would contest the primary (supposed to be held in November) to be the PM candidate in next year’s general elections. We had called Sánchez a stalking horse candidate, and El Pais parliamentary correspondent Fernando Garea has an article tracing his 8-month path from relatively unknown member of parliament (he didn’t attract much attention when presenting a 154

book in Madrid last December) to leading the PSOE. Garea writes Sánchez has taken advantage of the opportunities offered by chance, as he has been a Madrid city councillor, and an MP in 2009-11 and after 2013, but “always by chance, in mid-term after the resignation of people who went before him on party lists”. This means that, though known to the party apparatus (he was intermittently drafted for party jobs under Zapatero’s party organization secretary José Blanco), he was never high on Madrid party lists. Garea writes “he has never managed a team, never led, never went beyond a discrete role and now he has to manage his ambition which has propelled him to an unprecedented lightning race”. Also, that Sánchez will show the extent of his independence from the regional party apparatus when he designs his executive committee. Also of interest, before the weekend Pedro Sánchez was profiled by Carlos Cué in El País (English Edition) as part of a new generation of young leaders (between the ages of 28 and 43) from PSOE, United Left, Podemos and UPyD. BES with Vitor Bento as new leader Vítor Bento took over the leadership of Banco Espírito Santo (BES ) earlier than expected, after the Portugal’s central bank ordered the immediate appointment of a new chief executive and other board members at BES, Diario Economico reports. Their appointment, together with other new board members and a new governance model for BES, should be ratified at the July 31 shareholders meeting. Earlier on Sunday, Portugal’s prime minister said taxpayers would not be called on to bail out failing banks, making clear there would be no state support for BES. BES, the government and the Bank of Portugal have given assurances that the bank is ringfenced from the problems of the Espírito Santo family group and that its solvency is not at risk. Analysts say that in principle there is another €6.4bn available from the bailout funds, but that it is subject to EU state aid rules, meaning that those funds will only be paid if there is some burden sharing with the private sector, the FT reports. Bloomberg quotes Moody’s Investors Service saying that “the problems detected at the parent company of Banco Espirito Santo and their likely impact on the wider banking system should not have a significant impact on the sovereign’s credit metrics and the macroeconomic fundamentals of the country.” Portugal’s government debt agency on July 11 said it plans to auction as much as €1.25bn of treasury bills on July 16. It also said it plans to hold one or two bond auctions during the third quarter. Political novice wins Slovenia elections A political newcomer won Slovenia’s election on Sunday, Miro Cerar and his six-week- old SMC party won 34.8 % of the vote, which translates to 36 seats in the 90-seat parliament, Reuters reports. That would give the 50-year-old law professor the strong mandate his recent predecessors have lacked, potentially going some way to restoring political stability after years of turbulence and weak government, writes Reuters. The center-right SDS party was in second place with 20.6% and a string of smaller center- left parties also won seats and were lining up to join Cerar in government. Outgoing Prime Minister Alenka Bratusek called Sunday's snap election after losing public confidence. Cerar's government will now oversee a raft of crisis measures agreed 155

with the EU to reduce Slovenia's budget deficit and remake an economy heavily controlled by the state. Cerar opposes the sale of telecoms provider Telekom Slovenia and the international airport, Aerodrom Ljubljana. The outgoing government suspended the privatization process this month pending the formation of a new government, which is not expected before mid-September. Cerar’s success is the most impressive shooting career into politics we have seen in Europe so far. An impressive voter shift, punishing mainstream parties for their corruption scandals. He owes much of his celebrity to his gymnast father, twice Olympic pommel horse champion when Slovenia was part of Yugoslavia. In total there are now eight parties in parliament: Choices, choices, choices Jean-Claude Juncker is due to be elected president of the Commission this week, after which he will start negotiating the commission appointments. The Wall Street Journal that Juncker among the two Socialists who are most frequently mentioned, Pierre Moscovici seems to be the leading candidate – not Jeroen Dijsselbloem. Why is this so? “[Djisselbloem is] credited in some quarters for bringing order to the Eurogroup meetings after the presidency of … Mr. Juncker! And therein lies the problem. There’s been some sniping between the two men, culminating in Mr. Dijsselbloem’s remarks on a Dutch television show that Mr. Juncker was an “inveterate” drinker – possibly even during Eurogroup meetings.” Moscovici is said to have a good relationship with Juncker. The problem is only that Germany and the Netherlands might raise objections. The FT reports that Poland and the three Baltic countries have raised objections against Federica Mogherini as the EU’s next High Representative because she invited Vladmir Putin to an EU/Asia summit in Milan in October. Corriere della Sera reports that Matteo Renzi is basing his fiscal strategy on the appointment of a lenient European Commission and Eurogroup chief. Renzi decided to bring forward the decision on the 2015 budget to mid-August so he does not contaminate the Italian presidency with a discussion on the Italian deficit. The article says the budget would lock in the tax cuts announced for this year, which would leave a whole of some €13bn in 2015, after €4.5bn this year. Renzi has excluded the possibility of another mini-budget to compensate for the now increasingly like deficit overshoot. The issues in EU politics have become more complex since the eurozone and Ukraine crises. It has become an issue for the first time whether potential candidates for a senior jobs hail from the eurozone or not, or whether they have good relations with Putin. This comes on top of the usual criteria North vs. South, and Left-vs- Right equilibrium debates. The constellation has the classic hallmarks of second-choice least-bad candidates prevailing for some of jobs – though we believe Juncker to fill the key portfolios in the Commissions with people he trusts, which he can probably do by reshuffling portfolios and by appointing senior vice presidents without portfolio, which might give to some interesting power struggles. How to deal with financial stability risks

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The FT writes on a warning by S&P that the re-emerges of cov-light and other riskier types of corporate lending were posing financial stability risks. Cov-light loans – which carry fewer fiduciary restrictions – are now the norm in US corporate lending, which is usually taken as an indicator of a credit bubble. S&P made the point that before the 2007 crisis most cov-lite loans were issued by double-B rated (or better) companies. Now single-B companies are issuing those loans. S&P is a liquidity crisis were to occur, the default rate would be much higher than in 2008/09. In his FT column, Wolfgang Munchau asks what central banks should do to fight bubbles. He writes that the two corner solutions have not worked – ignore them and mop up later, and ignore everything else, and just focus on the bubble, as the recent experience in Sweden has shown. He says macropro is useful, but not a sufficiently strong instrument in the way it is applied in practice. He says central banks should for the moment continue with a two pronged approach relying on monetary policy focusing primarily on economic stability, and macropru on financial stability – given the lack of alternatives. But in the long-run, central banks need new generation macro models with an explicit role for the financial sector. Such models are in their infancy now, but Munchau notes that there is some promising work currently being undertaken. Eurozone Financial Data 10y spreads Previous This Yesterday day Morning France 0.333 0.333 0.333 Italy 1.744 1.694 1.686 Spain 1.624 1.572 1.570 Portugal 2.810 2.684 2.694 Greece 5.126 5.081 5.01 Ireland 1.138 1.115 1.102 Belgium 0.433 0.439 0.438 Bund Yield 1.203 1.205 1.213 exchange rates This Previous morning Dollar 1.360 1.3609 Yen 137.760 137.97 Pound 0.795 0.7949 Swiss Franc 1.214 1.2143

ZC Inflation Swaps previous last close 157

1 yr 0.72 0.72 2 yr 0.75 0.75 5 yr 1.2 1.2 10 yr 1.64 1.64

Eonia 11-Jul-14 0.05 10-Jul-14 0.04 09-Jul-14 0.03 08-Jul-14 0.03

Euribor-OIS Spread previous last close 1 Week -3.229 -2.629 1 Month 2.129 0.829 3 Months 9.786 10.186 1 Year 35.857 37.657

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 14.html?cHash=99af09f31fc772730126513cdc396621

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mainly macro

Comment on macroeconomic issues

Simon Wren-Lewis

I am an economics professor at Oxford University, and a fellow of Merton College. This blog is written for both economists and non-economists. This Blog

Sunday, 13 July 2014 Why macroeconomists, not bankers, should set interest rates More thoughts on the idea that interest rates ought to rise because of the possibility that the financial sector is taking excessive risks: what I called in this earlier post the BIS case, after the Bank of International Settlements, the international club for central bankers. I know Paul Krugman, Brad DeLong, Mark Thoma, Tony Yates and many others have already weighed in here, but - being macroeconomists - they were perhaps too modest to draw this lesson. To most macroeconomists, the theory of monetary policy is pretty straightforward. Interest rates should be set at a level which closes the output gap, which can be defined as the level of output and unemployment that will keep underlying inflation constant. We can call this real interest rate the Wicksellian natural rate. The difficulty is not in the concept, but in the practice of putting numbers to this concept when inflation is noisy, the output gap is hard to estimate, there are lags in the system etc etc. But, respond those putting the BIS case, wasn’t that what monetary policymakers thought they were doing in 2007, and look what happened next. Monetary policy cannot afford to ignore the financial sector, and the risk of excessive lending and bubbles that subsequently blow up the economy. There are signs, they say, that what happened in 2007/8 may be happening again now, so we need to raise rates to prevent another crash, even though there is still a negative output gap and inflation is below target. Which might seem plausible, until you notice what is going on here. The implication is that a financial crisis only happens because interest rates are set at the wrong level. The Great Recession was all the fault of the Fed, who kept interest rates too low after the 2001 recession. The gradual deregulation of the financial sector in the decades before? - not an issue. The widespread misselling of subprime mortgages? - these things happen. All the other examples of misselling and fraud? - boys will be boys. An industry that profits from a massive implicit public subsidy? - we see no subsidy. Classifying subprime products as AAA? Massive increases in bank leverage in the 00s? - all the result of keeping interest rates too low.

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When those putting the BIS case tell you that macroprudential controls (a.k.a. financial regulations) are ‘untested’ and ‘uncertain in their impact’, what they are really saying is that the financial system cannot be regulated to make it safe when interest rates are low. There is no evidence for that proposition, and a lot of history that says otherwise. We do not have to accept a deregulated financial sector which has the power at any moment to derail the real economy. But of course most working in the financial sector hate regulation. They have an interest in perpetuating different stories about the Great Recession. If you spend too much time around bankers, there is a danger that you come to believe these self-serving stories. But, you might say, what harm would a modest increase in interest rates do? Again, basic macroeconomics, which I have not seen anyone putting the BIS case address. Raising rates implies in current circumstances a larger negative output gap, which will reduce inflation further below its target. As happened in Sweden, and accurately predicted by macroeconomist Lars Svensson. Two things could then happen. First, interest rates come back down again (in Sweden’s case by outvoting the governor for the first time since it gained its independence in 1999), but the cost of lost resources and higher unemployment created in the meantime can never be redeemed. Second, interest rates stay high for long enough that the public will conclude that the inflation target has in reality been revised down, and we risk converging to a deflationary steady state (technical discussion here), or in non-technical terms a Japan-like lost decade or more of low output and deflation. To see clearly why this makes no sense, consider the symmetric case. Suppose someone argued, when inflation was above target, that we should not raise rates, but instead allow the output gap to be positive. I suspect those currently making the BIS case would scream disaster – it is the 1970s all over again. So why is that wrong but doing the same thing in reverse OK? In fact it is worse than that. If long run expected inflation rises, a central bank can always signal its true inflation target by sharply raising rates. In the opposite case it may not be able to, because of the Zero Lower Bound. I like to praise the current UK government when I can. In setting up a Financial Policy Committee that is separate from the Monetary Policy Committee they did exactly the right thing. This formalises an assignment: macro prudential policy to control financial sector excess, and interest rates to control demand and inflation. Most macroeconomists know this makes sense. But the financial sector has a pecuniary interest in pretending otherwise. Those that get too close to that sector should be kept well away from setting interest rates. http://mainlymacro.blogspot.com.es/

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ft.com comment Columnists July 13, 2014 2:17 pm What central banks should do to deal with bubbles

By Wolfgang Münchau It is a mistake to view macroprudential regulation as a potent independent policy tool

©Bloomberg The world has conducted two controlled experiments on how to fight financial bubbles in the past decade. Both failed. The first was to ignore the bubble and to mop up later. The idea seemed plausible to a lot of people. But it was based on the false premise that the costs of mopping up would be bearable. More ON THIS STORY//Editorial Janet Yellen’s asset price boom/ BIS warns over ‘euphoric’ markets/ Cautious outlook for second half of 2014/ John Authers Role of banks recedes/ BoE limits mortgages to protect recovery WOLFGANG MÜNCHAU// Europe’s dowry/ Europe needs investment/ Merkel versus Renzi/ Europe’s debt horrors The second experiment has just concluded in Sweden, also with calamitous results. There, the central bank did the exact opposite. It had previously raised interest rates to rein in a domestic housing bubble. In doing so, it generated deflation and raised unemployment. It recently corrected that policy error by cutting the interest rate back to 0.25 per cent. These two experiments present the opposite ends of our thinking: either ignore bubbles or ignore everything else. What should central banks do? The consensus view is that they should rely on macroprudential regulation. The Hong Kong Monetary Authority, for example, imposed restrictions on loan-to-value ratios for mortgages. The Bank of England recently placed caps on mortgages with very high income multiples. Central bankers love macroprudential tools because they are in thrall to an old idea that is simultaneously true and useless. The Tinbergen rule, named after a Dutch economist, states that you need one policy instrument for each policy target. If you have two targets – price stability 161

and financial stability – you need two instruments. Monetary policy deals with prices, macroprudential regulation takes care of bubbles. Problem solved. Or is it? For a start, the instruments are not entirely separate. Monetary policy affects not only retail prices but also the prices of financial assets. If a central bank commits to keeping interest rates at zero for the foreseeable future, it sets a benchmark for the price of risk-free securities directly and other securities indirectly. There is also a more fundamental problem. Consider Spain’s housing bubble. The country has an above- average share of brilliant economists and bankers yet hardly any of them expressed concern about pre-2007 house prices. So what would macroprudential supervision have accomplished in those years? Even if our hypothetical macroprudential regulators had correctly identified the risks, they would still have focused on the banking sector. Yet the real tragedy of post-bubble Spain occurred in the household sector. The country’s conservative bankruptcy rules meant that many mortgage holders have been saddled with huge debts for the rest of their lives. Macroprudential regulation might have saved the banks but it would not have saved Spain. Central bankers are fooling themselves if they think macroprudential regulation is a potent independent monetary policy tool. It is a useful supplementary tool, nothing more, nothing less. Our best hope lies in a unified framework. Unfortunately, the workhorse models used in mainstream economics do not have a concept of finance. Default cannot happen in these models because their fundamental building block is the “representative agent”, jargon for “your average Joe”. But the average Joe cannot simultaneously default and be defaulted on. You need two Joes for that – none of them is average. Specifically, you need a financial sector in those models, one that includes what we have seen in the past decade – default, credit crunches, rent-seeking, extortion of governments, antisocial behaviour, unethical behaviour, criminal behaviour – to mention just a few. The great James Tobin, another Nobel-prize winning economist, produced a model with an explicit role for asset markets as long ago as 1969. But rather than building on his work, the economic mainstream rode off in a different direction. The financial crisis gave rise to new approaches but they are still not mainstream. Central banks do not actually use them. I have been intrigued by some pioneering work by Markus Brunnermeier and Yuliy Sannikov at Princeton, who constructed a model in which the world has two states: one in which banks lend freely and one in which they do not. The policy prescriptions of this model are not fundamentally different from what central banks have done recently. But with the possibility of a future credit crunch integrated into the model, interest rate policy cannot be blind to asset price developments. Such a model would suggest an earlier rise in interest rates in the UK, for example, compared with standard models. For the eurozone, the model would justify aggressive policy easing because a fall in the rate of inflation or outright deflation would harm financial balance sheets and add to instability. There are several competing approaches. Modern monetarists focus on money, as opposed to credit, as the driving force. But despite their huge differences, both ideological and practical, none of them supports the experiment that just failed in Sweden or the one that failed 10 years ago. And none is particularly keen on macroprudential regulation. http://www.ft.com/intl/cms/s/0/e5cbf972-08ee-11e4-9d3c- 00144feab7de.html#axzz37QowSIgY

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ft.com Comment Editorial

July 3, 2014 6:14 pm Janet Yellen’s asset price boom Caution on rates is wise but Fed could do more on bubbles They say the US Federal Reserve is for ever blowing bubbles. Janet Yellen did little to counter that view this week with her reiteration that tighter interest rates are almost always the wrong tool to curb asset price inflation. She was right, however, to hold the line. Central banks have a poor record of anticipating asset bubbles, let alone preventing them. There is no reason to suppose that their foresight has improved. In contrast, it is within the Fed’s power to bolster the economy’s resilience to bursting bubbles via tougher macroprudential controls. Bubbles will always be with us, she argued. The goal should be to make them less explosive. More ON THIS STORY// Yellen holds firm on rate rises/ BIS warns over ‘euphoric’ markets/ Martin Wolf Bad advice from Basel/ Markets Insight Fed complacent on credit market risk/ Fed warns banks they face tougher tests EDITORIAL// A new team for the EU’s top body/ The immigration crisis that shames America/ Brazil after the World Cup/ The tests posed by Espirito Santo Ms Yellen is in good company. On Thursday, Sweden’s central bank reversed its stance of tightening interest rates to head off asset price bubbles by slashing them to just 0.25 per cent. Far from rebuilding confidence, the Riksbank’s strategy of “leaning into the wind” had brought Sweden to the brink of outright deflation. In place of the blunt monetary instrument, the Riksbank will look at further toughening banks’ capital requirements. At the Bank of England, Mark Carney has taken macroprudential policy a step further by promising to vary the loan-to-value ratio on mortgages with the housing boom cycle. Central banks everywhere are starting to vary their bank stress tests to take the asset price cycle into account. The debate is far from settled. This week the Bank for International Settlements threw a contrarian straw into the wind by insisting that central banks should tighten early and clearly to stave off another cycle of bubbles. Ms Yellen is wise to ignore their advice. Without easy monetary policy, the US, the UK and other leading economies would have grown by far less in recent years. Premature tightening would have reduced growth, risked deflation and increased the value of the debt burden that the BIS so fears. The BIS was right to warn of the dangers of “balance sheet depression”, which can persist for years. Alas, its remedy would worsen the disease. Without growth, the balance sheet can only deteriorate further.

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That said, there are grounds to worry that the Fed is not doing enough to limit the impact of future asset price shocks. Unlike the BoE, which seems serious about counteracting the UK’s chronic housing boom-bust cycle, the Fed’s macroprudential tool kit is limited. Ms Yellen has made it clear the Fed will increase capital cushions as conditions demand. But almost all the onus is on the formal banking sector. Much of the risk, however, has shifted into shadow banking. There are real concerns the Fed is behind the curve. Regulators are almost never as nimble as the markets they regulate. Ms Yellen must do more to demonstrate that the Fed, and its sister agencies, will follow the search for yield into whichever asset classes it goes, and via whichever entities. On the bright side, the US economy’s strong labour market numbers in June – with 288,000 new jobs added – is another signpost on the way to ending the historically easy monetary policy of the past few years. The Fed’s taper will almost certainly be completed by the autumn. And there is a rising chance that it will begin to raise interest rates in late 2015 if not before. For six years, the Fed has done its best to boost asset prices to rekindle the real economy. The path was ugly but undoubtedly the lesser of two evils. At some point, US interest rates will begin to normalise and the search for yield may go into reverse. Volatility will return to the markets and risks will rise. It is imperative the Fed makes use of every macroprudential tool it has to protect the US recovery from the bubbles it has helped create. http://www.ft.com/intl/cms/s/0/e5cbf972-08ee-11e4-9d3c- 00144feab7de.html#axzz37QowSIgY

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ft.com/markets

MARKETS INSIGHT July 14, 2014 6:24 am Investors beware: economists at large By Mohamed El-Erian Analytical underpinnings of risk-taking are far from robust In a perfect world, investors would turn to economists for predictions on two key issues supporting equity prices at current valuations: productivity trends and the effectiveness of macroprudential policies. In the real world, however, I suspect many investors have yet to grasp the extent to which these arcane topics will influence the next stage of the market cycle; and those that do may get insufficient guidance from economists. Let’s start with some context. More ON THIS TOPIC// Gavyn Davies Are asset prices ‘artificially” high?/ The Short View Markets feel toppy, but might get toppier/ Bankers warn over US business loans rise/ John Authers Correction better than comeuppance MARKETS INSIGHT// Euro strength/ Fear factor will return to haunt Yellen/ Big, bad bank fines/ End to China property boom barely begun While counterfactuals are tricky, most market analysts would agree on two related market hypotheses: first, that unusually sluggish economic growth has not harmed stock market performance as much as would have been expected from traditional models; second, that hyperactive central banks have boosted asset prices using experimental measures, not as an end in itself but as a means of stimulating higher economic activity through the “asset channel”. The result has been a notable gap between a buoyant Wall Street and a struggling Main Street. Fortunately, as illustrated by the recent set of US employment reports and the modest pickup in growth in Europe, economies heal over time. While such healing continues to fall short of the economic lift-off everyone seeks, it poses a growing policy dilemma for central banks, in particular for the Federal Reserve, given America’s economic outperformance relative to Europe and Japan. Fed’s beliefs Up to now, Fed officials have been comfortable keeping their foot on the accelerator while engineering a skilful transition from balance sheet purchases (known as “quantitative easing”, which they are likely to exit completely in October, according to last week’s release of the FOMC Minutes) to aggressive policy guidance on low interest rates. They have maintained a gradualist policy approach while recognising that certain assets are approaching bubble territory. Indeed, Fed chairwoman Janet Yellen recently noted that the risk-taking induced by unusually low interest rates “can go too far, thereby contributing to fragility in the financial system”.

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There are two major reasons why most Fed officials are in no rush to take the punch bowl away, and they are critical to supporting current market valuations. First, they feel that, notwithstanding the decline in the unemployment rate to 6.1 per cent, there is still slack in the labour markets. As such, they are not worried about inflationary wage growth. Second, they believe financial market excesses can be effectively countered by the recent revamp of macroprudential policies, both nationally and internationally. Both hypotheses are just that – hypotheses. And they are subject to notable risks given that the Fed, and everyone else for that matter, is in uncharted policy waters. Should the recent disappointing productivity performance continue, the Fed may find wage pressures increasing at a faster rate than it finds comfortable. Also, strengthened macroprudential measures may have failed to keep pace with investors who believe the collapse in market volatility occasioned by economic and policy conditions is a green light for leveraging every risk factor – be it credit, default, duration, equity or liquidity. Prediction failure Judging by past experience, economists are not well placed to make confident predictions about the risk of greater economic and financial instability. Productivity trends are hard to measure accurately, let alone predict. The record on assessing financial instability is even worse. It is not just that most economists misjudged the run-up to the 2008 financial crisis; even Fed officials, who arguably are a lot closer to markets, were shocked by last year’s severe “taper tantrum”. And if all these people cannot get their arms around the underlying fragility of the financial system, it is difficult to be confident about the effectiveness of macroprudential measures. All of which is to say that the analytical underpinnings of the current phase of risk taking in financial markets are far from robust. Yes, the Fed’s policy approach could succeed in the next few quarters in engineering a handover from financial excesses to economic lift-off, thereby validating high market valuations and pushing them even higher, especially if the world has indeed transitioned to a paradigm of significantly and permanently lower levels of nominal and inflation-adjusted growth. But the timing is inherently uncertain. And the probabilities of doing so may not overwhelmingly dominate those of a less pleasant scenario – that of stagflation and greater financial instability. This configuration of more balanced risk is not yet reflected in asset prices and the levels of implied and realised volatility. Mohamed El-Erian is chief economic adviser to Allianz, chair of President Obama’s Global Development Council and author of “When Markets Collide” http://www.ft.com/intl/cms/s/0/11284bb6-0773-11e4-81c6- 00144feab7de.html#axzz37QowSIgY

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Política La ambición de Pedro En diciembre empezó un recorrido discreto y ahora será el líder de la oposición, bajo el estigma del apoyo de los aparatos regionales Sánchez promete la victoria al PSOE Fernando Garea 14 JUL 2014 - 00:48 CET147

Pedro Sánchez atiende a los periodistas, ayer, tras votar en Madrid. / JUANJO MARTÍN (EFE) El pasado 11 de diciembre, un joven diputado asomaba la cabeza con la presentación de su libro La nueva diplomacia económica españolaen la librería Blanquerna, muy cerca del Congreso. Le hicieron la presentación Ramón Jáuregui y Trinidad Jiménez y asistió una parte importante de la dirección del PSOE, pero el acto no tuvo brillo público ni repercusión en los medios. Y eso que algunos veteranos del Grupo Parlamentario habían alertado a los periodistas de que Pedro Sánchez estaba llamado a grandes misiones en el partido. Siete meses después, ese diputado que entonces carecía de brillo público, ha sido elegido por los militantes secretario general del PSOE y compareció anoche en Ferraz prometiendo “cambiar el partido, para ser mayoría y recuperar las señas de identidad, como la de proteger al más débil”. Y hasta proclamó el “inicio del fin de la etapa de Mariano Rajoy”. Todos reconocen en Sánchez la ambición como su principal característica y así lo demostró anoche nada más ganar.

MÁS INFORMACIÓN// 'Recapitalizar el PSOE', por JOAQUÍN PRIETO/ Sánchez promete la victoria al PSOE/ Madina sufre la derrota y Pérez Tapias saborea su resultado/GRÁFICO Resultado de la votación

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También le reconocen la capacidad de aprovechar las oportunidades que el azar le brinda, como ha hecho en los últimos meses hasta culminar ayer. Fue concejal de Madrid entre 2004 y 2009 y diputado entre 2009 y 2011 y desde 2013 hasta ahora, pero siempre de carambola y en mitad de las legislaturas por renuncia de los que iban delante de él en la lista. Hace solo dos años y medio era únicamente el diputado revelación para la Asociación de Periodistas Parlamentarios que le premió como tal y luego desapareció de la política porque no tenía fuerza ni para lograr ir en un puesto de salida en la lista de Madrid. Ahora es el líder de la oposición y asumirá la dirección del partido que más años ha gobernado y que, a pesar de todo, tiene más escaños tras el PP.

Trabajó en el aparato del PSOE junto a jóvenes políticos reclutados por José Blanco, pero desde puestos muy discretos y de forma intermitente. Con él estaban Óscar López y Antonio Hernando, entre otros, que sí hicieron carrera entonces por sí solos. La última intervención de Sánchez como fontanero discreto fue en octubre en el equipo que preparaba la conferencia política y por gestión directa de Elena Valenciano, aún número dos del partido, que le recuperó. Imposible verle entonces como el líder porque estaba fuera del campo de juego. Alguien que conoce bien el partido explicaba recientemente con agudeza que Sánchez “es la bicicleta que José Blanco había puesto en la carrera hace menos de un año, fiel a su costumbre de poner siempre una bicicleta aunque sea en una carrera de fórmula uno, con la previsión de que si todos se estrellan quedará siempre su bicicleta”. Su horizonte eran las primarias de noviembre y hace apenas dos meses explicaba con detalle su calendario para esa fecha y su decisión de seguir adelante con el recorrido por toda España. Muchos dentro del partido sonreían, le miraban con desdén y explicaban que sólo buscaba situarse para el futuro y que terminaría apartándose en el camino. Por

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ejemplo, en la última campaña de las europeas, Ferraz dio un papel en sus actos a Carme Chacón, a Eduardo Madina y a Patxi López, teóricos aspirantes entonces, pero a Sánchez lo dejó al margen y él hizo su recorrido por su cuenta y empujado por su ambición. Fue creciendo, convirtiéndose en una moto, las primarias se convirtieron en voto directo de militantes, se apartaron de la carrera Chacón y Susana Díaz, aprovechó su momento y fue mutando en el vehículo al que se subieron muchos. Empezando por los aparatos territoriales del PSOE, que le ayudaron a recoger avales y cuyos máximos responsables le vieron como el candidato idóneo frente a Madina, al que no perdonaron que forzara la elección directa, en lugar de en un congreso con delegados. Pero ayer, los militantes pusieron a Sánchez al frente del partido en votación directa y secreta, imposible de cuestionar incluso por los que le reprochan que es el candidato de los barones regionales. Eso no le quitará el estigma de la tutela de los dirigentes regionales y, especialmente, de Susana Díaz. Ese es su reto a partir de ahora, en el que se incluye la decisión sobre el tipo de oposición que quiere hacer. Si hace pactos con Rajoy, si busca acuerdos con el resto de formaciones de la izquierda y si mantiene el calendario de primarias. Su obsesión era la unidad y la integración y ayer la mostró en su comparecencia. Dentro del partido su prueba de fuego será el diseño de su nueva ejecutiva en la que mostrará si es autónomo de los aparatos territoriales. Nunca ha formado equipos, ni ha liderado. Nunca ha pasado de un papel discreto y ahora le toca gestionar su ambición, la que le ha empujado en una fulgurante carrera con pocos precedentes. http://politica.elpais.com/politica/2014/07/13/actualidad/1405282716_727501.html

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Sánchez reivindica su autonomía para decidir sobre las primarias del PSOE El próximo secretario general reitera que buscará la unidad e integrar a Madina y Pérez Tapias El diputado madrileño apuesta por abordar un proyecto "ganador" y de izquierdas El País Madrid14 JUL 2014 - 11:53 CET97

ATLAS El próximo secretario general del PSOE, Pedro Sánchez, ha reivindicado hoy su autonomía para poner fecha a las primarias previstas en noviembre para elegir al candidato socialista al Gobierno. En una entrevista en la Cadena SER, Sánchez ha señalado que la nueva dirección debe tener la capacidad de analizar el calendario político, con las elecciones municipales y autonómicas de 2015 en el horizonte, para después decidir “entre todos”, si bien la última palabra la tendrá el Comité Federal. No obstante, el diputado madrileño ha remarcado que propondrá que la consulta se celebre en noviembre y ha asegurado que se celebrará “sí o sï”.

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Sánchez, que fue elegido este domingo por los militantes para liderar el partido, ha insistido en su intención de configurar una Ejecutiva de unidad que pueda abordar un “proyecto sólido, solvente y ganador”, de “izquierdas y realista”. Ha destacado de nuevo que quiere ser el secretario general de todos para “cambiar el PSOE y cambiar España” y que hablará con sus contrincantes en la carrera por el liderazgo, Eduardo Madina y José Antonio Pérez Tapias, para que se integren en la nueva dirección.

MÁS INFORMACIÓN// Sánchez promete la victoria al PSOE/ La ambición de Sánchez/ Andalucía se vuelca con el nuevo líder del PSOE Sobre la presidenta de la Junta de Andalucía, Susana Díaz, ha subrayado que es un referente no solo en el partido, “sino también social”, pero ha evitado pronunciarse sobre una posible presencia de la dirigente andaluza en la futura Ejecutiva. El ganador de la consulta de este domingo se entrevistará esta misma mañana con Díaz en la sede socialista de la calle de Ferraz. Sánchez ha señalado que tiene por delante dos semanas de conversaciones para formar la nueva dirección, que saldrá del Congreso extraordinario que celebrará el partido los próximos 26 y 27 de julio. Durante la entrevista en la SER, Sánchez también ha reiterado su apuesta por reformar la Constitución y ha señalado que espera que el presidente del Gobierno, Mariano Rajoy, “cuente” con el PSOE para resolver la situación de Cataluña. Ha desvelado, además, que anoche habló con Rajoy, al que pedirá una entrevista más adelante, y con el Rey, que le desearon “suerte”. Preguntado por si se plantearía una gran coalición con el PP, Sánchez ha sido rotundo: "Nunca". Por otro lado, Sánchez ha reiterado su oposición a que los eurodiputados socialistas voten a favor de la elección del luxemburgués Jean Claude Juncker para presidir la Unión Europea. http://politica.elpais.com/politica/2014/07/14/actualidad/1405325352_813720.html

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17 compromisos de Pedro Sánchez EL HUFFINGTON POST | Por Antonio Ruiz Valdivia Publicado: 13/07/2014 21:44 CEST Actualizado: 13/07/2014 21:45 CEST ¿Y ahora qué? Pedro Sánchez toma las riendas del PSOE tras unas trepidantes semanas de campaña. Los militantes socialistas lo han elegido para ser su secretario general (con el recuento al 80%). A partir de esta noche se abre una nueva etapa en la socialdemocracia española con un nuevo líder que ha desgranado algunos de sus objetivos a lo largo de los últimos días. Estas son algunas de sus promesas. 1. Reforma de la Constitución para avanzar hacia un modelo federal 2. Cambio de la Ley de Partidos para hacer obligatorias las primarias abiertas 3. Modificar la Ley Electoral para establecer la paridad obligatoria en las listas electorales, mejorar la proporcionalidad y acercar al representante con su representado 4. Incompatibilidad para percibir remuneración por el desempeño de más de un cargo público 5. Limitar los mandatos de la Presidencia del Gobierno a un máximo de dos legislaturas 6. Prohibir las donaciones privadas de empresas a los partidos políticos y limitar la cuantía de las donaciones particulares a dos mil euros 7. Fin del aforamiento 8. Supresión de indultos por motivos políticos 9. Una reforma fiscal progresista 10. Propondrá la convocatoria de primarias para elegir en noviembre al candidato del PSOE a La Moncloa en 2015 11. Dimisión de los cargos a los que se abra juicio oral 12. Endurecer el Código Penal en casos de corrupción 13. Mecanismos de consulta directa para que los militantes se puedan pronunciar sobre hechos de interés político 14. Prohibir que los expresidentes y exministros puedan formar parte del consejo de administración de empresas vinculadas a sectores estratégicos (telecomunicaciones, energía…) 15. Ofrecerá un puesto en la Ejecutiva Federal a sus rivales, Eduardo Madina y José Antonio Pérez Tapias. 16. Derogar la reforma laboral 17. Ley de Muerte Digna http://www.huffingtonpost.es/2014/07/13/pedro-sanchez-psoe_n_5582009.html 172

The Opinion Pages| Op-Ed Columnist Obamacare Fails to Fail JULY 13, 2014

Paul Krugman How many Americans know how health reform is going? For that matter, how many people in the news media are following the positive developments? I suspect that the answer to the first question is “Not many,” while the answer to the second is “Possibly even fewer,” for reasons I’ll get to later. And if I’m right, it’s a remarkable thing — an immense policy success is improving the lives of millions of Americans, but it’s largely slipping under the radar. How is that possible? Think relentless negativity without accountability. The Affordable Care Act has faced nonstop attacks from partisans and right-wing media, with mainstream news also tending to harp on the act’s troubles. Many of the attacks have involved predictions of disaster, none of which have come true. But absence of disaster doesn’t make a compelling headline, and the people who falsely predicted doom just keep coming back with dire new warnings. Consider, in particular, the impact of Obamacare on the number of Americans without health insurance. The initial debacle of the federal website produced much glee on the right and many negative reports from the mainstream press as well; at the beginning of 2014, many reports confidently asserted that first-year enrollments would fall far short of White House projections. Then came the remarkable late surge in enrollment. Did the pessimists face tough questions about why they got it so wrong? Of course not. Instead, the same people just came out with a mix of conspiracy theories and new predictions of doom. The administration was “cooking the books,” said Senator John Barrasso of Wyoming; people who signed up wouldn’t actually pay their premiums, declared an array of “experts”; more people were losing insurance than gaining it, declared Senator Ted Cruz of Texas. But the great majority of those who signed up did indeed pay up, and we now have multiple independent surveys — from Gallup, the Urban Institute and the Commonwealth Fund — all showing a sharp reduction in the number of uninsured Americans since last fall. I’ve been seeing some claims on the right that the dramatic reduction in the number of uninsured was caused by economic recovery, not health reform (so now conservatives

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are praising the Obama economy?). But that’s pretty lame, and also demonstrably wrong. For one thing, the decline is too sharp to be explained by what is at best a modest improvement in the employment picture. For another, that Urban Institute survey shows a striking difference between the experience in states that expanded Medicaid — which are also, in general, states that have done their best to make health care reform work — and those that refused to let the federal government cover their poor. Sure enough, the decline in uninsured residents has been three times as large in Medicaid-expansion states as in Medicaid-expansion rejecters. It’s not the economy; it’s the policy, stupid. What about the cost? Last year there were many claims about “rate shock” from soaring insurance premiums. But last month the Department of Health and Human Services reported that among those receiving federal subsidies — the great majority of those signing up — the average net premium was only $82 a month. Yes, there are losers from Obamacare. If you’re young, healthy, and affluent enough that you don’t qualify for a subsidy (and don’t get insurance from your employer), your premium probably did rise. And if you’re rich enough to pay the extra taxes that finance those subsidies, you have taken a financial hit. But it’s telling that even reform’s opponents aren’t trying to highlight these stories. Instead, they keep looking for older, sicker, middle-class victims, and keep failing to find them. You might ask why, if health reform is going so well, it continues to poll badly. It’s crucial, I’d argue, to realize that Obamacare, by design, by and large doesn’t affect Americans who already have good insurance. As a result, many peoples’ views are shaped by the mainly negative coverage in the news media. Still, the latest tracking survey from the Kaiser Family Foundation shows that a rising number of Americans are hearing about reform from family and friends, which means that they’re starting to hear from the program’s beneficiaries. And as I suggested earlier, people in the media — especially elite pundits — may be the last to hear the good news, simply because they’re in a socioeconomic bracket in which people generally have good coverage. For the less fortunate, however, the Affordable Care Act has already made a big positive difference. The usual suspects will keep crying failure, but the truth is that health reform is — gasp! — working. http://www.nytimes.com/2014/07/14/opinion/paul-krugman-obamacare-fails-to- fail.html?partner=rssnyt&emc=rss&_r=0

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Discover Blogs review: U.S. inflation and growth - has the economy gained enough pace to generate an uptick in inflation? by Jérémie Cohen-Setton on 14th July 2014 93 What’s at stake: Most discussions over the past few weeks on the blogosphere have centered around whether the U.S. economy is, eventually, gaining enough pace to generate an uptick in inflation. While Q1 GDP was drastically revised down, other indicators suggest that the economy is indeed heating up. Is inflation about to pick up? Real Time Economics writes that minutes from the Federal Reserve’s June meeting suggest there is a growing gap between officials who believe U.S. inflation could remain too low for the Fed’s comfort and those who believe a spike in consumer prices could be closer than forecasters think. Some policy makers “expressed concern about the persistence of below-trend inflation,” the minutes said. Indeed, a couple even suggested the central bank might have to let unemployment fall below its long-term normal rate in order to ensure inflation moves back toward the 2% target. That sentiment was far from unanimous, however. “Some others expected a faster pickup in inflation or saw upside risks to inflation expectations because they anticipated a more rapid decline in economic slack.” Joe Weisenthal writes that it's becoming conventional wisdom that the economy is heating up for real this time. After numerous false starts and disappointments since the financial crisis, it appears we've kicked into a higher gear. Deutsche Bank economist Torsten Slok make for a good overview of the case that inflation is coming. First, capacity utilization is high. Meanwhile, surveys show that businesses are finding it harder and harder to fill job openings. Third because companies are having a harder time finding employees, they're indicating that salary increases are coming. Calculated Risk writes that for most of the '90s there was a huge "gap" between capacity utilization and CPI. There were periods when capacity utilization was higher than now - and inflation lower. As an example, capacity utilization was close to 83% in 1998, and YoY inflation averaged 1.5%. So I don't think the first graph presented by Deutsche Bank is convincing that inflation is "right around the corner". Also note that the last two other pieces of information are from a small survey and also not convincing. Source: CR (SEE below) Ryan Avent writes that there are two ways one can reconcile the view that inflation is going to remain low with what appears to be happening in labor markets. One possibility is that both markets and the Fed have it wrong (or that markets have it wrong because the Fed has it wrong). It could be the case that there is more inflationary 175

pressure in the economy than markets anticipate, and that either the Fed will have to act faster to check that pressure or will reveal that it is in fact happy to accept a rate of inflation a bit faster than anything America experienced over the past two decades. The other possibility is that tightening labor markets simply aren't going to exert much inflationary pressure on the economy. In the 2000s, nominal wage growth reached 4.5% amid rising commodity prices, yet core inflation never reached 2.5%. In the 1990s wage growth reached 5%, yet core inflation declined steadily. It may simply be the case that we aren't appreciating just how many margins there are along which labor markets have room to adjust. Tim Duy writes that the Fed has consistently predicted higher inflation, and consistently been surprised that that inflation has not yet arrived despite rapidly falling unemployment rates. If you are betting on inflation over the medium-term, you are essentially betting that the Fed will not do what it has done since Federal Reserve Chair Paul Volker - tighten policy in the face of credible inflationary pressures. Over the last twenty years (mean core-PCE inflation: 1.7%; mean core-CPI inflation: 2.2%.), core measures of inflation have more often than not been at or below the upper range of the Fed's error band, especially for core-PCE inflation. And this included periods in which the US economy was at times substantially outperforming the current environment no less. What to make of the downward GDP revision in Q1 Stephen Cecchetti and Kermit Schoenholtz write that growth from the fourth quarter of 2013 to the first quarter of 2014, originally thought to have been about +0.1% in April, was revised last week to –2.9%. News reports varied between shock and concern. Was the anemic recovery over? Or, was it just that this winter was especially harsh? Kevin Drum writes that there are two way to look at this. The glass-half-full view is: Whew! That huge GDP drop in Q1 really was a bit of a blip, not an omen of a coming recession. The economy isn't setting records or anything, but it's back on track. The glass-half-empty view is: Yikes! If the dismal Q1 number had really been a blip, perhaps caused by bad weather, we'd expect to see makeup growth in Q2. It's just horrible news if it turns out that during a "recovery" we can experience a massive drop in GDP and then do nothing to make up for it over the next quarter. Gavyn Davies writes that if confirmed in future releases, this would be the weakest quarter for US real GDP outside a recession since the Second World War. The markets largely ignored this piece of news because investors still seem convinced that the first quarter was hit by a series of temporary shocks to GDP. The extreme weather was clearly the main such shock (a point confirmed with micro data by Atif Mian and Amir Sufi), but there was also an outsized downward revision to the official estimate of consumers’ expenditure on health services. Another reason why the markets are ignoring any recession risk in the US is that the GDP data are at odds with many other sources of information on the underlying growth rate in the American economy, including the improving employment data, buoyant business surveys, and robust manufacturing and durable goods reports. Stephen Cecchetti and Kermit Schoenholtz point to two factors that deserve deserve special attention: (1) the statistical noise created by seasonality; and (2) the propensity

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to revise GDP many years after the period being measured. Seasonality in GDP is enormous. The chart below shows that the seasonal adjustments swamp the small changes in the adjusted growth rates. If you looked only at unadjusted data, you could say that the U.S. economy goes through a depression in the first quarter of every year, as the level of output plunges on average by 18 percent! When the seasonal factor is large and variable, as it is in the first quarter of every year in the United States, it is heroic to draw inferences from a percentage point here or there.

Source: Stephen Cecchetti and Kermit Schoenholtz Stephen Cecchetti and Kermit Schoenholtz write that revisions can also be quite big. Prior to last week’s release of revised first-quarter data, the biggest revision on record was only 2.5 percentage points. So, a 3-percentage point revision only three months after the quarter ended is enormous. Nevertheless, further large revisions may still lie ahead! Statistically, the revisions to economic growth for quarter t between the t+3- month estimate (which we just received last week for the first quarter) to the t+10-year estimate (which will not be available for nearly a decade) have ranged from minus 6 percentage points to plus 7 percentage points over the past 40 years, with a standard deviation of about 2 percentage points. | Read more at Bruegel http://www.bruegel.org/nc/blog/detail/article/1385-blogs-review- us-inflation-and- growth/?utm_source=Bruegel+economic+blogs+review&utm_campaign=f14a281be0- BEBR29&utm_medium=email&utm_term=0_14a9e32a9c-f14a281be0-277483461

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SUNDAY, JULY 06, 2014 Is Inflation Coming? by Bill McBride on 7/06/2014 02:42:00 PM Joe Weisenthal at Business Insider writes: These Three Charts Show Inflation Is Finally Right Around The Corner After this week's strong Jobs Report, it's becoming conventional wisdom that the economy is heating up for real this time. After numerous false starts and disappointments since the financial crisis, it appears we've kicked into a higher gear. A stronger economy should mean higher inflation. That's because as the economy grows, slack diminishes in the economy (both industrial slack and labor market slash) and that puts pricing pressure on existing resources. It makes sense, as the unemployed become more scarce, employed workers have greater bargaining power for wages. I also think the economy is picking up, and I agree that as slack diminishes, we will probably see real wage growth and an uptick in inflation. However, this is convincing: These three charts from Deutsche Bank economist Torsten Slok make for a good overview of the case that inflation is coming. ... Historically, when Capacity Utilization is as high as its now (suggesting not much industrial slack) the inflation rate has been much higher.

Here is the first chart. This shows capacity utilization and the year-over-year change in CPI.

Capacity Utilization has been increasing, and the author write "No good reasons why this gap should persist" (gap between Capacity utilization on the chart and CPI). Whenever I see a correlation chart like this, I like to see what happened in earlier periods. The second graph shows the same data, but this time starting in 1990 (instead of 2001). For most of the '90s there was a huge "gap" between capacity utilization and CPI. There were periods when capacity utilization was higher than now - and inflation lower. As an example, capacity utilization was close to 83% in 1998, and YoY inflation averaged 1.5%. So I don't think the first graph is convincing that inflation is "right around the corner". (the last two graphs are from a small survey and also not convincing). My view is inflation is increasing a little (as was expected), but is not a concern this year.

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Read more at http://www.calculatedriskblog.com/2014/07/is-inflation- coming.html#t0oh7EiLQ0IGtDM6.99 MONDAY, JULY 07, 2014 Dorms as "Parents' Home": The long term trends for higher enrollment by Bill McBride on 7/07/2014 09:44:00 AM On Friday I noted an article by Derek Thompson in the Atlantic: The Misguided Freakout About Basement-Dwelling Millennials More than 15.3 million twentysomethings—and half of young people under 25—live "in their parents’ home," according to official Census statistics.

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There's just one problem with those official statistics. They're criminally misleading. When you read the full Census reports, you often come upon this crucial sentence: It is important to note that the Current Population Survey counts students living in dormitories as living in their parents' home. As Thompson noted, most of the recent increase in the percent living "in their parents' home" is related to living in dorms. This is an important point since there is a long term trend for higher school enrollment (so we shouldn't "freak out" about the reported increase in young people living at home). And higher school enrollment generally means lower labor force participation (as I've pointed out before, the decline in the overall labor force participation rate is due to several factors, but two of the most important are aging of the baby boomers and more younger people staying in school). This graph uses data from the BLS on participation rate, and the National Center for Education Statistics (NCES) on enrollment rates (most recent data for 2012). This graph shows the participation and enrollment rates for the 18 to 19 year old age group. These two lines are a "mirror image". Note: I added the participation rate for men and women too. One of the key labor stories in the 2nd half of the 1900s was the surge in participation by women.

The third graph shows the participation and enrollment rates for the 20 to 24 year old age group. Once again the participation rate is declining as the enrollment rate is increasing. The participation rate (all) was rising in the '70s and early '80s because of the increase in women entering the labor force. So don't worry about the kids living in their parents' basements - they are actually living in dorms. In the long run, more education is a positive for the economy. Hey, the kids are alright! http://www.calculatedriskblog.com/2014/07/dorms-as-parents-home-long-term-trends.html

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Daily Morning Newsbriefing July 11, 2014 The stupidity of Portugal’s early exit The Portuguese banking crisis span out of control yesterday, with the suspension in share of Banco Espirito Santo (BES), sending European stock markets tumbling, and triggering a sharp rise in Portuguese bond yields. Portugal’s banking crisis is also a cautionary tale of government exiting their programme prematurely for prestige reasons. BES Shares were suspended from trading after falling an additional 17%. Shares of the lender's controlling shareholder, Espírito Santo Financial Group (ESFG), were also suspended, quoting "ongoing material difficulties" as were the share of its parent company, Espírito Santo International (ESI). Earlier this week, ESI missed interest payments on some of its short-term securities triggering massive nervousness amongst investors over the health of Portugal’s financial sector. Portuguese 10-year borrowing costs for Portugal’s government paper rose 21 basis points on Thursday, to 3.97%. The reason why markets are concerned about Portugal is that the country is no longer under a bailout programme. How Portugal would deal with an eventual problem with the domestic bank is not clear, according to Marketwatch. Analysts now worry that Portugal exited the bailout programme too soon. Reuters notes that the markets still differentiate between countries, e.g. there is no sign Ireland is yet affected, but that the turmoil is spreading throughout Southern Europe. Greece's sale of three-year bonds yesterday attracted only mediocre demand compared with recent offerings. Athens raised €1.5bn, well below the €2.5bn-€3bn it was widely expected to achieve. Total bids were only €3bn. Spain's Banco Popular Espanol was forced to postpone the sale of contingent convertible debt citing poor market conditions. In Italy a drug company pulled its stock offering. And stock markets across the continent fell, along with the euro. Portugal’s benchmark stock index slumped 4.2% to 6,105.24, its biggest drop since July last year. Hardest hit shares were southern European banks, with Banco Comercial Português down 6% in Lisbon, Banca Monte dei Paschi di Siena off 4.3% in Milan and Banco Popular Español 2% weaker in Madrid. BES seeks to reassure the markets by sending messages to show that it is independent of the struggle in ESI. Yesterday it said it had a capital cushion of €2.1bn which exceeds its exposure to ESFG and to its retail customers, Jornal de Negocios reports this morning. BES is one of the European banks operating in Spain through branches and not subsidiaries, which means they are not covered by Spanish deposit insurance and also are not regulated by the Bank of Spain. This has allowed BES to elude efforts by 181

the Bank of Spain in the last couple of years to limit the remuneration of time deposits by Spanish Banks to prevent a recurrence of the kinds of damaging “liability price wars” seen before the banking rescue. As Cinco Días reported in February, the Bank of Spain had limited deposits with a maturity up to 12 months to paying up to 1.25%, while BES offered 2.50%. Cinco Días called this “an oasis of yield for the conservative investor”. At the start of 2013, when the BdE limited 1y deposit yields to 1.75%, BES offered 4.60% for deposits above €50,000 according to El Confidencial which touted its “aggressiveness”. Italian Senate Reforms: A substantive package Matteo Renzi’s victory at European elections had all sorts of important political effects – one of them is the acceleration of his political reforms. Yesterday the constitutional affairs committee of the Senate agreed a compromise on the future of the Senate as part of a wider constitutional reform. The compromise came after endless haggling, the usual chaos and a final leaders‘ summit. It is essentially carried by Renzi’s own coalition, and Silvio Berlusconi’s Forza Italia. The conclusion of the Constitutional Reforms pave the way to an agreement on electoral reforms. The reforms will go to the floor of the Senate next week. The reform will reduce the powers of the Senate and turn it into a committee of the regions – similar, though not quite, to Germany’s Bundesrat. These are the main points drawn up from various sources, in particular this. Here are the main points: The chamber of deputies will be the main parliamentary assembly. Only the assemby will have the right to express confidence in the prime minister. The present, and likely future, electoral systems guarantee that the largest party coalition has an automatic majority in the chamber of deputies. The future Senate will be made up of 100 Senators, 95 of which are to be elected by the Regional Councils. There is a complicated regional key about how this is distributed. For example, one of the Senators in each of the regions will have to be a mayor. The indirect election of the Senate was a compromise Renzi had to concede. He wanted them nominated, not elected, so that they do not claim indepenent powers. An additional five Senators will be appointed by the Head of State and will remain in office for seven years. The Senate will have full legislative powers on constitutional reforms and laws. It will be a revising chamber for other legislation, but the chamber is not bound by the revisions. On certain legislation, the chamber requires an absolute majority to overturn a Senate revision; Title V of the Italian institution, which sets out the powers of the regions and the state, has been revised. The state gets the explicit right to act in the fields of energy, strategic infrastructure, and transmission grids. The regions will also get certain powers back (much haggling here too, but Renzi essentially got what he needed). The President of the Republic will be elected by the combined 630 deputies in the chamber and the 100 Senators under a specified voting procedure.

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A referendum is possible, but requires 800,000 signatures. When the hurdle of 400,000 signatures is met, the Constitutional Court will provide an opinion on whether the referendum is eligible. The constitution raises the hurdle for a legislative initiative by the public, raising the number of required signatures from 50,000 to 250,000. The upside is that the chamber has to take up the initiative in a required time. For Renzi what matters is that the Senate can no longer topple the prime minister, and that the prime minister can rely on his majority in the chamber to pass important economic reforms. The new electoral system will still favour electoral blocks of parties – not single parties – but it will benefit the large parties. The downside is, of course, if Renzi fails to turn around the economy in the next two and half years, Beppe Grillo could emerge as the winner of the next elections, with unprecedented (for Italy) powers. Renzi said he needs to pass the political reforms without which he cannot pass the economic reforms. That judgement is probably right. But it is also a risky procedure because it relies on Renzi’s ability to deliver not only the reforms, but also the results of the reforms before the next elections. TLRTO in Italy Reuters has a story quoting Iganzio Visco as predicting that TLTRO could raise Italian GDP by between 0.5% and 1% by 2016, as Italian banks could draw more than €200bn. Unicredit said it would borrow between €14-15bn in TLTRO loans, and would pass on the cheap financing rates when lending to businesses. In a speech yesterday, Visco said the process by which banks can offload their non-performing loans, worth some €165bn, has been very slow. So far only €5bn have been sold to specialist invesotors. Italy’s economic recovery seems to be stall. In line with figures from Germany, industrial output in Italy also declined sharply in May, back on geopolitical uncertainties. Reuters says it was the steepest fall since November 2012. The extent of the fall came as a surprise. Istat also revised the April data for industrial production downwards, and described them as "very negative". The German economics ministry said yesterday that the recent declines in industrial production were only temporary, and that the economy had since picked up. Eurozone unites in opposition to US Another spy scandal and the expulsion of the German CIA rep is making the big headlines. But there is a parallel story going on possibly greater signficance. German banks and industry are also becoming alarmed about the US’s use of extra-terroritorial powers, and how this migh distort competition. Frankfurter Allgemeine leads its business section, reporting on the outrage by German bankers and industry leaders at the fines imposed on European banks for violating US sanction rules. BNP Paribas was fined €9bn, and both Deutsche Bank and Commerzbank are also in the pipeline for reprisal by the US courts. The paper quotes Ulrich Grillo, head of the German federation of industry, as saying that the US was strategically weakening the European banking sectors in order then to buy the banks on the cheap. The paper also made an interview with Pierre Gattaz, the head of Medef, the French industry association. Gattaz made an almost identical point. Europe must defend itself against US attempt to weaken the European banking sector. 183

Grillo made another important point. He claimed that differential tax treatments had allowed US companies to amass a total of €900bn in wealth, which it could deploy for foreign acquisisions by outbidding European rivals. He was referring specifical to the GE bid for Alstrom. It was imperative that global competition requires global tax harmonisation. We don’t usually report on the demands by lobbyists. But this is unusual in scope and in tone. The combination of the spying affair and the mega-fines on European banks leads to an unprecedented alliance of the Left and the business elite – and in a country governed by a Grand Coalition, this can have powerful effects. We ourselves do not buy into grand scale conspiracy theories, according to which the US justice system and the economic elites are colluding. But what we are seeing are a coincidence of a number of factors – including a president with an obvious lack of interest in his European allies – that are dividing the EU and the US. We would be surprised if TTIP could be passed in such an environment. IMF: Spain has turned a corner but unemployment remains high In its latest chapter 4 consultation report on Spain, the IMF finds that “Spain has turned the corner” with improving growth, employment, and current account indicators, and a healthier financial system with record low sovereign yields. However, unemployment remains “unacceptably” high with falling incomes, low productivity growth and public and private deleveraging dragging on growth. The IMF improves its outlook significantly relative to the previous semester’s report, but the outlook still significantly undershoots the Spanish government’s projections in the stability program update last submitted to the European Commission. In particular, the IMF has doubled its growth forecast for 2014 and now agrees with the 1.2% projection by the Spanish government. The IMF advises:  coordinated corporate debt restructuring and a new personal insolvency regime;  further recapitalizing banks;  lowering the tax wedge on the hiring of unskilled workers;  compensated by higher indirect taxes;  reducing the dual nature of the labour market;  “active employment policies”;  favouring firm-level over sectoral collective bargaining;  growth- and job-friendly fiscal consolidation;  ECB monetary expansion “to achieve its inflation targets”. The side effects of monetary policy I- Papadia Francesco Pappadia says that he is sceptical on the effectiveness of macroprudential policies. Yet he does not agree that interest rates should be used to stabilise financial markets. He also sees stability risks that need to be addressed? So how to square this? His first observation is that an environment of price stability in the long-run will reduce financial stability risks. In a conflict arises, policy makers should use macropru as a “first line of defence“, and interest rates as a last ressort.

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We don’t agree entirely with that conclusion. First, price stablity and financial stability may co-exist in structural conflict – or at least independent of each other in the sense that it is possible for economies to generate persistent financial instability even in periods of long-term price stability. Macroprudential methods still need development and fine-tuning, but if one concludes that they are not very effective, as the BIS has done, then one arrives at the “last line of defence” pretty quickly. The dilemma would not really be resolved. We do not have an answer either. But we fear that Tinbergen is not going to be of much help here. The side effects of monetary policy II – Bini-Smaghi Lorenzo Bini-Smaghi makes a strong case against the argument that monetary policy should discipline fiscal policy. He says the Bundesbank is right to point out that low interest rates have unintended adverse consequences. They might indeed discourage politicians from pursuing structural reforms. But it is not clear that a central bank should incorporate these effects into their own policy frameworks because it would jeopardise its own price stability objective. It would also undermine its claim to independence if it engaged as a political player. Third, it is not clear that higher interest rates would encourage structural reforms. When credit conditions are too tight, there are powerful offsetting effects. And it runs against the eurozone’s own experience. Governments were not rewarded by a monetary relaxation when they tightened fiscal policy during the recession.

Eurozone Financial Data

10y spreads Previous day Yesterday This Morning France 0.325 0.333 0.339 Italy 1.651 1.765 1.764 Spain 1.529 1.624 1.648 Portugal 2.568 2.810 2.813 Greece 4.883 5.126 5.10 Ireland 1.089 1.138 1.130 Belgium 0.418 0.433 0.439 Bund Yield 1.231 1.203 1.204

exchange rates This Previous morning Dollar 1.364 1.3604 Yen 138.240 137.76 Pound 0.797 0.7941 185

Swiss Franc 1.214 1.2138

ZC Inflation Swaps previous last close 1 yr 0.72 0.72 2 yr 0.75 0.75 5 yr 1.2 1.21 10 yr 1.64 1.64

Eonia 09-Jul-14 0.03 08-Jul-14 0.03 07-Jul-14 0.03 04-Jul-14 0.03

OIS yield curve 1W 0.048 15M 0.071 2W 0.052 18M 0.049 3W 0.063 21M 0.058 1M 0.058 2Y 0.080 2M 0.070 3Y 0.122 3M 0.069 4Y 0.232 4M 0.083 5Y 0.353 5M 0.059 6Y 0.506 6M 0.084 7Y 0.672 7M 0.070 8Y 0.834 8M 0.068 9Y 0.983 9M 0.065 10Y 1.119 10M 0.064 15Y 1.609 11M 0.051 20Y 1.835 1Y 0.058 30Y 1.968

Euribor-OIS Spread previous last close 1 Week -1.929 -2.229 186

1 Month 2.586 2.986 3 Months 10.343 10.743 1 Year 37.757 38.157

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 11.html?cHash=715c8ee842f940e19706abe2ef52a1af

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Speech

Other Formats Vice Chairman Stanley Fischer At the Martin Feldstein Lecture, National Bureau of Economic Research, Cambridge, Massachusetts July 10, 2014 Financial Sector Reform: How Far Are We? Although the recession in the United States that started in December 2007 ended in June 2009, the impact of the Great Recession, which began when Lehman Brothers filed for bankruptcy on September 15, 2008, continues to be felt in the United States, Europe, and around the world.1 After the bankruptcy of Lehman Brothers, policymakers, working through the G-20, quickly reached agreement on the macroeconomic policies needed to minimize the damage done by the crisis. For their part, central bankers and supervisors of financial systems, working through the newly established Financial Stability Board (FSB) and the newly enlarged Basel Committee, rapidly developed a program for reform of the financial sector and its supervision. In this lecture I will ask how much has been achieved so far in implementing the ambitious financial sector reform program that was widely agreed at the early stages of the global financial crisis. From among the range of topics in which financial sector reforms have been instituted since 2008, I focus on three: capital and liquidity for banks and other financial institutions, macroprudential supervision, and the problem of too big to fail (TBTF). What Happened? The 2007-09 crisis was both the worst economic crisis and the worst financial crisis since the 1930s. Following the collapse of Lehman Brothers, many thought that we were about to witness a second Great Depression. That did not happen, in large part because policymakers had learned some of the lessons of the Great Depression. Nonetheless, the advanced economies were put through severe economic and political tests. Fortunately, policymakers succeeded in dealing with the situation better than many had feared they would; unfortunately, we are still dealing with the consequences of the collapse and the steps necessary to deal with it. Former Congressman Barney Frank has been heard to say that economists have a wonderful technique, that of the counterfactual, to analyze what has been achieved by preventing disasters, but that real people base their judgments more on the current state of the world than on disasters that have not happened. True as that may be, we should from time-to-time allow ourselves to recognize that as bad as the Great Recession has been, it would have been much worse had policymakers not undertaken the policies they did--many of them unorthodox and previously untried--to deal with the imminent crisis that confronted the United States and global economies after the fall of Lehman Brothers. And for that, we owe them our gratitude and our thanks. The Financial Sector Reform Program Several financial sector reform programs were prepared within a few months after the Lehman Brothers failure. These programs were supported by national policymakers, including the community of bank supervisors.

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The programs--national and international--covered some or all of the following nine areas:2 (1) to strengthen the stability and robustness of financial firms, "with particular emphasis on standards for governance, risk management, capital and liquidity"3 (2) to strengthen the quality and effectiveness of prudential regulation and supervision; (3) to build the capacity for undertaking effective macroprudential regulation and supervision; (4) to develop suitable resolution regimes for financial institutions; (5) to strengthen the infrastructure of financial markets, including markets for derivative transactions; (6) to improve compensation practices in financial institutions; (7) to strengthen international coordination of regulation and supervision, particularly with regard to the regulation and resolution of global systemically important financial institutions, later known as G-SIFIs; (8) to find appropriate ways of dealing with the shadow banking system; and (9) to improve the performance of credit rating agencies, which were deeply involved in the collapse of markets for collateralized and securitized lending instruments, especially those based on mortgage finance. Rather than seek to give a scorecard on progress on all the aspects of the reform programs suggested from 2007 to 2009, I want to focus on three topics of particular salience mentioned earlier: capital and liquidity, macroprudential supervision, and too big to fail. Capital and Liquidity Ratios At one level, the story on capital and liquidity ratios is very simple: From the viewpoint of the stability of the financial system, more of each is better. This is the principle that lies behind the vigorous campaign waged by Anat Admati and Martin Hellwig to increase bank capital ratios, set out in their book, The Bankers' New Clothes: What's Wrong with Banking and What to Do about It, and in subsequent publications.4 But at what level should capital and liquidity ratios be set? In practice, the base from which countries work is agreement among the regulators and supervisors who belong to the Basel Committee on Banking Supervision (BCBS). At one time the membership consisted of the members of the G-10 plus Switzerland. It now includes the membership of the G-20 plus a few other countries.5 Following the global crisis, the BCBS moved to the Basel III agreement, which strengthens capital requirements, as opposed to Basel II, which tried to build primarily on measures of risk capital set by internal models developed by each individual bank. This approach did not work, partly because the agreed regulatory minimum capital ratios were too low, but also because any set of risk weights involves judgments, and human nature would rarely result in choices that made for higher risk weights. In the United States, the new regulations require large bank holding companies (BHCs) to use risk-weighted assets (RWAs) that are the greater of those produced by firms' internal models or the standardized risk weights, some of which have been raised, thus mitigating the problem of the use of internal risk ratings. What has been achieved? Globally  The minimum tier 1 capital ratio has been raised from 4 percent to 6 percent of RWA.  There is a minimum common equity tier 1 capital ratio of 4.5 percent of RWA.  There is a capital conservation buffer of 2.5 percent of RWA, to ensure that banking organizations build capital when they are able to.  A countercyclical capital buffer has been created that enables regulators to raise risk- based capital requirements when credit growth is judged to be excessive.  A minimum international leverage ratio of 3 percent has been set for tier 1 capital relative to total (i.e., not risk-weighted) on-balance-sheet assets and off-balance-sheet exposures. 189

 There is a risk-based capital surcharge for global systemically important banks (G-SIBs) based on these firms' systemic risk. In addition, in the United States  The Federal Reserve is planning to propose risk-based capital surcharges for U.S. G- SIBs, based on the BCBS proposal for G-SIBs.6  The relevant U.S. regulators (the Fed, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (FDIC)) have raised the Basel III leverage ratio for U.S. G-SIBs to 5 percent; U.S. G-SIBs that do not achieve this ratio will face limits on their ability to distribute dividends and to pay discretionary employee bonuses.7  Foreign banking organizations with U.S. nonbranch assets of $50 billion or more will have to form U.S. intermediate holding companies that will have to meet essentially the same capital requirements as U.S. BHCs with $50 billion or more of assets. Many of these rules do not apply to community banks, in light of their different business models. One more point on bank capital: The Swiss and Swedish regulators have already gone far in raising capital requirements, including by requiring bail-in-able secondary holdings of capital in the form of contingent convertible capital obligations (CoCos). The United States may be heading in a similar direction, but not by using CoCos, rather by requiring minimum amounts of "gone-concern" loss absorbency--in the form of long-term debt--that would be available for internal financing recapitalization through a new orderly liquidation mechanism created by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). In addition to enhanced capital ratios and tougher measures of risk-based capital, the Basel III accord includes bank liquidity rules, another key element of global financial regulatory reform. The Basel Committee has agreed on the Liquidity Coverage Ratio (LCR), which is designed to reduce the probability of a firm's liquidity insolvency over a 30-day horizon through a self- insurance regime of high-quality liquid assets (HQLA) to meet short-term stressed funding needs. The BCBS is also working to finalize the Net Stable Funding Ratio (NSFR), which helps to ensure a stable funding profile over a one-year horizon. The bottom line to date: The capital ratios of the 25 largest banks in the United States have risen by as much as 50 percent since the beginning of 2005 to the start of this year, depending on which regulatory ratio you look at. For example, the tier 1 common equity ratio has gone up from 7 percent to 11 percent for these institutions. The increase in the ratios understates the increase in capital because it does not adjust for tougher risk weights in the denominator. In addition, the buffers of HQLAs held by the largest banking firms have more than doubled since the end of 2007, and their reliance on short-term wholesale funds has fallen considerably. At the same time, the introduction of macroeconomic supervisory stress tests in the United States has added a forward-looking approach to assessing capital adequacy, as firms are required to hold a capital buffer sufficient to withstand a several-year period of severe economic and financial stress. The stress tests are a very important addition to the toolkit of supervisors, one that is likely to add significantly to the quality of financial sector supervision. Macroprudential Policy and Supervision In practice, there are two uses of the term "macroprudential supervision."8 The first relates to the supervision of the financial system as a whole, with an emphasis on interactions among financial markets and institutions. The second relates to the use of regulatory or other noninterest-rate tools of policy to deal with problems arising from the behavior of asset prices.9 For

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instance, when central bank governors are asked how they propose to deal with the problem of rising housing prices at a time when the central bank for macroeconomic reasons does not want to raise the interest rate, they generally reply that if the need arises, they will use macroprudential policies for that purpose. By that they mean policies that will reduce the supply of credit to the housing sector without changing the central bank interest rate. Sector-specific regulatory and supervisory policies in the financial sector were used extensively and systematically in the United States in the period following World War II until the 1990s and are now being used in other advanced and developing countries. Elliott, Feldberg, and Lehnert review the use of such measures in the United States.10 Frequently, these policies were aimed at encouraging or discouraging activity in particular sectors, for example agriculture, exports, manufacturing, or housing; sometimes broad, non-interest-rate measures were used to try to deal with inflation or asset-price increases, for instance, the use of credit controls. The issue of how monetary policy should relate to asset-price inflation had been on the agenda of central bankers for many years before the Lehman Brothers' failure.11 The issue became more prominent in the United States in the 1990s and the first few years of this century, and temporarily culminated in the Fed's "mopping-up" approach, namely that monetary policy-- meaning interest rate policy--should not react to rising asset prices or suspected bubbles except to the extent that they affect either employment and/or price stability. Operationally, this approach was much more likely to lead to action after the bubble had burst than as it was forming.12 The policy was tested in the bursting of the tech bubble in 2001 and appeared to be successful as the economy recovered from 2002 onward.13 However, the mopping-up doctrine did not include the second element of the macroprudential approach--the use of regulatory and supervisory measures to deal with undesired asset-price movements when the central bank interest rate was judged not to be available for that purpose. At present, the word macroprudential is used primarily in the second sense--of the use of regulatory and supervisory noncentral bank interest rate tools to affect asset prices. In this sense, the use of the word takes us back to a world that central bankers thought they had left by the 1990s.14 Now, from etymology to economics: I want to review my experience with macroprudential policies--in the second sense of noninterest regulatory and supervisory policies--as Governor of the Bank of Israel to draw a few key lessons about the use of these policies. To set the background: There was no financial crisis in Israel during the Great Recession. As domestic interest rates declined along with global rates, housing prices began to rise.15 This is a normal part of the textbook adjustment mechanism and is expected to encourage an increase in the rate of homebuilding. The rate of building increased, but not sufficiently to meet the demand for housing, and prices continued to rise.16 The banks are the largest financial institutions in Israel and dominate housing finance. The supervisor of banks reports to the governor of the central bank. Starting in 2010, the supervisor began to implement a series of measures to reduce the supply of housing finance by the banks. Among the measures used were increasing capital requirements and provisioning against mortgages; limiting the share of any housing financing package indexed to the short-term (central bank) interest rate to one-third of the total loan, with the remainder of the package having to be linked to either the five-year real or five-year nominal interest rate; and, on different occasions, limiting the loan-to-value (LTV) and payment-to-income (PTI) ratios.17 Additional precautionary measures were implemented in the supervision of banks.18 The most successful of these measures was the limit of one-third imposed in May 2011 on the share of any housing loan indexed in effect to the Bank of Israel interest rate. Competition among the banks had driven the spread on floating rate mortgages indexed to the Bank of Israel rate down to 60 basis points, which meant that mortgage financing was available at an 191

extremely low interest rate. The term-structure was relatively steep, so that the requirement that the remaining two-thirds of any financing package had to be indexed to a five-year rate-- whether real or nominal--made a substantial difference to the cost of housing finance. In addition, increases in both LTV and PTI ratios were moderately effective. However, increasing capital charges had very little impact in practice. There are three key lessons from this experience. First, the Bank of Israel did not have good empirical estimates of the effectiveness of the different macroprudential measures. 19 This problem is likely to be relevant in many countries in large part because we have relatively little experience of the use of such measures in recent years.20 Policymakers may thus be especially cautious in the use of measures of this type. Second, measures aimed at reducing the demand for housing are likely to be politically sensitive.21 Their use requires either very cautious and well-aimed measures by the regulatory authorities, and/or the use by the government of subsidies to compensate some of those who end up facing more difficulty in buying housing as a result of the imposition of macroprudential measures. Indeed, it often appears that there is a conflict between cautious risk management by the lenders and the desire of society to house its people decently. Third, there is generally a need for coordination among several regulators and authorities in dealing with macroprudential problems of both types. There are many models of regulatory coordination, but I shall focus on only two: the British and the American. As is well known, the United Kingdom has reformed financial sector regulation and supervision by setting up a Financial Policy Committee (FPC), located in the Bank of England; the major reforms in the United States were introduced through the Dodd-Frank Act, which set up a coordinating committee among the major regulators, the Financial Stability Oversight Council (FSOC). In discussing these two approaches, I draw on a recent speech by the person best able to speak about the two systems from close-up, Don Kohn.22 Kohn sets out the following requirements for successful macroprudential supervision: to be able to identify risks to financial stability, to be willing and able to act on these risks in a timely fashion, to be able to interact productively with the microprudential and monetary policy authorities, and to weigh the costs and benefits of proposed actions appropriately. Kohn's cautiously stated bottom line is that the FPC is well structured to meet these requirements, and that the FSOC is not. In particular, the FPC has the legal power to impose policy changes on regulators, and the FSOC does not, for it is mostly a coordinating body. After reviewing the structure of the FSOC, Kohn presents a series of suggestions to strengthen its powers and its independence. The first is that every regulatory institution represented in the FSOC should have the goal of financial stability added to its mandate. His final suggestion is, "Give the more independent FSOC tools it can use more expeditiously to address systemic risks." 23 He does not go so far as to suggest the FSOC be empowered to instruct regulators to implement measures somehow decided upon by the FSOC, but he does want to extend its ability to make recommendations on a regular basis, perhaps on an expedited "comply-or-explain" basis. Kohn remarks that he does not hold up the U.K. structure of macroprudential supervision as ideal for all countries at all times and further notes that the U.K. system vests a great deal of authority in a single institution, the Bank of England. This element is not consistent with the U.S. approach of dispersing power among competing institutions. These are important, and difficult, issues. Kohn's proposals clearly warrant serious examination. It may well be that adding a financial stability mandate to the overall mandates of all financial

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regulatory bodies, and perhaps other changes that would give more authority to a reformed FSOC, would contribute to increasing financial and economic stability. Financial Reform and TBTF Diagnoses of what went wrong with the financial system at the start of the Great Recession in the United States generally placed heavy emphasis on the problem of too big to fail. The TBTF problem derives from the typical response of governments confronted by the potential failure of a large bank, which is to intervene to save the bank and some of its noninsured creditors.24 In the words of Governor Tarullo, "...no matter what its general economic policy principles, a government faced with the possibility of a cascading financial crisis that could bring down its national economy tends to err on the side of intervention."25 I will start by discussing some of the main steps in the links between TBTF and the crisis, and between the financial sector reform program and TBTF. We begin with the link between TBTF and government intervention: Once investors believe that governments will intervene to prevent large banks from becoming bankrupt, they become willing to lend to these banks at lower rates than they would lend without the implicit guarantee. This could lead to such banks becoming larger than optimal and to encouraging them to take more risks than they would absent expected government intervention to reduce the likelihood of their becoming bankrupt. A great deal of empirical work has attempted to measure the premium--in terms of a lower cost of financing--that the large banks typically receive. The results vary, but a representative set of estimates--that of the International Monetary Fund in its April 2014 issue of the Global Financial Stability Report--reports that in 2013 their estimates of the premium were approximately 15 basis points in the United States, 25-60 basis points in Japan, 20-60 basis points in the United Kingdom, and 60-90 basis points in the euro area.26 The estimated premium in the United States was higher at the height of the financial crisis, and has been declining since then in response to the significant steps made in the regulatory reform agenda. Do large banks, with lower costs of financing, take bigger risks? The empirical relationship between bank size and their risk-taking has been examined by Laeven, Ratnovski, and Tong, who find that "large banks tend to have lower capital ratios, less stable funding, more market- based activities, and (to) be more organizationally complex than small banks."27 From this they conclude that "[l]arge banks are riskier, and create more systemic risk, when they have lower capital and less-stable funding. [They] create more systemic risk (but are not individually riskier) when they engage more in market-based activities or are more organizationally complex."28 The key to these results is the recognition that banks have several sources of financing, and that the more they rely on market interest rate-sensitive short-term funding, the less stable they are likely to be. Organizational complexity is certainly an issue: Maintaining managerial control, especially risk control, in a multi-activity bank, where individual rewards may be massive, is extremely difficult--think for instance of Baring's in the late 1990s, or Societe Generale, or the so-called London Whale at JPMorgan Chase. Strong risk management is essential but faces the hurdle of the structural incentives for risk-taking implied by limited liability for individuals and by what may be a human proclivity to take risks.29 But of course, banks that are heavily consumer deposit financed also fail from time to time, as a result of bad lending decisions. It could be that large banks can finance themselves more cheaply because they are more efficient, that is, that there are economies of scale in banking. For some time, the received wisdom was that there was no evidence of such economies beyond relatively modest-sized banks, with balance sheets of approximately $100 billion. More recently, several papers have found that economies of scale may continue beyond that level. For example, the title of a paper by Joseph Hughes and Loretta Mester, "Who Said Large Banks Don't Experience Scale

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Economies? Evidence from a Risk-Return Driven Cost Function"30 suggests that large institutions may be better able to manage risk more efficiently because of "technological advantages, such as diversification and the spreading of information...and other costs that do not increase proportionately with size." That said, these authors conclude that "[W]e do not know if the benefits of large size outweigh the potential costs in terms of systemic risk that large scale may impose on the financial system." They add that their results suggest that "strict size limits to control such costs will likely not be effective, since they work against market forces..." The TBTF theory of why large banks are a problem has to contend with the history of the Canadian and Australian banking systems. Both these systems have several very large banks, but both systems have been very stable--in the Canadian case, for 150 years.31 Beck, Demirguc- Kunt, and Levine (2003) examined the impact of bank concentration, bank regulation, and national institutions on the likelihood of a country suffering a financial crisis and concluded that countries are less likely to suffer a financial crisis if they have (1) a more concentrated banking system, (2) fewer entry barriers and activity restrictions on bank activity, and (3) better- developed institutions that encourage competition throughout the economy.32 The combination of the first finding with the other two appears paradoxical, but the key barrier to competition that was absent in Canada was the prohibition of nationwide branch banking, a factor emphasized by Calomiris and Haber in their discussion of the Canadian case.33 In addition, I put serious weight on another explanation offered in private conversation by a veteran of the international central banking community, "Those Canadian banks aren't very adventurous," which I take to be a compliment.34 Why is the TBTF phenomenon so central to the debate on reform of the financial system? It cannot be because financial institutions never fail. Some do, for example, Lehman Brothers and the Washington Mutual failed in the Great Recession. Other banks were merged out of existence, often at very low prices, with the FDIC managing the resolution process. Banks in the United Kingdom and in Europe failed during the Great Recession. It cannot be because equity- holders never lose in bank crises. It could be because until now, bond holders in large banks rarely have lost significantly in crises--rather, for fear of contagion, they ended up being protected by the government. Almost certainly, TBTF is central to the debate about financial crises because financial crises are so destructive of the real economy. It is also because the amounts of money involved when the central bank or the government intervenes in a financial crisis are extremely large, even though the final costs to the government, including the central bank, are typically much smaller. In some cases, governments and central banks even come out slightly ahead after the crisis is over and the banks have been sold back to the private sector. Another factor may be that the departing heads of some banks that failed or needed massive government assistance to survive nonetheless received very large retirement packages. One can regard the entire regulatory reform program, which aims to strengthen the resilience of banks and the banking system to shocks, as dealing with the TBTF problem by reducing the probability that any bank will get into trouble. There are, however, some aspects of the financial reform program that deal specifically with large banks. The most important such measure is the work on resolution mechanisms for SIFIs, including the very difficult case of G-SIFIs. In the United States, the Dodd-Frank Act has provided the FDIC with the Orderly Liquidation Authority (OLA)--a regime to conduct an orderly resolution of a financial firm if the bankruptcy of the firm would threaten financial stability. And the FDIC's single-point-of-entry approach for effecting a resolution under the new regime is a sensible proposed implementation path for the OLA. Closely associated with the work on resolution mechanisms is the living will exercise for SIFIs. In addition, there are the proposed G-SIB capital surcharges and macro stress tests applied to

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the largest BHCs ($50 billion or more). Countercyclical capital requirements are also likely to be applied primarily to large banks. Similarly the Volcker rule, or the Vickers rules in the United Kingdom or the Liikanen rules in the euro zone, which seek to limit the scope of a bank's activities, are directed at TBTF, and I believe appropriately so. What about simply breaking up the largest financial institutions? Well, there is no "simply" in this area. At the analytical level, there is the question of what the optimal structure of the financial sector should be. Would a financial system that consisted of a large number of medium-sized and small firms be more stable and more efficient than one with a smaller number of very large firms? That depends on whether there are economies of scale in the financial sector and up to what size of firm they apply--that is to say it depends in part on why there is a financing premium for large firms. If it is economies of scale, the market premium for large firms may be sending the right signals with respect to size. If it is the existence of TBTF, that is not an optimal market incentive, but rather a distortion. What would happen if it was possible precisely to calculate the extent of the subsidy or distortion and require the bank to pay the social cost of the expansion of its activity?35 This could be done either by varying the deposit insurance rate for the bank or by varying the required capital ratios for SIFIs to fit each bank's risk profile and structure. This, along with measures to strengthen large banks, would reduce the likelihood of SIFI failure--but could not be relied upon to prevent all failures. Would breaking up the largest banks end the need for future bailouts? That is not clear, for Lehman Brothers, although a large financial institution, was not one of the giants--except that it was connected with a very large number of other banks and financial institutions. Similarly, the savings and loan crisis of the 1980s and 1990s was not a TBTF crisis but rather a failure involving many small firms that were behaving unwisely, and in some cases illegally. This case is consistent with the phrase, "too many to fail." Financial panics can be caused by herding and by contagion, as well as by big banks getting into trouble. In short, actively breaking up the largest banks would be a very complex task, with uncertain payoff. The Bottom Lines The United States is making significant progress in strengthening the financial system and reducing the probability of future financial crises. In particular  By raising capital and liquidity ratios for SIFIs, and through the active use of stress tests, regulators and supervisors have strengthened bank holding companies and thus reduced the probability of future bank failures.  Work on the use of the resolution mechanisms set out in the Dodd-Frank Act, based on the principle of a single point of entry, holds out the promise of making it possible to resolve banks in difficulty at no direct cost to the taxpayer--and in any event at a lower cost than was hitherto possible. However, work in this area is less advanced than the work on raising capital and liquidity ratios.  Although the BCBS and the FSB reached impressively rapid agreement on needed changes in regulation and supervision, progress in agreeing on the resolution of G- SIFIs and some other aspects of international coordination has been slow.  Regulators almost everywhere need to do more research on the effectiveness of microprudential and other tools that could be used to deal with macroprudential problems.  It will be important to ensure that coordination among different regulators of the financial system is effective and, in particular, will be effective in the event of a crisis. 195

 A great deal of progress has been made in dealing with the TBTF problem. While we must continue to work toward ending TBTF or the need for government financial intervention in crises, we should never allow ourselves the complacency to believe that we have put an end to TBTF.  We should recognize that despite some imperfections, the Dodd-Frank Act is a major achievement.  At the same time, we need always be aware that the next crisis--and there will be one-- will not be identical to the last one, and that we need to be vigilant in both trying to foresee it and seeking to prevent it. And if, despite all our efforts, a crisis happens, we need to be willing and prepared to deal with it.

1. I began work on this lecture when I was a resident Distinguished Fellow at the Council on Foreign Relations and completed it after I joined the Federal Reserve Board on May 28, 2014. I am grateful to Dinah Walker of the Council on Foreign Relations for research assistance and to Nellie Liang, Skander Van den Heuvel, Mark Van Der Weide, William Bassett, Beth Kiser, Barbara Hagenbaugh, and Stacey Tevlin at the Federal Reserve Board for discussions, advice, and assistance. Views expressed are my own and not necessarily those of the Board of Governors of the Federal Reserve System, the Federal Open Market Committee, or the Council on Foreign Relations. Return to text 2. This is a combination of the areas of reform presented in the G-30 report, Group of Thirty (2009), Financial Reform: A Framework for Financial Stability (PDF), (Washington, D.C.: Group of Thirty, January); the FSB report, "Improving Financial Regulation: Report of the Financial Stability Board to G20 Leaders (PDF)," Financial Stability Board, September 2009; and some that I added. Return to text 3. Group of Thirty (2009), p. 21. For an incisive account of measures to deal with the TBTF problem, see the 2009 speech by my Federal Reserve Board colleague, Daniel K. Tarullo (2009), "Confronting Too Big to Fail," speech delivered at the Exchequer Club, Washington, D.C., October 21. Return to text 4. Anat Admati and Martin Hellwig (2013), The Bankers' New Clothes: What's Wrong with Banking and What to Do about It (Princeton, N.J.: Princeton University Press). Return to text 5. A full list of jurisdictions and institutions represented on the Basel Committee on Banking Supervision can be found at www.bis.org/bcbs/membership.htm . Return to text 6. As my colleagues Chair Yellen and Governor Tarullo have noted, it may be appropriate to go beyond the risk-based surcharges proposed by the BCBS. The goal would be to reach a point where any remaining TBTF subsidies have been offset and where other social costs of a potential failure by the firm have been internalized. Return to text 7. In addition, the subsidiary banks of the U.S. G-SIBs will need to meet a 6 percent leverage ratio to be considered well capitalized from the viewpoint of prompt corrective action regulations. Return to text 8. The word "macroprudential" appears to have been invented in the late 1970s and was used by Andrew Crockett and others at the Bank for International Settlements (BIS) in the 1990s and later. It began to come into central banker usage in the first decade of this century. But it was the consequences of the failure of Lehman Brothers that made it a household word. See Piet

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Clement (2010) "The Term 'Macroprudential': Origins and Evolution (PDF)," BIS Quarterly Review, March, pp. 59-67. Return to text 9. For an authoritative, recent statement by Chair Yellen, see Janet L. Yellen (2014), "Monetary Policy and Financial Stability," speech delivered at the 2014 Michel Camdessus Central Banking Lecture, International Monetary Fund, Washington, D.C., July 2. Return to text 10. For a comprehensive review of the use of such policies, see Douglas J. Elliott, Greg Feldberg, and Andreas Lehnert (2013), "The History of Cyclical Macroprudential Policy in the United States," Finance and Economics Discussion Series 2013-29 (Washington: Board of Governors of the Federal Reserve System, May). Return to text 11. Among the suggested solutions was the proposal that the consumer price index should include the prices of assets as representing the costs of future consumption. See Armen A. Alchian and Benjamin Klein (1973), "On a Correct Measure of Inflation," Journal of Money, Credit, and Banking, vol. 5 (1), part 1, pp. 173-91. Return to text 12. As is well known, support for the mopping-up approach was not unanimous, with, for example, researchers at the BIS, notably Claudio Borio and Bill White, presenting the view that monetary policy should be used to deal with asset-price inflation. See Claudio Borio and William R. White (2003), "Whither Monetary and Financial Stability? The Implications of Evolving Policy Regimes (PDF)," paper presented at "Monetary Policy and Uncertainty: Adapting to a Changing Economy," a symposium sponsored by the Federal Reserve Bank of Kansas City, held in the Jackson Hole, Wyo., August 28-30. See also Raghuram Rajan (2005), "Has Financial Development Made the World Riskier? (PDF)" paper presented at "The Greenspan Era: Lessons for the Future," a symposium sponsored by the Federal Reserve Bank of Kansas City, held in the Jackson Hole, Wyo., August 25-27. Return to text 13. It could be argued that the low interest rates of the 2003-06 period were the result of the mopping-up approach. I do not see any necessary connection between the mopping-up doctrine and monetary policy in the period following the mopping up of the hi-tech boom. Return to text 14. According to the ProQuest database, of the roughly 1,600 articles referring to the term "macroprudential" after the start of the Great Recession, almost all refer to regulatory and supervisory interventions. Return to text 15. House prices tended to increase more rapidly in countries that did not experience a financial sector crisis during the Great Recession. For a more detailed account, see Stanley Fischer (2014), "Macroprudential Policy in Action: Israel," in George A. Akerlof, Olivier J. Blanchard, David Romer, and Joseph E. Stiglitz, eds., What Have We Learned? Macroeconomic Policy after the Crisis (Cambridge, Mass.: The MIT Press), pp. 87-98. Return to text 16. The supply of land to the market in Israel is fundamentally controlled by the government, which owns more than 90 percent of the land. Return to text 17. For more details, see Fischer (2014). Return to text 18. Mortgages in Israel are not nonrecourse loans; in the event of nonpayment, the lender can seek to attach other assets of the borrower in addition to the house itself. Return to text 19. Typically the impact was calculated based on an estimate of how much a measure would increase the effective interest rate paid by the borrower, but this calculation generally resulted in an overestimate of the impact of the policy change. Return to text 20. Elliott, Feldberg, and Lehnert (2013) present empirical results on the use of macroprudential (sense 2) measures in the United States, but their results are at too high a level of aggregation to be useful in making decisions on the deployment of specific supervisory or regulatory measures. The literature is growing. For example, Kuttner and Shim examine the effects of actions in 57 197

countries since the 1980s on house prices and housing credit growth. See Kenneth N. Kuttner and Ilhyock Shim (2013), "Can Non-Interest Rate Policies Stabilise Housing Markets? Evidence from a Panel of 57 Economies ," Bank for International Settlements working paper no. 433 (Basel: BIS, November). Return to text 21. This is a general problem but is particularly the case in the Israeli context where the bulk of the male population is conscripted into the armed forces for three years at a relatively low salary, and there is a general view that young couples deserve to be able to buy an apartment when they marry. Return to text 22. Donald Kohn (2014), "Institutions for Macroprudential Regulation: the UK and the U.S. " speech delivered at the Kennedy School of Government, Harvard University, Cambridge, Mass., April 17. Return to text 23. The FSOC would become more independent as a result of implementing Kohn's suggestions. Return to text 24. In describing the TBTF diagnosis, I draw on Tarullo (2009). In addition, see Gary H. Stern and Ron J. Feldman (2004), Too Big to Fail: The Hazards of Bank Bailouts (Washington, D.C.: Brookings Institution Press); Charles W. Calomiris and Stephen H. Haber (2014), Fragile by Design: The Political Origins of Banking Crises and Scarce Credit (Princeton: Princeton University Press); and Financial Stability Board (2010), "Reducing the Moral Hazard Posed by Systemically Important Financial Institutions (PDF)," FSB report (Basel: BIS, October). For a very readable account, see chapter 11 of Alan S. Blinder (2013), After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead (New York: Penguin Books). Return to text 25. Tarullo (2009), p.2. Return to text 26. International Monetary Fund (2014), Global Financial Stability Report (Washington, D.C.: IMF, April), chapter 3. Return to text 27. Luc Laeven, Lev Ratnovski, and Hui Tong (2014), "Bank Size and Systemic Risk (PDF)," International Monetary Fund Staff Discussion Note 1404, May. Return to text 28. Large banks also hold less capital than small banks because they are more diversified--for example, small U.S. banks have larger geographical concentrations and larger single-name concentrations than larger banks. Return to text 29. In this regard one cannot fail to be impressed by the fact that in countries with a death penalty for corruption, some people appear nonetheless to be willing to take the chance of becoming rich illegally. Return to text 30. See Joseph P. Hughes and Loretta J. Mester (2011), "Who Said Large Banks Don't Experience Scale Economies? Evidence from a Risk-Return-Driven Cost Function (PDF)," working paper 11-27 (Philadelphia: Federal Reserve Bank of Philadelphia, July). Return to text 31. If this lecture had been delivered in 2005, I would have added the British banking system to the above list. This is evidence that the regulatory structure also matters. Return to text 32. Thorsten Beck, Asli Demirguc-Kunt, and Ross Levine (2003), "Bank Concentration and Crises (PDF)," National Bureau of Economic Research working paper no. 9921 (Cambridge, Mass.: NBER, August). Return to text 33. Calomiris and Haber (2014), pp. 305-11. Return to text 34. This comment pushes one in the direction of supporting the Volcker rule and other restrictions on commercial banks undertaking capital market activities. One criticism of the 198

Volcker rule is that two of the key failed institutions in the recent financial crisis--Bear-Stearns and Lehman Brothers--were not banks. It is hard to see why this fact suggests that permitting commercial banks to combine their activities with those of investment banks would be a stabilizing factor for the banking system. Return to text 35. See footnote 6 above. Return to text http://www.federalreserve.gov/newsevents/speech/fischer20140710a.htm

ft.com comment Columnists July 10, 2014 6:23 pm The biggest danger for the euro is the lack of trust

By Philip StephensAuthor alerts The argument between Italy and Germany asks a question at the heart of the currency’s future

©Ingram Pinn Listening in on the altercation between Rome and Berlin about the inviolability or otherwise of the eurozone’s fiscal rules, it is tempting to conclude that an irresistible force is hurtling towards an immovable object. Tempting, but misleading. The argument between Italy’s Matteo Renzi and Germany’s Angela Merkel is real enough. It asks a question at the heart of the future of Europe’s single currency. Can an arrangement that will always fall well short of a textbook monetary union be at once economically robust and politically sustainable? Germany – joined by other northern 199

states – likes to focus on the first of these conditions; Italy and other more indebted economies on the second. The two, of course, should be seen as self-reinforcing. The challenge is to find the equilibrium. More ON THIS STORY// Comment Merkel and Renzi/ Global Insight Renzi’s boast looks like history repeating/ Renzi likens EU to ‘old boring aunt’/ Renzi hits back at Bundesbank chief/ Britain left isolated by Juncker defeat ON THIS TOPIC// The A-List Folly of central banks’ tightening/ Greek debt sale raises less than expected/ Draghi seeks new Brussels reform powers/ Investors dive deeper into European ‘junk’ PHILIP STEPHENS// Money out of misery/ Balham – murder in suburbia/ Do not cling to the past/ Britain cast adrift On some things Berlin and Rome agree. The other day I heard a senior member of Ms Merkel’s government remark that the eurozone’s most precious asset is credibility. A week earlier one of Mr Renzi’s colleagues offered precisely the same judgment at a private gathering in Rome hosted by Aspen Institute Italia. The common ground extends to the urgency of structural reforms. The Italian prospectus begins with a call for more economic integration in the EU – specifically the extension to services of the single market. Governments should also throw their weight behind opening Europe’s markets through a transatlantic trade and investment pact with the US. Closer to home, the emphasis should be on reforms to liberalise labour markets, on measures to promote investment and incentives for research and development. The list of must-do’s offered by Berlin is striking for its similarities: deepening the single market, lowering barriers to employment, recasting EU structural funds to promote growth, drawing in private investment for infrastructure and nurturing digital industries. So where is the argument? Crudely put, it runs as follows: Ms Merkel says that fiscal restraint provides its own pathway to growth – German ministers now talk about “growth-friendly consolidation”. The Italian response is that an unpopular programme to liberalise the economy may well require a breathing space on the budgetary timetable. More supply is not much good without demand. To Mr Renzi’s mind, investment that raises Italy’s long-term growth potential (and thus creates more room to pay down debt) should be treated separately from current spending. To which my German friends retort there are no such things as “good” and “bad” borrowing. There is only borrowing. Economists and hedge funds who in 2012 predicted the certain demise of the euro badly misread the politics Both have right on their side. Ms Merkel faces domestic political pressure to talk up the credibility that comes with persuading markets that governments will stick to the rules of the growth and stability pact. Tearing these rules up in 2005 (Germany and France were then the culprits) prefigured the Greek debt explosion and the subsequent crisis. Italy, with the same eye on domestic politics, worries about political credibility. This rests on a resumption of growth. Germany may be right to argue that a stable debt and

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deficit framework is a prerequisite for growth, but if markets conclude the remedy is killing the patient, then the whole system would lose credibility. A reforming Italian government sticking to the letter of the fiscal law would not be much use if it were turned out of office by a populist revolt. I remember well the British government’s vain efforts to keep sterling in the European exchange rate mechanism. The higher it raised interest rates, the more convinced the markets became that such hikes were not politically sustainable. For all that, the divide is narrower than it looks. One of the lessons of the eurozone crisis is that rhetoric intended for domestic consumption is tempered by realism when leaders arrive in Brussels. The legions of economists and hedge fund investors who in 2012 predicted the certain demise of the euro badly misread the politics of the crisis. They overlooked the gap between public positioning and private pragmatism, and underestimated the political resolve. Greeks marched against austerity while insisting they would remain part of the eurozone. Germans refused to underwrite the debts of weaker partners and then proceeded to do just that. Economists were left with egg on their faces. Hedge funds are now piling into peripheral economies with the reckless abandon that saw them take flight in 2012. To say the acute phase of crisis has passed, however, is not to conclude that the euro has been fixed. To adapt an observation once offered by Alexis de Tocqueville, the most dangerous moment may yet arrive during the process of reform. In the circumstances, a long public argument around rules versus flexibility would be as futile as was the earlier debate between austerity and growth. In both cases, the eurozone requires both. Ms Merkel has to be persuaded that any loosening of the fiscal reins is not an excuse for heavily indebted eurozone members to ease up on efforts to strengthen the underlying productivity of their economies. Mr Renzi has to know that if he delivers on economic reforms he will not be floored by overzealous interpretation of the budgetary rules. The debate, in other words, is as much about sequencing as about the desired economic destination. What makes things tricky is that the two leaders each feel compelled to claim victory in order to satisfy their domestic political constituencies. Credibility, Ms Merkel and Mr Renzi agree, is the key to the euro’s future. Finding the equilibrium, they should now recognise, requires above all else the establishment of trust. http://www.ft.com/intl/cms/s/0/e2453328-0794-11e4-b1b0- 00144feab7de.html#axzz373KIGS3c

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ft.com Comment The A-List

Lorenzo Bini Smaghi July 10, 2014 The folly of central banks tightening to keep governments on the leash The Bundesbank is right to remind us that the unprecedented monetary accommodation in the eurozone has produced undesirable side effects. In particular, the policy has reduced the pressure on politicians to pursue speedy budgetary consolidation and to implement structural reforms. In the summer of 2011, for instance, as soon as the European Central Bank intervened to purchase Italian and Spanish government bonds through the Securities Market Programme and the spread on interest rates decreased, the commitments made earlier by those two governments began to be diluted. The same thing happened two years later, after the announcement of the Outright Monetary Transaction by the ECB contributed to sharply reduced market tensions, but also structural reforms. It is not clear, however, whether or how central banks should incorporate these effects into their own policy frameworks. In other words, should central banks try to calibrate monetary policy – in particular, by being tighter than would otherwise be the case – with a view to keeping a tight leash on governments and inducing them to play their own part? There may be some good reasons for doing so but on balance it would be a serious mistake. Here are several reasons why. The first is that the central bank would jeopardise its own objective, which in the case of the ECB is primarily the achievement of price stability. If a central bank maintains a more restrictive monetary policy, just to put pressure on politicians, it risks missing its own target, which is an inflation rate below – but close to – 2 per cent. In the current environment, with an inflation rate below 1 per cent, the risk of missing the target is already very high. Second, by using its policy instruments to achieve not only price stability but also to try to influence governments’ actions, the central bank undermines the basis of its own independence. Such independence is predicated on the fact that, by pursuing only one objective, the central bank does not have to address trade-offs. Only elected politicians can make choices between mutually exclusive objectives. The central bank does not have the legitimacy to influence governments’ choices in one direction or another. Third, it is not at all clear that keeping interest rates higher than would otherwise be the case strengthens policy makers’ incentives to implement the right policies. The reaction largely depends on the room for manoeuvre and the environment. The eurozone 202

experience during the crisis shows that, when monetary and credit conditions are too tight, the fiscal contraction produces extreme recessionary effects, which are counter-productive and may even increase the public debt instead of reducing it. This in turn can ultimately lead to a rejection of such policies by public opinion. Theory and practice show that fiscal contractions are successful when they benefit from easy monetary conditions, in particular when the nominal rate of interest is lower than the nominal rate of growth of the economy. Fourth, structural reforms take time to produce their effects, as shown by the German experience in 2002-04. If monetary conditions are too restrictive and the fiscal contraction is not gradual enough, the short-term costs of implementing structural reforms become too high and policy makers are discouraged. Finally, the attempt to use monetary policy to create incentives for governments to implement fiscal consolidation and structural reforms does not seem to have been particularly beneficial to the eurozone. While the euro member states implemented a much sharper fiscal contraction and much broader reforms than the other major economic areas – the US, Japan and the UK – they have not been rewarded by a relatively more accommodating monetary policy, as reflected by the strong euro exchange rate. It is no surprise that the overall results are much more disappointing. Eurozone growth remains fragile and lagging behind the other major economies, while deflationary fears are mounting. To sum up, the argument that the central bank risks crossing the line of fiscal policy should be turned upside down. The truth is exactly the opposite. It is by trying to influence fiscal policy through a tighter monetary policy than would be justified by the primary objective of price stability – and by not using all the instruments available to monetary policy, including the intervention in the largest segment of the financial market, government bonds – that the central bank is most at risk of interfering with other policies and becomes vulnerable. It is by not achieving price stability, and consequently making it harder for other policy makers to do their own part of the adjustment, that the central bank puts at risk its most valuable asset: its independence. The writer is a former member of the executive board of the European Central Bank and is visiting scholar at Harvard’s Weatherhead Center for International Affairs and at the Istituto Affari Internazionali in Rome http://blogs.ft.com/the-a-list/2014/07/10/the-folly-of-tightening-to-keep-governments- on-the-leash/

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ft.com comment Columnists July 10, 2014 4:14 pm Mental illness is our most pressing health problem

By Martin Wolf Given the considerable economic costs to society, treatment would pay for itself Depression and anxiety cause more misery than physical illness, poverty or unemployment. They also impose huge economic costs. Yet they are amenable to effective and relatively cheap treatments. In the UK, however, fewer than a third of adult sufferers are treated, compared with 90 per cent of those with diabetes. Only a quarter of children with these mental illnesses receive effective treatment. This undertreatment is unjust and hugely inefficient. It is largely due to continued prejudice and a lack of awareness of the existence of effective treatments. This terrible failure must end now. This, in sum, is the argument of a compelling new book, Thrive: The Power of Evidence-Based Psychological Therapies, by Professor Richard Layard of the London School of Economics and Professor David Clark of Oxford. The former is a well-known economist. The latter is a psychologist and one of the world’s leading experts on cognitive behavioural therapies. While I am able to assess the economic arguments, I cannot judge the claims made for CBT. But, the authors note, the National Institute for Health and Care Excellence, which is responsible for assessing the effectiveness of treatments for the National Health Service, recommends its use. That makes the undersupply of these services remarkable, if not shocking. More ON THIS STORY// High cost of mental health problems forces employers to act/ Depression still has stigma/ Mental health issues top industry agenda/ Law firm offers work experience to ex-offenders/ Opinion: Today’s best bosses understand commerce’s social role ON THIS TOPIC// Academics urge WHO over e-cigarette rules/ WHO warns over antibiotic resistance/ Editorial Weaning the world off its sweet tooth/ E-cigarette makers face WHO ruling hurdle MARTIN WOLF// Sceptics losing grip/ Bad advice from Basel/ No cause for complacency/ Defend Argentina from vultures In Britain one in six adults suffers from depression or crippling anxiety disorders. The same is true in the US and continental Europe. These conditions can be disabling. Indeed, their impact on a person’s ability to function in society is on average 50 per cent more disabling than that of angina, asthma, arthritis or diabetes. For sufferers, mental illness is the “enemy within” – an assault on the self more agonising than most physical ailments. Moreover, according to the World Health Organisation, mental illnesses account for 38 per cent of all ill health in high-income countries. Heart disease, stroke, cancer, lung disease and diabetes together account for only 22 per cent in these countries. Yet, perhaps because of the stigma of mental illnesses, health systems and employers largely ignore the severity of these effects.

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Above all, mental ill health is today overwhelmingly the most important form of sickness affecting children and adults of working age. As the impact of infectious diseases has largely vanished, physical illness predominantly affects the elderly. This means that the economic consequences of mental illness are vastly greater than those of physical illness, not to mention the life-long damage done by mental illness in childhood. An extraordinarily high proportion of those in prison, for example, suffer from mental illness. About 90 per cent of those who kill themselves also suffer from mental illness. Suicide is a silent plague: “As many people in the world die from suicide as from homicide and warfare combined.” In 2000, 815,000 people killed themselves. Moreover, the authors stress, mental illness makes it far more difficult to treat physical illnesses. People with mental illnesses find it hard to stick to their treatment plans. In addition, the consequences of mental illness contribute significantly to physical maladies. In all, the case for treating mental illness at least as energetically as physical illness is overwhelming. The question, though, is whether that is possible. The book argues that today drugs and, even more, CBT have been proved in rigorous clinical trials to be effective. This is a matter of a properly scientific approach to development and testing treatments. Mental ill health is today overwhelmingly the most important form of sickness affecting children and adults of working age “For some conditions,” argue the authors – citing depression, anxiety disorders, post- traumatic stress disorder, and bulimia – “we have treatments that lead to sustained recovery in half or more people, with many others seeing worthwhile improvements.” This is not perfect. But it is immensely better than nothing. Moreover, such treatments can also be effective in treating children as young as eight. The most encouraging aspect of all is that, it turns out, we are the captains of our souls. It is possible, it seems, to help people in agony regain lost control. Given the economic costs to society, including those caused by unemployment, disability, poor performance at work and imprisonment, the costs of treatment would pay for themselves. The cost of therapy is also not high: about the same as six months’ treatment of diabetes routinely supplied by health systems today. Yet the commitment of most high-income countries to provide universal healthcare is grossly violated in the case of mental illnesses for no good reason and at vast economic, social and personal cost. This, argue the authors persuasively, is a scandal. Most of us know people afflicted by mental illness. All know its devastating consequences. Indeed, the authors argue that the failure to tackle mental illness is one of the reasons unhappiness is so prevalent in societies that are so rich by historical standards. If the claims made for these treatments are correct, our failure to provide them is not just a crime but a blunder. We must not let outworn prejudice stop us from taking needed action. http://www.ft.com/intl/cms/s/0/1bd87d6e-076f-11e4-81c6- 00144feab7de.html#axzz373KIGS3c

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World Affairs

Joseph E. Stiglitz, a Nobel laureate in economics and University Professor at Columbia University, was Chairman of President Bill Clinton’s Council of Economic Advisers and served as Senior Vice President and Chief Economist of the World Bank. His most recent book, co-authored with Bruce Greenwald, is Creating a Learning Society: A New Approach to Growth, Development, and Social Progress. JUL 9, 2014 American Delusions Down Under NEW YORK – For better or worse, economic-policy debates in the United States are often echoed elsewhere, regardless of whether they are relevant. Australian Prime Minister Tony Abbott’s recently elected government provides a case in point. As in many other countries, conservative governments are arguing for cutbacks in government spending, on the grounds that fiscal deficits imperil their future. In the case of Australia, however, such assertions ring particularly hollow – though that has not stopped Abbott’s government from trafficking in them. Even if one accepts the claim of the Harvard economists Carmen Reinhart and Kenneth Rogoff that very high public debt levels mean lower growth – a view that they never really established and that has subsequently been discredited – Australia is nowhere near that threshold. Its debt/GDP ratio is only a fraction of that of the US, and one of the lowest among the OECD countries. What matters more for long-term growth are investments in the future – including crucial public investments in education, technology, and infrastructure. Such investments ensure that all citizens, no matter how poor their parents, can live up to their potential. There is something deeply ironic about Abbott’s reverence for the American model in defending many of his government’s proposed “reforms.” After all, America’s economic model has not been working for most Americans. Median income in the US is lower today than it was a quarter-century ago – not because productivity has been stagnating, but because wages have. The Australian model has performed far better. Indeed, Australia is one of the few commodity-based economies that has not suffered from the natural-resource curse. Prosperity has been relatively widely shared. Median household income has grown at an average annual rate above 3% in the last decades – almost twice the OECD average. To be sure, given its abundance of natural resources, Australia should have far greater equality than it does. After all, a country’s natural resources should belong to all of its people, and the “rents” that they generate provide a source of revenue that could be used 206

to reduce inequality. And taxing natural-resource rents at high rates does not cause the adverse consequences that follow from taxing savings or work (reserves of iron ore and natural gas cannot move to another country to avoid taxation). But Australia’s Gini coefficient, a standard measure of inequality, is one-third higher than that of Norway, a resource-rich country that has done a particularly good job of managing its wealth for the benefit of all citizens. One wonders whether Abbott and his government really understand what has happened in the US? Does he realize that since the era of deregulation and liberalization began in the late 1970s, GDP growth has slowed markedly, and that what growth has occurred has primarily benefited those at the top? Does he know that prior to these “reforms,” the US had not had a financial crisis – now a regular occurrence around the world – for a half-century, and that deregulation led to a bloated financial sector that attracted many talented young people who otherwise might have devoted their careers to more productive activities? Their financial innovations made them extremely rich but brought America and the global economy to the brink of ruin. Australia’s public services are the envy of the world. Its health-care system delivers better outcomes than the US, at a fraction of the cost. It has an income-contingent education-loan program that permits borrowers to spread their repayments over more years if necessary, and in which, if their income turns out to be particularly low (perhaps because they chose important but low-paying jobs, say, in education or religion), the government forgives some of the debt. The contrast with the US is striking. In the US, student debt, now in excess of $1.2 trillion (more than all credit-card debt), is becoming a burden for graduates and the economy. America’s failed financial model for higher education is one of the reasons that, among the advanced countries, America now has the least equality of opportunity, with the life prospects of a young American more dependent on his or her parents’ income and education than in other advanced countries. Abbott’s notions about higher education also suggest that he clearly does not understand why America’s best universities succeed. It is not price competition or the drive for profit that has made Harvard, Yale, or Stanford great. None of America’s great universities are for-profit-institutions. They are all not-for-profit institutions, either public or supported by large endowments, contributed largely by alumni and foundations. There is competition, but of a different sort. They strive for inclusiveness and diversity. They compete for government research grants. America’s under-regulated for-profit universities excel in two dimensions: the ability to exploit young people from poor backgrounds, charging them high fees without delivering anything of value, and the ability to lobby for government money without regulation and to continue their exploitative practices. Australia should be proud of its successes, from which the rest of the world can learn a great deal. It would be a shame if a misunderstanding of what has happened in the US, combined with a strong dose of ideology, caused its leaders to fix what is not broken. http://www.project-syndicate.org/commentary/joseph-e--stiglitz-wonders-why- australian-prime-minister-tony-abbott-wants-to-emulate-the-us-economic-model

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ft.com GlobalEconomy EU Economy July 10, 2014 11:57 pm Mario Draghi coaxes politicians to lead in next set of reforms By Peter Spiegel in BrusselsAuthor alerts

©AP European Central Bank president Mario Draghi Ever since he took the helm of the European Central Bank nearly three years ago, Mario Draghi has called for eurozone governments to undertake reforms to liberalise their economies. But Mr Draghi went a step further on Wednesday, dipping his toe into an increasingly contentious debate over whether eurozone governments should be compelled to take steps, such as liberalising labour markets and overhauling pension schemes. In his vision, a new set of eurozone rules are needed that would ensure recommendations made by Brussels are actually implemented. More ON THIS STORY// Markets Insight Euro strength/ Draghi seeks new Brussels reform powers/ Europe’s SMEs still face credit crisis/ Mario Draghi related news ON THIS TOPIC// Draghi shakes up ECB deliberations/ Money Supply Live – Mario Draghi’s press conference/ ECB’s loan-buying plans stall/ The Macro Sweep US housing booms as Japan loses momentum IN EU ECONOMY// French and Italian industrial output falls/ Eurozone’s economic recovery stutters/ Sweden cuts interest rates to 0.25%/ Eurozone inflation holds steady in June “There is a clear case for some form of common governance over structural reforms,” Mr Draghi said. “The outcome of structural reforms – a continuously high level of productivity and competitiveness – is not merely in a country’s own interest. It is in the interest of the union as a whole.” The ECB president offered no specific prescription in his speech, and officials who have spoken to him say he has no new proposal up his sleeve. So why intervene at this juncture?

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One explanation is that Mr Draghi is frustrated by the demands of Italy and France for radical ECB action to rescue their economies and for more flexibility over deficit targets, while themselves doing little to improve their competitiveness. The ECB chief was originally an advocate of a Berlin-backed plan to require eurozone countries to enter into “contractual arrangements” with Brussels, legally binding them to a reform programme – a plan akin to forcing all governments into the kind of policy straight-jackets once reserved for bailout countries. But the proposal did not enjoy universal support, even within the ECB. “Purists” argued that the EU’s existing process – governments are required to submit reform plans to Brussels for the European Commission and other national capitals to review and apply peer pressure – was more in keeping with the bloc’s traditions. ECB officials believe the “contractual arrangement” proposal is dead. Angela Merkel, the German chancellor, found herself isolated when she tried to get agreement on the plan at two different EU summits in the past six months. Even Finland and the Netherlands, two traditional German allies, resisted. Herman Van Rompuy, the European Council president, has told colleagues he may bring the plan up at the final summit of his tenure in October but ECB and EU officials believe getting it approved would be a Sisyphean effort. Those who have spoken with him said Mr Draghi is trying to “start a conversation” about how to give EU recommendations on reforms more teeth. At the height of the eurozone crisis, such admonitions from Frankfurt were embraced so enthusiastically by national politicians that they quickly became EU law – and were followed by bold action by the ECB to pull Europe’s common currency back from the brink. In depth Austerity Europe

Europeans are braced for a new age of austerity as governments across the region take action to eliminate unsustainable budget deficits In 2011, Mr Draghi backed a “fiscal compact” to enshrine tough budget rules in national constitutions, spurring it to passage. Weeks later, he launched a €1tn programme providing cheap loans to banks that saved many from collapse. In 2012, he urged a “banking union” to strip oversight of financial institutions from national authorities and give it to a Frankfurt-based supervisor. Once those principles were agreed by EU politicians, he unveiled a conditional bond-buying programme that helped end the eurozone crisis. With the crisis out of its acute phase, it is unclear whether Mr Draghi still has the ability to spur political leaders into action. And it is even less clear if the ECB chief feels the

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need to see such political action before he can take bolder moves to fight the risk of deflation which currently stalks the eurozone. “These are not crisis times so the ability of Draghi to extract reforms is much more limited than it used to be,” said Mujtaba Rahman, head of European analysis at the Eurasia Group risk consultancy. “But there is a subliminal message regarding quantitative easing – this bank has not and is unlikely to undertake such a major move without some quid pro quo from governments.” If Mr Draghi’s June decision to cut interest rates to below zero is any indication, the ECB may no longer feel it needs political cover to take a more aggressive monetary policy action to fight deflation. Instead, those who have spoken to Mr Draghi believe he is trying to send a message to politicians calling for him to do still more – as French industry minister Arnaud Montebourg did again on Thursday – that it is now their turn to act. http://www.ft.com/intl/cms/s/0/9bbdcdd6-084b-11e4-9380- 00144feab7de.html?siteedition=intl#axzz373KIGS3c

ft.com Management Recruitment July 9, 2014 9:14 pm Forget the CV, data decide careers By Tim Smedley

©AFP Automatic for the people: algorithms are filling jobs, such as those in call centres “I no longer look at somebody’s CV to determine if we will interview them or not,” declares Teri Morse, who oversees the recruitment of 30,000 people each year at Xerox Services. Instead, her team analyses personal data to determine the fate of job candidates. She is not alone. “Big data” and complex algorithms are increasingly taking decisions out of the hands of individual interviewers – a trend that has far-reaching consequences for job seekers and recruiters alike. More ON THIS TOPIC// Time will come when electronic health records turn into web apps/ Technology sees rise of the ‘expert patient’/ Comment Big Data – welcome to the Matrix/ Merryn Somerset Webb We’re in a bull market for complacency 210

IN RECRUITMENT// Letters to a new chairman/ Dealing with an employee who always calls in sick/ Control in a cockpit is usually clearer than in a corporation/ Stern Words Tips for high stakes board game The company whose name has become a synonym for photocopy has turned into one that helps others outsource everyday business processes, from accounting to human resources. It recently teamed up with Evolv, which uses data sets of past behaviour to predict everything from salesmanship to loyalty. For Xerox this means putting prospective candidates for the company’s 55,000 call- centre positions through a screening test that covers a wide range of questions. Evolv then lays separate data it has mined on what causes employees to leave their call-centre jobs over the candidates’ responses to predict which of them will stick around and which will further exacerbate the already high churn rate call centres tend to suffer. The results are surprising. Some are quirky: employees who are members of one or two social networks were found to stay in their job for longer than those who belonged to four or more social networks (Xerox recruitment drives at gaming conventions were subsequently cancelled). Some findings, however, were much more fundamental: prior work experience in a similar role was not found to be a predictor of success. “It actually opens up doors for people who would never have gotten to interview based on their CV,” says Ms Morse. Some managers initially questioned why new recruits were appearing without any prior relevant experience. As time went on, attrition rates in some call centres fell by 20 per cent and managers no longer quibbled. “I don’t know why this works,” admits Ms Morse, “I just know it works.” Organisations have long held large amounts of data. From financial accounts to staff time sheets, the movement from paper to computer made it easier to understand and analyse. As computing power increased exponentially, so did data storage. The floppy disk of the 1990s could store barely more than one megabyte of data; today a 16 gigabyte USB flash drive costs less than a fiver ($8). It is simple, then, to see how recruiters arrive at a point where crunching data could replace the human touch of job interviews. Research by NewVantage Partners, the technology consultants, found that 85 per cent of Fortune 1000 executives in 2013 had a big data initiative planned or in progress, with almost half using big data operationally. HR services provider Ceridian is one of many companies hoping to tap into the potential of big data for employers. “From an HR and recruitment perspective, big data enables you to analyse volumes of data that in the past were hard to access and understand,” explains David Woodward, chief product and innovation officer at Ceridian UK. Members of one or two social networks stayed in their job longer than those belonging to four or more This includes “applying the data you hold about your employees and how they’ve performed, to see the causal links between the characteristics of the hire that you took in versus those that stayed with you and became successful employees. Drawing those links can better inform your decisions in the hiring process.” Data sets need not rely on internal data, however. 211

“Social media data now gives us the ability to ‘listen’ to the business,” says Zahir Ladhani, vice-president at IBM Smarter Workforce. “You can look at what customers are saying about your business, what employees are saying, and what you yourself are saying – cull all that data together and you can understand the impact. “Most recruitment organisations now use social media and job-site data,” says Mr Ladhani. “We looked at an organisation which had very specialised, very hard to find skill sets. When we analysed the data of the top performers in that job family, we found out that they all hung out at a very unique, niche social media site. Once we tapped into that database, boom!” Ceridian, too, has worked with companies to “effectively scan the internet to see what jobs are being posted through the various job boards, in what parts of the country,” says Mr Woodward. “If you’re looking to open a particular facility in a part of the country, for example, you’ll be able to see whether there’s already a high demand for particular types of skills.” Experts appear split on whether the specialisation required for executive recruitment lends itself to big data. “I hire 30,000 call-centre people on an annual basis – we don’t hire that many executives,” says Ms Morse, adding “there’s not enough volume”. However Mr Ladhani disagrees, believing that over time the data set an organisation holds on senior management hires would become statistically valid. As more companies start to analyse their employee data to make hiring decisions, could recruitment finally become more of a science than an art? “The potential is clearly much greater now than ever before to crunch very large volumes of data and draw conclusions from that which can make better decisions,” says Mr Woodward. “The methods and computing power being used in weather forecasting 10 years ago are now available to us all . . . who knows where this may go.” It is a trend worth considering – to get your next job, perfecting your CV could well be less important than having carefully considered the footprint you leave in cyberspace. ------Case study: Demographic drilling down helps LV= recast recruitment ads Kevin Hough, head of recruiting at insurance firm LV=, was a pioneer of ‘Big Data’ before he had heard the term. The insurer has 5,800 employees across 17 UK sites. A year ago, the question of where best to target its recruitment advertising provided an innovative answer. “We took all of the postcode data from our HR database – where our current staff live and where they are located – and split that by their [seniority]” explains Mr Hough. “Using software called Geo-Maps, which works similarly to Google Maps, we could zoom in and out of clusters of our people to see where they are willing to travel from to get to work. “On top of that we were able to overlay where people were applying from, taken from our recruitment data. The next iteration was where our Facebook and LinkedIn followers are from: the demographic of people following us, what interests them, the

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diversity and inclusion breakdowns, male and female and so on, on which social media platform. “We were able to build up a profile of who our successful candidate was, the age demographic, and where people were hunting for jobs. What was really interesting was the reach some of our advertising was having, and more importantly some of the gaps.” Recruitment advertising at LV= has subsequently been redesigned. The investment and expertise required to analyse the data were negligible, says Hough. “For Geo-Maps it was literally as basic as getting a licence for the software and uploading our data to it from a spreadsheet. Sometimes with all the clever systems that people have in organisations you can be blinded to the simple, raw data that is sat there.” Next, LV= will add performance review data. “The ongoing piece is to say of that group we recruited a year ago, which are still there? It helps to shape not only how we attract the people, but will even start to shape some of the roles themselves.” http://www.ft.com/intl/cms/s/2/e3561cd0-dd11-11e3-8546- 00144feabdc0.html?segid=0100320#axzz373KIGS3c

ft.com World Latin America & Caribbean July 10, 2014 5:59 pm Some Argentines excel, but others would be odd World Cup victors

By Simon Kuper in São PauloAuthor alerts

©Reuters Alejandro Sabella celebrates Argentina's World Cup semi-final win over Holland Watching Argentina’s coach Alejandro Sabella, one is strangely reminded of the actor Peter Sellers. In the 1979 film Being There, Sellers plays a simple gardener who through a series of accidents becomes a political star in Washington. His gardening clichés are received as great wisdoms. In the film’s last scene he is shown walking on water.

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Perhaps Sabella’s bumbling façade conceals a brilliant tactical brain. If so, he hides it well. After his team beat Holland on penalties in Wednesday’s fantastically boring semifinal, he repeatedly explained to the press conference that the match had been drawn but that Argentina had won on penalties. He also drifted into a long reminiscence about a game that his River Plate once played against Gremio. More ON THIS STORY// Robert Shrimsley Brazil can learn from UK/ Brazil poll contenders fear World Cup hangover/ The World Brazil’s psychological trauma/ The World German fans’ joy matched by heroes’ restraint/ beyondbrics Brazil’s Rousseff should forget Neymar ON THIS TOPIC// Simon Kuper Lessons Brazil need to learn from best/ Brazil suffers World Cup horror show/ Simon Kuper Dutch tactical nous faces Messi magic/ Simon Kuper Fred and Müller – clash of forward styles SIMON KUPER// World Cup poor guide to player’s value/ Why Brazil’s already won/ Colombia enjoys boost on and off pitch/ France finds peace before German battle Still, if Argentina beat Germany in Sunday’s final, Sabella may also be acclaimed for walking on water. But the question then would be: who made Argentina world champions? After years of cogitation, Sabella started the World Cup with a line-up that lasted just 45 minutes against Bosnia. Lionel Messi intervened at halftime to improve the hapless team’s forward passing. An experiment with the slow uncreative “playmaker” Fernando Gago then failed. Injuries further complicated matters. Argentina’s starting line-up against Holland differed in five places from Sabella’s team of four weeks ago. Certainly Argentina’s players do not seem to regard the coach as their omniscient leader: while Sabella was instructing Ezequiel Lavezzi on the touchline during the game against Iran, the forward squirted a water bottle over him. Sabella’s initial Argentina was a slow, “broken team”, with defenders who stood watching attacks and attackers who scarcely defended. It depended for goals entirely on Messi’s inspirations. In the last two games against Belgium and Holland, we’ve seen a new Argentina: never brilliant, but a compact team that denies opponents space. It is marshalled from midfield by a brilliant tactical brain, Javier Mascherano. He distributes the ball, because most of Argentina’s defenders cannot, and has won 22 tackles this tournament – more than any other player here, according to data provider Opta. He may also be counselling Sabella: at the last World Cup, Mascherano sat on a small committee of senior players consulted on tactics by coach Diego Maradona. This new Argentina typically only needs one goal. That is fortunate, because Messi has neither scored nor created one in the last two games. He is exhausted and feels as if his legs weigh 100 kilos each, his father Jorge told the Brazilian newspaper Folha de São Paulo. In most games Messi has walked around in apparent torpor, twice performing his match-winning interventions only in the last minute, as if he’d been waiting in hope that the others could do it by themselves. Still, as Jonathan Wilson, the historian of football tactics, notes: “The paradox of Messi: he makes Argentina a better side because nobody

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dares attack him.” Keeping several opponents near him is Messi’s main service to the team. Some other Argentines have excelled: Pablo Zabaleta and Ezequiel Garay in defence, while Mascherano’s latest companion in midfield, Lucas Biglia, ran a dizzying 15km against Holland. Up front, Lavezzi adds speed, though he struggles to see beyond 10 yards. Gonzalo Higuaín has improved during the tournament. But several Argentine players would make very peculiar world champions. Monaco’s reserve goalkeeper Sergio Romero won the shootout against Holland, but he frequently drops balls. Maxi Rodriguez was a solid pro, but at 33 is distinctly post-peak. Marcos Rojo is young, strong and fast but rather gormless. Federico Fernández, who has played four games here, is an extraordinarily unaccomplished defender who, though now benched, may end up with a World Cup winner’s medal. However, the bookmakers favour Germany. The Germans beat Argentina 4-0 in the quarter-final in 2010 using an effective “Messi strategy”: one man on him, and one always directly behind waiting for the second ball. Bayern Munich, chief supplier of this German team, have also shut out Messi’s Barcelona. And Thomas Müller will fancy running at Argentina’s 33-year-old centre-back Martín Demichelis. Argentines could probably live with defeat. The tens of thousands of fans celebrating in São Paulo on Wednesday were preoccupied with Brazil. People kept raising seven fingers to commemorate their ancient rivals’ 7-1 hiding by Germany. For Argentines, this tournament is already almost perfect. http://www.ft.com/intl/cms/s/0/fc5ef104-0848-11e4-9380- 00144feab7de.html#axzz373KIGS3c

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Juncker's first move - the incoming President of the European Commission should show he means business by rationalising the college of Commissioners by André Sapir and Guntram B. Wolff 9th July 2014 76849 When European Commission president-designate Jean-Claude Juncker takes over the office later this year, his task will be to prove that the European Union and its institutions are relevant for dealing with globalisation and global demographic, technological and environmental change. In our recent Bruegel policy brief, The great transformation: memo to the incoming EU Presidents, we discuss the central challenges that he as well as the Presidents of the European Council and the Parliament face. We argue that the three Presidents jointly have to work on developing a proper growth strategy and driving a reflection process on treaty change. The reform of the institutions is of central importance to deal with the challenges – and is a primary obligation of the new European Commission president and the topic of this blog post. One early move that Juncker should make is to do away with the current European Commission college structure of one portfolio for each of the 28 member states. This would demonstrate that he is prepared to make changes, and would be a signal to those that are disenchanted with the EU that he recognises their basic concerns, primarily the need for growth and jobs. An effective Commission would have only a dozen policy areas in which it would take action. While the number of commissioners cannot easily be reduced, it should be acknowledged that not every commissioner can have a full portfolio without leading to inconsistency of policy and excessive activism. A solution would be for every commissioner to have the full rights of a commissioner with a full vote in the college. However, not every commissioner would be responsible for a distinct portfolio. An alternative constellation would consist of several clusters of competences for which several commissioners would be jointly responsible. A first step should be the appointment of a senior vice president without portfolio responsible for the European growth strategy. The senior vice president would oversee all the relevant Commission activities to ensure that policies are implemented to their maximum effectiveness to promote growth. There would be a particular focus on single market and industry, the digital agenda, science and research, education and skills, and regional policy. The senior vice president would have a small staff, consisting essentially of the part of the General Secretariat currently in charge of the Europe2020 strategy. Meanwhile, the enterprise and single market portfolios should be merged into a single market and industry portfolio to emphasise that European industrial policy should be 216

about framework conditions and deepening the single market while reducing national regulatory fragmentation. Industrial policy based on subsidies and support for national champions is not the right approach for more growth and jobs in Europe. The rigorous enforcement of competition rules is central for economic performance. Attempts to make competition policy subject to narrow industrial policy interests are unwarranted, as are claims that it prevents the emergence of European champions. Many sectors remain dominated by national operators in the different national markets, and substantial regulatory barriers still prevent companies, in particular in the services sector, offering their products in other EU countries. The single market agenda is therefore more relevant than ever. However, acknowledging the inherently complex nature of competition policy, a high-level committee of five independent experts should be appointed to review once a year the actions of the European Commission, and give independent advice on the direction of competition policy. Their reports should be public but should not be binding. The economic and financial affairs commissioner must play a central role in the growth strategy, including by shaping the EU-wide fiscal stance, but she will have to operate independently of the many requests from within the Commission and focus on her mandate and the need to keep fiscal policy credible. In many countries, debt levels are already very high and fiscal consolidation is therefore important. These moves will help to create a better foundation for a coherent strategy to address Europe's big challenges. These are threefold: boosting feeble economic growth in the face of emerging-economy competition, streamlining the EU's institutional set-up and proving that it is capable of dealing with pressing external matters, and, ultimately, facing up to the need for treaty change in order to clarify the relationship between the euro area and the EU, and move beyond the factional politics of ‘More Europe’ versus ‘Less Europe’ to ‘Better Europe,’ with the right competences allocated to European level while others remain at, or are even repatriated to, national level. The appointment of Jean-Claude Juncker has been a difficult process, and the signals he sends early in his mandate will be important to heal rifts and set the tone. Changes to improve the functioning of the top-heavy Commission college, and to focus it on the right priorities, will be central. | Read more at Bruegel http://www.bruegel.org/nc/blog/detail/article/1382-junckers-first- move/?utm_source=Bruegel+Update&utm_campaign=2f9448e5e5- Bruegel+Update_Week_28_2014&utm_medium=email&utm_term=0_cb17b0383e- 2f9448e5e5-277483457

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Daily Morning Newsbriefing July 10, 2014 Germany’s domestic bail-in law and its critics German newspapers are beginning to question the ubiquitous claims by politicians that the new bail-in directive would protect taxpayers against bank failures. The German cabinet yesterday approved a package of four laws to translate the EU Bank Recovery and Resolution Directive into domestic law. Frankfurter Allgemeine reports that the German Monopolkommission says the rules had “catalogues” of gaps that would allow banks to reduce the extent to which investors are bailed-in. Another criticism is that the bank resolution fund is far too small to be credible. It is interesting to see how the story was reported in Ireland. The Irish Times writes that Germany has given up its previous opposition to retroactive bank recapitalisation. The story says the draft bills that now goes in front of the Bundestag does not mention retroactive bank recapitalisation explicitly, but “Berlin sources” had confirmed that this was part of the package agreed. The article was referring to the interim role of the ESM as a final backstop during 2015 – the year before the bank resolution funds is becoming active. The article says that capital could be replaced “in part or in full with a retroactive application of direct recapitalisation”, but says decisions would be taken on a case by case basis, and by mutual agreement. What the article did not say is that Germany will almost certainly block retroactive bank recapitalisation, as it can under ESM voting. Hans-Werner Sinn said the cabinet took the decision on the day when the rest of the country was celebrating Germany’s victory over Brazil. He then went on to do the math on the package. The bail-in accounts for a maximum of 8% and the fund for a further 5%. The remaining 87% were the taxpayers’ risk. With bank assets in the crisis countries are €9.1tr, and Germany’s liability share of 28%, this translates into a risk to taxpayers to the tune of €2.1tr. The biggest problem, however, is not the exposure itself, but the ability of the debtor countries to blackmail the creditors. To keep those risks small and to keep the losses to under the threshold of 13%, the creditor countries will have to accept low interest rates for a long time to come, as well as QE. How not to support the idea of a bigger role for the euro A quiet news day in our turf – but a lot of commentaries and big themes. What has happened often in debates on the future of the euro is that somebody proposes something we would agree with in principle until we see the person’s ulterior motivation. Michel Sapin’s call for a stronger international role of the euro is one of those. Sapin does not want to strengthen the eurozone. He is outraged by last week’s 218

court ruling in New York against BNP Paribas, which pleaded guilty of violating the International Emergency Economic Power Act, and the Trade with the Enemy Act (yes, no joke!), fast fined almost $9bn, and face a ban from US dollar clearing operation for one year. BNP has been accused of bypassing the laws to trade with Sudan, Iran and Cuba. For more details of the case, see here, for example. Sapin then said the eurozone must “mobilise itself to bolster the usage of the euro as an international exchange currency." Barry?Eichengreen has a good comment in the FT. He recalls similar events in which the US used its financial muscle extra-territorially – in the Suez crisis, and most recently in relation to Argentinian debt. The reason BNP Paribas got trapped was because it provided credit to the banned countries in dollar – and this credit passes the Fedwire system for clearing. Eichengreen says it is not clear what France can do to alter the status quo. They could set up dollar clearing off-shore, but it is doubtful that this could be sufficiently low cost because clearing requires a backup through the central bank. The alternative would be to build a euro market, but these would have to be big and liquid. Such a market would have to be as deep and liquid as the dollar market to constitute a viable alternative. “But France lacks the moral authority to orchestrate this process. Not only did one of its biggest banks egregiously violate international norms by doing business with Sudan and other unsavoury regimes. The government also failed to detect the violation or, worse, did not try. Arbitrary and capricious use of US financial leverage would, in time, create widespread disaffection with the dollar. But steps by the US against BNP Paribas were hardly arbitrary and capricious. Such terms better describe Mr Sapin’s remarks.” Spain introduces token tax on deposits At its regular council of ministers last Friday the Spanish government approved a 0.03% tax on bank deposits, estimated to bring in €375M a year which will be apportioned among regional governments, writes Expansión. The tax was introduced at the end of 2012 at 0% as a way to nullify a raft of taxes introduced by regional governments at around 1%, because in case there are taxes for the same concept in national and regional legislation the national tax prevails. Two years later the government has decided to set a nonzero tax. Such a small tax amounts to a rounding error in government revenue, but it has generated a fair amount of criticism among commentators in the financial press worried about banks passing the tax through to savers. According to Expansión there is some language about the unavailability of “supply and demand elasticity” of deposits in the impact assessment accompanying the decree. French government presents details on budget cuts Michel Sapin unveiled the outline of the 2015 budget expenditures in the French parliament and gave more details about the €18bn savings to be achieved by 2017. The savings are to be realised by some 1200 departments and agencies which will have to tighten their belts. Among the ministries the biggest hit taken by the ministries of Defence, Ecology, and the finance ministry itself, while the budgets for education, justice and security will actually increase, Les Echos reports.

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In 2015 the government wants to cut overall expenditures by €4bn. Les Echos has some of the details: The highly sensitive Defence ministry will have to cut €500m from its budget every year. Funds are also reduced for the Economy (-9.8%), Finance (- 7.9%) at the Foreign ministry (- 4.8%) or for Ecology (-3%). Local authorities will have to bring up €11bn of the savings over the next three years. Etienne Lefebvre comments that while the savings targets look good on paper, the measures to realise those savings are more opaque, and risk to be short lived. Also the outline is made on the back of an overly optimistic growth forecast. UMP in new troubles over €75m debt A week after Nicolas Sarkozy was put under investigation, an independent audit of his UMP party revealed that the party has €79.1m in debt, while another party communication places the debt at €74.5m, which will limit its funds for the presidential campaign in 2017. Half of the debt comes from the purchase and refurbishment of new party headquarters in Paris three years ago and the rest accumulated over the years to the end of 2013 including Sarkozy's 2012 campaign, Reuters reports. The audit concluded that the party has to renegotiate the 2017 deadlines for its credits with the banks and cut running costs. A The party officials announced a 20% cut in party running costs and said its political campaign funds for the next three years would be limited to €19m – about half its spending in the run-up to the 2012 elections, according to the FT. Guillaume Tabard in Le Figaro wrote that unless it got its house in order, “the UMP will end up crushed between a Marine Le Pen who still has room to grow and a Manuel Valls who, by virtue of the old principle of triangulation, is carving out a reformist position less and less to the left.” Greek MPs approve PPC sell-off, referendum question still in the air The Greek Parliament on Wednesday approved legislation paving the way for the part- privatization of the Public Power Corporation (PPC) but opposition parties did not give up their efforts to force a discussion about a referendum on the sale, Kathimerini reports. Opposition parties including Syriza are expected to deliver their requests for a referendum on Thursday. It will then be up to Parliament’s Scientific Service, a team of experts that advises House Speaker Evangelos Meimarakis, to decide whether the number of MPs backing disparate proposals can be polled together. The process is made even more complicated by the fact that Syriza and the Communist Party have made it clear that they do not want the votes of Golden Dawn MPs to be added to theirs. Only 8% of the Greek unemployed receive benefits Macropolis cites reports implying that only 8% of the registered unemployed in Greece actually receive unemployment benefits. Those without jobs in Greece receive unemployment benefits only for the first 12 months they are out of work and even then only qualify for the monthly payment if they have amassed a certain amount of social security credits in previous years. According to the Manpower Employment Organization, the number of registered unemployed has risen since 2014 by 45%, while the number of Greeks receiving benefits has plummeted by 47%. The cost of the German pensions reform 220

Germany’s Grand Coalition decided two notable reforms – both at the behest of the SPD. One is the minimum wage, the other is the reduction in the pension age from 67 to 63 – which one should probably not call a reform. Frankfurter Allgemeine has a fuming article, approving citing a libertarian free market think tank Stiftung Marktwirtschaft, which calculated that the reform constitutes an unbelievable redistribution of wealth from the young to the old. The reforms will cost a 20 year old €4000, while a 60 year old would benefit to the tune of €12,000. The think tank calculated that the sum of official and hidden state debt (which includes contingent liabilities for future pensions) has gone up from €5.9tr to €6.4tr as a result of those reforms – about 250% of German GDP. The article quotes Bernd Raffelhüschen, a German financial econmist, as saying that the sustainability analysis of this package looked “spooky”. ECB to give banks only 48 hours before AQR/Stress Test results are published Reuters reports that the ECB will give banks only 48 hours to review the AQR/stress tests results before publishing them in October. The article said there is still a dialogue going on with the banks, some of which have raised objections about the short time frame, and about the ECB’s decision to publish leverage ratios alongside regulatory capital ratios, on the grounds that the leverage ratio is not a formal regulatory requirement. Banks have made extensive preparations ahead of the tests, including raising over 100 billion euros ($136 billion) in the nine months to April, shedding assets and writing off bad debts. Bruno Maçães reinvents the wheel What always irks in discussions about the future of the eurozone is when people propose as new ideas policies that have been tried again and again and that have demonstrably failed. One of these comments was from Bruno Maçães, Portugal’s European affairs state secretary in Vox, who made a plea against a United States of Europe – the ultimate strawman in any European debate. He argues against proposals to centralise power over fiscal policy or structural reforms, and wants more subtle form of co-ordination, based on contracts and partnerships. Member states would reforms and received the necessary support in turn. This is unbelievably naïve. We mention this comment only to demonstrate the extent to which our debate on the future of the euro is moving in circles. The whole experience with the stability pact has taught us that voluntary agreements that are not policed are for the birds. Germany and France were able to break the pact because they could. They are sovereign nations. When sovereign nations can breach a pact that has been an integral part of EU law, why should a contract work? If the member states value absolute sovereignty of fiscal policies that much, they will regain monetary sovereignty in the long-run. Renzi complains about clogged implementation of reforms One of the biggest obstacles for all kinds of economic reforms is not the decision itself but the implementation. This is what Matteo Renzi seems to have discovered according to an article in Corriere della Sera this morning. Renzi said it was not good that

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measures decided by his government and its predecessor were subsequently blocked in the administrative pipeline. He said this was an acute problem now since the quid-pro- quo for fiscal flexibility is not the reform as such, but the implementation of the reform. There are current five reform laws in the clogged pipeline, and a number of so-called decrees. The laws relate to the abolition of provincial government bodies, the housing tax, a law on drug addiction, on emergency housing, and the Expo. The decrees include the income tax cut. Eurozone Financial Data 10y spreads Previous This Yesterday day Morning France 0.323 0.325 0.328 Italy 1.621 1.645 1.667 Spain 1.500 1.529 1.550 Portugal 2.459 2.568 2.595 Greece 4.812 4.883 4.88 Ireland 1.073 1.089 1.085 Belgium 0.417 0.418 0.422 Bund Yield 1.222 1.231 1.209 exchange rates This Previous morning Dollar 1.361 1.3634 Yen 138.310 138.45 Pound 0.795 0.7961 Swiss Franc 1.215 1.2151

ZC Inflation Swaps previous last close 1 yr 0.75 0.75 2 yr 0.77 0.77 5 yr 1.22 1.22 10 yr 1.64 1.64

Eonia 8-Jul-14 0.03 7-Jul-14 0.03 4-Jul-14 0.03

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3-Jul-14 0.03

OIS yield curve 1W 0.044 15M 0.046 2W 0.050 18M 0.048 3W 0.063 21M 0.071 1M 0.056 2Y 0.078 2M 0.067 3Y 0.119 3M 0.065 4Y 0.223 4M 0.057 5Y 0.354 5M 0.056 6Y 0.510 6M 0.061 7Y 0.674 7M 0.059 8Y 0.837 8M 0.058 9Y 0.986 9M 0.051 10Y 1.122 10M 0.061 15Y 1.623 11M 0.072 20Y 1.854 1Y 0.071 30Y 1.996

Euribor-OIS Spread previous last close 1 Week -2.129 -1.829 1 Month 2.529 2.829 3 Months 10.443 10.643 1 Year 37.957 36.457

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 10.html?cHash=8dfe505f6a03428e0fd423dd595bbbf1

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ft.com Comment Opinion July 8, 2014 5:51 pm France lacks the moral authority to depos e the dollar By Barry Eichengreen Paris failed to detect BNP Paribas’ violation of international norms, writes Barry Eichengreen

©Bloomberg Michel Sapin is not the first French finance minister to complain about the dollar’s singular position in the international financial system. It is almost 50 years since Valéry Giscard d’Estaing coined the phrase “exorbitant privilege” to denote the dominant role of the greenback in global monetary affairs. Nor is the BNP Paribas affair that irked Mr Sapin – the French bank has been fined $9bn for breaking US sanctions on Sudan and Cuba – the first time America has thrown around its financial weight to advance its political agenda. In 1956 it used Britain’s dependence on dollar credit to force London and Paris to roll back their invasion of Suez. More ON THIS STORY// Editorial French fury and dollar dominance/ France hits out at dollar’s dominance/ BNP fine is double-edged sword for US/ Sapin urges euro deals after BNP fine/ BNP pleads guilty and faces $8.9bn fine ON THIS TOPIC// BlaBlaCar sets course for $100m funding/ The World Why we should stop telling the French off/ French minister attacks tourist tax rise/ Christopher Caldwell The right to die IN OPINION// Swaminathan Aiyar India’s state shackles/ US-German spying saga/ Liu Xiaoming Follow the Basic Law/ Elliott - Argentina has to talk to holdouts BNP Paribas fell foul of US law because the credit it provided to governments subject to American sanctions was denominated in dollars, which is what exporters in other countries customarily require. Once the dollars sourced by BNP’s New York branch passed through the US financial system – through Fedwire or another US-based network for clearing and settlement since there is no other convenient, low-cost way of making dollar payments – they came under US law.

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In fact this is only the second recent effort by US authorities to use the dollar’s position to extend their legal reach. Last month the Supreme Court ordered Buenos Aires to compensate in full “holdout” creditors who rejected the debt restructuring after Argentina’s 2002 default, setting the international bankruptcy regime on its ear. The judges’ leverage was that payments to holders of Argentina’s dollar bonds were routed through the Bank of New York Mellon and again, therefore, through the US payments system. They may not like it, but it is not clear what France and other critics can do to alter the status quo. They might try to set up dollar clearing offshore, an echo of the eurodollar market that sprang up in Europe in the 1960s in response to US controls on international transactions. But low-cost clearing requires liquidity. The Federal Reserve provides the necessary liquidity to financial institutions that transact in dollars in the US, including subsidiaries of foreign banks. In theory, the Fed might provide dollar liquidity for offshore transactions, as during the global financial crisis, but it would not be inclined to provide liquidity to an offshore market established expressly to circumvent US sanctions. The only feasible alternative, then, is to induce non-US exporters to take euros and renminbi in payment for goods and services. When Mr Sapin called for a “rebalancing” against the dollar using “the big currencies of the emerging countries”, there is no doubt which big emerging country he had in mind. But for the euro and renminbi to be attractive to European and Asian companies exporting, say, pharmaceuticals to Cuba, markets in those currencies will need to be deep and liquid. Market participants will have to be able to buy and sell those currencies at a cost as low and predictable as they can for dollars. They may not like it, but it is not clear what France and other critics can do to alter the status quo Market liquidity requires a diverse clientele. Only if market participants include a wide variety of buyers and sellers who require a currency at different times will bid-ask spreads be low and stable – the hallmark of a liquid market. Building market liquidity therefore requires solving what economists call a “co-ordination problem”, inducing a diverse set of participants to enter the market at the same time. This, evidently, was what Mr Sapin was trying to orchestrate by exhorting companies in other countries to contemplate use of the euro and “big emerging currencies” in lieu of the dollar. But France lacks the moral authority to orchestrate this process. Not only did one of its biggest banks egregiously violate international norms by doing business with Sudan and other unsavoury regimes. The government also failed to detect the violation or, worse, did not try. Arbitrary and capricious use of US financial leverage would, in time, create widespread disaffection with the dollar. But steps by the US against BNP Paribas were hardly arbitrary and capricious. Such terms better describe Mr Sapin’s remarks. The writer is professor of economics at the University of California, Berkeley http://www.ft.com/intl/cms/s/0/4b51cc12-0689-11e4-ba32- 00144feab7de.html#axzz373KIGS3c 225

David Cameron will be able to reform relationship with EU, says Jean-Claude Juncker Brussels politician who Mr Cameron failed to stop becoming president of the European Commission says Britain will be able to repatriate powers from the EU ahead of an in-out referendum

David Cameron with Jean Claude Juncker Photo: AP By Bruno Waterfield, and Peter Dominiczak 10:00PM BST 08 Jul 2014 Britain will be able to claw back powers from Brussels ahead of an in-out referendum on the country’s membership of the EU, Jean-Claude Juncker has said. David Cameron failed last month to prevent Mr Juncker becoming president of the European Commission. None the less, Mr Juncker said yesterday that he would not oppose attempts to repatriate powers from Brussels to Westminster. In a leaked recording of a meeting with Brussels MEPs, Mr Juncker said that he does “not want the EU without Britain”. The comments will come as a major boost to Mr Cameron, who clashed with European leaders including Angela Merkel, the German Chancellor, after he was heavily outvoted when he tried to stop Mr Juncker’s nomination. Related Articles// Cameron: I can still do business with Jean-Claude Juncker 29 Jun 2014/ David Cameron: Why I still believe Britain can do business in Europe 29 Jun 2014/ A long, tough campaign – and the right one 29 Jun 2014/ Cabinet ministers attack 'cowardly' EU leaders in Juncker row and unite behind Cameron 28 Jun 2014/One step closer to quitting Europe 27 Jun 2014/ Fears over Jean-Claude Juncker's drinking 26 Jun 2014 The Prime Minister last month warned that keeping Britain in the EU had “got harder” because of Mr Juncker. He described Mr Juncker’s nomination as a “bad day for the EU” and pledged to wage a “long, tough fight” to reform Brussels before campaigning for the UK to remain in the EU in the in-out referendum he has promised to hold in 2017. However, speaking to MEPs, Mr Juncker said that he is ready to begin talks with the UK to return “competences” – EU jargon for powers – back to the UK.

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He said: “I would like Britain to stay as an active constructive member of the European Union. If Britain puts forward a proposal it will be taken under consideration. “I am not in principle saying that no kind of repatriation can take place. If Westminster wants to recover competences, OK. If the others agree, it shall be done be done.” The comments will delight Conservative MPs who want Britain to remain in the EU under different terms. However, they will be treated with suspicion by some Tory eurosceptics who want to leave the bloc because they believe that reforming the EU is impossible. Mr Juncker, who is expected to be confirmed as European Commission president during a vote of MEPs next week, added: “I've never opposed the idea of a well-structured, well-organised, profoundly negotiated repatriation of competences from Brussels to national parliaments. “I don't want the EU without Britain. Britain is an essential element of policy making in Europe because the British are a common sense and down to earth people.” Mr Juncker also denied that he is an arch-federalist who wants to see the formation of a “United States of Europe”. He conceded that he used the term “before Mr Cameron was born” but insisted that he no longer believes in creating a European super-state. Before his nomination, senior Tories had warned that Mr Juncker would insist on creating an “ever-closer” EU that would harm the UK’s interests. Mr Juncker reacted angrily when David Campbell Bannerman, a Tory MEP, asked him if as a federalist, he would abandon “ever closer union… in order to keep the UK in Europe?” Mr Juncker said: “I am not a federalist. I do not believe in the United States of Europe, I have made it perfectly clear, year after year, day after day. I don't think the European Union will become a state .I would fight against that because I think we have to respect nation states [and] parliaments.” He added: “I never used the expression United States of Europe. Yes, when I was 14 or 15 before Mr Cameron was born. After his appearance, I've never used it. “I am not a federalist. I am not in favour of totally centralised decision making in Brussels. I don't like this idea of the Brussels machine taking over power everywhere.” Despite insisting that he is not a federalist. Mr Juncker heads an international educational organisation that is affiliated to the European Movement, which has the objective of the "establishment of a united, federal Europe". He is president of the International Centre for European Studies, or Le Centre international de formation europeenne (CIFE) , which describes its vision as "a federal concept of European education". In March this year. Mr Juncker backed plans for school students to be given a "European Union education" in the classroom to tackle "ignorance" and growing public Euroscepticism. //http://www.telegraph.co.uk/news/politics/david-cameron/10955145/David- Cameron-will-be-able-to-reform-relationship-with-EU-says-Jean-Claude-Juncker.html

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ft.com GlobalEconomy EU Economy

July 9, 2014 8:02 pm Mario Draghi seeks new Brussels powers to enforce economic reform By Claire Jones in London and Peter Spiegel in Brussels Mario Draghi has called for Brussels to be handed sweeping new powers to enforce eurozone countries’ promises to take tough action to reform their economies. Reopening a high-level debate about how much more integration is needed to make monetary union more sustainable, the ECB president said on Wednesday: “There is a strong case for us to apply the same principles to the governance of structural reforms as we do to fiscal governance.” More ON THIS TOPIC// Investors dive deeper into European ‘junk’/ Surveys damp hopes of eurozone recovery/ Survey suggests slowing eurozone recovery/ Wolfgang Münchau Merkel versus Renzi IN EU ECONOMY// Eurozone’s economic recovery stutters/ Sweden cuts interest rates to 0.25%/ Eurozone inflation holds steady in June/ German retail sales fall 0.6% in May The European Commission was given new powers during the eurozone crisis to enforce fiscal rules that limit member states to budget deficits of 3 per cent of economic output. Violations of those rules can now lead to fines. Mr Draghi added: “With the benefit of hindsight, it would have been useful to establish, alongside existing convergence criteria, a set of structural criteria that had to be met to enter the euro area and then respected once inside.” The idea of forcing struggling economies to implement labour market and pension reforms has long been promoted by Berlin. It advocated mandatory “contractual arrangements” that would bind individual eurozone governments to annual reform programmes. That effort stalled earlier this year when Berlin failed to win the support of other member states at the last summit just before May’s European elections, in which anti- EU parties made unprecedented gains. Other eurozone leaders have offered variations on the German proposal, with Jeroen Dijsselbloem, the Dutch finance minister who chairs the eurogroup of eurozone finance ministers, suggesting such reforms be required of any country that is given more time to hit EU deficit and debt targets. Both France and Spain last year were given two more years to hit their targets, with no reform prerequisites. More recently, the government of Matteo Renzi, the new Italian prime minister, has urged the eurozone to offer rewards – rather than punishments – as incentives for

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enacting such reforms, arguing they impose short-term costs, such as higher unemployment, while gains take longer to materialise. The ECB has long viewed structural reforms as vital if the eurozone’s economy is to return to full health. Top ECB officials have repeatedly warned governments against abandoning measures that they believe would strengthen longer-term growth prospects by improving productivity. There is rising concern within the ECB and the European Commission that the recent benign financial market conditions in the eurozone has slackened governments’ willingness to implement needed reforms. In his address, Mr Draghi also cautioned that, without reforms, imbalances between member states risked becoming permanent. “Firms face very different operating environments across the euro area . . . the World Economic Forum ranks Finland third in terms of global competitiveness, whereas Greece ranks 91st.” While Spain is widely touted as the poster child of economic reforms, introducing sweeping labour market reforms at the height of the eurozone crisis, both Italy and France have encountered criticism over their failure to implement changes to their labour markets and pension systems. Mr Draghi attacked attempts by European centre-left leaders, led by Mr Renzi, to allow more flexibility the fiscal rules adopted during the crisis. “It is . . . of considerable relevance and importance that Europe has already made extensive progress in strengthening its rules, for example through the fiscal compact,” the ECB president said, referring to the 2012 treaty that enshrined deficit and debt limits into the constitutions of eurozone countries. http://www.ft.com/intl/cms/s/0/1accb91e-0790-11e4-b1b0- 00144feab7de.html#axzz373KIGS3c

Cameron plans strike crackdown as one million public workers walk out Prime minister branded 'Bullingdon bully' by Unite leader over threat to impose turnout threshold and time limit for union ballots Patrick Wintour and Matthew Taylor The Guardian, Thursday 10 July 2014

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David Cameron said: 'I think the time has come for setting a threshold. It is time to legislate and it will be in the Conservative manifesto.' Photograph: Rex Features David Cameron has been accused by union leaders of being a "Bullingdon bully" after he vowed that the Conservative election manifesto would tighten the screw on strike laws in response to what he regards as Thursday's illegitimate mass walkout of up to 1 million public-sector workers. Cameron attacked the low turnout thresholds in union strike ballots and challenged the validity of mandates to take industrial action derived from ballots conducted more than a year ago in some cases. The prime minister said: "I think the time has come for setting a threshold. It is time to legislate and it will be in the Conservative manifesto." In a sign of how the political battle may unfold, the education secretary, Michael Gove, will accuse the teaching unions of not standing up for education but for their pay and pensions. On Newsnight on Thursday, Gove said teachers who were joining the strike were a minority. He said: "The ballot which legitimates this strike is, I think, something like two years old and the turnout which validates that ballot was small. "There are lots of people who, as members of trades unions, will respect the fact that it's a legally constituted ballot but I absolutely think that this strike is damaging. The truth is that there are a small group of people and they tend to be ideologically motivated and they are opposed to what we are doing." He added that it was important that children could be protected from "politically motivated industrial action". Cameron also rounded on Ed Miliband for neither supporting nor condemning the strikes, billed as some of the largest since the general strike of 1926. They cover teachers, civil servants, transport staff, firefighters and a range of local government staff protesting over real-terms pay cuts. Dave Prentis, the leader of Unison, the largest public-sector union, also vented his frustration at Miliband's stance, saying: "It is time for Labour to make up its mind. Public-service workers are people who should be Labour's natural supporters and they deserve Labour's unashamed backing in return." The unions in local government are seeking a pay rise worth £1 an hour. The unions claim ministers have in effect served notice that pay freezes in the public sector will continue until 2018, by which time the deficit is due to be eradicated. Unite, Labour's largest financial backer, released a Survation opinion poll apparently showing that some of the union-bashing rhetoric of the 1970s and 80s no longer instantly chimes with the public mood. It showed that the public back the right to strike in this dispute by 61% to 31%, support a £1-an-hour increase in council workers' wages by 48% to 35%, and oppose public-sector real-terms pay cuts lasting to 2018 by 56% to 25%. The poll did not ask voters if they support a change to the strike ballot threshold. 230

But Len McCluskey, the Unite general secretary, attacked the prime minister's plans to tighten the strike laws. "The whiff of hypocrisy coming from Cameron as he harps on about voting thresholds is overwhelming," he said. "Not a single member of his cabinet won over 50% of the vote in the 2010 election, with Cameron himself getting just 43% of the potential vote. "If he practised what he preached then no Tory councillors would have been elected in the last 20 years and Londoners would have been spared the circus of Boris Johnson. So we'll take no lessons from the Bullingdon bully, who gives tax breaks to his City chums yet plots to deprive lowly waged workers of their right to fight poverty pay." The Cabinet Office said: "This is a strike that will achieve nothing and benefit no one. The vast majority of dedicated public-sector workers did not vote for this week's strike action. We believe most people will come to work as usual, but rigorous contingency plans are in place to minimise the impact of action and ensure that key public services remain open." The unions said up to a million people were expected to take part in the strikes. The TUC general secretary, Frances O'Grady, said low-paid workers had borne the brunt of the financial crisis and the austerity drive and were still not benefiting from the fledgling recovery. "The economy may be picking up, but having paid the price in pay freezes and below- inflation pay increases for several years there is to be no financial let-up for town hall employees and other public-sector workers," she said. "For them there are no shares to be had in the UK's economic recovery. Instead, several more years of penny-pinching and frugal living lie ahead." Union leaders say more than a million workers were balloted before Thursday's industrial action. They plan more than 50 marches and rallies across England and Wales including protests that will end in a rally in Trafalgar Square. There will also be picket lines at schools, council offices, depots and fire stations. But Tory MPs said strike action in schools had been supported in a ballot in 2012 by 22% of NUT members, and 33% of NASUWT members. Under British laws a single strike ballot can make successive rounds of industrial action lawful if the strikes can be shown to stem from the same dispute. The Conservatives have been talking about revising strike laws for nearly a year, but have been forced to put their plans into the manifesto rather than legislation because of Liberal Democrat opposition. The Tories are considering two strike threshold options. Under the first, backed by Johnson and Gove, a strike could only take place if it was supported by a majority of the entire membership, not just those who vote. Under the second, a minimum turnout of, for example, 60% would have to take part, regardless of how they voted. The TUC published research on Wednesday showing that since the coalition took office, local government workers, NHS staff, teachers, firefighters, civil servants and other public servants were on average £2,245 worse off in real terms.

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O'Grady said: "It won't have been an easy decision for hard-pressed public sector workers to vote to lose a day's pay this week, nor will they take delight in any disruption caused to the public." "But if the government continues to hold down pay, our public services will struggle to hold onto and recruit skilled and dedicated staff. When that happens we all pay the price." http://www.theguardian.com/politics/2014/jul/09/david-cameron-strikes-1m-walk-out- bully-threats?CMP=EMCNEWEML6619I2

ft.com World LatinAmerica&Caribbean Society

July 9, 2014 5:57 pm Eight lessons rock-bottom Brazil need to learn from the best

By Simon Kuper in São Paulo

©EPA Ten years ago this week, the German team was at rock bottom. It had exited Euro 2004 without beating anyone, not even Latvia. Germany’s sorry side served chiefly as raw material for German comedians. Nobody even seemed willing to become national coach. That week I asked Jürgen Klinsmann what was wrong with Germany. “We don’t have a killer up front,” he smiled. “We are still making the mistake of passing sideways. The lack of speed may be another reason.” I asked if he might become coach of Germany. “No!” Three weeks later, Klinsmann became coach of Germany. He and his assistant Joachim Löw ditched tradition and revolutionised the way Germans play football. Just before this World Cup, Klinsmann, now coaching the US, eulogised the new German team to the magazine Elf Freunde: “These high-speed players with their technique, who can play furious attacking football with fast positional changes. Everything that we scribbled in theory on flipcharts in 2004 has become reality.” Tuesday’s 7-1 hammering of Brazil in the semifinal possibly even qualifies as hyperreality.

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More ON THIS TOPIC// Robert Shrimsley Brazil can learn from UK/ Brazil poll contenders fear World Cup hangover/ Brazil suffers World Cup horror show/ Simon Kuper Dutch tactical nous faces Messi magic SIMON KUPER// Fred and Müller – clash of forward styles/ World Cup poor guide to player’s value/ Why Brazil’s already won/ Colombia enjoys boost on and off pitch Now a Brazil at rock bottom needs to revolutionise the way it plays football. Here are eight lessons from Germany: 1. Never let a crisis go to waste. You will never have greater consensus to rethink everything in your football than now. In German parlance, this is “zero hour”. 2. Your past is irrelevant. Brazil’s five world titles mean nothing today. They serve only to kid you that you are still good at football. Your aim must be to play like Germany 2018, not Brazil 1970. 3. Don’t blame individuals. Brazilian fans on Tuesday night were jeering poor, hapless Fred, but it is not his fault that he was arguably the country’s best striker. The system has failed. Fred is only a symptom. 4. The most important thing in football is the pass. It is not the dribble, or passion, or psychology. The Germans obsess about the geometry of passing. Brazil, by contrast, no longer thinks seriously about tactics, which is why coach Felipe Scolari and the Brazilian media spent half the tournament obsessing about the players’ penchant for tears. 5. Learn from the best countries. Accept that you no longer understand how to play football. The Germans from 2004 learned passing from the Dutch and Spaniards, pace of play from the English Premier League, minority recruitment from the French and fitness from Americans. In depth World Cup Brazil 2014

The world’s biggest football tournament is taking place in Brazil – soccer’s spiritual home. Can the World Cup win over a sceptical Brazilian public? 6. The corollary: you probably need a foreign coach. Klinsmann was a German but a longtime expatriate who had ended up in California. Brazil should have asked the Spaniard Pep Guardiola to coach them in the World Cup, as Ronaldo suggested. Hire a European now. 7. Set the bar at number one. For Germany or Brazil, the only aim is to be the world’s best. At Euro 2008, a young German team reached the final, where they were passed off the park by Spain. Germany’s coach Löw did not congratulate himself on finishing second. Instead he thought: “I want a team like that,” and began working out how to become like Spain.

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8. You will not immediately become good but you can almost immediately become professional. Germany leads football in nutrition, statistics, physical preparation and so on. Brazil must aim to match that. Brazil has a harder route to reform than Germany did. The German football federation, with 6.85m members, is the largest single-sport association on earth. Brazil has no comparable central power to push change at all levels. Brazil does have a lone genius, Neymar, who sometimes serves to disguise Brazilian football’s malaise. (Lionel Messi has the same retarding effect on Argentina.) And geographically, Brazil is poorly connected to cutting-edge football countries. All this impedes learning. But there can be no excuse for turning up in Russia in 2018 (presuming Brazil qualify) with talk of 1970 and jogo bonito. That’s dead. http://www.ft.com/intl/cms/s/0/e5b7e294-077b-11e4-81c6- 00144feab7de.html#axzz373KIGS3c

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ft.com/markets MARKETS INSIGHT July 10, 2014 9:25 am Euro strength defies Draghi’s loosening plans By Ralph Atkins ECB hamstrung till Fed adopts policy that lifts the dollar The eurozone economy has failed to spring into life. The danger is of a damaging deflationary slump. Official interest rates have been slashed, and pushed into negative territory. Surely the euro ought to have weakened by now? The resilience of Europe’s single currency is one of the great perversities of the post- 2007 crises era. The eurozone has been left behind as the US and UK economies recover. The Federal Reserve has almost wound down its large-scale asset purchase – or “quantitative easing” – programme; the Bank of England is mulling an interest rate hike. More ON THIS TOPIC// Draghi shakes up ECB deliberations/ Money Supply Live – Mario Draghi’s press conference/ ECB’s loan-buying plans stall/ The Macro Sweep US housing booms as Japan loses momentum MARKETS INSIGHT// Fear factor will return to haunt Yellen/ Big, bad bank fines are here to stay/ End to China property boom barely begun/ ‘Dragon kings’ lurk under market calm Yet the euro is still 10 per cent higher than in mid-2012 on a trade-weighted basis. The latest aggressive monetary policy loosening announced last month by Mario Draghi, the European Central Bank president – including a negative interest rate on the ECB’s overnight deposit facility – produced barely a flicker. The euro is 7 per cent higher against the dollar than a year ago. Frustration at the damage inflicted on exporters erupted this week – at least in France. Fabrice Brégier, chief executive of Airbus’s passenger jet business, urged ECB action against the euro’s “crazy” strength, accusing the ECB of failing to use the currency as “a weapon . . . as a key asset to promote its economy”. Options limited What was left unsaid was quite how the ECB – which would also prefer a weaker euro – was supposed to control the exchange rate. Rather, the euro’s relative strength is the result of capital inflows into the eurozone and a Fed dovishness that has prevented the dollar appreciating and which exasperates many European policy makers. While exchange rates are impossible to predict, Mr Draghi’s options for action seem limited – unless he nobbles Janet Yellen, the Fed’s chairwoman.

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Last week, Mr Draghi rejected the idea that the ECB was being outgunned by the Fed. “There isn’t much relationship between what happens here and what happens there,” he insisted. June’s ECB policy easing had succeeded in pushing short-term eurozone market interest rates significantly lower, he said. To reinforce his point about decoupling, the ECB president could also have noted that the “spread”, or difference, between yields on 10-year US Treasuries and equivalent German Bunds is wider than at any time since the 1990s. His problem is that the link between interest rate differentials and the exchange rate has broken down. Instead, the rise of the euro is largely a “flows story”. Since mid-2012, when Mr Draghi averted the eurozone’s collapse by pledging “whatever it takes” to preserve its integrity, foreign investors have flocked to eurozone bond and equity markets, attracted by a turnround story and higher yields in countries on its “periphery” such as Spain, Italy, Portugal and Ireland. The eurozone’s attractiveness increased when emerging markets were hit last year by financial turmoil – and when Russia’s annexation of Crimea increased global geopolitical tensions earlier this year. China, meanwhile, has been diversifying its massive foreign exchange holdings away from dollars – adding to demand for eurozone assets and driving up the euro. Draghi’s dilemma Those flows may have slowed or gone into reverse recently. “There is some evidence that in the past few weeks this has started to shift down a gear quite meaningfully,” says Jens Nordvig, global head of currency strategy at Nomura. April saw the largest foreign and locally driven outflows from eurozone fixed income securities since mid-2012, according to calculations by BNP Paribas. “Foreigners locked in profits at a higher euro,” says Robert McAdie, the bank’s global head of fixed income strategy. With yields on eurozone bonds having reached historic lows – and some periphery countries’ bonds yielding less than US Treasuries – the region might have lost some of its allure for investors. Significant outflows would weaken the euro. But they may be only temporary. For now many investors continue to bet that the ECB’s monetary policy actions will push bond and equity prices still higher; Mr Draghi has not ruled out full-blown US-style QE. It is hard for the ECB to win either way, however. The Frankfurt institution is perceived as inherently more cautious than the Fed, implying a bias towards a tougher monetary policy, which would logically mean a stronger currency. Currently the market chatter is about whether Mr Draghi might leave office early – perhaps to become Italy’s president – and be replaced by Jens Weidmann, president of Germany’s ultraconservative Bundesbank. Until a change in the Fed’s policy stance leads to a stronger dollar – and thus weaker euro – the way out of Mr Draghi’s dilemma is not obvious. http://www.ft.com/intl/cms/s/0/4955f3ea-078b-11e4-b1b0- 00144feab7de.html#axzz373KIGS3c 236

Daily Morning Newsbriefing July 09, 2014 Be careful what you wish for: Italy likely to see wish of a Socialist Econ Commissioner fulfilled We got an inkling yesterday of how the apparently irresistible force of Matteo Renzi might dissipate into thin air. It was Ecofin day in Brussels yesterday, the first under the Italian presidency, and Matteo Renzi intervened from Venice to demand that all digital investments must from now on be excluded from the deficit calculation – given the importance of the digital economy both for the economic recovery and for European democracy. That demand was swiftly rejected by Siim Kallas, the acting economics commissioner in the outgoing Barroso Commission. There was no distinction behind good and bad categories for the calculation of a deficit he said. La Repubblica reported an angry reaction from Renzi’s office. What Kallas said was “irrelevant”, and that the Commission was “myopic”. Pier Carlo Padoan was apparently taken by surprise by Renzi’s digital initiative, as Corriere della Sera reports. All the Ecofin was able to agree was a luke warm commitment to include economic reform in the assessment of a country’s fiscal position (as though this did not happen before). The Italian media also made much of the apparent promise given by Jean-Claude Juncker to the S&D group in the European Parliament that the next economics commissioner would be a Socialist. La Repubblica reports that this was apparently a French demand, in support of their own candidate Pierre Moscovici. One should, however, also point out that Jeroen Dijsselbloem is also a member of the Socialist Party (though when you listen to him from Italy, you would not necessarily recognise this easily). Dijsselbloem is quoted by Reuters as saying bluntly: "We don't do flexibility per country, we do flexibility for all of the countries." Wolfgang Schauble said that reform and fiscal consolidation were no contradiction. Italy had to do both. Reading Huffington Post this morning we got a sense of the next fight to come. Renzi is apparently determined to nominate Federica Mogherini as High Representative as well as Pier-Carlo Padoan as eurogroup chief. The main problem, the article said is how to replace them domestically though Renzi seems to have his right hand man Graziano Delrio for the job of finance minister. This has the feel of a slow-motion train wreck on so many levels. We can understand that Renzi needs to make an impression domestically that he can forge the European debate. But we see very little room for manoeuvre in practical terms. The minute Renzi gets concrete – like his proposed exemption of digital spending from deficit rules – the 237

proposal is rejected. By proposing two Italians for top jobs he may eventually secure the appointment of one of them though others will point out that Italy is far from under- represented in top jobs already. It is hard to see how Mario Draghi could be at the helm of the ECB and Padoan at the helm of the eurogroup – especially as Spain has quite a bit of support with its nomination of de Guindos. Our best guess now would be that Renzi will not prevail on any substantive change in the fiscal rules. And that he will not prevail on the nomination of the eurogroup chief. He may prevail with Mogherini as candidate for the job of High Representative. The CDU/CSU feels sorry for the AfD Germany’s Frankfurter Allgemeine is the mouthpiece of the country’s sururban conservatism, and we always noted an undisguised sympathy for the AfD, the anti-euro party. That sympathy radiates also to deep inside the CDU and in particular the CSU. We reported yesterday that the European Parliament’s ECON committee did not elect AfD chief Bernd Lucke to one of mostly ceremonial jobs of the vice-chairmanship of the committee – the jobs are usually distributed across the party groups under some formula. Werner Mussler und Hendrik Kafsack of FAZ describe how the CDU members of the committee express outrage about the vote. They are even outraged at the argument put forward by Sven Giegold (which seems totally plausible to us) – that you do not want to hand confidential ECB documents to somebody who wants to break-up the eurozone. The article quotes Markus Ferber, the conservative Bavarian MEPs, as rallying to the support of Lucke, defending his honesty. The truth is the Lucke says what some of these CDU/CSU guys are thinking but are not allowed to say. Over the years, we would expect the CDU, post-Merkel, to open up to co-operation with the AfD, just as the SPD opens up to co-operation with the Left Party. The Left Party’s uncritical support of Vladimir Putin was a setback for SPD/Left cooperation. But the parties are now talking to each other. Expect the German political dialogue to become more confrontational once the Grand Coalition love-in ends. France lost influence in the EP France has secured hardly any strategic positions in the new European Parliament, writes Les Echos. There is Sylvie Goulard, Elizabeth Morin-Chartier and Alain Cadec, that's it. Never before has the founding member lost so much presence. Partly this is the result of voting for the Front National, which with 24 MEPs failed to form a political group. The vote dispersion played against France: the UMP is only the third strongest in the PPE, the Socialists are the sixth in their group, while the French Greens without Daniel Cohn-Bendit lost two third of their force. France has less influence than Poland, Spain, Italy and the UK, concludes the article. The Berlusconization of Europe’s elites In his El País column, Josep Ramoneda writes that the “Berlusconization” of Sarkozy is indicative of a growing sense of impunity among the political class. Though, he says, his political credit is spent in Paris, he is still treated with reverential fear in “the Paris bubble”, illustrated by the grovelling journalists who interviewed him after he was released from police custody the last week.

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The combination of ostentatious power displays with cynical “outsider” populism to get out of political trouble has, according to Ramoneda, the ultimate effect of replacing the left/right political axis with an elite/people opposition. Ramoneda links this to the success of populist discourse which he represents by the catchphrase “the caste” to refer to the elites, popularised by Podemos. He ends with a warning that Europe has historical experience of what happens when politics becomes a confrontation between “impudent elites and indignant masses”, as “money and the military always take ultimately the same side”. For a couple of years, high-brow commentators have borrowed Acemoglu and Johnson’s concept of “extractive elites” in Spanish political commentary, but the success of Podemos is replacing this with the cruder “the caste” which is now being used even by people who are critical of the concept. Greece to tap markets today Greece prepares to tap the markets today, Kathimerini reports. Sources say that the Finance Ministry is most likely to issue 3-year bonds – which do not currently exist for Greece – and to borrow an amount of between €2.5bn and €3bn. Market analysts expect an interest rate of below 3%. The timing is good, after Monday’s Eurogroup decision for the disbursement of the €1bn sub-tranche and OTE telecom borrowing €700m through a six-year bond with a coupon of 3.50% on Monday, and the troika inspection starting on Thursday. Greece exports continued to fall Greece’s exports continued to fall for the second successive month, by 8.3% in May, following a steeper drop of 20.8% posted in April, while imports followed an upward trend with 2.6% growth in May, Macropolis reports on the Elstat flash estimates. Without oil products exports actually rose by 1.5% in May. This is mainly attributed to a 2.8% increase in exports to the EU, while exports to third countries showed a modest drop of 0.9%. German bail-in rules to become active from 2015 Reuters reports that German bail-in rules will become active possibly next year, a year before the deadline set by the Bank Recovery and Resolution Directive. Germany’s domestic law forms part of a package of legislation to be presented to the German cabinet today. The legislative text makes that the pompous – and false- statement that the law will ensure that taxpayers will in future be shielded from the resolution costs of banking crises. The article also points out that Germany has not yet legislated to translate the EU bank levy for the resolution fund into domestic law – where the deadline is 2015. Will TTIP weaken financial regulation? We have come across an article in Corporate Europe Observatory, a campaign group critical of the power of large corporations, published last week. It claims to have got hold of leaked document from the European Commission that suggests that the TTIP trade agreement with the US would weaken global financial regulation by applying home country rules. The rules are weaker in the EU than in the US, which thus allows European banks to trade in the US under EU regulation. It is also 239

supported by the US banking lobby, which is trying to reduce the levels of US legislation. The result would be a regulatory race to the bottom. “These so-called “regulatory cooperation” proposals would guarantee that the financial sector is not harmed by measures taken by regulators, would allow EU banks to operate in the US on the EU's (generally laxer) rules, and in general that financial corporations on one side of the Atlantic do not have to abide by host country’s laws but only by home country laws on the other side of the Atlantic. The implications for decision-making on financial reforms and control over the financial sector are serious.” Why has the Yen depreciation had so little effect Via Mark Thoma’s blog, we came across this interesting article by Mary Amiti, Oleg Itskhoki, and Jozef Konings on why the 30% Yen depreciation had so little effect on net exports. This is clearly off our reservation but of interest inasmuch as some of these described effects might apply to the eurozone as well. The authors identify a low pass through rate for Japanese exports, possibly due to local currency pricing, or policies to price to market, as well as the fact that the largest exporters are also importers. The following is their specific finding: “… the incomplete pass-through is the most pronounced for exporters with large import shares—each additional 10pp of imports in total variable costs reduces exchange rate pass-through by over 6pp. We also show that large exporters are import-intensive, have high foreign market shares, set high markups, and actively move them in response to changes in their marginal costs. Thus, the prices of the largest firms, which account for a disproportionate share of trade, are insulated from exchange rate movements both through the hedging effect of imported inputs and through active offsetting markup adjustment in response to cost shocks.” Karl Whelan is extremely downbeat on the ECB The European Parliament has published a series of contributions on the monetary dialogue. There is no way we can do justice to this large number of papers. The one that caught our eye was the presentation by Karl Whelan, who gave a blunt criticism of the effectiveness of the ECB’s policy response, which he writes has been inferior to that of other central banks. He estimate that the decision of June 5 will only have a modest impact on the economy. They will not contribute much to the resumption of bank lending. He says most banks will treat the TLTRO as an unconditional two-year LTRO. He concludes that large asset purchase programmes are overdue, and likely to happen. Odendahl on diverging real interest rates Christian Odendahl has a thoughtful commentary on the divergence of real interest rates in the eurozone. In a decentralised monetary union it is essential that policy is strongly anti-cyclical. During a crisis, it needs to be expansive, and financial regulation should actively facility lending. During a boom, the opposite must happen. But it didn’t. “While diverging real interest rates are a common feature of a decentralised monetary union, fiscal, regulatory and monetary policy play an important part in counteracting their upside-down dynamic. But as long as eurozone fiscal and monetary policy does not change to support growth, and inflation remains very low as a result, real interest 240

rates in the South will remain high – too high for a meaningful recovery. The recent news on a stalling recovery should come as no surprise.” Eurozone Financial Data 10y spreads Previous This Yesterday day Morning France 0.330 0.323 0.320 Italy 1.443 1.647 1.648 Spain 1.422 1.500 1.532 Portugal 2.360 2.459 2.479 Greece 4.695 4.812 4.81 Ireland 1.014 1.073 1.067 Belgium 0.425 0.417 0.415 Bund Yield 1.258 1.222 1.221 exchange rates This Previous morning Dollar 1.360 1.3617 Yen 138.340 138.37 Pound 0.795 0.7948 Swiss Franc 1.215 1.2152

ZC Inflation Swaps previous last close 1 yr 0.77 0.76 2 yr 0.78 0.77 5 yr 1.23 1.23 10 yr 1.66 1.65

Eonia 7-Jul-14 0.03 4-Jul-14 0.03 3-Jul-14 0.03 2-Jul-14 0.02

OIS yield curve

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1W 0.047 15M 0.044 2W 0.053 18M 0.045 3W 0.070 21M 0.055 1M 0.058 2Y 0.063 2M 0.066 3Y 0.140 3M 0.065 4Y 0.220 4M 0.079 5Y 0.353 5M 0.077 6Y 0.515 6M 0.061 7Y 0.681 7M 0.059 8Y 0.848 8M 0.058 9Y 1.000 9M 0.056 10Y 1.133 10M 0.055 15Y 1.638 11M 0.053 20Y 1.868 1Y 0.051 30Y 1.966

Euribor-OIS Spread previous last close 1 Week -2.129 -2.129 1 Month 2.657 2.557 3 Months 10.714 10.714 1 Year 38.357 38.357

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 09.html?cHash=149c6f697976cfbdc02d8f3d8fdd7d2f

European Parliament committees.publication.wai.showresult

 03.03.14

 14.07.2014 Monetary Dialogue 2009-2014: Looking backward, looking forward

 Charles Wyplosz, Graduate Institute of International and Development Studies, Geneva The Monetary Dialogue  Guillermo de la Dehesa, Chairman of the Centre for Economic Policy Research (CEPR) Improving Monetary Dialogue with the ECB  Sylvester C.W.Eijffinger, CentER and EBC, Tilburg University and CEPR with research assistance performed by Louis Raes, Tilbuurg University Monetary Dialogue 2009-2014: Looking backward, looking forward  Karl Whelan, University Colege Dublin The Monetary Dialogue and accountability for the ECB  Gregory Claeys, Mark Hallerberg, Olga Tschekassin, Bruegel Options for the Monetary Dialogue under an evolving monetary policy  Anne Sibert, Birkbeck, University of London and CEPR Monetary Dialogue 2009-2014: Looking backward, looking forward 242

 Stefan Collignon, Scuola Superiore Sant'Anna, Pisa and London School of Economics. Research assistance by Sebastian Diessner, London School of Economics Central bank accountability in times of crisis. The Monetary Dialogue: 2009- 2014  Ansgar Belke, University of Duisburg-Essen and IZA Bonn Monetary Dialogue 2009-2014: Looking backward, looking forward Texts of Monetary Dialogue  Mario Draghi, President of the ECB Introductory remarks  Full text of the hearing EN  Full text of the hearing DE  Full text of the hearing FR http://www.europarl.europa.eu/committees/en/econ/publications.html?id=ECON00014#menuzone

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The eurozone's real interest rate problem Written by Christian Odendahl, 08 July 2014 When the UK was considering euro membership, former chancellor Gordon Brown suggested five criteria that needed to be met. The first, and arguably most important, concerned interest rates. Specifically, he said economies of the eurozone needed to be sufficiently compatible to live with common eurozone interest rates on a permanent basis. The recent crisis suggests they were not. The main underlying reason is that real interest rates, that is, the interest rates after adjusting for inflation, can diverge quite drastically in a monetary union – and unfortunately in the wrong direction, thereby amplifying boom and bust cycles. This is especially true in a diverse and decentralised monetary union like the eurozone. Fiscal and regulatory policies need to work aggressively against this phenomenon, to ensure countries grow steadily without protracted booms or slumps. Before the crisis, the eurozone clearly failed on this account. Today it continues to do too little to avoid such harmful divergence, which points to a period of low and uneven growth in the eurozone. In the eurozone, market forces and the benchmark rates set by the European Central Bank (ECB) collaborate to make nominal interest rates converge in normal times. If there were differences, markets would make use of it and ‘arbitrage’ the difference away. As a result, nominal interest rates for government bonds or corporate loans across the eurozone are usually similar. However, it is real interest rates which ultimately matter for investment and consumption decisions because they represent the real cost of borrowing. If nominal interest rates are 2 per cent but inflation is also 2 per cent, the cost of borrowing is zero because everything will have become more expensive over the year. Since inflation rates differ across countries that are at different points of the business cycle, real interest rates can and usually are very different across countries in a monetary union. Unfortunately, this divergence tends to amplify the cycle. When an economy is booming, inflation is usually high; whereas when an economy is stagnating or in recession, inflation tends to be low. Real interest rates will thus be low in booming countries with high inflation. This gives the boom a further push, as lower real interest rates encourage consumption and investment. In stagnating economies, where inflation is low, real interest rates will be high, further weakening the recovery. Spain in the early 2000s is a case in point: the more the economy boomed and the more inflation rose, the lower real interest rates became (see charts). This stimulated the economy further, as low interest rates made investment (for instance in real estate) more worthwhile. Since there was no national Spanish interest rate but a eurozone one, such self-reinforcing dynamics played out almost uncontested – until the crash. In Germany, with low inflation and growth in the first half of the 2000s, the opposite was the case: low inflation led to high real interest rates. Thus, the economy was further weakened at a time when it needed stimulus, prolonging the period of subpar 244

growth. Now the pattern is reversed, Spain has experienced a depression and struggles to recover while Germany is growing. Real interest rates show the same upside-down pattern: Spain’s real interest rates are significantly above Germany’s, crippling a recovery in Spain while low real rates in Germany potentially stimulate its already robust economy further. Chart one: The difference between real interest rates for German and Spanish governments

Source: Haver Analytics, CER calculation; the calculation is simplified: 10 year government bonds minus current CPI (instead of inflation expectations). Chart two: Real interest rates for firms in Europe

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Source: Haver Analytics, CER calculation; the calculation is simplified: 1-5 year interest rates on firm loans minus current CPI (instead of inflation expectations) for the past, and IMF inflation expectations for 2014-2019. Divergent real interest rates are a natural phenomenon in a monetary union. The policy response to them is not: fiscal and regulatory policies need to be used aggressively in order to counteract the negative effects of this upside-down divergence – especially in a decentralised monetary union like the eurozone where there are no automated fiscal transfers. In a boom, fiscal policy needs to be very restrictive – Spain’s surpluses before the crisis were not large enough. Financial regulation should make lending more expensive in booming countries, thus effectively increasing interest rates for businesses and consumers there. At the same time, eurozone member-states that are in recession or only growing slowly need to be able to use fiscal stimulus to counteract the negative effects of higher real interest rates. Financial regulation should facilitate lending in these countries. Unfortunately, the eurozone is not drawing the right conclusions. Most countries are consolidating their budgets during a period of low growth and inflation, instead of counteracting the drag from high real interest rates. For the future of eurozone growth, that means too high real interest rates will continue to weigh on countries like Spain, Italy and even France. The verdict on German fiscal policy is still out, given that Germany has yet to boom. Likewise, regulatory policies are not being used to lower interest rates in countries in recession or stagnation, and to tighten standards in the booming parts. The reason is not a policy failure by regulators – they stand ready to counteract booms, certainly more so than in the past. The failure lies with the ECB and the overall fiscal policy in the eurozone. Both have prevented the eurozone from growing at a sufficient level by being too cautious (ECB) or outright restrictive (fiscal policy). Ideally, the overall fiscal and monetary policy stance should raise average growth and inflation to an appropriate level. Regulatory policies could then curtail a lending spree in the booming parts that enjoy too low real interest rates while facilitating lower real interest rates in sluggish economies. 246

Finally, the financial sector is adding to the divergence in real interest rates: banks and, more importantly, firms have to pay a premium on borrowed money for the simple fact of being in, say, Italy. This is because financial risk after the crisis is still attached to the government of the state where the bank or firm is located. The European banking union was supposed to bring an end to this ‘country risk’ but it has so far only partially succeeded: in the event of a major crisis, German banks will still be perceived as safer, reducing their borrowing costs now, and vice versa for Italian or Spanish banks. Thus, some country risk will remain for the coming years. As the cruel logic of a crisis mandates, this country risk adds to the real interest rates in the worst-affected countries, worsening the macroeconomic dynamic outlined above. For the growth prospects of the eurozone, in particular those countries currently growing slowly, this has important implications. While diverging real interest rates are a common feature of a decentralised monetary union, fiscal, regulatory and monetary policy play an important part in counteracting their upside-down dynamic. But as long as eurozone fiscal and monetary policy does not change to support growth, and inflation remains very low as a result, real interest rates in the South will remain high – too high for a meaningful recovery. The recent news on a stalling recovery should come as no surprise. Christian Odendahl is chief economist at the Centre for European Reform. – See more at: http://www.cer.org.uk/insights/eurozones-real-interest-rate- problem#sthash.9HHgA1Jw.dpuf http://www.cer.org.uk/insights/eurozones-real-interest-rate-problem

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July 07, 2014 Why Hasn't the Yen Depreciation Spurred Japanese Exports? Mary Amiti, Oleg Itskhoki, and Jozef Konings The Japanese yen depreciated 30 percent from its peak in the fourth quarter of 2011 against its trading partners. This was expected to boost its exports as the lower yen makes Japanese goods more competitive on global markets. Instead, the volume of Japanese exports of goods actually fell by 0.6 percent over this same period, as can be seen in the chart below. Weaker external demand surely contributed to this poor export performance. Yet over the same period, U.S. goods exports grew by more than 6 percent, which suggests that other factors are also at play. In this post, we draw on our recent paper “Importers, Exporters, and Exchange Rate Disconnect” that highlights another channel to help explain these puzzling developments. In that study, we show that a key to understanding why there is low pass-through from exchange rates into export prices is that large exporters are also large importers, so they face offsetting exchange rate effects on their marginal costs. In the case of Japan, the connection between the yen and production costs has been made stronger since the country replaced nuclear power with imported fuels in the aftermath of the 2011 earthquake.

It has been well established that exchange rate changes are not fully passed through to export prices in foreign currency terms; that is, a 10 percent depreciation in the yen results in a less than a 10 percent fall in Japanese export prices and, thus, a relatively smaller boost to export quantities in response to a depreciation. This low pass-through has generally been attributed to “local currency pricing” and to “pricing-to-market.” If firms choose to invoice their exports in foreign currency terms, then prices are “sticky” in that currency, so exchange rate changes mechanically translate into changes in the

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exporter’s markup, with a weaker yen increasing the profit margin of exporters. A local currency pricing study shows that Japanese exporters to the United States generally invoice in U.S. dollars. In addition, exporting firms often tend to adjust their markups in response to an exchange rate depreciation, even if they do not invoice in the foreign currency, with the size of this adjustment depending on demand conditions in each export market. The new finding in our study is that the incomplete pass-through is the most pronounced for exporters with large import shares—each additional 10 percentage points of imports in total variable costs reduces exchange rate pass-through by over 6 percentage points. We also show that large exporters are import-intensive, have high foreign market shares, set high markups, and actively move them in response to changes in their marginal costs. Thus, the prices of the largest firms, which account for a disproportionate share of trade, are insulated from exchange rate movements both through the hedging effect of imported inputs and through active offsetting markup adjustment in response to cost shocks. Our research uses highly disaggregated data for Belgian firms, which unfortunately are unavailable for Japan. However, the intuition from that study applies more widely. The fact that large exporters are also large importers appears prevalent across many countries. Although we do not have the data for Japan to see whether larger exporters are also the larger importers and whether that import share has been growing, the chart below shows that imports of fuel—an intermediate input into the production process— have been growing rapidly since the Japanese earthquake in 2011 led to the closure of all nuclear plants in Japan. Fuel imports spiked immediately after the earthquake and have been steadily rising from 4.4 percent of GDP to 5.9 percent.

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Other imported inputs could well be growing, too, but they are more difficult to identify in the aggregate data. The point is that the yen depreciation drives up the marginal costs of Japanese exporters that import their intermediate inputs and therefore results in a smaller share of the depreciation being passed on into their export prices in foreign currency terms. The magnitude of the price adjustment depends on how important imported intermediate inputs are in a firm’s total costs. In the case of Japan, the replacement of nuclear power with imported fuels works to increase the impact of the weaker yen on the production costs of exporters. Disclaimer The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Mary Amiti is an assistant vice president in the Federal Reserve Bank of New York’s Research and Statistics Group. Oleg Itskhoki is a professor of economics at Princeton University. Jozef Konings is professor of economics at University of Leuven. http://libertystreeteconomics.newyorkfed.org/2014/07/why-hasnt-the-yen-depreciation- spurred-japanese-exports.html

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Daily Morning Newsbriefing July 08, 2014 A Renzi man to chair the Econ committee The newly constituted Economic and Monetary Affairs Committee of the European Parliament has elected Roberto Gualtieri as its chairman. Gualtieri, a historian, is a member of the S&D, and a close ally of Matteo Renzi. While Italy will not be able to fill the jobs of economics commissioner or eurogroup chief, this is a potentially important and influential position if exercised properly. The Committee has the right to question the president of the ECB (note to MEPs: questioning is not the same as asking questions). To counter-balance the Italian at the top, the Committee elected two Germans as his 'Aufpasser', Markus Ferber, a fiscal conservative from the Bavarian CSU, and Peter Simon of the SPD. The German AfD leader Bernd Lucke was rejected as a third VP in a secret ballot. We noted Sylvie Goulard’s statement that the pro-European majority in the committeet were now acting together against the eurosceptics. She said Lucke’s repeated calls for a breakup of the eurozone violated the treaty. Spanish government sources are confident that economy minister Luis de Guindos is “close” to being nominated next week to chair the Eurogroup, writes El Mundo. According to these sources, the Dutch government has communicated informally that the current Eurogroup chair Jeroen Dijsselbloem will be nominated to the Commission leaving his position vacant a year ahead of schedule. In this way Mariano Rajoy might attain his objectives in the European top job negotiations: sending de Guindos to the Eurogroup and PP leading EP candidate Miguel Arias Cañete to the Commission, in addition to having already secured an EP vice-presidency for Ramón Luis Valcárcel. Possible candidates to replace de Guindos would be: Álvaro Nadal, chief economic advisor to PM Rajoy; José Manuel Soria, currently the minister for Industry and Energy; and foreign minister José Manuel García Margallo. Frankfurter Allgemeine had an interesting article on how Jean-Claude Juncker might change the Commission. He is seeking a female quota of 40% - which is going to be hard to achieve given the nomination he has already received: Oettinger (Germany), Katainen (Finland), Dombrovskis (Latvia), Ansia (Estonia), Hahn (Austria), Mimica (Croatia), and quite likely Dijsselbloem (Netherlands) and Moscovici (France). The only potential female candidate are Mogerhini (Italy) – but it not clear whether Italy’s foreign minister will be chosen as the High Rep – Malstrom (Sweden) and Georgieva (Bulgaria). To achieve the quote Juncker is considering asking governments to make more than one nomination. The article also says that Juncker is not going to follow orders from the member states on the allocation of portfolios as has been the practice in the past. The article said the most likely candidate for the economics commissioner job were 251

Moscovici and Dijsselbloem (what about Katainen? Was he not supposed to take over from Olli Rehn?). One of the options under consideration, the article says, is a new structure in the leadership of the Commission, with two tiers of commissioners – with only the upper tier able to take votes. Another option are vice-presidents without portfolio. German industrial production slumps in May There was more evidence of an economic slowdown from Germany’s Federal Statistics Office yesterday, which reported a fall in industrial production by 1.8% in May relative to April, after a revised fall of 0.3% in April relative to March. The less volatile 3-m average comparison between March/April/May to the previous three-month period registered a drop of 1.1%. Most of the recorded slump was accounted for by manufacturing, and within that category especially from intermediate goods and consumption goods. There were strong increase in goods relative to construction and energy. The German economics ministry, which always puts a spin on these data releases, said it was taking solace from the continued positive sentiment indicators, which suggest that the recovery was well on track. But it did acknowledge that geopolitical factors were playing a role. Well, good luck with that. There has been a persistent gap between the confidence indicators and the hard data, and the confidence indicators are now adjusting back towards the data – which makes it a perfect backward-looking indicator. We also believe that these numbers probably do not reflect the underlying trend. We are not heading for another recession. We are still in a scenario of a weak and fragile recovery. De Grauwe on the negative effect of austerity on Spanish debt sustainability Writing in Vox, Paul de Grauwe compares Spain and the UK and observes that, despite the strong effect of the OMT announcement by the ECB in lowering Spanish sovereign bond yields, the debt sustainability of the Spanish state has not improved. This is in contrast with the UK whose debt-to-GDP ratio appears to have stabilised over the past two years. De Grauwe points out that this is despite Spain having improved its primary budget balance by a higher percentage of GDP than Britain (i.e., Spain “instituted more intense austerity measures”). The reason for this is two-fold according to de Grauwe. On the one hand the UK experienced currency depreciation which increased nominal GDP growth, and on the other hand Spain’s greater austerity effort again depressed GDP growth relative to the UK. For a given level of nominal yields on government debt, debt sustainability requires a larger primary surplus for Spain than for the UK. Austerity in Spain causes an accelerating feedback loop on its debt as growing debt motivates greater austerity measures which depress growth, raising the primary surplus threshold for debt sustainability and making debt grow more. Austria's Erste faces €1.6bn loss in Eastern Europe Austria's Erste, the Eastern Europe's third-biggest lender, got punished by investors after their surprise announcement of a €1.6bn loss this year due to a law cutting bank charges in Hungary and higher provisions for soured loans in Romania, Reuters reports.

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Investors wiped more than €1bn off Erste Group's market value and took evasive action against rivals on Friday. Erste's warning was another reminder of the challenges of operating in Central and Eastern Europe. Hungary's parliament approved of a bill last Friday that will cut bank charges on foreign-currency and forint-denominated loans to compensate borrowers after the Supreme Court ruled that banks had unfairly charged them. The charge in Romania was due to the central bank there clamping down on non-performing loans ahead of an ECB's review of large European banks, Erste said. Two trade unions in open revolt against Hollande's government The social dialogue between the unions, employers and the government - hailed as one of Hollande's rare successes - is about to derail as the large CGT union and the FO announced an unprecedented boycott of the labour summit today, over what they call unfair government's preference towards employers, due to reap €40bn in tax credits over the next three years standing accused of giving nothing in return. Last week it was the employers' association Medef that threatened to boycott the meeting unless the government delayed the implementation of an early retirement scheme for workers in strenuous jobs. It got the concession - a one-year delay until 2016 - but at the price of irking the unions. The boycott was the result. Médiapart accuses Francois Hollande of destroying the social basis behind his electoral success in 2012 by completely breaking away from his electoral campaign. Le Monde says while it looks like the honeymoon between trade unions and the French government is over, Manuel Valls promised to consult with trade unions about all those 'hot' subjects. Elsa Freyssenet in Les Echos warns that the "rupture" will set a precedent for future turbulences and it will be interesting to see today whether the number of rebels inside the Socialist party is rising as a result. Golden Dawn and Dimar to table own proposal on power company The part-privatisation of the electricity company PPC got a new political momentum with Golden Dawn and Dimar saying they would table their own referendum proposals. Syriza got the backing from the Independent Greeks for its proposal, while the Communist party said it would only support a plebiscite if it is on the liberalization of the whole electricity sector and not just on the sale of the so-called “small PPC.” Parliament Speaker Vangelis Meimarakis indicated in comments recorded by Kathimerini that said it was possible that different proposals for a referendum could be considered together, with all five political parties this would imply 125 MPs, enough to start a debate on the referendum. There was thus a possibility that the House’s plenary session, which is in recess for summer, could be convened for a debate on a possible referendum on the PPC sell-off – a plan that is due to go before a vote in the House on Wednesday. For the penary session to reconvene, a presidential decree must be issued. Noonan joins Renzi's camp on budget rules Ireland's finance minister Michael Noonan came out in support for Renzi's call for more flexibility in the budget rules, saying the EU’s fiscal rules should be “re-examined” in light of the changing euro zone climate. On his way into the eurogroup meeting of finance ministers, Mr Noonan said:

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“I think that the set of fiscal rules which, in effect amount to a fiscal union, were designed . . . in times of great crisis. Now that the euro zone has settled down, I think the rules should be revisited and a more precise interpretation of some of them be laid out. If that means some flexibility in the interest of growth and jobs in Europe, then that would be welcome.” While cautioning against any hope of “dramatic” changes, he said there had already been a move towards flexibility, even from the European Commission. “If there’s a move towards flexibility . . . I think that could contribute to the common purpose across Europe, that European economies would grow more rapidly, that more jobs, particularly for your young people, would be created,” cites the Irish Times. Privatisation programme setback for Renzi We noted a comment from Reuters Breakingviews on the fall in the share price of Fincantieri, a state-owned shipbuilder. Fincantieri floated last week, but was forced to cut the size of its IPO after institutional investors walked away. The shares now are trading below last week’s float price. Given that most of the shares were sold to the general public, this is potentially unhelpful for Italy’s future privitisation plans. The article goes into some Fincantieri-specific details and concludes that while bond markets have given Renzi a lot of credit, public equity markets work differently. Krugman on the BIS and Wicksell We had commented recently that the problem with the BIS’ analysis was its lack of an identifiable model. We were subsequently surprised to read Gavyn Davies’ interpretation that the BIS was Wicksellian in its analysis – as opposed to the Keynesian approach of the Federal Reserve. Paul Krugman debunked that one in his blog yesterday. Knut Wicksell’s natural rate of interest was, for all practical purposes, a concept similar to the interest rate in the Keynesian framework – the one that stabilises employment and inflation. The rate the BIS has in mind is a different one: “No, what the BIS is arguing is that there is some other appropriate rate, defined as a rate sufficiently high to discourage bubbles, and that central banks should target this rate even though it is above the Wicksellian natural rate – or, equivalently, that the economy should be kept permanently depressed in order to curb the irrational exuberance of investors.” Sinn and Rogoff in favour of debt forgiveness Hans-Werner Sinn told a truth yesterday: “It’s not nice for the creditor to recognize that he won’t get his money back, but the sooner he faces the truth, the better.” In an interview with Bloomberg, he is quoted as saying that households, companies, banks and states were over-indebted, and that national central banks were over-indebted within the euro-system. With debt levels at unbearable levels, it is time for a debt conference to grant partial debt relief. In a Project Syndicate column Ken Rogoff writes that it is difficult to envisage an endgame that does not involve debt restructuring and rescheduling to a significant degree – or otherwise the ECB would be subjected to a massive burden. He said the overhang of public and private sector debt constitute an important factor in the

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eurozone’s lagging recovery. He favours debt-financed investment programmes (though not indiscriminate stimulus). How the Fed could rebalance the eurozone Brad DeLong has a very good comment in Project Syndicate, in fact enough material for several comments. The element of interest to us is how the Fed can help rebalance the eurozone. He writes that the the EZ is now on a path once described by Marx as “parliamentary cretinism”, where populist leaders are emerging, and where everybody blames their misery on foreigners. This is a very dangerous moment from which the EZ is incapable of escaping on its own. “Here is where the Fed comes in. By shifting its monetary-policy regime to target 4% annual inflation – or 6% annual nominal GDP growth – the US would set in motion rapid rebalancing in the eurozone. Rather than see the 30% euro appreciation that would follow from the ECB’s current monetary policy, German exporters would scream for measures to prevent America’s “competitive devaluation,” finally bringing about moderate inflation in the north rather than the current grinding depression in the south.” The eurozone has always needed an external impetus for generating growth. We agree with DeLong that this would indeed work. But we do not see that the Fed will go for a 4% inflation target, and certainly not in order to bail out another economy. The eurozone has all tools it needs to save itself – Eurobonds, QE, adoption of eurozone- wide NGDP or price level targeting – it just refuses to deploy them for ideological.

Eurozone Financial Data

10y spreads Previous This Yesterday day Morning France 0.325 0.330 0.327 Italy 1.448 1.566 1.559 Spain 1.413 1.422 1.424 Portugal 2.341 2.360 2.370 Greece 4.657 4.695 4.68 Ireland 1.056 1.014 1.006 Belgium 0.421 0.425 0.423 Bund Yield 1.267 1.258 1.265 exchange rates This Previous morning Dollar 1.360 1.3598 Yen 138.600 138.46

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Pound 0.793 0.7934 Swiss Franc 1.215 1.2151

ZC Inflation Swaps previous last close 1 yr 0.77 0.77 2 yr 0.78 0.78 5 yr 1.23 1.23 10 yr 1.66 1.66

Eonia 4-Jul-14 0.03 3-Jul-14 0.03 2-Jul-14 0.02 1-Jul-14 0.03

OIS yield curve 1W 0.060 15M 0.043 2W 0.060 18M 0.045 3W 0.060 21M 0.070 1M 0.060 2Y 0.061 2M 0.069 3Y 0.147 3M 0.069 4Y 0.234 4M 0.075 5Y 0.376 5M 0.053 6Y 0.540 6M 0.053 7Y 0.713 7M 0.051 8Y 0.885 8M 0.049 9Y 1.033 9M 0.048 10Y 1.173 10M 0.047 15Y 1.680 11M 0.064 20Y 1.909 1Y 0.042 30Y 2.007

Euribor-OIS Spread previous last close 1 Week -1.843 -2.643 1 Month 2.657 2.657 3 Months 9.314 11.614 1 Year 39.257 39.257 256

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 08.html?cHash=e426307ecf808a2dc9ac3f5bf86d92f3

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vox Research-based policy analysis and commentary from leading economists Revisiting the pain in Spain Paul De Grauwe, 7 July 2014 There has been a stark contrast between the experiences of Spain and the UK since the Global Crisis. This column argues that although the ECB’s Outright Monetary Transactions policy has been instrumental in reducing Spanish government bond yields, it has not made the Spanish fiscal position sustainable. Although the UK has implemented less austerity than Spain since the start of the crisis, a large currency depreciation has helped to reduce its debt-to-GDP ratio Related// Austerity is unavoidable after a bout of profligacyDaniel Gros/ The coming revolt against austerityCharles Wyplosz/ Fiscal consolidation: Too much of a good thing?John Van Reenen/ Fiscal austerity and policy credibilityMarco Buti, Lucio R Pench The different macroeconomic adjustment dynamics in Spain – a member of a monetary union – and the UK – a stand-alone country – is stark. Paul Krugman popularised this contrast in his New York Times blog with the title “The Pain in Spain” (Krugman 2009, 2011), and commented on my own analysis in De Grauwe (2011). Following the Greek sovereign debt crisis in 2010, Spain – together with other countries of the periphery – was hit by panic in the government bond market, leading to massive dumping of government bonds, fast increases in government bond yields, and a liquidity crisis, forcing the Spanish government to institute an intense austerity program. Although the UK faced similarly unfavourable fundamentals – a banking crisis, a deep recession, and exploding government debt – it was spared the panic, the ensuing liquidity crisis, and sky-high interest rates. This difference between Spain and the UK was explained by the fact that Spain did not enjoy a liquidity backstop from the central bank, while the UK government could count on the Bank of England to provide liquidity in times of crisis. In De Grauwe (2011), I concluded that what Spain (and other Eurozone countries) needed was a liquidity backstop provided by the ECB. Two years after the start of the sovereign debt crisis, the ECB announced it would be ready to provide such a backstop in the Eurozone. It is therefore interesting to analyse how this announcement affected the ‘pain in Spain’, and to revisit the difference in macroeconomic and budgetary adjustments in Spain and the UK. Crashes and bubbles in the government bond markets Figure 1 shows the evolution of 10-year government bond yields in Spain and the UK. The most remarkable phenomena are:  First, the dramatic increase in the Spanish government bond yield at the start of the sovereign debt crisis in 2010.

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 Second, the equally dramatic decline of this yield from the middle of 2012. Today, in 2014, the yields of Spanish and UK government bonds are more or less equal – very much like before the sovereign debt crisis. This remarkable turnaround in Spanish government bond yields appears even more remarkable against the evolution of the government debt to GDP ratios in the two countries, shown in Figure 2. We observe that in 2010, at the start of the sovereign debt crisis, the Spanish government debt ratio was significantly lower than the UK one. Since then, however, the Spanish debt ratio increased much faster than the UK debt ratio and now exceeds 100% of GDP – almost 10 percentage points above the UK debt ratio. The latter appears to have stabilised, while the Spanish debt ratio is still on an upward-sloping path. Thus, despite this unfavourable development in the most important fundamental variable explaining the yields, the latter declined dramatically. The fundamental reason why this was possible was the ECB’s announcement in 2012 that it would perform the role of lender of last resort in the government bond markets. This took the fear factor out of the market, and allowed yields in the Spanish (and other) government bond markets to decline without fundamentals showing much – if any – improvement. De Grauwe and Ji (2014) provide more empirical evidence, showing that the decline of the spreads since 2012 in the peripheral countries cannot be explained by improvements in fundamental variables such as the government debt-to-GDP ratio, the real exchange rate, the external debt position, and the growth of the economy. Instead, the decline in the spreads was caused by the announcement of Outright Monetary Transactions. (See also the extensive empirical analysis of Saka et al. 2014 confirming this conclusion.) Figure 1. 10-year government bond rates in Spain and the UK

Source: Datasource The formula for debt sustainability (see Annex for details) requires that the primary surplus, S, equals or exceeds the difference between the real interest rate, r, and the real growth rate, g (in symbols, S=(r-g)B). 259

We now compare the yearly evolution of r, g, and S in Spain and the UK since 2010 – the first year of the sovereign debt crisis. We first concentrate on r and g, in Figures 3 and 4. We use yearly data. Figure 2. Government debt-to-GDP ratios in Spain and the UK

Source: Eurostat and European Commission Spring Forecast 2014 Debt sustainability in Spain and the UK Figure 3 shows how, since the crisis, the Spanish government yields have been systematically higher than the UK yields. In 2014, the Spanish yields tended to converge again with the UK yields. The nominal growth rate, g (see Figure 4) – which is the sum of the real growth rate and inflation – evolved in a very different manner in the two countries. We see that over the whole period the nominal growth rate in the UK was significantly higher than in Spain. This was made possible by the fact that in the UK – a stand-alone country – the adjustment mechanism included a large currency depreciation that led to a significantly higher nominal growth rate than in Spain, where currency depreciation was not possible and where intense austerity measures were imposed. Figure 3. 10-year government bond yields

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Source: Eurostat and European Commission Spring Forecast 2014 Figure 4. Nominal GDP growth in the UK and Spain

Source: Eurostat and European Commission Spring Forecast 2014 Figure 5. Nominal interest rate - nominal growth rate

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Source: Eurostat and European Commission Spring Forecast 2014 In Figure 5, we show r – g. The contrast between the UK and Spain is very strong. In the UK, r – g remained negative – implying that the UK could stabilise its debt to GDP ratio without having to generate a positive primary balance. In Spain, however, r – g was positive throughout the period. Thus Spain, as a member of a monetary union, was caught by a dynamic instability of its debt-to-GDP ratio that it could only counter by generating a positive primary balance. From Figure 5 it can be seen that the need to apply austerity (a positive S) in order to stabilise the debt to GDP ratio was much higher in Spain than in the UK. Even in 2014, when the Spanish interest rate had declined significantly thanks to the ECB’s Outright Monetary Transactions programme, Spain had to generate 4% of GDP more austerity than the UK to stabilise the debt (see Table 1). This in a way can be said to be the price Spain paid for being in a monetary union. Table 1. Primary surplus needed to stabilise debt (% GDP) 2011 2013 2014 UK -1.22 -1.94 -1.995 Spain 2.30 4.34 1.836

Neither of the two countries managed to generate the conditions for stabilising their debt-to-GDP ratios in 2014, but the UK comes close as can be seen from Table 2 and Figure 2. In 2014 the UK is forecasted to have a primary deficit of 3.5%, which is too high to stabilise the debt-to-GDP ratio, but comes close to it. This is not the case in Spain. In 2014 Spain needs to achieve a primary surplus of 1.8% to stabilise its debt to GDP ratio (see Table 1), while its primary balance shows a deficit of 2.8% – a gap of 4.6%. Thus if Spain wishes to stabilise its debt-to-GDP ratio in 2014, it would have to institute an additional austerity effort of 4.6% of GDP – a heroic effort.

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Table 2. Observed primary balance (% GDP) 2011 2013 2014 UK -5 -4.5 -3.5 Spain -7.6 -4.2 -2.8

Source: IMF Fiscal Observer, April 2014 It cannot be said that Spain did not try to bring down its debt-to-GDP ratio. In fact, it tried harder than the UK. Figure 6 shows the increase of the cyclically adjusted primary balance in Spain and the UK. It measures the intensity of austerity measures over that period. It can be seen that Spain instituted more intense austerity measures than the UK since the start of the sovereign debt crisis. Figure 6. Change in cyclically adjusted primary balance, 2010–2014 (% GDP)

Source: IMF Fiscal Monitor, April 2014 Conclusion The ECB’s Outright Monetary Transactions programme was instrumental in reducing Spanish government bond yields. This alleviated the Spanish fiscal position, but did not make it sustainable. The continuing unsustainability of the Spanish government debt has to do with two factors:  First while r (the interest rate) declined, g (nominal growth) remained much lower in Spain than in the UK. The latter was due to the deflationary forces in the Eurozone – themselves a result of excessive austerity and the absence of currency depreciation (which was made possible in the UK thanks to the expansionary monetary policies of the Bank of England). As a result, r – g continued to be positive in Spain, thereby keeping Spain on an explosive debt path.  Second, as Spain was kept on an explosive debt path, it was forced to apply stronger austerity measures. These in fact did not help to solve the Spanish fiscal crisis as it fed back into a low g, keeping Spain on the same explosive debt path. We know from history that it is

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generally not a good idea to fight excessive debt levels by organising deflation. This lesson from history was forgotten in Europe. Annex In order to analyse the sustainability of the Spanish versus the UK fiscal position, we start from the well-known definition of the government debt constraint:

B = government debt to GDP ratio; = the rate of change of the government debt to GDP ratio; r = nominal interest rate on the government debt; g = nominal growth rate of the economy; S = primary budget surplus. When r > g, there is an explosive dynamic that leads to an ever-increasing debt ratio. This explosive development can then only be stopped by generating a sufficiently large surplus in the primary budget balance, S. More formally, a necessary condition for maintaining solvency is that B be stabilised, i.e. = 0 or S=(r-g)B. References  De Grauwe, P and Y Ji (2014), “Disappearing government bond spreads in the eurozone – Back to normal?”, CEPS Working Documents, May.  Krugman, P (2009), “The pain in Spain …”, The Conscience of a Liberal, 19 January.  Krugman, P (2011), “The Pain in Spain”, The Conscience of a Liberal, 4 May.  Saka, O, A Fuertes, and E Kalotychou (2014), “ECB Policy and Eurozone Fragility: Was De Grauwe Right?”, CEPS Working Documents, June. http://www.voxeu.org/article/revisiting-pain-spain

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vox Research-based policy analysis and commentary from leading economists Managing credit bubbles Alberto Martin, Jaume Ventura, 5 July 2014 There is a widespread view among macroeconomists that fluctuations in collateral are an important driver of credit booms and busts. This column distinguishes between ‘fundamental’ collateral – backed by expectations of future profits – and ‘bubbly’ collateral – backed by expectations of future credit. Markets are generically unable to provide the optimal amount of bubbly collateral, which creates a natural role for stabilisation policies. A lender of last resort with the ability to tax and subsidise credit can design a ‘leaning against the wind’ policy that replicates the ‘optimal’ bubble allocation. Related// Understanding bubbly episodesJaume Ventura, Vasco M. Carvalho, Alberto Martin// Credit booms go wrongAlan Taylor, Moritz Schularick Credit markets play an increasingly central role in modern economies. Within the OECD, for instance, domestic credit has risen from 100% of GDP in 1970 to approximately 160% of GDP in 2012 (as measured by the Bank for International Settlements). To be sure, this growth masks large variations across countries and over time, but there is a common feature to all these different country experiences that stands out. Credit has often alternated between ‘booms’ – periods of rapid growth – and ‘busts’ – periods of stagnation or significant decline. Moreover, there is some evidence that these credit booms and busts have become more common in recent years (Mendoza and Terrones 2012, Dell’Ariccia et al. 2012). These credit booms and busts tend to be accompanied by changes in key economic variables. In particular, it is well documented that credit booms are associated with high asset prices and high growth rates of real GDP, consumption, and investment (Mendoza and Terrones 2012, Dell’Ariccia et al. 2012). In spite of this, credit booms are still viewed with concern by policymakers and academics. The reason is that they eventually end, and their aftermaths are often characterised by financial crises and low economic growth (Schularick and Taylor 2012). This has prompted calls for policies that restrain credit during booms, in the hope that smaller booms will lead to smaller crises. To evaluate the merit of these calls for policy, one must have a view of the forces driving these credit cycles. Credit may fluctuate for variety of reasons, of course, and different types of fluctuations may call for different policy responses. At a very general level, fluctuations in credit may reflect changes in demand or in supply. And these, in turn, may reflect changes in a variety of factors like preferences, technology, or expectations. Recently, though, macroeconomics has focused on credit fluctuations that are driven by fluctuations in borrowing constraints. This is at the heart of ‘financial accelerator’ models that build on Bernanke and Gertler (1989) and Kiyotaki and Moore (1997), and that have become prevalent in the aftermath of the financial crisis.

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The basic narrative in these models is simple – when a borrower obtains credit, she is exchanging goods today for a promise to deliver goods in the future. These promises are only valued by lenders if they have some prospect of being repaid. This depends on the future income of borrowers that can credibly be pledged to lenders, and we can refer to this as the economy’s stock of collateral. If borrowers are constrained, it is this stock of collateral that determines the amount of promises that can be issued. If borrowers are constrained, understanding credit booms and busts requires a theory of collateral fluctuations. In recent work (Martin and Ventura 2014), we construct a macroeconomic model with financial frictions and provide such a theory. Fundamental vs bubbly collateral The key innovation of our work is to distinguish between fundamental and bubbly collateral. Fundamental collateral is the part of a borrower’s pledgeable income that corresponds to future output, i.e. it consists of a borrower’s rights to future production. Bubbly collateral is instead the part of a borrower’s pledgeable income that corresponds to bubbles or pyramid schemes, i.e. it consists of a borrower’s rights to future contributions to such schemes. The macroeconomic literature has exclusively focused on fundamental collateral, studying its implications for credit, investment, and growth. This view of collateral is incomplete, though. Whenever fundamental collateral is insufficient (say, because of weak enforcement institutions), we show that there is room for investor optimism to sustain bubbles that expand the economy’s stock of collateral and total credit. What are the macroeconomic effects of bubbly collateral? By definition, it enables borrowers to obtain credit in excess of their fundamental collateral. Intuitively, current borrowers can obtain ‘excess’ credit today because it is expected that there will be ‘excess’ credit in the future as well, i.e. it is expected to be rolled over. This is the crowding-in effect of bubbles, which ceteris paribus increases investment. But this future ‘excess’ credit will divert some of the resources of future generations away from investment, i.e. resources will be diverted to roll over this credit. This is the crowding- out effect of bubbles, which ceteris paribus reduces investment. The macroeconomic consequences of bubbles depend on the relative strength of these two effects. In particular, we find that the crowding-in effect dominates when bubbly collateral is low, and the crowding-out effect dominates when bubbly collateral is high. This gives rise to an ‘optimal’ bubble that trades off these two effects and provides the amount of bubbly collateral that maximises long-run output and consumption. A role for policy An essential feature of bubbly collateral is that its stock is driven by investor sentiment or market expectations. The credit obtained by borrowers today depends on market expectations about the credit that borrowers will obtain tomorrow, which in turn depend on tomorrow’s market expectations about the credit that borrowers will obtain on the day after, and so on. Because of this, markets may sometimes provide too much bubbly collateral and sometimes too little of it, which creates a natural role for stabilisation policies. We show that a lender of last resort with the authority to tax and subsidise credit can in fact replicate the optimal bubble allocation. To do so, it must adopt a policy of ‘leaning against the wind’ – taxing credit when bubbly collateral is excessive and subsidising it 266

when bubbly collateral is scarce. We show that such a policy raises steady-state levels of output and consumption. It may have ambiguous effects on macroeconomic volatility, though. The reason is that, by managing the economy’s stock of collateral, the policy reduces the responsiveness of credit to ‘investor sentiment’ shocks, but it may enhance the response of credit to standard productivity shocks. One interesting aspect of the proposed policy is that it requires an actual transfer of resources to or from borrowers. In this regard, it is more of a fiscal than a monetary policy, which is commonly associated with the control of bubbles. However, we show that the policy can also be interpreted as an asset purchase scheme – not unlike the ones adopted by various governments since the onset of the recent financial crisis. When the bubble bursts or deflates in our economy, the stock of bubbly collateral falls and so does the market value of promises that are backed by it. The proposed policy requires the lender of last resort to intervene in such circumstances and purchase these promises at a loss, paying a price that exceeds their market value. By doing so, it raises the economy’s collateral ex post and thus total borrowing ex ante. Moreover, we argue that the same conditions that give rise to bubbly collateral in the first place (i.e. low interest rates) also guarantee that this policy can be financed by issuing debt. These results provide a coherent and rich view of credit booms and busts, in which both fundamental and bubbly collateral play a key role. They also provide a useful blueprint to guide policy in dealing with credit bubbles. But the theory has limitations. An important one is that the gap between the optimal bubble and the existing one is perfectly observed – the role of policy is simply to bridge this gap. Reality is more complicated because market participants and policymakers may be uncertain as to whether fluctuations are driven by fundamental or bubbly collateral. Introducing this type of uncertainty is an important next step in this research agenda, and there is still much work to be done. References Bernanke, B and M Gertler (1989), “Agency Costs, Net Worth and Business Fluctuations”, The American Economic Review, 79: 14–31. Dell’Ariccia, G, D Igan, L Laeven, and H Tong, with B Bakker and J Vandenbussche (2012), “Policies for Macrofinancial Stability: How to Deal with Credit Booms”, IMF Staff Discussion Note 12/06. Kiyotaki, N and J Moore (1997), “Credit Cycles”, Journal of Political Economy, 105: 211–248. Mendoza, E and M Terrones (2012), “An Anatomy of Credit Booms and their Demise”, NBER Working Paper 18379. Martin, A and J Ventura (2014), “Managing Credit Bubbles”, CREI working paper. Schularick, M and A Taylor (2012), “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870–2008”, The American Economic Review, 102: 1029–1061. http://www.voxeu.org/article/managing-credit-bubbles

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Daily Morning Newsbriefing July 07, 2014 Forward guidance, German edition. Is this really the time to discuss the next rate rise? We always wondered how long it would take for a German opposition to Mario Draghi to emerge with in the executive board in the ECB. After Jurgen Stark and Jorg Asmussen both disagreed on key elements of ECB policy (Stark on SMP, Asmussen on lower interest rates), it now appears that their successor Sabine Lautenschlager is taking up the tradition with her own form of forward guidance. In an interview with Frankfurter Allgemeine she says that she will be “the first central banker to demand higher interest rates and a reduction in liquidity provision when this is justified”. She also said (hat tip and translation by Reuters): "I absolutely do not see the purchase of government bonds on the horizon. I really don't see that right now". She said was "rather critical" of the OMT. (In other words she disagrees with everything Mario Draghi has done, or said he would do.) Sweden constitutes a good case study of how a policy of premature interest rate increases can backfire. The Swedish central bank’s monetary policy committee last week outvoted its governor to cut the interest rates back from 0.75% to 0.25%. While Sweden operates under an inflation target, the central bank previously prioritise financial stability objectives, but this policy triggered outright deflation. Lars Svensson, who used to serve on the committee and who used to get outvoted all the time by the hawks, welcome the decision, but says it too late. He writes that the policy to stabilise financial markets had the exact opposite effect. By throwing the country into deflation, the Riksbank has increased the households’ real debt burden. “The big mistake in Swedish monetary policy was to start increasing the policy rate in the summer of 2010 instead of leaving it at 0.25 percent. If the policy rate had been left at 0.25 percent until now, inflation would now have been much closer to the target, unemployment would have been substantially lower, and household real debt most likely lower.” Frankfurter Allgemeine has an article on the conflict between inflation targeters and financial stability targeters, as evidenced by the recent debate following the BIS’ annual report. Gavyn Davis has a similar discussion, which he classifies as Keynesian vs Wicksellian. Lautenschlager’s comments serve as a reminder that the ECB’s forward guidance policies are credible only to the extent that there is a majority that sustains it. The two

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German central bankers in the governing council are clearly not on board to support Draghi’s commitment to keep rates low for a long time, and his policy not to rule out QE. If will be interesting to see what happens if core inflation rates at under 1% by the end of the year – which is when the ECB is most likely to re-consider its current policy stance. Italy wants to prevent Katainen and/or de Guindos Corriere della Sera reports that the Italian government is alarmed at the prospect that Jyrki Katainen is set to become the next economic commission, and that Luiz de Guindos is headed for the permanent job as eurogroup chief. The article said that Pierre Moscovici could emerge as a candidate who could stop either Katainen at the Commission or de Guindos at the eurogroup. Given that Mario Draghi is at the head of the ECB, Pier Carlo Padoan cannot be a candidate for the eurogroup, and that this would also preclude Matteo Renzi’s other idea – of Federica Mogherini as the successor to Catherine Ashton as the EU’s High Rep. Tito Boeri has a good discussion on Lavoce about what flexibility means in practice. He looked at article 5.1 of the reformed stability pact from 2005 – in which countries can get a maximum of three years to slow down the path towards structural balance (which in Italy’s case is the medium-term objective). But this is only applies to countries with deficit of below 3%, and can only be invoked by countries that implement the reform. A pure announcement is not enough. To benefit, Italy would least need to do one big structural reform, accompanied by all the measures of implementation. He writes that the government should not keep on proposing more and more reforms, but focus on one of them and see it through. It is always hard to estimate the impact of a reform on growth – which is why any assessment by the Commission will be qualitative. For as long as Italy reforms, it should be able to get a prolongation on the deficit reduction path. Could this work for Italy? Biagio Bossone, Marco Cattaneo and Giovanni Zibordi have a comment in which they look at Hjalmar Schacht’s Mefo bills, discounted bills that circulated as money. They propose that the Italian government could issue similar bills, which they call CCF in amounts sufficient to close the output gap. CCFs would be bills of exchange. They would be issued free of charge to companies and employees, and they are accepted to fulfil any financial obligation to the state, such as the payment of taxes or social contributions. The government would not reimburse them in the future. But they can be immediate cashed into euros. Failure of Gowex raises doubts over Spain’s SME stock exchange MAB A scathing report by US shortseller Gotham last week precipitated the failure of Spanish WiFi provider Gowex, which this weekend admitted to cooking its books for at least 4 years. This has dealt a serious blow to Spain’s alternative stock market MAB where Gowex was listed in 2010. The facts of Gowex’ case are fairly summarized by the Financial Times which highlights the fact that Gowex had the backing of Spain’s market regulator CNMV which was launching an investigation on Gotham for market manipulation even as it asked Gowex to address the allegations in the report. 269

Amusingly and worryingly, Gowex had been named one of Europe’s “Best New Listed Companies” by the Federation of European Stock Exchanges and the European Commission less than a year ago. The MAB was created in 2008 as a stock market for SMEs, with relaxed reporting standards (for instance, biannual rather than quarterly reporting) to reduce the cost of listing for small firms at a time when bank credit was becoming scarcer. In addition, firms listing on the exchange and investors trading on it enjoyed various subsidies and tax incentives. Since its inception the MAB has been plagued by accusations of lack of professionality and transparency, writes El Diario. The paper notes that since the listing of media producer Zinkia in 2009 only 20-odd firms have listed on the exchange, and five of the largest have failed (Zinkia, Bodaclick, Nostrum, Negocio and now Gowex). In fact, Gowex had over 50% of the MAB’s total market capitalization at the start of last week. In his blog on Cinco Días, Miquel Roig wonders whether market regulators have the resources to ensure fraudulent reporting doesn’t get a pass, and muses that “maybe more Gothams are needed to uncover more Gowexes” and the media could have done a better job reporting Gowex over the years. Why the electric power strike is key to Syriza's strategy In a stand-off between the government and employees striking against the part- privatisation of the Public Power Corporation (PPC), worker unions on Saturday vowed to defy a civil mobilization decree, Kathimerini reports. The government used this measure, usually reserved for national emergencies, after unions flouted a court decision Friday that found their strike “illegal and abusive.” The article quotes analysts saying that this showdown helps both sides to "save face," for the unions to show that they only quit after a tough fight and for the government to display its determination. Politically, this moment is more decisive for Syriza than for the government. The question is whether the opposition party can get together 120 MPs it needs to call for a referendum on the privatisation. Currently, they can only count on 102 MPs who would support such a motion. They thus still need to convince the Communists (13 MPs) and some from the independents not yet signed up (18 MPs). After a first rebuttal from Communist leader Dimitris Koutsoubas, Syriza indicated it would consider adjusting its proposal to suit the Communist Party's demands. Macropolis says this is a dry-run for Syriza's capacity to garner support for its attempt to trigger early elections next March by refusing to back the presidential candidate, which also needs the support of 120 MPs. Syriza says that even if they fail this time, they learn lessons for the next time. But in that case, the taste of failure would weigh heavily on their chances to win, argues Macropolis. Independent from this, what is noteworthy is that during those last weeks, Syriza formed closer ties to trade unions which might serve them well in the future. Irish coalition talks start with new Labour leader Joan Burton is the new labour leader, who is to start talks with Enda Kenny about coalition politics and personnel this week. The next 48 hours will be decisive for the Irish government, says this article. Both sides want the coalition to continue until elections in 2016 but at the same time Burton will have to prove itself to the electorate after losing drastically in the local and European elections. Burton, who won the contest 270

with a landslide 77% of the votes last Friday, will push hard for a stronger Labour team in government according to the Irish Times. Burton’s big message as new leader will be social recovery, meaning that economic recovery is not enough. She will push the idea of a “living wage”, which is higher than the minimum wage. She will also try initiatives on housing, not only on social housing but also to make housing more affordable for lower income families. Another focus is jobs. While these measures are costly, she might pick up on proposals of using off-balance funds. She also is expected to strongly advocate Matteo Renzi's call for more flexibility in EU fiscal rules to allow investment in the future. IMF expects to downgrade growth forecast Reuters reports Christine Lagarde hinting at a slight cut in the Fund's growth forecasts for 2015. Lagarde said central banks' accommodative policies may have only limited impact on demand and that countries should boost growth by investing in infrastructure, education and health, provided their debt stays sustainable. She said this month’s update of the global economic outlook would be "very slightly different" from the forecasts published in April – which envisaged an increase in global output by 3.6% in 2014 and 3.9% in 2015. She said activity was picking up, but the momentum could be less strong than anticipated because of weak investment. A taxonomy of financial crises Selin Sayek and Fatma Taskin offer a useful taxonomy of the financial crises that together have made up the eurozone crisis. They group Portugal’s crisis with that of Malaysia and Thailand in 1996-1997. The Irish and Spanish crises are in the same group of as 1992 Japanese crisis. There are also similarities between the recent Italian case and the 1991 Finnish crisis. The Greek crisis has characteristics of the 1996–1997 crises of Indonesia and the Philippines. This classification suggests that the periphery countries are very dissimilar to each other, which would argue against a one-size-fits-all crisis resolution approach. On the limitation of the Taylor rule Simon Wren-Lewis has a good comment on the limitations of the Taylor rule as a policy instrument. He says the best way to understand it is as a horse for all courses. The problem is that in the current recession the natural rate of interest is likely to be a lot lower than the constant in the Taylor rule. He cites the balance sheet recession as one of several reasons. Also, at very low levels of inflation, inflation itself is less responsive to excess demand. In this case the Taylor rule would prescribe a policy action that is too conservative. How to raise private investment We have reported on the DIW’s recent research coming out strongly in favour of measures to support private investment. What surprised about this comment by Marcel Fratzscher in the Wall Street Journal is the extent of his opposition to an increase in public investment. He writes that a strategy based on private investments should contain three pillars. The completion of the single market for services, tax rebates for companies that invest, and a private investment fund to raise investment among SMEs. All measures should be time-limited for five years.

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Eurozone Financial Data 10y spreads Previous This Yesterday day Morning France 0.323 0.325 0.322 Italy 1.447 1.453 1.454 Spain 1.392 1.413 1.423 Portugal 2.314 2.341 2.345 Greece 4.679 4.657 4.68 Ireland 1.067 1.056 1.056 Belgium 0.422 0.421 0.418 Bund Yield 1.295 1.267 1.266

exchange rates This Previous morning Dollar 1.359 1.3578 Yen 138.670 138.63 Pound 0.792 0.7918 Swiss Franc 1.216 1.2158

ZC Inflation Swaps previous last close 1 yr 0.77 0.77 2 yr 0.78 0.78 5 yr 1.23 1.23 10 yr 1.66 1.66

Eonia 4-Jul-14 0.03 3-Jul-14 0.03 2-Jul-14 0.02 1-Jul-14 0.03

OIS yield curve 1W 0.052 15M 0.043 2W 0.055 18M 0.045 3W 0.056 21M 0.056 1M 0.060 2Y 0.065 2M 0.069 3Y 0.136 272

3M 0.056 4Y 0.241 4M 0.060 5Y 0.386 5M 0.058 6Y 0.554 6M 0.057 7Y 0.725 7M 0.060 8Y 0.892 8M 0.058 9Y 1.045 9M 0.053 10Y 1.184 10M 0.046 15Y 1.679 11M 0.065 20Y 1.909 1Y 0.065 30Y 2.044

Euribor-OIS Spread previous last close 1 Week -2.000 -1.4 1 Month 2.829 1.429 3 Months 9.329 9.729 1 Year 36.857 37.257

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 07.html?cHash=3f61ff74bad0bd742c0f4e92a7d6a541

Opinión

TRIBUNA El cambio que España necesita Solo es posible crecer de manera sostenible si aumenta la productividad Jesús Fernández-Villaverde7 JUL 2014 - 00:00 CEST De 1975 a 2013, el producto interior bruto per capita de España creció un 1,5% al año. De los 27 países para los que la OCDE nos da cifras de producto interior bruto per capita para esos años, España fue la decimonovena nación. Por delante de nosotros estuvieron Estados Unidos, Reino Unido, Alemania, Austria, Bélgica, Holanda y Suecia, entre muchos otros. Si nuestra experiencia de crecimiento durante las últimas cuatro décadas es preocupante, aún lo es más que el producto interior bruto per capitaa finales de 2013 esté en el mismo nivel que en 2003 —nuestra década perdida ya es una realidad— o que la productividad total de los factores no haya crecido desde los años ochenta del siglo pasado.

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La búsqueda del crecimiento económico no es una obsesión de los economistas. Sin crecimiento, España no reducirá su alarmante cifra de desempleo, no podrá reducir su deuda (pública y privada) y no podrá financiar el Estado de bienestar en el medio plazo. ¿Cómo podemos incrementar el crecimiento? El recientemente publicado Barómetro de los Círculos (www.circulodeempresarios.org) nos traza unas líneas claras de las reformas económicas que España precisa. Y aunque el barómetro realiza una magnífica labor en diagnosticar nuestros problemas y resumir esas reformas, las mismas han sido reiteradas por muchos comentaristas desde hace décadas. Los economistas han identificado que las naciones crecen cuando se emplean más factores productivos —más empleo, más capital humano y más capital físico— y cuando los mismos se emplean más eficientemente. La respuesta a nuestra pregunta de cómo incrementar el crecimiento es, pues, casi inmediata: conseguir que España emplee más factores y que los emplee de mejor manera. La falta de crecimiento de la productividad es una losa que pesa sobre nuestro futuro Para crear más empleo necesitamos completar la reforma de nuestro mercado de trabajo. Aunque se ha avanzado mucho, en especial en la flexibilidad interna de las empresas, aún queda camino por recorrer en temas como la negociación colectiva, la simplificación de las figuras contractuales, moviéndonos hacia un mercado centrado en un contrato de empleo indefinido y un sistema de mochila de costes de despido. Otras reformas a considerar incluyen fomentar el trabajo a tiempo parcial, el alargamiento voluntario de la vida laboral eliminando las distorsiones fiscales a la misma y repensar la estructura del salario mínimo interprofesional y de las políticas activas de empleo. Para acumular más capital humano, España precisa reformar su sistema educativo para formar no solo estudiantes con más conocimientos y habilidades (en especial en idiomas y matemáticas), sino también estudiantes creativos, curiosos y emprendedores y con unos conocimientos básicos de finanzas. La economía mundial va a cambiar muy rápidamente durante las próximas décadas y la capacidad de los trabajadores de adaptarse a esos cambios pasa por las habilidades analíticas necesarias para entender las nuevas tecnologías y saber aprovecharse de ellas. Para acumular más capital físico, necesitamos que el crédito fluya a las empresas que van a invertir y conseguir que las familias y las Administraciones públicas ahorren más para financiar esta inversión. El flujo de crédito pasa por completar el saneamiento del sistema financiero, la desbancarización de la economía española mediante la creación de nuevos mecanismos de canalización del ahorro a los emprendedores y la mejora en el capital riesgo. El incremento del ahorro de las familias se basará en un tratamiento fiscal del ahorro menos distorsionante que el actual. El incremento del ahorro de las Administraciones públicas vendrá de una más decidida senda de consolidación fiscal que la que hemos visto en los últimos tres años. Todo ello ha de completarse con un acceso a fuentes de energía más baratas y que aprovechen todas las potencialidades geológicas que España disfruta sin caer en el populismo ingenuo que tan costoso nos fue en estos temas hace tres décadas. Que pequeñas y medianas empresas crezcan y se transformen en grandes multinacionales es el mejor camino para asegurar el crecimiento

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Pero, antes que nada, España tiene que comenzar a emplear sus recursos más eficientemente. Como mencionaba anteriormente, nuestra productividad total de los factores lleva atascada desde hace décadas. La falta de crecimiento de la productividad es una losa que pesa sobre nuestro futuro: en el largo plazo, solo es posible crecer de manera sostenible si aumenta la productividad. Este avance de la productividad vendrá de una estrategia multidireccional, con énfasis, desde los poderes públicos en la seguridad jurídica, en una Administración de justicia rápida y predecible, en una desregulación generalizada de nuestros mercados, en la eliminación de las barreras a la creación y entrada de nuevas empresas, en una vigorosa política de defensa de la competencia y en facilitar la adopción e innovación tecnológica. Pero la sociedad civil también tiene una misión que cumplir. En particular, y como los Círculos siempre han enfatizado, con una mejora en la calidad de la gestión empresarial. Aunque España puede estar orgullosa de muchas de sus empresas y de sus gestores, todavía podemos esforzarnos más, sobre todo en el sector de la pequeña y mediana empresa. Numerosos emprendedores tienen grandes ideas, pero quizás carecen de la experiencia o de la formación para convertirlas en productos de éxito. Que nuestras pequeñas y medianas empresas crezcan y se transformen en grandes multinacionales es el mejor camino para asegurar el crecimiento económico. En estos momentos de cambios para todos nosotros, las reformas económicas que España necesita y que el Barómetro de los Círculos resume serán los cimientos de una España más próspera, con más bienestar y más unida. Jesús Fernández-Villaverde es miembro del Consejo Asesor del Círculo de Empresarios. http://elpais.com/elpais/2014/07/02/opinion/1404317812_053739.html The Wall Street Journal Opinion Europe Europe Doesn't Need More Public Spending Government-induced growth is artificial and elusive. And it risks deepening the Continent's crisis. By Marcel Fratzscher July 3, 2014 12:11 p.m. ET Europe is stuck in a deep slump and facing the prospect of many more years of stagnation and high unemployment. European leaders are right in their diagnosis that a growth stimulus is urgently needed to end the crisis. But they are wrong in their solution: The Continent doesn't need more public spending and bigger government. It needs more competition, innovation and the completion of the single market.

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Important reforms—including to the structure of labor and product markets and to social security systems—have already been implemented in some of the crisis countries. But those reforms won't yield quick results. It took Germany five years after Chancellor Gerhard Schroeder's labor-market reforms and tax cuts in the early 2000s to catch up with neighbors. Germany was lucky, since its reform agenda coincided with a booming European and global economy. Europe's crisis countries aren't as lucky today. Many political leaders see the solution for breaking the crisis cycle in a fiscal stimulus and bigger government. But government-induced growth is artificial and elusive. And i- t risks deepening the crisis, since most European governments are too highly indebted to increase spending. Today's low interest rates on government debt aren't the result of virtuous policies, but of an expansionary monetary policy and guarantees by the European Central Bank. The ECB is buying time for governments to implement reforms—not to renege on them. The abandonment of the stability-and-growth pact—the commitment to reduce government debt to below 60% of GDP and limit fiscal deficits—is also a fatal signal for Europe's ability to reform and fight future crises. And most of the additional fiscal stimulus won't likely be used to finance public investment but rather public consumption. The answer lies elsewhere. A new study by the Berlin-based German Institute for Economic Research shows that the biggest drag on the European economy is the miserably low level of private investment. Relative to GDP, euro-zone private investment has declined by about 4% cumulatively since 2008. Almost all eurozone countries have a massive investment gap, amounting to 2% of euro-zone GDP, or about €200 billion annually. Private investment is crucial because it has the power to remedy many weaknesses, both on the supply side and the demand side of the economy. It creates employment and income for households, makes banks more profitable, helps governments consolidate and reform, and ultimately boosts growth and competitiveness. The Continent thus needs to foster private-sector investment to put it on a path of sustainable growth. A European private-investment agenda should contain three elements. First, national governments and the European Union must complete the single market for services while enhancing competition and innovation. Second, they should provide tax incentives for companies by making investment expenditures tax deductible and lowering costs, similar to what Germany did in 2004 and again in 2009. Finally, Europe should create a private investment fund—based on the already- existing structures within the European Investment Bank—with the specific task to raise investment among small and medium-size enterprises in the European Union. The fund would then raise and provide financing to nonfinancial SMEs at favorable interest rates. This could be done by providing guarantees to banks offering loans to SMEs, by financing cross-border joint ventures between private firms and between the private and public sectors. Such a program should be limited in duration, say, up to five years, and not have a regional or specific industrial focus. The underlying goal would be to improve the 276

overall allocation of capital. Such a fund would reduce the risk to individual banks and companies, similar to what the ECB is trying to do through its own instruments, but in a more direct way. The European political class wants to turn the Continent's economy around through more government spending. But a much better strategy would be to strengthen the private sector and the functioning of markets by fostering investment, improving competition and innovation, and completing the single market. Brussels, and national authorities, would be wise to give private-sector job creators a helping hand rather than burden the European public with yet more government debt. Mr. Fratzscher is president of the German Institute for Economic Research. http://online.wsj.com/articles/the-way-out-of-the-euro-zone-crisis-1404403908

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Beliefs, Facts and Money Conservative Delusions About Inflation Paul Krugman On Sunday The Times published an article by the political scientist Brendan Nyhan about a troubling aspect of the current American scene — the stark partisan divide over issues that should be simply factual, like whether the planet is warming or evolution happened. It’s common to attribute such divisions to ignorance, but as Mr. Nyhan points out, the divide is actually worse among those who are seemingly better informed about the issues. The problem, in other words, isn’t ignorance; it’s wishful thinking. Confronted with a conflict between evidence and what they want to believe for political and/or religious reasons, many people reject the evidence. And knowing more about the issues widens the divide, because the well informed have a clearer view of which evidence they need to reject to sustain their belief system. As you might guess, after reading Mr. Nyhan I found myself thinking about the similar state of affairs when it comes to economics, monetary economics in particular. Some background: On the eve of the Great Recession, many conservative pundits and commentators — and quite a few economists — had a worldview that combined faith in free markets with disdain for government. Such people were briefly rocked back on their heels by the revelation that the “bubbleheads” who warned about housing were right, and the further revelation that unregulated financial markets are dangerously unstable. But they quickly rallied, declaring that the financial crisis was somehow the fault of liberals — and that the great danger now facing the economy came not from the crisis but from the efforts of policy makers to limit the damage. Above all, there were many dire warnings about the evils of “printing money.” For example, in May 2009 an editorial in The Wall Street Journal warned that both interest rates and inflation were set to surge “now that Congress and the Federal Reserve have flooded the world with dollars.” In 2010 a virtual Who’s Who of conservative economists and pundits sent an open letter to Ben Bernanke warning that his policies risked “currency debasement and inflation.” Prominent politicians like Representative Paul Ryan joined the chorus. Reality, however, declined to cooperate. Although the Fed continued on its expansionary course — its balance sheet has grown to more than $4 trillion, up fivefold since the start of the crisis — inflation stayed low. For the most part, the funds the Fed injected into the economy simply piled up either in bank reserves or in cash holdings by individuals — which was exactly what economists on the other side of the divide had predicted would happen. Needless to say, it’s not the first time a politically appealing economic doctrine has been proved wrong by events. So those who got it wrong went back to the drawing board, right? Hahahahaha. In fact, hardly any of the people who predicted runaway inflation have acknowledged that they were wrong, and that the error suggests something amiss with their approach. Some have offered lame excuses; some, following in the footsteps of climate-change deniers, have gone down the conspiracy-theory rabbit hole, claiming that we really do have soaring inflation, but the government is lying about the numbers (and by the way, we’re not talking about random bloggers or something; we’re talking about famous Harvard professors). Mainly, though, the currency-debasement crowd just keeps repeating the same lines, ignoring its utter failure in prognostication.

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http://www.nytimes.com/2014/07/07/opinion/paul-krugman-conservative-delusions-about- inflation.html?partner=rssnyt&emc=rss&_r=0

Jul 7 10:13 amJul 7 10:13 am6 Not Knut Gavyn Davies takes on the de facto debate between the hard-money men at the BIS and the monetary doves, and frames it as a conflict between Keynes and Wicksell. But I don’t think that’s right. The BIS position is in fact just as inconsistent with Wicksell as it is with Keynes. That doesn’t mean that the BIS is wrong (although I believe that it is); it does mean that its view is much stranger and harder to defend than Davies suggests. So, for those wondering what this is all about: The Keynesian view of monetary policy is that the central bank should, if it can, set interest rates at a level that produces full employment. Sometimes it can’t: even at a zero rate the economy remains depressed, so you need fiscal policy. But in normal times the Fed and its counterparts should be aiming at the full-employment interest rate. Wicksellian analysis is an older tradition; it argues that there is at any given time a “natural” rate of interest in the sense that keeping rates below that level leads to inflation, keeping them above it leads to deflation. I have always considered these approaches essentially equivalent: the Wicksellian natural rate is the rate that would lead to full employment in a Keynesian model. I have, in fact, treated them as equivalent on a number of occasions, e.g. here. Now, what about the BIS? It is arguing that central banks have consistently kept rates too low for the past couple of decades. But this is not a statement about the Wicksellian natural rate. After all, inflation is lower now than it was 20 years ago. No, what the BIS is arguing is that there is some other appropriate rate, defined as a rate sufficiently high to discourage bubbles, and that central banks should target this rate even though it is above the Wicksellian natural rate – or, equivalently, that the economy should be kept permanently depressed in order to curb the irrational exuberance of investors. It’s true that they don’t put it that way – probably because the policy recommendation sounds outrageous when you do. We can’t regulate finance effectively, so we have to accept a permanent slump instead? Really? But that’s what it amounts to. http://krugman.blogs.nytimes.com/2014/07/07/not-knut/ Jul 6 9:56 amJul 6 9:56 am76 Slump Stories and the Inflation Test 279

Noah Smith has another post on John Cochrane’s anti-Keynesian screed, in which he takes on various “structural” stories about the continuing weakness of the economy. As usual, Noah is very mild and eager to give the benefit of the doubt, although even so there’s not much there. What I’d like to point out, however, is that there’s an overarching reason not to take any of this stuff seriously. All the anti-Keynesian stories (except “uncertainty”, which as Nick Rowe points out is actually a Keynesian story but doesn’t know it) are supply-side stories; Cochrane even puts scare quotes around the word “demand”. Basically, they’re claiming that unemployment benefits, or Obamacare, or regulations, or something, are reducing the willingness of workers and firms to produce stuff. How would you test this? In a supply-constrained economy, the kind of monetary policy we’ve had, with the Fed quintupling the size of its balance sheet over a short period of time, would be highly inflationary. Indeed, just about everyone on the right has been predicting runaway inflation year after year. Meanwhile, if you had a demand-side view, and considered the implications of the zero lower bound, you declared that nothing of the sort would happen: Now, the equation [the quantity equation for money] still holds. But all that tells us is that any changes in the money supply are offset one for one by changes in velocity … Actually, in the real world it’s even worse, because central banks don’t control the money supply, they only control the monetary base. Broad aggregates like M2 may well be unaffected by what the central bank does: increase the monetary base, and all that happens is an offsetting fall in the money multiplier. (I was arguing against neomonetarism, but the point holds more generally.) Reality: Photo

Credit

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It seems to me that the failure of the inflation predicted by anti-Keynesians to appear — and the fact that this failure was predicted by Keynesian models — is a further big reason not to take what these people are saying seriously. http://krugman.blogs.nytimes.com/2014/07/06/slump-stories-and-the-inflation-test/

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Swedish Sadomonetarist Setback July 5, 2014 11:36 amJuly 5, 2014 11:36 am53Comments OK, this is fairly amazing. I’ve written often about sadomonetarism among central bankers — the evident urge to find some reason, any reason, to raise interest rates despite high unemployment and low inflation. The most influential hive of this kind of thinking is the Bank for International Settlements, which for some reason commands great respect even though it offers an ever-changing rationale — inflation! Any day now! Or maybe not! Financial stability! — for its never-changing advocacy of tight money. But the place where policy makers most dramatically gave in to this urge is Sweden, where the majority at the Riksbank decided to indulge its rate-hike vice while freezing out one of the world’s leading experts on deflation risks, my friend and former colleague Lars Svensson. Well, guess what: Lars has been proved so dramatically right by events — raising rates didn’t curb rising debt, but it did push Sweden into deflation — that the Riksbank has done an abrupt U-turn, slashing rates (and overruling the governor and first deputy governor). Actually, the drama of this U-turn may be a very good thing, since it might convince investors that this is a real regime change. http://krugman.blogs.nytimes.com/2014/07/05/swedish-sadomonetarist-setback/ Jul 5 3:05 pmJul 5 3:05 pm49 How Prophets Get Lonely At Bloomberg View, Leonid Bershinksy weeps over the cruel world that for some reason isn’t listening to Jaime Caruana of the BIS, who warns that we must raise interest rates now now now. Why is this prophet so lonely? Well, it might have something to do with the fact that three years ago Caruana and the BIS warned that interest rates must rise to avert a surge of inflation. That didn’t happen — in fact, low inflation and the threat of deflation came instead. Now, everyone gets things wrong sometimes. But when that happens, you’re supposed to think about why you were wrong, and reconsider your policy views. If the BIS did any soul-searching, nobody else noticed — and it’s still calling for higher rates, with a new justification (and where it used to warn about inflation, now it’s arguing that deflation isn’t so bad.) Why, exactly, should anyone take its views seriously at this point? But being a hard-money guy seems to mean never having to reconsider. I missed my chance to mark the anniversary, but it’s now five years plus since the WSJ warned that wildly inflationary monetary and fiscal policies were bringing on the bond vigilantes. And to read their opinion pages, you’d think they were right all along. http://krugman.blogs.nytimes.com/2014/07/05/how-prophets-get-lonely/

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vox Research-based policy analysis and commentary from leading economists Lessons from history for the European Financial Crisis Selin Sayek, Fatma Taskin, 5 July 2014 The European Monetary Union is unprecedented, but the Eurozone Crisis is not. This column draws upon the experiences of previous banking crises, and compares the Eurozone Crisis countries. Like Japan before the 1992 crisis, Spain and Ireland had property bubbles fuelled by domestic credit. The Greek crisis is very distinct from crises in other Eurozone countries, so a one-size-fits-all policy would be inappropriate. The duration and severity of past crises suggest the road ahead will continue to be very rough. Related// Eurozone mired in recession pauseCEPR Business Cycle Dating Committee/ To end the Eurozone crisis, bury the debt foreverPierre Pâris, Charles Wyplosz/ Eurozone crisis: It ain’t over yetPaolo Manasse/ The Eurozone crisis: Fiscal fragility, external imbalances, or both?Pietro Alessandrini, Andrew Hughes Hallett, Andrea F Presbitero, Michele Fratianni As of July 2014, we continue to debate whether the European economy is out of the woods. The effectiveness of policies and the prospects of full recovery are under scrutiny. The unique nature of Europe’s monetary union begets further questions of whether policies should be designed to resolve a single euro crisis, or whether they should be designed to resolve multiple European crises occurring simultaneously. A discussion of whether the sui generis European project has led to a sui generis set of financial crises would provide a framework for these policy discussions. There is an incredible wealth of information and experience that could shed light on these questions – financial crises are not new. Countries all over the world have experienced economic crises in the past, sharing similar vulnerabilities prior to the crisis. So past crises could guide us in designing policies in Europe. Yet each crisis comes as a surprise, with its own distinctive characteristics. The latest of these crises, the euro crisis, is no different.1 Its distinctive characteristics are twofold:  First, the crisis started off with a global shock that led to synchronous crises.  Second, the euro crisis is experienced by the European Monetary Union – a union that has no historical precedent.2 If so, then how much could we learn from past experiences? The need for a different framework to compare crises

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The existing literature studies whether on average the nature of crises change over time and/or across countries. Studies by Gupta et al. (2007), Rose and Spiegel (2010, 2011, 2012), and Frankel and Saravelos (2012) are among many that test for such differences making use of the ‘early warning system’ framework. While this framework allows for comparisons of crises on average, it does not allow the identification of case-specific information. The information about whether crises are different from each other on average hides possible divergences from average. On average, crisis behaviour could be sufficiently different across regions (or across time), yet two crises occurring in two different regions (or at two different time periods) could share sufficient similarities. In order to identify such case-specific similarities, a tool that does not rely solely on the information regarding the relationship between averages but also takes into account individual specific information is needed. One such tool is the matching technique, which aims to statistically match similar observations and provide a way of clustering observations according to a set of pre-determined dimensions. In Sayek and Taskin (2014), we make use of the propensity score matching methodology to provide an alternative anatomy of the ongoing European financial crisis in light of this globally accumulated banking crisis experience. In this propensity score matching exercise, the treated units are defined as the crisis episodes that occurred on or after 2007 – labelled as ‘new’ crises – and the control group as all the crisis episodes that occurred prior to 2007 – labelled as ‘old’ crises. Conditional on whether a country has been in a crisis at some point, the new crises are matched with the old crises. As such, the dataset used to carry out the matching exercise includes the 165 episodes of crisis (non-crisis episodes are not included in the dataset), where ‘being in a crisis currently’ is interpreted as a treatment. The current crisis episode is marked by its global nature and by occurring predominantly in high-income countries. The matching results suggest that these two characteristics of the recent crisis episode are quite distinctive – the current crisis shares no commonalities with past crises in either the dimensions defining the global economic environment or their national income or institutional qualities. However, despite these differences, the GIIPS economies share extensive commonalities in their respective pre-crisis domestic vulnerabilities with several past banking crisis experiences. Specifically, the euro periphery crises match mainly with crises of the 1990s, which are either among the big-five crises or the East Asian crises (see Figure 1). Figure 1. Radius matching

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Echoes of past crises The current-account imbalances and the evolution of private sector credit show significant similarities between the respective pre-crisis periods of the recent Portuguese crisis and the 1996–1997 Malaysia and Thailand crises. On the other hand, the build-up of the recent Irish and Spanish crises share with the 1992 Japanese crisis a property bubble that was fuelled by an exuberant domestic credit expansion. The unlikely match of the recent Italian case and the 1991 Finnish crisis seems to be mainly on account of the pre-crisis low levels of economic activity and the transmission of global slowdowns through international trade linkages. On the other hand, the match between the recent Greek crisis and the 1996–1997 crises of Indonesia and the Philippines bear significant similarities in their public sector debt patterns. These matches also provide important information on how similar the GIIPS crises are among themselves. Findings suggest that the GIIPS crises encompass some very dissimilar crises as well as very similar ones. For example, the Spanish and Irish crises share a significant amount of similarities in their pre-crisis conditions, whereas the Greek crisis is very distinct from all other GIIPS crises. This finding is evidence against a one-size-fits-all policy prescription for the GIIPS countries. Therefore, the policy design of each country’s recovery should take into account the particularities of each crisis. The duration and severity of the matched past crisis experiences suggest the road ahead will continue to be very rough. The specific matched crises of Indonesia, Malaysia, and Japan took 6, 7, and 10 years to disappear, respectively. This is suggestive that policy design should not only be case-specific, but should also be designed very proactively. Unless a shift in the policy structure is implemented in Europe, the dismal growth conditions in the current crisis countries are likely to continue for several years more. Footnotes 1. In the remainder of the column, the euro crisis will refer mainly to the crisis of the periphery Eurozone countries, namely Greece, Ireland, Italy, Portugal, and Spain (GIIPS). 2. The terminology owes to Eichengreen (2008). 285

References  CEPR Business Cycle Dating Committee (2014), “Eurozone mired in recession pause”, VoxEU.org, 17 June.  Eichengreen, B (2008), “Sui generis EMU”, NBER Working Paper 13740.  Frankel, J and G Saravelos (2012), “Can leading indicators assess country vulnerability? Evidence from the 2008–09 global financial crisis”, Journal of International Economics, 87: 216–231.  Gupta, P, D Mishra, and R Sahay (2007), “Behavior of output during currency crises”, Journal of International Economics, 72: 428–450.  Rose, A K and M M Spiegel (2010), “Cross-country causes and consequences of the 2008 crisis: International linkages and American exposure”, Pacific Economic Review, 15: 340–363.  Rose, A K and M M Spiegel (2011), “Cross-country causes and consequences of the 2008 crisis: An update”, European Economic Review, 55: 309–324.  Rose, A and M M Spiegel (2012) “Cross-country causes and consequences of the 2008 crisis: Early warning”, Japan and the World Economy, 24, 1–16.  Sayek, S and F Taskin (2014), “Financial crises: lessons from history for today”, Economic Policy, forthcoming. http://www.voxeu.org/article/lessons-history-eurozone-crisis

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vox Research-based policy analysis and commentary from leading economists Why leaning against the wind is the wrong monetary policy for Sweden Lars E.O. Svensson, 5 July 2014 Sweden has pursued a tighter monetary policy than is necessary to achieve the inflation target in order to reduce risks associated with household indebtedness. The net benefit to ‘leaning against the wind’ has been hotly debated; this column argues strongly against it. By reducing inflation, the Riksbank has in fact increased household debt, and contractionary pressure has worsened the employment situation. The author estimates that the benefits to leaning are worth only 0.4% of the costs. Related// Debt deflation and the Riksbank’s policy Lars E.O. Svensson// Financial stability is a task for central banksItai Agur, Maria Demertzis There is a lively ongoing debate about whether raising interest rates beyond the level needed to stabilise prices – ‘leaning against the wind’ – is a justified modification of flexible inflation targeting (as discussed in Smets 2013). In a new paper, I explain why leaning against the wind is the wrong monetary policy for Sweden (Svensson 2014). According to the Riksbank’s own recently published calculations, the benefit of this policy – in the form of lower risks from household debt – is completely insignificant compared to the cost in terms of higher unemployment and lower inflation (Sveriges Riksbank 2014). Since inflation has fallen much below the inflation target and households’ inflation expectations, the policy has instead actually increased households’ real debt burden and, if anything, increased any risks from the debt. Thereby it has made more difficult the work of the Finansinspektionen (FI, the Swedish FSA) to reduce any such risks. ‘Leaning against the wind’ is a monetary policy that is tighter than that necessary to achieve the inflation target and to support Swedish economic policy’s most important goal: full employment. It thus leads to lower inflation than the inflation target and a higher unemployment rate than is sustainable in the long-run. The Riksbank has been leaning against the wind rather aggressively in the last few years, with the purpose of reducing household indebtedness and thereby any associated risks. Leaning against the wind would be justified in Sweden under two conditions, as discussed in a paper by Smets (2013):  The macroprudential policy of the FI is insufficient to reduce any risks from household debt.  A higher policy rate leads to benefits in the form of lower risks of a future crisis – benefits that are larger than the costs in terms of higher unemployment and lower inflation over the next few years.

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Regarding the first condition, the FI has already taken several actions that have reduced risks from household debt. It has introduced a loan-to-value cap for mortgages, increased risk weights on mortgages, increased capital and liquidity requirements for systemically important banks, and proposed that banks suggest individually adapted amortisation plans to their borrowers. The FI considers these actions sufficient at present, but is monitoring the developments and is prepared to take additional action if justified. It is difficult to maintain that macroprudential policy in Sweden would be insufficient. Regarding the second condition, I show in the paper, in some detail, that the Riksbank’s own calculations imply that the benefit of a higher policy rate – in the form of possible both lower probability and less depth of a future crisis – is negligible compared to the policy’s cost (Sveriges Riksbank 2014). Expressed in terms of a lower expected future unemployment, the benefit is only about 0.0038 times the cost (in the form of higher unemployment) during the next few years. That is, the benefit is only about 0.4% of the cost. Thus, none of the conditions that would together justify leaning against the wind in Sweden are satisfied. Without any noticeable benefits, the Riksbank’s leaning against the wind over the last few years has led to high costs in the form of a higher unemployment rate – arguably about 1.2 percentage points higher than necessary – and an inflation rate of around zero; that is, two percentage points lower than the inflation target and household inflation expectations. That inflation over the last few years has fallen much below the target and household expectations implies that the households’ real debt burden has increased substantially. The real value of a given loan has (in two and half years) become 5% larger than if inflation had equaled the target. This has, if anything, increased the risks from household debt rather than reducing them, thereby making the FI’s work to reduce any such risks more difficult. As the FI writes in its latest stability report:1 "A lower than expected inflation rate contributes to increasing the real debt burden, that is, debt relative to the general price level. This may in turn contribute to the building up of financial risks and make it more difficult for households, firms, governments, and countries to manage their balance sheets. If inflation becomes negative over a longer period, there is deflation and a further-increasing debt burden, and expectations about falling prices may lead to falling aggregate demand and thereby even lower prices. As the experience of Japan since the 1990s has shown, such a spiral may be difficult to break out of." Thus, it is difficult not to conclude that the Riksbank’s leaning against the wind is the wrong monetary policy for Sweden. References  Finansinspektionen (2014), “The Stability of the Financial System”, (“Stabiliteten i det finansiella systemet,” in Swedish).  Smets, F (2013), “Financial Stability and Monetary Policy: How Closely Interlinked?” Sveriges Riksbank Economic Review 3: 121-160.  Sveriges Riksbank (2014), “The Effects of Monetary Policy on Household Debt,” box in Monetary Policy Report February 2014.

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 Svensson, L E O (2014), “Why Leaning Against the Wind is the Wrong Monetary Policy for Sweden,” working paper. Footnote// 1 Finansinspektionen (2014, p. 12), so far only available in Swedish (hence my translation from Swedish here). http://www.voxeu.org/article/why-leaning-against-wind-wrong-monetary-policy-sweden

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Lars E.O. Svensson Visiting Professor, SIFR - The Institute for Financial Research, Swedish House of Finance, Stockholm School of Economics Affiliated Professor, Institute for International Economic Studies, Stockholm University Twitter @leosven Good to lower the policy rate, but much too late [English translation of "Bra att sänka, men alldeles för sent", blog post on SvD Börsforum.] It is good that the Riksbank at last lowered the policy rate to 0.25 percent. But it is much too late. For several years, Sweden has had too high a policy rate, too low inflation, and too high unemployment. But better late than never. As Finansinspektionen (the Swedish FSA) has pointed out, the low inflation has actually increased the households’ real debt burden, that is, debt in relation to the general price level. This has, if anything, increased any risks associated household debt, not reduced it. The Riksbank’s policy of leaning against the wind has thus actually been counterproductive with respect to household debt, in addition to leading to inflation below the target and unemployment above a long-run sustainable rate. The big mistake in Swedish monetary policy was to start increasing the policy rate in the summer of 2010 instead of leaving it at 0.25 percent. If the policy rate had been left at 0.25 percent until now, inflation would now have been much closer to the target, unemployment would have been substantially lower, and household real debt most likely lower. This entry was posted in Blog post on July 3, 2014 by admin. http://larseosvensson.se/2014/07/03/good-to-lower-the-policy-rate-but-much-too-late/ Lars E.O. Svensson Visiting Professor, SIFR - The Institute for Financial Research, Swedish House of Finance, Stockholm School of Economics Affiliated Professor, Institute for International Economic Studies, Stockholm University

Unemployment and monetary policy – update for the year 2013 New Ekonomistas post (in Swedish). Here is an English translation: How much higher is the unemployment rate because of the Riksbank’s monetary policy the last few years? This is a controversial question that the Riksbank prefers to avoid. Previously I haved reported a calculation of how much higher the unemployment rate has become up to the beginning of 2013, compared with if the policy rate had been kept unchanged at 0.25 percent since June/July 2010. My calculation has been criticized with obscure arguments in a speech by Per Jansson (for instance, that a low policy rate would not have been “realistc”). I have responded to Jansson’s criticism in a previous post. Now I have updated the calculation to include the whole year of 2013. The annual average during 2013 of the unemployment rate has as far as can be judged become about 1.2 percentage points higher, corresponding to 60 000 more unemployed, compared with what it would have been with an unchanged policy rate of 0.25 percent since the summer of 2010. With such a low policy rate, the inflation rate would have been higher and very close to the inflation target, and, as far as can be judged, the

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household debt-to-income ratio would have been a few percentage points lower, not higher. The update is shown in figure 1 (click here for a larger figure in a separate window). The red lines show the actual outcome in percent for the policy rate, the CPIF inflation rate, and the unemployment rate, as well as the outcome in percent of disposable income for the household debt-to-income ratio. The blue lines show the so-called counterfactual outcome if the policy rate had been kept unchanged at 0.25 percent since the summer of 2010. The earlier calculation of the counterfactual outcome ended in the beginning of 2013. Now I have updated the calculation to include the full year of 2013. I have used the Riksbank’s standard method and standard model, Ramses, to calculate the deviations from the actual outcome that a low policy rate of 0.25 percent would have caused (this is done with so-called unanticipated monetary-policy disturbances, see this speech). Then I have used the analysis in this paper, the results of which are discussed in this post, to calculate the effect on the debt ratio, the ratio between the households’ debt and their disposable income. (The effects on the debt ratio is included because the debt ratio is what that the Riksbank focuses on, not because it would be the best indicator of any risks associated with household debt).[1]

Figure 1. Actual outcome and outcome for the low policy rate for the CPIF inflation rate, the unemployment rate, and the household debt-to-income ratio, updated to include the year 2013. Sources: The Riksbank, Statistics Sweden, and own calculations. Even if the differences between the actual outcome and the outcome with the lower policy rate would only be half as big, it is still clear that the low policy rate would have led to a much better outcome for inflation and unemployment. The difference in the outcome for the debt ratio is so small that it would not have affected any risks with household debt. Table 1 shows the annual averages for 2013 of the unemployment rate and the CPI and CPIF inflation rates, and the debt ratio in quarter 4 of 2013. The annual average of the unemployment rate has become about 1.2 percentage points higher, compared to what it would have been with the low policy rate. CPI and CPIF inflation have become about 291

1.2 and 1.1 percentage points lower, respectively. With the low policy rate, target achievement for inflation had thus become much better. The debt ratio has at the end of 2013 become about 3 percentage points higher than what it would have been with the low policy rate, about 173 percent instead of about 170 percent.

[1] The paper “‘Leaning against the wind’ increases (not reduces) the household debt- to-GDP ratio” derives how the policy rate affects nominal debt and nominal GDP, in order to calculate how the debt-to-GDP ratio is affected. A lower policy rate increases nominal faster than it nominal debt, so it reduces the debt-to-GDP ratio. In order to calculate the effect on the debt-to-income ratio, I have as a simple approximation assumed that real disposable income varies half as much as real GDP. Since a lower policy rate then still increases nominal disposable income more than nominal debt, the debt-to-income ratio still falls. This entry was posted in Blog post, Ekonomistas, New on February 6, 2014 by admin. http://larseosvensson.se/2014/02/06/ekonomistas-unemployment-and-monetary-policy- update-for-the-year-2013/

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vox Research‐based policy analysis and commentary from leading economists The euro crisis: Muddling through, or on the way to a more perfect euro union? Joshua Aizenman, 3 July 2014 After a promising first decade, the Eurozone faced a severe crisis. This column looks at the Eurozone’s short history through the lens of an evolutionary approach to forming new institutions. German dominance has allowed the euro to achieve a number of design objectives, and this may continue if Germany does not shirk its responsibilities. Germany’s resilience and dominant size within the EU may explain its ‘muddling through’ approach to the Eurozone crisis. Greater mobility of labour and lower mobility of under-regulated capital may be the costly ‘second best’ adjustment until the arrival of more mature Eurozone institutions. The short history of the Eurozone has been remarkable and unprecedented – the euro project has moved from the planning board to a vibrant currency within less than ten years. Otmar Issing’s optimistic speech in 2006 reflects well the buoyant assessment of the first decade of the euro – an unprecedented formation of a new currency without a state.1 Observers viewed the rapid acceptance of the euro as a viable currency and the deeper financial integration of the Eurozone and the EU countries as stepping stones toward a stable and prosperous Europe. The growing current-account deficits of GIIPS (Greece, Ireland, Italy, Portugal, and Spain) in the early 2000s supported their growing borrowing at declining sovereign spreads. Intriguingly, GIIPS bonds’ interest rates dramatically converged during the 1990s to the German rate (see Figures 1 and 2). Observers viewed emerging Europe’s large current-account deficits as a validation of the gains associated with ‘capital flowing downhill’,2 possibly dispelling concerns about the limited benefits of importing foreign savings as a means of financing domestic growth.3 The celebratory assessment of the euro continued well into its tenth-year anniversary, only to crash with the unfolding events of the Eurozone crisis. German dominance of the Eurozone In Aizenman (2014), I look at the short history of the Eurozone through the lens of an evolutionary approach to forming new institutions. This lens provides a useful perspective on the formation of global exchange-rate regimes, currency unions, and the like.4 It suggests that Issing’s optimism on “The euro as a currency without a state” overstates the evidence. At best, the euro is a currency without a state, under the dominance of Germany. This statement by itself may be good news – Cohen (1994) identified the presence of a dominant state “willing and able to use its influence to keep a currency union functioning effectively” as a key condition for the stability of a union.5 The growing dominance of Germany in the Eurozone suggests that it may meet Cohen’s condition. Yet, Germany would only stabilise the Eurozone as long as it does not shirk its growing responsibility for the euro’s future. This would require Germany to invest

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more in upgrading Eurozone institutions and balancing its dominance gains with the economic and political responsibilities that come with it. Figure 1. GIIPS and German government bond rates

Sources: ECB, Bloomberg, http://iuwest.wordpress.com/ Figure 2. GIIPS and German current account/GDP

Source: Gavyn Davies, Financial Times 294

The Eurozone crisis put an end to the euro honeymoon, bringing to the fore the key importance of Germany’s economic and political decisions in determining the Eurozone’s viability and future.6 The challenges associated with managing the growing fragility of the euro may induce a reluctant Germany to face an upcoming stark tradeoff – the vibrant growth of Germany, while running large current account surpluses under a pegged exchange rate with the other Eurozone countries, may come to an abrupt end if the Eurozone unravels. Germany has not yet been exposed to the full costs of the macro straightjacket associated with the euro. The economic benefits of the Eurozone to Germany and GIIPS were initially frontloaded. Being a member of the Eurozone mitigated Germany’s real appreciation, in comparison with retaining the Deutsche Mark. For GIIPS, the availability of cheap borrowing at a time of growing optimism about the euro supported growing current-account deficits, and vibrant consumption and investment – which eventually contributed to unsustainable growth and real estate booms. Similar to the experience of emerging markets that liberalised their financial systems in the 1990s under a fixed exchange rate, the increasing costs of the resultant balance-sheet exposures were below the radar screens of markets and policymakers – until an abrupt stop, which was followed by capital flight crises (Calvo 1998). This may reflect a fundamental problem with the pricing of sovereign risk in which the private sector, as the ‘interest rate taker’, overlooks the growing marginal impact of borrowing on sovereign risk (Aizenman 2004). This externality also holds under a flexible exchange rate, but has probably been magnified by the economic strength of the Eurozone core and by moral hazard – the presumption that the growing costs of unwinding the euro will induce bailouts down the road.7 The Eurozone crisis forced GIIPS countries to confront the costs of their excessive borrowing prior to the crisis, as it terminated their easy access to funding their current accounts and addressing their growing fiscal deficits. The resilience of the German economy In contrast, beyond the growing balance-sheet exposure of its financial system, Germany has not yet been fully exposed to the downside risk of higher unemployment and lower growth that has already hit most of the Eurozone countries. The resilience of the German economy probably reflects:  The advantage of running a sizeable current account surplus under a fixed exchange rate with its Eurozone counterparts,  The relative efficiency of the German labour market, and  The country’s specialisation in exporting advanced manufacturing products and highly demanded capital goods. Muddling through Germany’s resilience and dominant size within the EU may explain its ‘muddling through’ approach towards the Eurozone crisis – doing enough to prevent the unravelling of the Eurozone while resisting policies that may mitigate the depth of the crisis if they involve short-run costs to Germany.

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A manifestation of this approach is the revealed asymmetric bias of the ECB’s inflation targeting. The short history of the ECB reveals a strong deflationary bias, which probably reflects the well-known German aversion to moderate inflation.8 So far, we have not seen the willingness of the ECB to follow symmetric inflation targeting. Observers have noted that the ECB’s revealed inflation targeting is closer to targeting Germany’s inflation rather than targeting inflation of the entire Eurozone. While this may not be a surprise considering the bargaining clout of Germany, the resultant low Eurozone inflation – approaching 0.5% as the time of writing – puts further drag on the adjustment of the GIIPS countries. The net outcome is the continuation of accelerated debt deflation, which pushes the Eurozone toward the prospect of a Japanese-style lost decade (see Moghadam et al. 2014).9 Another manifestation of Germany’s ‘muddling through’ approach is the prevalent view of German observers that its persistent current-account surplus is a reflection of the country’s efficiency and is irrelevant to the adjustment challenges facing the global economy, the Eurozone, and the GIIPS countries.10 Ironically, Germany’s attitude toward the Eurozone resembles the attitude of the US toward the Bretton Woods system in the 1960s – benign neglect of the growing tensions, which led to the ultimate demise of the Bretton Woods system (see Zimmermann 2002).11 Chances are that unravelling the Eurozone would be much more costly than the end of the Bretton Woods regime (see Eichengreen 2013). Towards a more resilient and successful union? Approaching the fifth year of the Eurozone crisis, one detects green shoots that, with proper stewardship, may lead to the emergence of a more resilient and successful union. Recent output projections suggest that the worst may be over for GIIPS countries, and recovery may be around the corner. Their primary fiscal deficits have been drastically trimmed and are moving toward surpluses. GIIPS countries are also gaining access to borrowing at declining sovereign spreads. These developments may be the bonus of the ‘positive contagion’ triggered by Draghi’s policy stance. The challenges facing the ECB and Germany is to do what it takes to prevent a reversal of these gains. The tentative recovery of GIIPS may be threatened if and when global interest rates rise, or when the risk tolerance towards GIIPS debt deteriorates. The chance of pushing these countries’ future to the wrong side of the debt Laffer curve would be mitigated by a greater willingness for debt concessions tied to deeper structural reforms. The mixed messages from Germany regarding its lacklustre support of Draghi’s policies – including the country’s constitutional court ‘thunderbolt’ ruling in February – are the elephant in the room, raising serious questions about the durability of any green shoots. In the same vein, the Balkanisation of the banking system induced by the Eurozone crisis is also a double-edged sword. Rapid financial integration in the Eurozone prior to setting efficient and prudent supervision and banking union helped contribute to over- borrowing by GIIPS. The challenge facing the Eurozone financial system remains that of finding a healthy balance between banking integration and prudent regulations. This challenge remains a work in progress in both the US and the Eurozone, and time will tell if GIIPS countries’ greater access to renewed borrowing will backfire. An underappreciated development has been the growing mobility of labour in the Eurozone and in the rest of the EU.13 Although this mobility is mostly confined to younger workers and immigrants, it facilitates easier adjustment and increases the flexibility of 296

labour markets. Greater mobility of labour and lower mobility of under-regulated capital may be the costly ‘second best’ adjustment until the arrival of more mature institutions in the Eurozone. The ‘muddling through’ process may prove to be a stepping stone toward a more perfect euro union. The challenges facing the Eurozone are not unforeseen or unprecedented. The history of other unions provides examples where crises, with the proper leadership, created new institutions and upgraded existing ones in ways that increased their resilience.14 Author’s note: Insightful comments by Jerry Cohen, Barry Eichengreen, Andrew Rose, Paul Wachtel, and the 20th Dubrovnik Economic Conference participants are gratefully acknowledged. References Aizenman, J (2004), “Financial Opening: Evidence and Policy Options”, in R Baldwin and A Winters (eds.), Challenges to Globalization, University of Chicago Press: 473– 498. Aizenman, J, B Pinto, and A Radziwill (2007), “Sources for Financing Domestic Capital – Is Foreign Saving a Viable Option for Developing Countries?”, Journal of International Money and Finance, 26: 682–702. Aizenman, J (2012), “The Euro and the global crises: finding the balance between short term stabilization and forward looking reforms”, VoxEU.org, 5 June. Aizenman, J (2014), “The Eurocrisis: Muddling Through, or On the Way to a More Perfect Euro Union?”, NBER Working Paper 20242. Cohen, Benjamin (1994), “Beyond EMU: The problem of sustainability”, in B Eichengreen and J Frieden (eds.), The Political Economy of European Monetary Unification, Boulder, CO: Westview. Eichengreen, Barry (2013), “Mother of all sudden stops”, VoxEU.org, 14 September. Fratzscher, Marcel (2013), “Investment, not the surplus, is Germany’s big problem”, Financial Times, 18 November. Issing, Otmar (2006) “The euro – a currency without a state”, Helsinki, 24 March. Gourinchas, Pierre-Olivier and Olivier Jeanne (2006), “The Elusive Gains from International Financial Integration”, Review of Economic Studies, 73: 715–741. Jauer, Julia, Thomas Liebig, John P Martin, and Patrick Puhani (2014), “Migration as an adjustment mechanism in the crisis? A comparison of Europe and the United States”, OECD Social, Employment and Migration Working Paper 155. Moghadam, Reza, Ranjit Teja, and Pelin Berkmen (2014), “Euro Area – ‘Deflation’ Versus ‘Lowflation’”, iMFdirect, 4 March. Prasad, Eswar S, Raghuram G Rajan, and Arvind Subramanian (2007), “Foreign Capital and Economic Growth”, Brookings Papers on Economic Activity, 1: 153–209.

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Rajan, R (2005), “Has Financial Development Made the World Riskier?”, Proceedings of the Jackson Hole Economic Policy Symposium, Federal Reserve Bank of Kansas City, August: 313–369. Schäuble, W (2013), “Ignore the doomsayers: Europe is being fixed”, Financial Times, 16 September. Zimmermann, Hubert (2002), “The fall of Bretton Woods and the emergence of the Werner Plan”, in From the Werner Plan to the EMU: in search of a political economy for Europe, Brussels: PIE Lang: 49–72. Footnotes 1 “After more than seven years, the euro is firmly established as the currency of over 300 million people. Its internal stability is evidenced by the fact that inflation has been steadily low from the very start, despite a sequence of negative price shocks (in particular a continuous surge in oil prices). As an international currency, the euro is second only to the US dollar.” “The EU has always been, and will remain, a unique undertaking for which there are no models that can easily be adopted. It is important to allow an evolutionary process, which is open to further steps of integration, yet safeguards what is already in place and working well, and which assigns competencies to nation states or even regions as appropriate. In fact, we have been in the midst of such a process for quite some time, and Monetary Union is and will remain one of its major success stories.” (The opening and the closing of a speech by Otmar Issing, Member of the Executive Board of the ECB, in Helsinki on 24 March 2006.) 2 The IMF’s World Economic Outlook (October 2008: 228) noted “…emerging Europe’s ability to borrow foreign capital for long periods suggests that the standard growth model, with capital flowing downhill, remains relevant.” “In emerging Europe, the large current account deficits are related to a rapid liberalization of domestic financial markets and open capital accounts, which attracted large capital inflows and prompted a rapid rise of foreign bank ownership. The process of integration into the EU also enhanced foreign capital inflows by improving prospects for economic and policy stability.” 3 Gourinchas and Jeanne (2006) found that the welfare gains in switching from financial autarky to full capital mobility equal a paltry 1% increase in domestic consumption for the typical emerging market. Aizenman et al. (2007) and Prasad et al. (2007) noted that fast-growing developing countries have tended to self-finance their investment, and run current-account surpluses. 4 See Aizenman (2013) for further discussion and references dealing with the evolutionary approach of forming currency unions and new institutions. 5 The second stability condition is the presence “of a broader constellation of related ties and commitments sufficient to make the loss of monetary autonomy, whatever the magnitude of prospective adjustment costs, seem basically acceptable to each partner.” 6 Ironically, there are curious parallels between the global role of the US since the end of the Bretton Woods system and the role of Germany in the Eurozone. The

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presumption in the 1970s was that the demise of the Bretton Woods system would propagate a symmetric global-financial architecture, where major currencies would freely float against each other. Within two decades, it became clear that in the post- Bretton Woods system, the US had kept its hegemony. The US dollar has retained its position as the leading global currency, with the country enjoying the exorbitant privilege of running growing current-account deficits supported by an increasingly vibrant demand for US government bonds by the foreign central banks, as well as by the private sector in foreign countries (as a ‘safe haven’ asset). The global financial crisis, propagated globally from the US, induced a reluctant US Treasury and Federal Reserve Board to adopt unprecedented steps aiming at stabilising the global economy. In the same vein, the presumption was that forming the euro as ‘a currency without a state’ would provide a more symmetric structure to Europe and contain the fear of a German hegemony. This supposition seemed to work only in ‘good times’ – the first decade of the euro. 7 Chances are that the elusive “Great Moderation” did not help by masking the growing tail risks in the OECD countries (Rajan (2005)). The countries joining the Eurozone experienced two decades of growing optimism associated with their deepening financial integration and convergence to low inflation before the Eurozone version of the “capital flight” crisis hit. 8 A hint of this bias is provided in Issing’s (2006) opening statement cited above. A symmetric inflation targeting would also require an aggressive expansionary-monetary policy in the presence of a sequence of deflationary prices shocks, such as a sequence of lower prices of commodities, and other deflationary developments that impact the Eurozone’s consumer price index (CPI). 9 There are several key differences making a lost decade much more destabilising in the Eurozone than in Japan. Unlike the Eurozone, Japan is a mature currency and fiscal union of its 47 prefectures, a country with a large net foreign asset position, and overall homogenous population and economic structure. In contrast, low employment and growth in the Eurozone would increase the strength of the ‘anti-euro’ camp, leading to deeper social and political instability and threatening the survival of the Eurozone. 10 The debate about the merits of current-account imbalances is as old as the debate about the merits of financial integration. Supporters of current-account surpluses tend to focus on competitiveness as the key driver of surpluses, viewing it as a virtue (see Schäuble 2013). Opponents of current-account surpluses focus on the truism that current-account surplus reflects the excess of saving over investment (see Martin Wolf’s column in the 16 September edition of the Financial Times). On balance, this debate is less relevant at times of strong global growth, but at times of global deflationary stance, the global adding-up property – stating that the sum of global current accounts is zero – matters. It implies that current accounts of large countries matter in the global distribution of employment and economic activities. The sheer size of Germany suggests that its current-account surpluses have a non-trivial effect on the Eurozone and the global economy (see Fratzscher’s 18 November 2013 column in the Financial Times). At times of global deflationary pressure, global employment is not a zero-sum game – higher investment and lower saving in surplus countries would help in mitigating global protectionist threats and underemployment pressures.

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11 “…the new [Nixon’s] government took no initiative to do anything about the monetary turmoil as long as it did not see its domestic priorities endangered by the “market”. Frist, it tried to get domestic inflation under control by tightening macroeconomic policies and cutting government expenditure. When this policy failed and appeared to scare away voters, the government undertook a series of expansionary steps which struck the fatal blow to the Bretton Woods system. … As a result of the policy of “benign neglect”, however, the US deficits rose out of all proportion. When the dollar-holders desperately tried to cash in their reserves, Nixon acted in August 1971, after years of precipitously increasing speculative crises, closed the gold window, imposing a ten percent surtax on all imports.” Zimmermann (2002: 66). 12 The banking system of the US was ‘Balkanised’ during the three decades after WWII. While this system came with its costs, the US grew at a healthy rate during that period. The deregulation of the US banking system in the 1990s came with its short- term benefits, and the longer-run costs manifested during the 2008–2009 crisis. Chances are that the growth challenges of countries are less the balkanisation of their banking and financial systems, and more their structural distortions. 13 Jauer et al. (2014) reported “there is tentative evidence that the migration response to the crisis has been considerable in Europe, in contrast to the United States where the crisis and subsequent sluggish recovery were not accompanied by greater interregional labour mobility in reaction to labour market shocks. Our estimates suggest that, if all measured population changes in Europe were due to migration for employment purposes – i.e. an upper-bound estimate – up to about a quarter of the asymmetric labour market shock would be absorbed by migration within a year. However, in the Eurozone the reaction mainly stems from migration of third-country nationals. Even within the group of Eurozone nationals, a significant part of the free mobility stems from immigrants from third countries who have taken on the nationality of their Eurozone host country.” 14 This is in line with European Commission President Romano Prodi statement in 1999, “I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created.” http://www.voxeu.org/article/germany-and-future-euro

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vox Research‐based policy analysis and commentary from leading economists Why Europe needs two euros, not one Jacques Melitz, 2 July 2014 As the Eurozone cautiously implements stabilising reforms, Germany is forced to go further with concessions than it would prefer. This column suggests that it would be beneficial for discontented members to consider the formation of a second monetary union. The second euro can be constructed better than the first, bringing the discontented members exchange-rate adjustments relative to Germany, and avoiding competitive devaluations. Related// Economic flaws in the German court decision Paul De Grauwe// Currency wars and the euro Jens Nordvig// Preventing a Eurozone bank and bond run Catherine Dobbs, Michael Spence One basic feature of the sickly situation in the Eurozone today is that the system does not clearly bear any essential flaw from the standpoint of Germany. All things considered, the country has not done badly since the Great Recession of 2008-2010. And as the Eurozone moves forward gingerly with necessary reforms in order to avoid a break-up of the system, it is evident that Germany is constantly under pressure to go further with concessions than it would prefer. In these circumstances, it may be time for radically new thinking. I would like to propose that the discontented members would do well to consider seriously the formation of a second euro. Such proposals have been made (Dobbs and Spence 2012), but the lingering unsatisfactory macroeconomic conditions seems to call for a rethink. Three advantages of a second euro A second euro would have three fundamental advantages.  First, the second euro could be constructed in a better manner than the previous euro from the discontented members’ point of view. There is no need to repeat the errors of the past.  The second argument comes in two parts. First, the creation of a separate monetary union by the discontented members would bring them exchange rate adjustment relative to Germany, which is the single most important exchange rate adjustment that they need. Second, by forming a second monetary union rather than reverting to separate currencies, they would still avoid the problem of competitive devaluations that hounded the earlier EU after the breakdown of Bretton-Woods and up to the appearance of the Maastricht Treaty as a possibility on the horizon in 1986 (when the Single European Act came).  Thirdly, there are strong indications that the discontented members of the Eurozone will get a worse deal from the movement towards reforms of the 301

system that is now proceeding with grudging German approval than they would by forming a second euro. Every German concession faces major political opposition at home, to say nothing of an occasional legal challenge. Furthermore, these roadblocks are probably in Germany’s true interests. Of course, these three basic arguments for a second common European currency pave the road to one more.  A second euro could serve as a bargaining tool in negotiations with Germany. But I would like to rest the case for a second euro strictly on its own merits and, therefore, strictly focus on the first three arguments. One issue I shall disregard is the costs of the transition, which prominently include the interpretation of outstanding debts in euros. It is important, however, that the status quo could fall apart in the Eurozone in any event, and if only for this reason, it is a good idea to entertain the best of the alternatives. Furthermore, if the only serious argument against two euros is really that ‘it is better to stick to a bad marriage than to go through the costs of a divorce,’ it would seem good to know it and to behave accordingly. First advantage of a second common currency Any optimal design of a new social regime with broad distributive consequences should be done in ‘the veil of ignorance’ about where the chips will fall in the future, and from this point of view, the Eurozone contained two spectacular flaws.  First, a monetary union should provide monetary control by the central bank. But the rules of the Maastricht Treaty violated this condition. They made monetary control by the ECB contingent on the willingness of commercial banks to lend to individual firms and households. The ECB was not free to buy and sell in open market operations. The term ‘open market operations’ surrounding the ECB describes certain kinds of refinancing transactions with banks and, since 2010 – first, under the ‘Securities Market Program’ and, more recently, under the program of ‘Outright Monetary Transactions’ – purchases of bonds of member government that are under financial stress with effects on the monetary base that must be sterilised. These are not open market operations in the true sense. It is a fact that a number of the central banks in Europe that preceded the ECB operated for decades in the manner that the ECB was allowed to do without any problem, and under ordinary circumstances the ECB would have been able to do the same. However, constitutions must allow for conditions that are only likely to happen once every half a century or more. In the face of the situation that arose in 2010-2012, where member banks of the Eurozone preferred to rebuild their balance sheets than to lend to their customers, and where the official intervention rate on the interbank market approached the zero interest rate floor, once the ECB had exploited a few loopholes, the new constitution left it powerless to increase the money supply at all without engaging in legally questionable actions or emergency measures that required bending the rules.

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 Second, in a monetary union any threat to the payment system resulting from insolvency of the banking sector in any political region of the system is a collective problem to be shared by all. This condition was also not met. Unlike the situation in the US following the savings and loan crisis in the 1980s and 1990s, the Irish paid for the insolvency of their banking sector, the Spanish paid for theirs, and in Cyprus, it even looked for a while that small bank depositors would have to contribute heavily to pay for theirs. Help from the rest of the Eurozone in these cases came late, haltingly, and moderately, and came to the national governments who avoided the meltdown of their banks (on terms that Spain has never accepted). Repairing both these problems, of course, is simple. As regards to open market operations, there must be some designated securities that the central bank can buy and sell. To avoid partiality to any private interests, the purchasable securities should be public or semi-public, so that the beneficiaries are essentially taxpayers. To avoid partiality to any country, an international mix of debts is necessary. Avoiding moral hazard is also easy. The central bank should only be able to buy securities that have aged sufficiently. For example, suppose that the required ageing is three years. Then, the outstanding stock of government securities that would be eligible for purchase by the central bank would be enormous and, yet, no new issues could be monetised until the lapse of a significant time. The euro-nomics group (Brunnermeier et al. 2012) has recently made an interesting suggestion that would permit the central bank to buy a ready-made assortment of securities with different maturity dates satisfying my condition. The group proposes creating a new intermediary (which they call the ‘European Debt Agency’) that would hold an imposed combination of government securities (in fixed, irreversible weights) against which the intermediary would issue new securities (which they term ‘European Safe Bonds’) to the public that the central bank could subsequently buy and sell. This would help but it is not essential.1 Joint responsibility for the solvency of the banking sector in any political region of the monetary union also requires some preconditions that are fully manageable. If risks of insolvency are to be borne collectively, evidently all the member banks must be subject to uniform prudential rules and a collective supervisory authority. Further, in case of a meltdown of the financial sector in a member country, the costs of compensating the depositors or creating new bank capital, or both, must be borne collectively. There has been a move toward some form of banking union (29 June, 2012) and therefore the satisfaction of the first precondition, but little advance toward the second one, which is equally basic (for a good, detailed discussion of the required degree of fiscal union, see Pisani-Ferry et al. 2012). Of major note, the needed degree of fiscal union is quite limited. Even joint insurance of all demand deposits may be going too far. Something like the Single Bank Resolution Fund (as distinct from the Single Resolution Mechanism) that has been mentioned but is nowhere in sight, could well suffice. Second advantage A repeated question about the Eurozone is whether the members form an optimal currency area. But another question – which is actually closer to Mundell’s original 303

contribution (Mundell 1961) – is whether the right number of currencies in the Eurozone is as high as 18, the number of member countries in the system. If the right number is neither 1 nor 18, then 2 may be far, far better than either extreme. Let me begin by recalling the reasons why 18 would be too many. First, some of the members are probably small enough to have no scope for using monetary or exchange rate policy as a tool of economic stabilisation over the business cycle (McKinnon 1963). Next, the 18 members do form an economically integrated group of geographical neighbours, and therefore their mutual efforts to use monetary and exchange rate policy to their advantage could easily lead them to enter into non- cooperative games with costly Nash consequences. Finally, national monetary policy can mean Treasury-dominated monetary policy, which can lead to very poor outcomes apart from strategic games with any foreigners, near and far. If 18 is wrong, there are a couple of reasons to veer toward 2, if not all the way. First, studies of the question whether the Eurozone is an optimal currency area generally tended to show no more than one major possible fault line in a single monetary policy for the 12 initial members (including Greece, which entered in 2001, but excluding the UK and Denmark) – roughly between north and south (see, e.g., Bayoumi and Eichengreen 1992). Subsequent events since the crisis of 2008-2010 have underlined this fault line. In particular, the under-pricing of German goods relative to southern European ones in the current debacle in the Eurozone is too well-known to require new development. The recessionary and deflationary consequences also need not be rehearsed. My main point, though, is that judging from past studies of synchronisation of business cycles and asymmetries in economic performance in the Eurozone (and therefore excluding the UK and Denmark), two currencies may be enough – one including Germany, the Netherlands, and Austria, and another comprising the countries bordering the Mediterranean and stretching to Portugal. Next, history provides an important reason for 2 instead of 18 in the case that 1 is wrong. The only experience with freely floating exchange rates in the EC – the EU’s predecessor – was short-lived and unfortunate. It followed the breakdown of Bretton- Woods in 1971. Soon after this experience, the members of the EC tried to return to some semblance of exchange rate stability, and in any scenario of a break-up of the Eurozone, it is difficult to imagine that the members would tolerate general floating. The strategic game aspects, if nothing else, weigh too heavily against this alternative. Yet, the past also teaches us that no system of fixed exchange rates ever worked in the EC. The main effort to bolster exchange rate stability after the ineffectual ‘snake,’ the European Monetary System (EMS), led to major realignments every nine months in 1983-1985. It is highly questionable that the EMS was dynamically stable and would have survived much longer despite major capital controls, had not the prospect of Eurozone come to save it. Thus, a further reason to envisage a second euro is that neither floating nor fixed exchange rates would work in the event of a break-up of the Eurozone. On the other hand, having three major currencies in the EU seems tolerable. The floating of the British pound relative to the euro has raised no difficulty, even though it means having two major currencies in the system. The Common Agricultural Policy also now depends heavily on direct subsidies rather than price controls, so that exchange rate movements cannot wreak the havoc in agriculture that was possible in

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the 1970s and 1980s. Two euros would be a far cry from return to separate liras, pesetas, francs, escudos, drachmas, etc. Third advantage We are now living through a veritable tragicomedy in the Eurozone. Faced with a situation where Greek, Spanish, Portuguese, and Italian governments were forced to borrow at unsustainable interest rate premiums, the ECB was compelled to step in to lower the interest rates in order to prevent defaults that would have spread to the banking system and forced some countries out of the Eurozone. But at every step along the way, the question raised in Germany, and that has now come up twice before the German Constitutional Court, is whether the ECB is acting within its mandate. And the tragicomic aspect is that the ECB probably is not and the Court of Karlsruhe thinks so but simply forestalls crises for political reasons. However, in its most recent decision (7 February 2014), the Court has left little room for future manoeuvre by explicitly dismissing the ECB’s argument that the Outright Monetary Transactions program is legitimate on grounds that it ensures the proper functioning of monetary policy and avoids the breakup of the Eurozone. Therefore, the scope for expansionary monetary policy in the future in the Eurozone is now more circumscribed than ever.2 Is this then a game that the large section of the Eurozone membership with grave need for expansionary monetary policy has an interest in continuing to play? It would be easy to write a new set of rules that would impose tough inflation targets on another central bank, yet still allow expansionary monetary policy in deep recessions, and provide the central bank the ability to engage in selective aid measures in circumstances that threaten the very survival of the monetary union without inviting such circumstances to arise. Very significantly, no joint bonds backed by ‘joint and several’ guarantees of the member governments would be called for. Let us remember too that the Eurozone courted some of its current problems by announcing early on that the whole system hinged on the Stability and Growth Pact despite the no-bail-out rule, instead of warning markets that government defaults remained possible (despite the Pact), and the organisation would only intervene to insure the safety of the banking sector and the payment system. The prospects for banking union are admittedly better than those for adequate monetary control. Yet, as mentioned before, the fiscal implications of banking union have not received the attention they need. The Single Bank Resolution Fund that has been mentioned will require a separate treaty and remains only a vague possibility.3 However, without a mechanism assuring the collective bearing of the costs of a major insolvency, there is no reason to expect that we can avoid a repetition of the experience since 2010 with ‘the diabolic loop’, as the euro-nomics group (Brunnermeier et al. 2012) terms it between bank risk and government bond risk (Ireland, Spain, and Greece, see also Shambraugh 2012.) Conclusion Germany was unquestionably the leader in the pre-euro European Monetary System. It was never clear when Eurozone got started why the country agreed to renounce its monetary independence. The question ‘What’s in it for Germany?’ never got a satisfactory answer. But, in compensation, the country did obtain virtually free rein to

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set the rules in the Eurozone. At first supporters of a single currency (including the present author) vaguely expected that the constitutional problems that might arise would be ironed out as they appeared. But this overly sanguine expectation has proven false. In these circumstances, isn’t it time to give some serious thought to a second euro? References Bayoumi, T and B Eichengreen (1992), “Shocking aspects of European monetary unification”, CEPR Working Paper 643, May. Brunnermeier, M, L Garicano, P Lane, M Pagano, R Reis, T Santos, D Thesmar, S van Nieuwerburgh and D Vayanos (2012), “European Safe Bonds (ESBies),” Princeton University, 2 April. McKinnon, R (1963), “Optimum currency areas”, The American Economic Review, 53, September, 717-725. Mundell, R (1961), “A theory of optimum currency areas”, The American Economic Review, 51, pp. 657-664. Pisani-Ferry, J, A Sapir, N Véron and G Wolff (2012), “What kind of European Banking Union”, Bruegel, 25 June. Posen, A and N Véron (2014), “Europe’s half a banking union”, Europe’s World, Summer, pp. 10-18. Shambaugh, J (2012), “The euro’s three crises”, Brookings Papers on Economic Activity, Spring, pp. 157-226. Sinn, H W (2014), “Responsibility of states and central banks in the Euro crisis”, CESifo Forum, 15 (1), Spring. Footnotes 1 The euro-nomics group’s concern is also broader than mine. The members want to create safe assets rather than merely define a set of member government securities that could be purchased by the central bank without causing any moral hazard. Therefore, they define an appropriate level and combination of purchasable government securities differently than I do. 2 See Sinn’s revealing report to the German Constitutional Court, (Sinn 2014), which raises legal or political questions about every least fiscal implication of the OMT program for Germany, including, for example, the potential future effects on its part of seignorage revenues. 3 For a more optimistic appraisal, see Posen and Véron (2014). http://www.voxeu.org/article/why-europe-needs-two-euros-not-one

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Las pensiones públicas, víctimas del 'austericidio' La nueva reforma se traducirá en una pérdida de poder adquisitivo de todos los pensionistas Antonio González González / Borja Suárez Corujo 06/07/2014 - 20:11h La Actualización del Programa de Estabilidad 2014-2017 que el Gobierno remitió a Bruselas hace pocas semanas cuantifica el recorte sufrido por el sistema público de pensiones tras la reforma de 2013. Hay que lamentar que esa estimación no fuera recogida en la memoria económica de la Ley 23/2013, sobre el factor de sostenibilidad y el índice de revalorización; ni tampoco en el informe del comité de expertos que sirvió de base para esa regulación. Parece lógico pensar que un cambio de tanta envergadura, como veremos, debería haber llevado consigo un ejercicio de transparencia equivalente. A esta primera crítica se añade que la reforma fuera impuesta unilateralmente por el Partido Popular, sin diálogo ni apoyo del resto de fuerzas políticas e interlocutores sociales. Gráfico 1: Proyecciones 2010-2060 del gasto asociado a envejecimiento (en % del PIB)

Fuente: Actualización del Programa de Estabilidad 2014-2017 (p. 78) Pero, siendo lo anterior grave, lo verdaderamente preocupante son los datos que reflejan el enorme impacto de esta reforma en el gasto en pensiones: según el citado documento (página 78), se situaría en 2050 en un nivel similar al de hoy (10,5% del PIB) y sería aún más bajo (9,6%), diez años después. Para entender las implicaciones de estos cálculos oficiales conviene echar la vista atrás. 307

La reforma de pensiones de 2011 –consensuada política y socialmente– perseguía como objetivo fundamental reforzar la sostenibilidad del sistema. Trataba de suavizar el previsible incremento del gasto consecuencia del proceso de envejecimiento de la población vinculado al alargamiento de la esperanza de vida y a la jubilación de la generación del baby boom. Frente a las estimaciones que, antes de esa reforma, situaban el gasto en España en 2050 por encima del 17% del PIB, las medidas entonces articuladas moderaban ese crecimiento para dejarlo –según la Comisión Europea – en el 14%. Un nivel muy superior al actual, pero perfectamente asumible en términos comparados; no en vano Francia, Italia o Austria superan ese umbral holgadamente ya en la actualidad. Las tensiones financieras que sufre la Seguridad Social desde 2012 fueron utilizadas por el Gobierno de Rajoy, primero, para devaluar las pensiones ese año (una pérdida de poder adquisitivo de casi dos puntos, que se sumaba a la congelación de 2011 del Gobierno Zapatero) y, a continuación, para plantear ante la opinión pública la necesidad de introducir urgentemente más cambios. Esos desequilibrios presupuestarios nada tenían que ver con problemas estructurales, sino que eran consecuencia de una coyuntura adversa agravada por una política económica centrada en la reducción del déficit y no en el empleo. Pero el Ejecutivo de Rajoy lo ignoró e impulsó nuevas modificaciones como falsa prolongación de la reforma ‘socialista’. De hecho, encontró el parapeto de ésta para regular un novedoso factor de sostenibilidad, ya previsto en 2011 aunque en términos bien distintos. En efecto, la reforma del PP adelanta trece años el calendario de aplicación y configura un sistema de pensiones ‘menguantes’ en el que la cuantía de la nueva pensión se reduce automáticamente conforme se eleva la esperanza de vida. Pero, además, modifica el mecanismo de revalorización abocando a todos los pensionistas a la pérdida segura de poder adquisitivo –así lo diagnostica la OIT– como consecuencia de dos circunstancias: en el corto plazo, la adversa situación económica y el altísimo desempleo, y, en el largo plazo, el lastre que supondrá en la nueva fórmula el cuantioso incremento del número de pensionistas. Pues bien, lo que el mencionado Programa de Estabilidad revela es la magnitud del recorte que, según el Gobierno, va a suponer la conjunción de ambas medidas (factor de sostenibilidad y mecanismo de revalorización): un gasto del 10’5% del PIB en 2050 supone un ‘ahorro’ (sic) creciente, un recorte, de casi 4 puntos porcentuales de PIB (actualmente 40.000 millones de euros) en esa fecha respecto de la estimación previa a esta reforma. De manera que la parte de la riqueza nacional que gastaremos en pensiones públicas dentro de cuarenta años será la misma que hoy, con la diferencia de que el número de pensionistas se habrá doblado: de 8 pasaremos a más de 15,2 millones. Es evidente que ni el Gobierno ni el poder financiero que alienta estos cambios están pensando en que los jubilados de mitad de siglo vayan a ser mucho más pobres que los de hoy. Creen seguramente que la transformación demográfica de nuestras sociedades debe llevarnos a un cambio de modelo, hacia una limitación de las pensiones públicas y una progresiva extensión del peso de los planes (privados) de pensiones. Es decir que su apuesta –no explícita– consiste básicamente en que en 2050 un tercio aproximadamente del gasto total en pensiones proceda del ámbito privado.

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Éste puede ser un planteamiento de reforma legítimo, siempre que se encuadre dentro de los límites constitucionales y que se plantee abiertamente a los ciudadanos. Por eso hay que insistir en dos ideas fundamentales. Gráfico 2: Porcentaje de gasto en pensiones sobre el PIB

Fuente: The 2012 Ageing Report, Comisión Europea En primer lugar, el cambio de modelo que se persigue –el paso a un sistema de pensiones mixto– es una opción político-ideológica, no algo inevitable. En este sentido, importa insistir en que las dificultades que hoy atraviesa la Seguridad Social son de naturaleza coyuntural, pues derivan de la pérdida de tres millones de empleos durante la crisis. Con la particularidad de que disponemos de instrumentos para hacer frente a esas tensiones –54.000 millones de euros en el fondo de reserva–, así como de orientaciones de política económica que resultarían eficaces para estabilizar la situación financiera – priorizar la creación de empleo–. Por su parte, los problemas estructurales del sistema de pensiones fueron razonablemente abordados por la reforma de 2011 que, a cambio de sacrificios, garantizaba la sostenibilidad de un modelo de reparto reconocible como tal. Los retos estructurales persisten, sí, pero tienen más que ver con aspectos relacionados con la insuficiencia de las pensiones de determinados colectivos –las mujeres, señaladamente–. Y, en segundo lugar, es posible que a mitad de siglo el gasto total (público y privado) en pensiones no implique una reducción importante sobre el 14% del PIB previsto antes de la reforma (‘ruptura’) de 2013. Pero sí supondrá, en todo caso, un cambio muy relevante en su composición, con una sensiblemente menor aportación del sistema público y un peso mucho mayor de las pensiones privadas. Y no debe desconocerse que ese nuevo sistema, más individualista, ha de traer consigo enormes desigualdades en función de la capacidad de ahorro y un debilitamiento del Estado de Bienestar con el consiguiente incremento de la pobreza.

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Daily Morning Newsbriefing July 04, 2014 Renzi vs Germany: The conflict escalates The conflict between Italy and Germany over fiscal policy escalated further yesterday, and could even endanger the election of Jean-Claude Juncker in the European Parliament, Corriere della Sera reports. Juncker needs 376 Yes votes among 751 MEPs. The EPP itself is not unanimous. The Fidesz MEPs will follow their leader and vote No. Forza Italia might not support Juncker either, but the real problem is the Partito Democratico, the biggest section in the Socialist group, which might withhold support as might Spain’s PSOE which is debating the issue as part of its present leadership contest. The decisive date is next Tuesday when Juncker will appear in front of the Socialist group, and where he will explain how he intends to interpret the fiscal rules. The article also made the point that Matteo Renzi’s economic adviser had noted that the policy documents of both the EPP and the Socialists were opposed to budgetary flexibility. The paper said there was discontent among various Italian MEPs, also at the prospect of Merkel’s insistence that Jyrki Katainen and Luis de Guindos might occupy the two most important economic posts in the new regime – that of Economics Commissioner and eurogroup chief respectively. After Renzi’s outburst in the European Parliament, when he told the EPP leader that he does not take orders from a German, came a fierce response by Jens Weidmann, who is quoted by La Repubblica: “Renzi says that Europe appears bored, and then tells us what we should do. I tell him that to raise debt further is not a prerequisite for growth, and that the promises should follow the facts, the reforms must be made and not just announced." Weidmann also said that there was a danger that low interest rates would not lead to reforms, but would only be used to blow up current spending. The paper noted: “the Empire Strikes Back”. In another article in La Repubblica, Renzi is quoted as saying: “In Germany, Merkel decides the policies, and the line of the chancellor is a different one.” Wolfgang Schauble, speaking at the same conference where Weidmann spoke, also rejected any notion of flexibility insisting: “We must stick to what was agreed upon.” The only discussion he had with Pier Carlo-Padoan is how the policy implementation can be improved. There are a number of accidents waiting to happen. Renzi’s comments about Manfred Weber – I don’t take orders from a German – are not quite on the scale of Silvio Berlusconi’s remarks to Manfred Schulz on a similar occasion a decade ago, but they are politically not very clever. We also feel that Renzi may misjudge Merkel’s position. Of course, she decides the policy, but she operates under significant constraints. Considering that her cabinet has just passed a balanced budget – the first since 1969 – and did so by foregoing much-needed investment spending, Germany will

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not accept budget overshoots elsewhere, or only to a very small extent. The German definition of flexibility is a decimal point or two – to be fully compensated the following year. Renzi’s budget is clearly not consistent with the EU’s fiscal framework. Weidmann has made a point that is likely to feature prominently in the discussions. If you are asking for flexibility, you have to deliver the reforms first, not just announce them. This is going to be a problem for Renzi, who is still struggling with his political reforms – which he wants to complete before he gets to the economic reforms. His problem is that the economic reform programme is not very concrete yet. Why the left should support Juncker Blogging at Politikon, Jorge Galindo argues against Eduardo Madina’s statement that “his” PSOE MEPs would not support the appointment of Jean-Claude Juncker as EU Commission President, presumably deviating from the favourable vote of the rest of the PES European Parliament group. While personalised in Madina, this is a position shared by all of the PSOE leadership candidates. Galindo states that the Euro crisis is more political than economic, and that the intergovernmental method has been damaging to the EU as a political process. Hence the pre-election commitment by various national and European parties to the Spitzenkandidat process, to give the Commission a supranational political mandate. Even Alexis Tsipras, points out Galindo, said that “Juncker should be the first to attempt to form a majority” while corresponding with a number of concessions to the centre-left. As a left-wing majority (even with the support of the Liberals) appears impossible, the only alternative to Juncker is what Britain’s Cameron intended, imposing a candidate external to the Spizenkandidat process. Galindo ends by reminding the PSOE leadership that part of the job of politicians is to explain to the voters the short-term concessions necessary to achieve long-term goals, in this case for the Parliament to win its long-running tug-of- war against the Council and for Europe to prevail over the member states. The PSOE’s economic programme through its leadership hopefuls With a thorough questionnaire on their blog last week, Economistas Frente a la Crisis probed the opinions of the candidates for secretary general of Spain’s PSOE, on which it is difficult to find substantive disagreements between them. Therefore, the exercise is more useful as evidence that the PSOE consensus diverges from the Brussels consensus. The interviews are lengthy, so we only report the parts clearly at variance with the European conventional wisdom. The respondents are Pedro Sánchez, Eduardo Madina and José Antonio Pérez Tapias, plus Alberto Sotillos who failed to obtain the necessary endorsements by party members to be declared a candidate this week.  On “competitiveness”, all candidates agree that for Spain improving productivity is preferable to reducing labour costs.  On tax reform, all agree fiscal balance should be achieved by raising tax revenues as both government revenue and expenditure are below the EU average; also, because of their greater potential for progressivity they support raising direct taxes rather than indirect (consumption) taxes.  To fight unemployment, all except Sotillos mention “aggregate demand”, to be increased at the European level; all reject “internal devaluation” as a job creation strategy and would roll back the PP’s labout market reforms as well as the idea that 312

“normative rigidities” are responsible for high unemployment, preferring “active employment policies”.  On the welfare state, all are against cuts to education and health care which they consider cornerstones of the welfare state; Sotillos makes a special mention of support for families with dependents, which Sánchez puts forward as a as a way to support the welfare state while creating jobs; all defend the current pension system, with Madina and Sotillos arguing that sustainability would be assured just by solving the problem of high unemployment.  On European fiscal policy they all agree on the need to reform European fiscal rules, with different emphasis; Sánchez points out the zero deficit goal has no support in economic theory, Madina criticises the procyclical bias of current policies, Tapias advocates eliminating R&D spending from deficit calculations, and Sánchez aims at “democratizing” the ECB and rolling back key elements of the Maastricht treaty; only Madina defends on the introduction of a constitutional debt brake by Zapatero’s government in the Summer of 2011.  On Inequality, Sánchez proposes redistributive fiscal policy and reinforcing the welfare state, Madina focuses on improving education and increasing investment in it, and Tapias and Sotillos go for “basic income” solutions. ECB to improve signal-to-noise ratio The debate about minutes has been going on for over fifteen years. It finally happened yesterday. From January 2015, the ECB will publish accounts of the meetings of its Governing Council – with some unofficial dry-runs later this year. As pre-announced before, the frequency of the meetings will change to a six-week cycle, and the reserve maintenance period will also be adjusted to coincide with the new rhythm. Non- monetary meetings will continue to be held in the previous once-a-month cycle. He made this following comment on what the ECB’s internal models are saying: “Now, using our internal analysis, our internal models, we have asked the question whether this new measure, depending on its take-up, will have an impact on the inflation rate and the growth rate of the euro area. And the answer the models gave is that they do have an impact. It's going to be a significant impact, and it will certainly be very helpful. Of course, depending on the take-up, it will be very helpful in taking the inflation rate back to below but close to 2% over the horizon that we have discussed on other occasions.” He also gave more details about the TLTRO. Mario Draghi put the total available funds from these two and further TLTROs at around €1tr. In the first two operations, the banks can borrow up to 7% of their eligible loan book. As regards the subsequent six operations banks can draw additional funds if they generate eligible lending over the first two years of the programme in excess of a given benchmark – up to three times the difference between their actual eligible lending and the benchmark. The Governing Council yesterday set the benchmarks as follows:  For banks that with positive eligible net lending in the twelve-month period to 30 April 2014, the benchmarks are always set at zero.

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 For the rest, the average monthly net lending of each bank in the year to 30 April 2014 is extrapolated for 12 months until 30 April 2015. For the year from 30 April 2015 to 30 April 2016, the benchmark monthly net lending is set at zero.”  Banks that borrow in the TLTROs and fail to achieve their benchmarks as at 30 April 2016 will be required to pay back their borrowings in full in September 2016.  The dates are 18 September and 11 December for the initial TLTROs, with additional operations carried out in March, June, September and December 2015 and in March and June 2016. Reuters reports that the Eurozone Future Inflation Gauge published by the Economic Cycle Research Institute rose from 94.0 in April to 95.3 in May, reaching a 25-month high. The group expects inflation to bottom out in the coming months. IMF sees French deficit at 3.4% next year In its latest report on France the IMF estimates that the risks for the government's fiscal plans are substantial, especially with respect to timing and strength of the recovery and how popular discontent impacts on policy. The IMF estimates that the French economy grows 0.7% this year and 1.4% next year, while the government has based its fiscal consolidation plan on an economy to grow 1.0% this year and 1.7% next year. The IMF said the biggest home-grown risk to the economy was that a recovery in investment fails to materialise. The IMF put the deficit at 4% this year and 3.4% for next year, rather than the government's target for 3.8% this year and 3% next. Michel Sapin said earlier on Thursday the government was standing by its forecast at least until second quarter growth figures are published in mid-August, Reuters reports. He also said the 2015 budget would target a public deficit of 3%of GDP as agreed with EU partners. The IMF warned that resistance to belt-tightening would build as specific measures come up for discussion. The government's support from its own Socialist party is already fraying over its plans to cut spending growth. Last month, France saw its longest rail strike in years as unions challenged relatively modest reform plans for the sector. Yesterday Manuel Valls reacted to an employers' boycott with a series of measures that trade unions hold against him in the upcoming negotiations. Sarkozy lashes out against judges, like Berlusconi Nicolas Sarkozy is on the frontpages of all newspapers with his televised counter offensive, in tone and attitude very much like Silvio Berlusconi, observes Mediapart and JDD. Like Berlusconi, Nicolas Sarkozy poses as a victim of illegitimate, terrorizing, cruel and unjust judges who are obsessed with political power. The UMP, meanwhile, is condemned to wait and see what the judges have to say. The leaders inside the party all came out in support of Sarkozy. Alain Juppe also made sure to take his distance after Sarkozy's TV intervention, saying that vilifying the judicial system seems not a good method. According to the latest CSA poll for Les Echos, Sarkozy's popularity is now trailing behind Alain Juppe for the first time. Irish economy gets a boost

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Ireland's economy grew by 2.7% in the first quarter this year, according to Reuters. The rise in the first three months of the year was driven by a 1.8% increase in exports. The domestic economy remained subdued, with personal consumption falling 0.1% in the first quarter compared with the previous three months. The new EU accounting rules also added more than 6% to the size of the economy, which has a positive impact on the size of the national debt as a percentage of GDP, which in turn affects bond market interest rates. The Irish government is under less pressure to find new budget cuts for next year after yesterday's release of positive economic data, writes the Irish Times. Michael Noonan said the latest estimate alone would mean this year’s budget deficit would be closer to 4.5% of GDP, compared to the target of 4.8%. The debt-to-GDP ratio is now closer to 116% rather than the 124% estimated at the end of last year. Some economists said the government may be able to reach its deficit target for next year with a €1bn budget package, rather than the €2bn package envisaged earlier. Finland's delinquent debt figures close to 90's recession peak The number of people in payment difficulties is now close to the level seen in the wake of Finland’s 1990s economic depression, according to data from Finland’s leading credit rating agency, Suomen Asiakastieto. Last month around 365,000 cases of bad debt were recorded by Finland’s leading credit agency. That is a few thousand short of the peak in 1997, but that number is expected to be surpassed in the autumn, YLE reports. On the dearth of private investment Germany DIW research institute has done a very good job recently to highlight the problem of underinvestment in Germany. In this article, the authors argue that the decisions taken so far threaten to generate a long period of stagnation and high unemployment. In their analysis the problem is the lack of private investment is the real problem, as well as dysfunctional markets. We also found their classification of our crisis useful: a debt crisis, a bank crisis, an economic crisis, and a confidence crisis. None have been resolved.

Eurozone Financial Data

10y spreads Previous This Yesterday day Morning France 0.352 0.323 0.319 Italy 1.444 1.437 1.445 Spain 1.451 1.392 1.391 Portugal 2.368 2.314 2.335 Greece 4.692 4.679 4.68 Ireland 1.130 1.067 1.077 Belgium 0.450 0.422 0.417 Bund Yield 1.283 1.295 1.287

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exchange rates This Previous morning Dollar 1.365 1.36 Yen 139.160 138.78 Pound 0.797 0.7925 Swiss Franc 1.214 1.2157

ZC Inflation Swaps previous last close 1 yr 0.77 0.77 2 yr 0.78 0.78 5 yr 1.23 1.23 10 yr 1.66 1.66

Eonia 2-Jul-14 0.02 1-Jul-14 0.03 30-Jun-14 0.34 27-Jun-14 0.03

OIS yield curve 1W 0.046 15M 0.041 2W 0.072 18M 0.043 3W 0.053 21M 0.070 1M 0.071 2Y 0.065 2M 0.079 3Y 0.135 3M 0.079 4Y 0.243 4M 0.075 5Y 0.388 5M 0.072 6Y 0.554 6M 0.072 7Y 0.728 7M 0.062 8Y 0.895 8M 0.048 9Y 1.050 9M 0.065 10Y 1.190 10M 0.044 15Y 1.683 11M 0.056 20Y 1.910 1Y 0.054 30Y 2.045

Euribor-OIS 316

Spread previous last close 1 Week -1.071 -1.671 1 Month 2.886 1.186 3 Months 9.614 9.814 1 Year 37.557 38.457

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 04.html?cHash=2ba752a2da3ed656e3e2a78e6c7e18e9

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ft.com Comment blogs Brussels blog Last updated:July 3, 2014 3:58 pm Mario Draghi shakes up ECB deliberations By Claire Jones in Frankfurt and Ferdinando Giugliano in London The European Central Bank is to shake up the way it conducts monetary policy, moving its monthly meetings to a six-week cycle and publishing regular accounts of its deliberations from January 2015. The publication of the minutes brings the ECB into line with other big central banks, including the Bank of England, the US Federal Reserve and the Bank of Japan. It constitutes a major about-turn for policy makers in Frankfurt, who have long worried that revealing what happened during their monetary policy meetings could increase pressure on them to act on national lines.

Since the launch of the single currency in 1999, the ECB has often clashed with eurozone politicians. Lawmakers in Germany, and officials at the Bundesbank, have been highly critical of the ECB’s unconventional policies, while governments in the south of the bloc have accused it of doing too little to foster growth. Mario Draghi, ECB president, said it would hold “dry runs” over the next six month to decide issues such as whether to reveal how individual policy makers vote. The ECB’s governing council on Thursday left its main refinancing rate at 0.15 per cent. It continues to charge a fee of 0.1 per cent on banks’ deposits above a certain threshold parked in its coffers. The rate decision was widely expected after the central bank in June unveiled a extraordinary measures to counter the threat of deflation in the eurozone. At 0.5 per cent, inflation is still just over a quarter of the central bank’s target of below but close to 2 per cent. There are also signs that the bloc’s recovery is weakening, with activity slowing both in the manufacturing and services sectors. In the 318

press conference, Mr Draghi revealed more details of the offer of cheap loans that the central bank made to eurozone’s lenders in June. More ON THIS STORY// Money Supply How has ECB targeted loans/ Money Supply Live – Mario Draghi’s press conference/ Eurozone’s economic recovery stutters/ European Central Bank news/ ECB’s loan-buying plans stall IN BRUSSELS// Britain left isolated by Juncker defeat/ Juncker nominated for top EU job/ World Weekly podcast What would a Juncker presidency mean for Europe?/ Allies abandon Cameron ahead of summit As part of the so-called targeted longer-term refinancing operations, banks will be able to borrow up to €400bn in two windows in September and December 2014. Lenders will be in the position to raise up to an extra €600bn in auctions scheduled for 2015 and 2016 if they beat lending targets set by the ECB. The ECB president also reiterated the bank’s commitment to take more unconventional measures to stave off the risk of deflation and did not rule out extra rate cuts. “The risks surrounding the economic outlook for the euro area remain on the downside,” Mr Draghi said, singling out geopolitical risks and developments in global financial markets as potential threats to the recovery. Mr Draghi parried calls by the Bank for International Settlements for central banks to raise rates to temper “euphoric” financial markets, saying they should be primarily concerned with hitting their inflation targets. The ECB president sided with his Fed counterpart, Janet Yellen, saying central banks should raid their macroprudential tool kits as a first line of defence against financial stability concerns. The euro fell sharply against the dollar during Mr Draghi’s press conference although analysts noted that this was mainly the result of the strong US jobs data, which were published at the same time the ECB president began to speak. The Europe-wide FTSE Eurofirst 300 closed up 1 per cent, with the Xetra Dax 30 rising 1.2 per cent in Frankfurt and the Paris CAC 40 up 1 per cent. Sovereign bond yields in the eurozone periphery mostly fell. Spain’s 10-year borrowing costs went down 3 basis points to 2.68 per cent, while Italy’s fell 5 basis points to 2.86 per cent, according to Reuters. Additional reporting by Michael Hunter and Dave Shellock http://www.ft.com/intl/cms/s/0/0c038850-029e-11e4-8c28- 00144feab7de.html#axzz36UFJ1V8w

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ft.com Comment Opinion July 3, 2014 6:06 pm Merkel and Renzi are the partners who can reshape Europe By Kalypso Nicolaidis The Italian prime minister counterbalances the German chancellor, writes Kalypso Nicolaidis

©AP Few European leaders relish the memory of British isolationism. That might once again seem to be in prospect, after the sorry sight of David Cameron’s crushing defeat that culminated last week in the coronation of Jean-Claude Juncker as president of the European Commission. But many of the British prime minister’s European peers think he hardened his line now to soften his electorate later – and that next time he will do more to help others help him. Many share his goal: a British yes to a reformed EU. One reason for cautious optimism is Europe’s leaders. Who can doubt that Matteo Renzi, Italy’s prime minister, is man of the hour? His Democratic party has performed better than any in Italy since 1958 – and better than the 186 parties that gathered this week at the opening of the European Parliament. No other leader comes close to his mandate for change. As Italy takes over the EU’s six-month rotating presidency this week, and with the next commission not in place until October, he is well placed to define the agenda for the next five years. More ON THIS STORY// Italy undermined by ‘crony capitalism’/ Philip Stephens Britain cast adrift/ Europe jobs – Runners and riders/ Merkel to limit Juncker fallout/ Schäuble pledges to keep UK in EU ON THIS TOPIC// EU telecoms chiefs cheer E-Plus decision/ Analysis Telecoms – Scrambled signal/ Bulgarians clash over Russian role in bank rescue/ Push to secure EU’s remaining top jobs IN OPINION// Payday doubts at Wonga/ Capital punishment works in banking/ Tom Holland The grisly delusions of Isis/ The modern art bubbble In many ways – ideology, geography, policy – Mr Renzi is the perfect counterbalance to the soft hegemony of Angela Merkel. As they are both likely to

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stay in power for the foreseeable future, it is the entente between him and the German chancellor that is most likely to shape the new Europe. This “Merkenzi” alliance could be good news for both the EU and the UK. The EU needs pragmatic leaders who agree that there are no absolute answers to the question of whether it should do more or less. Mr Renzi has spoken of the need for collective action on energy, infrastructure, climate and immigration. But he has also said that he is fed up with the EU acting like an “old boring aunt”. Italian, Spanish and Greek citizens do not need Brussels to tell them that they should not tolerate corruption and nepotism. The next step will be for member states to recognise that repatriation of powers, such as more leeway in deciding which benefits migrants receive from their welfare states, is not a sovereigntist retreat but an essential part of federalism. Mr Renzi will also seek a deal with Berlin on a gentler interpretation of the EU budget constraints. But he will do so cunningly while praising the German model, for instance, on labour laws. Wanting stronger growth in her own country, Ms Merkel might come to see the virtue of “using the rules to their maximum”, as an Italian official quipped, to allow countries implementing reforms extra time to meet debt targets by excluding some investment and educational costs from public deficit calculations. In many ways, the Italian prime minister is the perfect counterbalance to the soft hegemony of the German chancellor Ironically, the success of the European parliamentarians in imposing their candidate to head the commission could turn out to be a Pyrrhic victory. Now that Mr Juncker has a whip, he may no longer be their creature; indeed, he could become their master. Heads of states will also be able to reassert their authority more creatively as they learn to take accountability seriously. This could include making their selection of candidates to the commission more transparent. There is also little doubt that national parliaments will become more involved, from better monitoring of the European Council to greater involvement in the reform proposals over domestic fiscal issues emanating from the commission. Politicians on both sides of the channel must remember that according to the EU’s founding treaties, the “ever closer union” is “of the peoples” of the continent. European politicians must respect this plurality. In this spirit, political arithmetic may encourage moves from containment to engagement with eurosceptic voters who may be against EU policies but often not against the EU itself. Engaging eurocriticism while isolating the extremists on the right and left will require addressing the roots of populist movements fed on widespread inequalities. If the EU starts moving in the right direction, the British public could warm to the idea that changing Europe from within, not quitting it, is the bigger prize. Mr Renzi dreams of a Europe not only about rules but with a soul, while Ms Merkel prefers a Brussels with teeth. It will be left to others, including Mr Cameron, to fill in the wrinkles of our old nagging auntie. The writer is a professor of international relations at the University of Oxford

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ft.com Comment Blogs The World Rome and Berlin lock horns Ferdinando Giugliano Author alerts Jul 04 08:423 commentsShare

Today Germany and France will meet in their World Cup quarter final in Rio de Janeiro, the latest episode in one of Europe’s classic football rivalries. But off the pitch, a different duel is gripping the continent’s political scene: the one between Germany and Italy. On Wednesday, Matteo Renzi, Italy’s rock-star prime minister, inaugurated Rome’s rotating presidency of the EU with a passionate speech to the European parliament, centered around the need for Europe to find its lost soul. “If Europe took a selfie, what image would come out? One of tiredness and resignation,” said the analogy-loving PM, as he called on the EU to do more to boost growth. Ten days ago, in an address to the Italian parliament, the 39-year old former mayor of Florence compared the EU to an “old, bording aunt”, that only cares about telling member states what to do. Mr Renzi had barely ended his speech in Strasbourg before Manfred Weber, a German MEP for the centre-right Christian Social Union and chair of the European People’s Party, lashed out at his words. Italy should not demand more flexibility, he said, because of its huge debt, currently at 135 per cent of gross domestic product. He added that giving Italy more space would be unfair towards countries such as Ireland and Portugal, which put up with strict budget limits while having to pass painful structural reforms. Mr Weber’s attack was perhaps not as savage as the one famously launched by Martin Schulz, now president of the European Parliament, against Silvio Berlusconi when Italy last held the EU presidency in 2003, to which the then Italian leader responded by comparing Mr Schulz to a concentration camp guard. But his pointed words were enough to trigger a stern response for Mr Renzi. “If Weber was speaking on behalf of Germany,” Italy’s PM said, “I remind him that during the last Italian presidency there was one country which was given not only flexibility, but also the opportunity to violate the [fiscal] limits and that country now grows” – a clear 322

reference to Germany which in 2003 busted the 3 per cent budget deficit limit imposed by the EU’s stability and growth pact. On Thursday night, it was the turn of another senior German policy maker to take a pot shot at Mr Renzi. Jens Weidmann, Bundesbank president, said in a speech that by comparing the EU to an “old, boring auntie”, Italy’s PM had demonstrated his government was not willing to give up its fiscal sovereignty – a necessary step in the “fiscal union” which Italian policy makers often call for. “Consolidation is not a drag on growth, but a prerequisite for sustainable growth,” Mr Weidmann added. Another sharp response followed from Rome: “If the Bundesbank is thinking of scaring us, it has probably got the wrong country. For sure, it has got the wrong government,” official sources said. These exchanges show that the cohabitation between Matteo Renzi and German chancellor Angela Merkel, may be more difficult than many assume. Mr Renzi appears more willing to lock horns with German policymakers than his last two predecessors, Enrico Letta and Mario Monti. In this, he more resembles Silvio Berlusconi, who consistently criticised Berlin’s economic policies, especially in the final months of his last term in office. Unlike Mr Berlusconi, however, Mr Renzi is not a figure of ridicule in the EU. In fact, he has gained political stature after his thumping victory at the elections for the European Parliament last May. Mr Renzi has also been careful to praise Germany for aspects of its economic model, including its labour market, rather than simply going head-to-head with Berlin as Mr Berlusconi did. This will make it harder for German officials and lawmakers to discredit him in the eyes of their European allies. At the same time, Mr Renzi is now learning the hard way what it means to face Germany’s “nein” to calls for less austerity and more solidarity. His electoral successes may help him to get his message across to his European partners. But in Brussels and elsewhere in the EU, fiscal and economic strength still matter greatly in determining a country’s political clout. http://blogs.ft.com/the-world/2014/07/rome-and-berlin-lock-horns/

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The great transformation: Memo to the incoming EU Presidents by André Sapir and Guntram B. Wolff on 3rd July 2014 | The European Union’s leadership spent the last five years fighting an acute and existential crisis. The next five years, under your leadership, will be no less difficult. You will have to tackle difficult economic and institutional questions while being alert to the possibility of a new crisis. You face three central challenges:The feeble economic situation prevents job creation and hobbles attempts to reduce public and private debt; (2) EU institutions and the EU budget need reform and you will have to deal with pressing external matters, including neighbourhood policy and the EU’s position in the world;You will have to prepare and face up to the need for treaty change to put monetary union on a more stable footing, to review the EU’s competences and to re- adjust the relationship between the euro area and the EU, and the United Kingdom in particular.The EU needs to adapt its economies to the global Great Transformation by deepening the single market, improving product markets and improving governance.

This strategy needs to be combined with measures to boost the public capital stock to reap demand and supply-side benefits. A reform of the EU budget is imperative to orientate it more towards growth, while reform of the Commission should deliver a more coherent approach to growth policies. Neighbourhood policy should be redesigned to allow for different forms of collaboration and global trade should be promoted. Finally, the treaty reform will have to focus on concrete measures to create a fiscal capacity with appropriate legitimacy and a new relationship with the UK. | Read more at Bruegel

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Daily Morning Newsbriefing July 03, 2014 Sit back and watch: Renzi vs Germany It has been a bit of a surreal experience for us to read the front pages of Frankfurter Allgemeine and La Repubblica this morning. The Germans celebrate the first budget since 1969 without a net borrowing requirement, while Repubblica and Corriere della Sera report on the clash between Matteo Renzi and the EPP leader, Manfred Weber, who is from Bavaria. After Renzi’s speech, Weber said: “Italy has a debt of 130% and you want money in exchange for reforms? And how can we be sure that you do the reforms? In the last years we have lost confidence.” Renzi retorted that he would not take lectures from a German, given Germany’s own breach of the stability pact. The German cabinet, meanwhile, passed its “historic” balanced budget through further cuts in investment expenditure – a point made by an opposition politician in the Bundestag (there are not many, as virtually everybody is in the government coalition). The budget plan foresees a reduction in the debt-to-GDP ratio from 78% to 70% by 2017, and then down to 60% by 2025. Germany’s constitutionally enshrined balanced- budget rule did not require the zero deficit until 2016, but the government decided to bring forward the deadline. The article also mentioned there would be no compensation to tax payers as a result of the fiscal drag – an issue that has been hotly debate in Germany. In Strasbourg, meanwhile, Renzi gave a dash-for-growth speech to the European Parliament to inaugurate the Italian EU presidency, which started this month. He said that without economic growth Europe will wither. “If Europe took a selfie – it would look clapped out and bored.” That speech prompted Weber’s response. Claudi Perez, in an article in El Pais, remarked that Renzi “belongs to that breed of outstanding storytellers”, and applauds his attempt not only to reform Italy, but also to free Europe from the German crisis narrative. He makes the point that Renzi needs some slack on fiscal policy, for otherwise his political capital would erode quickly. We think that Renzi should not overstretch his reference to Germany’s fiscal transgression in 2003. The argument is useful as a reminder that reforms cost money. The 2005 reforms of the stability pact already incorporated this extra degree of flexibility. Renzi made the same remark to Angela Merkel in the European Council – all duly and prominently noted in the German press, which watches fiscal developments in Italy like a hawk. The irony is, of course, that Germany has the fiscal space to increase domestic demand, while Italy has none. While the mix of current policies leaves the overall fiscal stance in the eurozone unchanged, the politics of this is toxic, especially now that Germany itself entered the nirvana of a budget surplus. It achieved this through heavy cuts in investment, and through sacrifices especially at the level of local and regional government. If Italy is starting to expand its fiscal balance while Germany 326

contracts it, we would expect Germany to reiterate very loudly and clearly that there can be no backstop for Italy, including from the ECB, given Renzi’s behaviour. Portugal's local spending a risk for fiscal deficit target Auditors warn that local budgets could become a potential threat to the overall fiscal deficit target for this year, as local authorities only managed to achieve a budget surplus of €67m until May, which is only 10% of the annual target. The note from the Technical Unit for Budgetary Support (UTAO) sent to the MPs in Parliament says this means that the pace of consolidation has to be ten times faster in the second half to achieve the end- of-the-year target. The problem seems to be more on the expenditure than the revenue side: Spending should have dropped 9% but only did 1%. Worst performance is spending on goods and services: Instead of a 11.7% fall, spending under this category was growing 6.2 On the German minimum wage Arguably the single most important legislation of the German grand coalition is the law to introduce a statutory minimum wage. The legislation will provide a floor of €8.50 per hour for all workers in all industries, with only a few exceptions, including for jobs earmarked for the long-term unemployed and for young people on training programmes. The German commentariat has enormous problems with the Mindestlohn because it believe that state interference in wages goes against free market principles. An enlightened sceptic is Thomas Ochsner of Suddeutsche Zeitung, who brought some constructive criticism about the way the law is implemented. He writes in an editorial that it was wrong for the government to set the initial wage, rather than leaves this decision to the committee that will have the job to revise the number in future years. He said this committee was too heavily influenced by the protagonists themselves – employers and trade unions – with no voting rights for independent experts – a situation that is different in the UK, where the independent advisers contributed greatly to the accepted of the minimum wage by many of the critics. The PSOE leadership contest Spain’s PSOE is having a leadership contest to replace its current Secretary General Alfredo Pérez Rubalcaba after the debacle in the European Elections, which will be resolved with a vote of party members on June 13 followed by a party conference on June 26/27. Three candidates have cleared the hurdle of receiving the endorsement of 5% of party members: Pedro Sánchez, Eduardo Madina, and José Antonio Pérez Tapias, reports EFE. A fourth candidate, Alberto Sotillos, did not get the requisite endorsements. Sánchez is an MP and economics professor from Madrid and sometimes said to represent the economic right wing of the party; Madina is an MP from the Basque country who’s also the whip of the PSOE parliamentary group in the Spanish parliament; and Pérez Tapias is a professor of philosophy in Granada and a former MP until the previous parliamentary term ending in 2011. Tapias, the older of the three, represents the left of the party as the candidate of minority faction Izquierda Socialista and is noted for being one of few Socialist MPs to have voted against introducing a debt brake in the Spanish constitution, one of the last acts of Zapatero’s government in September 2011. Sánchez could be considered a stalking horse candidate as he leads the 327

other two in endorsements but had not been mentioned as a Secretary General hopeful before the current contest, unlike Madina who had been talked about for years alongside others who finally did not enter this contest. Both Sánchez and Madina take pains to deny they are the candidate of the party apparatus, reflecting general discontent among the party base. Tapias has stated that should he become Secretary General he would not run in a subsequent party primary to be the party’s candidate for Prime Minister in next year’s general election, but the others have made no such commitment. Before Rubalcaba’s announcement to step down, the PSOE had scheduled an open primary for its candidate for PM to be held in November. The primary process for the 2015 general election is one of the main issues to be decided by the upcoming party conference, and the PSOE is not used to having a candidate separate from the party secretary general, be it at the national or regional levels). Spain’s PSOE on a collision course with Schulz over Juncker The latest controversy in the PSOE regards the plan by Martin Schulz to have the PES group in the European Parliament support Jean Claude Juncker for Commission President. Before the European elections the PSOE had come out against Juncker for his support for austerity policies, and all three candidates for secretary general have reiterated that position. Diario Progresista reports on calls for the candidates to “prevent” Spain’s socialist MEPs from voting for Juncker, presumably breaking the party discipline of the PES parliamentary group. Manuel Valls urges ECB to do QE Manuel Valls reiterated French calls for the ECB to help bring down an "overvalued" euro, telling Les Echos in an interview he wanted to see more, including quantitative easing. He welcomed the ECB's announcement of a raft of measures to counter the threat of deflation, including cutting the deposit rate below zero and offering more long- term loans aimed at boosting bank lending to businesses. "It's a strong signal but my idea of a central bank is one that could go further, including by buying assets on the markets," he said. "Monetary policy cannot go only through interest rate moves." France has a tradition of asking for EU and ECB action to weaken the euro, irking some of its partners and in particular Germany, which in May rebuffed previous calls by Valls for a "more appropriate" monetary policy. To our knowledge, this is a first time we heard a eurozone PM make an explicit call for quantitative easing. Portugal and Ireland pre-fund repayments Portugal and Ireland are funding near-term debt repayments ahead of schedule on Wednesday, Reuters reports. Portugal will sell its first dollar bond in more four years as it sets about raising funding for next year while Ireland is offering investors the chance to swap a bond that matures in 2016 for longer-dated debt. Around 37% of Portugal's €138bn of debt falls due by the end of 2016, while around 23% of Ireland's €144bn also matures during that period, according to Thomson Reuters data. Portugal's deal has already attracted over $2bn of demand, and is set to price at around 265bpover the 10-year US Treasury, which equates to a yield of around 5.2% at current market rates. Portugal's 10-year bond yields were unchanged on Wednesday at 3.61%,

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as investors appeared to put trust in the government's conclusion that there was no threat to financial stability or public accounts from the BES probe. Ireland, also fully funded for this year, will buy back debt maturing in April 2016 and offer investors the chance to exchange their holdings for a 2023 bond, the country's debt agency said on Wednesday. Greek privatisation plans challenged or shelved Today is the show-down moment between the Greek government and the unions, as Public Power Corporation (PPC) workers begin rolling strikes in protest at the government’s privatization plans, which Antonis Samaras insisted he has no intention of abandoning, Kathimerini reports. If the strike goes ahead and has a high participation rate, the government is expected to take legal action to try to prevent it. If this is not successful, the coalition has indicated it is willing to issue the striking workers with civil mobilization orders. At the political front Samaras also faces opposition from Alexis Tsipras, who in a surprise move called for a referendum on whether part of PPC should be privatized. Syriza plans to start talks with other groups on Thursday to see if there would be enough support in Parliament for such a move. A referendum would need the support of at least 120 of 300 MPs before it could be put before Parliament and another 180 MPs for a plebiscite to be held. Although Democratic Left and Independent Greeks indicated that they would be willing to back the idea of a referendum, the Communist Party said that it would only support a plebiscite if people are allowed to vote on the liberalization of the electricity sector in general and not just on the sale of small PPC. The government’s plans to sell stakes in Greece’s water companies have now been completely shelved, writes Macropolis. In May the Council of State ruled the privatisation of the Athens Water Supply and Sewerage (EYDAP) as unconstitutional. The privatisation of the Thessaloniki water (EYATH) was shelved after strong opposition from its residents. They had organised an unofficial referendum on the privatisation to coincide with the first round of local election on May 18, with 98% of those who voted opposing the EYATH's sale. The cancellation of the privatisation processes for both water utilities raises concerns over the achievement of the privatisation targets, particularly for 2015. The latest official targets of privatisation revenues had been set at €1.5bn for 2014 and at €2.24bn for 2015. Producer prices continue to decline Producer prices in the eurozone fell by 0.1% on an annual basis in May, unchanged from April, which means that the overall deflationary trend since 2012 remains unbroken. The best one can say about these latest Eurostat PP data is that the rate of decline has been decelerating a little over the last six months. The biggest contributor to the -0.1% headline number was the energy sector, where producer prices fell by 0.3%, and the non-durable consumer goods sector, where they were down by 0.1%. Price were flat in the intermediate goods sector, and rose by 0.1% for consumer durables. These data tell us not to expect a turnaround in the HICP inflation data for a while. Bulgaria's bank run result of feud between two men

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Silvia Merler at Bruegel gives us some background on the bank run on Corporate Commercial Bank and First Investment Bank in Bulgaria, when depositors were withdrawing the equivalent of 10% and 20% of the banks' assets. An emergency line of 3.3bn Bulgarian levs (€1.7bn) was approved by the European Commission on Monday, and tensions have eased since then. The run on the First Investment bank has been ignited by a cyber-attack with e-mails, social-media posts and mobile-phone messages sent to FIB customers, fanning fears about the safety of their deposits. And it worked, as around €400m were withdrawn from FIB in a matter of hours. Behind this is a political feud between two business men, Tsvetan Vassilev, largest shareholder in CCB and Delyan Peevski, a controversial businessman and member of parliament for the ethnic Turkish minority party,. Though the exact circumstances are yet to be worked out, media reports suggest that the crisis in CCB was caused by the withdrawal of large amounts of money from Peevski, who transferred the money to First Investment Bank. And that Vassilev people retaliated this by spreading the rumour on FIB. The First Investment Bank reopened its doors on July 31. The KTB bank stays close until July 21st, according to Bulgaria’s central bank, which has begun delving into the lender’s accounts and has appointed independent auditors to find out what went wrong. If rescue talks fail, Bulgaria plans to nationalise CCB, according to the Economist. When eurozone debt explodes Zsolt Darvas and Pia Hüttl at Bruegel have done a debt sustainability analysis for the European periphery and concluded that despite the fall in sovereign debt yields, the crisis is not yet over. The fall in yields has improved the overall baseline scenario relative to a simulation the authors did in February. But they point out that the scenarios are vulnerable to negative growth, primary balance and interest rate shocks. For example, they noted that if nominal GDP were 1% lower than in the baseline assumptions, Greek public debt would still be 133% of GDP. They calculated similar shocks for a 1pp deviation in the primary balance, or a 1pp rise in the interest rate and came to similar results. But while these countries can probably withstand a single such shock, that is not so for multiple shocks. Here is the kicker: “Under the combined shock of 1pp slower growth, 1% of GDP smaller primary budget surplus, 1pp higher interest rate and 5% of GDP additional bank recapitalisation of the banking sector by the government (which is not an extreme scenario), the debt ratio would explode in Greece and Portugal and stabilise at a high level in Ireland.”

Eurozone Financial Data

10y spreads Previous This Yesterday day Morning France 0.348 0.352 0.358 Italy 1.471 1.548 1.531 Spain 1.396 1.451 1.469 Portugal 2.366 2.368 2.371 Greece 4.697 4.692 4.67 330

Ireland 1.124 1.130 1.117 Belgium 0.452 0.450 0.454 Bund Yield 1.25 1.283 1.30 exchange rates This Previous morning Dollar 1.366 1.3656 Yen 138.530 139.15 Pound 0.795 0.7963 Swiss Franc 1.214 1.2142

ZC Inflation Swaps previous last close 1 yr 0.79 0 2 yr 0.79 0 5 yr 1.22 1.23 10 yr 1.65 1.66

Eonia 1-Jul-14 0.03 30-Jun-14 0.34 27-Jun-14 0.03 26-Jun-14 0.04

OIS yield curve 1W 0.050 15M 0.049 2W 0.057 18M 0.052 3W 0.060 21M 0.078 1M 0.064 2Y 0.071 2M 0.073 3Y 0.135 3M 0.074 4Y 0.252 4M 0.071 5Y 0.403 5M 0.068 6Y 0.567 6M 0.066 7Y 0.739 7M 0.065 8Y 0.904 8M 0.064 9Y 1.058 9M 0.062 10Y 1.196 331

10M 0.061 15Y 1.687 11M 0.060 20Y 1.914 1Y 0.059 30Y 2.047

Euribor-OIS Spread previous last close 1 Week 0.471 -1.429 1 Month 3.286 2.586 3 Months 11.271 9.471 1 Year 36.786 39.086

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 03.html?cHash=550c6a1eff787d72614cdbe9ae696010

Economía Internacional ANÁLISIS Cómo reformar a la “vieja tía aburrida” Renzi ha de convencer a Merkel para que Bruselas aplique las reglas fiscales con suavidad Claudi Pérez 2 JUL 2014 - 20:49 CET7 La tarea de la política consiste en resolver, no sólo en relatar; y en todo caso en poner la vela donde sopla el aire, no en pretender que el aire sople donde uno pone la vela. Italia y su continuo espectáculo político han tenido siempre notables relatores: desde Lampedusa y Maquiavelo hasta (salvando las galácticas distancias) los líderes de los últimos años. Los Berlusconi, Monti y compañía llegaron al poder con grandes, descomunales promesas bajo el brazo, pero nunca resolvieron: no hicieron nada por sacar a Italia de ese triángulo vicioso del crecimiento cero, los niveles de deuda insostenibles y las desventajas de la camisa de fuerza en la que se está convirtiendo una Unión Monetaria asimétrica, con resultados discutibles en la gestión de la crisis, con un “pacto de estabilidad” al que siempre le falló el apellido “de crecimiento”. Si acaso, mostraron un talento inabarcable para ponerse de perfil y jurar y perjurar que harían reformas —que nunca llegaron— para que la tormenta de la crisis del euro arreciara sólo sobre España, menos hábil para vender aceite, prosciutto o promesas políticas. Renzi demostró este miércoles que pertenece a esa estirpe de los narradores sobresalientes. Posee un discurso atractivo, fresco, alejado de los tonos lúgubres del europesimismo imperante, y ha logrado encarnar las ansias de regeneración en su país. Hiperactivo, pequeñoburgués, católico y buen conocedor del poder económico, en Estrasburgo estuvo a la altura de las ambiciones que se le suponen: se declaró capaz no solo de reformar Italia, sino de hacer lo mismo con Europa, a la que describe, con su eficaz lenguaje irreverente, como “esa vieja tía aburrida”.

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No es fácil aquello de pasar de las musas al teatro. Renzi llegó al poder en febrero con una cuchillada política digna de las tragedias de Shakespeare y le faltó tiempo para anunciar que haría cuatro reformas, una cada mes: ley electoral, mercado laboral, burocracia y sistema impositivo. Pero han pasado cuatro meses y apenas ha estrenado su casillero. Gerhard Schröder, campeón alemán de las reformas antes de irse a ganar millones a Gazprom, solía decir que es mucho más fácil aprobar medidas ambiciosas que activarlas con éxito: Renzi ni siquiera ha dado aún el primero de esos dos pasos. Las reformas en casa son inaplazables para un país bloqueado, con una deuda que pesa como una losa y con dudas sobre su banca, que podría salir tocada del próximo examen del BCE. Para evitarlo, los italianos maniobrarán con la finezza que les caracteriza: al cabo, tienen figuras clave en las instituciones, que barren para casa a la menor ocasión (“prudencia, Rusia es el primer mercado de exportación del mueble italiano”, dijo el excomisario Antonio Tajani en plena escalada en Ucrania). Renzi tiene planes para Europa. Sabe que sus reformas en Italia no bastan, y que hay un lapso de tiempo entre su aprobación y los primeros resultados, en los que el capital político suele esfumarse a toda velocidad. Para evitar ese estrangulamiento necesita que la Comisión haga con Italia lo contrario de lo que hizo al principio, en lo más duro de la crisis, con todos los demás: Bruselas debe aplicar las reglas fiscales con suavidad. El electorado dejó claro el 25-M que no tolerará una tercera recesión; ahora sólo queda que Renzi haga lo que no ha podido hacer nadie y convenza de eso al nombre en el que desembocan todos los análisis sobre Europa: el de Merkel, dueña de la vela y del viento y de todo lo demás. A Renzi le toca hacer carrera con dos pesos sobre los hombros: ser la enésima gran esperanza de la izquierda (aunque es más socialcristiano que socialdemócrata) y usar su talento como relaciones públicas para persuadir a Merkel de que Europa necesita imperiosamente un paquete de inversión para evitar que los viejos fantasmas (los Le Pen y compañía) no acaben de salir del armario. No hay crecimiento sin inversión: la legislatura depende de que un florentino adicto al Twitter convenza a frau Nein de que hay que colocar ahí la vela para resolver de una vez por todas la crisis. http://internacional.elpais.com/internacional/2014/07/02/actualidad/1404326945_16 7323.html

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The Opinion Pages| Op-Ed Columnist |NYT Now Charlatans, Cranks and Kansas JUNE 29, 2014

Paul Krugman Two years ago Kansas embarked on a remarkable fiscal experiment: It sharply slashed income taxes without any clear idea of what would replace the lost revenue. Sam Brownback, the governor, proposed the legislation — in percentage terms, the largest tax cut in one year any state has ever enacted — in close consultation with the economist Arthur Laffer. And Mr. Brownback predicted that the cuts would jump-start an economic boom — “Look out, Texas,” he proclaimed. But Kansas isn’t booming — in fact, its economy is lagging both neighboring states and America as a whole. Meanwhile, the state’s budget has plunged deep into deficit, provoking a Moody’s downgrade of its debt. There’s an important lesson here — but it’s not what you think. Yes, the Kansas debacle shows that tax cuts don’t have magical powers, but we already knew that. The real lesson from Kansas is the enduring power of bad ideas, as long as those ideas serve the interests of the right people. Why, after all, should anyone believe at this late date in supply-side economics, which claims that tax cuts boost the economy so much that they largely if not entirely pay for themselves? The doctrine crashed and burned two decades ago, when just about everyone on the right — after claiming, speciously, that the economy’s performance under Ronald Reagan validated their doctrine — went on to predict that Bill Clinton’s tax hike on the wealthy would cause a recession if not an outright depression. What actually happened was a spectacular economic expansion. Nor is it just liberals who have long considered supply-side economics and those promoting it to have been discredited by experience. In 1998, in the first edition of his best-selling economics textbook, Harvard’s N. Gregory Mankiw — very much a Republican, and later chairman of George W. Bush’s Council of Economic Advisers — famously wrote about the damage done by “charlatans and cranks.” In particular, he highlighted the role of “a small group of economists” who “advised presidential

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candidate Ronald Reagan that an across-the-board cut in income tax rates would raise tax revenue.” Chief among that “small group” was none other than Art Laffer. And it’s not as if supply-siders later redeemed themselves. On the contrary, they’ve been as ludicrously wrong in recent years as they were in the 1990s. For example, five years have passed since Mr. Laffer warned Americans that “we can expect rapidly rising prices and much, much higher interest rates over the next four or five years.” Just about everyone in his camp agreed. But what we got instead was low inflation and record-low interest rates. So how did the charlatans and cranks end up dictating policy in Kansas, and to a more limited extent in other states? Follow the money. For the Brownback tax cuts didn’t emerge out of thin air. They closely followed a blueprint laid out by the American Legislative Exchange Council, or ALEC, which has also supported a series of economic studies purporting to show that tax cuts for corporations and the wealthy will promote rapid economic growth. The studies are embarrassingly bad, and the council’s Board of Scholars — which includes both Mr. Laffer and Stephen Moore of the Heritage Foundation — doesn’t exactly shout credibility. But it’s good enough for antigovernment work. And what is ALEC? It’s a secretive group, financed by major corporations, that drafts model legislation for conservative state-level politicians. Ed Pilkington of The Guardian, who acquired a number of leaked ALEC documents, describes it as “almost a dating service between politicians at the state level, local elected politicians, and many of America’s biggest companies.” And most of ALEC’s efforts are directed, not surprisingly, at privatization, deregulation, and tax cuts for corporations and the wealthy. And I do mean for the wealthy. While ALEC supports big income-tax cuts, it calls for increases in the sales tax — which fall most heavily on lower-income households — and reductions in tax-based support for working households. So its agenda involves cutting taxes at the top while actually increasing taxes at the bottom, as well as cutting social services. But how can you justify enriching the already wealthy while making life harder for those struggling to get by? The answer is, you need an economic theory claiming that such a policy is the key to prosperity for all. So supply-side economics fills a need backed by lots of money, and the fact that it keeps failing doesn’t matter. And the Kansas debacle won’t matter either. Oh, it will briefly give states considering similar policies pause. But the effect won’t last long, because faith in tax-cut magic isn’t about evidence; it’s about finding reasons to give powerful interests what they want. http://www.nytimes.com/2014/06/30/opinion/paul-krugman-charlatans-cranks- and-kansas.html?partner=rssnyt&emc=rss&_r=0

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Jul 2 12:50 pmJul 2 12:50 pm84 Trick or Tweak Sam Tanenhaus asks, “Can the G.O.P. Be a Party of Ideas?” Why, no. This is another edition of simple answers to simple questions. More specifically, the “reform conservatives” seem mainly to be offering supposedly new ideas for the sake of being seen to offer new ideas. And there isn’t much there there; can you find anything in the Tanenhaus piece that sounds like an important new idea rather than a minor tweak on the current conservative catechism? I can’t. I mean, converting federal poverty programs into bloc grants is supposed to be a major departure? But then, the whole notion that new ideas are what politics is about is greatly overrated. Governing isn’t like selling smartphones; the underlying shape of the problems you have to confront changes quite slowly, and the basics of policy debate are quite stable. In particular, the central policy debate in US politics hasn’t changed in decades, nor should it. Liberals want a strong social safety net, financed with relatively high taxes, especially on high incomes. Conservatives want much less of a safety net, and much lower taxes on the affluent. Thirty-five years ago conservatives did produce a new argument — the claim that high taxes and generous benefits were producing such a drag on the economy that even lower-income Americans would be better off if we slashed all of that. And they got most of what they wanted — much lower taxes on top incomes, an end to welfare as we knew it, though not to the big middle-class programs. But growth failed to take off while inequality soared, so that the income of typical families grew much more slowly after the conservative revolution than before: So much for that big idea. Is there anything like that on the horizon? No — and it’s not clear why you should expect anything of the kind. What’s certain is that tweaking policy at the edges isn’t going to do much. And I suspect that at some level the reform conservatives know this. The point of their proposed policy tweaks, I’d argue, is less to achieve results than to let the GOP dissociate itself from soaring inequality and stagnating incomes, without changing its fundamental policy stance. And it’s not a trick that’s likely to work.

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Credit EPI http://krugman.blogs.nytimes.com/2014/07/02/trick-or-tweak/?module=BlogPost- Title&version=Blog Main&contentCollection=Opinion&action=Click&pgtype=Blogs®ion=Body Jul 1 8:30 pmJul 1 8:30 pm80 Neomonetarist Delusions Danny Vinik notes that “reform conservatives”, who are trying either to rescue the right from its intellectual torpor or to provide cover for its fundamental anti-intellectualism — your choice — have gotten a fair bit of lip service for some of their ideas, but none at all for one key proposal: activist monetary policy to assure full employment. This was predictable. The neomonetarist movement starts from an acknowledgement of reality: shortfalls of aggregate demand do happen, and they do matter, and we need an answer. Like the original monetarists, however, they reject any government role in the form of discretionary fiscal policy. Instead, they argue that the Fed and its counterparts can do the job all on their own if they really want to. I don’t buy this on the economics; to do what’s needed central banks either have to take on a lot of risk, which is in effect a form of fiscal policy, or change inflation expectations, which is far beyond conventional monetary policy. But we don’t need to hash this out here. The more important point is that the neomonetarists are deluded in imagining that there is any constituency for their ideas in the modern conservative movement. Remember what happened when the Fed began a partial move toward the kind of policy they want: practically the whole Republican establishment began screaming at Ben Bernanke that he was debasing the currency. And surely you don’t think that the failure of inflation to materialize has changed their minds.

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And underlying this total opposition to monetary expansion lie two deep forces. First, much of the right is thoroughly committed to the view that bad things only happen because of the government, that the private sector will never have problems if it has low taxes and the security of the gold standard. Paul Ryan is effectively the intellectual leader of the GOP — and he gets his monetary economics from characters in Ayn Rand novels. Moreover, the Kalecki argument about why business interests oppose activist fiscal policy applies to monetary policy too. If “captains of industry” want the body politic to believe that prosperity depends on their “confidence” — so that any criticism leads to depression — they’re going to hate monetarism as much as they hate Keynesianism, because both imply that full employment depends on policy, not their hurt feelings. So there’s really no constituency for neomonetarism. Milton Friedman would be an isolated outcast in today’s conservative movement, and his would-be successors have no home. Jul 1 4:48 pmJul 1 4:48 pm34 Stability or Sadomonetarism? Simon Wren-Lewis is harsh about the current tight-money crowd, exemplified by the Bank for International Settlements, who are urging tight money despite weak economies, for fear that investors will take excessive risks. But he’s not harsh enough. He’s right that it’s more or less insane to argue that the economy must be kept persistently depressed for fear that investors will be too exuberant — and at the same time to argue against fiscal expansion or anything else that might offset rising rates. What he doesn’t note, however, is that while the BIS has argued for raising interest rates at least since 2010, it keeps changing its reasoning. Here’s what it said in 2011 (pdf): Tighter global monetary policy is needed in order to contain inflation pressures and ward off financial stability risks. It is also crucial if central banks are to preserve their hard-won inflation fighting credibility, which is particularly important now, when high public and private sector debt may be perceived as constraining the ability of central banks to maintain price stability. Central banks may have to be prepared to raise policy rates at a faster pace than in previous tightening episodes. And it praised the ECB for what we now know was a terrible decision to raise rates. So, that was three years ago, and Europe in particular is struggling with dangerously low inflation. Has the BIS changed its prescriptions? No, it’s just changed the reason for demanding the same thing. What all this suggests is that the BIS basically just wants to raise rates, and is always looking for a reason. It’s about sadomonetarism, not stability. Jul 1 2:32 pmJul 1 2:32 pm36

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The Secret of Belgium’s Success No, not about soccer. But since we’re talking about Belgium, a little-known fact is that the Belgian economy has actually done considerably better than its neighbors since the crisis began: Photo

Credit How have they managed this? Well, a leading hypothesis is that Belgium has benefited from not having a government, which means that it can’t pursue austerity policies: Photo

International Monetary Fund (for 2007 to 2013)Credit Just saying. 339

Jul 1 10:51 amJul 1 10:51 am79 Learned Macroeconomic Helplessness One of the oddest, most frustrating things about the six years plus since the Great Recession began is the incessant whining from pundits that it’s all very complicated, and nobody knows what to do. As Dean Baker says, the story of this slump is remarkably simple; I would give more role to household debt than he does, but basically yes, it’s a huge slump in housing. Here’s residential investment as a percentage of GDP:

Credit This created a big hole in demand, one that couldn’t be filled with conventional monetary policy; so the answer should have been some mix of fiscal expansion, unconventional monetary policy, and debt relief. This wasn’t hard or unconventional economics; it was not much beyond Econ 101. What about all the objections raised? Expansionary monetary policy would cause inflation! Budget deficits will drive up interest rates! We need to reduce deficits to encourage the confidence fairy! Two things: First, none of this came from the standard economic models, which said that money wouldn’t be inflationary in a liquidity trap, deficits wouldn’t drive up interest rates, and contractionary policy would be contractionary. And so it proved: low inflation, low interest rates, and here’s the effect of austerity from 2009 to 2013:

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So basic models told us what to do, and the models have worked very well. The only complicated thing about responding to this crisis has been the ideological unwillingness of influential people to take yes for an answer. We had the knowledge and the tools to have avoided most of the pain, but we didn’t, and instead cried “It’s all so complicated.” Jun 30 5:40 pmJun 30 5:40 pm97 The Iraq Stain I don’t write much about Iraq and all that these days, but this report from James Risen brings back the horror of the whole thing. And I don’t just mean the fact that we were lied into war; that most of our media and policy elite rushed to join the bandwagon; that the venture led to awesome waste of lives and money. No, Iraq was also a moral cesspit. Not only were we taken to war on false pretenses, it was clear that this was done in part for domestic political gain. The occupation was treated not as a solemn task on which the nation’s honor depended, but as an opportunity to reward cronies. And don’t forget the torture. So in a way it’s not too surprising to learn that we didn’t just, incredibly, rely heavily on politically connected mercenaries, but that said mercenaries threatened violence against our own officials: Just weeks before Blackwater guards fatally shot 17 civilians at Baghdad’s Nisour Square in 2007, the State Department began investigating the security contractor’s operations in Iraq. But the inquiry was abandoned after Blackwater’s top manager there issued a threat: “that he could kill” the government’s chief investigator and “no one could or would do anything about it as we were in Iraq,” according to department reports. And guess what: American Embassy officials in Baghdad sided with Blackwater rather than the State Department investigators as a dispute over the probe escalated in August 2007, the previously undisclosed documents show. But it’s still shocking, and a reminder of just how deep the betrayal went. Jun 30 10:34 amJun 30 10:34 am73 Oldies But Goodies Ah — so we learn that Ezra Klein’s Vox is under attack — as is the current Democratic agenda — because it’s “tired”, recycling ideas from the 60s and even earlier. Indeed. You know what else is tired? The whole engineering agenda, which keeps recycling old ideas like conservation of energy and mass. The point, of course, is that attacking ideas simply because they’ve been around for a long time is an act of deep intellectual laziness. What matters is whether the ideas work; clinging to old ideas only becomes a problem if you refuse to change in the face of contrary evidence. Yes, liberals call for progressive taxation and redistribution to limit inequality and reduce poverty; these aren’t new ideas, but they are ideas that work. 341

Conservatives cling to supply-side economics, which is also an old idea — but the problem is that it’s an idea that keeps failing, but they refuse to accept that reality. A case in point: remember the attempt to privatize Social Security in 2005? A fair number of allegedly liberal commentators supported that effort, on the grounds that we needed new structures for the information age, or something. In fact, a simple defined- benefit program makes even more sense in an unstable economic landscape. The age of the idea is neither here nor there. And sometimes old ideas that have for whatever reason fallen out of the discourse can actually be liberating, even revolutionary — which is why Mark Thoma’s classic remark that “new economic thinking means reading old books” was so on the mark. The liquidity trap is an old idea, going back in essentially its modern form to Hicks 1937, yet people who understood it came across as radicals after 2008 — and were right. So yes, the liberal agenda these days involves a lot of harking back to old concepts — concepts that were largely abandoned during the era of right-wing ascendancy. But those old concepts worked, whereas the “new” (now themselves quite old) ideas didn’t. Back to the future!

Stagflation and the Fall of Macroeconomics

June 28, 2014 3:00 pmJune 28, 2014 3:00 pm78Comments Simon Wren-Lewis and Mark Thoma write about the rise of New Classical Macroeconomics — basically the rejection of Keynes and the attempted assimilation of macro into micro. Unusually, I have some bones to pick with both, although we clearly agree on the big stuff. Mark writes about the rise and fall of new classical macro — which is, I’m sorry to say, much too optimistic. Anti-Keynesian views, indeed real business cycle theory asserting that inadequate demand can never be a problem, retains a firm grip on much of the profession. It’s still quite hard to publish papers doing anything like what I would consider useful business cycle analysis in good journals, and it’s still very hard for young macroeconomists with a reality sense to get appointments and promotion. More broadly, the fundamental shift in intellectual criteria that Simon has written about several times — from “does the model fit the facts?” to “does it have rigorous foundations in maximization?” — remains very much in force. You might have expected both the 2008 crisis and the years of poor performance that followed — years in which new classical types made massively wrong predictions, while people who remembered IS-LM did much better — would have changed this a lot. But remember that new classical macro fundamentally elevated microfoundations above empirical success; so orthodoxy largely brushed aside empirical failure. But my small quarrel with Simon involves how we got into this state. He dismisses the stagflation of the 1970s, on the grounds that IS-LM macroeconomics quickly adapted to the new information. Indeed, this happened very fast: by 1978 both the leading undergraduate macro textbooks, Dornbusch-Fischer and Gordon, had accelerationist

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Phillips curves and extensive discussions of stagflation. (Compare this with new classical macro, which failed decisively in the 1980s, but never adjusted at all.) Nonetheless, I remember the 70s quite well, and stagflation did indeed play a role in the rise of new classical macro, albeit in a subtler way than the caricature that it proved Keynes wrong, or something like that. What mattered instead was the fact that stagflation had in effect been predicted by Friedman and Phelps; and the way they made that prediction was by taking a step in the direction of microfoundations. Specifically, they asked what a more or less rational price-setter would do in the face of persistent inflation; their answer was, raise prices preemptively, and if everyone did this it would shift the Phillips curve up by the amount of expected inflation. Sure enough, the Phillips curve did seem to shift as predicted. What this did was to give immense prestige to the notion that you could use the assumption of rationality to make better predictions than you could using historical experience alone. And for a while, this created a presumption that more rationality in the model was always progress. In the 80s, as I said, this was proved wrong, and the whole enterprise should have been reconsidered. But by then you already had a self-perpetuating clique that cared very little about evidence and regarded the assumption of perfect rationality as sacrosanct — if you weren’t assuming that, you weren’t doing real economics. So the effects of events were asymmetric: the 70s led Keynesians to adapt, but new classicals shrugged off the 80s, just as they are shrugging off the Great Recession. In the long run, new classical macro may erode in the face of its uselessness. But in the long run — well, you know.

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Daily Morning Newsbriefing July 02, 2014 Eurozone economy slowing down significantly At the beginning of the year there was a lot of euphoria about the economic recovery. Confidence indicators suggested very strong gains, but the Q1 GDP figures were disappointing. Evidence is now mounting that Q2 is going to be disappointing as well. We are now in a situation where the PMIs are adjusting to the data – which means that the previous readings gave us a wrong coincident reading of where the economy stood at the time. They are less wrong today, but not really useful either. Those data may have contributed to the significant delay in the ECB’s monetary policy response. One of the micro data we tend to look are German engineering orders because they give a good indication of demand conditions for the German engineering industry. The VDMA reports that orders in the German engineering sector (plant and machinery) was down by 2% on the year in May – the combination of a 5% increase in domestic business and a 4% decrease in exports. The more stable three-month average showed a fall of 8% for exports and increase of 9% in the domestic business. The domestic economy is doing well. What drives the slowdown is a fairly strong downturn in foreign orders, especially from outside the eurozone. The latest Markit manufacturing PMI, at 51.8, is a notch below the flash estimate. Spain is doing well, reaching an 84-month high, while France and most other countries are slowing down. If you look at the main chart, one sees this is a pretty feeble recovery, especially considering that the index was significantly overshooting. Markit was saying that the recovery was stalling, and that the ECB needed to do more to reassert the momentum. Unemployment remains unchanged at 11.6%, according to Eurostat, but the labour market is deteriorating again in Italy, according to Istat. A closer look at the data reveals an improvement in male unemployment, but this is more than offset by a very strong deterioration in female unemployment (by 0.5pp). Officially registered unemployment has gone up by 0.1pp to 12.6%. Given the latest output estimate by Istat, this complements a scenario of continued stagnation. Youth unemployment has gone down by 0.3pp, but remains extremely high at 43%. In an op-ed in El País Santiago Carbó writes that the US is having a debate on whether to worry about rising inflation when the economy is not quite at full employment, which is an enviable position to be in from a European perspective as he expects low inflation and high unemployment to persist for many years. Pointing to Eurostat’s advance of June inflation at 0.5%, he wonders whether the ECB shouldn’t start thinking of when to act again. 344

In another op-ed, Antón Costas writes that the direction the European economy is taking is one of speculative financial markets, a dispirited civil society and populist politics, while the political leadership declares the euro crisis over, falsely in his opinion. He attributes the cause of populisms to growing inequality and proposes solutions such as Renzi’s program of attention to inequality and a European minimum wage. Is this the end of Sarkozy's political ambitions? Nicolas Sarkozy has been placed under formal investigation for active corruption, peddling influence and benefiting from a “breach of confidence”, a case that some in the UMP believe compromises his chances for a comeback in 2017. The decision came after 15 hours of questioning under police custody, unprecedented for a former president, writes the Journal de Dimanche. This investigation involves him, his lawyer and a judge in peddling influence to get information on an investigation into funding irregularities in his victorious 2007 election campaign. Specifically, magistrates will seek to establish whether Sarkozy tried to get a judge promoted to the bench in Monaco in exchange for information on that campaign finance inquiry. This case is one of a series of scandals, all dismissed by Sarkozy and his allies as an attempt to bring him down. Le Monde writes that the series of six scandals already took a dent in his popularity among right wing voters. His support inside the UMP is also showing signs of eroding, according to Mediapart, with several UMP MPs expressing that this is now too much. His friends loudly complain about the „wave of hatred“ and „unfair juridical treatment,“ according to Le Figaro. They insist that Sarkozy is a victim, and if there is no condemnation, one cannot disqualify him as a candidate. Greek government and unions in showdown over part-privatisation The Greek government may issue civil mobilization orders if unions carry through with their threat to go on strike from midnight on Wednesday in protest at the government’s plans to sell off part of the Public Power Corporation (PPC) to private investors, Kathimerini reports. Government spokeswoman Sofia Voultepsi said: “They do not own PPC and electricity, they do not have the right to turn the switches off, this would be sabotage against the state.” She added that the government would take “any measures” needed to prevent the unionists forcing blackouts across the country. Syriza, meanwhile, has thrown its full weight behind the protests. Their spokesman Panos Skourletis said that if PPC is privatized, a leftist government would nationalize it again. The bill for the part-privatization of the electricity firm is due to be discussed at committee level in Parliament on Wednesday. BES shares rebound after short-selling ban Portuguese bond yields fell on Tuesday as worries eased that a probe into three holding companies of the Banco Espirito Santo could create the type of financial instability that might force the government to act, Reuters reports. Portuguese 10-year yields were 6 basis points lower at 3.62%, having risen as much as 10 bps on Monday. A rebound in Portugal's government bonds mirrored a recovery in BES shares after market regulators in Lisbon and London banned naked short-selling. BES shares earlier fell to their lowest since July last year, before reversing those losses to close up nearly 14% on the day. Some analysts expect volatility in BES share prices to continue as BES's relationship with its founding clan and its many holdings is yet to be clarified.

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The effects of June 5 Marius Zaharia of Reuters is taking stock of what the ECB’s actions on June 5 yielded. The answer is not a great deal so far. He noted that the take-up rate of weekly repos remains high, which suggest that there cannot be significant north-south flows. There has been no evidence so far that negative rates have encouraged banks to lend. The daily average turnover in overnight Eonia lending was €27.3bn, just a little over the 2014 average. On Tuesday, banks took €97bn in new loans, and paid back €115bn - this is due to the usual quarter-end window dressing. The negative rate may have contributed to the slight depreciation of the euro from its high of close to $1.40, but it is not that far off. And it reduce the risk of spikes in money market rates (though we noted yesterday that Francesco Papadia is not even sure about that). Another impact is a fall in borrowing costs for Grand Coalition or Stitch-Up? Martin Schulz has been re-elected president of the European Parliament with an absolute majority of 409 votes out of a total of 612 valid votes, writes Euractiv. What we noted was how the different the reporting of the story was. While the Euractiv writes that Schulz was supported by a Grand Coalition of S&D, EPP and Alde, Britain’s Daily Telegraph, clearly not used to the notion of a Grand Coalition, describes this as a “stich- up”. The committee elections have yet to happen. The BIS and its critics We noted that our own reaction to the BIS annual report– while critical– was nothing compared to the barrage of criticism in the media and blogosphere yesterday. Ryan Avent at the Economist’s Free Exchange blog stated boldly that dead economies blow no bubbles. He was particularly trenchant on the BIS’s support for rising interest rates on the grounds that monetary policy was now ineffective in supporting growth, and should instead focus on financial stability alone. He makes the point that macroprudential policies may be more effective than the BIS acknowledges. And that central banks, like the ECB, have not yet used their complete arsenal. Martin Wolf focuses on the effect of the policies. He writes the BIS is right to warn about bubbles – and has had a good track record in the financial crisis. But he says it is grotesque to embrace outright deflation as the best way to handle a balance-sheet recession. The result would be further indebted, more bankruptcies, and even weaker economies. There were reasons why the world abandoned the pre-Keynesian consensus in the 1930s. Simon Wren-Lewis offers a more detailed dissection of the financial stability argument. He begins with a concession: if you only have one tool and two targets and if you see a financial crisis coming, then any rational policymaker would do raise interest rates even if inflation is below target. But he makes the important point that this action might precipitate lower interest rates in the future – as the higher rates bring down inflation further. He cites the Swedish case where the central bank did exactly that. So what the BIS has advocated has already been tried, and it did not work. Wren-Lewis raises two important points, which are worth quoting in full:

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“I want to make two observations that follow from the BIS argument. The first is that they are in effect saying that the Zero Lower Bound (ZLB) constraint on monetary policy is even more severe than we thought, because if we leave interest rates at the ZLB for too long this generates an unacceptable risk of financial instability. That in turn must strengthen arguments (pdf) for raising inflation targets above 2%. Strangely, I do not hear advocates of the BIS case also arguing for higher inflation targets. The second is that, the more severe the ZLB constraint is in practice, the more compelling the case for using fiscal stimulus when we hit the ZLB. (Fiscal policy has become more expansionary in Sweden.) Again, this is something you do not hear BIS advocates argue for – in fact they often push austerity.” We agree, of course, that it would be hopping mad to raise interest rates in the eurozone, but we are less sure about the UK or the US, for example, where inflation rates are not so far away from their targets. We would also share the BIS’s scepticism on macropru policies. As we are seeing in the UK right now, they are being applied very cautiously as the central bank is extremely hesitant to prick the housing bubble, or even acknowledge the existence of a bubble in a market where price-to-income and price-to- rent ratios are off the charts. We, too, think that there is a case for a gradual normalisation of rates in the UK, while for the eurozone, we would advocate an ECB- funded pan-European investment programme (which would drive up investment and inflation simultaneously, a rare case of a single instrument achieving two goals). Wren- Lewis did an excellent job in identifying the internal contradictions of the BIS’ warning. As we pointed out yesterday, the analysis is not based on a discernable economy model of any kind, and this makes it harder to have a rational discussion. But the BIS is surely right to warn about financial instability, which would be extremely costly coming so soon after the crises of the last decade. We recommend that the BIS adds some clarity about its framework for macroeconomic analysis.

Eurozone Financial Data

10y spreads Previous This Yesterday day Morning France 0.347 0.348 0.356 Italy 1.489 1.471 1.467 Spain 1.420 1.396 1.394 Portugal 2.433 2.366 2.369 Greece 4.732 4.697 4.69 Ireland 1.117 1.124 1.116 Belgium 0.454 0.452 0.458 Bund Yield 1.248 1.25 1.254 exchange rates Previous This

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morning Dollar 1.369 1.3679 Yen 138.970 138.86 Pound 0.799 0.7972 Swiss Franc 1.214 1.2139

ZC Inflation Swaps previous last close 1 yr 0.75 0.8 2 yr 0.85 0.82 5 yr 1.21 1.23 10 yr 1.76 1.66

Eonia 30-Jun-14 0.34 27-Jun-14 0.04 26-Jun-14 0.04 25-Jun-14 0.04

OIS yield curve 1W 0.024 15M 0.042 2W 0.031 18M 0.044 3W 0.038 21M 0.048 1M 0.044 2Y 0.061 2M 0.055 3Y 0.117 3M 0.063 4Y 0.224 4M 0.061 5Y 0.363 5M 0.050 6Y 0.526 6M 0.054 7Y 0.696 7M 0.053 8Y 0.859 8M 0.052 9Y 1.012 9M 0.047 10Y 1.148 10M 0.046 15Y 1.641 11M 0.045 20Y 1.868 1Y 0.050 30Y 2.003

Euribor-OIS Spread previous last close 1 Week 2.386 0.786 348

1 Month 4.386 3.286 3 Months 12.071 11.071 1 Year 37.486 38.986

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 02.html?cHash=dd943870ea58be520cd4503d708e6941

ByMark Thoma MONEYWATCH July 1, 2014, 5:45 AM Making the case for industrial policy Nobel Prize winning economist Joseph Stiglitz's latest book, "Creating a Learning Society: A New Approach to Growth, Development, and Social Progress," co-written with Bruce C. Greenwald, takes on one of the most sacred ideas in economics, the benefits of free trade between nations. Ever since Adam Smith and David Ricardo pointed out the benefits of absolute and comparative advantage, economists have promoted the advantages of specialization and trade among nations: Protectionism of markets or industries within a country is to be avoided, and open markets are the key to prosperity for all. There may be winners and losers within a country, with an example of the latter being workers who become unemployed as production moves to countries with an advantage in a particular industry. Still, it's generally possible to compensate the losers and still have enough left over to make everyone in a country better off. But is this true always and everywhere? If not, what are the exceptions to the argument that free trade has the potential to make everyone better off? And when is protectionism in one form or another justified? Stiglitz argues that protectionism in the form of industrial policy can sometimes make a country better off, particularly for developing economies. Taking off from Robert Solow's work on economic growth and Kenneth Arrow's research on "learning by doing," Stiglitz argues that knowledge is the most important determinant of economic growth. Thus, learning and the acquisition of knowledge ought to be at the forefront of economic development strategies. Unfortunately, when markets are left to their own devices, they don't produce enough learning. In particular, learning produces spillover effects within an economy, what economists call externalities, and the spillovers prevent firms from capturing the full value of their investment in learning. For example, other companies can mimic the firm that invests in learning, and that reduces the advantage of the investment and removes the incentive to invest in learning. Thus, an important market failure is associated with investment in learning, and that leads to underinvestment in new knowledge.

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From the perspective of the economy as a whole rather than the individual firm, the spillovers from learning are a positive outcome. The more firms that have the needed know-how for production, marketing, etc., the more growth the economy will have. Thus, government has a role to subsidize learning and to protect companies that are "learning by doing." If the knowledge needed to compete in particular industrial sectors isn't present, how can the country have a presence in these markets? A country might have everything it needs to be strong in a particular area if only it had the necessary knowledge, and government can use industrial policy to promote the needed learning. But which industry should a developing country's government protect and promote? Isn't the marketplace much better at picking winners than governments? Stiglitz makes a strong argument that the evidence for that argument "is not as compelling as free-market advocates claim. America's private sector was notoriously bad in allocating capital and managing risk in the years before the global financial crisis, while studies show that average returns to the economy from government research projects are actually higher than those from private-sector projects -- especially because the government invests more heavily in important basic research. One only needs to think of the social benefits traceable to the research that led to the development of the Internet or the discovery of DNA. But, putting such successes aside, the point of industrial policy isn't to pick winners at all. Rather, successful industrial policies identify sources of positive externalities, that is, sectors where learning might generate benefits elsewhere in the economy." As this discussion from The World Bank states, "the question Stiglitz challenges us to ask is not, 'What can an economy produce today?' but 'What can it learn to produce?' and 'What production processes can catalyze learning in other sectors?'" Stiglitz and Greenwald make a strong case for protecting infant industries while they "learn by doing" and also for protecting other areas. For example, "financial-market liberalization may undermine countries' ability to learn another set of skills that are essential for development: how to allocate resources and manage risk." The economists' bottom line is that while free trade is still generally desirable, in some circumstances "industrial protection and exchange rate interventions may bring benefits -- not just to the industrial sector, but to the entire economy." http://www.cbsnews.com/news/joseph-stiglitz-makes-the-case-for-industrial-policy/

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mainly macro

Comment on macroeconomic issues

Tuesday, 1 July 2014 The financial instability argument for raising rates There is a nice juxtaposition of recent articles in the Economist. This one, by P.W. (it is weird this convention they have for signing with just their initials), puts the “case against maxing out monetary policy” (a.k.a. raise rates now). The Fed, Bank of England and ECB“argue that the priority is to restore growth and to do battle against low inflation. But [they] grievously misread the risks before the financial crisis, which weakens their claim to be reading them correctly now.” Let’s call the proposition that we should raise rates now to avoid financial instability the BIS case, after the Bank of International Settlements who have been making this argument ever since the recession began. In contrast Ryan Avent writes that there are two big problems with this argument. I want to expand on his discussion, and be a little less polite. I want to begin by conceding a point. Suppose, as a monetary policymaker, you believe a financial crisis is possible, and that by raising rates you may be able to prevent it. Assume, crucially, that there is nothing else you can do to help prevent the financial crisis. In that case, you will consider raising rates, even if inflation is below target. If you have just one instrument (interest rates) and two targets (inflation and preventing a crisis) you will be influenced by both targets. If you want this point expressed more formally, see this post and the paper by Mike Woodford it discusses. However that is not the end of the story. If you raise rates to prevent financial instability when inflation is below target, inflation will remain below target or may fall even further. You cannot ignore that. So if interest rates are raised today to head off a financial crisis, they will have to be lower in the future to deal with the lower inflation or even deflation you have caused. This is not just what macroeconomic theory says. In mid-2010 the Swedish central bank started raising interest rates (from 0.25% to 2%), despite forecasts that inflation would stay below target and with unemployment well above its natural rate. They did this explicitly because they were worried about the build up of household debt and a possible housing bubble. Inflation began to fall, and since 2013 it has been at or below zero. As Lars Svensson has pointed out, even on its own terms this is not a very clever policy, because with lower inflation the real value of debt is higher than it would otherwise have been. But the key point for the current discussion is that now interest rates are coming down again (currently 0.75%), because you cannot ignore inflation being over 2% below target. Some of those making the BIS case understand this. What they hope is that if interest rates are raised to, say, 2% and stay there, that will still give us enough monetary 351

stimulus to eventually get inflation back up to target. It clearly was not correct in the Swedish case, and with Euro inflationstill at 0.5% it looks pretty improbable there too. But maybe it could be correct for the US and UK. So by raising rates by a modest amount today we might prevent financial instability, but at the cost of delaying the recovery. I want to make two observations that follow from the BIS argument. The first is that they are in effect saying that the Zero Lower Bound (ZLB) constraint on monetary policy is even more severe than we thought, because if we leave interest rates at the ZLB for too long this generates an unacceptable risk of financial instability. That in turn must strengthen arguments (pdf) for raising inflation targets above 2%. Strangely, I do not hear advocates of the BIS case also arguing for higher inflation targets. The second is that, the more severe the ZLB constraint is in practice, the more compelling the case for using fiscal stimulus when we hit the ZLB. (Fiscal policy has become more expansionary in Sweden.) Again, this is something you do not hear BIS advocates argue for – in fact they oftenpush austerity. As Ryan Avent says, we can avoid all these difficulties by adding an extra instrument, which is macroprudential regulation. If parts of the financial system appear prone to instability because people are taking insufficient account of risks, bring in controls (or maybe taxes) of various kinds to stop this happening. Now, as R.A. notes, those taking the BIS position counter that such measures are untested and may not be effective. Here is a typical example in the FT, where it is stated that “macroprudential policies will fail to stop investors taking irrational risks”. So we must raise interest rates, and delay the recovery, because nothing else can stop some in the financial system taking excessive risks. To which I can only say, summoning all my academic gravitas, what audacity, what impudence! Not only have we had to suffer the consequences of the Great Recession because of excessive risk taking within a largely unregulated financial system, we now have to cut short our main means of getting out of that recession because they might do it again. I do not know what planet these people are on, but if its mine, can they please get off and play their games elsewhere. http://mainlymacro.blogspot.co.uk/2014/07/the-financial-instability-argument- for.html

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