SUERF

46th ECONOMICS CONFERENCE 2019 THE EUROPEANMONEYANDFINANCEFORUM SUERF T HE EUROPEANMONEYANDFINANCEFORU 46 of the OeNB in cooperation SUERF with European Economic Union: and Monetary th ECONOMICS CONFERENCE 2019 CONFERENCE ECONOMICS M The first and the next and 20 the next Theyears first OESTERREICHISCHE NATIONALBANK EUROSYSTEM Contents

Contents

Ewald Nowotny Opening remarks 6 Session 4 The international role of the euro Keynote Lecture Martin Summer Jean-Claude Trichet The international role of the euro from different perspectives 106 European Economic and Monetary Union: from the past into the future 12 Kerstin Jorna From start-up to scale-up: the global role of the euro 108 Session 1 Toward a better EMU: past lessons, structural adjustments Arnaud Mehl The euro’s global role: past, present and future 114 Luiz de Mello Making the most of the EMU: Challenges and opportunities for structural reforms 26 Session 5 Peter Mooslechner Digitalization of money: future challenges 20 years of EMU, 10 years in crisis mode: Kurt Pribil What might the future “new normal” of monetary policy look like? 36 Remarks on digitalization of money and future challenges 124

Session 2 Ulrich Bindseil Monetary and financial stability Controlling CBDC through tiered remuneration 128 Andreas Ittner Andrei Kirilenko Macroprudential policy complements ECB monetary policy 52 On crypto assets 140 Ed Sibley Session 6 Monetary and financial stability: the implications for prudential supervision 56 Completing European Economic and Monetary Union Martin Wolf Doris Ritzberger-Grünwald Escaping the trap: secular stagnation, monetary policy and financial fragility 64 Completing European Economic and Monetary Union: next steps 148

Session 3 Bruno Cabrillac Monetary and fiscal stability Integration and convergence in the EMU: a complex dynamic 152 Ernest Gnan Isabel Schnabel Monetary and fiscal stability – a post-crisis view on a complex relationship 76 Reconciling risk sharing with market discipline: a constructive approach to euro area reform 162 Gottfried Haber Strengthened EU fiscal framework: fiscal discipline versus economic stabilization 82 Ludger Schuknecht Mitigating fiscal risks from the financial sector 94

2 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 3 46th ECONOMICS CONFERENCE 2019 46th ECONOMICS CONFERENCE 2019 Ewald Nowotny Opening remarks Governor Oesterreichische Nationalbank Ladies and gentlemen, global level since the 1930s; as well as It is my pleasure to welcome you to a second, specifically European crisis, the 46th Economics Conference of the which posed a severe – and one might Oester­reichische Nationalbank, orga- even say “existential threat” – to the nized in cooperation with SUERF, the single currency, as ECB Vice-President European Money and Finance Forum. Luis de Guindos recently put it in front Two decades after its introduction, the of the European Parliament.1 It was euro is arguably the most tangible result only thanks to the joint efforts of Euro- of the European unification process – a pean governments and institutions that token for the European project that we the crisis has been overcome, as well as use day in, day out; something that we thanks to the support that the Euro- share with our fellow citizens – as many pean citizens have been lending to fiscal as 340 million people living in 19 coun- consolidation and the sometimes severe tries of the continent. adjustment programmes and structural Since the start of Economic and reforms that were necessary. The ECB Monetary Union (EMU), the number for its part has contributed by backstop- of euro area countries has gradually ping the financial system and providing ­increased from 11 to 19. As the com- monetary stimulus. mon European currency, the euro Some of the shocks that led to this swiftly established itself as the second crisis were exogeneous. Many were not most important currency of the world specific to the euro area. But quite a and has come to serve as a stable mon- few observers have attributed certain etary anchor for most of our neighbour- aspects – as well as the depth of the cri- ing countries in Central, Eastern and sis – to a faulty design of the monetary Southeastern Europe. union: its “lopsided” nature, with mon- In a recent survey, 74% of Europeans etary integration lacking a fiscal coun- said they were in favour of EMU, with terpart and institutions that allowed one single currency, the euro. This is unsustainable imbalances between the highest level of support for the euro member countries to emerge. ever recorded. It is also testimony to But while the single currency was the success of the Eurosystem in fulfill- certainly not perfect when it was intro- ing its mandate of maintaining stable duced 20 years ago, it would be wrong prices and in providing an environment to blame the crisis on its existence for economic growth and high employ- alone. The challenges the euro area has ment over the past 20 years. It is not by faced and that we continue to face are accident that approval rates for the euro very similar to the challenges – if not declined when unemployment rose the very same ones – that led to the cre- during the recession and crisis of 2008– ation of the single currency in the first 2013 and thereafter rebounded signifi- place. cantly when the euro area returned to a The single currency was not invented path of stable growth. as the political symbol, the most tangi- So the euro has been a success – ble result, of European unification it is hasn’t it? We are well aware that the today. To be sure, the single currency past 20 years have seen one of the worst was from the beginning also part of the financial and economic crises at the political desire to express a European

1 Euro at 20 years: the road ahead. Address by Luis de Guindos, Vice-President of the ECB, at the European Parlia- mentary Week, Brussels, February 19, 2019. https://www.ecb.europa.eu/press/key/date/2019/html/ecb. sp190219~6f4c9be85b.en.html.

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identity on the international scene. But money itself. As a result, the single Euro­ decisions on European monetary policy currency area. But countries will con- first and foremost, monetary coopera- pean currency acquired the double role came to be taken de facto in Frankfurt tinue to be hit by asymmetric shocks, tion in Europe was the response to the as the backbone of European economic and Bonn, and not jointly by all mem- and the question how to deal with challenges of creating an integrated integration as well as the face of Euro- bers of the Snake or the EMS, thus cre- trade- offs in economic policy will con- economic area in the face of interna- pean identity it still has today. ating political discord and discontent tinue to be at the core of political tional monetary instability. At the time As the following decades would show, among the European partners. ­debates. Imbalances within the euro the project of European integration was close monetary cooperation was diffi- The consequence that policy makers area will continue to arise from time to born in the 1950s, exchange rates were cult to implement and even more diffi- drew from these recurrent challenges time, and so will pressures to adjust. still governed by a stable Bretton Woods cult to maintain. On the one hand, eco- was the introduction of the joint cur- Debates on how such adjustment is best system. The risk that exchange rate nomic integration made the mainte- rency, the euro. In some respects, the engineered are here to stay, as was fluctuations would distort trade and nance of fixed exchange rates increas- euro is a technical solution for the re- ­already the case in the 1960s, 1970s, undermine common policies was largely ingly tenuous. With the liberalization of peated exchange rate crises in Europe: 1980 and 1990s. inexistent, or at least under tight con- capital flows, negotiated exchange rate the euro simply did away with the exis- The key difference to earlier decades trol. Once the Bretton Woods system realignments – the safety valve foreseen tence of several currencies, thereby and the crucial advantage we have now- entered into crisis, however, European in the Bretton Woods framework – eliminating the possibility for de- and adays is that today we have institutions unification risked being derailed as ­became a source of instability, as the revaluations in the first place. But more and procedures in place that help Europe well. The first proposals for monetary mere possibility of future realignments importantly, the euro is also a political to resolve these conflicts while elimi- cooperation in Europe were thus not would trigger speculative capital flows. solution in that it provides a framework nating the economic and political costs the expression of a genuine desire for a The point was proven by the crisis of with the help of which possibly diverg- of earlier exchange rate crises. Since European currency but a response to an the European Monetary System (EMS) ing political interests can be brought 1999 the common monetary policy for unstable U.S. dollar: This is true of the in 1992. Now the message was: float or ­together, discussed and resolved. While the euro area has been defined jointly Barre memoranda in the 1960s; the peg once and for all. Paradoxically, the before, countries had to prove that they by the ESCB. In the wake of the crisis, Werner plan of 1970 as well as the EMS crisis thus strengthened the cause were willing to follow the leadership of EU economic governance has been ­attempts to have the European curren- for monetary union, which European the German Bundesbank, responsibility ­reformed and strengthened in several cies fluctuate together against the U.S. governments had just agreed upon a for monetary policy is now shared important respects. First, national fis- dollar in the so-called snake. When couple of months earlier, at Maastricht. within the European System of Central cal policies are now subject to stricter Nixon cut the U.S. dollar’s link to gold Destabilizing capital flows were not Banks. Within the European System of European rules that place more weight in the summer of 1971, it became clear the only factor behind the failure of the Central Banks we pursue together the on the stage of the business cycle and that the future world monetary order different experiments in fixed exchange overarching objective of stable prices, the level of public debt. Moreover, the would be based on fluctuating fiat cur- rate regimes that were tried in Europe. as agreed upon by the European gov- European Commission’s role in moni- rencies. Tying one’s currencies to the Instability also resulted from incompat- ernments, laid down in the EU treaties toring Member States’ budget prepara- U.S. dollar was no longer an option. If ible national policies. In the 1960s and and broadly approved upon by the tion (European Semester) and in impos- Europe wanted to be sovereign in mon- 1970s, the consensus that monetary ­European citizens, as I have shown in ing sanctions has been strengthened etary affairs, it needed to manage its policy should target stable prices had the beginning. considerably. Second, a broader set of not yet evolved. Cooperation between While the euro provides a frame- macroeconomic indicators, going beyond fiscal and monetary policies was lim- work for resolving political and eco- fiscal indicators, is now regularly evalu- ited, and mechanisms that would help nomic disagreements, we cannot realis- ated at the European level to identify, enforce the agreed scope of adjustment tically expect it to make them disap- and counteract, macroeconomic imbal- were lacking. A recurrent theme was pear. Certainly, a common monetary ances at an earlier stage. Third, banking the perceived asymmetry in adjust- policy helps. So does real convergence, union brought about the introduction of ments, forcing the deficit countries to as do structural reforms that increase a single supervisory mechanism for implement austerity policies without the flexibility of economies to weather euro area banks and a framework for surplus countries providing their fair asymmetric economic shocks. Further resolving insolvent banks. Fourth, mac- share. Surplus countries, in turn, argued help is provided by an integrated capital roprudential supervision targets the sta- that they were pursuing sound anti-­ market that redistributes and buffers bility of the financial sector as a whole. inflationary policies that they did not ­income shocks affecting specific coun- To make the euro area even more want to put at risk. With Germany typ- tries or regions. Together all these factors resilient to shocks and increase its abil- ically being the key surplus country, the make the euro area more of an optimal ity to act, deepening EMU will remain

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a key task in the years ahead. In mid- hopes of the masterminds of a common 2015, Jean-Claude Juncker, President currency in the 1960s and 1970s. As of the European Commission, presented President Draghi has said in a recent the “Completing Europe’s Economic speech: “True sovereignty is reflected and Monetary Union” report. Four pil- not in the power of making laws – as a lars are meant to ensure the smooth legal definition would have it – but in functioning of EMU: a fully-fledged the ability to control outcomes and economic union that fosters prosperity ­respond to the fundamental needs of and convergence; a financial union that the people.”2 To ensure that the euro provides for cross-border banking and area is able to effectively shield Europe capital market regulation; a fiscal union from future crises in times of growing that ensures sustainable public finances; geopolitical tensions, the European and a political union that secures demo- Commission recently proposed to cratic accountability and legitimacy for strengthen the international role of the a complete EMU. euro and for the EU to stand together to So the euro has been a success? I promote its interests in shaping global would argue that it is indeed a reflec- affairs. We will discuss progress here in tion of the strength of the euro that the the afternoon today. Tomorrow we will debate for which we have come together then turn towards the consequences of today will focus on the next 20 years of digitalisation for monetary policy before our common currency. After taking closing the conference again on the topic stock of the achievements of the past ­ of “Completing monetary union”. 20 years, this conference will therefore Let me conclude. The European focus on the important areas just men- Union is often likened to a house, pro- tioned. Today, we will talk about the viding home and shelter for Europe’s structural adjustments that shall make people. I believe the best way to cele- EMU more robust in the future, the brate the first 20 years of the euro is to role of fiscal policy as well as about debate together how our European banking union and financial stability. In house can be adapted, enlarged and the afternoon, we will then come back ­refurbished to keep it ready for the next to the euro’s role as a bulwark in a chal- 20 years. I wish us all insightful, stimu- lenging international environment, lating and productive one-and-a-half which reminds us of the concerns and days here in Vienna.

2 Mario Draghi: Sovereignty in a globalised world. Università degli Studi di Bologna, Bologna, 22 February 2019. https://www.ecb.europa.eu/press/key/date/2019/html/ecb.sp190222~fc5501c1b1.en.html.

10 OESTERREICHISCHE NATIONALBANK Jean-Claude Trichet European Economic and Monetary Union: Former President of the European Central Bank from the past into the future

Dear Governor Nowotny, Dear Presi- cant international view which is not dent de Haan, correct does not really surprise me: the It is a great honor and a great privi- existence of a negative bias against the lege to be invited by the central bank of single currency has been observed since Austria in cooperation with SUERF to the inception of the euro. participate in this very important 46th I will make the three following points: Economics Conference, here in ­Vienna. 1. Contrary to many negative predic- I have to recognize in the audience tions, the euro, as a currency, is a many close friends. I have also the very remarkable success in terms of cred- vivid memory of having been often in ibility, stability and resilience. This Vienna over the past 25 years at the ­resilience is due, in particular, to a ­invitation of yourself, Ewald, and of large popular support. your predecessors Maria Schaumayer 2. The euro area is more of a success in and Klaus Liebscher. terms of real growth measured I also note that I have been invited ­during the period starting from its by SUERF many times and that I have inception until today. But the appre- always been impressed by the scientific ciation must be more nuanced as re- quality of the many conferences orga- gards nominal and real convergence nized under SUERF auspices. inside the single currency area. It is having in mind this long-term 3. In a medium- and long-term per- relationship and, I will add, close com- spective, EMU calls for further sig- panionship in turbulent times, in par- nificant reinforcing its economic, ticular with you, Governor Nowotny, fiscal and financial governance. that I am starting this lecture. Overall, the success of the euro and of When reading academic works, the euro area in terms of credibility,­ published observations, articles signed ­resilience, flexibility, popular support and by specialized journalists as well as real growth during its first 20 years is ­articles for a large public, coming par- impressive. It justifies reasonable opti- ticularly from non-European countries, mism as regards the long-term success of there is often the remark that the euro this unique, ambitious, historic en- had been a disappointment. The single deavor of the Europeans. To consoli- currency economic performance is sup- date this long-term success, a lot of posed to be very poor, particularly in hard work remains to be done as is comparison with the USA. The impact ­always the case when a bold historic of Economic Monetary Union (EMU) ­endeavor is in the making. The single on public opinion in member countries market with a single currency of the is deemed negative, dividing countries United States of America was not and eroding confidence in the Euro- achieved in a short span of time. Nei- pean project. ther in 20 years, nor even in 40 years! I think that this is a wrong view, From the Coinage Act of 1792 to the which does not represent reality, is Federal Reserve Act of 1913, there is a deeply misleading and can drive foreign maturing process of around 120 years. governments, leaders, economic agents And since the issuance of the first fed- and market participants to make wrong eral note in 1914 and today, an addi- decisions. The fact that there is a signifi- tional period of 105 years.

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1 A success in terms of currency It amounts to around 20% of for- ­inflation in line with our definition of ­imbalances. This was one of the major credibility, stability and eign exchange reserves, approximately price stability. lacunae in governance of the EMU resilience one third of the dollar foreign exchange from the start; 1.1 Credibility reserves and four times the yen reserves. 1.3 Resilience • Third, absence of banking union; In January 1999, the euro started from The euro is the unchallengeable sec- In very turbulent times, the euro, as a • Fourth, absence of a specific instru- scratch. The exchange rate was USD ond most important international cur- currency, and the euro area proved ment to fight against speculation (no 1.17 for 1 EUR. There was no doubt for rency. I would only add that the Inter- remarkable­ resilience. European Stability Mechanism at the most of the observers and economists national Monetary System is called to At the inception of the euro, a sig- beginning of the crisis); outside continental Europe that the change structurally with the growing nificant global analysis, outside conti- • Fifth, poor implementation of needed euro would not stand at par with the presence and use of the renminbi which nental Europe, was not only that the structural reforms all over the euro dollar in terms of credibility, medium is likely to contribute to significant single currency would not inspire con- area; and long-term capacity to keep its changes both for the US dollar and for fidence, but also that it would be short- • Sixth, absence of full achievement of ­domestic and international value. The the euro. lived, as a kind of audacious experience the single market, particularly in the idea that a currency born in particular deserving respect for its boldness but service sector. from the merger of the Dutch guilder, 1.2 Stability incapable to sustain the difficulties of The underlying concept of the euro the DM, the escudo, the peseta and the The international credibility of the euro hard times. In this early view, the capac- area was EMU, namely Economic and lira would overtime inspire a high level is echoed by its domestic, pan-Euro- ity of the currency to hold in the worst Monetary Union. The “Monetary of confidence, appeared then to be very pean stability. The ECB made clear economic and financial circumstances Union” was undoubtedly there: one sin- presumptuous. from its inception that it had a defini- would appear as a miracle. This explains gle currency, one exchange rate vis-à- At the time I am delivering this lec- tion of price stability that would be the why so many eminent economists pre- vis other currencies, one single credi- ture, the euro-dollar exchange rate is yardstick to judge its capacity to deliver dicted the end of the European endeavor bility, one inflation for the whole single approximately at its entry level (USD stable prices: less than 2%, quickly after the start of the financial crisis and, currency area. The “Economic Union” 1.12 today versus 1.17 at its inception). clarified in 2003 as “less than 2% but particularly, after the start of the sover- had lacunae in its design and was poorly The overwhelming majority of econo- close to 2% in the medium run”. eign risk crisis, the epicenter of which implemented before the crisis. All mists and market participants have no Since its inception from 1999 up to was in the euro area. taken together, the economic, fiscal and more any doubt on the capacity of the 2018, the average euro inflation is It was clear that the localization of financial governance of the whole euro euro to keep its international value. around 1.75%. It is an impressive result the sovereign risk crisis epicenter in the area was suboptimal. During part of the first 20 years of the over around 20 years, in line with the euro area was due to specific European That being said, many highly pessi- new currency, remarks were made on definition of price stability. errors as well as the localization in the mistic external observers missed three the fact that the euro was much too This does not mean that inflation USA of the epicenter of the subprime points when the sovereign risk crisis solid and too strong, which was highly should be close to 2% every year. The and the Lehman Brothers crises were erupted in 2010 and 2011. paradoxical for a currency deemed to delivery of price stability has to be due to mistakes made in the USA. I see The first mistake was to consider lack credibility at its inception! judged over a medium/long-term period. six main reasons why the euro area had that all member countries were in a cri- The international credibility and For instance, the most recent period to cope with this specific sovereign risk sis situation. As a matter of fact, out of success of the new currency are con- was marked by threats of deflation and crisis: the 15 countries members of the euro firmed by facts and figures: the euro is years of very low inflation, which the • First, refusal to fully apply the rules area at the time of the Lehman Brother by far the second international currency ECB fought with determination. When of the Stability and Growth Pact bankruptcy, 5 (namely one third) had after the dollar. According to the ECB1, I left the ECB at the end of 2011, average (SGP) before the crisis. Important in very serious economic, fiscal and finan- it represents 23% of the “international 2011 inflation rate was 2.72%, signifi- particular are the responsibilities of cial problems. The paradox of the euro debt outstanding” (62% for the US dol- cantly higher than 2%. What counts France and Germany, under the pres- area was that the area included both the lar, 2.4% for the Japanese yen). from the central bank standpoint – idency of Italy, in the years from 2003 worst public signatures in the eyes of In terms of “global payment currency”, whatever external and ­domestic circum- to 2004, where they refused that the market participants (for instance it represents 35.7%, approximately ten stances are – is to take the right deci- provisions of the SGP be applied to Greece, Portugal, etc.) and the best times the percentage for the yen and sions aiming at stabilizing medium-term them; ones (Germany, Netherlands, Austria, not so far from the dollar (39.9%). inflation expectations and effective • Second, absence of close monitoring etc.). The euro, as a currency, was re- of the evolution of the cost competi- flecting the average situation of the 1 The international role of the euro, June 2018. https://publications.europa.eu/en/publication-detail/-/ tiveness of member countries and euro area and not only the part of it publication/62eb1ad2-78ec-11e8-ac6a-01aa75ed71a1. of associated domestic and external which was in crisis, which represented

14 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 15 Jean-Claude Trichet Jean-Claude Trichet

a minority. Seen from this standpoint, Greece. And 4 new countries (Slovakia, Comparisons are also remarkable favor of leaving the euro to avoid the the remarkable resilience of the euro, as Estonia, Latvia and Lithuania) came in, when directly comparing confidence in economic adjustment (“austerity”) and a currency, was not a miracle. after the start of the global financial the European parliament with confi- that the Germans would massively take The second mistake was to underes- ­crisis, so that the euro area includes dence in national parliaments: 48% ver- advantage of the crisis to get back to timate the capacity of the euro area to now 19 countries. Is there a better refu- sus 35% for “confidence” and, overall, their previous national currency, the be flexible, to correct its weaknesses in tation of the fragility of the area than a 39% versus 58% for “no confidence”. Deutsche Mark. Nothing could be fur- terms of economic governance and to significant expansion in a period of This means a difference of +9% for the ther from the truth! The Greeks were demonstrate both solidarity at the level ­major financial crisis? European parliament and –23% for the massively in favor of preserving their of the area and strong national capaci- national parliaments. The same differ- euro-participation (67% are approving ties to adjust in the crisis countries. In 1.4 Popular support ence is observed as regards comparison the previous sentence on the euro). And the crisis, the Stability and Growth The conventional wisdom was, and still between the European Commission the Germans were (and are) strongly in Pact (SGP) was reinforced, the Fiscal is, that popular support is dramatically and national governments: 43% versus favor of the euro (81% are approving Stability Treaty was signed and ratified, lacking for the European integration 35% for “confidence” and 39% versus that sentence in the last survey). the Macroeconomic Imbalance Proce- project. This belief was reinforced by 59% for “no confidence”, namely +4% As said before, this popular sup- dure (MIP) was set up, Banking Union the unexpected success of a political for the Commission and –24% for na- port, so far away from the conventional was created and the European Stability populist persuasion in the UK and in tional governments. wisdom outside Europe explains largely Mechanism Treaty signed and ratified. the USA. It appeared quite natural that Finally, it is equally noteworthy that the remarkable resilience of the euro All four first weaknesses mentioned a political wave characterized by nation- the support to the European Union is and of the euro area. earlier were addressed. Ireland, Portugal alism, protectionism and xenophobia presently higher than during all the and Spain, in particular, demonstrated would be present in continental Europe ­period starting with the great financial 2 The euro and the euro area are a real capacity to adjust. and would have also a strong anti-Euro- crisis. The bottom line is that nothing is posting significant real growth pean Union component, as was the case satisfactory: our fellow citizens are giv- in comparison with other ad­ in the UK for instance. ing a weak confidence level to all insti- vanced economies, even if real It is unchallengeable that the frus- tutions whether national or European. convergence between member tration of public opinion, generalized in Still the confidence vis-à-vis Europe and countries is insufficient the advanced economies, is also present its institutions is significantly higher 2.1 A real economy growth in the European Union and in the euro than confidence in national institutions. Even if the average global observer can area. But the paradox is that this dissat- As regards the euro, the support be reasonably convinced that, all taken isfaction is directed significantly more given by the European citizens inside into account, the single currency was a towards national governments, parlia- the euro area to the single currency is success in terms of stability and credi- ments and national institutions, than high and much higher than the percep- bility, that the euro area demonstrated towards the European institutions tion of global observers. 75% of citizens strong resilience in exceptional circum- (Commission, Council and European of member countries approve the sen- stances and that a surprising but un- Parliament). tence: “A European economic and mon- challengeable popular support is accom- The third mistake was to neglect The surveys “Eurobarometer” are etary union with one single currency, panying this historic European endeavor, the attachment of people in the euro particularly interesting2. 42% of citi- the euro”, while 20% are against the there is a negative dimension which will area to the single currency. It is this zens members of the European Union sentence. The fact that the question is immediately be presented as the ultima popular support that explains the “tend to trust the European Union”, pertinent is confirmed by the response ratio: the euro and the euro area are ­capacity of the euro area to adapt and to significantly more than those who “tend of the UK citizens (28% approve, 59% supposed to be indisputable real econ- prove a remarkable resilience. to trust their national governments or disapprove). The present proportion of omy failure! To make a long story short, let me parliaments” (35%). This is even more 75% in the euro area member countries Comparing the euro area to the mention the fact that 15 countries were impressive when comparing the per- is the highest in the survey since its United States, the economic weakness members of the single currency area on centage of citizens who “tend not to ­inception in 2003. of the single currency area appears at September 15, 2008, the very day of trust”: 48% for European Union com- One of the most frequent errors first look unchallengeable. But it is the bankruptcy of Lehman Brother. All pared to 59% for national governments made by observers outside the euro area ­because of two optical illusions. 15 are still members today, including and 58% for national parliaments. was that the euro was rejected by public First, the nature of the comparison opinion. I was often confronted to the of the real growth figures: usually done in 2 “Standard Eurobarometer 90 – Public opinion in the European Union”, November 2018. view that the Greeks were massively in absolute terms, not taking demographics

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into account. Then the comparison is These IMF figures suggest multipli- the same order of magnitude on both 2.2 Economic convergence between always to the advantage of the USA cation of the GDP per capita by 1.80 in sides of the Atlantic. Member States must make which benefits from a yearly positive the euro area and 1.81 in the United It is also suggested from time to further significant progress demographic growth differential of States. The difference is very modest time that countries outside the euro If growth per capita in the euro area is around + 0.7%. Second, in the most and does not suggest a significant advan- area did better, and even much better, comparable to the growth per capita in recent period, real growth in the euro tage for the United States. In any case, than countries inside the single cur- the USA since the inception of the euro, area was hampered not only by conta- it does not confirm at all the growth rency, since its inception. It is always another dimension of the euro area gion of the global financial crisis in failure of the euro area that is often part possible to find a very bright European must be examined, namely convergence 2007–2008 but also by the sovereign of the conventional wisdom. economy out of the euro area: Norway between members countries in terms of risk crisis in 2010–2013, the euro area These results are significantly depend- or Switzerland, for instance. But I had nominal evolution of inflation and in- being at its epicenter. The recovery ing on the chosen starting year. The the curiosity to compare the euro area terest rates, of synchronization of the started in the USA mid-2009 while the ­period 1998–2018 is more favorable to with the UK over the 20 first years of timing of business and financial cycles, sustained recovery in the euro area the USA, while the period 2000–2018 the euro. Contrary to common belief, and of real convergence in terms of started several years afterwards, in 2013. is more at the advantage of the euro the IMF data are giving an advantage to growth and standard of living. From The correct judgment should, in my area. The bottom line is that there are the euro area vis-à-vis the UK in terms this stand point, according to the IMF4, view, start with the setting up of the no IMF figures that would suggest that of growth of GDP per capita, whatever the situation of the euro area is nuanced euro – January 1999 – up to now, the growth capita of the euro area as a the starting year is. If we trust the IMF and depends on the convergence criteria namely the same period of almost whole is significantly different from the figures, the catching up process of the analyzed. 20 years already mentioned. It seems US growth per capita since the setting euro area vis-à-vis the UK is visible. At • Nominal convergence of inflation and the most pertinent period of time for up of the euro. the inception of the euro (1999), the interest rates took place in the period­ three reasons: first, it corresponds pre- Data have always to be examined GDP per capita of the euro area was of convergence before the setting up cisely to the period of the euro; if the carefully. Even if an overwhelming around 21.6% below the UK level. In of the euro. There has been a signifi- euro is responsible for economic fail- ­majority of the GDP of the euro area 2018, the IMF estimates put the euro cant reversal during the financial cri- ure, it should be visible in that period. was set up at the inception of the euro area around 6% below the UK level. sis, particularly as regards interest Second, it is a period sufficiently long to (the first “11” and then “12” with Greece), This overall encouraging situation rates at the time of the sovereign cri- cover more than an economic cycle. the additional 7 (Slovenia, Malta, Cyprus of the euro area in terms of real growth sis, but nominal convergence has Third, the starting point and the end- before the Lehman crisis and Slovakia per capita does not mean that the Euro- been significantly reestablished since. point are sufficiently far from the start and the three Baltic States after the peans can rest on their laurels. The • As regards business cycles, the syn- of the global financial crisis for the period Lehman crisis) are contributing posi- GDP per capita of the euro area remains chronization of the timing has improved not to be too influenced by the various tively to growth of the whole area significantly lower than in the USA but the amplitude of those cycles has steps of the crisis on the real economy ­despite the fact that they are small (36% lower) and a vigorous catching up diverged. As regards the timing of of the USA and of the euro area. economies. The reason is that they process should be at stake. The euro ­financial cycles, they have largely That being said, where do we stand? started from lower levels in terms of area has to do better and much better in ­diverged during the pre-crisis boom To be sure that my comparison GDP per capita. But this cannot explain many areas. Due to lack of appropriate period in several countries but have ­between the USA and the euro area the significant difference I am stressing structural reforms, unemployment, since been reestablished. As noted would be as sure and correct as possible, between perception and reality of the particularly youth unemployment, is with the business cycles, the ampli- I will rely upon IMF and World Bank euro area growth per capita. still much too high. Europe and the tude of financial cycles has become figures. According to the IMF3, the The results from IMF data are con- euro area are not innovative and cre- more uneven. 1999 GDP per capita of the euro area firmed by the World Bank data on real ative as they should and as the USA – • It is as regards the real economic was around USD 22,300 compared to growth per capita in the euro area and and also China – are in terms of High- ­convergence of growth and standard USD 34,500 in the USA. According to in the USA. To make a long story short, Tech and IT new businesses. Also in the of living that the results are most current estimates, the respective GDP World Bank data on real growth per domain of education and universities of contrasted. Real convergence has not per capita in 2018 was around USD capita from 1999 up to 2017 are the fol- excellence at a global level, the euro ­really occurred among the original 40,100 and USD 62,600. The dollars lowing: annual growth of 1.1% in the area is at a disadvantage in comparison 12 euro members (including Greece are current dollars over the period. euro area and 1.2% in the USA, namely with both the United States and the UK. which entered in 2001). In that

3 IMF Data Mapper, GDP per capita current prices – WEO, April 2019. 4 IMF Working Paper – Economic convergence in the Euro area: coming together or drifting apart, January 2018.

18 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 19 Jean-Claude Trichet Jean-Claude Trichet

­constituency, GDP growth and pro- unemployment is comparatively high in the years to come. President Macron5 this unfortunate situation to what ductivity growth have not reduced Greece a relatively low in Mississippi. listed recently major multidimensional we are observing in the domain of ­income disparities between high and Still there is an important issue in reforms for the medium-term future of digital technologies and digital plat- low revenue per capita countries. In inequalities in Europe, inside each coun- European Union. forms. As a matter of fact, the lack contrast, there has been an impres- try and between member countries First, indeed, one should not forget of significant banking restructur- sive convergence for those 7 coun- (like, in the USA, within and between that European Union has many other ing, both domestic and cross border, tries that have joined the euro after it States). Economic convergence inside dimensions than the economic and explains largely the significant dif- was set up. This puts into question the euro area must be improved, being monetary ones. Culture, domestic and ferences observed on both sides of the pertinence of the early economic understood that it is convergence external security, fight against terror- the Atlantic in terms of solidity and governance of the euro area and the ­towards full employment with the high- ism, control of the borders, monitoring profitability. effectiveness of the implementation est possible GDP per capita which is the of immigration, and defense are all of this governance in those early-­ goal. Reinforcing convergence inside ­areas where it is obvious that there are entry countries which didn’t converge. the euro area is of the essence and calls no pertinent national solutions but pos- If there is no doubt that the single cur- for consolidated and strengthened eco- sible European correct responses at the rency offers additional new economic nomic, fiscal and financial governance level of the continent. It is also com- opportunities and additional new poten- of that area. forting to note that there is a large pop- tial for growth to all member countries, The long-term goal of Europeans ular support to make progress in these it clearly doesn’t mean that belonging should be to run optimally their single fields, according to the Eurobarometer to a single currency is a guarantee to currency economy, avoiding the kind of survey: for instance, a “common de- ­attaining the highest-level GDP per sustained divergences that created the fense and security policy” is approved capita. As the USA example suggests sovereign risk crisis and, at the same by 76% against 18%; a “common foreign strongly, a State’s economic success still time, give all their chances to member policy” is approved by 65% against 26%. depends heavily on the quality of the countries and to the area as a whole to Second, in the specific domain of economic management, on the progress catch up in terms of job creation and Economic and Monetary Union, I see made in terms of productivity and on standard of living. six major recommendations to improve 2. Apply seriously and rigorously the pro- the level of investment in that State. For both responsibility and solidarity within visions of the two main pillars of eco- instance the State of Mississippi has not 3 We have to strengthen the EMU and to reach the ultimate eco- nomic and fiscal governance: the Sta- the same standard of living as Massa- economic, fiscal and financial nomic goal for all national economies bility and Growth Pact (SGP) – rein- chusetts (respectively USD 33,558, governance of the euro area and for the single currency area as a forced by the “fiscal compact” – and USD 71,456 in 2017, according to the The success of the euro, as a currency, whole: sustained growth, full employ- the Macroeconomic Imbalance Procedure US “Bureau of Economic Analysis” in and of the euro area in terms of credibility, ment and catching up the most advanced (MIP). I think personally that MIP is chained 2012 US dollars), even if the resilience, flexibility, popular support and economies in terms of standard of living. as important as SGP: it is of the es- USA has a single currency, together real economy success does not mean that 1. Rapidly achieve what has already been sence in a single currency area to with an achieved political federation, a the Europeans should or can rest on decided as regards Banking Union, correct the persistent divergences federal budget and a functioning single their laurels! It is exactly the contrary. both in its deposit guarantee and between national competitiveness capital market. By the way, according They have a lot of very hard work to do single resolution dimensions. It is and national and ­external imbal- to 2017 IMF figures, the Portuguese or to make a full historic success of their also necessary to eliminate the pru- ances. It is perhaps regrettable­ from the Greek standards of living (respec- extremely bold strategic endeavor. The dential obstacles that are still ham- that standpoint that too many criteria tively USD 23,116, USD 23,027) are first 20 years are, in my view, demon- pering cross border banking restruc- are examined by the Commission displaying approximatively the same strating that they were right in engag- turing. There is unfortunately nei- when monitoring MIP. It contributes gap vis-à-vis Germany (USD 46,747) ing on what is probably the most ther in the European Union nor in to neglect one absolutely­ ­essential ele- than Mississippi vis-à-vis Massachusetts. ­audacious economic and ­monetary the euro area a genuine single market ment: in a single­ currency area where This is only comparing average stan- structural reform ever attempted in of banking services. The European monetary realignment is excluded, dards of living. A full-fledged compari- times of peace. banking sector is lagging behind the persistent growing divergences be- son, taking also into account the level A long-term historic endeavor is US banking sector. I would compare tween national cost ­competitiveness of unemployment, would accentuate the necessarily history in the making. I see differences observed in Europe because many avenues for European progress in 5 Emmanuel Macron, President of the French Republic – Initiative for Europe – A Sovereign, United, Democratic Europe, Sorbonne Speech, September 26, 2017.

20 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 21 Jean-Claude Trichet Jean-Claude Trichet

cannot be durably tolerated. If main- Ministers and is Vice President of 6. Setting up a budget of the euro area. Fourth, the budget of the euro area tained, they will trigger either accu- the Commission. Running the econ- Such a budget could have several differ- could be designed to help countries mulation of permanent large-scale omy, budget and finance of the euro ent functions. badly in need of structural reforms in unemployment or abrupt and sharp area is less and less a legislation First, it could finance public spend- order to have an economy more flex- macroeconomic corrections that function (traditionally given to the ings that are national today and ible and efficient inside the single would be necessary to redress com- Commission) and more and more would be federal tomorrow. Several currency area. This financing would petitiveness of the country con- our executive function exerted with ideas have been proposed in this be particularly well adapted for dif- cerned, but are ­always very painful close cooperation of both the Com- ­respect, for instance financing at the ficult and costly structural reforms, for the disadvantaged fellow citi- mission and the Council. level of the euro area part of the giving positive results after a rela- zens, particularly the young. 5. Reinforce the democratic legitimacy of ­unemployment insurance expenses. tively long delay. The use of such 3. Improve the decision making inside the EMU by giving the last word to the It is also possible to consider ex- ­financing could be normally ear- European Stability Mechanism (ESM) members of European parliament penses in defense,­ security, border marked to euro area countries to the with the introduction of a qualified (elected in the euro area) in case control and in that case, the budget extent that, indeed, the best func- majority instead of unanimity as is there is a conflict between the gov- could cover such federal expenses at tioning of the euro area calls for the case presently. It is also to be ernment of a particular country and the level of the European Union as a ­significant reforms in a number of noted that the importance and the the European institutions (Commis- whole and not only of the euro area. member economies. size of the European Stability Mech- sion and Council) on the implemen- Second, the euro area budget could The European Council has taken a deci- anism are often underestimated: tation of the euro area governance. play the role of an anticyclical cush- sion in principle to set up a budget. I this institution was given a callable It is an ambitious idea for which ion which would accumulate capital understand from statements of Heads capital of 624 billion EUR on top of there is presently no consensus. Still through resources coming from and Ministers that this budget will its paid in capital of 81 billion EUR. it seems to me that it is necessary to member countries in the favorable probably materialize by concentrating With a subscribed capital of 705 bil- envisage ex ante the possibility of a episode of the euro area economic on the third and fourth possible func- lion EUR, the ESM is the interna- conflict between the democratic cycle in order to utilize it to correct tions (financing in particular pan Euro- tional institution which possesses ­legitimacy of a member country the depressive episode of the cycle. pean investments and structural reforms, the highest level of subscribed capital. challenging the European recom- This particular budget function and therefore helping a better conver- 4. Design a Minister of Economy of the mendations with the backing of his could help counter a possible reces- gence between the member countries). euro area who would preside over national Parliament on the one hand sion hitting the euro area as a whole, I would personally advise not to for- the Euro Group of Ministers of Fi- and the European institutions which whether associated with the normal get the importance of the anticyclical nance and would concentrate exclu- were created by a democratic pro- economic cycle or triggered by a cushion (second possible function) from sively on the economic, financial cess at the level of Europe as a global shock. Such a mechanism the economic standpoint, even if we are and fiscal governance of the euro whole, on the other hand. It is what would not normally operate fiscal still far away from a consensus on that area, without being simultaneously we have experienced in an acute epi- transfers from country to country matter. Minister of ­Finance of a particular sode of the Greek crisis. It seems to and would be neutral over the cycle. In conclusion turning to one of the country. I made this proposal already me that in such a situation, the coun- Third, it is possible to set up a bud- founding brain of the European Union, in 2011 on the occasion of my Char- try challenging the pertinence of the get which would be earmarked to I will quote Jean Monnet. I think what lemagne prize speech in Aachen6. In recommendations of the Commis- the ­financing of large pan-European he said is not only true for Europe but a medium-term perspective, one sion and Council should have the infra­structure investments, technol- also true in some respect for the con- could also think of giving the Minis- possibility to call for arbitration by ogy investment and R & D spend- stituency of Central Banks and for the ter of Economy the responsibility of the European parliament in a euro ings which would have a pan-Euro- international community as a whole, in being Vice President of the Com- area format. The latter would have pean dimension. For this particular a period of extraordinarily rapid struc- mission upon the model of the High the last word, after close consulta- function, the budget should be able tural changes: “Premature ideas do not representative of Common Foreign tion with the National parliament of to finance expenses at the level of exist, one must bide one’s time until the and Security Policy who simultane- the country concerned. I made this the European Union and not only right moment comes along.” ously chair the Council of Foreign proposal in 20137. the euro area.

6 Jean-Claude Trichet, Building Europe, Building Institutions, Karlspreis speech, June 2, 2011. 7 Jean-Claude Trichet, International Policy Coordination in the Euro area: towards an economic and fiscal federation by exception In: Journal of Policy Modeling (2013).

22 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 23 Session 1 Toward a better EMU: past lessons, structural adjustments Luiz de Mello1 Making the most of the EMU: Challenges Director for Policy Studies OECD and opportunities for structural reforms

Much progress has been made over the countries, and the European Union more last two decades to consolidate the mone- generally, have much to gain from further tary union. Nevertheless, further reforms efforts to complete the common market, are needed to ensure a faster conver- which is important to reduce transac- gence in living standards within the euro tions costs, facilitate labour mobility across area and to strengthen the architecture of international borders and remove regu- the monetary union in a manner that can latory obstacles to enterprise growth. enhance its resilience to downturns and As argued in the latest OECD ensure its long-term sustainability. ­Economic Survey of the Euro Area Achieving faster convergence in living (OECD, 2018), resilience and longer- standards requires structural reforms term ­sustainability can be improved to enhance productivity and labour through concerted efforts in several pol- ­resource utilisation, which are the key icy areas. These include progress with drivers of growth in GDP per capita. the banking union, balancing risk The analysis reported in the latest edition ­reduction and risk sharing; the estab- of the OECD’s Going for Growth lishment of a fiscal stabilisation tool for (OECD, 2019) shows that the euro area the euro area to ­absorb country-specific

Chart

Gaps in living standards and productivity among euro area countries A. Percentage difference in GDP per capita vis-à-vis the upper-half of OECD countries, 2018 % 6

4

–

–4

–6 R L PT SK EE LT SI ES IT OECD FR FI BE DE AT NL IE LU

B. Percentage difference in labour productivity and labour resource utilisation vis-à-vis the upper-half of OECD countries, 2017 % 6

4

–

–4

–6 R L PT SK EE LT SI ES IT OECD FR FI BE DE AT NL IE LU 1 The comments and analysis reported in this chapter are the author’s own and do not necessarily reflect those of the OECD and its Labour productivity Labour reource utiliation member and partner countries. Thanks go to Tomasz Kozluk and Jan Stráský for helpful comments and Agnès Cavaciuti and Patrizio Sicari for research assistance.This chapter is based on a presentation at the 46th Oesterreichische Nationalbank Conference on Source: OECD, National Accounts, Economic Outlook and Productivity Databases. ­European Economic and Monetary Union that took place in Vienna on 2–3 May 2019.

46th ECONOMICS CONFERENCE 2019 27 Luiz de Mello Luiz de Mello

Chart continued 1 Structural challenges and euro area countries and the best perform- policy options to facilitate ers among OECD countries shows that Gaps in living standards and productivity among euro area countries income convergence C. Productivity growth versus levels, comparison with other countries differences in labour productivity, Average productivity growth over 2002-17, % Gaps in living standards remain sizeable rather than resource utilisation, account among the euro area countries, despite for the lion’s share of gaps in living stan- CN twenty years of gradual economic and dards within the euro area (chart 1). ­financial integration. This suggests that In addition, productivity growth, 7 more needs to be done to secure effective which is the key driver of long-term 6 ID convergence in productivity, and ulti- growth, differs considerably among the mately income levels, in the euro area. euro area countries. This divergence LV 4 IN CR LU Indeed, a simple decomposition of differ- takes place against a backdrop of a gradual IE KR ences in GDP per capita ­between the decline in productivity growth in the 3 PL SK EE A TR SI AU Chart CO CL HU IS FI AT US DK NO DE PT JP BE BR AR C IL ES Gaps in labour utilisation among euro area countries RU N CA SE FR NL UK IT CH A. Labour force participation rate of workers aged 55 to 64, 2017 M GR – % 3 3 4 4 6 6 evel USD, 2002 Euro area Other countrie

D. Average annual growth rate over 200218 % 7 4 6 3 3 4 3 LU SI R BE AT FR IT SK ES PT IE OECD FI L NL LT ES DE

B. Labour force participation rate of workers aged 15 to 64, 2017

– % – IT LU R AT DE BE FI ES FR PT NL SI EE SK IE L LT Total factor productivity Capital deepenin 7 Source: OECD, National Accounts, Economic Outlook and Productivity Databases. 6

4

and common euro area shocks, comple- main areas, starting with the challenges 3

menting member states fiscal policies; and and policy options to enhance ­income creation of a genuine capital markets convergence among the euro area coun- union. tries and moving on to discuss the policy This note highlights the key issues and requirements to enhance resilience and directions for policy action in these two longer-term sustainability. IT R BE SK LU IE FR OECD ES SI PT AT DE L LT FI ES NL Women –64 Total –64

Source: OECD, abour Force Statistics Database.

28 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 29 Luiz de Mello Luiz de Mello

advanced economies as a whole, and since members of Central and Eastern Europe, Chart 4 the global financial crisis, even in the but this has not been the case among Insolvency regimes and regulation of professional services faster-growing emerging-market econo- the Southern members, such as Greece, A. Insolvency regimes differ considerably across countries mies. Italy, Portugal and Spain. Differences in Index scale from 0 to 3, from most to least efficient insolvency regime1 Convergence has been relatively swift total factor productivity have been the 3 over the last 20 years in the new euro area main culprit. Capital deepening (an

Chart 3 Distribution of reform responsiveness and top 2019­20 priorities by category A. Reform responsiveness rate to Top 5 OECD Going for Growth priorities RRI by category RRI by category 7 South Central East FI P SI IE IL IT LT SE ES L PL EE SK BE FR PT AT CL KR US TR DE NL UK DK R

C AU CA CH N HU M EA 6 NO OECD 7 Peronal cot to failed entrepreneur Lack of prevention and treamlinin Barrier to retructurin 6 1 A higher value corresponds to an insolvency regime that is most likely to delay the initiation of insolvency proceedings and/or increase their length. 2 Euro area member countries that are also members of the OECD, excluding Luxembourg, plus Lithuania; unweighted average. 4 B. Gaps remain in the regulation of professional services 4 3 Index scale from 0 to 1, from least to most restrictive, 2017 3 6 4 3 7– – – 3–4 –6 7– 7– – – 3–4 –6 7– SK SK ET SK SI ET L SK SI Less restrictive restrictive More Labour utiliation Labour productivity Source: OECD, abour Force Statistics Database. Note: Based on the Going for Growth Reform Responsiveness Indicator (RRI). Does not account for uality of reforms. RRI measures the responsiveness to recommendations in the Top 5 priority areas for each country, as identified in OECD Going for Growth. The priorities are identified every two years, hence the two year reporting period. EU OECD 3 bet 3 wort For Central and Eastern Europe, the coverage in the early years is based on a subset of countries that were covered in Going for Growth at the time. performin performin countrie countrie

B. Distribution of Top 5 Going for Growth 2019­20 priorities Source: OECD calculations based on the OECD questionnaire on insolvency regimes; Adalet McGowan, M., D. Andrews and V. Millot (2017), Insolvency Regimes, Zombie Firms and Capital Reallocation, OECD Economics Department Working Papers, No. 1399, OECD Publishing, Paris; Adalet McGowan, M., D. Andrews and V. Millot (2017), Insolvency Regimes, Technology Diffusion and Productivity Growth: Evidence from Firms in OECD Countries, OECD Economics Department Working Papers, South Central East forthcoming; OECD (2018), OECD Service Trade Restrictiveness Index (database).

Both Both ­increase in the capital stock per worker) and women. Indeed, in the case of workers has been taking place in tandem with total in the 55–64 age bracket, labour supply is factor productivity growth in the converg- lower than the OECD average in the Labour productivity ing economies. In the non-converging Southern euro area countries that have so Labour productivity countries, capital deepening has not been far been failing to catch up. sufficient to compensate for falling total Efforts are being made to address these factor productivity. challenges, although emphasis differs In addition to varying productivity across countries. Indeed, the euro area Labour utilisation Labour utilisation performance, the euro area countries also countries that have been catching up, differ in terms of labour resource utilisa- ­essentially those in Central and Eastern tion, albeit to a lesser extent, as noted Europe, have been focusing on structural Source: Extracted from the OECD ECO Reform Tracker. above. This is especially the case of social reforms that can be considered to aim Note: Based on the Going for Growth 2019 priorities. “Both” denotes priorities targeting both labour productivity and labour utilisation, primarily in the area of education and skills. groups whose labour supply tends to be ­primarily at productivity enhancement lower than average, such as older workers (chart 3).

30 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 31 Luiz de Mello Luiz de Mello

Despite these country-specific efforts, step in the right direction that facilitates programmes irrespective of socio-eco- gradual introduction of higher capital there are several actions of a structural the mobility of professionals and stream- nomic background. Initiatives in this charges on excessively high debt hold- nature that can contribute to improving lining cross-border administrative proce- area could be accompanied by measures ings of one country and the introduc- performance in the euro area as a dures in construction and business to foster the harmonisation of profes- tion of a European safe asset should be whole, as discussed in detail in the ­services. Nevertheless, additional barriers sions’ curricula, make the electronic considered. OECD’s Going for Growth exercise. in business services can be addressed European services e-card available to all More integrated capital markets can They include, for example, the need to through simplified administrative formal- sectors, and coordinate among the facilitate private risk sharing by allowing enhance support for innovation, which ities for the establishment and provision of member states the design and organisa- for more diversified financing and more together with technology diffusion, are cross-border services and guidance on tion of joint cross-border labour and tax substantial cross-border investment. essential for stronger productivity implementing EU legislation. It is also control activities. Progress on harmonising insolvency growth. Actions have been taken to this important to pursue the planned cross- ­regimes would remove an important end, including the updating and border cooperation on power system 2 Improving risk-sharing and barrier to cross-border financial inter- strengthening of the Better Regulation ­operation and trade in electricity, includ- improving longer-term mediation, by reducing legal uncertainty Guidelines and its toolbox in 2017 to ing interconnection capacity calculations sustainability and facilitating the efficient restruct­ decrease administrative burdens that and reserve margins. Risk sharing is important in a monetary uring of companies and resolution of hinder innovation by firms. To make Further support for investment and union to deal with large common or non-performing loans. The tax preference further progress in this area it would be growth could be financed through a real- asymmetric shocks. However, risk for debt financing over equity ­financing useful to increase R&D spending in the location of EU budget resources by, for sharing is limited in the euro area, on should be reduced, preferably in the EU budget, as well as taking additional example, reducing producer support to account of the incomplete banking context of the Common Consolidated measures to harmonise insolvency pro- agriculture. Production-based payments union and fragmented capital markets. Corporate Tax Base proposal. Fast- ceedings through minimum European in the Common Agricultural Policy also At the same time, public risk sharing paced financial innovation in the non- standards allowing simpler early restruc- distort markets for some agricultural through fiscal transfers currently is vir- banking financial sector and the departure turing, shortening the effective time to products. Reform efforts in this area could tually non-existent on account of the of the United Kingdom from the EU discharge, and more ­efficient liquida- be complemented by a reassessment of direct small share of the European Union budget also provide a rationale for further tion proceedings. support, which could be better targeted in relation to the size of the common ­convergence of supervisory regimes. to environmental and climate change market. Public risk sharing would help to mitigation and adaptation objectives. As discussed in the OECD Eco- counter large negative shocks, both at Structural reform efforts should nomic Survey of the euro area, since the euro area and country level. The also be focused on removing remaining ­financial intermediation in the euro Five Presidents’ Report correctly calls barriers to labour mobility within the area remains predominantly bank- for the creation of a fiscal shock-absorption European Union. Labour mobility based, efforts to improve private risk capacity at the euro area level to comple- ­remains low among the European sharing depend on actions on several ment national fiscal policies. This could Union countries, hampering the absorp- fronts. This includes the establishment be achieved through a fiscal stabilisation tion of country-specific shocks and a of a backstop for the resolution fund to function, such as a euro area unemploy- more efficient allocation of resources ensure its credibility in the event of ment benefit re-insurance scheme that across borders. Recent efforts to address large systemic shock, a role that could would be activated in case of large this challenge include a European services possibly be played, in a fiscally-neutral ­negative shocks (OECD, 2018; Claveres e-card simplifying administrative formal- way, by the European Monetary Fund, and Stráský, 2018a and 2018b). While ities required to provide services as recently proposed by the European ­financed by all euro area countries, throughout the European Union. Propos- Commission. Further progress on risk ­financing costs would over time be Another area where policy action als have also been put forward to reform reduction could also be achieved raised for countries that repeatedly can go a long way to support growth is the regulation of professional services through a common deposit insurance draw on the fund. This would mitigate related to competition in service and and introduce a proportionality test before scheme, which is necessary to complete the risk of permanent transfers and network sectors. This is because restric- adoption of new regulation on profes- the banking union. Moreover, initiatives ­provide a fiscal incentive to each country tive regulations in service sectors hinder sional services. to reduce the concentration of sovereign to pursue its own stabilisation policies. cross-border competition and investment, However, more could be done, for debt in banks‘ portfolios would reduce To strengthen countries‘ fiscal incen- and network sectors remain fragmented example by increasing investment in the link that exists in the euro area be- tives further, the access to the stabilisation along national lines in the euro area. mobility programmes, such as Eras- tween banks and their sovereign. A capacity should be conditional on com- The 2017 service package is a recent mus+, and facilitating access to these combination of policies, including a pliance with fiscal rules prior to the shock.

32 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 33 Luiz de Mello Luiz de Mello

Chart References Claveres, G. and J. Stráský. 2018a. Euro area unemployment insurance at the time of zero Cross­border risk­sharing nominal interest rates. OECD Economics Department Working Paper 1498. OECD. Paris. A. Cross­border risk sharing is limited B. European capital markets have much room to expand Claveres, G. and J. Stráský. 2018b. Stabilising the euro area through an unemployment benefits % of absorbed shocks through private and public risk sharing Outstanding loans and bonds of non-financial corporations as a % of GDP, average 2015–2017 re-insurance scheme. OECD Economics Department Working Paper 1497. OECD. Paris. OECD. 2018. OECD Survey of the Euro Area. OECD. Paris. OECD. 2019. Going for Growth. OECD. Paris. 4

4 7 3 6 3 4 3

Euro area United State Loan Bond Loan Bond Euro area United State Risk sharing through private financial flows Risk sharing through fiscal transfers

C. Links between banks and their own state remain high D. The supply of European safe assets is limited % share of domestic sovereign bonds in banks' portfolios, March 2018 Debt securities issued by governments and European institutions as a % of euro area GDP, 2016 3

7 6

4 3

FI SI IE Triple A-rated European IT LT ES L EE SK BE FR PT AT LU EA DE NL R national debts Intitution

Source: European Commission (2016), Cross-Border Risk Sharing after Asymmetric Shocks: Evidence from the Euro Area and the United States, Quarterly Report on the Euro Area 15(2), Brussels (Panel A). Eurostat, European Central Bank, US Bureau of Economic Analysis, Board of Governors of the Federal Reserve System, and Securities Industry and Financial Markets Association (Panel B). OECD calculations based on ECB (2018), Balance Sheet Items statistics, Statistical Data Warehouse, European Central Bank (Panel C). Source: Brunnermeier, M. K., Langfield, S., Pagano, M., Reis, R., Van Nieuwerburgh, S. and Vayanos, D. (2017). ESBies: Safety in the tranches. Economic Policy, 32(90), 175–219; OECD calculations based on public information released by European Institutions (Panel D). 1 Sovereign debt securities issued by the governments of Germany, Luxembourg and the Netherlands. 2 Triple A-rated securities issued by the European Investment Bank (EIB), as well as those issued by EU authorities through the European Stability Mechanism (ESM), the European Financial Stabilisation Mechanism (EFSM), the Balance of Payment facility and the Macro-Financial Assistance Programs.

34 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 35 Peter Mooslechner 20 years of EMU, 10 years in crisis mode: Former Executive Director Oesterreichische Nationalbank What might the future “new normal” of monetary policy look like?

Having contributed to the organization was very proud of this successful start and the design of the OeNB’s Econom- and first decade of EMU and at the ECB ics Conference for more than 20 years, press conferences and in his speeches he these more than 20 years in Central always mentioned to which extent the Banking and the Eurosystem coincide defined objective of the ECB’s mone- almost exactly with the first 20 years of tary policy – a year-on-year increase in the euro. This gives me a perfect back- the Harmonised Index of Consumer ground to review the developments Prices (HICP) for the euro area of over this period from a monetary policy ­below, but close to, 2% over the medium perspective, complementing the previ- term – was almost exactly reached since ous stimulating presentation by Luiz de the start of Monetary Union.2 Mello which concentrated on real devel- Contrary to this, the second part of opments as well as important institu- the first 20 years was characterized­ tional features of European Economic (i) by the crisis first – most significantly and Monetary Union (EMU) over the attached to the bankruptcy of Lehman last two decades. Brothers on September 15, 2008 – and the subsequent economic crash in 2009 The simplest EMU timeline ever: and (ii) by the economic, financial and extended version political crisis mode afterwards. From If one is asking for the simplest possible today’s perspective, more than 10 years timeline of EMU since its (formal) start after Lehman, the fundamentally critical in 1999, here it is!1 There were the ten point is that the euro area was not able early years, which might be called “the to leave the crisis mode (Corsetti et al., golden years” in parallel to “The Great 2019). Moderation” (Bernanke, 2004), when There are two elements, which macroeconomic policy objectives – from need to be added to this well-known growth to inflation – were, with the picture from my point of view. The first benefit of hindsight, achieved to a one, the future, is covered by the title ­remarkable extent globally. Most of of this conference as well. It’s the sim- these “golden years” – from 2003 on – ply asked but difficult to answer ques- were “Trichet years”, with the Euro- tion: “Where do we go?” But there is pean economy in very good shape, quite also a second very important but mostly in contrary to a number of pessimistic overlooked element, which needs to be predictions for the euro area, mainly taken into account explicitly, the prepa- coming from the USA (see for example ratory phase of EMU. What has hap- Feldstein, 1992 and Krugman, 1993). pened in this phase under the regime of Not surprisingly, Jean-Claude Trichet the European Monetary Institute (EMI)

1 See Bernanke (2015) and Hartmann and Smets (2018) for a much more detailed – and serious – account of the last 2 decades. 2 See, for example, Jean-Claude Trichet: Two successes of the euro – the single monetary policy and European financial integration, speech by Jean-Claude Trichet, President of the European Central Bank, at the Conference on ­experience with and preparations for the euro, organised by the Oesterreichische Nationalbank and the Austrian Federal Economic Chamber together with the Austrian Federal Ministry of Finance and the European Commission, Linz, May 11, 2006.

46th ECONOMICS CONFERENCE 2019 37 Peter Mooslechner Peter Mooslechner

mainly during the years 1997 – 1998, term view, or in more simple words on just the day before. In contrast, looking true for a significant number of devel- well before 11 countries formally entered the question “Where to exit?”, based on into the future, historical experience oping countries and countries like Aus- into Monetary Union with the ­beginning the current state of monetary policy in the confirms what Yuval Harari has argued, tralia and Canada for example. Keeping of 1999 is in fact of crucial importance Eurosystem and how it has developed that we don’t know how the world will this limitation in mind, all big central even today to understand how mone- from its beginning until today. This is look like in 2050, but what we know banks in the advanced economies have tary policy has reacted and to put many carried by the conviction, that we will for sure is that it will be completely dif- taken more or less the same measures elements into context correctly. Many achieve a situation which we then can ferent from the one we are used to to- to tackle the crisis in a surprisingly sim- things had to be set and were prepared call the “new normal”3 of ECB monetary day (or in the past).4 It is essential to keep ilar way, given the not negligible differ- ­before the operational start of the single policy at some point in time. this basic approach in mind when the ences in starting conditions, institu- monetary policy, which turn out to be By the way, what do we know about task is to tackle future issues, as suc- tional setups and historical traditions. rather significant for what has happened the attitude regarding the future of the cessful historical episodes of “Restaura- It is very relevant to consider that over the last 10 years in the crisis mode European population? There was an tion” are almost non-existent. this common international pattern of and they will for sure be re-discussed ­interesting study published by Bertels- What follows in the subsequent monetary policy interventions has taken intensively in the future again and again. mann Stiftung (2018) which reveals three sections of this note is (i) a review place in a significantly changed envi- that 67%, more than two thirds of the on how monetary policy-making has ronment. At this point I’d like to men- EU-28 population think that the past changed compared to the “golden years” tion only two important factors which was a better place to live in, and in the before the crisis, (ii) a short reminder shaped monetary policy making already age groups over 35 years more than on the importance of the preparatory before the onset of the crisis: structur- 70% gave this answer. Given the level phase, and (iii) a summary in eleven ally low inflation and a secular low in- of overall welfare, the absence of big points what to expect from the future terest rate environment. Together with wars and the long-term improvement in and what elements will be relevant in other influences5, e.g. financial market many economic and non-economic any forthcoming “new normal” of mon- ­developments in particular, this has ­indicators this is difficult to under- etary policy. ­resulted in significant changes in mon- stand. One explanation given in the etary policy implementation and opera- study is that nostalgia provides stability Two decades which couldn’t be tion long before the introduction of in moments of uncertainty and obvi- more different ­unconventional measures as a conse- ously there was a lot of uncertainty, How has monetary policy making in the quence of the crisis. The Bank of Japan change and innovation in many eco- Eurosystem changed over time? It is is the outstanding – even if extreme – Obviously, the pending challenge of nomic and social areas at high speed ­interesting to note as a starting point, example to illustrate that these funda- Eurosystem monetary policy at the over the last decades. These challenges that all (major) central banks globally mental changes in monetary policy were ­moment is the prospective exit from might have asked for too much adaptive have reacted to the 2007/2008 world there long before and, in the Japanese the crisis mode, when and how to exit. capacity by the people. financial and economic crisis in a rather case, stem from a (purely) national crisis Because this is a much too difficult and Nevertheless, this illustrates that similar way – perhaps with one signifi- in the early 1990s. However, if you study too sensitive topic for a simple econo- the Europeans seem to be more back- cant exception, the People’s Bank of these changes in the conduct of mone- mist, I will not touch upon this issue in ward oriented like Stefan Zweig, who China. However, it is easy to demon- tary policy in more detail, you recognize my contribution but leave it, as it should – for very good reasons – in 1942 wrote strate that framework conditions in that most of the heated public discus- be, to the Governing Council of the about “the golden age of security” ­before China not only were markedly different sions on monetary policy issues in fact ECB and the Governors as well as to the First World War, in particular, also but also the dynamics and the intensity concentrate on operational or instrument­ the related preparations by the ECB under the impression of the horrible of the crisis differed from the more related issues – like to buy or not to buy ­Executive Board. Therefore, in this circumstances of the Second World ­advanced economies, which was also assets, especially government bonds. short note, I will refrain from talking War. Eventually, this situation forced about monetary policy strategy, the him to commit suicide­ in February 1942 mandate of the ECB and the definition in the Brazilian exile, having sent the of it’s (primary) objective. The focus manuscript of “Die Welt von Gestern” 4 See Yuval Noah Harari (2018a) 21 Lessons for the 21st Century and, in particular, Harari (2018b) Change is the here will be on the future, on the long- (“The World of Yesterday”) to his publisher only constant. 5 Of course, it is very difficult if not impossible to assess, which factors were (and are) the most important ones in this respect. Significantly lower potential growth, globalization of financial markets, increased financial instrument 3 Because there is no common definition of the term „new normal“ at the moment and people might have quite different complexity, higher systemic and contagion risk and a new regulatory environment would also qualify as part of the things in mind when talking about the „new normal“, it will be used in quotation marks throughout this text. relevant set of factors obviously.

38 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 39 Peter Mooslechner Peter Mooslechner

20 years of EMU illustrated in 4 pictures Chart 3 Chart Structural changes in ECB tender operations ECB policy rates EUR billion MRO rate in % 4 % EUR billion Fixed rate Variable rate tender min.bid rate Fixed rate tender – full allotment FRFA – operations tender from MRO-operation 2. June 2 on from MRO-operation 15. October 2 6 4 4 MRO since 4 LTRO-36M 16. March 216 4 6 3 LTRO-6M 3 TLTRO II 3 LTRO-12M LTRO-3M 6 4

4 LTRO-3M – –4 TLTRO I 3 7 3 7 MRO Ece liquidity econdary ai MRO rate Depoit facility rate Marinal lendin facility rate EONIA Euro Overniht Repo Rate PreESTER

Source: ECB, Macrobond. 7 7 3 3 73 44 34 7 446 6 377 63 7 63 3 3 63 34 4 6 36 6 767 3 MRO TLTRO M TLTRO II LTRO M LTRO 3M LTRO 6M Chart LTRO M LTRO 36M OT W Total MRO rate rihthand cale Source: OeNB. ECB overall liquidity provision Note: Data on 30 day-basis, incl. une 2019. EUR billion 4 Chart 4 3 The (E)APP Quantitative easing ECB style 3 EUR billion EUR billion 4

Launch 3 3y-LTRO 1y-LTRO of PSPP Lehman 3 Brothers

– –

– –

– an an an an an 3 an 4 an an 6 an 7 an an an an an an 3 an 4 an an 6 an 7 an an – CSPP PSPP ABSPP CBPP III CBPP II SMP CBPP I Supplementary lonerterm –3 operation incl TLTRO Longer-term refinancing Ece liquidity –3 operation rihthand cale

–4 Source: Deutsche Bundesbank, OeNB. 3 7 3 7 Note: Data on 30 day-basis, incl. une 2019. MRO LTRO MLF CBPP SMP nonterilied CBPP CBPP3 ABSPP PSPP CSPP Autonomou factor Ece liquidity Ece liquidity

Source: ECB, OeNB.

40 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 41 Peter Mooslechner Peter Mooslechner

Let’s now undertake a short experiment first ten years. Today almost all tender During this preparatory phase, in essence setting as the dominant instrument, on illustrating 20 years of EMU in four operations are targeted long-term from approximately early-1997 to the market-oriented policy as a general pictures only (see charts 1 to 4 for details). tenders, no quantitatively important end of 1998, many concepts for the ­understanding and many things more Directly comparing the roughly defined short-term tenders any more. This is forthcoming single monetary policy had that were not really prevalent before in first ten years up to 2007 and the second to say the main refinancing opera- to be developed and agreed upon. To be the “old normal” of central banking inter­ ten years from the crisis onwards, it tions have disappeared. able to start with monetary policy opera- nationally. This approach was also mir- ­becomes immediately visible how differ- • Last but not least and perfectly known, tions right at the beginning of 1999, all rored in the principles of monetary ent the world has become and in which in the second decade of the Monetary relevant and important preparations ­policy operations, in particular (i) the particular way it has changed. Union quantitative easing “European had to be made not only before the end orientation on market principles and • Regarding ECB policy rates more or style” is still dominating the volume of of 1998 but early enough to leave time (ii) the harmonization of instruments in less textbook like small variations in liquidity provision in contrast to the for the ECB, the National Central Banks the toolbox of the ECB. key interest rates – almost­ ­exclusively period before the crisis, in particular operationally in charge as well as the In this respect, it is essential to re- the interest rate on the Main Refinanc- since the start of the ECB’s Asset counterparts, the so-called Monetary member that when these preparations ing Operations (MRO) – were standard Purchasing Program (APP) in 2015. In Financial Institutions (MFI’s), to pre- were discussed not only the later par- before the crisis. In the course of the more detail many measures of different pare technically for this operational ticipants of EMU were sitting at the crisis policy rates were brought down kind and of different characteristic start into a completely new world. This ­table but also the representatives of i.e. in rapid speed and to previously unex- were taken to address different inter- constituted a real challenge for all insti- the Bank of England, Sveriges Riksbank pected low levels. Since then they are mediate objectives over this period.6 tutions and people involved, as very dif- and Denmarks central bank negotiated anchored even below the nominal All in all, looking at these – extremely ferent national traditions of monetary until the end of the EMI period. Even if zero lower bound (in case of the simplified – empirical illustrations it policy making had to be merged into a it was clear right from the beginning, ­Deposit Facility Rate (DFR) at –0.4%). might come as a surprise even for mon- new harmonized Eurosystem monetary that these countries would not join the This has completely changed our etary policy experts how fundamentally policy setup.7 euro area, their central banks were not under­standing how the transmission the monetary policy setup has changed Against this historical background, only very active but had a big say in the process of interest rate policy works, over the first 20 years of EMU. Of course, it is important to recall that the ECB discussions. In the Monetary Policy and which transmission channels are all this happened in small steps and for was – and still is – the youngest of the Sub-Committee8, which was the one of active and – hopefully – effective. very good reasons, but eventually the major central banks in the world. the EMI committees to prepare the • Regarding liquidity provision, the world looks very much different in Therefore, the most modern monetary monetary policy strategy as well as the picture is very similar. From nowa- ­almost all monetary policy dimensions policy design of that time was given to operational framework for the forth- days’ perspective there was almost no now, which is of utmost relevance when this new institution – in terms of man- coming Eurosystem single monetary liquidity provision by the ECB in the thinking about any forthcoming “new date, in terms of instruments, in terms policy (Stage 3 as it was called at that first ten years of Monetary Union. normal” to be defined. of the operational setup, in terms of time), these central banks had an im- This was even true during the time of ­everything – and this was also reflected portant influence on which instruments the Lehman Brothers collapse. No Determinants of monetary policy in the in-depth evaluation of its mone- became part of the potential toolbox doubt, there were enormously diffi- design: past and present tary policy strategy undertaken in 2003 and how these instruments and their cult decisions to take, but in quantita- Looking back, it is useful and necessary (Issing, 2003). Where did these ele- use were defined. This turned out to be tive terms, compared to today’s vol- to remember the important but largely ments of modern design come from? Of especially important, because this influ- ume of liquidity provision, it was forgotten role of the intense preparatory course, everything in the academic lit- ence came on top of the already differ- ­almost nothing. phase for the start of monetary policy in erature at that time was taken into ent monetary policy traditions regard- • In parallel, lot’s of structural changes the newly established Monetary Union ­account and is reflected in the design of ing the later 11 participants in the single took place in ECB liquidity provision to come. This first took place to a large the ECB since the beginning (Hahn and monetary policy. Their approach was and tender operations since the start extent in the institutional ­setting of the Mooslechner, 2000; Mooslechner, 2000). characterized by a different institutional of the Monetary Union. Main refi- European Monetary ­Institute (EMI) – Important factors in this respect are history and a somewhat more pro- nancing tender operations with a established in 1994. Since June 1, 1998 ­independence, a focus on the price sta- nounced orientation on US monetary dominance of the weekly tender were EMI has been integrated in the institu- bility mandate, short-term interest rate policy standards. the overriding instrument during the tional structure of the established ECB.

7 6 See Hammermann (2019) for a detailed stocktaking of the Eurosystem’s asset purchase programmes; for the US See Scheller (2004) and James (2012) for a detailed account of these issues. Bernanke (2009) lists more than 25 different measures taken and specific programs introduced at the very beginning 8 Since November 1996, I had the privilege to participate in the meetings of the Monetary Policy Sub-Committee of the crisis only. first and subsequently the Monetary Policy Committee of the ECB.

42 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 43 Peter Mooslechner Peter Mooslechner

The set of policy instruments de- long historical tradition of using outright 11 factors that will probably of financial and economic inter- fined in 1998 as a blueprint for the start purchases as a standard tool of monetary shape any forthcoming linkages and prospective conse- of Monetary Union indicates, how much policy and refinancing, they were includ­ed “new normal” quences. “cultural compromise” was necessary to in the toolbox of policy instruments for Against the background of 20 years of 3. The simple interest setting (and get to a sufficiently harmonized toolbox the ECB right from the beginning.10 single monetary policy and its at least fine-tuning) mechanism of the past proposal. One example in this respect Outright transactions were by no two quite different episodes since the no longer applies, because the trans­ are outright transactions. These outright means the only critical issue to compro- start of Monetary Union, what to expect mission process of monetary policy transactions became an agreed part of mise on. Similar challenges were deci- for a future “new normal” of monetary as well as its potential effectiveness the ECB portfolio of instruments already sions on the use of minimum reserves policy in the euro area? Briefly, only have become much more compli- at that time (see table 1 where outright as well as the criteria for eligible collat- three operational aspects are taken here cated and difficult to understand. purchases/sales are listed under­ fine- eral and the concrete auction model to be as examples, for what would demand a On the one hand, this much more tuning operations as well as structural used in tender operations, to name only much broader and deeper analytical dis- complicated and diverse transmis- operations; ECB, 1998). They were not a few. However, from today’s perspec- cussion: These aspects will be (i) interest sion processes can also be used by ­created or “invented”­ due to the crisis tive and after all the hot discussions on rate policy, (ii) liquidity provision and monetary policy to address its oper- situation in 2008/2009 and also not at the ECB’s purchasing programs, out- (iii) forward guidance. ational target(s); on the other hand, the time when the large-scale APP was right transactions are of course the Altogether, the following assessments these diversities are based on unsta- ­introduced in 2015. Mainly because of most prominent example to illustrate and views need to be taken only with a ble transmission regimes and vola- the influence of the Bank of England9 the importance of this initial phase for clear “disclaimer”! Each and every point tile behavior of market partici- during the preparatory phase, who has a the conduct of the single monetary policy. presented below would warrant a lec- pants, which are difficult to iden- ture of its own and a much deeper and tify and to predict. Table 1 encompassing discussion of its entire 4. Absolutely unthinkable to many/ 11 ESCB monetary operations toolkit: EMI blueprint of 1998 features. Although I will try to be as most monetary policy makers ­before the crisis, interest rate pol- Monetary policy Types of transactions Maturity Frequency Procedure factual as possible, bearing in mind that ­operations Provision of liquidity Absorption of there are many different opinions and icy now increasingly intends to liquidity­ intentions on all these issues, there will steer the entire yield curve, the Open market operations be a broad range of different conclusions slope of the term-­­structure. In the Main refinancing • Reverse transac- – • Two weeks • Weekly • Standard tenders regarding the “desirable design” of any previous mainstream view mone- ­operations tions future “new normal”. tary policy restricted itself to steer Longer-term refi- • Reverse transac- – • Three months • Monthly • Standard tenders nancing operations tions 1. It’s obvious that in the aftermath of the (very) short-­term rate(s) only Fine-tuning • Reverse transac- • Foreign exchange • Non-standardised • Non-regular • Quick tenders the crisis monetary policy has and the term-structure was seen to ­operations tions swaps • Bilateral procedures newly defined what was previously be the result of the subsequent mar- • Foreign exchange • Collection of fixed-­ swaps term deposits understood as the “zero lower ket transactions only. This under- • Reverse transac- bound” (ZLB). Even the simple standing has changed completely, tions • Outright purchases • Outright sales – • Non-regular • Bilateral procedures nominal ZLB is no longer at zero, not at least in the context of large Structural operations • Reverse transac- • Issuance of debt • Standardised/ non- • Regular and non- • Standard tenders it’s somewhere below and the asset purchase programs. tions certificates standardised regular whole ZLB ­issue (real ZLB, effec- 5. Monetary policy today is perma- • Outright purchases • Outright sales – • Non-regular • Bilateral procedures tive ZLB…) has become much nently acting in a structural liquid- Standing facilities more complex but also relevant for ity surplus situation that has trig- The marginal lending • Reverse transac- – • Overnight • Access at the discretion of counterparties gered a structural change from the facility tions practical monetary policy making at the same time. previous liquidity shortage-based The deposit facility – • Deposits • Overnight • Access at the discretion of counterparties 2. Interest rate policy cannot any lon- corridor system to a floor system. Source: ECB (1998). ger be understood in the simple In the traditional corridor system textbook sense of monetary policy. the main refinancing rate was the 9 To be fair, it needs to be mentioned that the Bank of England was by no means alone in its demand to include Even simple and everyday interest (only) one key monetary policy ­outright transactions but supported by a number of other central banks. rate adjustments nowadays have to rate to transmit the intended mon- 10 Of course, the EMI had no final decision power to decide on these issues, but given the enormous time pressure on be seen against a much broader set etary policy signal, while in the the ECB once established in the second half of 1998, it had to rely on these EMI preparations and proposals to a large extent. For illustration: The operational details regarding the minimum reserve system were published on July 8, 1998 already. The entire set of monetary policy instruments and procedures was revealed on September 18, 1998. 11 Ulrich Bindseil’s impressive 2014 book gives some perception of the general complexity of the issues.

44 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 45 Peter Mooslechner Peter Mooslechner

now prevailing floor system the in many countries (Federal Reserve, talked to the markets and to the 11. Eleventh and last point. Forward negative Deposit Facility Rate 2019b; Praet, 2018). public in the past also, but under- guidance, how successful or how (DFR) steers the entire monetary 8. It is necessary to recall that from a standing this as a separate mone- damaging can or will it be and will policy transmission process through historical perspective, the opera- tary policy instrument, thereby it stay? On the negative side, there the interest rate channel. tional setup for liquidity provision, addressing different transmission is Ben Bernanke’s famous taper 6. The process and design of liquidity for example, by the Eurosystem, channels has increasingly become tantrum episode, where in a few provision has fundamentally altered the Federal Reserve and the Swiss relevant during the recent crisis days only the long-term interest its characteristic from the “old central bank was quite different. mode phase. Talking to market rate in the U.S. jumped by more normal”, where the central bank Central bank liquidity was pro- participants and influencing their than 100 basis points because of was providing a limited amount of vided from different sources: in expectations, but also the expecta- – expressed in a cautious manner – peak liquidity to a limited number the U.S. the bulk of ­liquidity pro- tion formation of economic agents mistaken communication or a wrong of banks only. The subsequent dis- vision came from what we in Europe in general, has developed into an perception of forward guidance tribution of liquidity was done via call asset purchases now, mainly equally important and accepted lead to an unwanted and unfavor- the money market(s) mechanism from purchasing treasuries; in policy instrument, used rather fre- able outcome. A second interesting according to the liquidity demands ­Europe – with the main exception quently nowadays. Take the exam- and more actual FG case is that the of individual banks. Due to the cri- of the Bank of England – liquidity ple of Mario Draghi’s press confer- FOMC members – via their famous ses and lasting, since then banks was created traditionally through ence on March 7, 2019. What he dot-chart – are still signaling that are now directly addressing the repo-­operations, whereas in the case presented there was the whole they may raise interest rates over central bank permanently to get of the Swiss National Bank capital portfolio of forward guidance: (i) the forthcoming years. At the same the liquidity they need and want, ­inflows and FX-interventions are Forward guidance on interest rates: time, market expectations-based which as a consequence resulted in the dominant channels of liquidity how future interest rates, how the calculations show that market par- a very high demand for central creation. This has continuously future policy path might develop; ticipants expect interest rates to bank liquidity. And one of the rea- changed in the course of the crisis (ii) FG on ECB re-investment pol- fall significantly in the foreseeable sons for this structural change is and there is a tendency towards­ icy regarding the stock of APP future. This two US examples illus- that the unsecured money market harmonization of operational tra- ­purchases; (iii) FG on long-term trate how challenging the task is to in its role as an allocator of central ditions in central banks globally. ­financing operations like the newly use FG efficiently­ to get the intended bank liquidity has disappeared. 9. The markedly higher amount of started TLTRO III and (iv) FG on (market expectations) outcome. There is still a lack of trust and ­liquidity provided by central banks FRFA (Fixed Rate Full ­Allotment). It is ­interesting to note, that for much too much risk aversion in the today comes together with a signif- In the light of this last point, when the time being FG by the ECB has market, therefore banks are still not icant longer maturity of central bank talking about today’s monetary been successful in avoiding similar willing to lend each other money in liquidity. In the case of the ECB, policy stance and what has changed mistakes like these. And, on the unsecured terms. ­almost all liquidity provided is during the crisis, it should be em- clearly positive side, there is the 7. With respect to the developments­ long-term, less than EUR 6 billion phasized that since October 200812 mentioned above and, in particular, out of more than EUR 2,000 billion – from shortly after­ the Lehman the introduction of non-conven- outstanding is what central banks collapse and for more than 10 years tional monetary policy measures, usually did in their main refinanc- now – the ECB has been conduct- balance sheet size management has ing operation and the weekly ten- ing no tender ­operations in their become a globally accepted new der. Short-term liquidity supply classic form anymore. Every eligible monetary policy ­instrument of its and ­demand in the MRO has dete- bank gets as much liquidity as it own and is used by the Fed, by the riorated to an almost unattractive ­demands, as long as it is able to ECB and many other central banks ­instrument demanded only by few provide enough collateral and com- now. Primarily introduced as an banks for very specific idiosyncratic plies with all the defined criteria of emergency crisis measure at the reasons. eligibility; completely different beginning, balance sheet size varia- 10. As a new monetary policy instru- from the “old normal” we were tion is recently discussed as a sub- ment “forward guidance” (FG) was used to and which is still repre- stitute for interest rate policies, added to the monetary policy tool- sented in the textbooks. compensating for the limited leeway box in an explicit and systematic central banks have in this respect way. Of course, central banks have 12 See ECB press release, Changes in tender procedure and in the standing facilities corridor; October 8, 2008.

46 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 47 Peter Mooslechner Peter Mooslechner

13 tremendously important “What- from the “old normal” from which the References ever it takes” speech by Mario current crisis mode has developed. Baquero, L., Ezzaim, M. and St. Sorbe. 2018. The size of central bank balance sheets: a new Draghi in London on July 26, 2012 Overall, it is hard to imagine that all monetary policy instrument. Tresor-economics 213. (Draghi, 2012) dealing with the these instruments and measures em- Bernanke, B. 2004. The Great Moderation. Washington DC. February 20. ­future role and profile of the OMT, ployed during and in the aftermath of Bernanke, B. 2009. Federal Reserve programs to strengthen credit markets and the economy. which turned out to have become the crisis will simply disappear. It is Testimony. Before the Committee on Financial Services, U.S. House of Representatives, Wash- the most effective and indispens- nearly certain that in a forthcoming ington, D.C. February 10. able example of FG, having proba- definition of a “new normal” all these Bernanke, B. 2015. The Courage to Act. New York – London. bly saved the sheer existence of the instruments will be present (Praet, 2019). Bertelsmann-Stiftung. 2018. Make Europe Great Again? Europeans view the past more euro at this decisive point in time. Of course, this does not automatically ­positively than the present. November 5. mean that they will be used in the same Bindseil, U. 2014. Monetary Policy Operations and the Financial System. Oxford. Any future “new normal” will for way and in the same intensity all the Corsetti, G., Eichengreen, B., Hale, G. E. Tallmann. 2019. The euro crisis in the mirror of certain be significantly different time. But they will be part of the stan- the European Monetary System. VoxEU 15. February. Are there any conclusions to be drawn dard monetary policy toolkit and they Draghi, M. 2012. Verbatim of the remarks made by Mario Draghi. Global Investment Conference. from this? At least I try to offer some will be regularly used in the “new nor- London. 26 July. personal conclusions, which are mainly mal” if necessary and appropriate. The Draghi, M. 2018. Economic and Monetary Union: past and present. Speech at the Europa-­ in line with what Harari thinks how the same applies for other significant ele- Konferenz Berlin. September 19. ments of the crisis mode, for the bal- ECB. 1998. The single monetary policy in Stage Three: General documentation on ESCB monetary ance sheet size, the steering mode of policy instruments and procedures. 16 September. policy rates and forward guidance, to Eichengreen, B. 2015. Hall of Mirrors. Oxford. mention only a few of these newly intro­ Federal Reserve. 2019a. Statement on Longer-Run Goals and Monetary Policy Strategy. January 29. duced features. Federal Reserve. 2019b. Statement Regarding Monetary Policy Implementation and Balance Unfortunately, given latest develop- Sheet Normalization. January 30. ments, we seem to be far from the point Feldstein, M. 1992. Europe’s Monetary Union – The Case against EMU. The Economist. June 13. of being able to define this “new nor- Hahn, F. and P. Mooslechner. 1999. Zur Fundierung des Designs des Europäischen Zentral- mal” in a meaningful way yet and not at banksystems. WIFO – Monatsberichte 1. all to enter into it quickly. At the same Hammermann, F., Leonard, K., Nardelli, S. and J. von Landesberger. 2019. Taking stock time, this means that on any account of the Eurosystem’s asset purchase programme after the end of net asset purchases. ECB these crises mode features of monetary ­Economic Bulletin 2. policy will be in place for a considerable Harari, Y. N. 2018a. 21 Lessons for the 21st Century. London. further period of time, which will Harari, Y. N. 2018b. Change is the only constant. Wired.co.uk. August 12. ­increase their likelihood to stay. No Hartmann, P. and F. Smets. 2018. The first twenty years of the European Central Bank: doubt, from a general macroeconomic ­monetary policy. ECB Working Paper Series 2219. future will look like. Given all the fun- as well as economic policy perspective, Issing, O. (ed.). 2003. Background Studies for the ECB’s Evaluation of its Monetary Policy Strategy. damental changes in monetary policy this persistent need for policy stimulus Frankfurt. orientation and implementation we more than a decade after monetary pol- James, H. 2012. Making the European monetary union. Cambridge (MA). have seen over the last decade, the icy went into the crisis mode must be Krugman, P. 1993. Lessons from Massachusetts for EMU. In: Torres, F. and F. Giavazzi (eds.). ­future “new normal” of monetary pol- seen as a very unpleasant European ­Adjustment and growth in the European Monetary Union. Cambridge. icy will very likely look much different ­crisis heritage. Mooslechner, P. 2000. Monetary Policy and Monetary Strategy in EMU: New Framework – New Challenges. Focus on Austria 2. Praet, P. 2018. Monetary policy in a low interest rate environment. Speech at the Congress of Actuaries Berlin. June 6. Praet, P. 2019. Providing monetary policy stimulus after the normalization of instruments. Speech at the ECB and its Watchers Conference Frankfurt. March 27. Scheller, H. 2004. The European Central Bank. Frankfurt. Williams, J. C. 2018. Moving Toward “Normal” U.S. Monetary Policy. Central Banking Forum Nusa Dua. Indonesia. October 10. Zweig, St. 1942. Die Welt von Gestern (The World of Yesterday). London. Stockholm.

13 As the literature on ECB monetary policy since the crisis is enormous, this represents a very restricted selection of sources of direct relevance for this paper only and leaves out many more other sources of a general nature.

48 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 49 Session 2 Monetary and financial stability Andreas Ittner Macroprudential policy complements Vice Governor Oesterreichische Nationalbank ECB monetary policy1

Ladies and Gentlemen, tackled with adequate macroprudential Many players contribute to financial measures. Currently, there are two main stability. If you take a broad view, examples for this interplay. ­financial stability policy encompasses First, low or even negative interest macroprudential policy as well as micro­ rates squeeze interest rate margins of prudential supervision and ­regulation, banks due to the so-called zero lower recovery and resolution frameworks as bound on deposits and thereby negatively well as deposit guarantee schemes. All affect bank stability. This assertion is these areas provide ­important contribu- corroborated by research by colleagues tions to financial stability, but it is the of the OeNB (Kerbl and Sigmund, 2016). broad consensus – at least since the In Austria, for example, the structurally ­Financial Crisis – that macroprudential low profitability of Austrian banks was policy is the most important area in one reason – among others – for imple- preventing – or at least mitigating – menting the systemic risk buffer (Finan- ­financial stability risks (Bank for Inter- cial Market Stability Board, 2018). national Settlements, 2011; International Second, the current low interest Monetary Fund, 2013; Smets, 2014). rates fuel booms in various asset markets: e.g. equity markets, bond markets, and Monetary and macroprudential real estate markets. In the euro area, policy complement each other macroprudential policy allowed a number A lot has been said on the similarities, of countries to address these partly unin- the differences, and the interplay on tended consequences, as borrower-based these two policy fields. I would like to measures and higher risk weights for compare their relationship to a game of mortgages were introduced to deal with doubles in tennis. To be successful, systemic risks stemming from real estate both players need to adapt to the other markets (European Systemic Risk Board, player’s game. If one player storms to 2019). the net, the other player must follow as Moreover, the revised ESRB Regu- soon as possible. Otherwise, they risk lation now explicitly stipulates that not being able to put the ball away or ­implications of monetary conditions for even getting passed. Both players share financial stability fall under the ESRB’s the same goal – in tennis it is the win, in macroprudential oversight mandate to monetary and financial policy it ulti- ensure that there are no taboo topics in mately is a long-term and stable ­increase the ESRB in the future. This is an impor- of people’s prosperity and well-being. tant precedent for macroprudential policy However, this common goal is reached in general. via different intermediate objectives. In my opinion, monetary and mac- Monetary and macroprudential roprudential policy areas are comple- policy have different intermediate mentary. Price stability contributes to objectives financial stability and vice versa. Never- Consistent with their complementary theless, monetary policy has ­potentially function, monetary policy and macro- unintended consequences that can be prudential policy have different interme- 1 Co-authors David Liebeg and Peter Strobl, Oesterreichische Nationalbank, Financial Stability and Macroprudential Supervision Division. The views expressed in this paper are exclusively those of the authors and do not necessarily reflect those of the OeNB or the Eurosystem.

46th ECONOMICS CONFERENCE 2019 53 Andreas Ittner Andreas Ittner

diate objectives. That of monetary policy requirements impede banking lending. ­authorities to deal with country-specific in the euro area is price stability: Prices Quite a few studies show that this is not consequences of a single monetary policy should increase at a rate of below, but the case. Gambacorta and Shin (2016) for the euro area. close to 2% year-on-year. That of macro- found that a presumed tension between prudential policy in the euro area is the increasing bank capital and bank lending Closing remarks reduction and mitigation of systemic­ risks. is more apparent than real and that better Monetary policy and macroprudential To be more specific, monetary policy capitalized banks improve the bank supervision can be combined very impacts the debt funding rates of banks, lending channel of monetary policy ­effectively. However, as in a team of while macroprudential policy primarily transmission: Higher bank capital is tennis doubles – to come back to the ini- impacts the spread between banks’ debt ­associated with greater lending. This is tial metaphor – excellent communication, funding costs and their loan rates (IMF because better capitalized banks have the clear allocation of responsibilities 2013). Initially, monetary policy targets substantial lower funding costs. and team spirit are preconditions. the risk-free rate of interest via the so- Schmitz et al. (2017) estimated that a called interest rate channel. Recently, 100 basis points increase in regulatory References asset purchase programs have extended capital ratios is associated with a decrease Bank for International Settlements. 2011. Central Bank Governance and Financial Stability. the objective function to the risk pre- of bank funding costs of about 105 basis Report by a study group under the chairmanship of Stefan Ingves, Governor, Sveriges Riksbank. mium of bonds, including bank bonds, points. Another recent paper by the European Systemic Risk Board. 2019. A Review of Macroprudential Policy in the EU in 2018. via the so-called risk-taking channel. Periès et al. (2019) strikes a similar Financial Market Stability Board. 2018. Recommendation FMSG/2/2018: guidance on adjusting Contrary to that macroprudential policy note by finding that countercyclical the systemic risk buffer. www.fmsg.at/en/publications/warnings-and-recommendations/2018/ aims at shifting the costs of systemic macroprudential interventions are sup- recommendation-fmsg-2-2018.html. risks back from the public to the banks, portive of monetary policy conduct Gambacorta, L. and H. S. Shin. 2016. Why bank capital matters for monetary policy. BIS i.e. it wants to make sure that loan rates through the cycle. Therefore, an allegedly Working Paper 558. April. cover all costs of capital, liquidity and apparent and often raised conflict does International Monetary Fund. 2013. The Interaction of Monetary and Macroprudential Policies. risks. Thereby it influences the spread in fact not exist. Kerbl, S. and M. Sigmund. 2016. From low to negative interest rates: an asymmetric dilemma. between debt funding and loan rates. OeNB Financial Stability Report 32. December. Different objectives require Periès, M. D., C. Kok and E. Rancoita. 2019. Macroprudential policy in a monetary union with separate sets of instruments cross-border banking. ECB Working Paper 2260. March. To sum up, the complementary nature Schmitz, W. S., M. Sigmund and L. Valderrama. 2017. Bank Solvency and Funding Cost: of both policies justifies separate objec- New Data and New Results. IMF Working Paper 17/116. tives. This implies that I favor that both Smets, F. 2014. Financial Stability and Monetary Policy: How Closely Interlinked? In: International objectives are pursued by two separate Journal of Central Banking. June. sets of instruments – also known as “Tinbergen Rule”. Alternatively, “lean- ing against the wind” would overbur- den monetary policy with a dual ­objective of maintaining consumer price stability and preventing asset price bubbles. To achieve the latter, interest rates would have to increase quite Macroprudential policy supports sharply, which is very likely to endanger monetary policy’s transmission the former at this juncture. mechanism The principle of separate sets of ­instruments is even more important in a Some argue that there is a conflict monetary union where asymmetric finan- ­between macroprudential measures – cial cycles across member states exist most importantly capital buffers – and (Periès et al. 2019). Therefore, the the transmission mechanism of monetary ­national mandate of macroprudential policy. They suggest that higher capital policy is essential to allow national

54 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 55 Ed Sibley Monetary and financial stability: the Deputy Governor Prudential Regulation Central Bank of Ireland implications for prudential supervision

Good afternoon, it is a pleasure to • Appropriate accounting of financial speak to you today. The theme of the assets; conference ‘”European Economic and • Excessively loose monetary policy; Monetary Union: the first and the next • Inadequate or flawed micro and macro­ 20 years” gives us wide scope to share pudential regulation; and some of our thoughts. We have much to • Deep flaws in supervision. learn from the last twenty years. The crisis also highlighted the funda- If we look back to 2007, problems mental importance of financial stability had started to crystallise and acceler- to protecting consumers and investors ated in 2008, particularly post Lehm- and that it is a collective responsibility ans, as market participants retreated to safeguard financial stability. Of the ­towards safe assets. This tendency was financial firms themselves, of regula- intensified by the complexity and lack tors and supervisors of all segments of of transparency in the financial system. the financial sector, of central banks, of In other words, due to the complexity macroprudential authorities, of resolu- of the market, participants could not tion authorities, and indeed of govern- establish with confidence which risks ments to ensure the right legislative and would end up with whom and how they institutional frameworks and incentives might be exposed to the ultimate holder exist for a stable financial system. And of certain types of risks. Consequently, the architecture of Banking Union has the market moved away from many been built to reflect this collective re- higher risks. This included Irish banks sponsibility. The global monetary pol- with their large property exposures. icy response since 2008, for example, The move away from the higher risks has dampened volatility and addressed due to concerns about solvency took the system-wide liquidity concerns. The form of a withdrawal of short-term continued monetary accommodation ­liquidity, leading to the failure of the has – in addition to incentivising banks Irish banks and many others. to lend – afforded banks the time and The crisis exposed a long list of con- space to build buffers, repair their bal- tributing factors including:1 ance sheets and deal with legacy issues. • Underestimation of the riskiness of In his remarks, Andreas Ittner men- securities created with financial engi- tioned the interaction of monetary pol- neering; icy and macroprudential policy. I will • Misaligned incentives; pick up the baton there. I will conclude • Excessive funding of long term assets by giving my thoughts on the Banking with short-term liabilities; Union. But in the first part of my remarks • Ratings agencies failures; today I will endeavor to address how • Flawed assumptions regarding house new measures to address financial sta- prices; bility have changed how we supervise • Elevated household debt; banks and discuss how in turn, our super­ • A belief by bankers that their institu- vision promotes and contributes to safe- tions were too big to fail; guarding financial stability. The Central • Global imbalances; Bank of Ireland has a wider and more

1 See David Aikman, Jonathan Bridges, Anil Kashyap and Caspar Siegert. 2018. Would macroprudential regulation have prevented the last crisis? Bank of England Staff Working Paper No. 747.

46th ECONOMICS CONFERENCE 2019 57 Ed Sibley Ed Sibley

diverse mandate than most Central Banks. memories fade. We must recognise the testing, for example, is now a key tool differences inconsequential – just as We are including the National Central important role of strong regulatory and of supervisors with the recent EU-wide single supervision does not mean that Bank, National Competent ­Authority supervisory frameworks in delivering a banking sector stress test showing the every institution has the same capital for credit institutions, investment firms, resilient and stable financial system.2 variety of macroeconomic variables requirements, banking union does not funds and insurance firms, National considered including GDP, inflation, mean that every banking system has the Macro­prudential Authority, National Res- Macroprudential policy, financial unemployment, asset prices and inter- same level of capital requirements. olution Authority and have important stability and prudential est rates.5 Stress tests involve macro Thus, capital requirements are deter- roles in conduct, consumer protection supervision considerations in identifying risks and mined through decisions taken by micro- and Anti-Money Laundering (AML). To promote financial stability, macro- setting out a plausible scenario while prudential supervisors with respect to Given this wide mandate and rela- prudential policy aims to strengthen the results showing how banks are affected pillar I and pillar II requirements, but tively large financial sector in Ireland, the resilience of the financial system so are a key input into setting individual also through the polices implemented we therefore must consider financial that it can withstand adverse move- bank capital requirements. by macroprudential authorities with stability in a holistic fashion across dif- ments in credit and property prices, Business model analysis also takes ­respect to the Other Systemically Im- ferent segments of the financial sector. and other macroeconomic shocks. macro-financial factors into account portant Institutions (O-SII) buffer and Moreover, given the nature of financial Policy measures are forward-look- when assessing risks faced by banks. the Countercyclical Capital Buffer services operating in Ireland, we neces- ing and seek to reduce the potential for Last year, for example, ECB Banking (CCyB), for example. Another aspect of sarily must take a wider European and imbalances to accumulate, given that Supervision published a thematic review banks’ capital requirements that is rel- global view. We concern ourselves, they could lead to financial distress. on profitability and business models, evant is the Minimum Requirement­ ­directly and through our work in the Intermediate objectives are: which highlighted that low profitability for own funds and Eligible Liabilities regulatory and supervisory ecosystem, • To prevent excessive credit growth and pressure on revenues from the eco- (MREL), which is decided upon by res- with the functioning of the financial and leverage; nomic environment, among other factors, olution authorities.­ system with the aim of ensuring that it • To prevent excessive maturity mis- affect the European banking sector.6 Supervisors must therefore cooper- is serving the needs of the economy, match and market illiquidity; The findings from the thematic review ate and coordinate effectively with consumers and investors. • To limit direct and indirect exposure feed into the Supervisory Review and macroprudential authorities and resolu- My key message today is a compre- concentration; and Evaluation Process (SREP). tion authorities – whilst respecting hensive approach to financial stability is • To reduce the potential for systemi- their differing mandates – to ensure the needed – not just at national level, but cally important banks to adopt desta- Capital requirements resilience and stability of the banking also at a European level. Not just for bilising strategies and to mitigate the Second, broadly speaking, capital levels system. banks, but also other segments of the impact of such actions.3 have increased markedly in Europe over financial system. This will require closer These are also of fundamental concern the past decade. At the end of 2009, the coordination, more information shar- for microprudential supervisors – we just average Tier 1 capital ratio stood at 10.2% ing and deeper embedding of macro-­ look at it from an individual institutional while at end-2018, this had improved to financial analysis and policy into pru- perspective. In the main, supervisors are 16.3%.7 Today, capital requirements of dential supervision. More also needs to involved in National Macroprudential banks are decided by different authorities be done in Europe with respect to reso- Authorities.4 But the advent of macro- and institutions. This reflects the vari- lution, deposit insurance, capital markets prudential policy has also coincided with ous elements that need to be taken into union and the cultures within financial a change in banking supervision. account when assessing bank capital re- institutions. I will return to this towards quirements. the end of my remarks. Lastly, the effect Macroeconomic assessments Different macroeconomic and finan- of the “regulatory pendulum”­ has been a First, macroeconomic assessments have cial cycles, different structures of econ- feature of financial booms and busts. It become a fundamental component of omies and different structures of finan- is important then that we do not let microprudential supervision. Stress cial systems, among other factors, jus- tify different capital requirements. 2 See Dagher, Jihad. 2018. Regulatory cycles: Revisiting the Political Economy of Financial Crises. IMF working Banking union does not render these Paper (18/8). 3 See details on macroprudential policy https://www.centralbank.ie/financial-system/financial-stability/macro- prudential-policy. 5 See Adverse scenario for the EBA 2018 EU-wide banking sector stress test. 4 See List of national macroprudential authorities and national designated authorities in EU Member States and 6 See SSM thematic review on profitability and business models. List of National Supervisors. 7 See EBA Risk Dashboard Q3 2013 and EBA Risk Dashboard Q4 2018.

58 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 59 Ed Sibley Ed Sibley

Borrower based measures The advent of macroprudential pol- liquidity adequacy assessment processes), Last year, ECB Banking Supervision Third, borrower based measures such icy has therefore coincided with and business model sustainability and gover­ undertook a review of recovery plans to as loan-to-income limits (LTI) and ­reinforced an important change in nance, culture and risk management. learn from best practice and experience loan-to-value limits (LTV) make both thinking about microprudential super- Ultimately, whether a firm can be resolved to help further shape operational suc- banks and borrowers more resilient. vision. This is embedded in our frame- should be reflected in our supervisory cess of plans going forward. work for supervision and our tools for risk appetite. Whilst much has been achieved, Increased Co-ordination stress testing. The supervisor is consulted on reso- there is still considerable room for im- Wider institutional fora are important Effective cooperation and coordina- lution plans, prepared by resolution au- provement in terms of feasibility, cred- when thinking about the joint responsi- tion given the multi-level and joint thorities, which gives us a deeper knowl- ibility and options for recovery. bility “authorities” have for financial ­responsibility is critical to preserve edge on legal structure, critical functions, This new EU recovery and resolu- stability. These vary in composition and ­financial stability. internal and external inter­dependencies tion framework is not a panacea. It mandate at national level. (i.e. essential services etc…), IT sys- ­remains a work in progress. But impor- At European level, the ESRB was Resolution, financial stability tems, access to financial market infra- tant work in progress. established in 2010 to oversee the finan- and prudential supervision structures, preferred resolution strate- Much work therefore remains to be cial system of the European Union The establishment of national resolu- gies, and separability to name just some done to ensure financial stability going (EU) and prevent and mitigate systemic tion authorities and the Single Resolu- of the contents. Moreover, supervisors forward. risk. It is an important forum which tion Board has been an important insti- should be actively working with resolu- The measures introduced to date brings together representatives of EU tutional development since the crisis. tion authorities to address impediments however, have already changed how we institutions, Governors of National However, the introduction of the Bank to resolvability. This is not without its supervisors think about risk and risk Central Banks, and high level represen- Recovery and Resolution Directive challenges, but if a bank is only surviv- mitigation. tatives of the National Competent (BRRD) and Single Resolution Mecha- ing because it is not resolvable, it is not Authorities.­ 8 nism (SRM) goes well beyond this, and viable, and requires appropriate super- Non-bank financial intermediation, finan- has also had a wider impact on how we visory intervention cial stability and prudential supervision. supervise banks. Supervisors now also review recov- To maintain financial stability, we cannot The BRRD was introduced to pro- ery plans, prepared by banks which solely focus on banks. vide authorities with a regulatory tool- map out what they will do if they get Non-bank finance has become an kit to manage bank failure, with the into difficulty. increasingly important source of financ- ­objectives of ensuring the continuity of • We now assess detailed recovery op- ing of economic activity. Since the cri- critical economic functions, minimis- tions, scope and timelines for action sis in 2008, globally (as reported by the ing the impact on the economy and for each bank.10 Financial Stability Board (FSB)), banks’ ­financial system, avoiding the destabili- • We have financial impact assessments share of total global financial assets has sation of financial markets and limiting and feasibility assessments which declined from 45% to 39%, as so-called the cost to taxpayers. ­include financial, operational, reputa- “OFIs” or other financial intermediaries Resolution is therefore fundamen- tional, legal and business model risks, take larger shares (from 26% to 31%).11 tally a financial stability issue. as well as a consideration of a much This evolution can bring with it dif- The BRRD has also importantly wider range of factors. ferent types of systemic risk which can For the euro area, the Macropru- changed how we supervise banks. • Plans are required to include the threaten financial stability, be they via dential Forum is composed of the Gov- Resolution authorities have the pri- ­assumptions underlying effects, gov- direct exposures or indirect exposures erning Council and the Supervisory mary responsibility for resolution plan- ernance and implementation, impact – for example when common assets are Board of the ECB and it is a platform for ning and execution. Nonetheless, super­ on critical shared services, critical held or move together. regular, high-level discussions, bringing visors should be actively considering functions and core business lines, Just one salient example of this is together microprudential and macro- the resolvability of a firm, alongside finan- ­impact on stakeholders and systemic Commercial Real Estate (CRE). prudential perspectives from across cial resources (for example, supervisors consequences, communications plans, • The size, interconnectedness and use ­Europe.9 review institutions’ internal capital and and preparatory measures. of high leverage makes CRE important­

8 See details of ESRB governance https://www.esrb.europa.eu/about/orga/board/html/index.en.html. 10 See ECB Banking Supervision Report on Recovery Plans, July 2018. 9 See details of Macroprudential Forum https://www.ecb.europa.eu/ecb/tasks/stability/framework/html/index.en.html. 11 See FSB Global Monitoring Report on Non-Bank Financial Intermediation 2018.

60 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 61 Ed Sibley Ed Sibley

for financial stability, and hence impor- from funds or insurance for ­example, lender of last resort to provide liquid- authorities, and indeed from govern- tant for supervisors. This is particu- they must cooperate more intensively.­ ity support if and when required. ments to ensure the right legislative and larly important in today’s monetary This is not easy to achieve. However to • More is needed to ensure that banks institutional frameworks and incentives policy environment with low interest maintain financial stability we must are resolvable without recourse to the exist for a stable financial system. rates and search for yield dynamics take a holistic perspective and pursue taxpayer. We have the infrastructure but the which are increasingly pushing up an integrated approach. This is impor- • Therefore, the second pillar of bank- effectiveness of the interaction between prices.12 tant to ensure that the entire financial ing union remains incomplete. macro and micro needs to be continu- • On the one hand, the fact that CRE system serves the best interests of con- • The third pillar of the banking union ally worked on, reinforced and improved. financing is moving outside domestic sumers and wider society. – a European deposit insurance Without effectiveness of both, the fi- banking systems is positive for finan- scheme (EDIS) – remains missing. nancial system is prone to excessive risk cial stability – potential losses can be Banking Union and CMU Deposit protection should transfer to taking, short-termism, and failure. This shared more widely, liquidity is increased So where does this leave us? Much prog- the European level, as has already does not serve the longer term needs of and foreign investors may exit an over­ ress has been made to increase financial happened with banking supervision the European economy nor its citizens. heating market sooner, thereby damp- stability in the EU and euro area, ini- and bank resolution. Thank you, I look forward to the ening a boom.13 tially with the establishment of the Euro­ • Completing Capital Markets Union discussion. • On the other hand, given growing pean System of Financial Supervision (CMU) should also be a priority. ­interconnectedness boom-bust cycles encompassing the European Supervi- Deep and liquid capital markets have could be amplified as CRE markets sory Authorities and the ESRB, and then the potential for private risk-sharing become more synchronised globally. with the establishment of the Banking to smooth economic shocks, thus Authorities need to be ever more Union – notably with the establishment ­increasing stability. ­vigilant in monitoring leverage and of the Single Supervisory Mechanism Much has changed for prudential super- ­maturity mismatches of non-bank (SSM) and Single Resolution Mechanism. vision in response to the measures entities.­ The first 20 years of EMU have been ­enacted to preserve financial stability • Forthcoming research by staff at the chequered; the culmination of a 30-year going forward. And what does the next Central Bank of Ireland highlights upswing in the global financial ­cycle, twenty years have in store? Well, a lot these risks and vulnerabilities and and the worst economic crisis since the of work: from regulators and supervi- that market-based finance can be a 1930s.15 sors of all segments of the financial sec- source of disruption of services to the The crisis resulted in many impor- tor, from central banks, from macro- real economy in and of itself.14 tant legislative and institutional innova- prudential authorities, from resolution What does this mean for supervision? tions, with the introduction of the SSM • It means all sectoral supervisors must and SRM being the most visible. have a wider view of the financial sys- However, the job is not yet complete. tem in which firms are operating. To list a few areas of priority: • It means supervisors must increasingly • Significant work is required in the focus on macro-financial dynamics. banking sector to ensure adequate • It means financial stability assess- risk reduction in the level of non-per- ments must be fully embedded in super­ forming loans and a build-up of MREL. visory risks frameworks. • The issue of liquidity in resolution • It means that where National Compe- will need to be addressed within tent Authorities for banking are separate Banking Union to ensure there is a

12 See ESRB Report on vulnerabilities in the EU commercial real estate sector, November 2018. 13 See Non-bank involvement in the Irish commercial property market, Central Bank of Ireland, Financial Stability Note (forthcoming). 14 Ibid. 15 See Europe and the euro 20 years on, address by Mario Draghi, at Laurea Honoris Causa in Economics by ­University of Sant’Anna, Pisa, 15 December 2018.

62 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 63 Martin Wolf Escaping the trap: secular stagnation, Associate Editor and Chief Economics Commentator Financial Times, London monetary policy and financial fragility

“Some say the world will end in fire, between real demand and the ups and Some say in ice.” (Robert Frost1) then downs of global credit. Crucially, the story is not yet over. These brilliant lines by the poet Robert The discussion below will begin by Frost capture the world‘s current econo­ delineating today’s strange world. It mic prospects. Some warn that today’s will then look at how it got there. A dis- world of high debt and low interest rates cussion of what comes next will follow. will end in the fire of inflation. Others prophecy that it will end in the ice of Our strange world deflation. Others, again, such as Ray We need to start by recognising just how Dalio of Bridgewater, are more ­opti­mistic: strange the world in which we now are the economy will turn out to be neither actually is. Prior to 2009, the Bank of Eng- too hot nor too cold, just like the baby land never lent to banks at a short-term bear’s porridge, at least in countries that rate of less than 2%. That had been low have had the fortune (and wit) to borrow enough to cope with the Napoleonic wars,­ in currencies they can create freely. two world wars and the Great Depre­ssion. If we are to make any sense of the Yet, for a decade its base rate has, remark- strange place in which the world economy ably, been very close to zero (chart 1.) is today and the even stranger places in Equally striking is the extraordinarily which it might be tomorrow, we need a low level of long-term real interest rates. story about where it came from. By “here”, UK data are again very useful, because I mean our world of ultra-low real and it has been issuing index-linked “gilts” nominal interest rates and populist pol- (longer term government bonds) since itics. The simplest story about how we the 1980s. The real yield on 10-year index- ended here is one about the interaction linked securities has been zero, or less,

Chart

Bank of England lending rate since 1694 %

6

4

6

4

October 74 7 4 4 March 64

Source: Bank of England.

1 https://www.sparknotes.com/poetry/frost/section9/.

46th ECONOMICS CONFERENCE 2019 65 Martin Wolf Martin Wolf

Chart Chart 4

The decline of real interest rates Central bank balance sheets over GDP % %

4

3

7

6

– 4

– 3

–3 3 6 4 7 UKyield on year indelinked ilt USyield on year TIPS

Source: Refinitiv, FT analysis. 7 3 7 US Federal Reerve Euro area ECB UK BoE apan Bo

Chart 3 Source: Refinitiv, Bank of England, FT analysis. Central bank intervention rates % Chart 6 Core inflation rates 4 year on year in % 4

3

6

4

–

– an 6 an an an an 4 an 6 an – USA apan UK Euro area Source: Refinitiv. Federal Reerve Sytem Bank of Enland Deutche Bundebank ECB Bank of apan

Source: Refinitiv.

been close to zero since 1995. Further- We should not be too surprised by since 2011. In the USA, the equi­valent to raise its federal funds rate to 2.5%, more, central bank balance sheets have this world of ultra-aggressive monetary real yield has recovered somewhat, but it but only with difficulty and already, at also expanded hugely since the crisis, policies, including outright asset pur- has been close to 1%, or less, since 2011 this very low rate by historical stan- especially the BoJ’s. Yet the BoJ has still chases by central banks and favourable (chart 2). dards, is shifting towards easing.2 been unable to get inflation much above long-term lending to banks, and yet The Bank of England’s ultra-low The European Central Bank’s rates are zero. Weak inflation is not ­Japans’s weak inflation. Ray Dalio of ­Bridgewater nominal interest rates are not unique. still close to zero, as are the Bank of problem alone. It remains strikingly has laid out the logic in his important The US Federal Reserve has managed ­Japan’s. The latter’s rate has actually low elsewhere, too (charts 3, 4 and 5). ­recent book Principles for Navigating Big Debt Crises.3 2 James Politi, 2019, Fed chair cements case for cut in interest rates, Financial Times, 10 July, https://www.ft.com/ content/8bf10bf0-a30c-11e9-974c-ad1c6ab5efd1. 3 Ray Dalio, 2018, Principles for Navigating Big Debt Crises, Bridgewater.

66 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 67 Martin Wolf Martin Wolf

Mr. Dalio’s central point is that gov- depression induced by a downward spiral Chart ernments of countries whose debts are of mass bankruptcy and collapsing Ratios of sectoral debt to GDP in mature economies denominated in their own currencies ­demand. Mr. Dalio calls this a “beautiful % of GDP are able to manage the aftermath of a deleveraging”. It is achieved by a mixture 4 crisis caused by excessive credit. Above of four elements: austerity; debt restruc- all, they can spread out the adjustment turing and outright default; money “print- over years, thereby preventing a huge ing” by central banks, not least to sustain Chart 6 asset prices; and other transfers of income and wealth. An impor­tant part of such 6 Debt sustainability deleveraging is keeping long-term in- 4 10-year bond yields less annual growth in nominal GDP terest rates below growth of nominal 6 incomes. That has now been achieved, even in Italy (chart 6). 7 7 7 4 US policymakers were the most Houehold Non-financial corporations Financial corporations overnment

3 successful in reacting comprehensively. Source: Institute of International Finance. Back in the 1990s, Japan took too long to adopt the right combination of policies. Chart So did the euro area after 2008, largely because of obstacles to active fiscal policy China’s indebtedness over GDP in the currency union, but also because­ % – of ideological resistance to using the full 3 – capacities of the central bank. The UK’s –3 response fell between that of the USA –4 and that of Japan and the euro area. 4 6 4 6 Even if the needed policies are success- USA apan ermany UK Italy France fully adopted, they are always unpopular. So, not least, is the aftermath of any finan- Source: Refinitiv, FT analysis. cial crisis. Sharing out losses generated by 6 4 6 Chart 7 Households Non-financial corporations Financial corporations overnment debt Debt over GDP of mature economies Source: Institute of International Finance. % of GDP 4

3 a financial crisis, followed by the inevitably of the huge current account surplus, weak recovery, always creates public rage. which had peaked at close to 10 % of gross 3 Where has this left us today? Not domestic product prior to the global finan­ where we would like to be, is the answer, cial crisis. Third, crisis-hit economies are in three respects. First, while financial still far below pre-crisis trend output

and household debt have fallen relative levels. Productivity growth is also low. to incomes in mature economies, that is Finally, the populist politics of left and not true for debts of governments or right remain in full force. All this is in non-financial corporates (charts 7 and 8). keeping with past experiences with big Second, the transatlantic crisis trig- debt crises. They have always thrown long 7 7 7 gered offsetting debt explosions else- shadows into the future. Houehold Non-financial corporations overnment Financial corporations where, notably in China (chart 9). That Source: Institute of International Finance. debt explosion was no accident: the surge Understanding our strange world in credit in China was needed to make So how did we end up in this strange higher investment offset the disappearance world?­ Crucially, the world of falling real

68 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 69 Martin Wolf Martin Wolf

interest rates on safe assets preceded the credit explosion, especially in the USA Where might the world economy notably of public debt, as the inflation crisis. Larry Summers has described that and ­peripheral Europe. This was not go next? of the 1970s did. Moreover, central banks phenomenon as “secular stagnation” that ­accidental: these credit bubbles were William White, former chief econo­mist know what to do in response to a surge in is, a world of structurally weak ­aggregate needed to drive ­demand in the early of the Bank for International Settle­ments, inflation. Yet higher inflation would also demand.4 2000s. They proved unsustainable, so presciently warned of financial risks lead to a rise in long-term nominal interest bequeathing­ the post-crisis world we ­before the 2007–09 financial crisis. Last rates, which front-load the real burden of have lived in since 2008. But that post-­ year, he warned of another crisis, point- debt service. Short-term rates would crisis world has not ended. The persis- ing to the continuing rise in non-finan- ultimately jump, as they did in the early tently ultra-low interest rates we see cial sector debt, especially of govern­ 1980s. Inflation- and term-risk premia ­today demonstrate that. ments in high-income countries and would surely rise. High-flying stock mar- We can divide the last two decades corpo­rations in high-income and emerging kets could well collapse, as they did in the into two periods. “Pre-crisis secular stag­ economies.6 Those in emerging coun- 1970s. Labour relations would inevitably nation” was a world characterised by low tries are particularly vulnerable, because become more strife-prone, as would and falling real interest rates and hugely much of their borrowing is in foreign politics. This disarray would hit unevenly, destabilising credit and property-price- currencies. This causes currency mis- causing bouts of currency disorder. The cum-investment bubbles. It was a world matches in their balance sheets. Mean- loss of confidence in public institutions, in which credit bubbles offset the under­ while, monetary policy fosters risk-taking, notably central banks, would be severe. lying forces of secular stagnation. while regulation discourages it – a recipe In the end, the likely stagflation would “Post-crisis secular stagnation” has for instability. end in severe recession, as in the 1980s. been a world of near-zero real interest Consider first the risks of inflationary None of this would be fun. It could even A decisive moment was the Asian rates, partial deleveraging, weak growth fire. Much of what is going on right be politically disastrous. ­financial crisis, after which the world’s and pervasive populist politics, also assisted­ now in the USA recalls the early 1970s: Now turn to deflationary ice. This most dynamic economies became net by the huge post-crisis Chinese stimulus. an amoral US president (then Richard might begin with a sharp negative econo­ expor­ters of capital. But there are other It is a world in which, at first, extreme Nixon) determined to achieve re-election, mic shock: a worsening trade war, a war significant factors: high gross savings rates fiscal and monetary policy kept demand pressures the Federal Reserve chairman in the Middle East or a crisis in private­ or in important emerging economies, above going and then just­ extreme monetary (then Arthur Burns) to deliver an eco- public finance, possibly in the euro area, all, China; persistently weak pro­duct­ivity pol­icy. Hyper-aggressive monetary pol- nomic boom. He also launched a trade where the central bank is relatively con- growth in high-income economies; ageing icy has been needed since the crisis war, via devaluation and protection. A strained in its ability to respond effectively.­ in many economies and so a declining ­because the credit channel no longer decade of global disorder ensued. This The result could be a deep recession, even demand for physical capital; and dein- works very well. Central banks have had sounds rather familiar, does it not? In the a lurch into deflation, so worsening the dustrialisation in high-income econo- to rely on the less efficient ­asset-price late 1960s, few expected the inflation of debt overhang. The big difficulty would mies. Also important have been rapid falls channel ­instead. That in turn has driven the 1970s. Similarly, a long period of stable be knowing how to respond given that in the relative prices of capital goods them to policy ­extremes. No central bank and low inflation has calmed fears of an interest rates are already­ so low. Conven- ­and shifts in the distribution of income actually wanted to run the monetary poli- upsurge, even though unemployment tional policy (lower short-term rates) and towards profits and the highly paid. The cies they have been following.­ They had no rates have fallen to 50-year lows in the conventional unconventional policy (asset overall eff­ect has been to shift the balance acceptable alternative.­ Deflationary debt- USA. Some suggest that the Phillips purchases) might well be insufficient. between ­potential income and desired destru­ction­ is ­politically intolerable. They curve – the short-term relationship A range of other possibilities exists: spending, against the latter. The result know that. ­between unemployment and inflation – still more negative rates from the central has been the falling real interest rates we In sum, pre-crisis secular stagnation is dead, because low unemployment has bank; lending to banks at lower rates have experienced. in the West looked like the Japan of the not raised inflation. More likely, it is than the central bank pays on their depos- The financial crisis was itself the 1980s. Post-crisis secular stagnation in sleeping. Inflation expectations may now its; purchase of a much wider range of ­consequence of this environment.5 Low the West looks like Japan of the 1990s and be anchored. But a strong surge of demand assets, including foreign currencies; (nom­inal and real) interest rates triggered 2000s. The developed world as a whole might still sweep that anchor away. monetisation of fiscal deficits; and even rising property prices and an associated­ has, alas, followed the Japanese trajectory. Such a rise in inflation could even be “helicopter drops” of money. Much of helpful. It would reduce debt overhangs, this would be technically or politically 4 Larry Summers, 2018, The threat of secular stagnation has not gone away, Financial Times, 6 May, https://www.ft.com/content/aa76e2a8-4ef2-11e8-9471-a083af05aea7. 5 This is a core argument of Martin Wolf, 2015, The Shifts and the Shocks: What We’ve Learned – and Have Still 6 William White, 2018, Bad Financial Moon Rising, Project Syndicate, 3 October, https://www.project-syndicate. to Learn – from the Financial Crisis, London: Penguin. org/commentary/global-economy-weak-fundamentals-by-william-white-2018-10?barrier=accesspaylog.

70 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 71 Martin Wolf

problematic. Some of it would require almost certainly outweigh a move to close co-operation with the government. somewhat higher interest rates. The world Meanwhile, if governments acted too would, above all, be moving out of “­secular slowly (or not at all) a depression might stagnation” into something less bad. ensue, as in the 1930s, via mass ­bankruptcy That shift might be tricky to manage But and debt deflation. Many fools recom- it would at least be to a much better world. mended just those policies in 2008. It is not necessary to repeat the mis- Yet none of these disasters is inevita- takes of either the 1930s or the 1970s. ble. They would be chosen catastrophes. But we have made enough mistakes As Mr. Dalio argues, a golden mean is ­already and are, collectively, making also conceivable. Fiscal and monetary enough more mistakes right now to risk policy would then co-operate to generate such outcomes. A breakdown of the global non-inflationary growth. Changes in economic and political order now seems fiscal incentives could be used to discour- conceivable. The impact on our debt- age debt and encourage equity. Govern- encumbered world economy and increas- ment fiscal policy could shift income ingly fraught global politics is impossible towards spenders, reducing reliance on to calculate. But it could be horrendous. debt-fuelled asset bubbles for sustaining Above all, the nationalistic strongmen demand. More debt could be moved out now in power – in the USA, above all – of the balance sheets of financial inter- would be unable to co-operate if things mediaries directly on to the balance went seriously wrong, as they might, sheets of households. perhaps even soon. A fragile world Even if real interest rates rose, perhaps economy needs sober and co-­operative­ because productivity growth strength­ened policymaking. But that seems highly durably or income shifted towards unlikely, in another crisis. That is, argu- spenders, the impact of robust non-infla­ ably, the single most worrying feature tionary growth on the debt burden would of our world.

72 OESTERREICHISCHE NATIONALBANK Session 3 Monetary and fiscal stability Ernest Gnan Monetary and fiscal stability – a post-crisis Council to the Board and Head of Economic Analysis Division Oesterreichische Nationalbank view on a complex relationship Secretary General SUERF It is with good reason that a conference No, in the sense that already during dealing with the first and the next 20 the negotiations for the Maastricht years of EMU devotes a session on the Treaty, many well-renowned economists relationship between monetary and fis- and policy makers had warned to set up cal stability. To begin with, it is com- a currency union without a political mon knowledge that in a heterogeneous union. Given the lack of readiness for monetary union like the euro area, fis- political union by most Member States cal policy is needed to cushion asym- (even during the Maastricht negotiations metric economic shocks in the various in the late 1980s/early 1990s, prior to euro area countries which cannot be the EU’s „Scandinavian“ and „Eastern“ dealt with by the single monetary pol- enlargement rounds), the compromise icy. This is to say, fiscal policy should be that emerged was a framework that designed in a way that countercyclical sought to provide fiscal stability and fiscal policy at the national level – at counter-­cyclical room for maneuver least through the working of automatic through preventive mechanisms that stabilizers, if appropriate also through should ensure deficit and debt levels in active discretionary measures – is fea- normal times. sible, without endangering fiscal sus- Economic history is full of examples tainability. The experience of the first where fiscal instability was the source 20 years of EMU has shown that this of financial and currency crises. Thus, fundamental aim has not been achieved: the concern that fiscal latitude might fiscal policy was at various stages procy- endanger the euro’s price stability was clical during economic upturns, imply- at the root of various provisions in the ing that the opportunity to build buf- EU Treaty aiming to ensure that the fis- fers for downturns was not (fully) used. cal policies of individual Member States In turn, fiscal policy had to be restric- should be „sound“. On the one hand, tive during downturns and in several various provisions (prohibition of mon- countries even during the crisis because etary financing, prohibition of privi- of serious threats of fiscal crises and leged access, inclusion of government even state bankruptcies. So, it seems bond interest risk premium in the con- fair to say that fiscal policy has not con- verge criteria for EMU participation) sistently supported macroeconomic and aimed to strengthen market discipline. financial stability during the first two On the other hand, the Excessive Defi- decades of EMU. Did this come as a cit Procedure, which was enhanced by surprise? Yes and no. various vintages of the Stability and Yes, in the sense that the EU Treaty Growth Pact (SGP), aiming at creating legislator would not have knowingly and the leeway for countercyclical policies, on purpose have designed a euro area if need be, and at preventing fiscal crises policy set up that could be expected not by setting rules that constrain national to work. And in principle, the frame- governments’ fiscal policies. work could have worked (and could still) The first 20 years of EMU have shown if only all players consistently adhered­ that market forces alone, while in prin- to the agreed rules. And indeed, during ciple seemingly useful, in practice work the first 10 years of EMU, while not late and then very abruptly, thus miss- perfect, EMU seemed to function quite ing to provide a reliable disciplinary smoothly. force on governments’ policies during

46th ECONOMICS CONFERENCE 2019 77 Ernest Gnan Ernest Gnan

calm times, while exacerbating fiscal are sufficiently destructive. Besides macroeconomic and monetary stability, • Should the use of fiscal space be coor- and financial fragility in crises situations. some other refinements in fiscal rules, while supporting potential growth as dinated within the euro area, imply- Hence, fiscal rules are an indispensable the main response taken by EU authori- best as possible. This would imply that ing that countries with balanced bud- complement to market discipline. At ties has been to create new mechanisms the SGP’s prescription to safeguard bal- gets or surpluses should be „encour- the same time, the track record so far for mutual assistance between the euro anced structural fiscal balances should aged“ to run deficits, while countries has also shown the limits to fiscal rules. area Member States. The European Sta- be taken seriously by all Member States. with a fragile fiscal position should EU governments and even EU institu- bility Mechanisms (ESM) has over time This would create fiscal space for down- ­refrain from stretching their fiscal tions at times seem not to fully identify developed into the main instrument to turns. Procyclical policies during booms space even further? with them. The preventive arm of the provide such assistance, and is currently and pre-election periods would be • How should the above questions be SGP failed on various occasions to pre- in the process of developing its portfo- avoided. Debt to GDP ratios would assessed given that euro area mone- vent breaching of the quantitative defi- lio of roles in this respect (see Chapters gradually be wound down in countries tary policy already is operating at or cit and debt levels. The mechanisms to 39 and 40 in ESM, 2019). Various mea- that exceed the Maaastricht rules sub- close to the effective lower bound for ensure corrective action at times create sures to install „shock absorption mech- stantially, thus preserving market con- interest rates? Particularly, as in such tensions between countries threatened anisms“ and „fiscal stabilisation mech- fidence. Asset price booms in those a situation fiscal policy is in principle with sanctions and the EU Commission nanisms“ among euro area countries are Member States in which monetary con- more effective (as long as it is consid- and other Member States. In fact, recent currently being discussed (see Katterl ditions resulting from the single mone- ered sustainable by markets). experience may suggest that in the and Köhler-Töglhofer, 2018; Prammer tary policy may be (too) easy would be • How to assess the interplay between event of non-compliance with the fiscal and Reiss, 2018). The idea to create Euro­ contained by macroprudential policies, (unconventional) monetary policy (in rules, it may in turn be rising risk pre- bonds, European Safe Bonds (ESBies) which may also include some fiscal particular sovereign bond purchases) miums (and thus market mechanisms) or Sovereign Bond Backed Securities measures. The structure of fiscal reve- and fiscal space? Is it a mere side effect that ultimately prompt governments to (SBBS), which are fully or partly issued­ nues and expenditures would be adjusted that central banks’ sovereign bond take corrective action. So, it might be a jointly by euro area governments, and to support potential growth and envi- purchases, besides their aim to loosen combination of market forces and fiscal numerous variations therof, have been ronmental sustainability, while not los- financing conditions for the economy rules that work best to avoid gross fiscal debated for several years. Finally,­ there ing sight of social acceptance. Fair com- at large, ease governments’ budget mistakes. is also the idea to create a „central Euro­ pensatory mechanisms to cushion costs constraints through lowering debt pean fiscal capacity“, in other words to for reform losers would help to extend servicing costs and by absorbing a pool a much larger fraction than the cur- policy reform space. substantial fraction of new bond issu- rent EU budget’s 1% of Member States’ The recent years have seen a marked ance and outstanding stocks? Or have GDP in a central euro area budget, with improvement in euro area countries’ we slipped into a regime where, faced a „European Minister of Finance“ being fiscal positions, which was partly due to with the effective lower bound on in charge (Juncker et al., 2015). sizable fiscal savings, partly facilitated ­interest rates, monetary policy oper- All these proposals have so far found by an extended and broad-based eco- ates through extending governments’ their limits in the tradeoff between nomic recovery, and not least strongly fiscal space? If this was the case, what ­effectiveness and relevance in terms of aided by ultra-low long-term interest could the long-run consequences for orders of magnitude, on the one hand, rates due to the Eurosystem’s uncon- macroeconomic and price stability be? and incentives for moral hazard and lack ventional monetary policies. Neverthe- • Finally, once inflation moved back to of willingness for (additional) fiscal less, debt to GDP levels in most euro target, could a normalization of mon- centralization and fiscal transfers (par- area countries have not declined notice- etary policies (hike in official interest ticularly permanent ones) between euro ably. This raises several questions and rates, melting down of central banks’ At the same time, the experience area Member States, on the other hand. concerns with regard to future fiscal sovereign debt holdings) threaten fis- since the global financial crisis, the It is not clear at this point, how far such sustainability: cal sustainability? In other words: Great Recession and the European Debt initiatives for ”euro area fiscal deepen- • First, how should Member States’ fis- how to prepare public finances for Crisis has also shown that even the ing“ will lead, and within which time cal policies respond to an economic monetary policy normalization? combination of market forces and fiscal horizon. cooling off, if it turned into a reces- This introduction only touched upon rules may not prevent fiscal crises – Against this background, for practi- sion? How much fiscal space do vari- some issues, with many more being ­ultimately even threatening the euro cal purposes, attention might usefully ous euro area countries actually have ­neglected. The two presentations in ­itself – if only the shocks affecting coun- focus on how fiscal policy, within the before concerns about fiscal sustain- this session pick out two themes. First, tries’ banking and economic systems existing frameworks, can contribute to ability resurface? Ludger Schuknecht addresses one aspect

78 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 79 Ernest Gnan

of the complex fiscal-financial stability topic briefly mentioned above, namely nexus, which has been highlighted by potential tensions between fiscal disci- the financial and sovereign debt crisis, pline and economic stabilization, an issue namely how to mitigate fiscal risks from which has been with the EU’s fiscal sta- the financial sector. The second contri- bility framework from the start and will bution by Gottfried Haber explores a remain relevant also in the years to come. References ESM. 2019. Safeguarding the euro in times of crisis. The inside story of the ESM. https://www.esm. europa.eu/sites/default/files/safeguarding-euro-times-crisis-inside-story-esm.pdf. Juncker, J.-C., D. Tusk, J. Dijsselbloem, M. Draghi and M. Schulz. 2015. Completing ­Europe’s Economic and Monetary Union. https://ec.europa.eu/commission/sites/beta-political/ files/5-presidents-report_en.pdf. Katterl, A. and W. Köhler-Töglhofer. 2018. Shock prevention and shock absorption instru- ments – the status quo. In: OeNB. Europe 2030: building a more resilient European monetary union. Monetary Policy & the Economy Q2/18. Prammer, D. and L. Reiss. 2018. How to increase fiscal stabilization at the euro area level? In: OeNB. Europe 2030: building a more resilient European monetary union. Monetary Policy & the Economy Q2/18.

80 OESTERREICHISCHE NATIONALBANK Gottfried Haber Strengthened EU fiscal framework: fiscal President 1 Austrian Fiscal Advisory Council discipline versus economic stabilization

After a peak in 2014, the continuous fiscal policies, to increase transparency reduction of general government’s gross and quality of the budgetary process or debt to GDP ratios within the euro area to implement a comprehensive surveil- and the EU-28 and the improvement of lance mechanism (see e.g. Calmfors and the structural budget balance during Wren-Lewis, 2011). Two main features the last decade might be linked – among of an effective surveillance mechanism others – to the evolvement and are numerical fiscal rules and Indepen- strengthening of EU’s fiscal framework dent Fiscal Institutions (IFIs) to moni- in the aftermath of the crisis. However, tor the compliance with fiscal rules. the legally based requirement of fiscal The enforcement of these two ele- discipline in the EU might have reduced ments has played an important role dur- macroeconomic stabilization facilities ing the economic governance process of of general governments. Fiscal sustain- the EU2, that has been stepped up due ability on the one hand and fiscal space, to the crisis since 2011 (chart 1): both on the national levels and the EU • The application of numerical fiscal level, on the other hand have led to a rules has been expanded in the con- discussion about the design of fiscal text of the second amendment of the rules and the pros and cons of a (cen- Stability and Growth Pact3 in 2011 tral) fiscal capacity. (Sixpack) when the expenditure benchmark and the debt reduction Review of the strengthened fiscal benchmark were introduced. In addi- framework in the European tion, fiscal rules have been further Union developed in terms of concretion and The deficit bias – leading to a poten- flexibility (e.g. in 2015 the imple- tially unsustainable increase of public mentation of the “matrix”, represent- debt – is supposed to be a trigger for a ing the scope of different required strengthened fiscal framework. The annual fiscal adjustments of the struc- deficit bias is based on disincentives tural budget balance that depend on particularly caused by moral hazard or the overall fiscal position and the eco- common pool problems that will lead nomic situation). to a mismatch of self-interest versus • IFIs became a compulsory part of the common welfare and/or short versus (national) fiscal framework based on long-term perspectives. For example, the Fiscal Compact (2012) and the policymakers tend to focus on discre- Twopack (2013) and were comple- tionary measures in the short term, mented with the European Fiscal paying insufficient attention to their Board (EFB) that was established in budgetary impact in the medium and 2016. the long term. Possible ways forward to IFIs are involved in the European Semes- counteract excessive discretionary be- ter – providing or endorsing macro havior of policymakers are to raise rep- and/or fiscal forecasts, assessing com- utational and electoral costs of unsound pliance with (national and EU) ­fiscal

1 Co-author: Bernhard Grossmann, Head of Office, Austrian Fiscal Advisory Council. 2 See https://ec.europa.eu/info/business-economy-euro/economic-and-fiscal-policy-coordination/eu-economic-gov- ernance-monitoring-prevention-correction_en. 3 The first amendment of the SGP included the introduction of a country-specific midterm budgetary objective (MTO) in structural terms as of 2005.

46th ECONOMICS CONFERENCE 2019 83 Gottfried Haber Gottfried Haber

Chart Member States. However, the impact of • to keep or reduce debt-to-GDP ratio Economic governance process of the EU in the aftermath of the crisis an IFI depends on certain conditions:4 at or to a sustainable level; Debrun and Kinda (2014) elaborated • to generate budgetary room of maneu- Fiscal policy: 2015 EC communication: Making the that IFIs can promote stronger fiscal ver to absorb shocks. best use of the �lexibility of SGP  Surveillance (Analysis, discipline if they are well-designed. Thus, the design of fiscal rules is crucial forecasts, reports, rules) 2013 „Twopack“ Thus, certain characteristics of IFIs are to ensure that rules work properly and

 Prevention (goals, programs, associated with stronger fiscal perfor- to avoid sub-optimal outcomes (i.e. to 2012 Fiscal compact assessments, recommendations) mance but the mere existence of a hamper automatic stabilizers’ work). At

 Correction (procedures) 2011 „Sixpack“ council is not. An operational indepen- this stage, it is worth to mention the dence from politics, the provision or existing trade-off between effectiveness Structural policies: SGP public assessment of budgetary fore- to reduce the deficit bias and simplicity  Europe 2020 strategy 1997 casts, a strong presence in the public of rules: the more inherent flexibility of

 Macroeconomic imbalance debate, and an explicit role in monitor- a fiscal rule – as to achieve optimal out- procedure (MIP) ing fiscal policy rules are key for effec- comes – the more scope is left for defi- tive fiscal councils. Coletta, Graziano cit bias. Local ownership, political will Crisis resolution: and Infantino (2015) found empirical and (complementary) monitoring by “European semester”:  Financial assistance (ESM etc.) support for the hypothesis of a positive IFIs are further criteria – separate from coordination framework for 5  ECB’s non-standard measures economic policies impact of IFIs on fiscal performance, in the design – to support the effective-  Banking & capital markets union cases of a strong legal status that ensures ness of fiscal rules. institutional and financial independence Source: Authors’ illustration. and access to inside information. But it is worth to mention that such empirical results might be subject to reverse cau- rules and adopting recommendations like market pressure or the policy mak- sality issues and affected by omitted that refer to national fiscal policy. How- ers’ increased awareness of financial ­determinants (e. g. see Beetsma et al., ever, IFIs represent “competence cen- vulnerability and contagion effects, the 2018). These findings – concerning the ters” related to national fiscal policy and evolvement and strengthening of EU’s mandate and design of an IFI – are very serve as link between Member States fiscal framework in the aftermath of the in line with the Austrian Fiscal Advi- and the EU as well. crisis has been crucial for that develop- sory Council’s experience. In addition, ment. From an IFI’s point of view, the the Austrian Fiscal Advisory Council IFIs’ and fiscal rules’ impact on impact of fiscal rules and of established suggests high transparency and quality increased fiscal discipline: some or underpinned independent monitor- standards for IFIs in order to support its evidence? ing institutions on fiscal discipline is a credibility and effectiveness. In general, the fiscal positions have sig- matter of particular interest. A brief Effective fiscal rules help to reduce From an empirical point of view, we nificantly improved in the Member survey of literature indicates strong evi- the deficit bias and – with respect to the have recognized an increasing number States of the EU and the euro area dence of a positive relationship refer- government’s macroeconomic stabiliza- of numerical fiscal rules in force in the (Euro-19) in the recent past: general ring to IFIs and of some evidence in the tion function – usually should ensure EU Member States since 1990 with an government’s gross debt decreased case of numerical fiscal rules: tax smoothing as defined by Barro and obviously higher dynamic in the period from its peak of 88.3% respectively While Beetsma and Debrun (2016) counter-cyclical fiscal policy as defined of austerity to (re)gain sound public 94.4% of GDP (2014) to 81.5% respec- identified a more general potential by Keynes (Portes and Wren-Lewis, ­finances since 2010 . Based on the Euro­ tively 87.1% of GDP (2018). Since ­impact of IFIs to discourage excessive 2014). Against this backdrop effective- pean Commission’s Fiscal rules data- 2010, the structural budget deficit has deficits as they can increase the likeli- ness corresponds to the reliability of base (2019), the number of national fis- been decreasing from 4.2% of GDP hood of electing competent govern- fiscal­ rules: cal rules almost doubled from around (Euro-19) and from 4.5% of GDP (EU- ments, some studies investigated the 28) to 0.7% respectively 0.9% of GDP ­direct link between the existence of an 4 General principles for IFIs to be effective (e. g. local ownership, broad-based political support, technical expertise, in the year 2018. Among other factors IFI and the fiscal performance of EU consistent communication etc.) were defined by the OECD (2017). 5 See Kopits and Symanski (1998) for criteria of good practice. Following the fiscal rules should be – among ­ others – well defined, transparent, simple, flexible and enforceable.

84 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 85 Gottfried Haber Gottfried Haber

60 (2010) to around 110 (2017) in the been any financial sanctions yet, except markets and inter-temporal con- moderate expenditure pressure stem- EU-28. During that time period, the in the context of statistical reporting sumption smoothing through credit ming from different interest groups by number of EU Member States under ­issues). The latter indeed matters from markets), as well pre-defined expenditure limits. How- the ­Excessive Deficit Procedure (EDP) the IMF’s point of view: high debt levels 4. a central/federal fiscal capacity or ever, OECD’s estimations show that ­according to the SGP decreased contin- and the record of weak compliance and insurance mechanism expenditure rules are not sufficient to uously from 24 EU-Member States to lax enforcement argue for a fundamen- Structural budget balance rules usually significantly reduce the deficit bias (Fall less than 10.6 This negative correlation tal reform of the EU fiscal rules provid- help to ease the trade-off between pro- and Fournier, 2015). Furthermore, the might be a simple indication for effec- ing simpler and more transparent rules moting fiscal discipline and permitting objective to reduce the volatility of out- tiveness of fiscal rules but subject to and a better aligning of political incen- macroeconomic stabilization. This type put can be more easily achieved by rules causality issues as well. However, more tives with rule compliance (Gaspar and of numerical fiscal rules lets automatic on balanced budgets, rather than on ex- sophisticated empirical analyses suggest Amaglobeli, 2019). stabilizers work and ensures sustainable penditures, revenues or debt (Sacchi and some evidence: In general, unconstrained debt levels as well. Thus, it is no sur- ­Salotti, 2015). discretion might lead to neglect public Space for macroeconomic prise that such kind of rules-based fiscal Macroeconomic stabilization gener- sector solvency (Debrun et al., 2018). stabilization and shock absorption policy reflects the core element of the ally needs counter-cyclical fiscal policy Heinemann et al. (2017) used meta-­ instruments European SGP. In comparison, expen- but the necessary achievement of mid- regression analysis to show a constrain- A resilient economic system is charac- diture rules are likely to reduce exces- term budgetary objectives (MTO) based ing effect of rules on fiscal aggregates, terized by low vulnerability to adverse sive deficits and hardly hamper auto- on the SGP might cause pro-cyclicity. but their results are limited by the en- shocks and a high degree of flexibility matic stabilizers that are predominantly Monitoring with the aid of fiscal stance dogeneity problem and publication bias. when absorbing shocks to avoid high existing on the revenue side. Increased analysis8 can help to evaluate the rele- Bergman et al. (2016) worked out that ­adjustment costs. Sound financial and attention has been paid to these expen- vance of this issue. The European Fiscal rules are effective in reducing struc- fiscal policies, as well as structural poli- diture rules in the recent past (e. g. Board (EFB, 2019) concluded in its recent tural primary deficits, but their positive cies to improve the growth potential in Bruegel, IMF, OECD) as they might assessment of the fiscal stance for the impact on the government’s efficiency the long run, and an efficient and well- is even larger. Conversely, Caselli and functioning national legal system (con- Table Reynaud (2019) could not find any sta- tractual certainty and safeguarding of tistically significant impact of rules on property rights) are crucial for Member Fiscal rules with regard to fiscal discipline and room for macroeconomic stabilization fiscal balance on average, once endoge- States to be less vulnerable to shocks Objective: long-term sustainability of public finances neity was adequately controlled for. (Katterl and Köhler-Töglhofer, 2018). Operative Strengthening of fiscal Support to macro- To sum up at this stage, there is no Thus, a sound policy mix ensures both Risks and implications economic stabilization clear-cut evidence of an optimal rule a wide-ranging regulatory system that rules discipline • No flexibility for Nominal • Consolidation might and its effectiveness. This result – usu- directly affects the degree of vulnera- economic stabilization • Boosts fiscal discipline worsen quality of public budget • Tends to procyclical ally based on the relationship between bility on the one hand and the establish- balance rule finances the existence of rules and sound public ment of fiscal buffers to absorb (at least fiscal policy Structural • Uncertainty of potential finances – should be seen with respect to some extend) shocks on the other • Boosts fiscal discipline • Let automatic stabilizers output/output gap budget • Defines room for work measures impede to different causes of non-compliance. hand. To be more specific, in a mone- balance rule discretion planning and monitoring Hence, unsound fiscal developments tary union the impact of country-spe- • Boosts fiscal discipline • Limited development of • Does not ensure • Possible integretion into might arise even in the case of existing cific shocks can be smoothed through Expenditure automatic stabilizers on balanced budget budgetary process rule the expenditure side • Possible evasions numerical rules. For example, non- the following different channels (Alcidi • Directly influenceable compliance could be caused by an extra­ and Thirion, 2017): Boosts fiscal discipline • Often distorted by • • Tends to procyclical special items ordinary bad situation of a comprehen- 1. counter-cyclical national fiscal policy Debt rule • Usually no operative rule fiscal policy sive exogenous crisis, but could be an 2. labour mobility7 but anchor • Possible evasions

issue of weak enforcement of rules as 3. market mechanisms (risk-sharing Source: Authors’ compilation. well (based on the SGP there have not through access to international capital

6 In June 2019 – taking the council’s decision on the abrogation of Spain’s EDP into account – all the excessive ­deficit procedures dating from the crisis were closed. 7 Labour mobility will not be considered in more detail: In theory it is an important channel for adapting to asym- 8 As applied by the EFB, a measure of the direction and extent of discretionary fiscal policy defined as the annual metric shocks, in practice, it has had only a limited effect and this is unlikely to change in the future (Alcidi and change in the structural primary budget balance in the context of the economic situation (represented by the Thirion, 2017). output gap).

86 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 87 Gottfried Haber Gottfried Haber

euro area that “in an economy operat- tion and create room for some (addi- similar to the first approach – the fiscal absorption capacity in the euro area ing around potential and in view of eco- tional) discretionary fiscal policy mea- space. The debt limit approach esti- ­related to the higher financial and credit nomic and geopolitical uncertainty, a sures during downturns. Thus, fiscal mates fiscal space as a distance of the market integration (i.e. cross-border neutral fiscal stance is appropriate for rules determine the dimension and pos- current debt-to-GDP ratio to a debt level loans and holdings of financial assets) in the euro area as a whole in 2020.” This sible use of national fiscal shock absorb- beyond, bearing the risk that ­sovereigns the period 1999 to 2015, apart from can be achieved with differentiated ers in terms of the general government’s will not fulfill their debt obligations.­ other factors like the activation of the ­fiscal stances at the country level to budget. “Fiscal space” literature (e. g. Based on the experience so far, fiscal EFSF or ESM (Cimadomo et al., 2018). ­respect the differentiated fiscal require- ECB, 2017; IMF, 2018) deals with this space in the euro area is very heteroge- This is a field of intensified discussion ments of the SGP for Member States at topic and tries to define the existing neously distributed among EU Member and research, usually coming up with the same time.9 In contrast, that flexible room of maneuver without violating States and for this reason very limited the conclusion that more risk sharing is approach was no option in the years (rule based) budget constraints. Refer- to overcome the crisisat the national needed for a resilient and sustainable 2011 to 2014. Due to necessary correc- ring to the ECB (2017) definition, fiscal levels. Against this backdrop, national monetary union (e. g. OECD, 2018; tive measures based on the ongoing space represents the scope for budget- fiscal or regulatory buffers (automatic ­Ioannou and Schäfer, 2017) and that the EDPs after the crisis on the one hand ary maneuver while preserving overall stabilizers, institutional set up, market completion of the banking union, capi- and the still bad economic conditions fiscal soundness.10 However, there is no flexibilities etc.) have been supplemented tal markets union and a fiscal capacity (negative output gaps) on the other commonly agreed approach to estimate by macroeconomic stabilization and would notably contribute to this. In a hand, the fiscal stance within the euro fiscal space. Based on recent policy shock absorption instruments in the EU currency union, risk-sharing takes place area was pro-cyclical and restrictive. ­discussions, the ECB identified three and the euro area to overcome the mainly through the savings (credit) and However, feasible pro-cyclicity might approaches, depending on different ­financial crisis in 2008 and 2009 and to capital market channels as well as be no single matter of fiscal rules with sources of constraints on fiscal policy. be prepared for exceptionally strong through fiscal transfers between Mem- regard to OECD countries (excluding Following these considerations, constraints economic and financial crises in the ber States. While international credit EU Member States) that are supposed on fiscal policy might arise from: ­future as well. Some important fiscal markets smooth the impact of shocks to be subject to less binding rules, while • fiscal frameworks, particularly fiscal policy related instruments11 have already on consumption through the continued our calculations show a high degree of rules, been implemented, e. g. the macroeco- credit supply, international capital mar- pro-cyclicity of fiscal policies as well. • a comprehensive debt sustainability nomic imbalance procedure (MIP) that kets are prone to smooth the impact of analysis (DSA), or was part of the “Sixpack” and was intro- an asymmetric shock on income in a • debt limits. duced in the year 2011, and the Euro- member state. Public transfers between A simple measure of fiscal space, e. g. pean Stability Mechanism (ESM) was Member States or stemming from a derived from the SGP (fiscal framework established as a lender of last resort (and central budget could ease both shocks approach) can be the distance of the as a successor to the European Financial on consumption and/or income.­ The structural balance to the MTO. This Stability Facility – EFSF) in October recent literature gives no indication on distance can also take flexibility instru- 2012. In addition, the EU’s budget can how those channels supplement or com- ments – depending on cyclical and contribute to macroeconomic stabiliza- plement each other. However, to find the other „relevant“ factors – into account. tion via its redistribution and conver- right balance between risk reduction and DSA reflects debt dynamic projections gence efforts among Member States and risk sharing, and public and private risk and the identification of stable debt direct provision of public goods. sharing, remains a challenge. Especially, ­levels in a most likely (benchmark) sce- These systemic and institutional increased risk sharing might lead to nario and in the presence of various ­instruments have been accompanied by moral hazard effects as well. ­adverse shocks. Each scenario corre- strong non-fiscal policy measures: the In addition, it is worth to mention To conclude at this stage, fiscal rules sponds to an underlying primary bal- development of a European financial that monetary policy, without the con- like structural budget balance rules are ance. The distance between realized union (banking union, capital markets ventional and unconventional measures designed to ensure sustainable debt levels primary balances and those that ensure union, macroprudential supervision) during and after the financial crisis in while they allow for automatic stabiliza- sustainable debt levels defines – very and monetary policy measures. Although general (e. g. Targeted Longer-Term the comprehensive financial union has Refinancing Operations – TLTRO; Asset not been completed yet, the ECB has Purchase Program – APP), significantly 9 Nevertheless, the EFB expects a pro-cyclical expansionary fiscal stance in the years 2019 and 2020 taking into account the fiscal measures that Member States have already adopted or sufficiently documented. ­already recognized an increased shock- contributed to gain fiscal space of euro 10 The IMF (2018) defines fiscal space as room for undertaking discretionary fiscal policy (fiscal stimulus or slower pace of consolidation) relative to existing plans without endangering market access and debt sustainability. 11 For more detailed information see e. g. Katterl and Köhler-Töglhofer, 2018.

88 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 89 Gottfried Haber Gottfried Haber

Table any case, pros and cons (i. e. macroeco- to change rules periodically in case of Interest savings of the Austrian general government comparison of nomic stabilization versus moral hazard any adjustment necessities. different estimations issues) must be considered. From a longer term perspective, fis- cal policy should be framed by fiscal Bundesbank FISK OeNB OeBFA Concluding remarks rules, complemented by a well-designed Fiscal measures do matter to ensure institutional framework, where fiscal Interest economic smoothing. While sound councils play a key role to safeguard EUR 35 billion EUR 9.3 billion EUR 3.5 billion EUR 17 billion savings public finances define the scope for (dis- sustainable public finances. In such a cretionary) fiscal stimulus in general, framework, an additional central fiscal General Federal General Federal ­automatic stabilizers hold an important capacity might counteract asymmetric Considered government (ESA) government excl. government (ESA) government excl. entities (no correction for off-budgetary (corrected for off-budgetary macroeconomic stabilization function. shocks without violating fiscal rules. reclassifications) entities reclassifications) entities As automatic stabilizers should not be However, inherent moral hazard issues Considered restricted by a fiscal (rules) framework, must be addressed. Hence, it is not an time 2008–2016 2009–2016 2012–2016 2009–2016 the design of fiscal rules is crucial. Basi- easy task to find the right balance be- horizon cally, structural budget balance rules tween risk reduction and risk sharing, Re-financing Re-financing rel. could ensure all of the desirable proper- and public and private risk sharing. Counter- Implicit interest Implicit interest based on forecast to average ties, such as fiscal discipline, a pre-defined Transparency of national budgets, factual of 2007 (4.9%) of 2008 (4.31%) assumptions interests 1999– (06/2012) 2008 (4.17%) room for discretion and unlimited func- simple and strict rules but still allowing tioning of automatic stabilizers.­ Referring for necessary stabilization measures as Source: Bundesbank, Office of the Austrian Fiscal Advisory Council (FISK), Oesterreichische Nationalbank (OeNB), Austrian Treasury (OeBFA). to the experience of implementing the well as strong and independent mone- SGP in the past, it seems to be prefera- tary institutions and fiscal councils play area Member States via lower interest level while full coverage by a common ble in terms of credibility to explore the a key role in ensuring sustainability of payments. In the case, of Austria inter- shock absorber. This could be sort of a existing flexibility of rules rather than public finances. est savings achieved significant volumes “reinsurance” for national unemploy- ranging from EUR 3.5 to EUR 35 bil- ment insurance systems and might be References lion, depending on the different entities established above a certain threshold. Alcidi, C. and G. Thirion. 2017. Assessing the Euro Area’s Shock-Absorption Capacity. Risk and time horizons taken into consider- The idea of an additional fiscal capacity sharing, consumption smoothing and fiscal policy. Brussels. ation (table 2). However, those savings to absorb asymmetric shocks is not new Andritzky, J. and J. Rocholl (eds.). 2018. Towards a more resilient euro area. Ideas from the in the past go along with increasing fis- and gained momentum at the EU level “Future Europe” Forum. Brussels. cal risk in the future due to expected in the recent past, for instance outlined Beetsma, R. and X. Debrun. 2016. Fiscal Councils: Rationale and Effectiveness. IMF Working interest changes. Indirect monetary fi- in the 2017 European Commission’s Paper WP/16/86. Washington, DC. nancing of public debt has also to be Reflection Paper, in the OECD’s Eco- Beetsma, R., X. Debrun, X. Fang, Y. Kim, V. Lledó, S. Mbaye and X. Zhang. taken into account as a possible issue, nomic Surveys for the euro area (2018) 2018. Independent Fiscal Councils: Recent Trends and Performance. IMF Working Paper which is under discussion. or in the European Fiscal Board’s first WP/18/68. Washington, DC. The wide range of national and Annual Report (EFB, 2017). While the Bergman, M., U. Hutchison, M. M. and S. E. Hougaard Jensen. 2016. Promoting sustainable ­international instruments for macro- European Commission promotes a Euro­ public finances in the European Union: The role of fiscal rules and government efficiency. economic stabilization and shock absorp- pean Investment Stabilization Function In: European Journal of Political Economy 44. 1–19. tion in the EU and euro area are regu- (EC, 2019), others support options con- Calmfors L. and S. Wren-Lewis. 2011. What should Fiscal Councils do? CESifo Working Paper larly subject to reforms and further cerning the creation of a euro area bud- 3382. ­developments. For instance, Gros (2014) get with some stabilization properties Caselli, F. and J. Reynaud. 2019. Do Fiscal Rules Cause Better Fiscal Balances? A New Instru- argues: “What the eurozone really needs or focus on unemployment benefits (see mental Variable Strategy. IMF Working Paper, WP/19/49. International Monetary Fund. Wash- is not a system that offsets all shocks by e. g. Andritzky and Rocholl, 2018). ington, DC. some small fraction, but a system that There is no single answer, whether and Cimadomo, J., O. Furtuna and M. Giuliodori. 2018. Private and public risk sharing in the protects against shocks that are rare, how to establish an additional fiscal euro area. ECB Working Paper Series 2148. May. Frankfurt. but potentially catastrophic.” Thus, minor ­capacity in order to strengthen the Coletta, G., C. Graziano and G. Infantino. 2015. Do Fiscal Councils Impact Fiscal Perfor- cyclical shocks that do not impair the ­resilience of the euro area against asym- mance? Government of the Italian Republic (Italy), Ministry of Economy and Finance, Depart- functioning of financial markets can be metric shocks, nor is there consensus ment of the Treasury Working Paper 1. Available at SSRN: https://ssrn.com/abstract=2588436. dealt with via borrowing at the national on the need for such a fiscal capacity. In

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Daianu, D. 2018. In the euro area, discipline is of the essence, but risk-sharing is no less important. SUERF Policy Note. April 30. Debrun, X., L. Eyraud, A. Hodge, V. Lledo and C. Pattillo. 2018. ‘Second-generation’ ­fiscal rules: From stupid to too smart. CEPR Policy Portal. https://voxeu.org/article/second-gen- eration-fiscal-rules-stupid-too-smart. Debrun, X. and T. Kinda. 2014. Strengthening Post-Crisis Fiscal Credibility: Fiscal Councils on the Rise – A New Dataset. IMF Working Paper WP/14/58. Washington, DC. European Central Bank. 2017. Conceptual issues surrounding the measurement of fiscal space. In: ECB Economic Bulletin 2/2017. Frankfurt. European Commission. 2017. Reflection Paper on the Deepening of the Economic and ­Monetary Union. Brussels. European Commission. 2019. Report on Public Finance in EMU 2018. Institutional Paper 095/ January 2019. Brussels. European Fiscal Board. 2017. Assessment of the fiscal stance appropriate for the euro area in 2018. 15 November. Brussels European Fiscal Board. 2019. Assessment of the fiscal stance appropriate for the euro area in 2020. June 25. Brussels Fall, F. and J.-M. Fournier. 2015. Macroeconomic uncertainties, prudent debt targets and fiscal rules: OECD Economic Department Working Papers 1230. Paris. Gaspar V. and D. Amaglobeli. 2019. Fiscal Rules. SUERF Policy Note 60. March. Gros, D. 2014. A fiscal shock absorber for the eurozone? Lessons from the economics of insurance. CEPR Policy Portal. https://voxeu.org/article/ez-fiscal-shock-absorber-lessons-insurance-eco- nomics. Heinemann, F., Moessinger, M.-D. and M. Yeter. 2017. Do fiscal rules constrain fiscal policy? A meta-regression-analysis. In: European Journal of Political Economy 51 (2018). 69–92. International Monetary Fund. 2018. Assessing fiscal space: an update and stocktaking. ­Washington, DC. Ioannou, D. and D. Schäfer. 2017. Risk sharing in EMU: key insights from a literature review. SUERF Policy Note 21. November 2017. Katterl, A. and W. Koehler-Toeglhofer. 2018. Stabilization and shock absorption instruments in the EU and the euro area – the status quo. In: OeNB. Monetary Policy & the Economy Q2/18. Vienna. OECD. 2017. Designing effective independent fiscal institutions. https://www.oecd.org/gov/bud- geting/designing-effective-independent-fiscal-institutions.pdf. OECD. 2018. OECD Economic Surveys Euro Area. http://www.oecd.org/eco/surveys/economic- survey-european-union-and-euro-area.htm. Portes J. and S. Wren-Lewis. 2014. Issues in the design of fiscal policy rules. University of ­Oxford. Discussion paper series 704. Sacchi A. and Salotti S. 2015. The impact of national fiscal rules on the stabilization function of fiscal policy. In: European Journal of Political Economy 37. 1–20.

92 OESTERREICHISCHE NATIONALBANK Ludger Schuknecht Mitigating fiscal risks from the financial sector Deputy Secretary-General OECD The debate on future risks for public needs may face a stronger reaction­ of ­finances so far mainly focusses on bud- financing costs as they may face both getary risks from population aging. In higher rates and higher risks spreads. many advanced countries, these risks This is particularly the case when the are in fact already materialising in rising risk environment changes. The risk social spending ratios, deficits and debt. premium relative to government defi- There is, however, another very important cits and debt had increased by the factor fiscal risk dimension. This emanates from of 4–8 in the context of the global fi- the financial sector. It has been present nancial crisis in comparison to earlier in developing and emerging economies years (Schuknecht, von Hagen and for decades. However, it has also become Wolsiwjk, 2011). Even sudden stops oc- visible and relevant in advanced­ coun- curred in countries like Greece, ­Ireland tries with the global financial­ crisis. or Portugal. During the crisis, public deficits and The sensitivity of public finances to debt ballooned as banks needed bailouts changes in financing costs is palpable. and real economies declined. Seven advanced country governments However, there has been no system- had to finance more than 10% of GDP atic analysis through which channels in 2018. The figure exceeded 20% in ­financial developments affect public Italy and United States and even 40% of ­finances and which risks could materi- GDP in Japan (table 1). In the case the alise in the future. A first risk map and United States or Italy, for example, a exploration of the transmission chan- 1% higher average interest rate would nels was developed in Schuknecht (2019). have implied almost ¼% of GDP higher This policy note summarises the chan- interest payments just in the first year. nels and elaborates on the policy impli- Over time, the refinancing effect would cations. compound. Moreover, fiscal balances in advanced 1 Budgetary effects of financing countries in 2017/18 were significantly conditions and asset prices worse in most G7 countries than 10 There are five channels that link the fiscal years earlier (table 2). The average debt and financial sphere: ratio had increased from 80% to almost 1. Direct effects on budgets from higher financing costs and changes in asset Table 1 prices. Government financing needs, selected 2. Indirect effects via the real economy, advanced economies in 2018 through automatic stabilisers, guar- Maturing Deficit Total antees and growth effects. debt financing 3. Fiscal obligations from bank and non-­ need bank financial sector difficulties. % of GDP Euro area 4. Risks with central banks, and Belgium 17.0 1.3 18.3 5. International obligations either via France 10.4 2.4 12.8 international credit exposure or via Germany 5.0 –1.5 3.5 Italy 20.6 1.6 22.2 international bailout programs. Portugal 12.7 1.0 13.7 As regards the first channel, there is an Spain 15.9 2.5 18.4 Other advanced economies important risk from potentially higher Japan 37.2 3.4 40.6 costs for the financing needs of govern- USA 18.7 5.3 24.0 ment when interest rates change. Govern­ ments with higher debt and financing­ Source: IMF Fiscal Monitor Oct. 2018.

46th ECONOMICS CONFERENCE 2019 95 Ludger Schuknecht Ludger Schuknecht

Table 2 global financial crisis, the growth decline more pro-cyclical behaviour unless Fiscal buffers: General government deficit and debt was much larger than tightening financing countries have accumulated sufficient

2007 2017 conditions would have suggested. This is buffers in good times. Third, govern- because economic confidence collapsed. ments should be very careful with as- Deficit Debt Deficit Debt Deficit Debt However, we do not understand well suming private sector risks. They need % of GDP Change (pp) 2017–2007 when we “switch” from “regular” to non-­ to understand what they are doing in USA –2.9 64.6 –4.6 107.6 –1.7 43 linear relations between finance and the investment projects, in public enter- Japan –3.2 175.4 –4.2 236.4 –1.0 61 Canada 1.8 66.8 –1.0 89.8 –2.8 23 real economy. prises or in the financial sector so that United Kingdom –2.6 41.9 –2.3 86.9 0.3 45 Financial effects on the real econ- explicit or implicit guarantees do not Germany 0.2 63.7 1.1 63.7 0.9 0 omy and the availability of finance can threaten fiscal stability. Fourth, finan- France –2.5 64.4 –2.6 97.4 –0.1 33 Italy –1.5 99.8 –1.9 131.8 –0.4 32 also affect public budgets through the cial sector and monetary policies can G7 –2.2 80.6 –3.4 118.6 –1.2 38 calling of government guarantees. For contribute to lower fiscal risks indi- example, public-private partnership rectly via money and credit develop- Source: Ameco. contracts may contain public support ments that smoothen boom bust cycles provisions. Or governments may have and the related overinvestment and to step in when providers go bankrupt. misallocation of capital. 120% of GDP in 2017. The average deficit ­financing for public debt (which has to Surprisingly, there are no studies on was above 3% of GDP in 2017, also some extend happened over the past such fiscal risks that materialised in the 3 Fiscal risks via the banking higher than in 2007 before the global ­decade). Third, tax systems should be past and data on the exposure to such sector financial crisis. Most G7 countries had made less sensitive to asset prices and, risks in the future is patchy. Since the global financial crisis, there debt ratios near the level that Italy perhaps more importantly, not contain Finally, financial developments affect has been growing awareness of fiscal posted in 2007. Hence, the vulnerability biases that are conducive to debt financing the allocation of capital which, in turn, risks from the banking sector. In fact, of governments to a worsening financial and asset price boom bust cycles. can affect potential growth and, the crisis resulted in huge costs for gov- environment has increased. thereby, public finances. Borio, Khar- ernment finances (table 3). The magni- Another noteworthy channel for roubi, Upper and Zampolli (2015) argued tude ranged from 4% (United States) to finan­­ cial­ developments affecting fiscal 2 Fiscal risks via the real economy that overinvestment in the real estate 35% of GDP (Greece) in advanced balances is via asset prices. When asset Fiscal balances are sensitive to real and financial sector in the boom, and countries, and several countries posted prices (notably house and equity prices) economy developments via so-called underinvestment in human capital (as double-digit losses. By 2015, gross costs boom, governments yield extra revenue ­automatic stabilisers. As revenue fluctuate young people started working in con- had risen to over USD 2 trillion. Costs from transaction taxes, capital gains and broadly with real economic activity and struction instead of studying) resulted in were also often very large as a share of wealth effects on consumption. These public expenditure remain unchanged, less human capital. When the crisis hit, banking assets. This prompted govern- revenue windfalls tend to reverse when the budget deficit falls and widens with the misallocated capital had to be written ments across the globe to demand more boom turns to bust (Eschenbach and economic upswings and downturns. In off. This resulted in an overly optimistic capital and liquidity (amongst other Schuknecht, 2004). After 2007, declines fact, budgetary sensitivities to changes assessment of the economic and fiscal things) from their banks. in revenue ratios in the countries most in economic growth are quite significant situation in boom times and less potential affected by the global financial crisis and amount to almost ½% of GDP for growth thereafter (Borio, Disyatat and were between 1% of GDP for the UK and each percent of higher or lower growth. Juselius, 2013). 6% of GDP for Spain. By contrast, While this implies a large stabilisation Policy implications from these trans- countries that did not face a housing bust effect of budgets without any active in- mission channels are complex. First, in the crisis, like Germany, ­Italy or France, tervention of the state, it can also mean there is a potential trade-off between did not report any significant­ decline in a significant deterioration in budget bal- the automatic stabilisation role of gov- the revenue ratio (Schuknecht, 2019). ances over an economic downturn. A ernment and the risks from cyclical What are the policy lessons? First, it major recession, like in 2009, with fluctuations for the budget. This is a is important to have sufficient fiscal growth of say 5% below trend worsens tough choice: more progressive taxes buffers so that higher financing costs do the deficit by 2 or 2 ½% just via auto- and counter-cyclical spending policies not constitute major fiscal risks and matic stabilisers. would enhance economic stability while sudden stops do not reoccur. Second, Financial factors can be a major reducing that of the budget. Second, debt managers should seek long term driver of economic downturns. In the balanced budget rules may result in

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Table 3 Chart Chart

Financial crisis support post 2009 Corporate sector debt ratio Holders of government debt by sector in 2016

Gross Impact Gross impact % of GDP % % of end 2009 % of GDP banking assets Austria 6.2 5.6 Belgium 7.2 8.9 Cyprus 20.0 .. 6 6 Germany 12.3 10.4 4 4 Greece 34.9 33.1 Ireland 36.3 20.4 Netherlands 17.3 13.5 Slovenia 12.0 13.2 Spain 7.4 3.9 7 6 UK US KR CH SE FR CA BE NL DE P IT ES AU United Kingdom 11.6 5.9 Source: IMF Global Debt Database. Dometic bankin ector Domestic non-bank financial institutions Central bank United States 4.3 6.4 Forein bank Foreign non-bank financial institutions Foreign official sector Average 7.4 .. Source: BIS. USD billion 2,114.0 .. today. There are a number of vulnera- Source: IMF, Fiscal Monitor, April 2015; World Bank, Global Financial Development Database. bilities in the banking system that could Definition: Total assets held by deposit money banks as a share of GDP. again turn into budgetary costs down poorly rated governments. The absence reduce implicit and contingent fiscal Assets include claims on domestic real nonfinancial sector which includes the road especially if financing costs of concentration limits and the exemption risks (see also BIS, 2017). Reducing central, state and local governments, nonfinancial public enterprises and private sector. Deposit money banks comprise commercial banks and start rising rapidly and significantly from risk weighting (as well as other public debt and deficits further and, other financial institutions that accept transferable deposits, such as demand deposits. again. Just as regards risks to public privileges) are the reasons for such a thereby, improving the financial health ­financing costs, snapback risks could distorted portfolio allocation in favour of governments themselves would, derive from an increase in the level of of government debt. however, be the best contribution for There are a number of factors that rates and from the risk appetite reflected The magnitude of exposure is huge stopping the bank-government “doom- raise fiscal costs of banking sector dif- in spreads. First, a number of European (chart 2). In Japan and Italy, the banking loop”. ficulties. These include high and rising countries posted significant shares of sector holds about 30% of all domestic debt in/credit to the private sector, non-performing loans even 10 years after government debt – about 60% and 40% 4 Fiscal risks from the non-bank government guarantees (especially blan- the crisis started. The list included in of GDP respectively. In France, Canada financial sector ket deposit guarantees), open-ended particular Greece and Cyprus, but non- and Belgium, the ratio to total debt and The non-bank financial system has grown ­liquidity support, regulatory forbear- performing loans also exceeded 10% of GDP is about 20%. Any major rating much faster over the past decade than ance, debt biases in the tax system and all loans in Portugal, Italy and Ireland at downgrade or re-assessment of govern- banking crises mutating to fiscal crises the end of 2017. Such risks continue to ment debt could undermine the bank- Chart 3 (see Schuknecht 2019 for a survey). Evi- prevail. ing system’s health via accounting Total global debt and the role of dence on the quantitative relevance, Second, private corporate sector losses. Given the link between financing shadow banking however, is very limited. debt, which had been one of the reasons conditions of banks and sovereigns, the % of global GDP USD trillion As a result, banks everywhere in- for financial sector difficulties in the real economy would also suffer via

creased their capital and contingent crisis, was significantly higher on average tighter financing costs and availability capital and their resilience as regards in the late 2010s than before the global (CGFS, 2011). short and long term funding, and they crisis (chart 1). Only few countries, The policy implications are clear designed resolution plans etc. Moreover, ­including notably Spain and the United and well known. Implementation of the under the auspices of the G20 and the Kingdom have reported significant G20/FSB regulatory agenda for banks

FSB, derivatives markets were regulated ­declines in corporate debt ratios. remains essential and, fortunately, and rules for relations with market-based Third and perhaps most importantly, progress is significant (FSB, 2019). Total lobal debt Broad hadow Potentially volatile public private bankin hadow bankin finance were developed. As the implemen- banks hold significant amounts of govern- Moreover, the reduction of non-per- USD trillion of lobal DP ment debt on their balance sheets. This tation of this agenda progressed, buffers forming loans, and the reduction in Source: IMF, 2018 GFSR (debt), BIS (size of shadow banking). and resilience of banks improved, espe- exposure can reach five or eight times regulatory privileges for government Note: Size of shadow banking refers to credit/assets managed by cially for the systemic ones. the capital of bank, notably in Europe. debt would enhance the health and non-bank financial sector in FSB member countries (85% of Still, the literature provides little Such an exposure could be particularly ­resilience of the banking system so as to global GDP). Potentially volatile implies potentially run-prone. guidance on risks in the financial system problematic when the debt is from

98 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 99 Ludger Schuknecht Ludger Schuknecht

the banking system. The BIS estimates has tripled to almost USD 13 trillion Table 4 ­exceeded USD 13 trillion (table 4). the run-prone part of “shadow banking” over the past two decades. Over 50% of International credit Losses on these exposures could get to be USD 50 trillion or about 70% of advanced country corporate bonds in banks and ­asset managers into trouble, % of global USD trillion global GDP. This is about one quarter the investment grade range were rated GDP with ­demands for government support of total global debt which is at a record BBB in 2018. The corresponding fig- Total 30.7 37.6 potentially in its wake. historic high (chart 3; see also IMF, ures in the past were in the 25%–45% Bank loans 13.3 16.3 The greater global financial interde- Cross border 8.0 9.8 2018, FSB 2018). Given the role of non- range. A much larger share of bonds Local in foreign currency 5.3 6.4 pendence and international financial banks in the global financial crisis, the was in the covenant light category, giv- International debt securities 17.5 21.3 risks are reflected in ever bigger IMF G20 also agreed on a regulatory agenda ing creditors significantly less rights. It is Held by banks 4.7 5.7 support programs. These exceeded 10% Held by non banks 12.8 15.6 for this part of the financial system. Prog- hard to conceive that a major downgrad- of GDP in the case of Greece, Portugal­ ress has been significant as well but it is ing wave would leave markets with­out Source: BIS Quarterly Review, September 2018. and Ireland in the early 2010s, not count- on the whole less well advanced than in turmoil which, in turn, would lead to calls ing the (even higher) regional Euro­pean the banking sector (FSB, 2019). for government support to fend of credit support. The Asian crisis programs crunches and corporate bankruptcies. 5 Other fiscal risks around the turn of the millennium Third, there continue to be risks There are two further transmission were all much smaller. from increasing concentration of deriv- channels: fiscal risks from central banks As regards policy implications, ative trading in Central Clearing Parties and international obligations. Central these facts have given rise to an extensive (CCPs). This is despite better rules and banks in 2018 held about USD 10 tril- debate over the need for global financial regulation and the fact that such clearing lion worth of government bonds or safety nets. With a global GDP of USD has increased transparency and reduced about one fifth of the total market. 70 trillion, a safety net of USD 1 trillion risks. Failure of an important CCP is Losses from government debt holdings (roughly 2018/19 IMF resources) can unlikely to leave the CCP market un- could burden fiscal balances, unless cover a 15% program for 10% of the scathed, and calls for government/central countries were willing to run central global economy. This is not little but it bank bailouts/guarantees could follow. banks with low or negative equity or is also not very much. Even a significant AMB was saved in 2009 to prevent a hide losses in transitional accounts. In increase in safety nets would not change melt-down in derivative markets. any case, it is hard to conceive that a the fact that national fiscal buffers and As regards policy implications, the central bank holding much debt of a financial resilience must be sufficient in There are a number of vulnerabili- full implementation of the G20/FSB government that is going broke can the vast majority of the global economy. ties in this industry, that could burden regulatory agenda for non-banks remains­ avoid fiscal and financial dominance. Moreover, all the principles of finan- budgets in the future. First, pension essential. Again, more resilient govern- As regards fiscal risks from interna- cial sector prudence applying to the funds in many countries are seen to be ments are likely to help maintain stabil- tional financial obligations, there is ­national level should apply in particular underfunded even at 2018/2019 asset ity in non-bank financial markets as well. plenty of evidence from past banking to the international level. International valuations (OECD, 2019). Rauh (2018) Still, it is worth asking whether this and financial crises. In fact, part of the credit is an important instrument of sees the underfunding in the USA to is enough. Do we perhaps need circuit- losses during the global financial crisis risk mitigation across nations but this amount to 20% of GDP. In a major breakers in bond markets just as in stock mentioned above were of an interna- only works as long as buffers elsewhere stress scenario, funding gaps could be markets to halt future runs? Moreover, tional nature, and large international are sufficient. Central banks should not significantly larger in some countries. It clearer rules in government bond mar- creditors such as Germany suffered neglect financial risks resulting from is hard to conceive that governments kets with collective action clauses and particularly large losses. their monetary policy and liquidity would not be “asked” to share into fund- circuit breakers against runs such as International credit includes banks’ measures. ing shortfalls when the incomes of mil- standstills and prolongations would cross border and foreign currency The introduction of a sovereign debt-­ lions of pensioners are at stake. ­reduce the economic and fiscal costs of credit and international debt securities restructuring framework including pro- Second, not only has corporate debt government debt problems. Moreover, (BIS). In 2018, international credit ex- longations and standstills could improve on average increased in the past decade such provisions would increase market ceeded USD 30 trillion, which is ­almost incentives and help make do with lim- but the quality of this debt has declined monitoring and, thereby, governments’ 40% of global GDP. Almost 5 trillion ited safety nets. It could limit fiscal when it was financed via the market. incentives to build sufficient fiscal buf- worth of bonds are held by banks across ­financial risks by preventing that inter- The size of the corporate bond market fers (Weder and Zettelmeyer, 2018). border, another 13 trillion by non-banks/­ national governments pay for the private asset managers. Bank lending exposure sector exiting a market without bail-in (cross border or foreign currency) (Zettelmeyer, 2018; Destais et al., 2019).

100 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 101 Ludger Schuknecht Ludger Schuknecht

Finally, we may want to be prepared ­lesson. Fiscal resilience protects the References to rethink the role of circuit breakers in ­stabilising role of public finances in Bank of International Settlement. 2017. The Regulatory Treatment of Sovereign Exposures. international capital markets. Capital downturns, it prevents the potential Basle: Discussion Paper. controls in the context of the Greece ­fiscal financial­ doom loop and it pro- Borio, C., P. Disyatat and M. Juselius. 2013. Rethinking Potential Output: Embedding Infor- and Cyprus programs hold perhaps tects the credibility of central banks and mation About the Financial Cycle, Basle: BIS Working Papers 404. more lessons for the future than most international safety nets. Borio, C., E. Kharroubi, C. Upper and F. Zampolli. 2015. Labour Reallocation and Productivity people realise, and the OECD code on One way to gage the outer bounds Dynamics: Financial Causes, Real Consequences. BIS Working Papers 534. capital account liberalisation provides a of fiscal risks in the past is to look at Borio, C., Lombardi, M. and F. Zampoli. 2016. Fiscal Sustainability and the Financial Cycle, rules-based international governance public debt developments in very severe­ Basle: BIS Working Paper 552. framework. crisis episodes. It is likely that all of Borio, C., J. Contreras and F. Zampoli. 2019. Banking Crises: Implications for Fiscal Sustainability. these effects came together in these Basle: BIS Mimeograph. 6 Conclusions ­episodes even though we do not know Committee on the Global Financial System. 2011. The Impact of Sovereign Credit Risk on Financial developments can constitute how much came through which chan- Bank Funding Conditions. Basle: CGFS Papers 43. significant fiscal risks via a number of nel. Amongst the European ­countries, Destais, C., F. Eidam and F. Heinemann. 2019. The design of a sovereign debt restructuring transmission channels: Government the biggest debt increase ­affected mechanism for the euro area: choices and trade-offs. CEP II Policy Brief 2019–25. ­financing costs, asset prices, real econ- ­Ireland (plus 95.7% of GDP between Eschenbach, F. and L. Schuknecht. 2004. Budgetary Risks from Real Estate and Stock Markets. omy implications, banks and non-banks, 2007 and the post crisis peak). The Economic Policy. 313–346. central banks and international link- ­corresponding figures for Spain and Financial Stability Board. 2018. Global Shadow Banking Monitoring Report 2017. Basle. ages. These risks, where measured and Portugal were 64.9% and 62.2% Financial Stability Board. 2019. Implementation and Effects of the G20 Financial Regulatory analysed, were often very large. How- of GDP. The United Kingdom saw debt Reform. 4th Annual Report. Basle. ever, we still understand too little about increase by 47.1%. We saw earlier that International Monetary Fund. 2015, 2018. Fiscal Monitor. Washington DC. them and do not have a good sense of the figures­ for the USA, Japan, France International Monetary Fund. 2018, 2019. Global Financial Stability Report/GFSR. Washington DC. what could happen in the future. This is and Italy were above 30% of GDP. In OECD. 2019. Budgeting Outlook. Paris. particularly true for risks from market- some countries, fiscal deficits deterio- Rauh, J. 2018. Fiscal Implications of Pension Underfunding. Stanford University and Hoover Manuscript. based finance and the compound effect rated by over 10% of GDP in just 2 or 3 Schuknecht, L. 2019. Fiscal Financial Vulnerabilities. SAFE White Paper 62. of fiscal-financial vulnerabilities. years. Schuknecht, L. and H. Zemanek. 2018. Social Dominance. CESIfo Working Paper 6997. The note also provides a number of These figures are truly staggering Schuknecht, L., J. v. Hagen and G. Wolswijk. 2011. Government Bond Risk Premiums in the policy lessons: The implementation of and should be seen against a G7 ­average EU Revisited. European Journal of Political Economy 27. 26–43. the international regulatory agenda for near 120% of GDP in 2017/18. Borio, Weder, B. and J. Zettelmeyer. 2017. The New Global Financial Safety Net. Struggling for banks and non-banks should continue. Contreras and Zampoli (2019) suggest ­Coherent Governance in a Multipolar World. In: Essays on International Finance 4. Regulatory privileges for governments that fiscal buffers of up to 60% of GDP Zettelmeyer, J. 2018. Managing Deep Debt Crises in the Euro Area: Towards a Feasible Regime. need downscaling. Governments should would have been needed to deal with Global Policy 9:1. reduce debt biases in their tax system. 99% of the fiscal risks over recent de- More reflection should also be given cades. And the numbers above suggest­ to circuit breakers such as trading stops that this might well have been barely in bond markets, orderly capital controls, enough. and debt-restructuring frameworks It is not clear whether a similar ­including prolongation and standstill further increase in the next crisis procedures when debt sustainability is could be weathered easily even with at risk. Credible limits on contingent central bank assis­tance. Long maturity and implicit liabilities in the financial public debt finan­cing and the “good sector (and beyond) protect government old” Maastricht thresholds of 60% for finances and reduce moral hazard. reasonably safe debt and of a “close to Building sufficient fiscal buffers is balance” budget in normal times might probably the most important policy not be so stupid after all.

102 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 103 Session 4 The international role of the euro Martin Summer The international role of the euro from Head of the Economic Research Division Oesterreichische Nationalbank different perspectives

Today, the euro is the currency of 19 from June to December 2015 and Direc- countries with over 340 million citizens. tor Intellectual Property. She served in It is the second most important cur- various cabinets, such as in the Cabinet rency in the world. In this session we of Commissioner Barnier (Internal would like to look deeper into the role Market and Financial Services), Vice- the euro has played on an international President Barrot (Justice & Home Affairs), scale as well as its future role as an Commissioner Barrot (Transport), international­ currency. Commissioner Verheugen (Enlargement) The international role of the euro is and Commissioner Barnier (Regional closely linked to the role of the Euro- Policy and Institutional Affairs). She pean economy in the world. A wider was also a member of the negotiation global use of the euro can – for instance team of the Nice treaty. Kerstin Jorna – lower trading costs for European holds degrees in law (University of Bonn businesses, it can become more attrac- and Hamburg) and a Diploma of Advanced tive as a store of value and thus lead to European Studies, College of Bruges. decreased interest rates payed by Euro- Arnaud Mehl is a Principal Econo- pean households, firms and govern- mist in the Directorate General Inter- ments. It stabilises access to finance for national of the European Central Bank European businesses in turbulent times (ECB), where he works on issues related and makes the European economy less to the international monetary system, vulnerable to exchange rate shocks. global policy coordination and spill- An increased international role of the overs, the G7/G20, global finance and euro, however, also means increased exchange rate communication. Before responsibilities. It has consequences for joining the ECB, he worked for the central bank mandates, for balance of French Treasury and Edmond de Roth- payment issues and other policy fields. schild Group. He is a graduate from Clearly, if we discuss the interna- Sciences Po Paris and ESCP Europe, a tional role of the euro today, we must former visiting student at Oxford Uni- think in trade-offs, weighting the ben- versity and holds a PhD in economics efits an increased international role of from University Paris Dauphine. His the euro would have, against potential main area of specialisation is interna- risks and costs that come with an in- tional finance and economic history, on creased global responsibility. which he has published several academic I am very happy that we could con- articles. vince two outstanding speakers to come to our conference to discuss with us this complex topic, both with a deep and long experience in questions of inter­ national macroeconomics and interna- tional currencies: Kerstin Jorna has been the Deputy Director General in the Directorate General of Economic and Financial Affairs of the European Commission since 2016. She has a long professional expe- rience in working for European Institu- tions. She was Director for single market policy, regulation and implementation

46th ECONOMICS CONFERENCE 2019 107 Kerstin Jorna1 From start-up to scale-up: the global role of European Commission Deputy Director-General for Economic and Financial Affairs European Commission the euro

“Great powers have great currencies.” attractiveness of the euro. Since that (Robert Mundell, Nobel Prize laureate) time, the architecture of Europe’s Eco- nomic and Monetary Union (EMU) has been significantly reinforced. The EU is a great power The European Union (EU) covers over Is the euro “great enough”? 4 million km² with 508 million inhabit- Here the answer is: not yet. If the euro ants, which makes it the world’s third larg- played a more international role there est population after China and ­India. would be less dependence on the US dollar The EU is also responsible for around and other currencies. But, a more promi- 16% of global GDP. It is the biggest global nent role on the global scene for the euro is market as well as the biggest trading not a question of “if” but rather of “when”. block, and the top trading partner for Strengthening the global role of the 80 countries. A stable business and legal euro would have a positive impact on the environment without capital account countries of the euro area countries and on restrictions makes the euro area a par- the other EU Member States, but also ticularly reliable and attractive partner. globally, by enhancing financial stability worldwide and offering stakeholders, The euro is a great currency particularly investors, more choice. The euro area (EA) covers 19 countries. That is why the European Commission Around 60 countries have linked their issued a Communication “Towards a currencies in one way or another to the stronger international role of the euro” euro. The euro area alone represents in December 2018.2 340 million people. In its first 20 years of Let us try putting on “inventor lenses” existence, the euro has become a leading for a moment and look at the euro from reserve currency, invoicing currency and that perspective. Any invention starts with issuing currency. Since its beginning, a great idea. We can thank Francois Mit- Europe’s common currency has been the terrand and Helmut Kohl for that. The second most important global currency. idea needs capital (in our case, political Nowadays it constitutes around 20% of capital) in order to go from proof of con- global reserves and around 20% of debt cept to market introduction. For the euro issuance. What is more, 36% of global it meant building the institutions and invoicing and settlement are processed in creating the regulatory environment. euro. Europeans identify the euro as There is no doubt that the first 20 years one of the main symbols of the EU. The of the euro were a success. euro brings benefits like lower exchange rate and currency conversion costs, a Were the inventors of the euro reduced interest rate on euro denomi- zooming in on the global impor­ nated assets, price transparency and tance of the euro? more robust access to funding in times At the time of a creation of a single of stress in the markets. ­currency, the internationalisation of the Yet, it is important to acknowledge euro was not the priority for policy- that the financial crisis, which shook the makers. Given the strength of the mul- world, also affected the international tilateral rules-based order in the early 1 [email protected]. The views expressed in the text are the views of the author only and may not be interpreted as stating an official position of the European Commission. I wish to thank Martyna Chmiel and Ralph Schmitt-Nilson for their support in 2 https://ec.europa.eu/commission/sites/beta-political/files/communication_-_towards_a_stronger_interna- the preparation of this contribution. tional_role_of_the_euro.pdf.

46th ECONOMICS CONFERENCE 2019 109 Kerstin Jorna Kerstin Jorna

2000s, European leaders considered • working with your suppliers to do There is a sectoral dimension to this. China, for example, is creating incentives that promoting the internationalisation more, Some markets such as energy, trans­ along the Belt and Road Initiative (BRI) of the euro was not a necessary condi- • understanding how to engage your portation (aircraft) and commodities to allow for greater use of the Renminbi. tion to foster European economic customers in a broader way, are subject to very strong US dollar In a recent bilateral agreement with growth and trade. But that picture has • extending your distribution channels, dominance, sometimes for mostly his- Pakistan creating the China-Pakistan changed dramatically. • improving your after sales service, torical reasons. Tackling these possible Economic Corridor, the two countries The EU economy was hit by the • above all, it means finding capital. inefficiencies in specific sectors could agreed to conduct bilateral trade trans- ­financial and sovereign crisis, which Let us look at each of these five in rela- improve euro liquidity. actions in their own currencies. was triggered in the USA but had a global tion to the euro. However, the example of the aircraft impact. Quick technological change is industry also shows the challenges and ­re-shaping the functioning of financial 1 Suppliers limitations of fostering an enhanced role markets. The rules-based multilateral Suppliers are all those who bring euro- for the euro. A consultation launched system is being challenged and new denominated products to the market. by the European Commission at the economic powers are emerging. Among bond issuers, sovereign debt issu- ­beginning of the year shows that com- The world order appears to be shifting ance stands out. ECB data show that on panies tend to accept US dollars even from a rules-based multilateral system average 98% of the outstanding govern- when their cost base is largely in euro and towards a multi-polar world in which ment debt securities issued by euro area even if it implies difficult and costly Europe needs to define its new role. member states is denominated in euro. hedging operations.3 One key reason for This means also revisiting the global Yet, there are large differences among this is the prevalence of global supply role of the euro. It is time for the euro the euro area member states, ranging chains and financing options that are pre- to move from start-up phase to scale-up from 100% to 69%. Unsurprisingly, dominantly denominated in US dollars. phase. This means zooming in on how the same data show much lower euro- Inertia in these markets is a significant to increase the global role of the euro denominated issuance in non-euro barrier to greater use of the euro. 4 After sales servicing and give it global impact. member states. Here, the average is that 22% of the debt issued in these 3 Distribution channels Strengthening the international position How do you take a successful countries is denominated in euro and Distribution channels are the euro pay- of the euro will not be possible without product from start up to some countries, like the UK or Denmark, ment infrastructures and market places. strengthening the euro area from inside. scale-up? do not issue euro-denominated govern- Recent EU reforms to Europe’s clearing This means completing the Economic and Let’s put our inventor lenses on again. ment debt at all. and settlement systems, as well as the Monetary Union, including the Banking Scaling up a successful product means: European organisations “owned” by introduction of an instant payments sys- and Capital Markets Union.

Chart the EU member states have a slightly tem last year, have equipped the euro Deepening EMU is critical for the less good record than their shareholders. with the safest and most efficient, open international attractiveness of the euro The global role of the euro: from start­up to The EIB and the EBRD issued respec- and large payment infrastructure in the for three key reasons. First, confidence in scale­up tively 34% and 50% of their debt in US world. For the development of the ­market the value of the euro is ensured by the pre- dollars in 2018. place, completing the Capital Markets dictability and credibility of the EU’s mon- booter to trenthen the ue of Union will be crucial. The ease with etary and economic policies, as well as the the euro: 2 Customers → Suppliers eurodenominated which financial assets can be bought medium- and long-term growth pros- bond iuance The customers are those who use the euro and sold is essential for the financial sys- pects of the euro area. By improving → Customers ue of euro for payment and reerve for payments/settlements as well as tem to work properly and to support economic resilience and boosting growth → Distributions channel euro holding reserves. Despite the euro’s ­investment and economic growth. The potential, initiatives seeking to deepen Scale­up payment infratructure and market place ­relatively wide use in international pay- liquidity of a currency is therefore a sig- the EMU can support the attractiveness → After sales servicing trenthenin the euro area ments, less than 60% of the euro area’s nificant characteristic of a healthy dis- of the euro to international investors. from inide external exports are actually invoiced in tribution channel. This is why we need to promote growth-­ → Capital buildin political capital Start­up and trut capital euro. This is in stark contrast with the In addition, there is an increasing enhancing reforms and take steps at United States, where about 90% of ex- competition for distribution channels. ­national level to fully implement the

Source: European Union (2019). ports are invoiced in US dollars. Along Note: Non-commercial reproduction is authorised provided the source is acknowledged. For with encouraging issuance in euro, pro- 3 After the conference, the European Commission has published the results to the consultation: https://ec.europa. any use or reproduction of material that is not under the EU copyright, permission must moting its use as an invoicing currency eu/info/sites/info/files/strengthening-international-role-euro-swd-2019_en.pdf. be sought directly from the copyright holders. will also be important.

110 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 111 Kerstin Jorna Kerstin Jorna

Country-Specific Recommendations. We EMU and its overall resilience, which The Commission teams are still in the linked to long-established market habits. need to be able to create predictability will increase the liquidity and credit midst of analysing the data, but below In the oil sector, oil benchmarks are ­almost around investment. These considerations quality of euro-denominated assets. are some first conclusions. exclusively denominated in US dollars are also at the heart of the current dis- The take up of the consultation was and all oil derivative products depend cussions on a Budgetary Instrument for 5 Capital very good, with more than 60 respon- on these benchmarks. In the aircraft Convergence and Competitiveness. That takes us to the capital part, the ­alpha dents covering the key market actors ­industry, the US dollar is dominant Second, a robust institutional set-up is and omega for any inventor seeking to with around half of the participants across the whole value chain. Moreover, essential to increase the confidence of “sup- scale up. For the euro, we are talking coming from the banking sector, fol- banks and other investors are very pliers” and “costumers”. This also depends about political capital and trust capital. lowed by industry associations. Other ­reluctant to provide credit and liquidity on the strength of the institutions, and How can we present a convincing pitch? types of ­financial institutions such as in currencies other than the US dollar. the way their competences are organised There are some very strong argu- exchanges, trading platforms, invest- When asked about factors that could across levels of government. A stronger ments in the euro’s favour. Article 63 of ment funds, insurance companies and support a greater role of the euro, the EMU requires stronger legitimacy and the EU Treaty prohibits all restrictions on credit rating agencies also participated consultation found strong support for governance and a fair and balanced politi- capital movements and payments, not in the consultation. the package of measures proposed by cal representation of interests of all only within the EU, but also between EU Overall, there is broad support for the Commission in its December 2018 Member States. Those are the guiding countries and countries outside the EU. increasing the global role of the euro. Communication. Respondents supported principles underlying the current ­reform This is a (quasi) constitutional guarantee. Not surprisingly, there is broad agree- coordinated action at three levels, i.e. discussions on the European Stability The rule of law provides assurance for ment on the importance of liquidity for the EU level, the national level and Mechanism. businesses’ autonomy and capital flows. the global role of the euro. It matters in market participants. Completing the I already mentioned the size and eco- terms of volumes traded in foreign ex- Banking Union and the Capital Market nomic weight of the euro area. Reforms change markets, listing of currency Union was widely considered as an ele- on banking union and deepening EMU pairs available and promotion of euro ment to enhance trust and confidence are already underway. currency pairs by market makers. A in the euro. Two non-euro member states, Bulgaria majority of respondents highlighted and Croatia, have signalled recently that the market liquidity of currency Conclusion their intention to join the euro area and pairs involving the euro was lower in We are in the middle of a next project are actively getting ready, which con- comparison to those involving with the around the euro. The first 20 years firms that political and trust buy-in US dollar. were about starting-up. Now we are ­remains strong. Concerning the cost of hedging, gearing towards scaling-up. The debate I note furthermore that the role of views are more differentiated. While around the euro echoes a wider Euro- the euro caught the attention of political 45% of respondents judge hedging costs pean debate: what is the place of Europe actors far beyond finance ministries, to be broadly the same in euro and US in the world? To what extent will other namely foreign ministries and chancel- dollars, 37% consider hedging more global actors influence our decisions Third, deep and broad financial markets leries. This also means more “political expensive in euro. about citizens, data and governance? are necessary to increase the attractiveness capital”. A main conclusion stemming from How do we protect and leverage our of the euro both as a currency for payments All of this will affect market partic- the sectoral contributions, is that the ­internal strength globally? In this debate, and as a store of value. Investors looking ipants and support the development of prominence of the US dollar is strongly the euro is one of the crown jewels. for safety and liquidity need a broad “trust capital”. ­variety of euro-denominated financial The glass is half-full as we enter the assets and well-developed secondary new political cycle in Europe. markets. In this respect, the completion of the Banking Union and the Capital What are the next steps? Markets Union – building on the pro- After several targeted consultations on posals made by the Commission in energy, foreign exchange markets, air- ­recent years – remains crucial. These craft, maritime and rail respectively, are central initiatives for the further the Commission will pull results together ­integration of financial markets in the in a report that is scheduled for June.

112 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 113 Arnaud Mehl1 The euro’s global role: past, present Principal Economist European Central Bank and future

The creation of the euro 20 years ago since it surpassed the pound sterling as aimed primarily to address Europe’s the world’s dominant currency during own internal challenges. It aimed to the interwar period.”2 complete the single market agreed to in This paper sketches briefly the salient the 1980s, and to secure its four developments in the euro’s international ­freedoms: free movement of goods, role since its creation twenty years ago, ­services, labor and capital. Volatility in before turning to an assessment of the legacy currencies was believed to progress made since 1999 in our empiri- lead to abrupt changes in national com- cal and conceptual understanding as to petitive positions and to disrupt trans- why international currency status mat- actions within the single market. Since ters in the first place. It concludes by exchange rates stability was hard to providing insights into the currency’s achieve under free movement of capital prospects as an international unit, in flows – as the 1992 Exchange Rate light of some lessons that can be gleaned Mechanism crisis had epitomized – the from history. solution, as it was proposed, was to adopt a single currency. 1 Salient developments However, some of the euro’s founding Once the single currency came into fathers had external ambitions in mind, ­being, it was quickly adopted in trans- too. They saw the euro as an opportu- actions between the euro area and other nity to create a currency with a strong economies in its immediate neighbor- global footing. This was stressed, for hood and also further afar in foreign example, in the Delors Report of the ­exchange and international debt markets. late 1980s: Economic and Monetary Underlying this development, observers­ Union (EMU) would give “the Commu- argued, laid economic logic of scale.3 nity a greater say in international nego- The euro area and the U.S. were tiations and enhance its capacity to roughly equal in economic size, and the ­influence economic relations”. The two accounted for broadly comparable point was further stressed by France’s shares of global merchandise trade. President François Mitterrand: “the Hence by the euro’s tenth anniversary, euro will be the strongest [currency] in a famous study by two prominent the world, stronger than the dollar” ­economists predicted that the single­ (quoted in Troitiño et al., 2017, p. 143). currency would overtake the dollar as a And observers on the other side of the global reserve currency by 2020 under Atlantic, such as Fred Bergsten, also the – admittedly already then conserva- hailed the euro as “the most important tive – assumption that the UK would development in the international join the euro, especially the City of ­monetary system since the adoption of London, which to-date remains the flexible exchange rates in the early main financial center doing business in 1970s” and predicted that the dollar euro outside the euro area (Chinn and would now have “its first real competitor Frankel 2007, 2008).

2 Bergsten (1997), p. 83. This, not completing the single market, was among the key objectives of the founding fathers of the euro, according to Feldstein, who stressed that “French officials have been outspoken in emphasizing that a primary reason for a European monetary and political union is as a counterweight to the influence of the United States both within European and in international affairs” (Feldstein 1997, pp. 72–73). 3 1 This paper represents solely the views of the author and not necessarily those of the ECB or the Eurosystem. We follow here the arguments presented in Bergsten (1997).

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Chart more than 70%. Moreover, the crisis US Treasuries by China and other Composite index of the international role of the euro aggravated financial fragmentation in emerging market economies in the Percentages at current and Q4 18 exchange rates, four-uarter moving averages the euro area, which also contributed years prior to the global financial crisis 3 to reduce the appeal of the euro as a contributed to compress US term pre-

global currency. And financial fragmen- mia – what Chairman Greenspan called tation has not fully reversed to-date.6 the low bond yield “conundrum”. But 6 ­Finally, structural factors, such as various central banks in small open economies are 4 legal and institutional barriers hinder typically more heavily exposed to for- the creation of a single pool of liquidity, eign spillovers in setting interest rates

and still fragment capital markets in than those presiding over an interna- Europe along national lines. Addressing tionally dominant currency.8 4 7 this issues are therefore of prime impor- Contant echane rate Current echane rate tance to the euro’s prospects, as we

Source: ECB (2019). discuss­ below. Note: Arithmetic average of the shares of the euro at constant (current) exchange rates in stocks of international bonds, loans by banks outside the euro area to borrowers outside the euro area, deposits with banks outside the euro area from creditors outside the euro area, foreign exchange 2 Why it matters settlements, global foreign exchange reserves and share of the euro in exchange rate regimes globally. Data at constant exchange rates were not available for foreign exchange settlements. Data for 2016 are used for 2017 and 2018 observations for the share of the euro in exchange But the euro’s first two decades did not rate regimes globally. The latest observations are for the fourth uarter of 2018. only provide evidence as to how its global standing evolved. They were also However, after quickly establishing the global financial crisis of 2007–09 characterized by significant progress in itself ­as a global currency, the euro gradu- and the euro area debt crisis of 2011–12 our conceptual and empirical under- ally lost international standing from the (see Coeuré, 2019, for a full exposition standing as to why international currency mid-2000s onwards. This is visible in of this reasoning). status matters in the first place. In par- chart 1, which shows a ­composite index Empirical research suggests that ticular, we now better understand that measuring the euro’s international role – alongside size and openness, stability is international currency issuers enjoy ­computed as a simple average of the shares a key determinant of international cur- greater monetary autonomy; that inter- of the euro as an international reserve, rency use. For investors, stability comes national currency status strengthens Another aspect about which more financing, settlement, and anchoring in particular from a currency’s ability the global transmission of monetary evidence is now available is that interna- ­currency. to act as a safe haven in times of global policy; and that geopolitics is one deter- tional currency status strengthens the By 2015-16, the euro’s international financial stress.4 Moreover, deep and minant of the global appeal of a currency. global transmission of monetary policy. role reached an historic low (it has recov- liquid financial markets are fundamental Take monetary autonomy first. There This reflects the fact that stronger use ered tentatively in the past two years). to a currency’s ability to attain interna- is increasing empirical evidence that in- of a currency as an international funding ­Today, the euro is the second most used tional status. They reduce transaction ternational currency issuers ­enjoy greater unit amplifies the international trans- currency internationally by most mea- costs, making the currency more attrac- monetary autonomy than other econo- mission of monetary policy. This channel sures. Somewhere between 20% and tive for international financing and settle- mies. The US dollar epitomizes the point: is well documented for the US dollar 30% of global foreign reserves, foreign ment, and – as more liquid markets owing to its pre-eminence in the global and for US monetary policy. When US exchange transactions, international ­mitigate rollover risk – they are perceived monetary and financial system, US mon- monetary policy eases, the US dollar debt and international trade transactions as safer by investors.5 etary policy drives global financial cy- depreciates; international lending in are denominated in euro. And over 50 However, the euro did not act fully cles in capital flows and financial asset dollars grows, because the balance countries or territories use or link their as a true, effective hedge during the crisis, prices (along with fluctuations in global sheets of borrowers in emerging market currency to the euro. But the euro often unlike the dollar. The number of AAA- risk appetite).7 Autonomy is not akin to economies, who often borrow in dollars, lags behind the dollar by a wide margin. rated euro area sovereigns fell from isolation, however: there is also evidence, appear stronger in US dollar terms. What is behind these developments? eight to three. Today, AAA-rated euro for instance, that official purchases of This, in turn, encourages global banks In short, the flaws in the design of Eco- area sovereign debt amounts to just nomic and Monetary Union exposed by 10% of GDP. In the United States it is 6 A quantity-based composite indicator of euro area financial integration remains at about half of its pre-crisis peak, while a price-based composite indicator is about 30% below. 4 This is what some have coined the “exorbitant duty” of international currency status (see Gourinchas, Govillot and Rey, 2011). 7 See Rey (2013) and Shin (2016). 5 As shown e.g. in He et al. (2019). 8 For a discussion of spillovers arising from US and euro area monetary policy shocks, see Ca’Zorzi et al., forthcoming.

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to provide the borrowers in question invoiced in US dollars, which is, in fact, rity and defence, to speak with one international currency after World War I with US dollar-denominated credit.9 what we mainly observe today, an assump- voice on international affairs, might was not just the war itself, but also two The easing in US domestic monetary tion known as “dominant currency also be important for the euro’s global important reforms introduced in 1913. conditions reverberates globally. ­pricing”. The simulations show that a outreach. One such reform was the creation of the Relatedly, currency choice in inter- tightening in US monetary policy elicits Federal Reserve system, which pro- national trade invoicing matters for a much stronger slowdown in global 3 Prospects in retrospect vided a lender of last resort in US dol- monetary policy transmission.10 Chart trade and global demand when trade is All in all, the euro’s first two decades lars and enhanced the domestic and in- 2 shows simulations using a calibrated invoiced in the dominant currency. The may also provide insights into the cur- ternational appeal of the US unit. And structural macroeconomic model of the reason is that when global trade is rency’s prospects as an international the other reform was the abolition of global effects of a tightening in US mon- mainly priced in US dollars, then even unit twenty years from now. Insofar as the ban on foreign branching by US etary policy. It compares the effects of transactions that do not involve the US the decline in the euro’s global attrac- banks, which allowed them to use the policy tightening under two different are affected. Tighter US monetary policy tiveness in recent years is primarily a US dollar to finance international trade scenarios – one assuming that interna- has again global outreach: it leads to a symptom of the fault lines in Economic and finance at lower costs. Results tional trade is invoiced in the exporters’ stronger US dollar exchange rate, hence and Monetary Union, there exists a came rapidly: by 1929, the US dollar currency, or “producer currency pricing”, a large share of global imports becomes close alignment between the policies had already surpassed sterling as a which is the conventional assumption in more expensive in local currency that could indirectly strengthen the global reserve currency and as an inter- e.g. the Mundell-Fleming model, and terms, and global demand switches ­euro’s global role and the policies that national financing currency, with e.g. a one assuming that international trade is from imports towards local goods. are needed to make the euro area more share of over 50% of global foreign A third and final aspect vis-à-vis ­robust.13 The international role of the ­exchange reserves. Yet another sup- Chart which our understanding is clearer now euro is primarily supported by a deeper portive policy was the Federal Reserve’s Dominant currency paradigm amplifies the effects relative to twenty years ago is that geo- and more complete EMU, including active role as market-maker in US dollar of US monetary policy on US and global trade politics is one determinant of the global ­advancing the capital markets union, in debt securities markets. In particular, Deviation from baseline in % appeal of a currency. One recent debate the context of the pursuit of sound eco- the Federal Reserve was a major player is whether the issuer of a global reserve nomic policies in the euro area. in the acceptances markets (letters of – – currency enjoys international monetary But history might additionally offer credit to international trade). This

–4 power, in particular the capacity to insights as to whether policies can indeed made those securities attractive to inter- – “weaponise” access to the financial and indirectly support the global standing national investors and borrowers because –6 11 14 – payments systems. Moreover, recent of a currency. One prominent example they were liquid. Obviously, history – – research supports the view that the US is above all the US dollar. Recent research does not necessarily repeat itself. But – dollar benefits from a substantial secu- suggests that the reason why the US whether it will be any guide for the euro’s – – rity premium. Nations that depend on dollar dethroned sterling as the main next 20 years, time will tell. the US security umbrella hold a dispro- –3 –4 portionate share of their foreign –3 –6 lobal lobal lobal lobal lobal lobal ­reserves in dollars. By one estimate, output ap import eport output ap import eport military alliances boost the share of a Prodcucer currency pricin Dominant currency paradim currency in the partner country’s foreign Source: ECB (2019). reserve holdings by about 30 percentage Note: Impact of a US monetary policy shock on the US economy (left panel) and the non-US global 12 economy (right panel). The chart shows the average response over the first two years. points. This suggests that European initiatives to foster cooperation on secu-

9 See Bruno and Shin (2015) for the argument that looser US monetary policy encourages global banks to leverage more in US dollars (on the supply side) and incentivises emerging markets to borrow more in dollars (on the demand side). Another channel for greater international transmission of liquidity shocks – also identified a few years ago – may reflect the role of international credit markets within global banking groups. Global banks respond to ­domestic monetary shocks by managing liquidity globally through an internal reallocation of funds, which affects their foreign lending. Cetorelli and Goldberg (2012) suggest that, in contrast, domestic monetary policy transmis- sion may be dampened. 10 See e.g. Casas et al. (2017). 11 See, for example, Tooze and Odendahl (2018) and Coeuré (2019). 13 This is the main conclusion of Coeuré (2019). 12 See Eichengreen, Mehl and Chiţu, forthcoming. 14 Before the Great Depression reduced liquidity in this market significantly.

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References Bergsten, F. 1997. The dollar and the euro. Foreign Affairs 76. 83–95. Bruno, V. and H. S. Shin. 2015. Capital flows and the risk-taking channel of monetary policy. ­ In: Journal of Monetary Economics 71(C). 119–132. Casas, C., F. Diez, G. Gopinath and P. O. Gourinchas. 2017. Dominant currency paradigm: a new model for small open economies. IMF Working Paper 17/264. Ca’Zorzi, M., L. Dedola, G. Georgiadis, M. Jarociński, L. Stracca. and G. Strasser. 2019. Monetary policy in a globalised world. ECB Discussion Paper. Forthcoming. Cetorelli, N. and L. Goldberg. 2012. Banking globalization and monetary transmission, In: Journal of Finance 67(5). 1811–1843. Chinn, M. and J. Frankel. 2007. Will the Euro Eventually Surpass the Dollar as Leading International Currency?” In: Clarida, R. (ed.). G7 Current Account Imbalances and Adjustment. Chicago: University of Chicago Press. 283–338. Chinn, M. and J. Frankel. 2008. Why the Euro Will Rival the Dollar. International Finance 11. 49–73. Coeuré, B. 2019. The euro’s global role in a changing world: a monetary policy perspective, speech at the Council on Foreign Relations. 15 February. Eichengreen, B., A. Mehl and L. Chiţu, L. 2019. Mars or Mercury? The geopolitics of interna- tional currency choice: In: Economic Policy. Forthcoming. European Central Bank. 2019. The international role of the euro. Frankfurt am Main. Feldstein, M. 1997. EMU and international conflict. Foreign Affairs 76. 60–73. Gourinchas, P.-O., N. Govillot and H. Rey. 2011. Exorbitant Privilege and Exorbitant Duty. Working Paper Series. University of California, Berkeley. He, Z., A. Krishnamurthy and K. Milbradt. 2019. A model of safe asset determination. In: American Economic Review. Forthcoming. Rey, H. 2013. Dilemma not trilemma: the global cycle and monetary policy independence. ­Proceedings - Economic Policy Symposium - Jackson Hole. Federal Reserve Bank of Kansas City. 1–2 Shin, H. S. 2016. The bank/capital markets nexus goes global. Speech at the London School of Economics and Political Science. 15 November. Tooze, A. and C. Odendahl. 2018. Can the euro rival the dollar? CER Insight. Centre for European Reform. 4 December. Troitiño, D., K. Färber and A. Boiro. 2017. Mitterrand and the great European design—from the Cold War to the European Union. In: Baltic Journal of European Studies 7 (2). 132–147.

120 OESTERREICHISCHE NATIONALBANK Session 5 Digitalization of money: future challenges Kurt Pribil Remarks on digitalization of money and Executive Director Oesterreichische Nationalbank future challenges

Good morning ladies and gentlemen, ­European Instant Payments System, today’s first session will discuss the dig- a system which will help us to better itization of money and the future chal- control credit transfers in the euro lenges. When thinking about the future area and to keep big data in Europe. of money, it’s important to think about 2. At the same time, we are convinced the history; and the history of money that we will still need cash in the fu- has always been linked with the history ture. Cash contributes to consumer of technology. protection – especially in a digitized A big invention was the idea of bal- world – and cash is great in a crisis. ance and double entry book keeping. 3. What about bitcoins and central This allowed for the emergence of bank digital currencies? Well, the banking and banks. Banks became key word for our central bank – places where all the various credits and which might surprise you – is debits of society came ­together in a ­caution. Caution is the sense that we ­single register. And again, banking led don’t see crypto assets (bitcoins) as to the invention of central banking in alternative to established currencies the 17th century. In return for lending but more as vehicle for speculation. gold to the sovereign, the Bank of And caution in the sense that the ­England ­acquired the right to print ­issue of central bank digital curren- ­paper money, which could then be used cies could interfere to much in – by the people to pay their taxes. In a what you might call – commercial sense, this was the origin of the modern banking activities. monetary system! It would be fair to argue that over the last 300 years things didn’t change that much. We have had ups and downs, booms and busts, but the basic principles of banking have remained remarkably similar. Yet, over the last 10 to 15 years we are witnessing a spectacular development of computing technology. So now we have FinTechs, a global spread of inno- vations in electronic payments and – of course – crypto assets. What I am trying to say is that payment behavior has started to change. But let me now come to our speakers. This development in payment systems I’d like to welcome very warmly is extremely relevant for central bankers. Mr. Ulrich Bindseil. Ulrich Bindseil has So before I hand over to our speakers, been Director General of Market let me say just a few words about the ­Operations at the European Central point of view of the Austrian Central Bank since May 2012. Before joining Bank on this matter. the ECB, he had worked for the There are 3 key points: Deutsche Bundesbank (1994-97) and 1. At the top of our agenda is the the European Monetary Institute. He ­implementation of an independent chairs the ECB’s Market Operations

46th ECONOMICS CONFERENCE 2019 125 Kurt Pribil

Committee, the Money Market Contact work focuses on the intersection of Group and the Bond Market Contact ­finance, technology and regulation. He Group. He is professor at TU Berlin is a recognized world expert on tech- and is author of many academic papers. nology in markets, including algorithmic This morning, he will talk to us about and high frequency trading. Between one form of central bank digital curren- 2010 and 2012 Professor Kirilenko cies and discuss its pros and cons. served as Chief Economist of the U.S. And our second speaker is Andrei Commodity Futures Trading Commission Kirilenko. Andrei Kirilenko is currently (CFTC). Today he will present a risk- the Director of the Centre for Global based classification of crypto assets. In Finance and Technology at the Imperial particular, he is going to discuss the fol- College Business School (London). lowing: ­Before he joined the Imperial College in • What fundamental economic problem 2015, he was Professor of the Practice do crypto assets solve that fiat cur- of Finance at the MIT Sloan School of rencies do not? Management and Co-Director of the • Which assets will survive? MIT Center for Finance and Policy. His • What are the regulators up to?

126 OESTERREICHISCHE NATIONALBANK Ulrich Bindseil1 Controlling CBDC through tiered Director General Market Operations European Central Bank remuneration

This paper discusses two concerns implemented in the form of deposit ­regarding Central Bank Digital Cur- money. A number of quite diverse ben- rency (CBDC), namely (i) risk of struc- efits of CBDC have been put forward in tural disintermediation of banks and the literature. The more important ones centralization of the credit allocation are briefly discussed below. process within the central bank and (ii) risk of facilitation systemic runs on banks Efficient retail payments in crisis situations. The paper proposes CBDC offers a number of advantages as solution a two-tier remuneration of with regard to the convenience, effi- CBDC. While the first tier would be ciency, stability and accessibility of retail attractively remunerated, the second payment. While electronic payments would be not. By choosing the per cap- with all their efficiency gains have been ita allowance of tier 1 deposits, and by possible for some decades on the basis making the tier two remuneration suf- of commercial bank money, offering ficiently unattractive, the central bank electronic payments directly in central could address risks of an unintended bank money could have additional advan- structural or ­cyclical ballooning of the tages. A comprehensive analysis of these central bank balance sheet at the ex- justifications of CBDC can be found for pense of commercial banks. example in Sveriges Riksbank’s (2018) second report on the e-krona project. 1 Introduction Collapsing demand for cash in the absence Both academics and central banks have of CBDC would imply that citizens recently started to analyze merits and would no longer have access to the central dangers of introducing CBDC, i.e. bank balance sheet. In that state of the some form of central bank money world, trust in the currency would ­handled through electronic means and ­entirely depend on trust in financial inter- accessible to the broad public2. CBDC mediaries issuing and managing com- could therefore be considered a third mercial money. form of base money, next to (i) overnight deposits with the central bank, cur- Prevent illicit payment and store of rently available only to banks, specific value with central bank money non-bank financial firms, and some of- This argument, which assumes a discon- ficial sector depositors; (ii) banknotes, tinuation or at least strong reduction in being universally accessible but argu- the role of banknotes, is developed in ably of limited efficiency and relying on detail by e.g. Rogoff (2016). Obviously, old technology. Some publications dis- this motivation of CBDC would not apply tinguish the case of “wholesale” and if CBDC circulates as anonymous token “general purpose” CBDC, the former money even for high amounts. Some, being only accessible to certain firms, like Häring (2018), who are strongly while the latter universally accessible to pre-occupied with the privacy of pay- all households. This paper discusses is- ments and fear that internet retailers and sues relating to general purpose CBDC state authorities use ­payments data to

2 1 Opinions expressed in this paper are my own ones, and not necessarily those of the ECB. I would like to thank for their helpful comments Recent publications include Engert and Fung (2017), CPMI-MC (2018), Kumhof and Noone (2018), Sveriges Dirk Bullmann, Benoit Coeuré, Reimo Juks, Michael Kumhof, Clare Noone, Martin Summer, Jens Tapking, Fabrizio Zennaro, and Riksbank (2018), Armerlius et al. (2018), Juks (2018), Nessen et al. (2018) – see also the further literature ref- participants to the 46th Economic Conference of the OeNB in co-operation with SUERF on 2 and 3 May in Vienna as well as participants erenced there. According to the survey of Barontini and Holden (2019, 7), 70% of responding central banks are to the conference on the Future of Central Banking in Talloires/France on 26 May 2019. All remaining errors are mine of course. currently engaged in CBDC work. Five central banks would be progressing on, or running pilot projects (p. 8).

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eventually curb the freedom of citizens, Financial stability and banks’ moral yield curves, this argument has become mittee on Financial Services United States will not agree with this specific argu- hazard rather irrelevant for the time being. House of Representatives, argues that ment for CBDC. This argument in favor of CBDC relate To isolate the more obvious, humble CBDC would lead to various distortions to the vision that CBDC is a tool to case for CBDC, namely that it could precisely because of bank disinterme- make feasible the “sovereign money” serve as an efficient retail mean of pay- diation. In sum, according to Pollock idea, i.e. a monetary system in which ment, from the perceived danger that (2018): on one side the central bank banks would no longer “create” sight CBDC leads unintendedly to a sover- would benefit from an unfair competitive deposits and thus means of payment eign money financial system (as it would advantage in deposit collection and (Benes and Kumhof, 2012, Häring, boost so much the relative attractiveness amass undue power and market share 2018, pp. 214–223, Mayer and Huber, of central bank money relative to bank (also likely misusing its regulatory powers 2014). For example, Dyson and Hodgson deposits) it seems essential to be able to to further strengthen its unfair advan- (2016) consider that CBDC “can make steer the issuance of CBDC in such a tages), on the other hand it would have the financial system safer: Allowing way that it serves the efficiency of retail competitive disadvantages in credit pro- ­individuals, private sector companies, payments, without necessarily putting vision, which it would however ignore, and non-bank financial institutions to into question the monetary order by leading to inefficiency, conflicts of inter- settle directly in central bank money making CBDC a major form of store of est and financial losses that eventually (rather than bank deposits) significantly value. It will be argued in this paper the taxpayer would have to bear. reduces the concentration of liquidity that such a steering is feasible, and with CPMI-MC (2018, 2) also express Allows overcoming the ZLB as one and credit risk in payment systems. less fundamental change than inherent somewhat similar concerns that structur- may impose negative interest rates This in turn reduces the systemic impor- e.g. in the proposal of Kumhof and None ally, CBDC could have negative effects on CBDC tance of large banks and thereby reduces (2018). The well-tested tool of tiered on credit allocation and thereby economic the negative externalities that the finan- remuneration seems to be a way to ensure efficiency. Also Carstens (2019) reiterates For example, Dyson and Hodgson (2016) cial instability of banks has on society. that the volume of CBDC will be well- such worries. Finally, CMPI-MC (2018, argue that “if digital cash is used to In addition, by providing a genuinely controlled. A system of financial accounts 2) emphasizes the cross-border issues completely replace physical cash, this risk-free alternative to bank deposits, a calibrated towards the euro area will illus- that CBDC may create. Indeed, also for could allow interest rates to be pushed shift from bank deposits to digital cash trate the mechanics and implications of banknotes, foreign demand has been a below the zero-lower bound.” Rogoff reduces the need for government guar- CBDC and will allow presenting flow of major factor in recent decades (e.g. (2016) develops this argument in detail. antees on deposits, eliminating a source funds implications. Jobst and Stix, 2017). According to this By allowing overcoming the zero-lower of moral hazard from the financial sys- view CBDC, if offered in the same per- bound (“ZLB”) and therefore freeing tem.” (See also Huber, 1999, pp. 5–6). 2 The structural and cyclical fectly elastic way as banknotes, could negative interest rate policies (“NIRP”) bank disintermediation issue facilitate further the cross-border access of its current constraints, a world with Seignorage income redirected to CBDC has both found support, and to central bank money. only digital central bank money would state (and citizens) caused strong concerns, with regards to Below the creation of CBDC is allow for – according to this view – strong For example, Dyson and Hodgson argue its impact on the structure and scale of ­captured in a financial account system, monetary stimulus in a sharp recession that CBDC “can recapture a portion of bank intermediation. Advocates of “sov- which very broadly replicates the euro and/or financial crises. This could not seigniorage and address the decline of ereign money” see bank disintermedia- area financial accounts as of Q2 2018. only avoid recession, unemployment, physical cash…” Also e.g. Mayer and tion as precisely the goal of CBDC. The ­accounts are simplified in particular and/or deflation but also the need to Huber (2014) give much prominence to ­Already Huber (1999, 18), a strong advo- with regards to netting and that the non- take recourse to non-standard mone- the assumed fiscal advantages of sover- cate of “sovereign money”, had correctly bank financial sectors (OFIs and ICPFs, tary policy measures which have more eign money. They estimate that e.g. in identified the financial account implica- i.e. “other financial institutions” and negative side effects than NIRP. Oppo- the euro area annual additional state tions of central bank money replacing “insurance companies and pension nents of NIRP will obviously dislike revenues would be in the order of mag- bank-issued sight deposits. Others have funds”) have been left away, or been this argument in favor of CBDC, and nitude of more than EUR 100 billion equally strongly rejected the idea of broadly integrated into the household sec- will thus see CBDC potentially as an (assuming a pre-2008 interest rate CBDC inflating the central bank balance tor. Also, the ECB’s asset purchase pro- ­instrument to overcome previous limi- level). Obviously, with the current low sheet at the expense of deposit funding gram is not reflected. tations of “financial repression” and levels of interest rates, and the outlook of banks. For example, Pollock (2018), If households substitute banknotes “expropriation” of the saver. on future interest rates as it is priced in in a testimony to the Subcommittee on with CBDC, then central bank and Monetary Policy and Trade of the Com- commercial bank balance sheets do not

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really change. However, if households ­respectively. In the former case, it has Table 1 substitute commercial bank deposits with been assumed here that the households Financial accounts representation of CBDC CBDC, then this would imply a fund- will not keep the money obtained in the ing loss for commercial banks and could form of bank deposits, but would pur- Households, pension and investment funds, insurance companies lead to “disintermediation” of the bank- chase bank bonds that the banks would EUR trillion EUR trillion Real assets 20 Household equity 40 ing sector. In particular sight deposits with in addition issue (however, from a Sight deposits 5–CBDC2 Savings + low remuneration could be expected to ­financial account perspective, it makes 4 Bank loans 5 time deposits shift at least to some extent into riskless no difference if the purchases of bonds CBDC +CBDC1+CBDC2 CBDC, leading to a loss of commercial by the central bank from households Banknotes 1–CBDC1 banks’ funding of equal size. Banks would imply additional deposits with banks or Bank bonds 4+S1 Corporate/ have to try to offer better conditions on additional capital market investments of Government bonds 7–S1 their deposits in order to protect their households into bank bonds). Equity 8 deposit base as much as possible – but Both S1 and S2 have positive ­effects Corporates this would imply higher funding costs in the sense that they reduce again the Real assets 13 Bonds issued 3 for banks and a loss of commercial bank dependence of banks on central bank Sight deposits 2 Loans 8 “seignorage”. Below, the creation of CBDC credit. Savings deposits 1 Shares/equity 5 has thus been split into two parts: CBDC2 will obviously have effects on Government Real assets 11 Bonds issued 9 CBDC1 which substitute banknotes and funding costs of the banking system, as Loans 2 CBDC2 which substitute deposits with typically central bank credit and bond Commercial Banks banks. It seems likely that indeed CBDC issuance are more expensive than the Loans to corporates 8 Sight deposits 7–CBDC2 would do both of those, but it is unclear remuneration rate of sight deposits (except Loans to government 2 Savings + with what weights. The effect of CBDC1 in unusual circumstances, as the ones time deposits 5 Loans to HH 5 Bonds issued 4+S1 on the rest of the financial accounts is prevailing e.g. in the euro area since Corp/state bonds 5–S2 Equity 3 neutral, but the effects of CBDC2 are 2014, in which obtaining credit from the Central bank deposits 0 Central bank credit 1+CBDC2 not: CBDC2 lengthens the central bank central bank was partially possible for –S1–S2 balance sheet as central bank credit will banks at negative rates, while sight depos- Central Bank Credit to banks 1+CBDC2 Banknotes issued 1–CBDC1 have to fill the funding gaps of the its of households with banks remained –S1–S2 banks. The central bank may want to non-negative). Moreover, a larger recourse Corporate/Government bonds S1+S2 Deposits of banks 0 avoid this effect by purchasing govern- to central bank credit could lead to collat- CBDC +CBDC1+CBDC2

ment and corporate bonds, whereby the eral scarcity issues and the question Source: Author’s compilation. source of the bonds could be either whether the central bank collateral households or banks, being captured in framework becomes crucial from a the financial accounts by S1 and S2, credit allocation perspective implying of the central bank. Bank funding costs rates with the monetary policy opera- its effective centralisation. Both ­effects will obviously increase because a cheap tions rate. Moreover, substitution effects will be analysed further in the next two funding source (sight deposits) decreases, from bank-based to capital market- subsections. and more expensive funding sources based financing of the economy would (central bank credit or bank bond issu- impact on the overall needed adjustment Effects on bank funding costs of ance) have to take over. The central of central bank rates. The fact that bank CBDC2 bank would have to compensate the funding is only one part of overall funding Following Juks (2018, section 4.2–4.3), ­implied tightening of financial condi- of the economy implies that the central one needs to understand what impact tions caused by a decrease of cheap sight bank will not reduce the short-term inter- CBDC will have on average funding ­deposit financing of banks by lowering est rates in a way that bank funding costs of banks, and therefore on bank the monetary policy rate. The extent of costs are stabilized, but only partially lending rates (see also e.g. Engert and the required lowering of short-term inter- so. Therefore, in the new equilibrium, Fung, 2017). In addition, it should be est rates would depend on the size of banks will have lost competitiveness understood how this may impact mone- CBDC2, on the relative share of bank and will lose some market share relative tary policy interest rate setting of the funding in the economy, and on the to other forms of funding (though capital central bank and the seignorage income spread between the other bank funding markets and non-bank intermediaries).

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Increase of banks’ reliance on therefore preferred assets in the form of tion of the economy, which may eventually central bank credit, collateral loans to banks collateralised with high be negative for the overall efficiency of constraints, and centralisation of quality securities or bills of exchange. the economy. credit allocation process? In view of the outstanding levels of To what extent could CBDC undermine government debt in developed econo- Cyclical bank disintermediation the decentralised, market-based financ- mies (end 2018 levels for e.g. the euro through CBDC ing of the real economy by increasing area and UK around 85%; USA around Mersch (2018), amongst others, has massively the central bank balance sheet, 105%; Japan around 235%), and the emphasized the destabilizing effects of and thereby making it, either via increa­ much lower level of banknotes in circu- CBDC in a financial crisis, namely by sed central bank securities holdings, or lation so far (around 10% of GDP for facilitating a run on the banking sys- via an increased funding of banks through advanced economies, and 8% for emerg- tem. CPMI-MC (2018, 2) also supports central bank credit, an important (but ing economies, see Riksbank, 2018, 6) the view that CBDC could make worse potentially inefficient) element of the it would appear that there would be bank run dynamics in a crisis. A run on credit allocation process? some scope for CBDC2 to be matched commercial banks can take three forms negative interest rates will always be State liabilities can be stores of value on the central bank asset side with in principle3, if one makes the distinction sufficiently effective in crisis times, also for households, in particular if they are higher holdings of government bonds, from the perspective of where the depos- because of political constraints on im- matched, in the state balance sheet, by such that neither (i) the reliance of its flow to, namely: “R1”, into deposits posing highly negative rates. In this sec- real assets that the state owns. However, banks on central bank credit would with other banks, i.e. within the banking tion, it is proposed to solve the problem probably the state would not want to need to increase, nor (ii) would the system; “R2”, into banknotes, i.e. the of political acceptance of very low inter- become a financial intermediary for central bank have to hold a credit risk classical physical bank run where queues est rates on CBDC by differentiating re- household savings, which would happen intense portfolio of securities. In any could arise in front of bank branches muneration according to the amount of if the state re-invested proceeds from case, currently at least the central banks and ATMs; “R3”, into non-bank deposits deposits held, i.e. “tiering”. Actually, issuing debt to households in the form of the UK, Japan and the euro area hold with the central bank, which in the past such reserve tiering systems have often of financial assets, or in the form of real large QE related portfolios that created decades was limited to deposits of offi- been applied by central banks for the re- assets not linked to state tasks, just for large amounts of excess ­reserves of cial sector institutions, but in the future muneration of deposits, and exactly for the sake or re-investment. This logic may banks, that would provide scope for could be facilitated by CBDC. Note that the purpose to control the total amount also be applied to central banks in a CBDC2 of at least the size of banknotes R2 and R3 are observable in aggregate of deposits. Under such a system, a rela- somewhat different way as central in circulation before reserve scarcity accounts while R1 is not. Indeed, R1 tively attractive remuneration rate is ap- banking starts from the liability side: to would emerge (without any further does not become visible in the aggregate plied up to some quantitative ceiling, the extent they issue means of payment, purchases of government bonds). More- accounts until the bank benefitting while a lower interest rate is applied­ for they need to re-invest the proceeds over, once the potential for matching from deposit inflows has paid back all of amounts beyond the threshold. The Eu- from doing do. However, the central CBDC with government exposures its central bank credit. rosystem has applied such tiering sys- bank probably does not want central would have been exhausted, the central tems for deposit accounts of public sec- bank money to become a large-scale bank can still try to minimise the impact 3 A two-tier remuneration tor institutions, notably of domestic store of value, i.e. investment vehicle, of the lengthening of the central bank system for CBDC government and foreign central banks as this would mean that the central balance sheet on the credit allocation For example Kumhof and Noone (2018, or sovereign wealth funds. Regarding bank would become a financial inter- process by aiming at diversified expo- p. 34) are well aware of the possibility the remuneration of government deposits, mediary. Turning to the asset side of the sures to the private sector (e.g. outright to address CBDC’s­ potential structural for example, article 5 of the Eurosystem’s central bank balance sheet, one may holdings of various securities types and and cyclical bank disintermediation DALM guideline4 specifies that a two- note different views of central banks on issuers proportional to market capitali- through applying unattractive and/or tier system applies as follows: what is the best match with its monetary sation; credit operations with banks negative interest rates on CBDC. How- 1. Remuneration of government depos- liabilities: The Fed and the Bank of against a broad collateral set). ever, they are skeptical that the tool of its shall be subject to the following England systematically invested the In so far, it could be argued that there proceeds from the issuance of banknotes is some scope for CBDC2 before the 3 Juke (2018, section 5) also distinguishes three forms of runs, although not identical ones. Still the conclusions are into government paper. The Deutsche central banks would have to enter or rather similar. Bundesbank in contrast traditionally extend particular credit exposures to 4 GUIDELINE OF THE EUROPEAN CENTRAL BANK of 20 February 2014 on domestic asset and liability ­management operations by the national central banks (ECB/2014/9), as amended by GUIDELINE OF THE EUROPEAN considered exposures of the central bank the private sector, and thereby play a CENTRAL BANK of 5 June 2014 amending Guideline ECB/2014/9 on domestic asset and liability management to the government as problematic and potentially larger role in the credit alloca- operations by the national central banks (ECB/2014/22).

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ceilings: (a) for overnight deposits, the CBDC in general would be sufficiently euro area population of 340 million; The tier 1 remuneration rate r1 could unsecured overnight market rate; (b) low (or temporarily lowered). However, the allowances of minors could be either be set in principle at a relatively attrac- for fixed term deposits, the secured a two-tier system seems to have important set to zero or they could be allocated to tive level, which could be the rate of re- market rate or, if not available, the advantages: a parent’s CBDC account). To recall: muneration of banks’ excess reserves, and unsecured overnight market rate. • It allows assigning the payment func- banknotes in circulation in the euro it could in addition be specified that it 2. On any calendar day, the total amount tion of money to tier one CBDC, while area are somewhat above EUR 3,500 could never fall below zero. The tier 2 of overnight and fixed term deposits the store of value function would be per capita (summing up currently to remuneration rate r2 should be set such of all governments with an NCB assigned to tier two, and would essen- around EUR 1.2 trillion); securities that tier 2 deposits are rather unattract- ­exceeding the higher of either: (a) tially be dis-incentivized through an holdings of the Eurosystem (including ive as store of value, i.e. less attractive EUR 200 million; or (b) 0,04 % of unattractive remuneration rate. Indeed, both investment and policy portfolios) than bank deposits or other short-term the gross domestic product of the central bank money should probably are currently around EUR 3 trillion; financial assets, even when taking into Member State in which the NCB is not become a large-scale store of value, and the banking system has excess reser­ account risk premia. The two rates domiciled, shall be remunerated i.e. a major form of investment of ves close to EUR 2 trillion. Everything could co-move in parallel with policy in- with an interest rate of zero per cent. households, as this eventually implies else unchanged, there would thus still terest rates, with in addition some special If the deposit facility rate on this day that the central bank would become be no need for large scale credit opera- provision when the zero lower bound is negative, then an interest rate no an investment intermediary of the tions with banks if CBDC of a total territory is approached. The rates would higher than the deposit facility rate economy (for which it has no particu- amount of EUR 1 trillion would be issued themselves not be regarded as policy shall apply. lar qualification). now. The central bank could moreover rates. Moving the rates would simply Similarly, the Eurosystem reserve • It ensures that CBDC is attractive to commit to increase the tier one CBDC serve keeping a similar spread over time ­management services (ERMS5), granting have in principle for all households, quota when the amount of banknote in to other central bank rates, and thus in accounts to foreign central banks and as reliance on tier one CBDC never circulation decreases. An amount of principle to other market rates. This public sector funds, also typically foresee needs to be dis-incentivized by a par- EUR 3,000 for tier one CBDC could be would stabilize over time the incentives the differentiation between a more ticularly low remuneration rate. interpreted as covering the average to hold CBDC. Of course, the existence ­attractive rate applying up to some limit, • Thereby tiering reduces the scope for monthly net income of euro area house- of banknotes, which are invariably remu- and a less attractive one without limits. popular criticism of the central bank holds, such that the normal payment nerated at zero, creates a variable spread If the remuneration rate for tier two (e.g. of financial repression, expropri- function of money would be covered. between the remuneration of banknotes ­deposits is sufficiently unattractive, then ation of money holders, etc.). CBDC tier one allowances for companies and CBDC, which may also have quan- the amount of such deposits should be • A two-tier system allows better steer- would not necessarily have to be high, as titative effects on both. low. The central bank should also be able ing of the amount of CBDC, which it could be argued that the main objec- Initially, for example the following to counter, through an as aggressive as provides additional confidence into tive of CBDC is to serve citizens. When remuneration could be considered by the needed lowering of tier ­two remuneration the manageability of the introduction estimating how tier one CBDC allow- ECB: rates, the inflow of ­additional deposits of CBDC. ances would be translated into total r = max(i , 0); r = (i – 2%), in a financial crisis. The central bank would need to commu- CBDC volumes, it should on one side 1 DFR 2 DFR In sum: central banks have ample nicate clearly at an early stage that the be taken into account that not all CBDC i.e. r1 would equal the rate of remunera- experience with tiered remuneration remuneration of tier two CBDC may be accounts will be opened rapidly, and tion of excess reserves, with however a systems. These could be readily applied made unattractive. For tier one CBDC, maybe some households will never open zero lower bound applying, while r2 to deposit-based CBDC and could address the central bank can commit to never an account, or will not hold the full tier would be two percentage points below the structural and the financial crises charge negative rates. one allowance on the account. On the the remuneration of excess reserves, related bank disintermediation issues The central bank could also provide a other side, some households will be however without floor. Alternatively, without exposing households using commitment with regard to the quantity willing to hold tier two allowances. the remuneration rate of tier two could CBDC for payment purposes to (per- of tier one CBDC. For example, it If foreigners would be eligible to open be set to never exceed zero, but to get ceived) final repression. Of course, an could promise to always provide per accounts, then they would always have negative when the deposit facility rate undue structural or transitionary increase capita a tier one quota of e.g. EUR a tier one ceiling of zero. Finally, a deposit falls below 2%, i.e. in CBDC at the expense of banks could 3,000, implying an amount of total tier based CBDC framework could in prin- r = Min(0, i – 2%) also be addressed by a single tier system one CBDC for households of around ciple be complemented by an anony- 2 DFR in which the interest rate applying to EUR 1 trillion (assuming an eligible mous token-based CBDC. If so, then This would ensure that tier two CBDC the anonymous token-based part would is never more attractively remunerated 5 https://www.ecb.europa.eu/paym/erms/html/index.en.html. be remunerated at the same level as ac- than banknotes in circulation. More- count-based tier two CBDC. over, the remuneration rate of tier two

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CBDC could be lowered exceptionally As remarked by Carstens (2019, p. 10), Coeuré, B. 2018. The future of central bank money. Speech held in Geneva. 14 May. in crisis times, i.e. such as to be lower central banks are not there to “put a Dyson, B. and G. Hodgson. 2016. Digital cash: why central banks should start issuing electronic than what would be implied by the re- brake on innovations just for the sake of it”, money. Positive Money. muneration formulas mentioned above, but to ensure that implications of major Engert, W. and B. S. Fung. 2017. Central bank digital currencies: motivations and implications. such as to prevent a run on the banking changes are well understood so “that Staff Discussion Paper 2017-16. Bank of Canda. system into CBDC. ­innovations set the right course for the European Central Bank. 2016. Guideline EU 2016/2249 of the European Central Bank of ­ economy, for businesses, for citizens, for 3 November 2016 on the legal framework for accounting and financial reporting in the European 4 Conclusions society as a whole”. From this perspective, System of Central Banks (ECB/2016/34) (recast), published in the Official Journal of the European This paper tried to further demystify this paper may suggest that central Union L 347/37, 20December 2016. CBDC, also by revisiting the question banks could be somewhat open to study- Häring, N. 2018. Die Abschaffung des Bargelds und die Folgen. Bastei Lübbe Taschenbuch. how to address the risk, rightly stressed ing CBDC, although the overall business Huber, J. 1999. A proposal for supplying the nations with the necessary means in a modern monetary in the literature, that CBDC could struc- case and the precise risks to change the system. Der Hallesche Graureiher 99–3. Revised version October 1999. turally, or cyclically (in relation to finan- financial system in a disruptive way need Jobst, C. and H. Stix. 2017. Doomed to disappear? The surprising return of cash across time and cial crises) disintermediate the banking further analysis. This conclusion seems across countries. CEPR Discussion Paper DP12327. system. A simpler and less innovative alter- similar to the one of Juks (2018), although Juks, R. 2018. When a central bank digital currency meets private money: effects of an e-krona native to the approach of Noone and Juks is less assertive on the tools to address on banks. Sveriges Riksbank Economic Review. 2018:3. 79–98. Kumhof (2018) is developed, which relies possible unwarranted effects of the Kumhof, M. and C. Noone. 2018. Central bank digital currencies – design principles and balance on a tiered remuneration­ of CBDC, in ­introduction of CBDC. The overall sheet implications. Bank of England. Staff Working Paper No. 725. line with long-tested central bank logic business case for CBDC will also still Mayer, T. and R. Huber. 2014. Vollgeld. Das Geldsystem der Zukunft. Unser Weg aus der and practice. It is ­acknowledged that the depend on preferences of households as ­Finanzkrise. Tectum. control of CBDC quantities is not equiv- money users and voters. In progressive Mersch, Y. 2017. Digital base money: An assessment from the ECB perspective. ECB. alent to the control of the impact of countries, in which the demand for Mersch, Y. 2018. Virtual or virtueless? The evolution of money in the digital age. Lecture at the CBDC on the financial system, since banknotes falls rapidly and in which Official Monetary and Financial Institutions Forum. London. 8 February. CBDC might be a catalyst for the fur- conspiracy theories about a deliberate Nessen, M., P. Sellin and P. A. Sommar. 2018. The implications of an e-krona for the Riksbank’s ther shrinkage of bank balance sheet at attempt of authorities to strengthen operational framework for implementing monetary policy. Sveriges Riksbank Economic Review the benefit of non-bank ­intermediaries, control of citizens and/or enhance the 2018:3. 29-42. in particular if CBDC accounts offer rela- ability to exert financial ­repression Pollock, A. J. 2018. Testimony to the Subcommittee on Monetary Policy and Trade of the Committee tively comprehensive account services power through the discontinuation of on Financial Services, United States House of Representatives. Hearing on The future of money: such that many households may no longer banknotes may be less popular, a busi- Digital currency. 18 July. feel a need to have a deposit accounts ness case for CBDC seems relatively Sveriges Riksbank. 2017. The Riksbank’s e-krona project – Report 1. September. with banks. plausible. Sveriges Riksbank. 2018. The Riksbank’s e-krona project – Report 2. October.

References Ahmat, N. and S. Bashir. 2017. Central bank digital currency: a monetary perspective. Bank Negara Malaysia. Staff Insights 2017/11. Barrdear, J. and M. Kumhof. 2016. The macroeconomics of central bank issued digital currencies. Bank of England. Staff Working Paper 605. Barontini, C. and H. Holden. 2019. Proceeding with caution – a survey on central bank digital currencies. BIS Paper 101. Benes, J. and M. Kumhof. 2012. The Chicago Plan Revisited. IMF WP/12/202. Bindseil, U. and M. Corsi, B. Sahel and A. Visser. 2017. The ECB collateral framework ­explained. ECB occasional paper 189. Cabrero, A., G. Camba-Mendez, A. Hirsch and F. Nieto. 2002. Modelling the daily banknotes in circulation in the context of the liquidity management of the ECB. ECB WP 142. Carstens, A. 2019. The future of money and payments. Speech held in Dublin. 22 March.

138 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 139 Andrei Kirilenko On crypto assets Director of the Center for Global Finance and Technology Imperial College London About 541 million years ago, in the before, many crypto assets will not survive space of just 20 to 25 million years, life on just as the post-Cambrian arthropods earth went through a sudden and remark- did not way back when. By some esti- able change. In what became known as mates, around two-thirds of crypto assets the Cambrian Explosion, a few simple offered through an initial coin offering organisms were replaced by a huge variety failed to survive 120 days. However, of more complex life forms with com- the ones that do will evolve into a class pound eyes, multiple legs, and sharp of financial assets more suitable to the teeth. Most of the Cambrian life forms digital era than many of the ones we went extinct, but pretty much all animals have now. and plants living today started their As an asset class, crypto assets are evolutionary journey at that time. probably closest to commodities. Accord- It has been argued that a rise in ing to the U.S. Commodity Exchange the level of free oxygen above a certain Act, there are three types of commodities threshold enabled different lineages of – agricultural, exempt (such as metals complex life forms to develop. These and energy) and excluded (interest rates, complex creatures used their eyes, legs exchange rates, credit rates, indices, mea- and teeth to prey on other organisms, sures, etc.). Specifically, according to which had to quickly learn how to hide ­Section 1(a)19 of the Commodity or grow shields lest they be consumed ­Exchange Act, “excluded commodity” is as food. The rest is history. We have seen a similar explosion in “(iv) an occurrence, extent of an ­occurrence, crypto assets over the last 10 years. It or contingency (…) that is started with Bitcoin, evolved to a more (I) beyond the control of the parties to complex form with Ethereum, had a sep- the relevant contract, agreement, or arate line with Ripple, and then splintered transaction; and into thousands of crypto tokens. (II) associated with a financial, com- Like the rising level of oxygen for mercial, or economic consequence.” early life forms, the crypto explosion may have been made possible by Moore’s Bitcoin, for example, fits into this Law, an observation that over time, ever definition quite well. It is an occurrence; more computational power is available is beyond the control of the parties to the at the same cost. Due to Moore’s Law, relevant contract; and is associated with sometime in the late 2000s, computing a financial, commercial, or economic con- power seems to have reached a critical sequence. However, some digital assets, threshold – it became possible to solve including the very Bitcoin could also be complex calculations on standalone considered exempt commodities (like personal computers, and communicate precious metals). While the difference the solutions to other computers over in classification matters for regulatory the Internet. treatment, it is fair to say that the The result was a decentralised, self- breadth of the existing statutory definition sustaining, computational ecosystem at least in the U.S. is sufficient for the governed by a protocol that issued new purposes of regulating crypto assets. crypto assets to those who provided The most important financial attri- computational resources – blockchain or butes of a physical commodity are (i) its distributed ledger technology. These assets storability over time and (ii) ease of its could be thought of as crypto life forms delivery in different locations and under inhabiting different blockchains. And as different circumstances (future states of

46th ECONOMICS CONFERENCE 2019 141 Andrei Kirilenko Andrei Kirilenko

the world). Think of gold – arguably the assets differ from each other by two essen- stable coins, cryptocurrencies, and crypto Chart most financial of the physical commodities. tial features: security and stability. We tokens. Expected return against risk of crypto assets Gold is capable of being stored over argue that security of a crypto asset re- CBDCs can be used to pay for any very long periods without any loss to its flects its technological vulnerability to good, service or financial asset. Their physical properties and it can be easily cyber fraud, manipulation, abuse, and technological advantage is being digitally Epected delivered without any infrastructure. In attack. Other things equal, use of a more native. Their economic advantage is return CRPTO contrast, electricity – another commod- advanced encryption technology would ­access to a central bank-regulated pay- TOKENS ity – is currently very difficult and render a crypto asset more secure rela- ment system. The probability of non- costly to store and requires considerable tive to other crypto assets at a point in adoption for such an asset could be kept CRPTO (and also very costly) infrastructure for time. In other words, security is a cross- very low as a central bank can simply CURRENCIES delivery. sectional attribute of a crypto asset. mandate its use within its regulated STABLE In turn, stability of a crypto asset re- ­jurisdiction. COINS Increain epected Increain return flects its potentially faulty governance. So far, there have been several exam- CBDC Other things equal, greater reliance on ples of what could be considered CBDCs, Full adoption Coin to Complete failure elements of regulated or self-regulated but none in credible jurisdictions. In Increain rik of not bein adopted governance with legal or procedural re- contrast, countries with credible national Source: Author’s compilation. course would render a crypto asset payment systems have publicly spoken more stable in terms of the value that against opening up CBDCs, often citing can be recovered. Thus, stability is a financial stability concerns. could offer a viable transition mecha- time series attribute of a crypto asset I have been asked by a dozen regula- nism from a fiat currency to a crypto that reflects its ability to retain value tors around the world for my views on ­asset, provided it is able to reach the across time for a given level of security crypto assets and CBDCs in particular. necessary adoption threshold. by adopting more legal, regulatory, and In my opinion, a CBDC really makes Crypto currencies were designed to credible self-regulatory (e.g. consensus) sense in an economic area where the scale up with Moore’s law, but their mechanism. added value is expected to increase in continuing creation to reward the owners Digital records are extremely highly On the demand side, we model the line with affordable computational power. of computers that keep track of their storable and can be delivered over digital adoption of a crypto asset as a choice To put it simply, if you have a global use has been proving costly. Their prob- communication networks anywhere in between security, stability, and the risk/­ platform like Amazon, Alibaba, Google ability of non-adoption fluctuates around the world at extremely low cost. How- return tradeoff for given investor or Facebook operating in your economic 50% and their expected return is high. ever, while a physical commodity cannot ­preferences. Intuitively, in order to get jurisdiction, you should seriously study The adoption of Ethereum is benefitting be digitally cloned, a digital record can adopted as quickly as possible, crypto how to give them an ultraliquid, digi- from its use as a platform for other be, which makes it hard to distinguish ­assets have to offer higher expected tally-native asset with access to the pay- ­applications, but the more popular it between the original and a copy. Block- ­return. Expected return, of course, is ment system that’s suitable for their ­becomes as a development platform, the chain technology uses cryptography and an economic and statistical construct – Moore’s Law driven business processes. higher are the chances that its percep- encryption to create and transmit an it is a sum of payoffs weighted by their Otherwise, don’t worry about it. tions of its purpose split, limiting wide- immutable database of digital records. As perceived probabilities. Whether those Stable coins are so called because spread adoption. And, of course, whether a result, it becomes possible to use payoffs actually materialise and whether they are collateralised by existing finan- or not crypto currencies are more fully blockchain to create scarcity of digital those perceived probabilities match cial assets or fiat currencies. Their tech- adopted relies a lot on what regulators objects, and, thus, create an entirely new anything deemed rational is a big and, nological advantage is their ability to be in key jurisdictions have to say about class of digitally native financial assets – at times, very technical part of the held in crypto wallets alongside exist- them. crypto currencies, tokens and coins. ­research agenda in financial economics ing crypto assets. Their economic Last of all are those crypto tokens. Digital scarcity, however, is necessary, and should not in any way, be viewed as ­advantage is the stability of the underly- These include utility tokens, security but not a sufficient condition for the investment advice. ing collateral. The probability of non- tokens, and other types of crypto tokens. survival of a supplied crypto asset. The key By plotting the expected return of adoption for a stable coin could range For the purposes of this article, tokens to the survival of a crypto asset is the prob- crypto assets against the risk of their from moderate to a coin toss: they need are for the most part viewed as future ability of its adoption for some form of use. not being adopted, we’re able to organise to offer a positive expected return to at- sales, investment and participation In recent work with Silvia Bartolucci, them into four large groups: central tract potential users. In so far as a stable schemes designed to fund software de- we posit that on the supply side, crypto bank issued digital currencies (CBDCs), coin scales up with Moore’s Law, it velopment. Investment in crypto ­tokens

142 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 143 Andrei Kirilenko

is a high-risk activity, vulnerable to out- First of all, regulators have to figure right fraud, failure, and inadequate per- out what aspect of a crypto asset they formance. To mitigate these risks and regulate and why. Is it cryptography/ profit from intermediation and future encryption (AML/KYC), P2P (payments­/ use, a vibrant­ ecosystem of crypto funds, intermediaries), consensus (gover- crypto exchanges (where crypto tokens nance), blockchain (entities/reporting)? are listed) and crypto custodians (where Second, the regulators need to answer crypto investments are held) has emerged. why are they regulating crypto assets. Some of these participants will go ex- Is it due to market failure/manipulation, tinct along with their token investments, asymmetric information/rent seeking, but others will survive – and make a lot financial bubbles/systemic risk? of sense for a number of digital projects, Third, regulators need to establish especially those that have the potential to under which regulatory mandate is the become global platforms. plan to regulate crypto assets? Do they In my view, crypto assets have a plan to regulate them under the monetary fundamental technological feature that policy mandate, financial stability separates them from previous genera- ­mandate, payments mandate, consumer tions of assets – as the affordability of protection, or fair and orderly markets available computing power increases, mandate? so too will their usefulness. This makes In my opinion, regulators ideally them much more suitable for financing should try not to regulate a specific asset, activities such as software development, crypto or otherwise. Rather, after digital payment and settlement platforms, ­defining broad attributes of an asset and e-commerce. In contrast, more phys- class, regulators should aim to regulate ical economic activities such as mining, principled activity – issuance, brokerage, car manufacturing, or running a grocery ­custody, etc. Furthermore, many shop, will do just fine without them. crypto assets follow a zero trust archi- Lastly, I have a few words on the tecture – “never trust, always verify any regulation of crypto assets, which again node or activity on the inside or outside should not be viewed as legal or invest- the network” – so aspects of the regulation ment advice. Regulation of crypto assets of crypto assets might could in fact has proven to be a non-trivial challenge evolve to follow a much lighter touch. to regulators around the world.

144 OESTERREICHISCHE NATIONALBANK Session 6 Completing European Economic and Monetary Union Doris Ritzberger-Grünwald Completing European Economic and Director Oesterreichische Nationalbank Monetary Union: next steps

“Completing Europe’s Economic and economic policies of euro area Member Monetary Union” is the title of a sig- States. The greatest progress has prob- nificant report authored by the five ably been made with respect to the Presidents of the European Union banking union, although the important (Commission, Council, Eurogroup, element of a cross-border deposit insur- ECB and Parliament) published in ance scheme is still under negotiation. 20151. But what exactly makes Euro- Moreover, the process of creating a cap- pean Economic and Monetary Union ital markets union has already been (EMU) incomplete? Some might joke started, but its completion is likely to that EMU lacks a 6th President. Indeed, take decades. The strengthened Stabil- the number of institutions responsible ity and Growth Pact has contributed to for economic policy already indicates a decline in public debt in almost all that EMU might have a governance issue.­ Member States, while the newly created To put it simply: What makes EMU European Fiscal Board helps not to lose unique is that it does not comprise just track of the optimal fiscal stance of the a single state. And since there is no po- euro area as a whole. litical will to create the United States of Additionally, the European Com- Europe, the euro area must mimic the mission suggested further innovations, most essential functions of a state. such as Sovereign Bond-Backed Securi- This is why the proposal of the five ties (SBBS), i.e. privately placed securities Presidents rests on four pillars: first, an with­out joint liability. Furthermore, the economic union that promotes conver- Commission proposed two new instru- gence, prosperity and social cohesion; ments within the new Multiannual Finan- second, a financial union that integrates cial Framework 2021–2027: a new Reform banking and capital markets regulation; Support Programme with an overall third, a fiscal union that guarantees budget of EUR 25 billion and a Euro- sound public budgets and sufficient pro- pean Investment Stabilisation Function vision of public goods; and fourth, a in the form of subsidized back-to-back ­political union that strengthens demo- loans of up to EUR 30 billion. Moreover, cratic accountability, legitimacy and in- the Meseberg Declaration2 of France stitution building. Undoubtedly, “com- and Germany proposed the establish- plete” does not necessarily mean perfect ment of a euro area budget to promote – even the dollar area is far from perfect. competitiveness, convergence and sta- Nevertheless, the tone of the European bilization in the euro area, including Commission has become a bit more ­investment in innovation and human pragmatic as it now talks about “deep- capital. This budget line would be based ening EMU” rather than “completing on an intergovernmental agreement EMU.” within the EU framework; its size yet Since the crisis, a couple of mea- needs to be specified. Putting aside any sures have been taken to deepen EMU. doubts about EU-wide agreement on As a case in point, the European Semes- these measures, the following question ter was established to better coordinate remains: Will they indeed be the game

1 Juncker, J.-C., D. Tusk, J. Dijsselbloem, M. Draghi and M. Schulz. 2015. Completing Europe’s Economic and Monetary Union. European Commission. 2 German Federal Government. 2018. Meseberg Declaration: Renewing Europe’s promises of security and prosperity. June 19.

46th ECONOMICS CONFERENCE 2019 149 Doris Ritzberger-Grünwald Doris Ritzberger-Grünwald

changer wished for or merely “baby Our second contributor, Bruno of Economic Experts (Sachverständi- steps on eurozone reform” as financial ­Cabrillac, presents other bold and vision- genrat), an independent advisory body observers called it?3 ary approaches. His discussion focuses of the German government. She is Re- on the following questions: Will a resil- search Fellow at the Centre for Eco- ient EMU take more than the consen- nomic Policy Research (CEPR) and at sual measures voiced by the Commis- the CESifo, as well as Research Affiliate sion and the Franco-German group of (prior to that Senior Research Fellow) economists? Will the Five Presidents’ at the Max Planck Institute for Research Report be implemented, or will it be on Collective Goods in Bonn. Isabel replaced by another vision? What are Schnabel received her doctorate from the major political disagreements and the University of Mannheim. She was a technical obstacles to achieving our Visiting Scholar at the International goals? How can we overcome them? Monetary Fund, the London School of cial Supervisory Authority (BaFin) and And last but not least, one of the main Economics and Harvard University. is a member of the Advisory Scientific questions for central bankers: How can ­Isabel Schnabel chairs the Advisory Committee (ASC) of the European Sys- the euro help Europe contribute to a Council of the German Federal Finan- temic Risk Board (ESRB). ­financially more stable and economically In December 2018, a Franco-Ger- more prospering world? man group made up of fourteen well- Finally, let me briefly introduce this known economists4, including Isabel section’s contributors: Bruno Cabrillac Schnabel, our first contributor, proposed is Deputy Director General of Econom- a comprehensive reform package calling ics and International Relations at the for the following: first, introducing Banque de France. Between 2008 and sovereign concentration charges for 2016, he was Director of Economics banks, common deposit insurance and and International European Relations. strengthened mechanisms to bail in He entered the Banque de France in creditors of failing banks; second, re- 1984, serving as economist initially in placing the current system of fiscal the Foreign Relations Department, then rules with a simple expenditure rule in the Research and Forecast Depart- guided by a long-term debt reduction ment. He was seconded to the Ministry target; third, establishing the economic, of Finance as Financial Counsellor in legal and institutional underpinnings Cairo and Tokyo, having worked as a for orderly sovereign debt restructuring foreign exchange and bond trader for of insolvent countries; fourth, setting eighteen months prior to that. In 1997, up a euro area fund that helps partici- he was appointed Head of the African pating Member States absorb large eco- Department (Zone Franc) of the Banque nomic disruptions; fifth, creating a syn- de France. In the early 2000s, he became thetic euro area safe asset as an alterna- Trade Commissioner and Banque de tive to national sovereign bonds; and France representative in Hong Kong sixth, designing a new euro area insti- and Macau, and later Financial Coun- tutional architecture, with institutional sellor for Africa at the French Ministry surveillance being separated from po- of Finance. litical decision-making by creating an Isabel Schnabel is Professor of Finan- independent fiscal watchdog within the cial Economics at the University of Bonn European Commission. and a member of the German Council

3 https://seekingalpha.com/article/4226361-eurozone-filibuster-eurozone-reforms-continues. 4 https://voxeu.org/article/how-reconcile-risk-sharing-and-market-discipline-euro-area.

150 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 151 Bruno Cabrillac Integration and convergence in the EMU: Deputy Director General Economics and International Relations Banque de France a complex dynamic1

Economic real convergence is enshrined foster cyclical convergence in the euro in the founding Treaties of the European area can contribute to reduce structural Union, as the Community should aim divergence. Eventually, the political “at reducing disparities between­ the ­unsustainability of long-term real levels of development of the various ­income divergence can only be dealt ­regions and the backwardness of the least with more integration, including fiscal favoured regions” (Art. 158). While real integration. income convergence, measured by the GDP per capita, among the twelve euro 1 Real income divergence among area first joiners has increased in the euro area first joiners could go on two decades before the euro, it has Since the introduction of the euro, both come to a halt in the last two decades. ß-convergence, which measures Since the Great Financial Crisis, these whether countries with lower GDP per countries are even drifting apart, to use capita grow faster than those with the words of a recent IMF paper.2 Look- higher GDP per capita (so-called “catch- ing at long-term potential growth, this ing up effect) and -convergence, which ­divergence could go on. measures the decline in dispersion of Real income convergence is neither countries’ GDP perσ capita, have im- a necessary condition, nor a by-product proved among EU members, but this of a deeper integration of the EMU, as improvement has slowed compared to shown by the example of the USA. the two prior decades. Moreover, most However, as the Delors Report already of that measured convergence is due to pointed out in 1989, long-term income Eastern European countries, whether divergence could be detrimental to the they joined the euro area or not. Recent whole EMU project as long as this project studies3 show that the Great Financial has not been finalized yet, first, because Crisis actually­ stopped convergence the incompleteness of the EMU as an among EU Member States and regions. Optimal Currency Area (OCA) limits Indeed, when focusing on the 12 euro the possibilities to mitigate real income area countries which have joined the divergence or its effects and second, euro between 1999 and 2001 (euro area ­because it can weaken the political first joiners), real income convergence ­narrative around the EMU and hence, has stopped since 1999 and even reversed its credibility. since the Great Financial Crisis. Greece, While deeper integration through Portugal and Spain, which have a real strengthening the single market and GDP per head lower than the average­ ­increasing intra euro area labour and EU, have stopped catching up; Ireland capital mobility could increase agglom- and Germany which have a higher GDP eration effects and contribute to real per head than average have enjoyed ­income divergence, it could, as well, higher real income growth. It looks like mitigate its effects. At the same time, the EMU has been “a source of a growing what has been (and could be) done to gap between a virtu­ous core and a sinful

1 Special thanks are due to Véronique Genre and Jean-Baptiste Gossé whose help was precious. 2 Economic Convergence in the Euro Area: coming together or drifting apart, J. Franks et al., IMF Working Paper 18/10, January 2018. 3 Building a stronger and more integrated Europe OECD Economics Department Working Papers 1491, A. Caldera Sánchez, July 2018.

46th ECONOMICS CONFERENCE 2019 153 Bruno Cabrillac Bruno Cabrillac

Chart Chart 3

EU Convergence: where do we stand? Old­age dependency ratio in Europe Cumulative change in GDP per capita 1999–2017 2016 2040 EU normalised to 3 3 LT 4 Initially better off RO Initially worse off 3 3 LV than average EU than average EU EE 3 SK Relative gain in PO GDP per capita BG C ML HU IE SI DE EU 2 4 6 ES 1 12 DK AT 14 16 FI SW – PT UK BE C FR NL – GR IT Relative fall in GDP per capita –3 IT EL DE PT FI EA L MT EE LT FR ES SI AT BE NL C SK LU IE EL IT PT LT ES L DE EA SI FI FR NL AT EE MT SK BE C IE LU evel of GDP per capita in 1999 (EU100; in PPS) Source: European Commission (2019), 2018 Ageing Report. Source: Eurostat.

Chart 4 Chart Percentage of adults scoring at each proficiency level in literacy and numeracy What could come next? GDP per capita trends applied forward Literacy Numeracy Option 1: 19992008 trend extended from 2018 Option 2: 20082018 trend extended from 2018 % % PPS PPS 6 6 4 4 4 4 4 4 3 3 3 3 FR DE IT ES OECD FR DE IT ES OECD L L L3 L3 Source: PIAAC (2016). 3 7 3 7 3 3 3 3 7 3 7 3 3 3 ermany Spain France Italy EA While projecting trends is not always • Rapidly diverging public debt-to- Source: Banue de France. relevant, notably when the period is GDP ratios makes any catch up ­encompassing an exceptional event, through public capital accumulation periphery”.4 France and Italy have con- Should the trend of the last two there is a rationale to do so: difficult, especially in France and Italy. tributed to convergence as they still enjoy ­decades go on over the coming two • All 4 biggest euro area economies are • The real economic divergence among a higher real GDP per head than the ­decades, real GDP per head divergence ageing, albeit not with the same the euro area first joiners and, in ­average EU (but not the euro area, for would lead to an increasing gap between speed. According to the 2018 Ageing ­particular, among the 4 biggest econ- Italy). However should the relative Germany and Italy, so that Italy’s GDP Report of European Commission, omies, has been mainly due to total slowdown of these two countries go on for per capita could represent 62% of the old age dependency ratio will factor productivity growth diver- the next ­decades, they would contribute ­Germany’s by 2040 (chart 2). If we ­increase in all euro area countries, gence.5 It is the reason why a hypo- to overall real economic divergence, first ­extend the trend of the last decade, this but more so in Italy (+10%) and thetical (and improbable)­ change of in the euro area, then in the whole EU. figure could decrease to 52%. Spain (+11%), and, to a lesser extent, this trend would anyway take time. in Germany (+7%). In addition, some underlying factors

4 Patterns of Convergence and Divergence in the Euro Area, Á. Estrada, J. Galí and D. López-Salido, IMF Working 5 Economic Convergence in the Euro Area: coming together or drifting apart, J. Franks et al., IMF Working Paper 18/10, Paper, 2013. January 2018.

154 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 155 Bruno Cabrillac Bruno Cabrillac

Chart Neither is real income convergence policies” in place, namely the EU cohesion Education spending an automatic product of institutional, policy could be made more effective 12 % of GDP economic and financial integration. ­ and more redistributive , but is funda- The US case is again supporting this mentally lacking the critical mass. 4 ­assertion as both ß-convergence and

4 -convergence have decreased among US states9 since the 1990s. This confirms 3 σthe famous 8 lessons of Massachusetts 3 for EMU drawn by Krugman.10 How- 6 3 3 4 4 6 6 7 ermany Spain France Italy EA ever, while the Solow exogenous growth paradigm has received mixed empirical Source: OECD. evidence, the catch up of many emerg- ing countries since the acceleration­ of are not playing in ­favour of a path divergence. As noted by a recent ECB globalization has given some credibility ­reversal. paper6 this evidence is ­supported by the to a positive link ­between convergence • Let us take education. Looking back- fact that “income ­dispersion in the and integration. One way to reconcile ward, performances measured by the United States is still broadly compara- this paradox could be to underline that PISA survey have been increasingly ble to that in the euro area, yet this has relative economic integration in the disappointing in most euro area coun- not materially affected the ability of the USA and the EU has decreased due to tries, and the initial gap between the Federal Reserve to conduct monetary rapid progress of global economic inte- 3 Deepening the single market four big countries has not been reduced.­ policy at federal level”. gration both on trade and on capital may not improve convergence According to a Eurostat survey, the per- However, as underlined by the flows. Net effects of specialization in but could mitigate the effects centage of people aged between 16 and ECB7: “although income dispersion in the the context of swifter integration at of real structural divergence 64 and lacking basic digital skills is still US monetary union is still broadly compa- the global level could have changed the very different across euro area coun- rable with that of the euro area, the latter ­dynamic of agglomeration­ effects. 3.1 Trade in goods and services tries (from 15% in Luxembourg to is less able to cope with any failure to ­attain The issue of potential increase in Intra-euro area trade in goods, at 20% 55% in Italy) and is significantly higher sustainable convergence. This is, ulti- ­regional income inequalities due to of GDP, is much lower than intra-US in Spain and Italy than in Germany. mately, because the euro area performs ­agglomeration effects, despite or even trade (35%) and has increased much Looking forward, according to the relatively­ worse than the United States in ­because of regional integration, has not less than extra euro area trade since the Ageing Report of the EU Commission, the fulfillment of optimum currency area, as been overlooked in the European Great Financial Crisis (respectively the gap between Germany on one hand concluded by a wide body of literature.” ­integration project. The Delors report11 +26% and +45% between 2008 and and Italy and Spain on the other hand Furthermore, not only the EMU is for example stated in 1989 that: “Com- 2018). This could reflect a still unachieved on education spending will increase sig- an incomplete OCA, – which, as Daniel munity policies in the regional and but loosing its steam specialization pro- nificantly in the next two decades. Gros is arguing8, may not be the most structural field would be necessary in cess ­inside the euro area. Reversing this important point –, but it remains order to promote an optimum allocation trend and achieving a more integrated 2 Is real divergence among euro ­perceived, for this reason and others, as of resources and to spread welfare gains goods market could have ambiguous area countries an issue? more reversible than the USA. Hence, throughout the Community. If sufficient ­effects on real income convergence as It is widely recognized that real ­income Daniel Gros is pointing out that the consideration were not given to ­regional the specialization process could lead to long-term convergence is not a neces- main difference between the Greece imbalances, the economic union would structural terms of trade divergences. sary condition for a functioning monetary and Puerto Rico crisis is that the Greek be faced with grave economic and po- Behind-the-border trade barriers union. As an illustration, most of the ­Government had the possibility to leave litical risks”. However, the “Community remain significant in the services sector proposals made to fix the euro area the euro and introduce a national flaws do not target directly real income currency.­ 9 Income convergence among US states: cross-sectional and time series evidence, J. C. Heckelman, The Canadian journal of Economics, 2013. 10 Cambridge University Press, 1993. 6 Real convergence in the euro area: a long-term perspective, Diaz del Hoyo et al., ECB Working Paper, December 2017. 11 Report on economic and monetary union, April 17 1989, European Commission, Committee for the Study of Economic 7 ECB Occasional Paper Series 203, December 2017. and monetary union, chaired by Jacques Delors. 8 Puerto Rico and Greece: A Tale of two defaults in a monetary union, Daniel Gros 18 June 2015 (updated 30 June 2015), 12 Building a stronger and more integrated Europe OECD Economics Department Working Papers 1491, A. Caldera CEPS. Sánchez.

156 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 157 Bruno Cabrillac Bruno Cabrillac

Chart 6 Chart

Labour market slack in Europe Measures of financial integration in the euro area Index of underemployment (unemployed, discouraged, unvolontary partial time, % of labour force) 4

4

3

3

3 4 6 7 3 4 6 7 ermany Spain France Italy EA Quantity-based financial integration composite indicator Price-based financial integration composite indicator Source: Eurostat abour Force Survey. Source: ECB. Note: Labour market slack is defined as the sum of unemployed, discouraged workers and involontary part-time work.

Chart 7 inter-state mobility in the USA: year on the scope of permanent cross border year migration is ten times higher in the transfers, notably potential social trans- Youth unemployment rate USA. fers, needed to mitigate real income % of active population Unemployment rates and broader ­divergence. The current European cohe- 6 measures of labour slack have consider- sion policy would then be more appro- ably diverged in the last two decades priate to deal with these challenges. 4 which reflects low labour mobility. As low intra euro area/EU labour This divergence has occurred in every mobility is the most important factor of 3 phase of the cycle: during the Great today’s distance between the EMU and Moderation, the Great Financial Crisis an optimum currency area, deepening and the subsequent recovery. While labour markets integration would also

youth unemployment rates divergence help foster EMU credibility. What 3 4 6 7 3 4 6 7 has somewhat receded since the begin- could be done in this field is much ermany Spain France Italy EA ning of the recovery, it remains at an ­beyond the scope of this paper but it Source: Eurostat abour Force Survey. incredibly high level. ­includes structural measures, notably Increasing labour mobility would to improve cross-border occupational even inside the single market. As illus- also concern other EU members. Deep- accelerate specialization and agglomera- pension portability rights beyond the trations, some estimates suggest that ening services trade liberalization inside tion effects and hence, as a first step, the full implementation of the services the EU would hence increase the com- geographical real income divergence. directive could add 1.7% to EU GDP13 parative advantage of the single market. However, it would reduce inequality of and the number of regulated professions opportunity among euro area countries remains high on the average compared 3.2 Labour market mobility and hence make income divergence to other OECD countries and signifi- Labour mobility remains low in the EU. more politically sustainable. In a second cantly different in the core countries of EU/EFTA foreign born population step, labour mobility could reduce real the euro area (higher in France and Italy, stood above 5% of the EU working age income divergence through reducing than in Germany). While ­services trade population in 2017, up from 3% in 1999 structural unemployment divergences. restriction in the EU remain­ around the due mainly to migration from Central­ Eventually, with deeper labour and capital OECD average, a lot of these restrictions and Eastern Europe. It is still well below mobility, geographical income disparities would mainly become an issue of 13 European Commission, 2017, Proposal for a Directive of the European Parliament and of the Council on the legal and operational framework of the European services e-card introduced by Regulation”, Commission Staff Working ­regional planning. It means more than Document, 2017. semantics: it would reduce the size and

158 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 159 Bruno Cabrillac Bruno Cabrillac

rate to others, allowing for more con- given country remained unsmoothed not necessarily result in real income vergent paces of capital accumulation. over the period 1999-2016, in the convergence, but it could help mitigate A more stringent discipline on macro United States at most 40% of a shock to the effects of divergence. However, on imbalances should reduce the financial state-specific GDP was unsmoothed the long term, the “whatever-it-takes” stability risks of higher net investment during this period”.18 to mitigate real income divergence relies positions. To mitigate potential pro-­ Cyclical convergence, economic and mainly on fiscal policy as Krugman put it: cyclical effects of increased capital financial integration and real conver- “In the US the heavily federalized fiscal ­mobility, crisis prevention and resolu- gence are closely intertwined. First, system offers a partial solution to the tion tools have to be developed. On this specialization and agglomeration effects problem of regional stabilization. Unless point, the euro area has made very could increase both structural and there is a massive change in ­European ­significant steps since the crisis. In addi- ­cyclical divergence (as shocks would institutions, this automatic cushion will tion, financial integration is an important ­become more asymmetric). Second, be absent.” Today, structural real income ingredient of the optimality of a currency ­cyclical divergence can lead, in a mon- divergence makes any step toward a EU current legislation on social security union15 and hence contribute to its etary but not fiscal union to overbur- euro area central fiscal capacity more coordination14 and recognition of profes- credibility. Finally, a deeper financial dening the national fiscal policies19 and politically difficult, not to mention a sional qualifications or to harmonise ­integration could also be a powerful to asymmetric adjustments where transfer union. To get out of this trap, further education standards. Eventually, driver of cyclical convergence through ­countries have less fiscal space, increasing there might be a way: strengthening the increased labour mobility gives a rationale private risk sharing directly or indi- structural divergence as it happened EMU to make it more alike an optimal for partly mutualising education spending. rectly (as financial integration of the during the European sovereign crisis.20 currency area and to improve cyclical euro area goes along with a decreasing A lot has been done for improving convergence. This would (i) increase 3.3 Financial integration home bias at the euro area level).16 cyclical convergence. A lot remains to the credibility of the EMU and its resil- Financial integration inside the euro be done and the relevant proposals made ience, (ii) help mitigate divergence area has deepened over the long run, 3.4 Fostering stronger cyclical by a group of 14 French and German through private risk sharing and (iii) but has dropped dramatically during convergence economists21 give an illustration of the give rationale to more fiscal transfers. the Great Financial Crisis and has not Differently from long-term real income heavy agenda to complete the work. As an example, in the same manner a fully recovered since. A lot has been convergence, cyclical convergence is a Since the beginning of the European Banking Union justifies a common fiscal done since the crisis to increase financial necessary condition of a functioning project, real income convergence, albeit backstop for the Resolution Fund, a integration: Banking and Capital Markets monetary union. Indeed, a common not being a necessary condition of the much more integrated labour market Unions are at the forefront of the euro monetary policy has difficulties dealing EMU, has been seen as one of its main could justify a fiscal capacity at euro area agenda since the European sovereign with desynchronized business cycles deliverables. Deeper integration would area level for some education spending. crisis. The Banking Union is still in- and/or potential asymmetric shocks. As complete and need to be accompanied Anna auf Dem Brinke, Henrik Enderlein by more intra-euro area cross border and Jörg Haas state: “cyclical conver- banks consolidations. The capital markets gence is a must have in the EMU”.17 In union is still in its first phase and a lot an economic and monetary union, risk remains to be done. sharing, ie the smoothing out of the More financial integration could consumption in case of an economic have a direct positive effect on real shock is normally higher. On this point, ­income convergence. It could facilitate the USA is also working better than the net cross-border capital flows from EU. “While in the euro area around countries with a structural higher saving 80% of a shock is to GDP growth in a

14 And even beyond the amendment on which the European Parliament and the Council of the EU reached a provisional 18 Risk sharing in the euro area, J. Cimadomo and S. Hauptmaier, A. A. Palazzo and A. Popov, ECB Economic Bulletin, agreement in March 2019. March 2018. 15 Currency union with or without banking union, V. Bignon et al., International Economic Review, May 2019. 19 Design failures in the Eurozone, can they be fixed?, P. De Grauwe, LEQS Paper, February 2003. 16 Institutional investors and home bias in Europe’s Capital Markets Union, Z. Darvas and D. Schoenmaker, Bruegel 20 Causes of European Crisis, J. Frankel, in: The Eurozone Crisis: A Consensus View of the Causes and a Few Possible WP, February 2017. Remedies. R. Baldwin and F. Giavazzi (eds.). Center for Economic Policy Research, 2015. 17 Why the Eurozone cannot agree on convergence and how structural reforms can help, Institut Jacques Delors, policy papers, 21 Reconciling risk sharing with market discipline: A constructive approach to euro area reform, 14 French and German May 2016. economists, CEPR policy insight, 91, January 2018.

160 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 161 Isabel Schnabel Reconciling risk sharing with market University of Bonn and German Council of Economic Experts discipline: a constructive approach to euro area reform

A great European, Hans-Dietrich Gen- stability of the banking sector, and the scher, once said: “Our future is Europe. European Stability Mechanism for crisis We do not have another one.” This is, in management; the Stability and Growth fact, an important and true statement, and Pact was reformed, and there are new it underlines the importance of thinking regulations in the ­financial sector, like about reforms in Europe. This is why a Basel III. group of seven French and seven German Nevertheless, there are several prob- economists (the “7+7 group”) published a lems that have not been solved. Many comprehensive report on euro area reform Member States still show very high last year (Bénassy-Quéré et al., 2018). public debt levels. Public debt increased This report has received a lot of atten­ sharply in the global financial crisis, and tion, and one of the reasons is that the the relatively good times afterwards have group of authors of the report was quite not been used sufficiently for consolida- heterogeneous. But in spite of some diver­ tion in some Member States. This is partly ging economic views, it proved not so hard due to the fiscal framework, which has to find a consensus. This gives some hope proven to be procyclical, partly ineffective that Europe can find a consensus on these and politically divisive. So debt levels issues in spite of the existing red lines. are still high and fiscal space in the next Two such red lines are debt mutualization crisis or recession is limited in many and permanent transfers among Member Member States, excluding, most impor- States. Within the “7+7 group”, those tantly, Germany. two red lines were respected. But further At the same time, monetary space is red lines exist that may have to be limited. The macroeconomic situation crossed to make the euro area stable. would have allowed for an earlier normali­zation of monetary policy, but Diagnosis: the euro area remains this has not happened. At the present fragile situation slowing growth makes the exit It is important to acknowledge that the from loose monetary policy unlikely. euro area remains fragile. But many politi- Consequently, the euro area may not be cians have lost this sense of urgency that able to rely on the ECB to the same ex- some­thing needs to be done. The feel- tent as it has done in the last crisis. This ing is that the crisis is more or less over is not so much because there are no and no reforms are needed in the short ­instruments left but rather because run. This may be a misperception. The these instruments become more and global economy currently experiences a more politically controversial, which slowing expansion, and the same is true may impact the ECB’s independence. for the euro area after a relatively long The European banking sector remains boom. Risks are rising. There is the trade relatively weak. Of course, capital ratios conflict, the imminent Brexit, and the are higher than before the crisis. But risk that the euro area crisis may re- especi­ally in the light of the observed turn. Of course, a lot of progress has ­reduction in loan-loss provisions, they been made. Europe has created new or are still not high enough. Non-performing improved institutions: the European loans have decreased, but they may rise Banking Union, which is crucial for the again fast in the next rec­ession. There has

46th ECONOMICS CONFERENCE 2019 163 Isabel Schnabel Isabel Schnabel

also been increased risk-taking, not euro area countries. Moreover, the shocks, to avoid procyclicality, and to finan­cial architecture needs to be least due to the low interest rate envi- shock was transmitted to Italian and create safe assets. These different phi- strengthened with two main features: ronment. Exposures to dome­stic sover- other European banks, which shows losophies translate into different policy breaking the sovereign-bank nexus and eigns remain very high, and the­ profit- that the sovereign-bank nexus is still implications. The “German” view would creating a European banking and capital ability of banks is structurally low. alive and strong. prescribe a regime for the orderly restruc- market. The second is that the credibil- Meanwhile, the popularity of EU turing of sovereign debt, credible fiscal ity of the fiscal framework has to be membership has risen, partly related to rules with sanctions, and a removal of the ­increased. This speaks in favor of an ex- the imminent Brexit. However, there is regulatory privileges for sovereign expo- penditure rule that is less procyclical a large heterogeneity across countries, sures of banks, whereas the “French” view and better enforceable. Moreover, rules political polarization and anti-European would argue for a fiscal capacity, Euro- are needed for a credible restructuring movements prevail in quite a few coun- pean ­deposit insurance and safe ­assets. of sovereign debt as a last resort. And tries. It seems likely that crisis manage- The central point of the report is finally, more stabilization is needed ment has contributed to that. Interest- that it is a mistake to argue that these through a European unem­ployment re- ingly, neither the debtor nor the credi- two views are contradictory. On the con- insurance scheme with an incentive-com- tor countries were very happy. While trary, the report argues that risk sharing patible design and without permanent the creditor countries had the feeling, and market discipline are complements transfers. they were paying for other people’s ­because they rely on each other. Note As to the financial architecture, there mistakes, the debtor countries had the that the “7+7 paper” is not a political is one core question: How can the sover- feeling that austerity programs had paper. It is not about forming packages eign-bank nexus be broken or at least be In comparison to the USA, there is been unfairly imposed on them. that are acceptable for political reasons. mitigated? There are various connections relatively little risk sharing in the euro Taken together, the status quo of the It rather is an economic paper, which between the state and the banks (see area. There was a sharp drop in finan- euro area remains unstable. The recovery argues that a consistent approach to euro chart 1). First, there are direct connec- cial integration after the financial crisis. has relied strongly on the ECB, which may area reform has to have both elements tions. One of them is through implicit or Financial integration proved not to be not be possible to the same extent in the – risk sharing and market discipline. explicit government guarantees, which resilient in the crisis because it was future due to limited monetary space. The argument in a nutshell is as fol- is bank rescues on the one hand, and, mostly interbank loans, which disap- At the same time, there is limited fiscal lows. If there is no discipline, risk sharing what people tend to forget, deposit insur- peared in the middle of the crisis. Hence, space. Therefore, it will be much more will tend to lead to moral hazard, and ance on the other. Deposit insurance can the risk sharing did not work when it diffi­cult to deal with the next recession this is not sustainable in the longer run. only be credible if it has an implicit was needed most. The banking and the or crisis. Hence, it is clear that some type of disci- ­govern­ment backstop. But this creates a capital markets are still segmented in pline is necessary. However, disciplining ­connection from the weaknesses of banks Europe, and so there is little financial Risk sharing and market discipline devices that are merely based on admin- to the sovereign. In the other direction, risk sharing and what is more, there is are complements istrative or political procedures are hard virtually no fiscal risk sharing. At the same time, there is a deadlock to enforce for political reasons. This is Chart In 2018, the importance of these that delays, or slows down, the reform where market discipline comes into play. ­issues became clear when there was a process, which poses a threat to the stabil- However, market discipline alone will Illustration of the sovereign­bank nexus sharp rise in Italian government bond ity of the euro area. As argued in the not be enough because market discipline Removal of privileges spreads in the context of the Italian gov- “7+7 report”, this is partly due to differ- without risk sharing will be destabilizing for sovereign exposures Default rik for overnment debt ernment formation and budget negotia- ent philosophies. The words “German” and therefore it cannot be credible. To give Eroion of uarantee State Domestic tions. On the one hand, this is a good and “French” used below in order describe an example, the government cannot say banks sign because it seems there was some the opposing views should not be taken that it no longer bails out banks if there Implicit and eplicit uarantee market discipline, and it partly worked literally. Now, what is the “German” are no stabilizing features that prevent a Resolution regime EDIS because the Italian government became view? The “German” view emphasizes meltdown of the entire financial system. Economic policy Economic ituation and meaure framework condition a bit more careful when they saw these the unity of liability and control, the Therefore, risk sharing and market dis- Lower ta revenue Integrated Decline in lendin increaed ependiture miallocation harsh market reactions. On the other role of market discipline, incentive cipline belong together, and one cannot banking market hand, there are studies showing that this compatibility, fiscal discipline, enforce- work without the other. Capital Markets Union increase was partly driven by redenomi- able rules, and the absence of a transfer Domestic nation risk. This also shows up in the union. The “French” view emphasizes How to reform the euro area economy Source: German Council of Economic Experts (2018). Based on Shambaugh (2012) and transmission of these increases to other the need to insure against asymmetric There are three important elements of Schnabel and Vron (2018). euro area reform. The first is that the

164 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 165 Isabel Schnabel Isabel Schnabel

it goes through the holdings of sover- Markets Union, and it could be supported should not be an automatic debt restruc- more stabilization may actually help to eign debt by banks, and this again cre- by removing the debt bias in taxation. turing of the stock of debts because this make market discipline more credible. ates a direct connection between the Furthermore, it would be important to could lead to self-fulfilling effects. How- What types of stabilization instru- problems of sovereigns and banks. expand the competencies of the European ever, there should not be ESM loans ments could be considered? One possi- In addition, there are indirect con- Securities and Markets Authority (ESMA). granted to insolvent countries without bility is a European unemployment in- nections running through the domestic One issue the “7+7 group” did not debt restructuring. Holdout problems surance against large shocks. The trigger economy. If there is a sovereign debt cri- agree on is whether there is a need for a should be mitigated through compre- would be a large shock, for example, to sis or if there is a domestic banking crisis, European safe asset. There are quite a hensive collective action clauses, and the unemployment rate, giving rise to a this will have an impact on the domestic few arguments why one may need such an some of this has already been agreed in one-time transfer – not a loan but a economy. In turn, this will feed back into asset. One of them is related to the regu- the last summit. Importantly, this inter- transfer. It would not be repayable. It problems at the sovereign or at the latory treatment of sovereign exposures. acts with the question of sovereign expo- would be financed through national banks. How strong these feedbacks are, In order to ensure that there is more diver- sures, because if bank holdings of domes- contributions, which would have an depends on whether there is an inte- sification in banks’ sovereign bond hold- tic sovereign exposures are reduced, this ­experience rating, meaning that if a grated European capital market, which ings, this would currently mean that lowers the costs of debt restructuring. country taps the funds, it will have to implies that firms in need of funding some banks would have to move into The third issue is fiscal stabilization. pay higher contributions in the future. can shift from bank funding to capital riskier assets. For example, German But why is there a need for fiscal stabili- Importantly, there should be no bor- market funding. It also depends on how savings banks may have to shift into zation in the first place? One reason is rowing by the fiscal ­capacity. Finally, well the banking sector is integrated. A ­Italian government bonds. Not every- that national fiscal space can be insuffi- there should be ex-ante conditionality, highly integrated banking sector allows body may think that this is the best cient in spite of responsible behavior. meaning that a country would be al- firms to switch to other European banks idea. So the question is whether a Euro- Some argue that, in such cases, it would lowed to access this fund only when it if the domestic banks are in trouble. At pean safe asset may provide a solution. be much better to have an insurance complies with the rules. the same time, if the European banking Regarding the fiscal framework, through the financial sector, namely sector is integrated, a domestic problem there is now emerging consensus on the through financial integration. However, will not affect the domestic banking sec- need to switch to a fiscal expenditure looking at the progress made in financial tor to the same degree. rule as the current rules are too hard to integration, it is unlikely that the desir- This points towards the most im- enforce and procyclical. They have too able level of risk sharing can be achieved portant banking sector reforms: little bite in good times, while being too in the medium run, and therefore a fis- • First, this is a credible resolution harsh in bad times. So the general idea cal mechanism may still be necessary.­ It ­regime, which includes a common fiscal in the proposals is that expenditures has also been argued that stabilization backstop and, importantly, a special should not grow faster than long-term already exists through the ESM pro- liquidity facility for banks in resolution. nominal GDP (i. e., potential growth plus grams. However, it is not wise to use • The second reform is a well-designed expected inflation), and that they should them as a substitute for macroeconomic European Deposit Insurance Scheme grow more slowly if the country misses stabilization. In fact, a major ­advantage of (EDIS). some long-term debt targets, which a fiscal capacity is that it can act as an au- • The third issue is setting an end to could be the 60% from the Maastricht tomatic stabilizer. the regulatory privileges for sovereign Treaty. One very important question Such an instrument should be designed A second instrument, which is discus­ exposures. ­remains: How can such rules be enforced? in a way that takes into account moral sed and partly exists already, is a pre- • The fourth is a truly European banking The proposal in the report was that one hazard problems and helps to prevent long- cautionary credit line at the ESM, which market, which implies that options and could force countries to finance­ exces- term permanent transfers. This inclu­des allows for access to short-term liquidity national discretions need to be phased sive expenditures through junior debts, design features like the reinsurance prin- at relatively low rates, without having out and that obstacles to Pan-European what some people have called account- ciple, ex-ante conditionality, experience to apply for a regular ESM program. mergers are removed rather than cre- ability bonds, in order to introduce an ratings and so on. But even if not all incen- There is relatively strict ex-ante condi- ating national banking champions. element of market discipline that can be tive problems can be dealt with perfectly, tionality, but no or little ex-post condi- In addition, a well-developed European enforced more easily. this does not necessarily mean that such tionality. Some people fear that, under capital market is desirable. Most impor- The second important issue is the instruments should not be introduced such circumstances, it will never be used. tantly, resilient capital flows should be question of orderly sovereign debt restruc- at all, because these downsides still have But such a liquidity line may help to sta- fostered, especially equity flows. This is turing, which is needed to make the no- to be weighed against the potential ben- bilize expectations in a way that a country one of the main goals of the Capital bailout rule credible. Importantly, there efits from stabilization. And, in fact, with sound fundamentals basically can-

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not lose market access. Then this instru- close to achieving the goal. Hence, there References ment could serve its purpose even if it is is a need for commitments on all sides, Bénassy-Quéré, A., M. Brunnermeier, H. Enderlein, E. Farhi, M. Fratzscher, C. Fuest, never used. determining what are the preconditions P.-O. Gourinchas, P. Martin, J. Pisani-Ferry, H. Rey, I. Schnabel, N. Véron, B. Weder How is it possible to deal with the and what are the consequences. di Mauro and J. Zettelmeyer. 2018. Reconciling risk sharing with market discipline: A political resistance in reaction to this type Finally, one has to take into account ­constructive approach to euro area reform. CEPR Policy Insight 91. of proposals? One has to start by con- the political developments when designing Schnabel, I. and N. Véron. 2018. Breaking the stalemate on European deposit insurance. vincing both politicians and the popula- economic programs. For example, there https://voxeu.org/article/breaking-stalemate-european-deposit-insurance. tion that the euro area is unstable in its are economic arguments why austerity Shambaugh, J. C. 2012. The euro's three crises. Brookings Papers on Economic Activity 43 (1). current form and that something has to programs were needed in the crisis. But 157–231. be done. A stable euro area contributes to these programs probably also contributed stronger economic growth and helps to to political polarization, which now makes strengthen the role of Europe in the reform much more difficult. Therefore, world. Simply waiting and not doing any- these issues have to be taken into account thing, or waiting for the next crisis are more broadly. very bad options. Clearly, it will always be hard to implement such reforms, Conclusions ­because there will always be opposition After the political events in Italy some from one side or the other. So it will be people have argued that no further steps necessary to form packages, but not only should be taken towards more Euro- for political reasons but also for economic pean integration because Italy is not reasons. This probably means that all playing according to the rules. But this sides will have to cross some of their is a bad idea. Italy should not be used as red lines. an excuse to delay the reforms but the Maybe it would help if some of the opposite is true. It rather shows how issues were discussed in the public more urgent the reforms­ really are. It would objectively. When looking at the dis- be unwise, both from the French and cussion about the European Deposit the German perspective, to reject any ­Insurance Scheme (EDIS) in Germany, further market discipline or risk shar- there are many wrong stories being told ing, instead one should put more energy about EDIS. This is a serious problem, into thinking about how to design in- and politicians should stand up and admit centive-compatible mechanisms for risk that, while there are some issues, there sharing. Some say that if the next crisis are also good reasons for implementing comes, none of these reforms will have EDIS. A much less emo­­­tional debate is been implemented. Therefore, they needed on these issues, and certainly come too late anyway. This is partly such red lines should not be an excuse true, of course, because ­reforms will not to act. Firm commitments are take time. But one should be aware that needed on both sides. In the debate ­reforms would have important implica- about risk reduction and risk sharing, tions for expectations. They may help many Member States in the euro area had to stabilize the expectations regarding the impression that risk reduction was a the future of the euro area and the willing- moving target, which was always adjusted ness to reform in order to make the euro at the time when some countries came sustainable. And this is the ultimate goal.

168 OESTERREICHISCHE NATIONALBANK 46th ECONOMICS CONFERENCE 2019 169 46th ECONOMICS CONFERENCE 2019 46th ECONOMICS CONFERENCE 2019 The Economics Conference hosted by the OeNB is an international platform for exchanging views on monetary and economic policy as well as financial market issues. It convenes central bank representatives, economic policy decision makers, financial market players, academics and researchers.

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