quarterlyEuropean review Union WORLD COMMERCE SUMMER 2018 REVIEW

Hans Kundnani Jeffry Frieden writes Europe needs a broader considers the troubling that substantial discussion of its future, transformation of the improvements are argues Guntram Wolff European Union needed to save the euro

THE GLOBAL TRADE PLATFORM www.worldcommercereview.com future ofEurope perspective introduceSturm that aneweBook makes thecasethat for suchquestionsare the offundamental importance economics institutional an of To reform theEuropean whichinstitutionsandrulesare project neededandwhen?Nauro Campos andJan-Egbert value the future: Europe’s makeproposals as Claeysto howof deficiencies. andZsoltDarvas to improve Grégory them The Commission’s proposal for MFFprovides thenext agoodbasisfor subsequent negotiations. Butithasanumber half-full glass A gaps data andfindfiscal constraints matter andplanning capacity infrastructure Adequate infrastructure isessential for growth. consider BrutscherandAndreas recent Philipp-Bastian Kappeler Europe’s Addressing line credit precautionary a saysAndritzky mislabellingtheESMas Fund’‘European Monetary willnotdothetrick through toolkit Strengthening theESMcanhelpto prevent andenhance crises deeperfinancialintegration intheeurolending area. Jochen ESM the Enhancing CONTENTS www.worldcommercereview.com spending? diverged, and that willnotplugthegapsineuro their friendship area architecture friendship considers between France Mody thefriendship Ashoka andGermany andfindsthat theirnational interests have Franco-German of myth The recovery Europe' to 'economic superstar' exceptional introducesDalia Marin anew VoxEU that eBook explores how Germany transformed itselffrom the'sickmanof Germany’s Explaining 'competitiveness' shouldgive causefor concern EU the of Hans Kundnani writes that theEUhasalready undergone asubstantial transformation, butthat arigid focus on transformation troubling The the needfor cohesion spending cohesion and MFF, consider Moës thenext andNicolas Zsolt Darvas thegradual convergence oftheregions in andthereduction agricultural EU in decline proposed the is large How CONTENTS www.worldcommercereview.com Trade war: how tensions have risen between China, the EU and the US the and EU the China, retaliation. Francesco Chiacchio discussespossiblescenarios for theEU between risen have The multilateral trading system has beenchallengedby unilateralist measures andsubsequent threats of tensions how war: Trade sector to cutgreenhousetransport gasemissionsandensure European decarbonisation targets transport the up clean to Simone Tagliapietra andGeorg Zachmannwrite that Europe would benefitfromfailure greater on road EUaction Europe’s Addressing alternative to settingthehouseonfire suggests that ifthedefenders of theEuropean want project to regain popularity, theywillneedto present aclear choices hard for calls populistsislikelytoThe exacerbate economic agenda ofItalian Italy’s long-standingproblems. Alessio Terzi populism Italian cause substantial harm protection argue that reward programmes appropriate for are areas particularly specific whereregulatory wrongdoing can whistleblower on Theo Nyreröd Spagnolo andGiancarlo compare thewhistleblower protection policiesintheEUandUS directive EU proposed A CONTENTS www.worldcommercereview.com Are SBBS really the safe asset the euro area is looking for? looking is architecture, would theprovision render ofsafe unnecessary assetsinthe euro area viapotentially hazardous SBBSs area euro the asset Claeys argues thatGrégory soundpoliciesat thenational level, combined withanambitiousreform oftheeurozone safe the really SBBS Are citizens Vítor Constâncio. Headdsthat itisequippedto continue for of price to stability euro deliver area onthepriority policy monetary ECB through four policy keyphases,Having andeffective developed theECBisamodern says itsmonetary central bank, the of future and Past trade digital and privacy and JoshuaMeltzer argue that the way forward isto Shieldbargain theEU-US reflect Privacy between by developing ofdata-based countries services isthreatened regulation. MattooExports by Aaditya theEU'sprivacy conflict the Resolving Initiative Road and Belt competitiveness relative to shipments airfor time-sensitive China’s and Richard Pomfret argues that theBRIcould beamajorstep towards Eurasian integration andgreatly improve rail’s Landbridge chains Eurasian value The regional linking Richard Pomfret looksat thecatalyst ontrade costs for anditsimpact theEurasian rail Landbridge services Landbridge: Eurasian The CONTENTS www.worldcommercereview.com alternatives reform' area euro to Watt discussesthestrengths ofrecent andweaknesses proposals andmakesrecommendations for and extensions approach constructive 'A There for iscurrently reform bothaneconomic andapoliticalwindow intheeuro ofopportunity area. Andrew proposal: the of Analysis crucial ones issues are central.future Guntram Wolff Insightconsiders theCEPR andargues that itleavesPolicy asidesomeofthemost its of discussion aboutwhat andwell-being willdetermine theprosperity When ofcitizens thinking livingintheeuro area, five broader a needs Europe realm monetary the a balanced reform package ignore cannot Jérémie Cohen-Setton andShahin Vallee to write provide that therecent CEPRPolicy missedanopportunity Insight reform area Euro reform area euro for if’ experiment basedontheproposals intherecent CEPRPolicy Insight proposals assessing to discussiononeuro areaThe policy reform hasentered phase. acritical George Papaconstantinou attempts a ‘what approach if’ ‘what A CONTENTS www.worldcommercereview.com bonds safer again safe the euro Claeys area. argues that Grégory animproved euro area architecture would makealleuro area sovereign bonds sovereign A recent CEPRPolicy suggestsintroducing Insight sovereign to bond-backedsecurities play therole ofsafe assetin area euro Make consequencesbut alsoitsasymmetric common instruments andpoliciesat theEuropean level, whosemere existence willreduce notonly its magnitude reduction risk and IglesiasandFederico Otero Miguel Doménech, Rafael Steinberg with argue thatcanonlybetackled thisrisk sharing risk Beyond to address anumberofcentral problems ofEMUarchitecture Insight Policy argues Dullien thatSebastian therecently publishedCEPR Policy leaves Insight economists’ too many questionsopenandfails 14 the of spots Blind required, argues Jeffry Frieden For theeuro area to bestable andmove forward productively substantial improvementseuro initsoperation are the save to plan A CONTENTS www.worldcommercereview.com Risk reduction and risk sharing in EU fiscal policymaking advancerisk and inparallelrisk sharing reduction if fiscal fiscal EU in sharing Larch dilemmaaround argue acentral that canonlybe thepolicy overcome fiscalcapacity andMartin Beetsma Roel risk and reduction package Risk well-sequenced and significantrisks, and could lead to more, not fewer, rescues coherent a requires GiudiceMarco andJoséLeandro Buti,Gabriele argue that therecent CEPRproposals seemunbalanced andcarry EMU Deepening ofeuro risk areainsolvency that membershipisthemainrisk shouldbecovered by joint sharing risk deal bad a The recent proposals for euro area reform have initiated anintensive debate.than Peter argues Bofinger that thespecific better is deal No CONTENTS www.worldcommercereview.com lending toolkit through a lending toolkit precautionary credit line precautionary and enhance deeperfinancialintegration intheeuro area. Jochen Andritzky saysarea. JochenAndritzky mislabelling theESMas Strengthening theESM canhelpto prevent crises Enhancing theESM ‘European Monetary Fund’‘European Monetary willnotdothetrick www.worldcommercereview.com design willtakemuchlonger. Hence, point for thisblogpostcanonlyprovide adeeperdebate. astarting in anticipation oftheeuro summitat theendofthismonth. However, fleshingoutthedetails ofanewinstrument’s creditthe detailsofdesign line. ofaprecautionary This to inform may serve thedebate that islikelyto unfold This lendinginstruments for before blogpost outlinessomeprinciples incentive-compliant delvinginto someof the facility, afate that instruments. hasalready befallensomeexisting precautionary satisfy memberstates’ financingneeds. Butalsotheopposite may occur –that nomemberstate ever signs up for acrisis.trigger Too-easy terms may leadto overuse ofthefacility, sothat theESMbecomes aregular source to same time, theESMmay finditselfbetween a rock andahard place ifithas to fear that cuttingthecredit linemay down, the ESM may have to lendto memberstates that pursueinappropriate At policiesorposeacredit the risk. Needless to say, instrument canbedangerous. anill-designed conditions for If access to thecredit lineare watered economic policies, itsetstheright incentives. financial markets, itbetter guards againstcrisis. And by rewarding compliance with European rulesandsound could bequite providing –ifitisdoneright. By meaningful astronger backstop againstcoordination failures in While hardly aleapforward for euro reform intheeyes ofmost, thisaugmentation oftheESM’s lendingtoolkit loan size cappedandrepayable infull. shocks.by external conditions Countries could receive satisfying certain anESMloanfor maybe five years, withthe interview, Germany’s credit for facility raised chancellor memberstates theideaofashort-term Angela Merkel hit the debate oneuro area reforms, proposed itto albeitnoonehasactually become ‘monetary’. Instead, inarecent Transforming theEuropean (ESM)into Mechanism a Stability Fund’‘European Monetary hascome to dominate Introduction www.worldcommercereview.com clearly welfare-enhancing (Mussa etal.2000;Jeanne2004). (Mussa welfare-enhancing clearly For example, may behitby acountry contagion from elsewhere. crises thesecases, lendingby In crisis theESMis access may from arise asometimesirrational financialpanicunrelated to a country’s orpolicies. long-runsolvency withalossofaccessfinancial crisis.Sovereign financing.to market typically start Suchlossesofmarket debtcrises The mechanismto ESMisacrisis prevent andresolve coordination failures that infinancialmarkets canlead to a The power ofex-ante conditionality be well thought through, to navigate difficult trade-offs difficult navigate to through, thought well be financial market turbulence. The design of such a facility has to to has facility a such of design The turbulence. market financial by incentivising strong economic policies and guarding against against guarding and policies economic strong incentivising by meaningful instrument, built on the existing policy framework, framework, policy existing the on built instrument, meaningful ... a revamp of its precautionary credit line could create a a create could line credit precautionary its of revamp a ... www.worldcommercereview.com common policiesandprovide anadditionalincentive for compliance. The ESMcould buildonthis. common Ex-ante policiessuchasfiscalrulesalready canbefitted bindnational policymaking. conditionality to Generally, thesituation oftheeuro area iswell suited for awider useofex-ante conditionality. many In areas, etal.2001). (Jeanne aimed at preventing crises, theex-ante approach can improve welfare compared to apurely ex-post approach policies, thancorrecting Rather theaimofex-ante Since isto itis conditionality incentivise goodpolicymaking. go shockhitsandfinancialmarkets awry.self-inflicted) following soundeconomic policiesreceive access credit to lineonwhichtheycandraw aprecautionary whena(not offersconditionality a way to provide positive incentives for strong policies:Onlymemberstates continuously While much attention ispaidto ex-post –thepolicies agreed conditionality uponfor programmes crisis –ex-ante credit lines.precautionary the form ofpreventive policies, and ex post. Lending facilitiesusing ex-ante are conditionality referred often to as monitored by lenderasacondition thecrisis for providing asafety net. Conditionality canbeappliedex ante, in policieswhicharePolicy thesetoffiscalandstructural agreed describes conditionality withthememberstate and economic andfiscalpolicymaking. adverse incentives iseven intheeuro more area, important where memberstates retain substantial sovereignty in politicians to adopt unsoundpolicies, orfinancialmarkets to continue to finance misconceived policies. Avoiding a financialsafety inacarmight net. driving, Justasairbags induce mechanismmay less-careful soacrisis induce practice, areIn crises hardly ever unrelated to policies. to Hence, consider theincentive itisimportant effectsof www.worldcommercereview.com the ESMinmonitoring ex-ante addsto conditionality andbolsters transparency confidence ofmarkets. credit lineshouldbeperceived asa stamp ofapproval for strong ofthis, policies. theanalysis provided As part by this would signal andstigmatise vulnerability theinstrument. ofsignalling Instead avulnerability, signing upfor a On theotherhand, memberstates shouldnotapplyfor thecredit lineonlyonce theyare at theverge ofacrisis, as under exceptional andunintended circumstances. idea oftheproposal. Hence, strong institutionalsafeguards are neededto ensure thecredit lineisonlydrawn on frequently. This would transform theESMfrom lenderto acrisis acommon financinginstrument, whichisnotthe On onehand, memberstates shouldnotrely onthecredit linefor fundingneedsordraw normal onittoo between overuse andunderuse, access. andbetween automatic access andcase-specific to consider inthedesign ofthecredit line’s trade-offs These lessons highlight two important conditionality: conditionality, andHaas, andnegotiate lending(Enderlein onlyonce conditionality 2015). inneedofemergency limited may or additionalconditionality apply. This to may remain induce unconstrained policymakers by ex-ante crisis. isprequalified Second, lending, whiletheideaisthat country asubscribing for emergency access may be isseenassendinganegative facility believes signal itmay thatof precautionary acountry become avictim This mirrors theexperience ofthe IMF, for whichtwo keyreasons have beenidentified. First, signing up to a and theEnhanced Conditions Credit Line(ECCL). To date, nomemberstate hasyet requested acredit line. Currently, credit theESMoffers lines,twotypes ofprecautionary the Conditioned CreditPrecautionary Line(PCCL) thedesignrightGetting www.worldcommercereview.com remains lost, thememberstate canstillchooseamacroeconomic adjustment programme. adjustment programmes to overcome deeper-rooted problems. the credit If lineisdrawn down access andmarket period.is inhibited for ashort doesnot replaceThe macroeconomic facility otherESMfacilities, inparticular The ideaofacredit lineisto offer financingifamemberstate’s bridge market access toissue sovereign bonds Conditions ofthecredit line protect theESMfrom Finding credit detailthat needsto risk. beworked theright balance out. isanimportant – asintheproposal ofa ‘discount window’ by andHaas(2015)–may Enderlein betoo automatic andtoo weak to à-vis the existing instruments withex-post conditionality. However, compliance definedsetofrules withaclearly sense that bothmemberstates cantrustthebackstop. there andfinancialmarkets isnoadvantageOtherwise, vis- While there mustremain conditions, scope to thecredit adjustthesetofpolicy linemustremain credible inthe (Tumpel-Gugerell, 2017; Wyplosz, 2017). withtoo thecriteria manyOverloading issuesshouldbeavoided, for muchlikeconditionality programmes crisis limited to thoserelevant for preventing economic crises, limitingtheirscope, debtsustainability. andensuring list’ andwhether conditions canbeadapted orremains case-specific, over time. The choice shouldbe ofcriteria With regard to thequestionis thesecondto what trade-off, extent ex-ante conditionality follows an explicit ‘check convinced ofthecredit line’s benefitsandsign upinadvance. robust backstop ofgovernment inthepricing at governments timesofelevated bonds, may risk, inparticular be gradual adjustment could beoffered given the country’s track record ofstrong thismore policies.If markets reflect decidesto applyforcountry otherfacilities(withex-post amore conditionality), comprehensive backstop andmore maturities, orlower interest rates underotherESMfacilities. otherwords, In ifmore fundsare crisis neededandthe Moreover, memberstates satisfying thecredit line’s ex-ante could conditionality begranted higheraccess, longer www.worldcommercereview.com that could severely alter thequalification assessment. on approving thecredit line, continuous whetherany monitoring would policiesare ascertain beingimplemented difficulttimes.line during Besidestheannualcheck-up before theESM’s bodytakesadecision topdecision-making political pressure to ex-ante soften andovercome conditionality the challenge ofwithdrawing access to thecredit renewable. Arequirement to reapply for annually(rather thefacility thananautomatic could extension) reduce As opposedto instruments, here thecurrent asdescribed shouldberepeatedly ESMprecautionary afacility Precautionary credit lines are usuallygranted for alimited time, suchasoneyear, andcansometimesberenewed. is notatransfer mechanism. member states would bemanageable. There isnodoubtthat theloanwould needto berepaid infull, asthefacility sizeable margin over theESM’s cost offundingto implications discourage for run,thesolvency overuse. theshort In manner. Given itsnature financing, asbridge interest for larger amounts drawn underthecredit line could includea However, credit for line, a precautionary there isnoreason notto applyBagehot’s principle, at leastinatiered management(Wyplosz, ofdebt-related 2017). cashflows dominated adjustment programmes through was replaced lower support by lendingrates oneinwhichsolvency and reduce reliance lending. oncrisis thecourse Over oftheeuro-area crisis, theBagehotapproach for macroeconomic andshouldtakeplaceThe postulates at Bagehotprinciple highlendingrates that lendingistemporary crisis to same time, andnotallcountries would qualifyfor thecredit line. This exceeds theESM’s current of€500billion.However, lendingcapacity notallmemberstates would draw at the The total gross publicfundingneedfor alleuro area memberstates amounts oneyear. to during about€1trillion accessMaximum underthecredit lineshouldtherefore belimited, for instance to oneyear’s gross financingneeds. www.worldcommercereview.com Economic Policy 16,407–432. Jeanne, O, JZettelmeyer, PBacchetta (2001),“International andAScott Bailouts, Moral Hazard andConditionality”, IMF (2015),CrisisProgram Review. IMF (2016),“Adequacy Net”, oftheGlobalFinancial Safety Policy Paper, Washington, DC Berlin. would aEuropean finance minister do?”,Enderlein, HandJHaas(2015),“What Delors Institut, 139,Jacques paper Policy References isa Jochen Andritzky Visiting Fellow at Bruegel orsuspendaccess whenpoliciesdeteriorate.curtail ■ credit line, theESMmustbeprotected from pressure to water down ex-ante conditionality, andmustbeenabledto and underuse. While sufficient assurancecrisis assistance for mustbe provided tomemberstates signing up tothe with goodpolicies. However, acleverbetween design needsto befound to overuse navigate thedifficult trade-off suitsthecurrentconditionality framework ofcommon policieswell, andcould strengthen incentives to comply However, thedevilisindetailsthat canmakeorbreak thecredit line’s success. to ex-ante subject Afacility questionable focus oftheongoingdiscussion. delivers amore substantial contribution to euro area thanchanging theESM’s financialstability legalstatute, a easy to implement. Suchaninstrument enhances theESM’s credibility asabackstop inasovereign and debtcrisis credit linecould additiontoA precautionary beasmallbutmeaningful theESM’s whichlooksfairly lendingtoolkit Conclusion www.worldcommercereview.com This article was originallypublishedonBruegel This article President oftheEurogroup Affairs intheEconomic Committee, andMonetary May. Wyplosz, C(2017),“A Fund?”, European Monetary provided paper Scrutiny inthecontext ofEconomic withthe Dialogues System”,Multipolar EssaysonInternational Finance 4,Centre forInternational Governance Innovation, Ontario. Weder, Net:Struggling NewGlobalFinancial forCoherent BandJZettelmeyer Governance Safety (2017),“The ina Tumpel-Gugerell, G(2017),EFSF/ESMFinancial Assistance –Evaluation Report. economies”, andFinancial ReformingtheInternational Monetary System, 75–142. Mussa, M,ASwoboda, JZettelmeyer (2000),“Moderating andOJeanne in fluctuations capital flows toemerging market Hazard)”, IMFworking paper, Fund. International Monetary ResultsonIMF-induced MussaTheorem Moral (andOther Jeanne, O, (2004), “The JZettelmeyer andIMFRDepartment www.worldcommercereview.com Adequate infrastructure isessential for growth. Philipp- recent data andfind fiscal constraints and planning Bastian Brutscher and Andreas Kappeler considerBastian Brutscherand Andreas Kappeler Addressing Europe’s infrastructure gaps capacity mattercapacity www.worldcommercereview.com A technological advances. theneed to overlooking replacerisks oldinfrastructure, complete longoverdue connections, andrespond to communication, and socialinfrastructures aretransport, already inplace intheEU. However, thisperspective investment. argue Some that thedeclineininfrastructure investment ahealthy reflects saturation effect–key investment needs, orhow infrastructure muchcountries shouldbespendingoninfrastructure andactual a heated debate. investment Infrastructure gapsare definedasthedifference typically between infrastructure Whether thisdeclineininfrastructure investment isdesirable orrather a gapis reflects at the worrisome core of The (EIB2017). decline was most-pronounced sector inthetransport levels, thoughthefallininfrastructure investment20% below pre-crisis inrecent years seemsto have levelled off. Investment ininfrastructure inthe EU istoday at 1.8%ofGDP,is according 2018.This to theEIBInvestment Report UN 2016). economic 2014)andfor growthCalderon making andServen more inclusive etal.2016, andsustainable (Woetzel large bodyofliterature ofinfrastructure hasunderscored for growth productivity theimportance (Berg etal.2012, infrastructure (EU2018).A global economy depends ontheavailability ofadequate critically andstate-of-the-art FinancialMultiannual Framework. And oftheEUand rightlyso–thelonger-term economic performance The needto invest more inEurope’s infrastructure hasbeenheavily discussedinthecontext oftheEU’s post2020 investors alsoneedto continue. planning are needed for infrastructure projects, bothat theEUandnational levels. privateto attract Efforts to explore thecausesofEurope’s infrastructure gaps. The results suggestthat more coordination and infrastructure investment intheEUhasbeenscaledback. This column usesdata from arecent survey dequate infrastructure isessential for growth. Since thefinancialcrisis, however, publicsector www.worldcommercereview.com infrastructure spendingto growth (OECD 2017a). dependonassumptionsaboutpotential substantially andoften GDPgrowthmethodologies vary andelasticitiesof are estimated at 4.7%ofGDPfor energy, water andsanitation, transport, andtelecoms (EIB2016). The underlying 2016, Woetzel etal. 2017, Bhattacharya world asa whole, estimated infrastructure investment needsrange between 3.9%to 9.7%ofGDPannually(OECD Several papershave attempted to estimate infrastructure investment needsandidentify substantial gaps. For the national, and sub-national levels sub-national and national, of infrastructure projects is strengthened at the EU, EU, the at strengthened is projects infrastructure of important that the planning and implementation implementation and planning the that important in the EU’s infrastructure is needed, it is equally equally is it needed, is infrastructure EU’s the in While there is little doubt that more investment investment more that doubt little is there While et al.2016,GCEC2014).Annual infrastructure investment needsinEurope www.worldcommercereview.com Figure 1.Infrastructure investment andsource, by sector 2005-2016 www.worldcommercereview.com ship. Note: BasedonEIBInfrastructure are Croatia, missingforBelgium, Lithuania, Database. Data Poland, 2016figures are preliminary. Romania,andtheUK. PPP: public-private partner Sources: EIBestimates basedonEurostat, Projectware, EPEC. - www.worldcommercereview.com Source: EIB Municipality Survey 2017. Survey Source: EIBMunicipality over provision ofinfrastructure capacity? ForQuestion: eachofthefollowing, would you saythat,overall, pastinvestment inyour has ensured municipality therightamountofinfrastructure, orledto anunder provision or Figure 2.Perceived under-provision ofinfrastructure www.worldcommercereview.com Source: EIB Municipality Survey.Source: EIBMunicipality municipalities); (6)Length process ofregulatory to approve aproject; (7)Political stability. and regulatory other government (4)Technical bodies); priorities(includingamong regional capacity between andnationalpolicy to plan andimplementinfrastructure projects; (5)Co-ordination cle atall?(1)Balance revenues between andoperating can expenditure; (2)Limitonamountofdebtthemunicipality (3)Access borrow; finance to external (excluding funding from ToQuestion: iseachofthefollowing whatextent anobstacleto theimplementation ofyour infrastructure investment Is a majorobstacle, activities? aminorobstacleornot anobsta- Figure to 3.Obstacles infrastructure investments by municipalities reported www.worldcommercereview.com Source: EIB Municipality Survey.Source: EIBMunicipality would you sayare how theresults assessment/swhendecidingwhether ornotto oftheindependent And important goaheadwithaproject?Question: Figure ofex ante 4.Importance assessments ofinfrastructure projects www.worldcommercereview.com What isbehindthedeclineininfrastructure investment inEurope? Figure 1shows that government investment Fiscal constraints holdbackgovernment investment ininfrastructure… 2017, Revoltella etal.2016). infrastructure hampersfirms’ to ability respond andkeepupwith to global competition (EIB growth opportunities to firms’ andICT infrastructure intheareas oftransport investment aclearpattern activities, emerges –poorlocal Upgrading Europe’s Europe’s infrastructure isalsokeyto preserving competitiveness. oflocal thequality Linking (EIB 2017). infrastructure pronounced investment with incountries withthelowest isparticularly to start infrastructure quality gaps weighs ontheconvergence thisfinding processby showing that thedeclinein inEurope. support Macro-data Poor infrastructure gaps. municipalitiesover-proportionally report This imbalance ininfrastructure investment Poor infrastructure investment risksunderminingconvergence andcompetitiveness ICT, transport, infrastructure gapsinurban andsocialhousing. oftheinfrastructure that municipalitiesare perceive often inchargepart ofthemselves. particularly Municipalities recent years (Figure to note that thisrefers isimportant 2).It to infrastructure investment overall andnotjustthe According, onethird underinvestment ofmunicipalities reported Survey to theEIBMunicipality ininfrastructure in jurisdiction. that municipalitiesshouldbewell placed to assessinfrastructure investment needs, gaps, andimpediments intheir arepresentative wasconducted outthissurvey of555municipalities in2017.Akeymotivation for survey carrying To contribute to thediscussiononinfrastructure investment needsinEurope andaddanewperspective, the EIB substantialMunicipalities inEurope infrastructure gaps report www.worldcommercereview.com decision-making. to prior ofinfrastructure implementation projects in assess thequality andconsider thisinformation important factor. consider orimportant two-thirds itacritical Consequently, municipalities lessthan40%ofthesurveyed ofex ante outsometype assessment, onlyabout theroughlya similarpicture. 60%ofmunicipalities that carry Of that municipalitiesattribute to ex-anteExamining theimportance assessments reveals ofinfrastructure projects developmentan urban strategy, only72%consult thisdocument intheprocess ofplanninginfrastructure projects. these strategies into consideration infrastructure whenitcomes allmunicipalitiesthat planning. have to actual Of 80% ofmunicipalitiesstate that theyhave development anurban strategy. However, notallmunicipalitiestake municipalities seemto beaware ofthecomplexities associated withanefficient allocation of resources. More than suggeststhat there Survey mightThe stillberoom EIBMunicipality for improvement –at in thisrespect firstglance, withthehighestsocial,projects economic, andenvironmental impact. Loosening fiscal constraints requires, however, mechanismsthat ensure that additionalinvestment goesinto the … buteffective planningand project execution is key to reviving infrastructure investment is mentioned by closeto 50%ofmunicipalitiesasamajorobstacle. gaps, 75%consider fiscal constraints to beamajorobstacle. processesThe lengthof regulatory to approve aproject fiscal constraintsreport (budgetand/ordebt ceilings, see Figure infrastructure 3). Among municipalitiesthat report linewiththisfinding,In whenaskedaboutthemainobstacles for infrastructure investment, 70%of municipalities plans to reverse thistrend, outlookssuggestacontinuation inothers, ofthisnegative budgetary development. fixed capital formation towards current expenditure. While insome countries, governments have recently presented strongly.in infrastructure hasdeclinedparticularly At thecore inpublicoutlays ofthisdeclineisashift from gross www.worldcommercereview.com Yermo 2013,OECD 2017b). andfunding regulations,some solvency andlimited investment Croce (Della and management andrisk expertise returns. Moreover, pensionfundsandinsurers are dis-incentivised from investing ininfrastructure by alackofdata, in Europe didnotsufficiently account risk fortheincreasepremia, whichshould inequity have pushedupallowed have heldbackcorporate investment sector (Grayburn andHaug2015). UnlikeintheUS,itseemsthat regulators The limited involvement ofprivate investors beexplained issues. by practical For canpartly instance, low returns management (OECD 2016). investment by theseinvestors, intheform anddebt, ofunlisted accounts equity for only1.1%oftotal assetsunder diversification becauseofthelow correlation of withotherassets returns (OECD 2011). Yet average infrastructure long duration, facilitate matching oflong-term liabilitieswithcash flows, andprovidefor portfolio opportunities investmentsInfrastructure have many that shouldappealto characteristics institutionalinvestors. They have a private investors ininfrastructure financing. The combination ofsubstantial infrastructure gapsand fiscal constraints may require a greater involvement of infrastructure investmentMaking more attractive for institutional investors atinfrastructure projects theEU, national, levels to andsub-national ensure effective useofpublicfunds. areMore therefore efforts needed to strengthen coordination andtheplanningimplementation of region inwhichtheyare located; andonly37%coordinate municipalities. withneighbouring improvement. Only45%ofmunicipalitiessay that theycoordinate theirinfrastructure investment withthe activities Also, whenitcomes to thecoordination ofinfrastructure investment withotherbodies, there activities isroom for www.worldcommercereview.com better development andbetter climate”, Institution,Washington, Brookings DC. A,JPMeltzer,Bhattacharya, ZQureshiandNStern onsustainableinfrastructure (2016),“Delivering JOppenheim, for Fund,International Monetary Working Paper WP/12/144. Berg, A,EFBuffieandA Cashin(2012), “Public investment, Puttingtogether thepieces”,growth, anddebtsustainability: References BrutscherandAndreas are Kappeler Philipp-Bastian Economists at theEuropean Investment Bank with EIBfinancing, ■ madethem bankable. Hubare two initiativesAdvisory that helpedraise ofmany the technical capacity and, oftheseprojects together well asprivate investors. The European Public-Private Centre Partnership Expertise andtheEuropean Investment €55.5billion,drawing inpublicas worth infrastructure 2017,theEIBprovided projects In €18billionto support they invest inare soundandwell executed. This isalsokeyto private attracting investors. Justliketaxpayers, private investors want to besure that theprojects Effective useof publicfundshas to beensured by strong coordination, planning, andimplementation procedures. planning andimplementation isstrengthened ofinfrastructure projects at theEU, national, levels. andsub-national While there islittledoubtthat more investment intheEU’s that the infrastructure isneeded, itisequallyimportant Conclusion private investors’ willingness to through engageininfrastructure projects PPPs orcorporate infrastructure projects. isalsolikelythat system aclearplanningandprioritisation also matters ofinfrastructure projects It for potential www.worldcommercereview.com Woetzel, J,NGaremo, JMischke, andRPalter MHjerpe (2016),BridgingGlobalInfrastructure &Company. Gaps, McKinsey toGoals Transform ourWorld”, United Nations. UN (2016),“Industry, innovation andinfrastructure: Why itmatters? 17 United Goals: NationsSustainableDevelopment role ofinfrastructure”, Oxford ReviewofEconomic Policy 32(3,1):410–430. Revoltella, D, P-B Brutscher, ATsiotras andCWeiss The local (2016),“Linking businesseswith globalgrowth opportunities: agenda forG20,OECDPublishing. silos:ActionsOECD (2017b),Breaking to develop infrastructure asanassetclassandaddress theinformationgap–An OECD (2017a),Investing inclimate, investing ingrowth, OECDPublishing. funds2015,OECDPublishing. oflarge reserve fundsandpublicpension pension OECD (2016),Annual survey Publishing. OECD (2011),“Pension fundsinvestment ininfrastructure: Asurvey”, International Futures Programme Paris, OECD Economics Economic 41,NERA Consulting. Grayburn andHaug (2015),“European regulators’ WACC decisionsriskundermininginvestment decisions” inInsight London. GCEC (2014),Better growth, better climate, GlobalCommission ontheEconomy andClimate, Washington, DCand post-2020”, COM(2018) 98final, Brussels. EU (2018),“A new, Multiannual modern Financial Framework foraEuropean Unionthatdelivers efficientlyonitspriorities Luxembourg. 2017/2018:FromEIB (2017),Investment recovery Report to sustainable growth, European Investment Bank, EIB (2016),Restoring EUCompetitiveness, 2016updated version, European Investment Luxembourg. Bank, Finance, Insurance andPrivate Pensions no36. Croce,Della RandJYermo (2013),“Institutionalinvestors and infrastructure financing”, OECD, Working on Papers no7034. working paper (2014),“Infrastructure,Calderon, overview”, An CandLServen growth andinequality: World Policy research Bank, www.worldcommercereview.com This article was originallypublishedonVoxEU.orgThis article www.worldcommercereview.com The Commission’s proposal for MFFprovides thenext a goodbasisfor subsequent negotiations. Butithas Darvas makeproposals asto howDarvas to improve them a number of deficiencies. Grégory Claeysa numberofdeficiencies. andZsolt Grégory A glasshalf-full www.worldcommercereview.com O constraints theproposal. andchallengeswhendrafting countries theideato reject increase theircontributions asashare ofGNI. Therefore, theCommission faced major On theotherside, Brexit willleave alarge holeintheEUbudget(seeourcalculations) butsomenetcontributor –butsomecountries thisstrategy. reject and cohesion policy compensated withdeepcutsinthetwo largest traditional EUprogrammes –theCommon Agricultural Policy (CAP) migration, security, defence, research, actions, external digital transformation andyouth mobility. This could be On oneside, have inrecent anumberofspendingpriorities gainedimportance years –suchasborder control, facing. Spending more withfewer that resources EU countries are currently ismissionimpossible, butthisisthetrade-off thecircleSquaring elements oftheproposal asreasonable, andsomeofthemeven asinnovative. We oftheproposal, highlight anumberofshortcomings yet given thevariousconstraints we regard anumberof in thecoming negotiations. assessment as Our can besummarised ‘glass half-full’, acautiouslypositive assessment. thiscolumn weIn provide ouroverall assessment oftheproposal andmakerecommendations onhow to improve it n May 2 expressed oftheplan,whileothersrejected itentirely. deepconcern aboutvarious aspects ofintense debates.subject Politicians form variousmemberstates andacross thepoliticalspectrum year EUbudget, Financial theMultiannual Framework (MFF)for 2021-27. theperiod The proposal isthe nd theEuropean Commission publisheditsproposal for thebroad seven- outlineofthenext www.worldcommercereview.com discussed andproperly analysed, andtheboldnessofsomeproposals butthedirection are welcome. clearly would be unfeasible perhaps at thenational level, liketheEU’s satellite programme. The detailsneedto be Netherlands. There are alsomajorsynergies inpan-European projects, likeresearch for example. projects Some way borders Greek are ofillegalmigrants andItalian onthearrival orthe protected inDenmark hasanimpact significant increase in research/innovation/digital fields;someincrease inmigration spending. For example, the spending categories that really constitute European publicgoods:hugeincrease inborder control anddefence; We listseven positive elements inthe MFFproposal. First, increased spending was proposed inanumberof Positives oftheCommission proposal require improvements require are unclear and it has a number of deficiencies which which deficiencies of number a has it and unclear are basis for subsequent negotiations, but many details details many but negotiations, subsequent for basis ... the Commission’s MFF proposal provides a good good a provides proposal MFF Commission’s the ... www.worldcommercereview.com and themanagement ofthesefunds. used for thewrong ofinvestment. types Larger national contributions might improve ownership selection, project funds have agrowth potential, butmay notalways deliver eitherbecausetheyare inpractice managedor poorly Furthermore, acomprehensive in2012)found literature Marzinotto that EUcohesion (doneby Benedicta survey coming from from theEUbudgetordirectly thenational budget might bedifferent. larger contribution to EUspendingprogrammes from memberstates, ofmoney while thepoliticalperspective EU fundingultimately comes from memberstates too, an increase innational co-financing would require an overall improved economic situation, memberstates have theresources to complement EUfundingat ahigherrate. While Fourth, increased ofspendingin CAP pillarIIisalso nationalcohesion and co-financing welcome. Given the forward to seeingthedetailsoftheseproposals, whichare to bepublishedinthecoming weeks. to results, more smallfarmers, by andby theimbalances supporting correcting incountry-allocations. We look Third, itisalsowelcome that theCommission aimsat amajorreform ofCAP, thefocus by shifting from compliance resources away from thesetwo traditional programmes (andespeciallyfrom towards CAP) newpriorities. major weaknesses, especiallytheincome subsidycomponent ofCAP. Therefore, we welcome theattempt to shift two mainspendingareas experience andtheempirical oftheirimplementation: we concluded that theyhave but reduced by 7%inreal ourMarch terms Policy (seeourcalculations). In Briefwe assessedthe rationale ofthese consider inflation, ie. in isproposedreal (15%),while terms to increasecohesion policy by 6%innominal terms, spending categories reasonable. isproposed CAP to bereduced by 5%innominalterms andeven more soifwe Second, considering theimpossibletaskofspendingmore withfewer resources, we findthe reallocations across www.worldcommercereview.com similar to theEU’sMacroeconomic andthe Imbalances fiscalsurveillance Procedure (MIP),as recommended earlier Nonetheless we callfor amuchbroader approach aregular to analysis theruleof law: ofallEUmemberstates, wisdom ofvarious European institutionsandmemberstates. objectively. However, ultimately memberstates would decidecollectively andwe have to trustinthecollective raisedA majorcriticism by somememberstates isthat deficiencies to theruleoflaw cannotbemeasured the European ofAuditors. Court governmental ofEUfunds. beneficiaries The Commission would drawofJustice and ontheopinions oftheEU Court tocountries that, could besubject whileaneventual underthisproposal shouldnotdisadvantage sanction non- oftheproposal are aspects Good that itwould applyto allfundsmanagedby memberstates andthereby allEU with EU’s Anti-Fraud andthe EU’s Office Public Prosecutor’s Office. corruption works well, ifjudicialreview iseffective, by independent court andwhethermemberstates cooperate The proposed procedure would assess, among others, whetherinvestigation andpublicprosecution offraud or for managing EUfunds. could hinder theproper implementation oftheEUbudgetandtherefore theruleoflaw isanessential precondition a fundamental value to oftheEU, enter theunioninfirstplace. andapre-condition Deficiencies onthis front we welcomeSixth, theattempt to formally monitor theruleoflaw inEUcountries. The oftherulelaw respect is would helpredirect EUspendingincaseofunforeseen developments. and years, possiblere-programming at mid-term, andprogramme withineachprogramme. reserves Suchflexibility Fifth, theproposal includesincreasedtools, between headings andemergency flexibility flexibility including extra www.worldcommercereview.com aligning oftheEUwithrevenue someobjectives sources oftheEU, whichwe findsensible. wouldwith theETS, contribute to theEU’s climate goals. Therefore, theseproposals would makeastep towards An agreement onCCCTB would helptaxavoidance, whichisamajorgoaloftheEU, whilea plastic-waste levy, along revenues oftheEUEmission Trading waste System tax. andtheintroduction ofanEUplastic-packaging [ETS]); by member states witha3%call rate basedontheCommon Consolidated Corporate Tax Base(CCCTB); 20% ofthe of revenues over MFF. thenext This would originate from three mainsources: ashare ofcorporate taxes collected Another goodproposal is to introduce abasketof ‘genuine’ own resources, whichcould represent asmuch12% increase intheprovision oftrulyEuropean European publicgoodsthat benefitevery country. ourview,In moving national contributions even closerto ofGNIissensible, thedistribution given theproposed should bebasedonacommonly agreed formula, to (liketherebates) whichad-hoccorrections are notnecessary. a viewto reducing theincreased burden originating from theUKrebate. National contributions to theEUbudget Brexit, since theUKbenefitted from thelargest rebate and some rebates to other countries were introduced with Gradually phasingout ‘rebates onrebates’ andotherrevenue mechanismsisthelogical correction outcome of many ofwhichappearto bequite reasonable. Seventh, theCommission alsomadesomeproposals to changetherevenue MFF, sideoftheEUbudgetinnext monitoring would ensure equaltreatment ofmemberstates. are inclear breach ofagreements. The samemust whenitcomes happen ofinstitutions.” to thequality Sucharegular the MIPhasemphasisedneedformonitoring policies, identifyingrisksandeven considering whencountries penalties (seehere Gonçalves andhere Raposo andInês ). As they argue: itscompliance “Despite Demertzis problems,by Maria www.worldcommercereview.com by Brexit, becausetheUKshouldbeexcluded from thecurrent MFFfor aproper MFF. comparison withthenext ofthe currentof thespendingpriorities andtheproposed MFF. next Suchcomparison ismade somewhat difficult Second, whileastated oftheproposal principle isimproved transparency, itdoesnotincludeaproper comparison organisations. multiannual budgetingframework augmented witha cashbudget, according to ofinternational bestpractices such acomplex Afundamental budgeting framework. reform is badlyneeded, suchasaproper accrual-based organisations that makelong-term investments, likethe World Bankandthe European Investment Bank–uses No othercountry, federation orinternational organisation – liketheUnited Nations, IMF, OECD, andalso ‘commitments’ and ‘payments’ thorny. makesthestructure programmes, oftheproposed thestructure budgetremains complex. Also, between thecontinued distinction some simplifications, like reorganising several spendingprogrammes and reducing the total numberofsuch We alsolistseven drawbacks andmakesuggestionsonhow to improve. First, whiletheproposal includes Negatives oftheCommission proposal value cost. to that oftheactual costs andthereforehigher thanactual we recommend amuchmore ambitiousapproach –reduce theretained to customs direct revenues to theEUbudget. We note, however, that 10%for costs would collection bestillmuch level from 1970to 2000).Since theEUisacustoms trade unionwithcommon policy, external we findit reasonable duties isretained by memberstates intheform of ‘collection cost’, whichisproposed to bereduced to 10%(the The Commission alsoproposes anincrease oftherevenues from customs duties:currently, a20%share ofcustoms www.worldcommercereview.com income support? sector, to one particular income sector, support even ifthat donotreceive isanimportant sectors ifotherimportant children from andtheyouth, the EUbudget. butschoolsandteachers donotgetincome support Why provide EU forprovide hospitals, andnurses. income support doctors Equally, iscrucialfor theeducational sector raising our For example, iscrucialfor sector thehealthofEuropean thehealth-care citizens, buttheEUbudgetdoesnot sector. andislimited to oneparticular asocialpolicy isclearly community biodiversity andlimitingclimate change. Butthegoal ofproviding afairstandard oflivingfor theagricultural MFFproposal.the next Certainly, hasanumberofcrucialgoalswithpan-European CAP value –like food security, , aconclusion current that EUbudgetisarelic stilllargely ofthepast” characterises noted aslongago2003,“The Third, there islittleEuropean value income added indirect transfers to farmers. As therenowned report Sapir of (a)current prices, (b) constant prices, (c)theshare oftotal EUspending, (d)theshare ofGNI. made. Proper shouldform thebasisofnegotiations. facts We suggestto present clearcomparisons alongthelines seven categories for whichacurrent price comparison ismade, constant comparison (ie. inflation-adjusted) isnot categories, andcohesion CAP policy, whichisastonishing (seeourown calculations). Furthermore, even for the categories (by excluding theUKfrom thecurrent MFF)–butitdidnotdothisfor thetwo largest spending theCommission fact, presentedIn current-price andwidelypopularised comparisons for seven mainspending proper comparison undertransparent assumptions. MFF, soonehasto becareful incomparing theoldandnewframeworks. Butthesedifficultiesshouldnothindera MFF thanplanned).Also, thespendingprogrammes oftheproposed MFFsomewhat differ next from thecurrent was approved, butinflation hasbeenmuchlower (whichhasled to higherspendingin real inthecurrentterms Another complicating isinflation, becauseastable2%inflation factor wasassumedwhenthecurrent 2014-20MFF www.worldcommercereview.com economic downturn. The volume ofsuchloanscould total €30billionandcould bepotentially interest-free. be granted to countries whofollowed facing alarge shock, soundfiscaland macroeconomic policiesbefore the disappointing. approved If asproposed, itwillbeineffective. Aloaninstrument hasbeenproposed that could Fifth, whilewe welcome theattempt to propose aeuro area design stabilisation instrument,is itsactual financed transfers direct to farmers, as we argued intheprevious point). propose arelative commitments (withresources increase action inexternal coming from ofEU- thereduction interest indoingsoifitwants to reduce themigration pressure ofarelative inthelongrun.Instead decline, we oftheworld,The EUhas aresponsibility for andhasan neighboursandotherparts helpingitsless-fortunate 1.28 (again,at current prices), soanincrease of1.2impliesadeclineasshare withafactor ofGNI. MFF (at current prices, excluding theUKform thecurrent MFF). Yet to EU27GNIisexpected increase byof afactor are multipliedby ofeither1.2or1.3compared elements ofthisspendingcategory afactor tocertain thecurrent Fourth, wecommitments findtheincrease action too timid. in external The Commission communication shows that development fundintotal allocations. CAP proposal increase suggests anunfortunate oftheshare payments ofdirect oftheshare andareduction oftherural Unfortunately, renationalisation hasbeenproposed, the ofincome andinfact neitherfullnorpartial support resources for otherspendingareas. National co-financing would allow for thelowering andthereby oftheEUbudget contribution to that free policy up proposed inour March PolicyCAP pillarIIrural Brief , similarto ofthe development thenational co-financing fund. make thispossible. Alessradical solutionwould transfers, ofdirect betheintroduction ofnational co-financing as A radical changewould betherenationalisation transfers ofdirect alongwiththeamendment ofstate aidrulesto www.worldcommercereview.com trusted group ofdomesticexperts. proposed national competitiveness councils shouldplay alarge role, becausesuchcouncils mustcomprise a Instead, thebesthopefor ahigherrate ofimplementation isto increase reform ownership, inwhichthealready- We donotseehow theEUbudgetcould incentivise implementation, andwe suggestthislimitation berecognised. France would bemore eagerto implement therecommendations to obtainafew millioneuros from theEUbudget. problems withtheEuropean Semester recommendations (seehere). It’s hard to seehow, for example, Germany and thereform tool toSixth, foster delivery reforms structural willlikelybe ineffective. There are majorimplementation fund, whichwould to beusedinacrisis foster investment throughout theeuro area. from theproposal oftheCommission, whichmight bepoliticallyfeasible: accumulating allECBprofits ina rainy-day instrument –adiscussionwe donotwishto enter here. Yet we highlight a(modest)possibledesign notthat far How to improve thisproposal? There isanextensive discussionofvarious optionsfor aeuro-area stabilisation here). wouldthe useofthisfacility takeresources away from otherfinancialassistance facilities(seeourdetailedanalysis Moreover, low amount (compared, €30billionisavery for example, to thedeclineininvestment 2008),and after programme shouldbeused. themselves, unlesstheysuffer –butinsuchacase, crisis theECB’s aliquidity MonetaryOutright Transactions (OMT) be seenassuch.Countries withsoundfundamentals are lessinneedoffinancialassistance astheycanborrow However, likesto takeafinancialassistance loanfrom nocountry officiallenderslikethe could EU,andthisfacility www.worldcommercereview.com 15 May2018conference oftheEuropean Economic Committee MFF. onthenext andSocial was originallypublishedonBruegel This article ClaeysGrégory isaResearch Fellow Fellow isaSenior andZsoltDarvas at Bruegel details are unclearandithasanumberofdeficiencieswhich require improvements. ■ Overall, inourview, theCommission’s MFFproposal provides agoodbasisfor subsequent negotiations, but many ERM II. encouraged to jointheeuro, firststep shouldbeatransparent thevery clarificationofthe conditions to enter the countries arethe decisionto non-euro jointheERMIIisbasedonanon-transparent to decision.If be discretionary While there are for clearcriteria entering theeuro area (theso-called criteria’,‘Maastricht intheEU enshrined Treaty), allowed to enter theEuropean exchange rate mechanism(ERMII),whichisaprecondition to enter theeurozone. For example, ever since joinedtheEUin2007itsmajoraimwas Bulgaria to jointheeuro area. was ButBulgaria not membership, inourview. And countries wishingto joinwilldosoeven withoutthissmallfinancialfacility. the euro justbecause afew hundred millioneuros isoffered for preparation –ie. moneywillnotincentivise euro problem). Countries willnotchangetheirmindaboutadopting likeSweden, andHungary theCzech Republic And seventh, tool theeuro-adoption isconceptually weak (andalsotoo smallinsize, butthat’s asecondary . The blogpost formed the basis of the presentation of Zsolt Darvas atthe formedthebasisofpresentation. The blogpost ofZsoltDarvas www.worldcommercereview.com introduce that a neweBook makesthecasethat suchquestions are Sturm neededandwhen?Nauro Campos andJan-Egbert To reform theEuropean whichinstitutionsandrules project value ofaninstitutional economics perspective are of fundamental importance forare thefuture offundamental importance of Europe Europe’s future: the www.worldcommercereview.com O This column introduces ( aneweBook implemented. created from scratch outreform to carry inEurope?”, goesalongway towards explaining why reforms have notbeen redesigned institutionsshouldbe orevenand agenciesare ourview, needed? In thequestion,“Which noteven asking institutions. union. highlights strategies ofmonetary and final part aspects The fifth for, andobstacles to, redesigning European ESM). The third focuses onfinancialinstitutionsandlabourmobility. discusseskeyinstitutional The fourth The second looksat prominent European institutions (the European Parliament, Funds, theStructural andthe The isorganised eBook into five parts. The first examinesthe Bretton Woods system and European integration. implemented? And how shouldtheyfitinto the existing institutional framework? Fund (EMF)sufficient? Are otherinstitutionsneeded? How shouldtheseotherinstitutionsbedesigned and globalisation wave that followed it. The overarching questionsthat motivate are: theeBook isaEuropean Monetary The individual chapters distil thelessonsfrom theBretton Woods institutionalframework andfrom the for thefuturequestions isoffundamental importance ofEuropean integration. Economists have debated what to doandhow innovative ways to makereform happeninademocratic, efficient, andsustainablemanner. the next economic downturn.the next The costs ofdoingnothingare large andrising, andwe mustthinkof that theEuropean integration needsto project bereformed andthat thisneedsto bedonenow, before hasalsobecomeeconomic hasdeepened. awidespread crisis It politicalcrisis. There islittledisagreement ne cannolongerbesure whether Europe isjustat acrossroads oronthebrink. The multi-faceted ) making thecasethat addressingCampos suchinstitutional 2018)making and Sturm 1 buthave beenmostlysilent onwho andwhen. Which institutions www.worldcommercereview.com those that are evaluates Crafts politicallyconnected. Nicholas theeconomic benefits from European integration European institutions. Hewarns that endingupproviding anEMFrisks fundsto thosewhoneedtheleastorto Axel Dreher examines thelendingoperations oftheBretton Woods institutionsto distillessons for thedesign of lessons for Europe, chiefly regarding current account imbalances, debtsustainability, conditionality, andsecurity. Harold Jamesargues that theideaofan EMFhasbeenwithusfor thelastfour decadesandremains asource of Bretton Woods andEuropean integration nothing are enormous are nothing if it finds Europe unprepared. The costs of doing doing of costs The unprepared. Europe finds it if have severe political and economic consequences consequences economic and political severe have it needs it now. The next economic downturn may may downturn economic next The now. it needs it The European integration project needs reform and and reform needs project integration European The www.worldcommercereview.com crisis was at least partly triggered by andithasproven intervention regulatory wascrisis at leastpartly costly. to bevery Hoffmann, Mathias argue that thedisintegration Seckinger the andChristian after Isabel Schnabel oftheEuropeansector banking Financial mobility institutionsandlabour example, 2018cooperation theApril agreement withtheEuropean Commission). how ithas acquired variousnewtasksover timeandhow itgradually developed closercoordination links(for employment have beenlarger. ofthe Mechanism (ESM).Heshows offersEuropean Korhonen ahistory Stability Kari They find their effects onpercapitaincome growth have beensmallerthanbeforecrisis, the whiletheon effects Becker, Peter Egger, von andMaximilian revisit fundsasthekeyinstitutionsfor Ehrlich structural convergence. andpro-globalisation/EU. (mostlyontheextreme rightandextreme left) Sascha between anti-globalisation/EU recently. They argue away ithasexperienced ashift from dividetowards thetraditional left-right anewcleavage andGerard oftheEuropean studyhow Roland theworkings Parliament Abdul Noury Simon Hix, have changed European institutions optimal levels ofcentralisation for different fields. policy onthedebateperspective onthefuture institutionsofEurope. suggestsdifferent Heargues that economic theory behaviour andpreventedin thepastdiscouraged opportunistic Harald openconflict. Badingerprovides acritical economy perspective. Nationalistic politicalsentiments have challengedamodeofoperation basedontrustthat argues that theEuropeanGiuseppe Bertola integration canonlybeproperly project understood from apolitical enhanced socialsafety nets(eg. insocialtransfers therise asashare ofGDP). in light oftheUK’s Heargues ofthosepositive sojourn. that thepoliticalsustainability netbenefits was due to www.worldcommercereview.com area sovereign that bondmarkets iscreated by national governments nottheirown. issuingdebtinacurrency Paul Grauwe De and Yuemei Jiargue that financialengineering cannotcure intheeuro thefundamental instability thereof. hinges ontherelevance to stabilsze theeffects ofnational ofidiosyncratic fiscalpolicy shocksandthe potency to play arole inthestabilisation ofbothidiosyncratic andcommon shocks. They note theneedfor risk sharing fiscal HaanandPatrickJakob De precondition Kosterink argue that fiscaldisciplineisanecessary for national fiscalpolicy union andfiscal Monetary economic benefitsofmigration. migration runsinto politicalheadwinds:recipient countries threaten withbarriers, despite ampleevidence onthe Overall, haspickedupsince role andplayed thecrisis adjustments. mobility inlabourmarket animportant Yet inEurope.in theUSandarise Loungani show aconvergence ofadjustment processes inEurope afallininterstate andtheUS,reflecting migration unemployment rates across euro area countries would have declinedby almost40%.Davide Furceri andPrakash thecrisis.variation inGDPafter They alsoargue that ifEuropeans were asmobileAmericans, thevariation in Tesar show that differences policies across inausterity countries canaccount for two-thirds oftheobserved roughly Hence, deepcross-border financialintegration ishighlydesirable. House, Chris Christian Proebsting andLinda acrossasymmetries countries. better sharing. risk Following integration thecrisis, banking was reversed, andthisexacerbated macroeconomic Egor Maslov, Stewen postulate that BentSørensen cross-border andIryna interbank lendingisnotsufficient for www.worldcommercereview.com between memberstates andinEuropean institutions. Trust grows withtheexperience ofsuccessful common budget constraints andincentives for soundpoliciesneed to bepreserved. There isaworrisome lackoftrustboth Clemens Fuest agrees and that whilefinancialstability resilience to economic shocks requiresrisk sharing, hard policy. monetary problemsand solvency ofcountries, thus allowing theECBto concentrate helpto banksinneedandon onliquidity disciplinebutitshould then bea sufficient whilekeepingmarket amountrisksharing responsible of forliquidity sharing,engage inrisk while maintaining disciplineinorder market to control moral hazard. The EMFcould build andGrowthStability Pact hasfailed. The gamenow isto findasolutioninwhich countries remain sovereign and Xavier Vives argues that theattempt to disciplinethrough imposefiscalandmarket Maastricht the Treaty and Redesigning euro area institutions Union isneeded. isnotsustainableunlessthedoom loopbetween banksandsovereignspolicy eases. Hence, agenuine Banking system withsufficiently legal control. well-developed Theeurocrisis hasshown that national responsibility forfiscal Lars Feld argues that fiscal competences oftheEUshouldbeintroduced itstransition after into ademocratic federal prevent asituation where theECBissoleinstitutioncapableto provide macroeconomic stimulus. are needed. Creating at theEUlevel fiscalcapacity to help countries whenfacinglarge negative shockscanalso thecrisis. during too Stronger much austerity rulesonthefinancialarchitecture andmore effective fiscalrules notes that theEuropeanPhilippe fiscalruleshave Martin allowed goodtimesand during forcedfor too laxapolicy Eurobonds national governments’ that are basedontheparticipating joint liability. They believe that real stabilisation canonlybeachieved through abackstop oftheECBandintroduction of www.worldcommercereview.com manner. must becreative, determined, andableto implement theneededreforms inademocratic, efficient, andsustainable political andeconomic consequences ifitfinds Europe unprepared. The costs ofdoingnothingare enormous. We The European integration needsreform project anditneedsnow. economicThe downturn next may have severe fleshed outmore ambitiously. reform oftheinstitutionalarchitecture shouldreceive greater andgreater priority weight andshouldhave been Their proposal encompasses reforms ofthefinancial, fiscal, andinstitutional architectures. Inouropinion,the from the ‘7+7’ French etal.2018),many economists (Bénassy-Quéré andGerman ofwhich contributed to theeBook. comparing them(Europeanreport Parliament 2018a,2018b). Yet proposal inourviewisthat themost important last five years orso.Indeed, the European Parliament created a website that tracks suchproposals andprepared a in answering thisliesinthemultitudeofdifferent proposals, suggestions, andpoliciesthat have emerged inthe How does the ‘institutional approach’ compare withothersinthefuture ofEurope debate? The maindifficulty institutions(Blanchardlabour market 2018).An institutionalmapofEurope for future shouldbeapriority research. institutionsabove,selected butthislistwas notexhaustive andthere are many we have nottouched upon,suchas mustbe. It about Thinking ‘who’ may unlockthedifficulties in compromising on ‘what’ and ‘when’. Westudieda few omissioninthefutureA serious ofEurope debate, inourview, isthat theinstitutionalquestionhasnotbeenraised. What have we learnedandwhat shouldwe donext? trust hasgrown isrisky. adding value over andabove what individualmemberstates canachieve. Yet relying oncurrent institutionsuntil inareas likedefence,undertakings border protection, migration, andeducation that offerfor hugeopportunities www.worldcommercereview.com European Future Parliament (2018b),“The ofEurope: Contours oftheCurrent Debate” European Future Parliament (2018a),“The ofEurope onReformingtheEU” Debate 2018. Campos, NandJ-ESturm (eds.), “Bretton Woods, Brussels andBeyond: RedesigningtheInstitutionsofEurope” Third Missing LegBlanchard, O(2018),“The oftheEuro Architecture: NationalWage Negotiations” Constructive to Approach Euro Reform” Area Rey, ISchnabel, NVéron, BWeder diMauro, andJZettelmeyer (2018),“ReconcilingSharingwithMarket A Risk Discipline: A,MBrunnermeier,Bénassy-Quéré, HEnderlein,EFarhi, MFratzscher, CFuest, JPisani-Ferry, Gourinchas, P-O PMartin, H References 1. See, forexample, theVoxEU debate oneuro area reform here Endnotes Economic Institute, Zurich ETH SturmZürich, isProfessor andJan-Egbert ofApplied Macroeconomics oftheKOF andDirector Swiss Nauro Campos isProfessor ofEconomics, BrunelUniversity London andResearch Professor at ETH- raising andaddingtheseissuesto thecurrent debate onthefuture ofEurope, ourtaskhasbeenaccomplished. ■ design a new framework for theEuropean integration project. We are convinced, however, that ifitsucceeds in We are aware cannotfully address thiseBook themany issuessurrounding theinstitutionalquestionofhow to , CEPRPolicy Insight No. 91. . . . , PIIE. , CEPRPress, www.worldcommercereview.com Download theVoxDownload Bretton eBook Woods, Brussels, andBeyond: RedesigningtheInstitutionsofEurope here was originallypublishedonVoxEU.orgThis article . www.worldcommercereview.com How large istheproposed decline inEUagricultural and cohesion spending? MFF, thegradual convergence oftheregions andthe Zsolt Darvas and Nicolas Moës consider the next consider Moës thenext andNicolas Zsolt Darvas reduction inthe needforreduction cohesion spending www.worldcommercereview.com I (see page23here orpage2here). goesdownspending clearly according to theMFFproposal, shows oftheCommission asan interesting report chart We therefore thesenumbersin thispost. clarify The shares ofagriculture andcohesion inthetotal EUbudget current MFF: andthenext becausethere areconfusion, at partly leastthree different ways to measure thechangesinspendingbetween the changes to theEU’s ontheactual Such lackofclarity agricultural andcohesion spendingcould potentially leadto oftheproposalprinciples istransparency. given that thesetwo areas together account for 60%of the proposed EUspending in2021-2027,andoneofthekey a comparison ofcurrent andfuture spendingon agriculture and cohesion spending. This ismore thansurprising, migration andborder management the current MFFfor andthenext many spendingitems –likeresearch, investments While theEuropean Commission’s maincommunication andthevarious accompanying compare clearly factsheets and cohesion policieschanged, compared to thecurrent 2014-2020MFF? FinancialEU Multiannual Framework (MFF):by how muchhave proposed spendingcommitments onagriculture we focus ofthenewproposal from onaspecialaspect n thisarticle theEuropean Commission for the2021-2027 • • • share intotal EUbudgetspending. inflation-adjusted euro values ('constant prices' or'real terms'), euro values ('current prices'), , security , defence neighbourhood andtheworld, andneighbourhood –nodocument presents , digital transformation , www.worldcommercereview.com Source: The chart onpage23ofthe2May2018European Commission communicationSource: The chart . Figure 1.Evolution areas intheEUbudget ofmainpolicy www.worldcommercereview.com euros is in fact increased.euros isinfact total EUspendingby theeuro values oftotal EUspending, we seethat cohesion spendinginterms ofcurrent-price projected MFF. inourMarch Policy onthenext Brief multiplying, By for example, theshare ofcohesion spendingin This increase iscloseto the28%gross national income (GNI) increase oftheEU27from 2014-20to 2021-27that we The proposed commitment ceiling ofthe2021-2027MFFis€1,279billion,whichamounts to anincrease of25%. committed to UKspending, leaving €1,026billionfor theremaining 27EUmemberstates. commitments in thecurrent 2014-2020MFFtotal €1,087billion, ofwhichabout€61billioncould beplannedto be in theshare ofEUspending might intheeuro notnecessarily meanareduction value ofspending. Total planned However, more merits detail. Since thestory total spendingincreases alotfrom 2014-20to 2021-27,thereduction in 2027 in EU27 average will decline from 29% in 2014 to 22% 22% to 2014 in 29% from decline will average EU27 in regions with GDP per capita below 75% of the the of 75% below capita per GDP with regions in If forecasts are right... the share of EU citizens living living citizens EU of share the right... are forecasts If www.worldcommercereview.com which is essentially 2% – practically identicalwhich isessentially to 2%–practically thevalue usedinMFFcalculations. presents forecasts upto 2023. We usetheseforecasts, andassumethat the2023inflation will prevail in2024-27, European Commission forecast includesthisindicator upto 2018 2019,whiletheIMFApril World Economic Outlook calculations inflation, we measuredUK. useactual astheGDPdeflator oftheEU27notincluding The May 2018 For economic acorrect comparison ofconstant price values, inflation has to beused. actual Therefore, inour was adopted. increase intherealactual value ofEUspendingwas larger than what was foreseen in2013,whenthecurrent MFF other, inflation. However, irrespective ofactual inflation inthepast years was wellbelow 2%,implyingthat the regulations, afixed 2%-per-year inflation isused to current convert and constantprice numbers from one tothe A complicating istheinflation factor rate used to calculate the constant price value ofEUspending.In theMFF MFF isfor the27remaining membersonly. We alsoseparate outtheplannedcommitments onspendingintheUKfrom the2014-20period, becausethenext funds to the ESFfor inourcalculations. the2014-2020period current MFF, are proposed to bemerged into theEuropean Fund Social for 2021-27,we theperiod addthesefour European Fund Social (ESF)andtheCohesion Fund (CF). Since four smallerfunds, whichare separate fundsinthe Fund for Regional Development (EAFRD), whilefor cohesion theEuropean Regional Development Fund (ERDF),the Guarantee Fund (EAGF –whichmostlyproves transfers direct to andthepillar2European farmers) Agricultural individualfunds:for theCommonmost important Agricultural Policy (CAP) thepillar 1European Agricultural orderIn to properly calculate thechangeineuro values (at bothcurrent andconstant prices), we focus onthe www.worldcommercereview.com while someUKregions benefitted fromtwo theother funds–see Table 1, comparing column 2and column 1). below 90%ofEUaverage (that’s why, for example, theUKdidnotbenefitfrom the Cohesion Fund in2014-2020, The ofthethird distribution fund, theCohesion Fund, isavailable for countries (ie. notregions) withGNIpercapita considered as ‘developed’ (allmeasured at purchasing power standards). 90% ofEUaverage are considered as ‘transition’, whileregions withGDPpercapitaabove 90%ofEUaverage are regions withGDPpercapitabelow 75%ofEUaverage are considered as developed’,‘less regions between 75%and oftwo ofthethreedistribution funds, namelytheERDFandESF, basedonregional isprimarily GDPpercapita: of economic convergence ofEuropean regions andcountries, whichreduces theneedfor suchspending. The The 6%nominal increase and7% constant price declineoftotal cohesion spendingshould beseeninthelight pillar 2European Agricultural Fund for Regional Development (EAFRD). pillar 1,theEuropean Agricultural Guarantee Fund (EAGF –whichmostlyproves transfers direct to from farmers) the 2% inflation rate inthefuture.two Among the main componentsCAP, of there is realignment towards theso-called The isproposed CAP to becutby 4%,whichcorresponds to of15%inreal areduction terms whenwe consider a is proposed to beincreased by 20%. While theCohesion Fund (CF) isproposed to bereduced by 37%,theEuropean Regional Development Fund (ERDF) and theIMFforecasts). The proposed realignment isalsonotable. between thethree mainfundsofcohesion policy real value, leadingto of7%inreal areduction terms (ifinflation willbe2%per year, astheMFFcalculations assume increased by 6%,sothere isnoplanned'cut', incontrast to inthemedia.However, many reports inflation erodes the The results ofourcalculations are includedin Table 1.Overall, cohesion spendingcommitments are plannedto be www.worldcommercereview.com es and2018prices from European Commission 2May2018proposal fortheMFF (pp. 29-30), from. For EAGF andEAFRD, current prices figures for 2014-2020 MFFfrom. For ERDF, ESF+andCF, current prices figures for2014-2020MFFare from table6.For 2021-2027MFF, current pric- Sources: European Commission, Bruegel annual current prices proposed values by theIMFinflation forecast (whichisessentially2%). ** For col. 5and6,we eachyear’s convert current prices into 2018prices usingtheGDPdeflator forEUexcl. UKfrom DGECFIN’sAmeco database(May2018). For col. 7, we deflate the Health andESIprogrammes, we approximate UKshare withtheUKshare ofTotal Cohesion Policy. * We compute thesenumbers by substracting theUKshare ofpreallocations programme per (computed from http://ec.europa.eu/budget/mff/preallocations/index_en.cfm). For Innovationthe Employment andSocial programme andtheHealth programme. For consistency, we therefore merge theseinstrumentsfor2014-2020aswell. Fund; Fund ESF+:European Social +;CF: Cohesion Fund. For 2021-2027,ESF+merges theformerESF, theYouth Employment Initiative, theFund forEuropean to theMostDeprived, Aid CAP: Common Agricultural EAGF: Policy; European Agricultural Guarantee Fund; European EAFRD: Agricultural Fund forRural ERDF: Development; European RegionalDevelopment Table 1.Agricultural andcohesion commitments inthecurrent andtheproposed MFF next www.worldcommercereview.com 2024-27 annual changeswe usethe2023IMFforecasts. ismissingfor2000-2002: we RegionaldataforBelgium usethe2003values. Note: regional dataisavailable upto 2016.From 2017onwards, we andGDPattheregional assumethatpopulation level changeatthesamerate asthecountry-level change. For casts dataupto forcountry-wide 2023. Source: Bruegelbasedondatafrom Eurostat regional (actual dataupto 2016),May 2018European Commission forecast 2018IMFfore dataupto oncountry-wide 2019andApril standards, 2000-2027 Figure ofEU27population 2.Distribution according to regional at capita GDPper purchasing power - www.worldcommercereview.com change andthereception/integration of migrants taken willalsobe into account.” catch upwiththerest oftheEU–whileotherfactors suchasunemployment (notablyyouth unemployment), climate of Cohesion Policy isandwillremain to states helpmember andregions lagging economically orstructurally to behind capita gross willremain domesticproduct thepredominant criterion fortheallocation offunds–asthemainobjective capita could bealsoconsidered, relative astheCommission per communication (seepages9-10)suggests:“The to how to allocate fundingacross thethree regions MFF. inthenext Furthermore, newindicators beyond GDPper Certainly, in allocations reported Table 2refer to thecurrent MFFof2014-2020andit is upto the negotiations as GDP –andmore developed regions even lessat 0.07%ofGDP. ESF, notCF).Less developed regions receive 1.6%oftheirGDP, whiletransition regions receive muchless–0.3%of funds to thesethree categories ofregions asashare oftheircombined regional GDP(considering onlyERDFand get animpression ofthereduced needfor cohesion funding, in Table 2we quantify thetotal allocation ofcohesion The clearimplication is that, withcontinued convergence, theneedfor is gradually reduced. cohesion policy To might notbereduced that much. data and, year, dependingontheselected 27 willlikelybebasedonpre-2021 theshare regions ofless-developed downward movement ofdeveloped regions. allocations forThis isalong-horizon whiletheactual projection, 2021- 2027, increasing theshare oftransition regions. The share oftransition regions isalsosomewhat increased by the living inregions withGDPpercapitabelow 75%oftheEU27average willdeclinefrom 29%in2014to 22%in Greece. forecastsand inparticular If are right andthereby convergence willcontinue, theshare ofEUcitizens increase around theresult 2010was primarily ofthemajor economic downturn European ofsouthern countries, Figure 2shows that the share ofEU27citizens regions livingintheleast-developed isgradually falling;atemporary www.worldcommercereview.com Table 2.Structural fundsaspercentage ofcombined GDPacross regionover types 2014-2020 This article was originallypublished onBruegel This article Fellow isaSenior Zsolt Darvas isaResearch andNicolas Moës Assistant at Bruegel post we willoffer our overall evaluation ■ ofthewholepackage. oftheproposalrelated concerning Claeys theeuro posts, willassessthepart area Grégory budget, andinanother thispostwe theagriculturalIn clarified and cohesion spendingnumbersoftheproposedMFF. next In subsequent Note: Structural fundsincludeEuropean Fund RegionalDevelopment Fund, andtheEuropean Social butdonotincludetheCohesion Fund. sion 2014/99/EU. Source: Bruegel, Table 1ofDGbudget(2016)andEurostat forregional GDP. To classifyregions, we usethelistprovided inAnnexes- I,IIandIIIoftheCommission ImplementingDeci More developed regions Transition regions Less developed regions 0.07% 0.30% 1.60% Share www.worldcommercereview.com transformation oftheEU Hans Kundnani writes that theEUhas already undergone a substantial transformation, but that arigid focus on 'competitiveness' shouldgive causefor concern The troubling www.worldcommercereview.com ‘P reality than the idealised project ofthe reality thantheidealisedproject ‘pro-European’ imagination. phases oftheEuropean may bethat, inthenameof project. It ‘more Europe’, aquite different EUisemerging in –there are somereasons otherwise to thinkthatunthinkable thisintegration isqualitatively different from previous since then–andindeedEUmemberstates have agreed to poolsovereignty inways that would have beenalmost transformation oftheEUthat goesbackto thebeginning oftheeuro crisis. Although integration hascontinued Fund steps theESMintoa goodthing. suchasturning fact, aEuropean In ofatroubling Monetary may form part These different visionsillustrate the way that deepening European integration isnotautomatically orinherently began have. would mean ‘more Germany’ –asmany ofthesteps that have beentakeninthelastseven years since theeuro crisis the eurozone’s fiscalrulesandthusincrease European ‘competitiveness’.If that vision were to prevail, ‘more Europe’ different reasons. They seeitasa way to increase control over EUmemberstates’ enforce budgetsandmore strictly the eurozone. Butmany inGermany, including Wolfgang thesameideafor Schäuble, entirely seemto support states. for Fund thecontext treasury ofthisvision, thenewEuropean In ofembryonic Monetary would beakind ofavisionfor a part ‘Europe quiprotégé’ inwhichthere would begreater ‘solidarity’ between citizens andmember However, there are two quite different aboutthe waysCommission’s ofthinking proposals. Macron,For they were be opento these ideas, whichwere originally putforward by French President EmmanuelMacron. much ofthedebate how ‘pro-European’ government thenewGerman would behasfocused onwhetheritwould currently being discussedby European leaders–isgenerally seenby ‘pro-Europeans’ asastep forward. Indeed, and turning theEuropean Fundand turning (ESM)into Mechanism aEuropean Stability Monetary –whichis proposal to deepenintegration oftheeurozone by creating aeurozone finance minister andbudget way. They intuitively seeintegration asgoodand ‘disintegration’ asbad. Thus, theEuropean Commission ro-Europeans’ inBrusselsandelsewhere tend to thinkaboutEuropean integration inasomewhat linear www.worldcommercereview.com However, than itstillseemedsofter ‘external conditionality’ becausethreats againstEUmemberstates lacked After theeuro began, crisis ‘internal conditionality’ oneurozone countries was tightened under III’.‘Maastricht Growth Pact. join theeuro were to through conditionality alsosubject theterms oftheMaastricht Treaty and andtheStability originally usedinthecontext oftheaccession process – ‘external conditionality’. EUmemberstates that wanted to Central to thetransformation place istheuseofconditionality. oftheEUthat seemsto betaking Conditionality was The of theEUinimageIMF remaking anyone else to make the case for it – is Angela Merkel Angela is – it for case the make to else anyone transformation of the EU – and has done more than than more done has and – EU the of transformation The figure, who, more than anyone else, embodies this this embodies else, anyone than more who, figure, The www.worldcommercereview.com else to Europe makethecasefor it–isAngela Merkel. Shehasspokenendlesslyofmaking ‘competitive’ –that is, The figure, who, more thananyone else, embodiesthistransformation oftheEU–andhasdonemore thananyone A ‘competitiveEurope’ be thefinal, logical step inthisprocess theEUinimage oftheIMF. of remaking oftheEuropeanwhat isleft integration project?” The transformation Fund oftheESMinto aEuropean Monetary may more unyielding thantheIMF. As Luigi Europe ZingalesputitinJuly2015:“If isnothingbutabadversion oftheIMF, that, indiscussionsaboutdebtrelief foris striking countries, crisis theEuropean Commission beeneven hasoften fathers hadinmindandalsoquite different from how most ‘pro-Europeans’ continue to imagine the EU.Indeed, it disciplineonmemberstatesimposing market –somethingquite different from that theproject the founding isasiftheEUinprocessIt ofbeingremade intheimageofIMF. increasingly seemsto It beavehicle for adjustment’ inIMFterms). This isnothow ‘solidarity’ was previously understood intheEU. Fundthat theInternational Monetary (IMF)shows – that is, loansinexchange for reform structural (or ‘structural of the middle:there hasbeenakind ‘solidarity’ intheeurozone of since began,butitisthekind thecrisis ‘solidarity’ Meanwhile, creditor countries felt theyhadshown ‘solidarity’ by agreeing to bailouts. The truthissomewhere in debtmutualisation. countries to further crisis, debtor countries demanded ‘solidarity’ andfelt theydidnotreceive itbecauseoftheresistance by creditor beginning oftheeuro crisis, there hasbeenmuchdiscussionoftheconcept of ‘solidarity’ intheEU. theeuro During This increased useof ‘internal conditionality’ hastransformed the meaning of ‘solidarity’ withintheEU. Since the campaign by election Freethe German Democrat Lindner. leaderChristian credibility . Butthat changedwiththethreat Greece to eject from theeuro inJuly2015–whichwas revived during www.worldcommercereview.com the EUusedpower insuchanefficient way that rulesultimately become internalised. Buttheidea oftheEUas bodies’. Leonard intended to applyFoucault’s analysis to theEUinapositive sense–theideawas to illustrate how FoucaultMichel saw thePanopticon asemblematic form ofamodern ofdisciplinethat aimedto create ‘docile by Jeremy Bentham –asametaphorfor theEU. etPunir Surveiller (translated In into andPunish EnglishasDiscipline ) Leonard’s WhyEurope Will book, Run the21 –imageforPerhaps –anddisturbing thenewEUthat seemsto beemerging themoststriking comes from Mark emphasis onthe ‘social economy’. market “competitive”. This ‘competitive’ Europe bearslittleresemblance to theoneof ‘pro-European’ imagination withits ‘overgenerous’“the European was model social nolongersustainableandhadto ditched” be inorder to makeEurope For example, former Greek Finance Minister Yannis Varoufakis says on logic isbehindtheimpositionofausterity ‘crisis countries’. of itsGDPand50percent ofitssocialspendinginorder to suggestthat “it cannot continue to sogenerous.” be This welfare state for Shelikesto say whichitisknown. that Europe has7percent oftheworld’s population, 25percent particular,In believes clearly that, Merkel inorder to be ‘competitive’, Europe needsto cutbackonthegenerous stood. to be ‘competitive’. Butinorder to become ‘competitive’, theEUmay behollowing outthemodelfor whichitonce oftheEUasacompetitor.thinking ofthisapproach willsay Supporters that inorder to beamodel, theEUneeds ofmodelfor therestEU asakind oftheworld. Led by Merkel,theyare now abandoningthisideaandincreasingly of becoming more ‘competitive’, anothersubtletransformation place. istaking ‘Pro-Europeans’ once thought ofthe able to compete economically, alsogeopolitically, andperhaps withotherregions intheworld. Butintheprocess st . In it, heevoked. In thePanopticon Century –thecircular designed prison that, intheir firstmeeting,Schäuble toldhimthat www.worldcommercereview.com This originallyappeared post ontheEuropean Politics andPolicy (LSE)blog Fellow at BirminghamUniversity Hans Kundnani isResearch at Director theEuropean Council onForeign Relations andanAssociate not somucha ‘Europe quiprotégé’ asa ‘Europe etpunit’. quisurveille ■ Panopticon may outto turn have beenprescient inasomewhat sense. darker What seemsnow to beemerging is www.worldcommercereview.com explores how Germany transformed itselffrom the'sick Explaining Germany’s exceptional recovery Dalia Marin introducesDalia Marin anew VoxEU that eBook man ofEurope' to 'economic superstar' www.worldcommercereview.com I new opportunities to move to production new opportunities theemerging economies market ofEastern Europe. This changedthe labour costs andto anincrease incompetitiveness. The decentralisation ofwage bargaining was triggered by the level etal.andBaccaro asDustmann argue inChapters 1and2oftheeBook. This ledto adramatic declineinunit from arigid system ofnational wage negotiations to adecentralised flexible system of wage bargaining at thefirm One leadingexplanation for Germany’s recovery istheastonishing transformation ofGermany’s relations industrial The relations institutionoflabour the US. costs; andfinallyitallowedGermany theto absorb ‘China shock’ more easilythaninother countries, inparticular andto to theexpansion networks ofproduction Eastern Europe exports; improving lowering ofGerman thequality decentralised wage bargaining lowering wages; to adecentralised, lesshierarchical infirms management style workers operated. Trade liberalisation withtheformerly plannedeconomies thefallofcommunism after ledto Eastern Europe was liberalised thefallofcommunism. after This event profoundly changedtheway and firms The astonishing transformation ofGermany’s economy happenedat thesametimeasinternational trade with globalisation didnotcontribute to invoting therise for thefarright inGermany. performance. They alsoexplain why Germany the absorbed ‘China shock’ more easilythanothercountries andwhy result oftrade liberalistion withEastern Europe thefallofcommunism after explain Germany’s exceptional export The contributors to findthat institutionsandinfirms’ theeBook changesinthelabourmarket businessmodelsasa recovery came about (Marin 2018). recovery cameabout(Marin accountingin exporting, for explains how AneweBook almost8%ofworld Germany’s exports. extraordinary superstar’. Unemployment declinedfrom 13%in2005to 6.1%in2016. Germany isoneoftheworld champions n thelate 1990sGermany was called sickmanofEurope’‘the 1997). (Bertram Today, Germany isan ‘economic www.worldcommercereview.com quality of their products to oftheirproducts stayquality competitive in world (seealsoStreeck markets 1997). bargaining may have haditsadvantages asa by acting ‘beneficial constraint’ which forced firms toupgrade the a decadebefore etal.2014).Baccaro (seealsoDustmann points outthat theold, rigid,system high-cost ofwage aroundin Germany turn asthecritical for theeconomy –played noessential role inthisprocess, which hadstarted agreements.deviations from industry-wide etal . emphasisethat Dustmann the reforms’‘Hartz –commonly viewed power between trade equilibrium unionsandemployer federations andforced unionsandwork councils to accept of wage bargaining at the firm level firm the at bargaining wage of wage negotiations to a decentralised flexible system system flexible decentralised a to negotiations wage industrial relations from a rigid system of national national of system rigid a from relations industrial is the astonishing transformation of Germany’s Germany’s of transformation astonishing the is One leading explanation for Germany’s recovery recovery Germany’s for explanation leading One www.worldcommercereview.com sectors, eg. carsversus whiletrade textiles), withEastern Europe (intra-industry takes place within thesamesector because thesetwo trade shocksare quite distinct. Trade (trade across type withChinaisoftheinter-industry to Eastern Europe.opportunities China’s hasadifferent rise Germany effecton riseofEastern thanthe Europe, following itsaccession to the wereWTO more thanoffset by additionaljobswhich were created fromrising export much better emphasisesinChapter thantheUS,asSuedekum 4. penetrationThe from joblossesfrom China import Trade liberalisation withEastern Europe was force alsoadriving behindGermany theChinashockso absorbing Europe lowered costs andhelpedto shares 2010). winmarket globally(Marin acute inthe1990s. to Eastern Offshoring whichbecameparticularly shortage helped Germany to cope withaskill skilled andinexpensive firms,offeredGerman butalsoapoolof for workers. opportunities notonlynewmarket This networks expanded production to Eastern firms Europe.German Eastern labourandthis Europe richinskilled was The opening-up ofEastern Europe thefallofcommunism businessinanother after also affectedGerman way: that persisted even whenthediscipliningroleGermany’) ofhighwages vanished. andastrong Mark Deutsche labourregimeindustrial before the1990smay have in hadalastingeffect onabusinessculture (‘Made ofquality management contributed shares etal.2015). market (seealsoMarin to large gainsinexport This way, thehigh-cost encourages firms to introducedecision making that products customers appreciate. findsthatMarin decentralised levels hierarchy ofthefirm are better informed demands. aboutmarket Givingthese moreworkers autonomy in hierarchical ofmanagement whichprovided style workers withincentives for quality. product Workers at lower Germany’s way and ofdoingbusiness(seealsoMarin Verdier 2014).Firms reorganised to amore decentralised, less wages compared to otherEuropean countries. Trade liberalisation withEastern Europe hada profound effecton Germany in inspite ofmorerebounded more After exports quickly thefinancialcrisis rapid increasesexporting. in argues inChapterMarin that 3oftheeBook wage moderation cannotexplain Germany’s more recent success in Globalisation andtechnology www.worldcommercereview.com dynamism in the German economy.dynamism intheGerman aninitiativethe government to rejuvenate start universities. German They alsoidentify alack ofentrepreneurial initial conditions for long-term growth inGermany. to substantially rise and 2005didR&Dspendingstart Only after Schnitzer and pointHarhoff outinChapter 5that thelossofhumancapitalandtalent afterWWII didnotcreate the againsteconomic policies.shock rather than abacklash as theinflow of refugees Germanyto in2015. They seethesuccess ofthe AfD asthe result ofapoliticalsupply –andnotbefore.over theleadershipof party They ruleoutotherexplanations ofthevote for thefar-right such Cantoni etal.identify thiscorrelation 2015 – thetimewhenconservative, after anti-immigrant memberstook elections. high vote inthe1920s-30salsohadhighervote shares shares for for theNaziparty theAfD inthe2016/17state right. worryingly, Somewhat theyidentify astunning historical persistence invoting municipalitieswith behaviour: et al.donotfindthat globalisation have andincreasing jobinsecurity contributed rise ofthe to the vote for thefar- The more favourable conditions labourmarket inGermany may explain why, Cantoni inChapter 10oftheeBook, young entrants. labourmarket way, therobots didnotraise thedisplacement for risks incumbent workers buthave replaced potential jobsfor reason isGermany’s way ofcoping withtechnical particular changeofretaining andretraining incumbents. This Moreover, findsthat Suedekum Germany’srobots hadamildereffect on labourmarket compared totheUS. The (Dauth etal. 2014). trade, eg. BMWversus Skoda)andwithinthesamemultinational (intra-firm firms trade, versuscars) eg. carparts www.worldcommercereview.com distortions intheeconomydistortions andtheneed to tax revenue. preserve to changeGermany’s competitiveness, external butrather to address domestic problems of such asthereduction improve competitiveness. its external Their answer isno, mix didnotintend to usethepolicy becausepolicymakers depreciate theircurrency. Ghironi and Weigert pursueafiscaldevaluation thenaskwhetherGermany didinfact to union,countries may introduce inamonetary toAbsent devalue thismixoftaxes the ability thecurrency to which isequivalent to adepreciation ofacountry’s currency, ashasbeenshown recently (Farhi etal.2014). taxwithadecrease inthepayrollin thevalue-added tax. This menuoftaxes corresponds to afiscaldevaluation balance inGermany’s favour, asGhironi andBenjamin Weigert explore inChapter 7.Germany combined anincrease themid-2000sGermany introducedIn amixoftaxes whichmay have relative shifted prices andtheexternal he documents) andshouldencourage private investment. suggests that thegovernment shouldincrease publicinvestment (to address thelow intangible capitalstock that account ismainlydriven surplus by low corporate investments, whichare lower andFrance. thaninItaly He investment goodsare imported. Therefore, littleinvestment currentGerman leadsto Hefindsthat the low imports. willface acurrenta country account ifitssavings surplus are large anditsinvestments are low. Many ofthe Chapter 6 In Wolff sideofthecurrent account. focuses ontheimport From anational accounts perspective, (viadecentralisedquality management andlow infirms), production costs (viaoffshoring toEastern Europe). becauseoflow successful wages (viadecentralised exporter is indeedavery wage bargaining), excellent product possible sources Chapters for orlow 1to 3ofthebookshow imports. thelarge large that surplus: Germany exports With almost8%ofGDPin2017Germany hasthelargest current account intheworld. surplus There are two The current account surplus www.worldcommercereview.com policymakers havepolicymakers suggested, would besufficient. They argue that in addition,decentralisation of wage bargaining etal.alsodonotbelieveDustmann reforms that copying inothercountries, theHartz assomeeconomist and a muchhigherlevel inorder to bechanged. labour contracts inGermany are eitherlegallyenforced ornationally implemented andtherefore require consent at transformation from sickmanofEurope to economic superstar. Many of theregulations which are determined by thedecentralisationother countries restrict ofwage bargaining, inGermany’s whichtheyconsider asakeyfactor transferable successIs theGerman story to othercountries? etal.suggestthat Dustmann existing institutionsin What learned? be can European affairs. reversed. Hethinksthat canbeaproductive acrisis moment for aprofound oftheoldways rethinking oforganising French andadaptability. emphasiseflexibility From ahistorical perspective, thebeliefs inboth countries have been have adifferent understandingofthe role ofthestate. visionisofrulesand German consistency,The whilethe James explores inChapter 9why theFrench donotcommunicate andthe Germans effectively.two The countries member ofacommon state. of federalism, whichwas asource oftheEuropeans oftension becausethemajority donotseethemselves asa debt crisis. The andGrowth Stability Pact to control publicindebtedness system was designed theGerman after the financialcrisis. into crisis transformedThe unwillingness apublic asalenderoflast thebanking resort to act The treaty delivered central bankindependence andlow inflation compared to previous years. This untilworked the euro area. Wyplosz argues that withtheMaastricht Treaty leaderoftheeuro Germany becamethedefacto area. toChapters turn adifferent 8and9oftheeBook topic –whyGermany’s way ofoperating leads often to tensions in The role ofhistory www.worldcommercereview.com Germany”, BruegelWorking Paper No. 2010/02. ofEastern Opening-Up Europe at20:Jobs, Skills, andReverse MaquiladorasMarin, D(2010),“The inAustria and Farhi, (2014),“Fiscal E, andOItskhoki GGopinath Devaluations”, ReviewofEconomic Studies81:725-760. Germany’s Resurgent Economy”, ofEconomic Journal Perspectives 28(1):167-188 C,BFitzenberger,Dustmann, (2014),“From SickManofEurope and ASpitz-Oener USchönberg to Economic Superstar: Integration”, oftheEuropean Journal Economic 12(6):1643–1675. Association W,Dauth, oftheEast andtheFar Rise SFindeisen andJSuedekum(2014), “The East: LaborMarkets German andTrade C(1997),“Germany: The sickmanofEurope?”,Bertram, Project Syndicate, 18September. References isChair inInternationalDalia Marin Economics at theUniversity ofMunich andCEPRResearch Fellow economic incentives. ■ have confidence inoneanother’s behaviour. Countries whichcan rely lessontrustmay have to introduce stronger markets. Germany isahigh-trustsociety,not wininexport according to the World Value Survey, inwhichcitizens that French decentralise exporters theirorganisation muchlessfrequently, andwhentheydodecentralise theydo allows themto puttheirown career interests above thewellbeing ofthefirm. France isacaseinpoint. Shefinds is that more autonomy notonlyfrees up managersto respond indecisionmaking to demands, market italso alsodoubtsthat adecentralisedMarin could management beeasilycopied style inany othercountry. The reason strengthening worker’s representation, canbeseenasapromising way forward for France. is essential to improve competitiveness. Macron’s reforms, fostering levelat thefirm flexibility labourmarket while www.worldcommercereview.com This article was originallypublishedonVoxEU.orgThis article theVoxDownload ExplainingGermany’s eBook Exceptional Recovery here Boyer (eds), Contemporary Capitalism: The ofInstitutions, Embeddedness Cambridge Press, University pp. 197–219. W(1997),“Beneficial Streeck, Constraints:On the Economic Limitsof Rational Voluntarism”, andR inJRHollingsworth 2015/05. Marin, D, andJTscheke JSchymik (2015),“Europe’s –it’s Superstars Export theorganisation”, BruegelWorking Paper No. International Economics 94(2):295–310. Marin, DandTVerdier (2014),“Corporate Hierarchies andInternational Trade: andEvidence”, Theory of Journal Marin, D(2018),“ExplainingGermany’s Exceptional Recovery” , AVoxEU.org CEPRPress. ebook, . www.worldcommercereview.com Ashoka Mody considers between France Mody thefriendship Ashoka have diverged, andthat willnotplug theirfriendship and Germany andfindsthat theirnational interests The myth ofFranco- German friendship German the gapsineuro area architecture www.worldcommercereview.com S authorities wereauthorities unhappy becausetheybelieved that borders should beopenedto allcountries, not justEuropean Rome, Europe’s greatest achievement, postwar whichopenednational borders to trade withinEurope. German phase ofEuropeanThe andBelgium ledthenext Netherlands integration, culminating in1957the Treaty of EDC there was too much integration” 2006). (Judt agreement. driveThe hadrunoutofsteam. unity French Prime Pierre Minister Mendès-France complained, “Inthe inferiorclearly ranks intheEuropean army. But, inAugust 1954,theFrench National Assembly backedoutofthe at politicalunion.Adenauer reluctantly agreed to thearrangement, whichwould have soldiersin placed German a European budget. The EDC Treaty, signed inMay 1952,remains to thisdate Europe’s attempt farthest-reaching a European Defence whichwould merge Community (EDC), national into armies aEuropean by army supported Later thesameyear, insisted whentheAmericans onallowing Germany to rearm, theFrench reluctantly proposed legitimacy. isourbreakthrough”(“This ), andreadily 2006). For agreed (Judt Germany, Europe was away to regain international in creating aEuropean Coal andSteel Community. Adenauer exclaimed to hisaides,istunserDurchbruch” “Das over Europe, andFrance’s foreign invited Schuman Germany’s minister Robert chancellor Konrad Adenauer to join The lasttimetheFrench successfully ledaEuropean initiative unity was inMay 1950. shadow stillcastaheavy WWII more. they needto rejuvenate theirown economy andbuilddomesticsocialcohesion. This may takeageneration or central to thedecisioncalculus, have diverged even further. French leadershave apressing task at hand: column discusses, however, provides nobasisfor history National interests, suchanexpectation. always between Francefriendship andGermany willhelpcomplete thegapsineuro area architecture. As this ince Emmanuel Macron’s asFrench election president inMay 2017,hopehaslingered that amythical www.worldcommercereview.com the reassurance oftheUS’s andUSPresident support; JohnFKennedy was anxious to retain politicalandmilitary as away ofcreating aunited European front againsttheUS’s economic andpoliticalmight. ButAdenauer needed the Élysée Treaty, 1963(Figure signed inJanuary 1).French President viewed deGaulle theÉlysée Charles Treaty A narrative firstemerged friendship ofFranco-German inthelead-up to the Franco-German Treaty of Friendship, even today remains afinancialdrag onthemeagre EUbudget. Policy (CAP), asystem ofsubsidiesfor European that farmers helpedundercut indeveloping farmers countries and all, even to European nations. As theprice for agreeing, theFrench installedtheegregious Common Agricultural nations. French leadersopposedthe Treaty becausetheybelieved ofRome that borders shouldnotbeopenedat – cannot be based on a redesign of the euro area euro the of redesign a on based be cannot – rhetorically by a mythical Franco-German friendship friendship Franco-German mythical a by rhetorically A new vision for the future of Europe – even if stirred stirred if even – Europe of future the for vision new A www.worldcommercereview.com tionship’ and‘Franco-German friendship’ are scanned mentionedinEnglish-language books by Google. Note: The figure NgramBooks was created Google usingthe Viewer withwhichthephrases (https://books.google.com/ngrams/info thefrequency ‘Franco-German rela reports - ). It Figure 1. The narrative ofFranco-German friendshipebbsandflows www.worldcommercereview.com as acentral ofUSforeign objective policy. witha Gorbachev Kohlbought theacquiescence ofSoviet leaderMikhail thisspeculation. Kohlwas backedUSPresidentno evidence to support George HW Bush,whoviewed unity German obsession withasingleEuropean inreturn for currency France’s green light to unify Eastand West Germany. There is Many have speculated thefallofBerlin that after Wall inNovember 1989,Kohlagreed to satisfy Mitterrand’s seemed briefly Whento Schmidt concede ground to Giscardd’Estaing, theBundesbankheldhimback. twohis first chancellorsterms,was ill-suitedGerman emphasisedthat asinglecurrency for divergent economies. with Starting chancellors pushedback. Willy Brandt andcontinuing andthenHelmutKohlin withHelmutSchmidt franc devaluations, France would gaingreater 2018b:Chapters withGermany (Mody 1and2). German equality –pushedforMitterrand asingleEuropean currency, believingthat by eliminating thehumiliation ofregular French with President George Pompidou in1969,successive French presidents – Valéry Giscard andFrançois d’Estaing the euro. however, fact, In relations between France and Germany were fraught theseyears. during Starting The narrative cooperation ofFranco-German grew to acrescendo in therun-upto Europe’s singlecurrency, differencestwo inthe nations’ interests. although relegated status, to remained secondary alive andwas recharged periodically to temporarily mask transactional ‘relationship’ existed between thetwo European nations. The phrase friendship’,‘Franco-German Although theimpetusfrom theÉlysée Treaty faded, anarrative evolved that, ifnotfriendship, at leastaconstructive of adoring improvisedWest. speechhedeclared, inashort when twice Berliners “IchbineinBerliner” Welle (Deutsche while theylast” 2012).Kennedy, ontheotherhand, travelled to Germany inJuneandwon thehearts oftheBundestag’shearing changes, famouslymoaned, deGaulle “Treaties, you see, are like girlsandroses. They last introduced inthe Treaty’s preamble languagethat recognised Germany’s specialrelationship withtheUS.Upon politicalally.Germany asanimportant Thus, Bundestag, inMay 1963,theGerman whileratifying theÉlysée Treaty, www.worldcommercereview.com bring theirfiscaldeficits belowbring the3%ofGDPlimit. Hard pressed bythe intrepid European Commission President were indeedyears of rare coincidence andFrench inGerman national interests. countries Both were strugglingto andFrench inGerman a newfervour scholarship, enough,around curiously 2002–2003 (seeFigure 2). Those voting rights intheEU’s governance. The continued, narrative nevertheless friendship ofFranco-German reaching Jacques Chirac continued atense relationship, at summitinDecember 2000over theNice sparring theallocation of After theeuro’s Chancellor Gerhard Schröder 1999,German andFrench introduction on1January President with thefirstbatch 2018b:120). ofmembers(Mody made anotherfateful decision.Despite fierce oppositionfrom hisadvisors,Italy jointheeuro heinsisted area that accustomed to Eurofudge, butrarely sorichlysweetened hasitbeen withcynicism” (Stephens 1997). Ayear later, Kohl andGrowthStability Pact, rather Pact. thantheStability Philip Stephens oftheFinancial Times commented: are “We of fostering economic growth. Kohlagreed onlyto aname change–thesystem offiscalrules would becalledthe At theAmsterdam summitinJune1997,French leaderspleadedto have thefiscalframework thegoal also reflect Kohl insisted onarigid framework centred onabudgetdeficitlimitof 3% ofGDP. independent central bank. The French wanted aEuropean fiscalframework that allowed discretion; national policy a European Kohl, central following bankunderpoliticalsupervision; theBundesbankmodel, insisted onahyper- circle ofadvisors. Superficially, Kohlgave the French theeuro, German terms. buthedidsoon The French wanted decade. Why hedidsowe willprobably never know, becauseheoperated withgreat autonomy, relying onaclose Kohl didchangehisposition.From withboundlessvigourfor 1991on,hepushedthesinglecurrency therest ofthe 2009:248). of aquidpro quonever cameup(Schabert Mitterrand’s closestadvisors, says that shewas andKohl, present meetingbetween Mitterrand andtheidea at every generous financial contribution to prop upthe Soviet 2018b:78).ElisabethGuigou,teetering Union(Mody oneof www.worldcommercereview.com franco-allemande,’ and‘La relation franco-allemande’ are andFrench-language mentionedinGerman- scanned books by Google. Viewer withwhichthephrases (https://books.google.com/ngrams/info thefrequency ‘Deutsch-französische Freundschaft,’ reports ). It ‘Deutsch-französische Beziehungen,’ ‘L’amitié Note: Three-year moving average. ‘Deutsch-französische Freundschaft’ and‘L’amitié franco-allemande’ in1945equals 100.The figure NgramBooks was created Google usingthe Figure 2. The believe Germans inarelationship withFrance; theFrench seekfriendship www.worldcommercereview.com of Franco-German friendship quickly beganto fade, quickly butitwas friendship of Franco-German reinvigorated 2018,the55 inJanuary (Macron 2017a:2017b). themes, Heinvoked especiallyacallfor warmbutfuzzy European sovereignty. The narrative (see Figure friendship Franco-German 3).Macron gave speeches inAthens inParis stirring andat theSorbonne Germany to agree to aeuro area budget. Anewhopewas kindled. revivedThe mediaquickly thenarrative of May 2017,EmmanuelMacron becameFrenchIn president withapromise that hewould persuadeareluctant thejoint guaranteebudgets andeurobonds (bondsthat would ofrepayment carry by euro area governments). bare minimumto prevent theeuro area from imploding. squashedfancifulideassuchaseuro Shefirmly area Through theglobalandeuro area ensured crises, taxpayer Merkel that theGerman was calledononlyto dothe mechanism,” nixed Merkel the idea,repeating: “And where to isthemoneysupposed come from?”2018b:324). (Mody When French President François Hollandehelpfullysuggested that theintention was to create a“solidarity to isthemoneysupposed comeAt from?” theBrusselssummitlater that month, anannoyed asked:“Where Merkel gathering ofEuropean headsof government), proposed aeuro area budgetto assistcountries introuble. December 2012,at theheight oftheeuro area crisis, Herman Van Rompuy, president oftheEuropean Council (the andherfinance Chancellor minister AngelaGerman Merkel Peer Steinbrück peremptorilyIn dismissedtheidea. pressure to takeanequivalent initiative, French President proposed asimilarEuropean Sarkozy fund. Nicolas establisheda$700billionfinancial US authorities rescue fund, the Troubled(TARP). Relief Assets Program Under When reached theGlobalCrisis its mostfearsome thefallofLehman phaseafter Brothers inSeptember 2008, andFrenchthem. German to undotherules, leaders, aneffort merely rather thanmaking waved themaside. Prodi recognised that theruleswere ‘stupid,’ buthefelt compelled asEuropean Commission president to implement Prodi,Romano Schröder andChirac pushedbackagainstany impositionofpenaltiesspecifiedundertherules. th anniversary anniversary www.worldcommercereview.com database. Source: Factiva. withwhichthephrases the frequency ‘Deutsch-französische This figure and‘L’amitié reports Freundschaft’ franco-allemande’ are mentionedin Factiva’s globalnews Figure 3.Macron’s revives election theFranco-German friendshipnarrative www.worldcommercereview.com Note: Core inflation istheannualpercentage changeintheHarmonized Indexof Consumer Prices excluding unprocessed andenergy. food Sources: Conference Board, “Total Economy (Adjusted Database Version)”; Eurostat. Figure 4. The great divergence ineuro area incomes andinflation www.worldcommercereview.com spends about45%ofGDP, falling. ratio now at runsabudgetsurplus, 65%ofGDPisquickly anditsdebt-to-GDP 3% ofGDP. ratio remains closeto debt-to-GDP stubbornly 100%ofGDP. Its contrast, government In theGerman ofitshighexpenditures, 2017).Because (Saeed theFrench government strugglesto rein initsbudgetdeficitbelow Juncker said, have “We areal problem withFrance. The French too much spend itonthewrong moneyandspend things” above 55%ofGDP. Macron was after elected, Soon theinimitableEuropean Commission President Jean-Claude France’s challenges are staggering. The French government’s extraordinarily highexpenditures have beenstuck economyThe German hasitsown troubles, asMarcel Fratzscher (2018)highlights. ButsetagainstGermany’s, 2018b:393). isdissipatingfirms (Mody evidence oftheFrenchshows etal.2017).As (Masuch further economy’s weakness, theinnovative energy ofFrench Bank’s governance metrics. Weakness isassociated insuchmetrics withlow long-term growth rates, asaECBstudy economy’s expansion a reflects weak governance system, with France substantially belowGermany inthe World France isoneofthefew advanced countries with anexpanding ‘informal’ or ‘shadow’ economy. The shadow weaknesses. (see Figureterritory 4). deflationary France’s economic thecrisis deep-rootedwoes during years economic reflect recovered from theGlobalCrisis, quickly theFrench economy stalledandthecountry’s inflation rate fell into near between thetwo countriesso farbehindGermany that isunrealistic. any partnership economyWhile theGerman The don’t prospects lookgood. However andappealingMacron’s daring European visionmay be, France hasfallen promote European unity. over France andthedifferencestwo inthe countries’ national interests could be overcome by a common desire to of theÉlysée Treaty. Aromantic viewofthat treaty bolstered thesensethat Germany’s substantial economic lead www.worldcommercereview.com most dynamiccountries intheworld. At thesametime, governments needto sensitively address socialstresses. tasksare at home:to rebuildthe primary economies inlong-term decline, especiallywhen measured against the Germany orFrance, and, hence, will continue to dividerather 2018a). For thanunify(Mody Europe to move forward, be basedonaredesign oftheeuro area. undertheeuro willalways policy favourThe single monetary either A newvisionfor thefuture ofEurope –even ifstirred by rhetorically amythical –cannot friendship Franco-German caught inbureaucratic tangles. insurance by isrestricted therealities ofFrench stresses. And education budgetary reforms have sofarremained andprecarious jobs,temporary thelevel willremainpromise ofsocialanxiety high.His to create greater social addressing thecountry’s problems. enduring Indeed, to theextent thatreforms hislabourmarket create more Although Macron seemsto recognise France’s handicaps, themeasures hehastakensofarbarely makeadent in trade tiesareGerman setto weaken further. Hungary, andPoland –have steadily increased. increasingly to China,Franco- looking With exporters German to France hasfallensharply, to three area non-euro European whileexports economies –theCzech Republic, decades ago, France (seeFigure was destination theprime for exporters German 5).Since then,theshare ofexports The wideningeconomic gapbetween France evident ininternational trade andGermany flows. isstarkly Two drag onlong-term growth prospects. retains inequalities (France its sadtitleaschampionofsocial atschool” 242016).Suchsocialdivisionsultimately are a ontheFrenchserved Parliament’s committee for cultural affairsandeducation,December saidin 2016,“France amongst thelowest rates ofupward intergenerational in mobility Western democracies. Annie Genevard, who rate rose thecrisis. during And that for boastssuchalarge government acountry expenditure outlay, France has Even more worrisome for France are itslong-standingsocialproblems. The traditionally highyouth unemployment www.worldcommercereview.com Source: IMFdata. Figure theirsights away shift exporters 5.German from theeuro area www.worldcommercereview.com June. Ragbag Treaty:Stephens, P(1997),“The EULeaders Ignored theRealIssuesatAmsterdam Summit,” Financial Times, 20 Press. ofMissouri University T(2009),“How World PoliticsSchabert, IsMade:France andtheReunificationGermany”. of London and Columbia: Saeed, S(2017),“Juncker: French Too Spend ‘The MuchMoney.’” Politico, 18May. Mody, A(2018b),“EuroTragedy: ADrama inNineActs” Mody, Euro Area’s A,(2018a),“The Political Deepening Divide,” VoxEU.org, 21March. Economics 41(2):159–205. EMoshammer,Masuch, K, andBPierluigi (2017),“Institutions, Public andGrowth Debt, inEurope,” Public Sector Macron, E(2017b),“Initiative forEurope,” 26September, University, Sorbonne Paris. Macron, E(2017a),“Speech by thePresident oftheFrench Republic,” 7September, Athens. ofEuropeJudt, T(2006),Postwar: since AHistory 1945. NewYork: Penguin Group US. Fratzscher, M(2018),The Illusion.NewYork: German Oxford Press. University France 24(2016),“French Inequality,Social StudentsMostAffected by OECD Finds,”December. 14 Welle ÉlyséeTreaty: Enemies,” Old Deutsche (2012),“The forOther AModel 23September. References Princeton University is Mody Ashoka Visiting Professor inInternational Economic Policy at the Woodrow Wilson School, challenge for generation. ■ thenext leadershaveGerman theirown homework to do;for France’s leaders, theirtaskat homeisthemonumental . NewYork: Oxford Press. University www.worldcommercereview.com This article was originallypublishedonVoxEU.comThis article www.worldcommercereview.com whistleblower protection policies intheEUandUSargue that reward programmes appropriate for are particularly specific regulatory areasregulatory where wrongdoing can causesubstantial harm A proposed EUdirective Theo Nyreröd Spagnolo andGiancarlo compare the on whistleblower protection www.worldcommercereview.com T to the US Sarbanes-Oxley Act (2002)butappliesmore Act extensively.to theUSSarbanes-Oxley establishment of includesthemandatory It The proposed directive offer shouldinprinciple increased protection to whistleblowers.It bearssome resemblance The EUdirective andwhy may protection prove insufficient improving whistleblower protection shouldhave inEurope. ahighpriority though hehasnow beenreleased onbail (Financial Times 2018). The lasttwo examples, inparticular, suggestthat billions ofdollarsintaxes, was arrested anarrest inSpainafter inApril warrant issuedby Switzerland on19March, Falciani,Hervé for whoblewthewhistleonbankhewas working inSwitzerland that helpedclients evade unrelated charges (The Guardian 2018). had moved illegalfundsfor Maltese politicians, isunderanarrest warrant from andCyprus Malta onseemingly papers (Financial Efimova, Times 2017).Maria anemployee at aprivate bankwhoclaimedthat heremployer withthePanama inconnection about corruption by inMalta writing acarbombafter was Caruana killed Galizia ofEurope to (Washington organisedpolitical connections intheheart crime 2017,Daphne Post October 2018).In Examples abound. On26February, was journalist, murdered aSlovakian JánKuciak, inhishomefor investigating Meanwhile, whistleblowers are andjournalists beinghunted intheEUby governments organisations. andcriminal traditional enforcementsophisticated making 2016). methodslessandeffective (Radu whistleblowers intheEU 2018,theEuropeanOn 17April Commission proposed adirective that provides increased protection for episodes ofretaliation suggest that itmay notbeenough. whistleblowers intheEU. This could to puttheEUonaparwithUSrespect protection, butrecent he European Commission hasrecently proposed adirective that provides horizontal protection for 1 . givenThis that isimportant globalorganised isbecoming crime increasingly www.worldcommercereview.com wrongdoing ina firm ‘work-related context’ 2). (Article defines‘whistleblower’ broadly trainees, to encompass sub-contractors, andany otherpersonassociated witha 14),places theburden (Article ofproofactions ontheemployer incasesofallegedretaliation 15),and (Article administrations prohibits that alsoallow awiderange for ofretaliatory 5).It (Article anonymous reporting confidential channels internal withmorefor allfirms than50employeesreporting andalarge rangeofpublic wrongdoing can cause substantial harm substantial cause can wrongdoing like a scalpel for specific regulatory areas where where areas regulatory specific for scalpel a like that reward programmes hold the promise of acting acting of promise the hold programmes reward that and insufficient, and the available evidence indicates indicates evidence available the and insufficient, and EU whistleblower protection is likely to be incomplete incomplete be to likely is protection whistleblower EU www.worldcommercereview.com fraction of his pay package that year ofhispay (Reuters 2018). fraction package Financial andthePrudential Authority Conduct decidedto Regulation Authority finehimonly£642,000–asmall whistleblower, going sofarasto request videofootage ofthepersonwho bought thepostagefor the letter. Yet, the Barclays Bank’s CEO, isenlightening. Heordered team to unveil hissecurity ofanuncomfortable theidentity International 2013),whistleblowers are significant stillexperiencing pushback. The recent caseofJes Staley, recognisedEven thecountry to have intheUK, 2014, someofthebestprotection intheEU(Wolfe Transparency protection isinsufficient andalways incomplete. Trading Commission. The reason why theUSintroduced financialincentives inkeyareas isthat intheir experience financial whistleblowers andExchange managed Securities by the Commission andtheUS Commodity Futures 2010,asaresponseIn to thefinancialcrisis,Dodd-Frank the introducing was enacted Act reward schemes for strengthened in2006. been eligible to receive rewards for from alongtime, Revenue theInternal Service andthesystem was considerably been eligible for rewards undertheFalse thetaxenforcement since ClaimsAct 1863.In area, whistleblowers have granting whistleblowers financialincentives areas. inkey regulatory For federal procurement, whistleblowers have the strongest protection for whistleblowers. However, theUShasgoneabove andbeyond protection by also competentlyIf implemented, theproposed directive may finallyputtheEUonaparwithUSwhichstilloffers to whistleblower protection several European countries, includingGermany, France andItaly, were judgedto have inadequate laws withrespect four European countries ashaving anacceptable level by ofwhistleblower areport protection. In Wolfe etal.(2014) member states, withsomeofthemofferingIn 2013, little to noprotection. International Transparency rated only The directive isamove asEuropean intheright direction, protection for whistleblowers islow anduneven among 2 . www.worldcommercereview.com (Buccirossi etal2017a,2017b). claims are ofperjury, submitted underpenalty andfraudulent claimants would beliablefor defamation suits not emerged asamajorproblem for USprograms (Nyreröd andSpagnolo 2017). This isprobably thecasebecause sometimes raised alsoinreference to protection (Mechtenberg etal.2017a,2017b), canbecontrolled, asithas The experience oftheUS,however, suggeststhat ofelicitingmaliciousorfraudulent therisk claims, anissue came outstrongly againstfinancialincentives for whistleblowers in2014,withaseven-page note of them. The Bank ofEngland’s Prudential andtheFinancial Regulation Authority Authority, Conduct for example, oftheseprogrammesDespite theevidence ontheperformance intheUS,European have authorities beencritical to rewardObjections programmes designed andadministered (seeNyreröd andSpagnolo 2017for arecent overview). amount evidence effective, ofempirical ontheUSexperience suggestingthat thesecanbevery if competently The EUdirective doesnoteven mention financialincentives. This is rather unfortunate, given thesubstantial fine, ifheiscaught, of course! hispotential mismanagementsomeone reporting (probably notto give himapremium), willjusthave to pay amild to aCEOthat reports, uncover violateswas judgedashighintheabove-mentioned thelaw of trying theidentity the UKregulators sent aloudandclearmessageto prospective whistleblowers. Evenwhere protection intheUK, Cases likethissuggestthat theUSCongress was rightinpushingfor rewards. establishedbyThe mildsanctions administrative costs among otherthings, that financial incentives willencourage maliciousorfraudulent claimsandproduce high 4 . 3 arguing, www.worldcommercereview.com 3. See https://www.fca.org.uk/publication/financial-incentives-for-whistleblowers.pdf3. See global corruption system. worked hard to make itsprotection even worse. No wonder spoke nobody uponVolkswagen‘s emission fraud orSiemens’ 2. Since thenFrance have andItaly introduced newandextensive whistleblower protection laws, while Germany has http://ec.europa.eu/newsroom/just/item-detail.cfm?item_id=620400 1. See Endnotes ofEconomics School Stockholm andUniversity ofRome Tor Vergata Theo Nyreröd isanindependent researcher, Spagnolo andGiancarlo isProfessor ofEconomics SITE- Barclays’s CEOdemonstrates. ■ captured agencies, regulatory thepromise willnotbekept. Butthisis thecasealsofor protection, asthecaseof course,cause substantial Of iftheseprogrammes harm. are negligently designed orimplemented by incapableor reward programmes likeascalpelfor holdthepromise areas ofacting specific whereregulatory wrongdoing can EU whistleblower protection islikelyto beincomplete andinsufficient, andthe available evidence indicates that Conclusions efficient meansof law enforcement wouldbenot toenforce the law atall. outweigh thesecosts (Nyreröd onedisregards andSpagnolo 2017).If benefitsand considers only costs, themost agencies suggestthat thesecosts canbecontained, andthat theirbenefitsin ofimprovedterms evidence largely is alegitimate concern that rewards generate claimsthat unmeritorious leadto higheradministrative costs, US As for administrative costs, theymustbeweighed againstthebenefitsoftheseprogrammes. Although there www.worldcommercereview.com Financial Times (2017), “Maltese journalistCaruana was Galizia assassinated, saysherson” onbreaches ofUnionlaw” reporting of persons European Commission (2018),“Proposal foradirective oftheEuropean Parliament andoftheCouncil ontheprotection 112(6): 1244-1325. Engstrom, D(2012),“Harnessingtheprivate attorney general: Evidence from quitamlitigation”, Columbia Law Review Theoretical InquiriesinLaw 15(2):605-633. regimes, context, whistleblowing? andthechallengeofoptimaldesign”, Bounty regulatory Engstrom, D(2014),“Whither blows thewhistleoncorporate fraud?”, A,AMorseandLZingales(2010),“Who Dyck, ofFinance Journal 65(6):2213-2253. org, 11October. Buccirossi, P, rewards, GImmordino andGSpagnolo(2017b),“Whistleblower andcorporate false reports, fraud”, VoxEU. Institute ofTransitionStockholm Economics 42. working paper Buccirossi, P, rewards, GImmordino andGSpagnolo(2017a),“Whistleblower andcorporate false reports, fraud”, Economics 43(2):368-390. Bigoni, M,CLe Coq, SFridolfsson andGSpagnolo(2012),“Fines, andrewards leniency inantitrust”, of Journal RAND whistleblowers” Bank ofEngland, Prudential andFinancial RegulationAuthority (2014),“Financial Conduct Authority incentives for References at thetime(seeNyreröd andSpagnolo(2018)foranoverview). falsifying papers thatstatement were2014). Other publishedlater, butwere already publiclyavailable as working papers more evidence incontrast to thatstatement publishedbefore thenote, includingBigonietal. (2012)andEngstrom (2012, such evidence was publishedinthemostdistinguished finance journalandwidelycirculated for beforeyears There was ofdisclosuresquality received by theregulators”, even etal. though Dyck (2010)isafamous research presenting paper isasyet noempirical4. They alsofalsely claim that“There evidence ofincentives leadingto anincrease inthenumber or . . , 17October. www.worldcommercereview.com This article was originallypublishedonVoxEU.orgThis article protection laws” Wolfe, S,MWorth, SDreyfus andABrown thesilence: (2014),“Breaking Strengths &weaknesses inG20whistleblower The Guardian (2018),“Malta corruption whistleblower handsherselfinto police” February. The Washington Post (2018),“Police ofEurope” onfraud believe ajournalistwas intheheart forreporting killed Transparency inEurope: Legal International protections (2013),“Whistleblowing forwhistleblowers intheEU” to unmaskwhistleblower” Reuters (2018),“Barclays CEOfined$1.5millionfortrying Romanian Centre forInvestigative Journalism. Radu, PC(2016),“Follow Adigitalguidefortracking corruption” themoney: Economics 44. working paper Nyreröd, andnumbers onwhistleblower TandGSpagnolo(2017),“Myths rewards” experiment”,from atheory-guided VoxEU.org, 4June. protection ofwhistle-blowersMechtenberg, inorganizations: Evidence L,GMuehlheusserandARoider(2017b),“The 11898. CEPR discussionpaper evidence”, andexperimental protection: Theory Mechtenberg, L,GMuehlheusserandARoider(2017a),“Whistle-blower Financial Times (2018),“HSBCwhistleblower Falciani Hervé arrested inSpain” . , International Center forJournalists, , 4April. , 20March. , Stockholm Institute ofTransition, Stockholm , 4May. . , 26 www.worldcommercereview.com exacerbate Italy’s long-standingproblems. Alessio Terzi suggests that ifthedefenders oftheEuropean project want to regain popularity, theywillneedto present a The economic agenda of Italian populistsislikelytoThe economic agenda ofItalian Italian populism calls Italian clear alternative to settingthehouse onfire for hard choices www.worldcommercereview.com P privatisation, primary surpluses) and surpluses) privatisation, primary ‘unorthodox’ (eg. financial repression, inflation, restructuring, etc). They goonto show that themenuofsolutionsto reduce itcanbedividedbetween ‘orthodox’ (fostering growth, shown how thedebtlevels nowadays we observe are unprecedented inadvanced economies innon-war periods. government spendsmore annuallyoninterest payments thanonpublicinvestment ratio intheworld, debt-to-GDP roughly hasthefourth-highest 135%,andby now Italy As the iswidelyknown, Though the listcould belonger, applyto Italy. two casesinpoint particularly The first relates to publicdebt required hard choices. European rulingclasses, whohave prevaricated over problems long-known andinconsistencies, becausethey However, someoftheirpremises are farfrom far-fetched. particular, In theyare rightfullycallingoutnational and competitiveness, publicfinances, shaky highspendingon retirees andlow spendingon rising inequality.youth, and or careful reasoning, andlikelyto augment rather thanalleviate Italy’s long-standingproblems –includingpoor unbacked populism,mostoftheproposalsby evidence atLooking theeconomics appearto ofItalian besuperficial, “People don’tthe linesof: understand, theyare irrational, ordaft.” money through auniversal basicincome. theworst In casesthere have beenarrogant explanations posited, along voters justseeklower taxes, whileFive-Star –largely Movement located supporters inthe poorer south–want easy thebestcase,In many have jumpedto simplisticexplanations, themostfrequent ofwhichargues that The League EU founder-country for parties embracing such inflammatory, for parties EU founder-country populistandilliberalrhetoric. only justtunedinto Italy’s theyhave current inan situation. beenshockedby Often, thestrength ofsupport rompted by anunfolding sell-offs, several andfinancial-market politicalcrisis haveinternational observers 2 . Reinhart etal(2015)have . Reinhart 1 . www.worldcommercereview.com significantly are rare birds in andassucharerecent unlikely economicItaly to dothejob history for have beenlarger, Eichengreen andPanizza required surpluses (2014)showed to how reduce theprimary debt year since 1990s. every theearly innearly surplus hasrunaprimary While somewillclaimthatItaly theseshould istheofficial approach surpluses inthe enshrined EU’strajectory. Runninglarge primary Fiscal However, Compact. buthardly privatisations, setdebtonadownward impact whichmightlarge-scale have hadapositive one-off doesnotholdbright hopes. case, toolkit theorthodox theItalian In The 1980sand1990swere by characterised set debt on a downward trajectory downward a on debt set might have had a positive one-off impact but hardly hardly but impact one-off positive a had have might characterised by large-scale privatisations, which which privatisations, large-scale by characterised hold bright hopes. The 1980s and 1990s were were 1990s and 1980s The hopes. bright hold In the Italian case, the orthodox toolkit does not not does toolkit orthodox the case, Italian the In 3 . www.worldcommercereview.com economists agree that withoutapoliticalunionthewholeeuro cannotholdtogether long-term construct andPhilippon 2017). (Martin drops bustcycles While inGDPduring individualsolutionsto thisproblem differ, most union(EMU)asitstandsisincomplete anddysfunctional, leading foreconomic andmonetary example to harsher The second caseinpoint relates to theeurozone architecture more broadly. now, By itiswidelyaccepted that reduce debtat themargin ingoodtimes, environment. external andhopingfor asupportive term, employing acombination options, oftheorthodox keepingfiscalaccounts broadly under control,to trying Stuck between arock andahard place, theapproach at national andEuropean level hasbeento focus onthe short states. advanced economies –are, however, generally againstcurrent EUtreaties, ortheycross red linesofothermember measuresUnorthodox –thoughmore frequently usedinthepastthanwe are ledto often believe, even in etal.2015). (Reinhart periods has generally happenedinpost-military-conflict (Marrazzolow-growth-high-debt and equilibrium Terzi 2017;Peruzzi and Terzi advanced 2018).In economies, this Italy only occasionally yieldthesignificantwould need kind that tobreak positive outofthecurrent boostofthe reaching reforms. structural While thisisasafe call The mostfavoured optionisfostering growth, whichusually comes asarecommendation to implement wide- conditions. However, 20years that ofreal underwent GDPstagnation, inacountry andwith noclearpath to exiting This piecemeal, small-step approach might betolerable for euro area memberstates economic undernormal aslargecrisis as2008willnothitany timesoon. concluded that thisispoliticallyunfeasible, theapproach hasbeento patches focus andhopethat a onshort-term 4 , wethat reform know waves have aheterogeneous and impact 5 . Having www.worldcommercereview.com one knows whatitmeans. economy If grows: Itold you. itstalls:You If didn’t dostructural reform.” remembering aquote oftheWorld itisworth thispoint, 4. On Bank chiefeconomist: “Structural reform advice. issafe No budgetsurplusaslarge and persistent as officially projected”.able to runaprimary estimates point donotprovide3. Intheirwords, much encouragement “The like willbe fortheviewthatacountry Italy “Clouds2. See are formingover Italy’s elections” by Terzi (2018) 1. Ausefulreference forthisis“A by Corsetti fortheEurozone: etal(2015) withDebt” Dealing NewStart Endnotes Alessio Terzi isanAffiliate Fellow atBruegel will soonnolongersuffice. ■ however,agenda might well leadto apoorer Italy; simplyhighlighting costs thesharp ofdismantling thestatus quo andwillneedtothe carpet present alternative aclearfunctioning to setting thehouseonfire. The current populist defendersIf oftheEuropean want project to regain popularity, theycannolongerhopeto brushproblems under answer. national sovereignty, anddemocratic politics. National andEuropean rulingclassesare yet to provide aclear whichinaeurofamous trilemma, settingstates that itisimpossibleto simultaneously have EMU, afunctioning recently economistAs DaniRodrik Harvard remarked around thestatus quo. this negative in the nearterm, radical equilibrium changesare more likelyto besought rather thansmalltweaks , at least Italian populistsare clearabouthow, at leastItalian to solve his www.worldcommercereview.com This article was originallypublishedonBruegel This article doi:10.1016/j.jinteco.2014.11.001 V, Reinhart, CM, &Rogoff,Reinhart, withdebt.” K(2015).“Dealing Journal ofInternational Economics, 96(S1),S43–S55. Peruzzi, M,&Terzi, A(2018).“Growth acceleration strategies.” Harvard CIDWorking Paper CIDWorking Series Paper, (91). Economic Review, 107(7),1904–1937.doi:10.1257/aer.20150630 P,Martin, themechanism:Leverage &Philippon, T(2017).“Inspecting andthegreat recession intheeurozone.” American Marrazzo, PM,&Terzi, A(2017).“Structural reform waves andeconomic growth.” ECBWorking Paper Series, (2111). problem?” NBERWorking Paper, 20316. Eichengreen, B, &Panizza, U(2014).“A surplusofambition:can Europe surplusesto solve rely onlargeitsdebt primary Bibliography Europe ReallyNeedFiscal “Does 5. See andPolitical Union?”by (2017) Rodrik www.worldcommercereview.com transport to cutgreenhousetransport gasemissions andensure Europe would benefit from greater on road EU action failure to cleanupthe Simone Tagliapietra andGeorg Zachmannwrite that Addressing Europe’s transport sector transport European decarbonisation targets www.worldcommercereview.com compared to 1990(European itadopted Commission, thisframework, in2014abinding40percent 2011a).In The European Unionhasthelong-term visionto reduce itsgreenhouse gasemissionsby 80-95percent by 2050 Transport: amajorobstacleto European decarbonisation not yet viable, butare potentially keyto ensure inthelonger term. deepdecarbonisation ofroad transport should focus itstransport-related research newcleantechnologies andinnovation that are fundingonsupporting Second, theEUshouldpromote taxation. discussionaboutthefuture aEurope-wide oftransport Third, theEU The to countries EUshould provide andcitiesthat takethisroute support thoughanewEUClean Transport Fund. modes.adopt more sustainabletransport This would beastrong signal to to invest theautomotive industry more strongly incleanvehicles, andto citizens to momentum andencourage countries and citiesto adopt plansto ban alldieselandpetrol vehicles by 2030-2040. reversed by adoptinganewEUpost-2020 strategy withthree maincomponents. First, theEUshouldfoster political far,So national andEUpolicieshave failedto foster decarbonisation. However, road transport thistrend canbe Policy challenge better public healthinEurope. would road alsoimproveDecarbonising transport incities, airquality whichremains afundamental challengefor becauseitisresponsibledecarbonisation ofroad for transport more than70percent ofoverall emissions. transport decarbonisation andmore aggressive policiesare neededto thissector. decarbonise focus shouldbe Aparticular exception whichhasseena20percent oftransport, increase. Transport isthusbecoming akeyobstacleto EU below 1990levels by 1990and2015,emissionsdecreased 2030.Between significantly withthe inallsectors Under theParis Agreement theEuropean Unionhascommitted to cutitsgreenhouse gasemissionsto 40percent The issue www.worldcommercereview.com Source: BruegelbasedonEEA(2017).Note: 1990=100. Transport: inwhichEurope’s theonlysector CO 2 emissionsare ontherise www.worldcommercereview.com of EU emissions), transport (26 percent), industry (19percent) (26percent), andbuildings(12percent)of EUemissions),transport industry the EU’s andheat generation (currently keygreenhouse responsible electricity gasemittingsectors: for 27percent international commitment to theParis Agreement. thesetargets Meeting requires aprofound transformation inall targetemissions reduction to beachieved by 2030compared to 1990–atarget that alsorepresents theEU’s from industry decreased byfrom 36percent, industry from agriculture andwaste by 32percent andfrom buildingsby 24percent. renewable energy technologies andby decarbonisation policies. thesameperiod, greenhouse In gasemissions decreased by asaresult 26percent, ofthesector’s partly transformation by underpinned rapid advances in andheat – 1990and2015,greenhouseBetween gasemissionsfrom –electricity themainemittingsector to reshape its transport policies transport its reshape to reduction in road-kilometres. But to do so, it needs needs it so, do to But road-kilometres. in reduction low-carbon transport technologies and promote a a promote and technologies transport low-carbon The EU has the potential to encourage innovation in in innovation encourage to potential the has EU The 1 . www.worldcommercereview.com and particulate matter,and particulate isakeycontributor to thisproblem, areas notablyinurban withhightraffic volume deaths eachyear inEurope (EEA,2016).Pollution from includingsulphurdioxide, road transport, nitrogen dioxide fundamental challengefor public healthinEurope. Air pollutionisresponsible for more than400,000premature emissions (Figure isalsodecisive road to improve 1).Decarbonising transport incities, airquality whichremains a focusPolicy whichisresponsible should primarily onroad for transport, 73percent sector’s oftheEU transport 15 percent in2050(EEA,2016). stronger policies. Undercurrent are policies, sector projected to emissionsfrom exceed thetransport 1990levels by have 2050. after actually to becompletely shortly decarbonised This obligation cannotbemetwithoutmuch However, to achieve –asimpliedby net-zero theParis emissionsby Agreement mid-century would –transport stronger policies are already required. emissionsby2050 target 60percent ofreducing transport compared to 1990(European Commission, 2011b), and by 60percent over for thesameperiod (European freight Commission, transport 2017a). To meetthecurrent are to expected grow activities transport inEurope, by 42percent between 2010and2050for passengertransport is therefore setto become themainobstacleto theachievement oftheEU’s decarbonisationgoals, especiallyas witha23percent emissionshasbeentransport, The withrising increase onlysector over theperiod. Transport vehicles (EVs) generation combined are withrenewable seenasapromising electricity approach to a decarbonise Technological development canenable aswitch inprinciple from fossil-fuelled vehicles to cleanvehicles. Electric Fostering innovation technological anddeployment ofcleanvehicles technological innovation anddeployment ofcleanvehicles, andpromoting amodalshift. Though necessary, isdifficult. road decarbonising transport The two toughest challenges are fostering 2 . www.worldcommercereview.com Figure greenhouse gasemissionsby 1.EUtransport mode, 2015 Source: BruegelbasedonEEA(2017). www.worldcommercereview.com Source: BruegelbasedonACEA (2017a). Figure 2.EUvehicle fleet by technology, 2015 www.worldcommercereview.com Source: BruegelbasedonEuropean Commission (2017b)andOECD(2017). Figure 3.EUautomotive industry, R&Dinvestment andpatenting activity www.worldcommercereview.com fleet the current growth rate, itwilltakearound 60years for themto reach 50percent ofthecurrent passengercartotal EVs represent only0.2percent oftheEU’s total vehicle fleet(FigureEVsIf 2). continue to penetrate themarket at increase therange ofEVs might beneededifEVs are to replace of asignificantfossil-fuelled proportion vehicles. However, ofroadsubstantial fraction transportation. technological breakthroughs further to reduce thecost and providers to bebetter combined through asingle gateway that creates andmanagesthetrip, for whichusers For from publicandprivate appscanallow services instance, information about transportation smartphone developments &Environment, indigital technologies (Transport 2018). more integrated modesofmobility. such as Newmobility ‘mobility-as-a-service’ canbeenabledby ongoing vehicles. andcycling, and This modessuchaswalking alternative entails promoting publictransport, transport A more approach would structural to road beto decarbonise replace transport travelled the kilometres by road Promoting shift amodal longer-term competitiveness oftheEuropean automotive industry. technologies (Figure 3). This represents decarbonisation inEurope, notonlyto arisk road transport butalsoto the developing internalfocused combustion engines onfurther rather thanonadvancing hybrid, orhydrogen electric resultingthe patenting from thisinvestment activity theEuropean stillappearsto beprimarily automotive industry 2016 compared to €30billioninJapan,€18theUSand€5 inChina(Figure 3).However, interms of The goodnews for Europe isthat itisby fartheworld’s largest investor inautomotive R&D, with€54billion spent in research anddevelopment investment inclean vehicles by theautomotive industry. additionto EVs,In othercleantechnologies might emerge inthefuture. This willonlyhappenbasedonmajor 3 . www.worldcommercereview.com plans to banthesalesofdieselandpetrol carsandvans by 2040(Petroff, 2017). istheintroduction ofbansondieselandpetrol cars. 2017,Francetransport In announced andtheUnited Kingdom of approachesA notableexample ofthevariety that could beadopted by countries andcitiesindecarbonising the variouslevels withoutcoordination canneutralise oreven hindereachother. measuresfragmented implemented becausepolicy at governance impedingthedecarbonisation oftransport risks systems European moreof policiesaimedat making transport connected, competitive andsustainable. Such of alternatives for to road freight transport areas. andinurban Ontop ofthis, theEUhasdeveloped awiderange taxes andcharges, anddifferent policiesin relation infrastructure andthecreationto thedevelopment oftransport zones.congestion andwalking management EUcountries charges, andcycling have parking different transport Cities are responsible enablingcar-sharing, policies, for suchaspublictransport, awiderange oftransport 581kg. 2016, whichwas 30percent more thantheEUaverage, used623kgandFrench whileGermans drivers onlyused demand.road For transport example, ofoilequivalent Belgians used741kilogrammes ofdieselandgasoline in (Table 1).And national andlocalpolicies on taxation, infrastructure choices and othermatters seemto determine governed frameworks by developed acomplex ofpolicy separately series at different levels –cities, national andEU an integrated approach. policy relevant,The governance is considering that road issueisparticularly transport But allthisischallenging, asreducing meanschanging demandfor people’s transport dailyhabitsand taking maritime, andincludingtheenvironmental inthefinalpurchase price ofgoods. cost oftransport chain. The environmental could offreight bereduced impact transport by promoting aswitch from road to rail and travel from –thelongerdoor-to-door times–whichmainlyarise thefirstandlastmileintransport transport can pay viaasingleaccount. Newapproaches could helpovercome amajorcomparative disadvantage ofpublic www.worldcommercereview.com Source: Bruegel. Note: red fordirect competence, orange forindirect competence. Table 1. The governance whoregulates ofroad transport: what? Maritime activity Maritime activity Rail Spatial planning chargingRoad Energy taxation Speed limits Congestion areas Parking fee Public procurement Public transport Walking andbiking Ride-sharing Car-pooling Car-sharing Alternative fuelsinfrastructure Emissions standards ondieselandpetrolBan vehicles City levelCity Country levelCountry EU level www.worldcommercereview.com clean vehicles, newrulesto promote thecombined useofdifferent modes andmeasuresfor freight on transport policies to decarbonise transport, includingnewCOpolicies to transport, decarbonise NovemberIn 2017,theEuropean Commission (2017c)proposed the ‘Clean Package’, Mobility anew setof into etal , 2016). account (Valin increase inCO have notdelivered. terms ofrenewable In fuels, theuseoffood-based biofuelsmight even have ledto anet However, have emissionsreductions beenmuchlessthanintended andtighter vehicle fuel economy standards vehicles, andby introducing a10percent renewable energy target fuelby for 2020(Table transport 2). decarbonisation by emissionsstandards introducingroad for transport mandatory newcarsandlight commercial in road-kilometres. Butto doso, policies. itneedsto reshape itstransport The to EUhasmainlytried promote The EUhas thepotential to technologies encourage andpromote innovation transport a reduction inlow-carbon Reversing Europe’s failure transport indecarbonising applied by 2025(Brunsden, 2017). andAthens 2017),whileMadrid areto bandiesel carsby considering similarproposals 2019(Embury-Dennis, to be completely phaseoutdieselcarsby 2024andpetrol carsby 2030(Paris, 2018). Copenhagen isdiscussingaproposal to moveCities are notablyto inthisdirection, alsostarting fight airpollution. isdevelopingParis aplan to global player incleanvehicles. are alsomeant to provide astrong signal to theEUautomotive industry, encouraging itto innovate andbecome a to cleanvehiclesthat shift thealready willcontinue underway to gather pace over thecoming years. These plans These plansare mainlydriven by apoliticalcommitment to reduce airpollution,andare basedontheexpectation 2 emissions if indirect emissions(ie. emissionsifindirect emissionsgenerated from land-usechange)are indirect taken 2 emissionstandards, newrulesfor publicprocurement of www.worldcommercereview.com Source: BruegelbasedonEuropean Union(2009a,2009b, 2011,2014),European Commission (2011a,2011b). Note: gCO Table targets and emissionsstandards, 2.EUtransport year ofadoptionandenforcement 2 /km =grams/km ofcarbon dioxide kilometre. per www.worldcommercereview.com major factor ininducingbehaviouralmajor factor changeonbehalf ofcitizens andpromoting modalshift. Cities shouldalsobeencouraged to adoptplansto banthecirculation ofdieselandpetrol cars, whichcould bea combustion engine businessmodelto thenewcleanvehicles businessmodels. andcleanmobility would leave awindow of10-20years theautomotive to fullyswitch industry from thetraditional internal the European automotive industry, andto foster itsfocus oncleanvehicles. Clearplanningofthesecommitments That is, thesecommitments shouldalsobeseenasasimplebuteffective tool to provide investment to certainty that itshouldinvestindustry more inthedevelopment ofcleanvehicles. The more EUcountries that makethesecommitments, thestronger thesignal willbeto theEuropean automotive petrol vehicles by 2040or, even better, by 2030. More EUcountries shouldfollow theexample ofFrance andadoptplansto andthe United bandieseland Kingdom, 1. Encourage EUcountries andcitiesto adoptplansto bandieseland petrol vehicles The EUtherefore needsto develop strategy. anewpost-2020 road transport This strategy shouldhave three pillars: allowing citiesinallEUcountries to alsomove ahead, andto takeadvantage ofincentives putinplace by theEU. overcome thispoliticalbarrier, allowing somememberstates to move –and road aheadindecarbonising transport standards because ofresistance from somecountries, suchasGermany (Carrington, 2013).Europe needsto sufficient Inthepast, the toensure decarbonisation. Councilhas caremission resisted road stricter transport The measures shouldbepromptly approved andimplemented. However, thissetofrulesmight stillnotbe the EU, represent apositive attempt to makeEUpoliciesmore effective. batteries. These measures, whichare at underdiscussionintheEuropean timeofwriting Parliament andCouncil of www.worldcommercereview.com Development Fund have andenergy infrastructure abudgetfor of€71billion network transport has abudgetof€24billion(European Commission, 2018a),whiletheCohesion Fund andtheEuropean Regional Europe Facility for Transport (CEF-T) orfrom andCohesion theStructural Funds. For 2014-20,CEF-T theperiod Such afundcould becreated better useof existing financial by making resources, suchasfrom the Connecting of transport suchascycling of transport andpoolingsolutionsallowingsharing incarownership areduction orthepromotion ofmore sustainablemodes measures suchasthedeploymentmoney to ofalternative support publicbuses, fuelsinfrastructure, zero-carbon ofdieselandpetrol vehicles.and citiescommitted to thephase-out This fundshouldallow citiesto bidfor EU For example, anEUClean Transport Fund could beestablishedto provide to countries dedicated financialsupport account CO European countries stillhave different taxation very regimes. transport For example, only ten countries takeinto credits, taxexemptions). vehicles’ emissions, carbon orsimplyallow fororotherspecialprovisions deductions (eg. subsidies, grants, tax strategies. For instance, to promote thedeployment ofcleanvehicles, taxes canbedifferentiated onthebasisof These taxes canbeusedto influence userdecisions, andpossiblyalso to influence theautomotive industry’s 2010). and usagetaxes (eg. taxes onfuel, tolls, roadspace, (Green commuter parking, taxdeductions) Fiscal Commission, system, from theinitialpurchase ofavehicle, to ownership taxes (eg. annualregistration tax,company cartaxation) Taxation tool to foster isakeypolicy decarbonisation. Different road transport taxes applythroughout thetransport 2. Stimulate taxation anEU-wide on thefuture reflection oftransport 2 emissionsinthecomposition oftheirvehicle registration taxes (ACEA, 2017b). Fuel cost savings – 4 . 5 . www.worldcommercereview.com phase technologies, suchashydrogen, solid-state batteries (liquidfuelsproduced orelectrofuels from CO To avoid theEUshouldfocus itspost-2020 this risk, transport-related research and innovation fundingonearly- demonstrating theirlonger-term potential to contribute decarbonisation. to road transport term, thisshould notprevent currentlyin theshort-to-medium less-mature technologies from developing and already commercially-viable cleanvehicles, suchasEVs. to fosterThough decarbonisation necessary road transport The introduction ofbansondieselandpetrol vehicles of by countries andcitiescould leadto aquicktake-up Mazzucato (2018). funding shouldbecome ordirected mission-oriented, at solvingspecificproblems, asmore generally suggested by allocate thismoney, targeting areas inwhichitcantrulyhave leverage. research EUtransport andinnovation After 2020,theEUshouldimprove research itstransport andinnovation funding. particular, In itshouldcarefully 3. More focused research andimpactful andinnovation fundingfor transport Council, 2017). taxation,among EUcountries asisbeingdoneinthefieldofdigital onthefuture taxation (European oftransport tool indelivering decarbonisation, theEUshouldpromote ofthispolicy Given anewdiscussion theimportance running adieselorpetrol vehicle. Germany, In by contrast, thedifference isonly25percent (Lévay etal,2017). advantage. Savings are where significantvehicle can cost 64percent runninganelectric inNorway lessthan which largely from arise the different –provideEVs cost taxation ofgasolineandelectricity withanimportant might notfindadequate private funding. percent oftheEuropean automotive industry’s total investment inresearch andinnovation) inareas that otherwise and electricity). This would be themostsensibleway to invest thelimited available resources (equivalent to 0.2 2 , water www.worldcommercereview.com 1. Other sources account1. Other for16percent oftheEU’s greenhouse gasemissions. Endnotes Simone Tagliapietra is aResearch Fellow, Fellow andGeorg Zachmann isaSenior at Bruegel never beexplored. ■ innovation thedevelopment funding, ofnewcleantechnologies theEUcanalsosupport that might otherwise ambitious andcoordinated by memberstates. actions Through better useofitstransport-related research and taxation andits onthefuturecentralwide reflection oftransport role indecarbonisation,theEUcanpromote more relatedbetter useofitstransport- fundingthrough anewEUClean Transport Fund. Through thelaunchofanEU- The to countries EUcan provide optionsby andcitiesindeploying making already support viablecleantransport citizens modes. to adoptmore sustainabletransport thus contributing to theindustry’s long-term competitiveness andsustainability. This will alsoprovide asignal to This willprovide astrong signal to theEuropean that itshouldinvest automotive industry more incleanvehicles, bans ondieselandpetrol vehicles by 2030-40by European countries andcities. Forroad transport. thisreason, theEUshouldfoster politicalmomentum andpromote thecollective adoptionof Given thestill-limited level ofambitionat national level, Europe would greatly benefitfrom on stronger EUaction isto beimprovedquality –theEuropean andif–indirectly isto have automotive asustainablefuture. industry isafundamental prerequisiteCleaning uproad transport iftheEuropean economy isto bedecarbonised, ifair Conclusions www.worldcommercereview.com European Commission (2011a)‘A Roadmapfor moving to acompetitive low carbon economy in2050’, COM(2011) 112 October T(2017) ‘Copenhagen’sEmbury-Dennis, mayor plansto banallnewdieselcars by 2019’, incity The 11 Independent, EEA (2018)Monitoring ofCO Environment Agency to theUNFCCC(2017) Nationalemissionsreported andto Monitoring theEUGreenhouse Mechanism,European Gas EEA (2016)TERM2016:Transitions towards system, European amore sustainablemobility Environment EEA Agency Carrington, D(2013)‘Angela Merkel “blocks” EU planonlimitingemissionsfrom newcars’, The Guardian, 28June enginebanincitiescouldBrunsden, J(2017)‘Diesel backfire, says Brussels,’ Financial Times, July18. http://www.acea.be/uploads/news_documents/ACEA_Tax_Guide_2017.pdf ACEA Tax Guide2017, European Automobile Manufacturers’ available Association, at ACEA Vehicles (2017a)ACEA Report: inuse-Europe 2017,European Automobile Manufacturers’ ACEA Association (2017b) References European Commission (€4billion).See (2018b). (€4 billion)andHungary 5. These fundshave mainlytargeted Poland Republic(€7billion),Slovakia (€28billion),Romania(€8theCzech inorderimpacts to improve airquality. 4. The EULIFEprogramme projects, to urbanmobility mainlyaimedatreducing already transport provides somesupport 2015and2016,newregistrations3. Between passengercars ofelectric grew by 11percent (EEA,2018). above theEUdailylimit PM10 [fineparticles] value” (EEA,2016). occurring atroad-side monitoring locations. Also, 16percent in2014,about was oftheEU urbanpopulation to exposed associated withvehicle emissions, was widelyexceeded across Europe in2014,with94percent ofallexceedances annual EUlimitvalue fornitrogen2. “The dioxide, ofconcern pollutants oneofthemainairquality andtypically 2 emissionsfrom passengercars –Regulation443/2009,European Environment Agency www.worldcommercereview.com setting emission performance standards oftheUnion’s for newlightcommercialsetting emissionperformance vehicles aspart integrated approach to European Union(2011)‘Regulation(EU)No510/2011 of theEuropean Parliament andoftheCouncil of11May2011 and 2003/30/EC’, Journalofthe European Union Official promotion oftheuseenergy from renewable sources andamendingsubsequentlyrepealing Directives 2001/77/EC European Union(2009b) ‘Directive 2009/28/EC oftheEuropean Parliament andoftheCouncil 2009on the of23April reduce CO oftheCommunity’s standards fornewpassengercarssetting emissionperformance aspart integrated approach to No443/2009oftheEuropean ParliamentEuropean Union(2009a) ‘Regulation(EC) andoftheCouncil2009 of23April international-discussions/ at http://www.consilium.europa.eu/en/press/press-releases/2017/12/05/digital-taxation-council-agrees-input-to- European Council taxation: (2017)‘Digital Council agrees inputto international discussions’, press release, available https://cohesiondata.ec.europa.eu/themes/7 European Commission Infrastructure (2018b)Network inTransport andEnergy, available at https://ec.europa.eu/transport/themes/infrastructure/ten-t-guidelines/project-funding/cef_en European Commission (2018a)Connecting Europe Facility, available at empowers andworkers’, itsconsumers anddefendsits industry COM(2017) 675final AEuropeanEuropean Unionthatprotects mobility theplanet, Commission onlow-emission (2017c)‘Delivering http://iri.jrc.ec.europa.eu/scoreboard17.html European Commission (2017b)The 2017EUIndustrialR&DInvestment Scoreboard, available at forall’,and connected mobility Staff (2017)177final Document accompanying Working COM(2017)283final European Commission (2017a)‘Europe ontheMove, fair agendaforasocially transition An towards clean,competitive resource system’, efficient transport COM(2011) 144final Paper,European Commission (2011b)‘White Roadmapto aSingleEuropean Transport –Towards Area acompetitive and final 2 emissions from light-duty vehicles,’ emissionsfrom light-duty Journalofthe European Union Official www.worldcommercereview.com amending Regulation (EC) No443/2009to for definethemodalities reaching the2020 target to amending Regulation(EC) reduce CO European Union(2014)‘Regulation(EU)No333/2014oftheEuropean Parliament andoftheCouncil of11March 2014 on BruegelPolicy Brief The authorsare grateful to Gustav Fredriksson andAlexander Rothforexcellent research isbased assistance. This article available athttps://ec.europa.eu/energy/sites/ener/files/documents/Final%20Report_GLOBIOM_publication.pdf M Dürauer and FdiFulvio ofbiofuelsconsumed (2016)The landusechangeimpact intheEU,European Commission Valin, H,DPeters, Mvan denBerg, SFrank, NForsell, PHavlik, JPirker, CHamelinck, AMosnier, JBalkovic, ESchmid, https://www.transportenvironment.org/sites/te/files/publications/2018_03_New_mobility_policy_paper_final.pdf Transport &Environment inurbantransport,’ (2018),‘Integrating services newmobility available at http://money.cnn.com/2017/09/11/autos/countries-banning-diesel-gas-cars/index.html Petroff,‘These countries want A.(2017) to ban gasanddiesel cars’,September, CNN,11 available at plan-climat-500-mesures-pour-la-ville-de-paris-5252#les-principales-actions-du-nouveau-plan-climat_2 (2018) ‘Nouveau Plan Climat:500 mesures laVille pour deParis’, available athttps://www.paris.fr/actualites/nouveau- OECD (2017)JRC-OECD, COR&DIP© databasev.1, 2017,Organisation forEconomic Cooperation Paris andDevelopment innovation-led growth, European Commission Mazzucato, research &innovation M(2018)Mission-oriented intheEuropean Union:Aproblem-solving approach to fuel comparison oftotal costpairwise ofownership’, Energy Policy 105:524-533 Lévay, PZ, offiscal effect incentives YDrossinos andCThiel onmarket (2017)‘The penetration ofelectric vehicles:A http://www.greenfiscalcommission.org.uk/images/uploads/gfcBriefing6_PDF_ISBN_v7.pdf Green Fiscal Commission (2010)‘ReducingCarbon EmissionsThrough Transport Taxation,’ Briefing Six,availablePaper at from new passengercars’, Journalofthe European Union Official reduce CO 2 emissions from light-duty vehicles’, emissionsfrom light-duty Journalofthe European Union Official . 2 emissions www.worldcommercereview.com have between China, risen Trade how war: tensions The multilateral trading system hasbeen challenged by unilateralist measures andsubsequent threats of retaliation. Francesco Chiacchio discussespossible the EUandUS scenarios for theEU www.worldcommercereview.com T by China,the EUandtheUSinterms oftrade policy. Here isthetimeline: what hasandwhatSo hasnotyet happenedthisyear? We focus onthemeasures takenandannouncements made European Unionfindsitselfinaprecarious positionin responding to theUS’ challenges. and announcements on tariffs. between the UnitedThe trade Statesconflict andChina may beescalating, whilethe Since the beginning oftheyear, themultilateral trading system hasbeenchallengedwithanumberofdecisions • • • • • • • February 28:President Trump’s agendaandannualreport policy residential washing machinesandsolarcells andmodules. 22:PresidentJanuary Trump approves recommendations to imposesafeguard large tariffs onimported aluminium onnational security. ofcommerce results 19:USsecretary ofaninvestigation reports of January into theeffect ofimports onnational security.mill articles ofcommerce results 11:USsecretary ofaninvestigation reports ofsteel January into theeffect ofimports without prejudice to (temporarily) exempted countries. March 8:proclamation ofUS’ steel (25%)andaluminium(10%),effective tariffs from on imported March 23, March 7:theECoutlinesEUplanto counter onsteel UStrade andaluminium. restrictions measuresMarch 6:theEuropean onChinesesteel anti-dumping products extends Commission (EC) released. moving forward for theEU. have beenandwillpotentially beaffected by the measures.various We end by discussingpossiblescenarios retaliation. We themainevents collect that have shapedthecurrent situation andshow whichtrade flows he multilateral trading system hasbeenchallengedby unilateralist measures andsubsequent threats of “for free, fair, andreciprocal trade” are . www.worldcommercereview.com • • • his decision to take actions onChina. his decisionto take actions and Practices Related to Technology Transfer, Intellectual Property, andInnovation”, President Trumpannounces March 22:following of theUS theOffice RepresentativeTrade (USTR) investigation on “China’s Acts, Policies, acceptable outcomes asrapidly aspossible”. ofCommerceMarch 21:Commissioner Malmström metUSSecretary Ross ), considering safeguard theUStariffslist ofproducts asdefacto measures. March 16:theEClaunchesapublicconsultation ontheUS’ tariffs measures andpossibleEU EU ( retaliatory impairment of the position of local industries local of position the of impairment redirection of flows towards the EU may cause an an cause may EU the towards flows of redirection trade diversion constitutes a risk to the EU, as the the as EU, the to risk a constitutes diversion trade In the event of a full-fledged China-US trade war, war, trade China-US full-fledged a of event the In “with aviewto identifyingmutually, “with www.worldcommercereview.com • • • • • • • • • • • List; China is in the Priority List; ChinaisinthePriority Watch List). Priority Watch Listor Watch List(Greece are andRomania theonlyEUmemberstates included, inthe Watch rights property onintellectual 27:USTRreleasesApril 2018Special301report that includedtrade relations. 24-27:PresidentApril Macron (April (April 24)andChancellor Merkel 27)meetPresident Trump, holdingtalks rubber originating intheUS,EU, andSingapore. 20:MOFCOMApril halogenated launchesprovisional measures butyl againsttheimported anti-dumping from 19. April US, starting 17:MOFCOMApril decidesto launchprovisional measures for anti-dumping grain sorghum originating inthe claiming that US’ steel andaluminiumtariffs safeguards. are actually response to recent US’ announcements. Onthesamedate, itfilesarequest for consultation at the WTO 5:MOFCOMApril publishesalistofUS’ tariffs potentially products ofits affected own,in by 25%import willbeheldonMay 15. A publichearing from to Chinathat 3:USTRpublishesaproposedApril 25%tariffs. could imported besubject listofproducts the EU, ofKorea, theRepublic Japan,and Thailand. March 27:MOFCOM investigation from launchesananti-dumping theUS, imported againstphenolproducts into theEU, inresponse to the US’ steel andaluminiumtariffs. March 26:theEClaunchesasafeguard investigation ofsteel to products prevent onimports trade diversion from theUS. imported products on certain involving approximately oftrade, US$3 billionworth andsolicited publiccomments ontariffs to beimposed March 23:MOFCOM issuesalistofdiscontinuation concessions againsttheUS’ steel andaluminium tariffs, March 23:USTRlaunchesa challengeto addressWTO China’s technology licensing requirements. ofphotographic paperfromimports theEU, US,andJapan,from March 23andfor 5years. ofCommerce (MOFCOM)March 22:theChineseMinistry measures decidesto for launchanti-dumping , identifying 36countries onthe , www.worldcommercereview.com moment that a good is perfectly substitutable. moment that agoodisperfectly ofeachthegoodsthat show would how beaffected muchisbeing exported The charts by tariffs. Imagine fora and highlighted are those(potentially) affected by the announced/implemented schemes. tariff products, andtheEU’s total listofproducts). to trade value, isproportional ofthebilateralThe linkages thickness different categories ofgoods(steel andaluminiumtargeted by UStariffs, theUSlistof China’sproducts, longlistof ofinternational thenetwork below tradeThe flows depict four between China,theEU, charts andtheUS for Below isatableonwhichtrade flows are mainlyaffected. The numbersaffected arein red. goods from specific regions. approximately $7.5billion,ofwhich$3.2billionfrom Part A,and$4.3billionfrom 'American' Part B),targeting very from theUSthat itcouldimported target iftheUSmoves forward with steel andaluminium tariffs (worth approximately $50billion),focusing more onlower-end products China announced discontinuation tariff concessions andalongerlistofits for 128products own (also worth around $50billion, possiblyaimingat China’s high-tech sectors andindustrial from steel ofproducts. andaluminium,theUStargeted Apart variety worth Chineseproducts over 1,300imported The result ofcontinuous ofthoseistheloomingprospect andretaliation trade restrictions measures involving a • • • May 8:President Trump andPresident discussbilateral Xi trade over phonecall. ‘draft framework’ May 3-4:US’ economic relationship, trade delegation ontheUS-China meetsChineseofficials providing a untilMay 1:extension 1JuneoftheEU’s exemption from UStariffs onsteel and aluminiumimports. inadvance. Asecond onMay 15 round oftrade talksisscheduledto start , while the EU has a two-part list of products listofproducts , whiletheEUhasatwo-part . th . www.worldcommercereview.com USD) Table 1. Trade affected possibly valueby announced/implemented ofmainproducts tariffschemes(billion of flows towards theEUmay causeanimpairment of the positionoflocalindustries. Furthermore, greater theeventIn ofafull-fledgedChina-UStrade war, trade diversion constitutesrisk a to theEU, asthe redirection to theUSby only2%. theEUcould turn, compensateonly some5%.In for supplyfrom thenewlyarriving Chinaby increasing itsexports to theUS,dueto thetariff, inChineseexports 10% reduction ifthey were able to theEU to increaseby their exports ofgoodsto theEU. ofthesamekind $81billion-worth Chinese producersChina exports could compensate for a For example, from Chinato thegoodsexported theUSthat would beaffected by theUSlistamount to $46billion. (USTR), China’s ofCommerce (MOFCOM), Ministry andDGTrade. for2017,except to affected by China’s Chinaofproducts Data forUS exports proposed retaliation list(2016data). aggregate isused.Note: Product code the6-digit categories Product where possible, listsretrieved ofthe otherwise upto selected the8-digit from US theOffice Trade Representative Source: USITC, Eurostat, Comtrade. USA USA EU28 EU28 China China EU28 China USA China USA EU28 Destination Steel 1.0 0.4 6.0 2.6 1.0 3.8 Aluminium 0.6 0.3 1.2 0.5 1.8 2.0 US list 206.4 113.4 77.2 26.2 46.2 80.6 CN's long 23.3 49.2 62.7 1.0 6.2 1.0 list EU's listA 3.2 6.2 1.8 8.2 - - EU's listB 18.2 4.3 7.3 2.4 - - Total EU's 13.4 36.5 26.4 7.5 1.4 4.1 list www.worldcommercereview.com Figure 1.Network ofbilateral trade flows – China’s list www.worldcommercereview.com Figure 2.Network ofbilateral trade flows –steel andaluminium www.worldcommercereview.com Figure 3.Network ofbilateral trade flows –US’ list www.worldcommercereview.com Figure 4.Network ofbilateral trade flows –EU’s list www.worldcommercereview.com This article was originallypublishedonBruegel This article Francesco Chiacchio isaResearch Assistant at Bruegel reduce to ofitsindustries theglobalchallengethat thevulnerability Trump andChinapose. ■ potentially loseaccess, at leastinrelative istimefor terms. theEUto It onits optionsinglobaltrade, reflect and to US andtheEUcould alsohave negative consequences for theEUasnewtrade could becreated and theEUwould also affecttheEU, butalsocreating costs bringing someopportunities for industries. However, adeal between the practice,In theraising ofbilateral tariffs willlikelycreate for theglobaleconomy substantial distortions that would by bilateral tariffs are substitutableandcansomehow around beshifted to otherdestinations. to covercapacity by thevoid schemes. tariff left Thus, oneofthekeyquestionsis to what thegoodsaffectedextent However, for ifthere EUindustries andinnovation isproduction might opportunities suchacrisis alsobring (through thechannel ofintermediate goods),possibly affecting technology diffusionand growth.productivity protectionism may alsoinduce costs higherproduction andaslowdown ofGlobal Value Chainparticipation www.worldcommercereview.com Landbridge rail services and its impact ontrade costs andits impact railLandbridge services Richard Pomfret looksat thecatalyst for theEurasian regional value chains Landbridge: linking linking Landbridge: The Eurasian www.worldcommercereview.com A Little investment inphysical capitalwas required becausethe track was already inexistence before the21 thechainsbycosts ofconnecting rail, which is faster withmore transport. timesthanmaritime precise delivery European andAsian value chains. providers National rail companies responded andotherservice by reducing the (Baldwin 2016). The catalyst behindthe Eurasian to linktheir was Landbridge demand from seeking global firms A common findingisthat mostGVCsare regional, withthree America, Europe,centres inNorth andEast Asia providers. significance oftheLandbridge for understanding thenature ofglobal value chains (GVCs) andthe role ofservice as aninstrument to increase Chineseinfluence. This emphasisignores economic theunderlying forces, andthe to England),andacademicdebate hasplaced inthecontext theLandbridge ofChina’s initiative OneRoad OneBelt, East Asia. Coverage ofthephenomenonhastended to focus on ‘firsts’ (thefirst train from China toSpain, to France, A dramatic development inthe2010shasbeenestablishment ofoverland railbetween theEUand freight services chains across Eurasia. additional customers and making further service innovations profitable. service further additional customers andmaking circleeffects created of reduced avirtuous costs, more andincreased frequent service route choice generating thatproviding madetherail route services attractive to alarger numberofpotential users. The dynamic scale Once hadbeencreated,growth theLandbridge was driven by freight forwarders, andother courier firms companies EU maritime trade,EU maritime improvement there service ispotential for withimplications for further globalvalue ontrade costs. anditsimpact rail services While traffic isstillsmall ontheLandbridge compared toChina- EU andEastAsia. series, look at thecatalyst Thistwo-part column,for the thefirstina Eurasian Landbridge dramatic development inthe2010shasbeenestablishment ofoverland railbetween the freight services st century. www.worldcommercereview.com Several rail linkswere inthe20 constructed containers through theSuezCanal. over 20,000twenty-foot-equivalent (TEU) carry from eastern Chinatravelledexports by seaand, to amuchlesserextent, airfreight. 2015thelargest By shipscould Europe to Asia around 1500destroyed overland trade. After China’s ‘open door’ reformsof of1978/9,transport trade between ChinaandEuropeOverland dates backmore thantwo millennia,until ofsearoutes discovery from China-Europe rail linksbefore 2011 andafter an ad hocbasis for German car companies seeking to shipcomponentsan adhocbasisfor carcompanies to seeking German theirjoint-venture assemblyfactories before containers 2011.Occasional blocktrainswere offlat truckscarrying runalongthe RailwayTrans-Siberian on implications for GVCs across Eurasia across GVCs for implications with potential for further service improvement and and improvement service further for potential with ... the rail Landbridge appears to be firmly established, established, firmly be to appears Landbridge rail the ... th century, butnonewas asignificant ofChina-Europe carrier freight www.worldcommercereview.com leading GVC sectors: cars and electronics. It was successful carsand electronics.leading GVCsectors: It because, although rail was more expensive thansea, The Chongqing-Duisburg blocktrain was acommercial providers response by to service demandsfrom two ofthe containers returned withcomponents inChina. for carfactories German to ensure smoothpassage, essentially asimpletransit agreement to sealsonbondedcontainers. respect The andBelarus-Poland borders.Kazakhstan Policy coordination amongthesixcountries’ governments was necessary rail companies transit collected Polish, fees andorganised andKazakh thechangeofgaugeat Belarus theChina- Corporation provided overall quotes to clients andorganised loadingandunloadingat thetermini, whilethe and Chinato provide asolutionintheform ofaChongqing-Duisburg blocktrain. BahnandChinaRailway Deutsche Yangtze ledto congestion. HPencouraged therailway companies ofGermany, Poland, Belarus, Russia,Kazakhstan The newinvestors may have viathe planned to export Yangtze Riverto Shanghai,butincreased shippingalongthe or HPprinter GVCs. assembly facilitieswhichFoxconn, Hewlett-Packard andothersbuiltinChongqingasthefinalstageof Apple laptop gate inChongqingwithoutborder-crossingelsewhere problems, to thefactory highlighting thenature ofthe and Chongqingwas openedin2010. The bondedtrain components brought from Asia imported and Southeast to produce inChina’s inlandprovinces. The policy’s was minor, impact until abondedtrain linkbetween Shenzhen The was catalyst China’s behindnewrail services Go West launchedin2001to provide policy incentives for firms users. but theywere commissionedfor their by asbespokeservices own useand firms were not availed by otherpotential journeys to andthrough GVCswere Chinashowed to international serve feasible, that rail long-distance services components from Lianyungang to theUz-Daewoo Such (now joint-venture GMUzbekistan). inUzbekistan factory inChangchunandBMWShenyang). Korean Similarblocktrains carried car China(VW/Audi in northeast www.worldcommercereview.com Sources: Ministry ofCommerce,Sources: Ministry General Administration ofCustoms, YuXinOu Rail Logistics Company, Feng Xuxia/China Daily Figure 1. The route oftheChongqing-Xinjiang-Europe International Railway www.worldcommercereview.com been regional value chainsinAsia orinEurope into Eurasian value chains. They alsobenefitfrom increased scale The astheywishto original transform drivers GVCs)remain (carandelectronics important what have largely The role providers ofservice route ran onadailyschedule. trials, whileother routes Duisburg-Chongqing-Duisburg flourished. By2018the were connections Some one-off Yiwu to London. 35Chinesecitiesand34European hadconnected theendof2017,Landbridge By citiesby rail. first China-France train went from Wuhan to Lyon 2017thefirstChina-UK train in15days. went In January from The process trial were continued 2015andregular after services establishedon successful routes. 2016the April In services. local governments took theinitiative orby eitherdirectly pushingalocalcompany suchas Yiwu Timex to establish forwarders suchas Vienna-based Far andSwiss-based Eastern Landbridge Interrail Group. OntheChineseside, and the Trans Eurasian Logistics joint venture between DBand theRussianrail company), andfrom freight and Europe. The initiative ontheEuropean sidecamefrom Bahn(anditslogistics Deutsche subsidiary, DBShenker, exercise discovery market to find routes onwhichcustomers were willing to pay between China for rail service or Suzhou Warsaw), asinFigure butmosttook theroute across Kazakhstan, 1. processThe trial-and-error was a different(Table routes were trialled Some ofthese 1). routes usedthe RailwayTrans-Siberian (eg. Harbin-Hamburg The success oftheChongqing-Duisburg train ledto aclassictournament. 2011and2015,at Between leastnine considerations forimportant GVCparticipants. overtypically 40days by seafrom Shanghaito Rotterdam) andpromised times, reliable bothofwhichare delivery it took less thanhalfthetime(16days between ChongqingandDuisburg, compared to aminimum36days and www.worldcommercereview.com Table 1.Railway routes from China to theEU, to endof2015 of intermediaries. Freight forwarders andcourier companies arranged multimodalconnections, consolidated part- A majorreason behindthewidersuccess ofthepost-2011 routes andincreasing hasbeentheearly involvement efficient in reducing transit timesandincreasing the rangeofservices. and reduced costs, asschedules become more frequent andcompeting routes have incentives to become more Source: Lietal. (2016:8). Harbin-Hamburg (DE) Changsah-Duisburg/Moscow/Tashkent Hefei-HamburgHefei-Kazakhstan: (DE) Yiwu-Madrid (ES) Zhengzhou-Hamburg (DE) Chengdu-Łódź (PL) Suzhou-Warsaw (Poland) Wuhan-Mělník (CZ) Chongqing-Duisburg (DE) Route November 2014 November 2012 October 2014 October October 2012 October Start April 2013 April June 2015 June 2014 July 2013 July 2011 Length (km) c. 11,000 11,808 13,052 11,200 10,863 10,124 11,179 9,820 9,826 Duration (days) 19-20 10.5 18 15 21 15 18 16 16 www.worldcommercereview.com A striking feature sofaristheabsence ofmajorinvestment.A striking ofthestory The runson20 Landbridge done in47minutes. This investment hascontributed to shaving thetime(eg. Chongqing-Duisburg took 16days from oneto theother. border, At Khorgos, ontheKazakhstan-China thetransfer for a40+container train canbe procedures: theincoming train andthe outgoing train are linedupsideby side, andacrane moves thecontainers andPoland. andbetween Belarus and Kazakhstan border are simple The container transfers at thechange-of-gauge track. The maininfrastructure investment between China hasbeenin facilitieswhere changeofgauge isnecessary been driven by commercially andprivate companies motivated state-owned countries alongaroute mustagree to simpletransit procedures. Against that backdrop, haslargely theLandbridge governments willingto facilitate transit trade. Time ofborder cost crossings andpredictability are crucial, andall Emergenceresponse, 2011reflected a after ofdemand, and oftheLandbridge conjuncture service-provider The role ofgovernments andrequireperishable loads. refrigeration, traffic withpart-container orto non-GVC destinations for many customers. appealto GVCs,The suchasagribusiness, addedservices where goodsmay be hubswithagreater areMultimodal convenient range ofspecialisedservice-providers places oforigin or famous astheworld’s largest for market smallgoods, hasbecome arail hubfor the Yangtze Delta. is acentre for ecommerce fulfilment, and Łódź hasbecome aneastern Europe hub. Yiwu inZhejiang Province, distance oftens ofmillionspeopleinGermany,short France, Belgium, Luxembourg, andtheNetherlands. Poland facilitators have offices Duisburg atthe hub, which provides access to rail, river, andiswithin roadandair transport hubs suchasDuisburg, Łódź, and Yiwu have become 300freight populartermini. Over forwarders andother container loads andoffered suchas refrigerated additionalservices containers. provision, Through suchservice 1 . th century rail- century www.worldcommercereview.com which arail linkbetween ChinaandEurope offers ausefulniche;thegoodsare butthe too bulky forairtransport, At costs, current auto transport components andlaptops/printers fitinto anintermediate ofgoods for category retailers. components to producer thenext-stage ofthefinalproduct to distribution andpromptcentres delivery andfinal Production alongthese GVCsrelies onminimising theneedfor inventories of by just-in-time securing delivery HP andAcer centres assemblersinChinaanddistribution for consumers intheEU. products oftheirelectronics componentbetween German suppliersand VW, Audi andBMWassemblyplants inChinaandbetween Apple, to The catalystreduce seeking was firms theirtrade carandelectronics for costs rail theLandbridge services across Eurasia. money anduncertainty) step is to2011), the next link the regional value chains of East Asia and Europe. This requires low trade costs (in time, regional zones orthePearl suchasSijori inthe1980sand1990sto River Delta ‘Factory Asia’ inthe2000s(Pomfret As theGVCphenomenonhasflourished, value chainsare becoming longerandmore complex. Following from sub- Conclusions coming up againstmore competitors for GVCtasks. inEurope inthelargersuccessful andAsia GVCparticipants Eurasian may GVCswhile findnewopportunities firms to greaterIf Eurasiancompetition. value chainsdisplace regional value chainsinEast Asia and Europe, then gainers. more Reduced trade costs competitive makeexporters inforeign import-competing butsubject markets costs haveReduced transport netbenefits, but aswithmosteconomic changesthere are potential losers as well as profitable service. isassociatedin 2011and12days withbetter the logistics in2017),butmost ofthetime-saving andprioritising www.worldcommercereview.com Eurasia. ■ improvementappears to established, befirmly service withpotential andimplications for further for GVCsacross they would fiton four container freighters that canpassthrough theSuez Canal. the Nevertheless, rail Landbridge abigincrease trade.maritime over 2016,42,000containers In passedthrough the2,000in2011,but Kazakhstan, shipped forsaleinChina. shipped assembled inChinaare to shipped anEUdistributioncentre andRange inBelgium Rovers assembledintheEUare 2. Car producers cars now usetheLandbridge trade fortwo-way Volvos withasingleassembly point. inhigh-end to have earnedover abilliondollarsintransit Bank(2015:43). Development feesin2015;seeAsian 1. The financial returns to the rail companies are commercially sensitive. However, Kazakhstan’s rail company is reported Endnotes PomfretRichard isProfessor ofEconomics at Adelaide University including two-way trade in has mushroomed to 6,235by December 2017,andover halfofthosewere in2017. The freight hasdiversified, providers haveService responded by reducing trade costs. Since alongtheLandbridge 2011thenumberoftrips freight, rail ismuchmore environmentally thanroad friendly orair. offersto pay that railAs anaddedsocialbenefit, for transport perover tonneof transport. thetime-saving maritime firms want faster and more thanintercontinental canprovidereliable delivery andare transport maritime prepared 2 . To keepperspective, traffic onthe isstillsmall railLandbridge compared toChina-EU www.worldcommercereview.com This article was originallypublishedonVoxEU.orgThis article on material inChapter 11ofPomfret (forthcoming). andcirculated PaperMarch intheERIADiscussion inJakarta asREITIWorking Series PaperERIA-DP-FY2018-01. draws It the regional value chainsinEast andtheEuropean Asia Union” andGVC presented workshop attheERIAservices on2-3 Author’s Eurasian note: This Landbridge: column providers The role “The isbasedonalongerpaper ofservice inlinking Press.University Pomfret, The Central R(forthcoming), Economies Asian intheTwenty-first Paving thenewSilkRoad, Century: Princeton Publishing Company. Pomfret, R(2011),“RegionalisminEast Whyhasitflourished since Asia: 2000andhow far willitgo?”, Scientific World China andEurope”, Institute ofEast StudiesWorking Asia Paper No.109, Universität Duisburg Essen. Li, Y, oftheNewSilkRoad Railways KBolton andTWestphal Effect on Aggregate (2016),“The Trade between Volumes 11. R,andGNogueraJohnson, (2012),“Proximity andProduction Fragmentation”, American Economic Review102(3):407- Baldwin, R(2016),The Great Convergence, Harvard Press. University 2015. Annual Report Bank(2015),Central Development Asian RegionalCooperation Asia Corridor Performance Measurement andMonitoring. References www.worldcommercereview.com competitiveness relative to shipments airfor time-sensitive Richard Pomfret argues that theBRI could beamajorstep Landbridge andChina’sLandbridge Belt and Road Initiative andRoad Belt towards Eurasian integration andgreatly improve rail’s The Eurasian www.worldcommercereview.com C organisations. At China’s 19 Cooperation inBeijing, attended by representatives from more than130countries and70international Initiative andRoad (BRI),theinitiativethe Belt was Road officiallylaunchedBeltand atthe Forum International for andofficiallyopenedin2016, after stood(AIIB), ready to mooted shortly provide funding. In May 2017, rebadgedas pledged over $50billioninChinesefundingfor infrastructure projects. The Investment Asian Infrastructure Bank September 2013PresidentIn XiJinpingonaCentral Asian tour initiative announced OneRoad theOneBelt and greatly improve rail’s competitiveness relative to shipments. airfor time-sensitive to eleven European countries onitsroute map(Figure 1). Express, whichcoordinated allChinaRailways Corp’s European showed services, from connections 27Chinesecities 2013, before President Xi’s announcement. Forum, andRoad thetime oftheMay 2017Belt By China Railway in2014,but thefirsttrain departed service, Yiwu businessleaders were optionsinJanuary Landbridge exploring been inoperation since in2018.Onthe 2011andoffers adailyservice Yiwu-Madrid route that isnow a weekly inbothEuropehad beenmarket-driven andChina. The mostpopularline, between ChongqingandDuisburg, has Eurasia. However, theBRIdidnotcreate theChina-Europe railway muchwas Landbridge; already happeningand The highprofile given by China to theBRIandAIIBhelped acrossto publicisetheoptionof overland rail service China’s andRoadInitiative Belt constitution, institutionalisingitspositionasaforemost foreign goalofPresident policy Xi. argues that future could onthenetwork beamajorstep construction towards Eurasian integration and Africa. oftheinitiativeEast andNorth series, and outlinesthehistory This column, thesecond inatwo-part current China-Poland mainlineto western Europe andaChina-Istanbulmainlinewithspursto theMiddle hina’s Initiative andRoad hasthepotential Belt to theEurasian extend to Landbridge includeboththe th National Congress 2017,theBRIwas incorporated inOctober into theChinese www.worldcommercereview.com easing of UN sanctions on Iran in January 2016.Oneweek later, inJanuary onIran easing ofUNsanctions President Xivisited Tehran. the On28January a recently openedrail tunnelundertheBosporus. China’s interest route inthesouthern was highlighted the after oftheCaspian Landbridge, thetrackAs for withthe north asouthoftheCaspian rail route already exists, including announcement highlight a route to Europe southoftheCaspian through and Sea Iran Turkey (Figure 2). Africa. Indeed,Chinesemapspublishedsince President EastandNorth mainline withspursto theMiddle Xi’s 2013 Eurasian to Landbridge include boththecurrent China-Poland mainlineto western Europe andaChina-Istanbul What cantheBRIaddto west rail connections from Chinaacross Eurasia? The BRIholdspromise for the extending across Eurasia across helped to publicise the option of overland rail service service rail overland of option the publicise to helped The high profile given by China to the BRI and AIIB AIIB and BRI the to China by given profile high The www.worldcommercereview.com Figure 1.China Railway Express route map, May 2017 www.worldcommercereview.com Source: Xinhua NewsAgency, May2014 Figure 2. The New SilkRoadrailway www.worldcommercereview.com Source: FinancialTribune.com Figure 3. The first China-Iran train route, January-February 2016 www.worldcommercereview.com routes, even intheface ofstrong opposition. country’s commitment to trade facilitation ifitwants to route, beonaLandbridge andChina’s search for alternative listed theKyrgyz asoneoftheeight Republic countries mostat risk by etal.(2018)highlighted Hurley thepotentialreport for debtdependence insmallcountries alongBRIroutes, and beyond limited transit fees andpotential hasto takeondebtto costs buildtheline. ifthecountry An independent The butcontroversial proposal ispopularwithChina andUzbekistan intheKyrgyz Republic, whichseeslittlebenefit line onFigure 1where thetrack doesnotyet exist. China andtheKyrgyz theonlydotted for Republic ofarailway andUzbekistan, construction linebetween Kashgar openness to theworld, includingeasingborder-crossing 2017-18negotiations advanced restrictions. In between September 2016PresidentIn died. successor, His Karimov President Mirziyoyev, immediately signalled greater the way. hadapoorreputationKarimov asatransit country, imposingsubstantial delays bothfor border checksandalong Oneconsideration Iran? underlong-timePresident was that Uzbekistan linethroughdirect innorthern Meshed coast, whichhadbeenopenedinDecember 2014,rather and thantransiting Uzbekistan Turkmenistan onamore Why train didthefirstChina-Iran takea circuitous Kazakhstan-Turkmenistanroute viathe linealongthe Caspian Africa. EastandNorth to theMiddle significance ofthetrans-Iranian route, notjustasanalternative passage to Europe, butalsoasapotential gateway schedule for 2018was announced.a twice-weekly point area inaMuslim The ofChinasignalled departure the September 2017thefirsttrain In to fromTehran departed Ningxia Yinchuan, capitalof AutonomousRegion, and first train left Yiwu for Tehran with32 It containers. daystook due fourteen to aslightly circuitous route (Figure 3). 1 . These ofa episodesillustrate theimportance www.worldcommercereview.com evaluated inmoney, timeandcertainty, component between German suppliersandcarassemblyplants in China, to The catalystreduce seeking was firms theirtrade carandelectronics for costs, rail theLandbridge services Conclusions Eurasian integration andgreatly improve rail’s competitiveness relative to shipments. airfor time-sensitive between ChinaandtheEUwould beamajorstep rail towards service costs wouldconstruction behigh,atwo-day thisscenario,In Chinamay thetwo options toAlthough betrialling determine trade-off. thebetter security/cost andsouthoftheCaspian –mutuallyexclusivemake thetwo Sea routes –north aslinesbetween ChinaandEurope. theintention timesby ahigh-speedChina-Europe constructing If isto rail cuttransport line, thecost islikelyto envisages withmultiple, anetwork potentially competing (orsubstituting)routes. transit fees. The BRIalsoenvisages improved Asia sum,theBRI withSoutheast andPakistan. In rail connectivity line willmakeasouthoftheCaspian route shorter, to demandhigher andalsoreduce thepotential ofKazakhstan toInvestment Andijan have Kashgar planssuchas the track connecting for adualpurpose China. The connecting the BRI,backedby theAIIB’s financialclout, could makeadifference. enhanced by investment inneworupgraded better rolling track, stock andotherfacilities. These are ways inwhich Public investment cancreate alternative routes andcould provide ahigh-speedoption.Future willbe prospects trade-off. better security/cost timesby ahigh-speedrail line, constructing Chinamaycut transport thetwo optionsto betrialling determine the a dangeralongsingleroute passingthrough several countries. Ontheotherhand, iftheeventual intention isto optionsandreduce becausetheyenhance therange hold-uppossibilities, oftransport whichareimportant always China’s desire for multipleroutes could come from two, notmutuallyexclusive, motives. routes Multiple are Why theBRIinvolve does multiplebelts? www.worldcommercereview.com Hurley, J,SMorrisandGPortelance (2018),“Examining Implications theDebt andRoadInitiative oftheBelt from aPolicy References annual GDP. terrain ontheroute; andwilldepend acommonly cited figure of$6billionisalmostaslarge asthe Kyrgyz Republic’s on thefront pageoftheFinancial Times, 2018).Construction costs 13April highdueto ofthelinewillbe themountainous ChristineLagarde1. IMFManagingDirector cited (featured, thestudyinawidelyquoted inBeijing speech forexample, Endnotes PomfretRichard isProfessor ofEconomics at Adelaide University the existing Landbridge, politicalproject.■ which hasbeenabottom-up rather commercial thanatop-down story Commentatorsnetwork. are right to seeChina’s BRIasalong-term vision. That visionshouldnotbeconfused with couldnetwork linkCentral Asia to Asia theChina-Pakistan Southeast to Corridor theEurasian andconnect rail substantial investment linefrom Chinato Uzbekistan. inashorter theEurasianWith rail alongertime-horizon, plusexplorationof theLandbridge ofalternative westward routes through whichmay Iran bereinforced by rail lines. ofcompetingas anetwork andcomplementary forThe Chinaisreflected inembracement importance China’s onthe Landbridge. BRIisnotjust piggybacking The vision of theoverland segment oftheBRIhas developed predated China’s BRI,althoughthetwo are related conflated. andoften hasgrown alongtheLandbridge 2011 thenumberoftrips rapidly, withover 3,000in2017. These development and between Apple, HPandAcer assemblersinChinaandconsumers intheEU. products oftheirelectronics Since www.worldcommercereview.com article was originallypublishedonVoxEU.orgarticle Editors’ note. This isacompanion column to "The Eurasian regional Landbridge: value linking chains", available here drawspaper onmaterial inChapter 11ofPomfret (forthcoming). andcirculated PaperMarch intheERIADiscussion 2018 inJakarta REITIWorking Seriesas Paper: ERIA-DP-FY2018-01. The the regional value chainsinEast andtheEuropean Asia Union" andGVC presented workshop attheERIAservices on2-3 Editors’ note: This column "The isbasedonalongerpaper Eurasian Landbridge: providers The role ofservice inlinking Press.University Pomfret, "The Central R(forthcoming), Economies Asian intheTwenty-first Paving thenewSilkRoad", Century: Princeton Perspective”, CGD Policy Paper 121,Center Washington forGlobalDevelopment, DC. . This www.worldcommercereview.com Exports of data-based services by developing ofdata-based countries services Exports Mattoo andJoshuaMeltzer argue that theway forward is threatened regulation. by Aaditya theEU'sprivacy Resolving the conflict theconflict Resolving between privacy and between privacy is to Shieldbargain theEU-US reflect Privacy digital trade www.worldcommercereview.com T Uruguay, Shield)willhave andtheUS(usingPrivacy beenrecognised asadequate (European Commission 2018). (for commercial organisations), Faroe Islands, Guernsey, Israel, Jersey, IsleofMan, NewZealand, Switzerland, law essentially equivalentprivacy to that oftheEU. When GDPRcomes into effect only Andorra, Argentina, Canada conditions. meetstheGDPR Oneisthatcertain thecountry ‘national adequacy’ requirement anational by enacting To ensure that thepersonaldata ofEUcitizens isnotabused, data canbetransferred outoftheEUonlyunder Strengthened regulation difficult, (Baueretal.2013). andsothreatens someofthese exports camefrom StrengthenedAfrica. toregulation theEUin2015–ofwhichone-fifth makesdata transfersexports more returns to healthtranscriptions anddiagnostics, contributed to ofdeveloping more country than$50billionworth whichrequirebusiness services, international flows ofdata. rangingThese services, from financial accounts andtax ofGDPRondeveloping countries.impact Many digitally developing delivered countries export data-processing and The current news focus ondata leaksassociated withFacebook, orontransatlantic data flows, have obscured the wider scope andstronger enforcement thantheData Protection Directive, whichitreplaces. On 25May 2018,theEU’s newGeneral Data Protection Regulation (GDPR) takeseffect(EuropeanIt has Union2018). return for source countries promising data notto flows. restrict EU-US Privacy Shield.EU-US Privacy Data destination countries would promise offoreign to protect theprivacy citizens in column argues that theway forward would beto design trade rulesthat thebargain reflect struckinthe transfers more difficult. Traditional trade rulesand cooperation regulatory cannot resolve this conflict. The he EU’s data by regulation making ofdata-based services threatens privacy exports developing country www.worldcommercereview.com (Kitchenman 1999). (Kitchenman lawscredit, could andprivacy create markets significant of ofinformation asymmetries andaffecttheefficiency by inhibitingtheflow ofinformation. For ofpersonalcreditexample, histories iscritical the to consumer reporting could adversely affectpoorer countries. Prematurely thedevelopment laws ofmarkets stringent privacy could hurt A national law imposesthesamestandard inthe on all firms country, whethertheyhandle EUdata ornot. This data flows data in return for source countries promising not to restrict restrict to not promising countries source for return in would promise to protect the privacy of foreign citizens citizens foreign of privacy the protect to promise would in the EU-US Privacy Shield. Data destination countries countries destination Data Shield. Privacy EU-US the in be to design trade rules that reflect the bargain struck struck bargain the reflect that rules trade design to be cannot resolve this conflict... the way forward would would forward way the conflict... this resolve cannot Traditional trade rules and regulatory cooperation cooperation regulatory and rules trade Traditional www.worldcommercereview.com privacy laws,privacy orto incurthesubstantial compliance costs associated withSCCs andBCRs? Is itpossibleto satisfy theEU’s legitimate needswithoutobliging othercountries to useEUstandards intheir Alternative routes to compliance becauseoftherequirements.opportunities months (NASSCOM-DSCI 2013). Two-thirds claimedasignificant lossofbusiness exporters services of thesurveyed 90% oftherespondents usedSCCs. These alsoinvolved acomplex process andtook onaverage more thanthree earlier, less-stringent EUData Protection Directive revealed that theBCRprocess took more thansixmonths, and benefits ofseamlesscross-border digital ofthe trade, Indiaoftheimpact especially in for smallerfirms. Asurvey routesBoth are costly andtime-consuming. The requirement ofapresence intheEUincreases costs andlimitsthe held liablefor breach, to beestablishedinanEUmember state. access for individualsthat would beoffered intheEU.Both also require adata controller orprocessor, whocanbe Contractual Clauses(SCCs) for eachbusinessdeal. instruments Both require levels ofprotection, oversight, and either BindingCorporate Rules(BCRs),designed for multinational companies to move data globally, orStandard acountry’sIf are firms test, national ashappenedinthecaseofIndia, lawrequired failstheEUadequacy to use Philippines to reassess itsapproach. suspendedinvestmentcountry plansbecauseoperating costs would increase, leadingthegovernment ofthe legislation tonational ensure privacy continued access to theEUdata processing basedinthat USfirms market, at homeandcompetitiveness inforeign islessofaconcern. where markets privacy When thePhilippines drafted avoid fallingfoul ofthenewEUregulation (Financial Times 2017). The increased access costs to would services hurt suggested that, onaverage, membersoftheFortune 500would needto spend$16millioneachonaverage to legislation would national privacy alsoincreaseEnacting theeconomy-wide cost ofdoingbusiness. Arecent survey www.worldcommercereview.com Instead ofthesetraditionalInstead routes, itmay bepossibleto build onarecent modelofinternational cooperation. international response: negotiation oftrade rules, andcooperation between regulators. The tension between international data flows anddivergent standards hasprovoked national privacy twotypes of • • • Privacy shield. rules, it considered privacy When theEUfirstenacted USlaws inadequate, andtransatlantic to lookoutfor theinterests ofcitizens from othercountries. their jurisdictions. The regulators whohave inotherjurisdictions control over theseentities are notmandated citizens, regulators needto influence thebehaviour ineachcountry ofdata-handling entities located outside not, by themselves, address thecentral problem of international data flows. To protect theinterests oftheir fragment operations to conform to differing regulations. Butidentical ormutuallyacceptable regulations do recognition ofnational regulations create helpfirms economies ofscale, becausetheydonotneed to in thiscaseandwould notbesufficient toensure international data flows.Harmonisation andmutual cooperationRegulatory . Traditionally this impliesharmonisation andmutualrecognition. This isunlikely disputeWTO settlement system to adjudicate protection. thepoliticallysensitive issueofprivacy tomeasure achieve was aspecificobjective, necessary itisprobably unrealistic analready strainedto expect in services”. While the panelsandappellateWTO bodyhave madejudgements inothercasesonwhethera between and unjustifiablediscrimination countries where like conditions prevail, oradisguisedontraderestriction XIV(c)). Article XIVlimitstheexceptionThe chapeauto Article to measures that donotleadto “unnecessary protection oftheprivacy ofindividuals inrelation to theprocessing data” anddisseminationofpersonal (GATS, to secure compliancenecessary withlaws consistent that are withtheGATS otherwise relating to “the Negotiation. The WTO’s General Agreement on Trade (GATS) inServices provides anexception for measures www.worldcommercereview.com for example oftheGATS. asAdditional XVIII Commitments under Article conformity unilaterally, to theirrequirements andpredictability butlendadditionaltransparency by listingthem, gradually deepeningthem.As afirststep, data source countries may stillspecify conditions anddetermine We countries to expect proceed step-by-step insmallgroups, into specificarrangements self-selecting and First steps standards standards to domesticneeds, to foreign andexport needs. at homeorwithcountriestransactions lessdemandingthantheEU. Countries would befree to tailordomestic adequacy, firms would notbeobliged to adoptmore stringent andmore costly standards for data, involving of conformity withEUstandards would bedoneby domesticregulators. Second, unlikeinthecaseofnational of BCRSandSSCs, firms would not be required to establisha costly presence intheEUbecauseany assessment A recognition agreement withtheEUwould have bigadvantages over existing options. First, unlikeinthecase assessment institutions. whilestrengthening theircasefor recognitioncan takeadvantage oftheopportunity by creating credible requires to itto negotiate alsogrant asimilar arrangement. Developing othercountries countries anopportunity Since the EUhasrecognised USconformity assessment Shield, mechanismsunderthe Privacy law services WTO and enforced by USinstitutions, notablytheFederal Trade ofCommerce. Commission andtheDepartment European citizens to European standards, inreturn for data unrestricted flows. This commitment ismonitored of Google ofthisdealisapromise and Microsoft to protect theprivacy by suchas At USfirms theheart updated theSnowden after revelations ShieldAgreement asthePrivacy ShieldFramework (Privacy 2018). data flows were threatened.In response, theEUandUSnegotiatedSafe a Harbor Agreement. This was www.worldcommercereview.com Economy. Protection Protecting Right: Privacy, Transmitting Moving Commerce,” Data, European Center forInternational Political Bauer, M,FErixon, MKrol, HLee-Makiyama, Data ofGetting andBVerschelde Economic Importance (2013),“The PacificAsia Economic Cooperation (2017), Privacy Framework. References Fellowis aSenior at Institution theBrookings MattooAaditya isResearch Manager, Trade andIntegration, at the World andJoshuaPMeltzer Bank, both data protection standards andmechanisms to ensure compliance. ■ oftherecent initiativeas part commerce. onelectronic Suchdiscussionscould helpforge abroader consensus on from abilateralApart orplurilateral approach, there may alsobescope for multilateral discussions, for example legal obligations ondata destination offoreign countries to protect theprivacy citizens. Partnership (CPTPP). thisagreement, In data source countries agreed theflow notto restrict ofdata, in return for which isoneofthemostinnovative elements oftheComprehensive andProgressive Agreement for Trans-Pacific These steps could pave theway ultimately for mutuallybindingobligations onsource anddestination countries, Paper (OECD –buildingonOECDandAPECprinciples onPrivacy 2013,APEC2017). make collective additionalcommitments whentheyconverge requirements inregulatory –say, ina ReferenceWTO countries whenthere istrustinenforcement,even diverge. thoughnorms parallel, In groups ofcountries could also step could beforA further data source countries to recognise conformity assessment inspecificdata destination www.worldcommercereview.com This article was originallypublishedonV This article (1995),General AgreementWTO onTrade inServices. Privacy ShieldFramework (2018),Privacy ShieldOverview. border Flows ofPersonal Data.” OECD (2013),“Recommendations oftheCouncil Concerning GuidelinesGoverning theProtection ofPrivacy andTrans- NASSCOM-DSCI ofEUPrivacy oftheImpact (2013),“Survey RegulationonIndia’s Exporters.” Services Perceived WF(1999),“USKitchenman, Credit Reporting: Outweigh Privacy Benefits Concerns, The Tower Group.” Roundtable, December.Services (2000),“CustomerGlassman, CA from Benefits Current InformationSharing by Companies,”Services Financial Financial Technological StudiesB.4 –Country India,” Developments Justice, European Freedom Commission D-G andSecurity. Greenleaf, G,DKorff, andIBrown Approaches (2010),“Different toNew Privacy intheLightof Challengesin Particular Financial Times (2017),“Global groups face bigbillsto comply withnewprivacy rules”, 20November. European Union(2018),General Protection Data Regulation. European Commission (2018),“Adequacy oftheprotection datainnon-EUcountries” ofpersonal oxEU.org , accessed 22May2018. www.worldcommercereview.com Constâncio. Headdsthat itisequippedto continue to deliver on Having developed its monetary policy through four policy key phases,Having developed itsmonetary the ECB is a modern andeffectivethe ECBisamodern sayscentral bank, Vítor Past and future ofthe ECB monetary policy ECB monetary the priority of price stability for of price stability euro areathe priority citizens www.worldcommercereview.com I Monetary Institute, explained why both a monetary aggregates Institute, explained why bothamonetary targetingMonetary strategy andaninflation targeting regime thepreparation union,a documentIn published in1997by theECBpredecessor, for monetary theEuropean world. the framework gotcloser to theflexible inflation targeting regime adopted bymany other central banks around the strategy pillarandthe inMay 2003,whenthe weight ofthemonetary ‘dominant role ofmoney’ were demoted and policy andlastsuntil the withthelaunchofsinglecurrency revision ofthemonetary The firstphase starts andadjustment beginning (1999-2003) First policy Phase:monetary identified.clearly process oftransformation over time. While thetransformation been gradual, hasoften four keyphasescanbe Within ofthe theboundaries Treaty, however, intheeuro area policy hasundergone a ofmonetary thepractice unchanged over itstwo decadesofexistence. Union. This high-level mandate inthe enshrined Treaty isthecornerstone ofallECBdecisionsandhasremained the general economic policiesinthe cansupport policy prejudice that to monetary ofprice stability theobjective 127 ofthe Treaty, intheeuro isonlywithout area. policy It ofmonetary objective istheprimary price stability The Treaty intheeuro ontheEuropean area. policy Uniondefinesthe Accordingcontours ofmonetary to Article The ECBjourney some lessons from this experience, both for economic thinking and monetary policy making. some lessonsfrom policy this experience, bothfor andmonetary economic thinking intheeuro area policy overto highlight theevolution thisperiod. ofmonetary Iwillthendraw ofthepractice intheeuro areapolicy over withareview from oftheECBjourney thepasttwo decades. 1999to date, Iwillstart to andoffer adoptahistorical perspective onmonetary would some liketoreflections takethisopportunity www.worldcommercereview.com not allow arole for money. calibration ofaM3target. The refusal ofpure inflation targeting was justified bythetheoretical reasonthat itdid reason at theEuropean that moneydemand functions level would notbestableenough to allow for areliable a tradition that understandablyexerted acrucialinfluence ontheinitialECBdecisions, was refused for thepractical were notconsidered fullyappropriate for theeuro area bond market bond policy transmission by intervening in the sovereign sovereign the in intervening by transmission policy addressing the impairment of the single monetary monetary single the of impairment the addressing its mandate, either in fighting against deflation or in in or deflation against fighting in either mandate, its From now on, the ECB will have no excuse not to fulfil fulfil to not excuse no have will ECB the on, now From 1 . The first regime, which was followed in by theBundesbank, www.worldcommercereview.com numbers representing for higherrisks mediumterm inflation. overhang:to produce thedifference amonetary M3 growth between actual andthe reference value, withhigher from credit orotheraggregates. The reference value for M3annualgrowth was calculated to be4.5%and was used and was related to the theoretical approach oftechnical inthat inflation monetarism money predicts anddiffers The reference aggregate value for themonetary M3 was considered arelevant variablefor inflation assessment couldn’t tell you” role. So, ifyou call pillars, itthetwo onepillaristhicker thantheotherisorstronger thantheother, buthow much I a questionby in1999:“it ajournalist isnotacoincidence thatIhave usedthewords thatmoneywillplayaprominent 2006,explaining theorigin ofthe In pillars’,‘two Issing quoted former President Otmar Wim Duisenberg’s reply to of technical monetarism quantitative reference growth value asonepillaroftheoverall formonetary oriented. So, strategy” stability sometrace explained: “Tofurther signaltheprominent role ithasassignedto money, theGoverning Council hasannounced a There was adominant clearly firstpillar witha reference value initiallyset at 4.5% growth rate for M3. The text and therisksto intheeuro price area stability asa whole.” aggregate;growth ofabroad and(iii)abroadly forfuture monetary basedassessmentoftheoutlook price developments to achieve thisobjective: (ii)aprominent role formoney, assignaledby theannouncement ofareference value forthe pillars’ policy, ofthestrategy andthe‘two objective ofthesinglemonetary used namelypriceof theprimary stability; the ECB’s strategy consists 1999:“The ofthree mainelements:(i)aquantitative definition MonthlyBulletinofJanuary on thetwo mainstrategies previously by examined andcharacterised thefollowing keyelements, in asdescribed strategy’ policy oriented monetary to attain thegoalssetoutin Treaty. The ofhybrid strategy based was asort GoverningOne ofthefirstdecisions Council, already in1998, was to announce theadoptionofa ‘stability- 3 . 2 was implicitlypresent. www.worldcommercereview.com 4.5%, registering 10.9%inDecember 2001andinDecember 6.6%in2002 ultimately for arevision ofthestrategy. Since 2001thegrowth to accelerate ofM3started to values well above the The experience sobering ofthefollowing few years determined theneedfor withtheframework, clarificationsand inaninflation targeting importance regime. and anotherrelated to apubliccommitment ofaquantified inflation target (lessthan2%),anelement ofutmost ofhaving twoambiguity seeminglydifferent approaches, targeting (the reference oneclose to monetary value) mentioned orusedsince then. pillarbecamethinner.The monetary the reference value onanannualbasiswas dropped. While stillat 4.5%,thereference value has, notbeen infact, a medium-to long-term perspective, theindications coming from theeconomic thereview analysis; of fourth, from analysis asameansofcross-checking, third, would mainly serve themonetary toterm risks price stability; withtheeconomic to analysis medium- to decisionswould identify short- start policy presentation ofthemonetary elements. First, themedium-term target for inflation was redefined toa valuebelow butclose to2%;second, the Consequently, framework includingthefollowing policy inMay 2003, theECBpublishedareview ofthe monetary corresponding inflation inthehorizon, intowas turning anembarrassing exercise. the differences between theECBapproach andtheinflation targeting regime framework announcement alively policy sparked debateThe intheacademiccommunity, monetary regarding monetary policy decisions policy monetary like thereference value referring to themedium-term of upto two years whichistheoperational horizon for unstablesince becameclearly 2001anddidnotjustifytheuseofaconcept themoneydemandfunction fact, In inflation that thebehavior ofprices didnotshow, even lags. when meaningful considering 6 . toThe explain continuous away needto try overhang the growing without monetary 5 . It thussuggested significantrisks . It for 4 . There were aboutthe criticisms www.worldcommercereview.com economic outlook of April 2005 considered that monetary policy intheeuro areaeconomic policy “should 2005considered outlookofApril that monetary remain firmly onhold” criticised atcriticised thetimeby anumberofcommentators inflation above 2%,witha rate ofthat of2.5% inthethirdyear. quarter Curiously, theinterest rate decision was wereRates increased inDecember 2005asthere was evidence that strong growth was contributing to in arise cannotcater for policy heterogeneity across memberstates.monetary forcriticised nothelping prevent that development. Idonotagree asitignores with suchcriticism that asingle with thebuild-upofmacroeconomic imbalances inseveral membercountries. With hindsight, theECBhasbeen strategyThe spanningfrom period therevision to thebeginning in2007coincided ofthemonetary ofthecrisis until thefinancialcrisis(2003-2007) policy Second Phase:monetary andfinancialon what variables. willhappento inflation from thosemonetary general financial conditions.In bothcases, however, quantitatively central bankscannot preciseextract calibration aggregates,monetary especiallycredit, astheyhave information content. thesameway, In central banksalsofollow and accountability forecast publishedby thecentral converge bank, to target, thisnumerical andthird, ahighdegree oftransparency decisionsthat maketheinflation includes:first, anannounced inflation policy numerical target;It second, monetary inSvenssonas described (2008). the ECB’s strategy canbeseenasconsistent policy withthebroad features monetary offlexible inflation targeting and accountability andmadetheECBstrategy even more aligned withinflation targeting. Itherefore believe that assessment, thedecisionstakenin2003and2004were steps towards important ahigherdegree oftransparency Finally, publishingitsstaffmacroeconomic projections inJune2004theECBstarted for theeuro area.In my 7 . Naturally, thisdoes notmeanthat allcentral banksdonotlookat what ishappeningwith 8 and even by some policy institutions. andeven byHowever, somepolicy the IMF’s 9 . A www.worldcommercereview.com episode or when in a monetary union, a financial instability episode is notgeneralised across union,afinancialinstability all countries episode orwheninamonetary Jeremy Stein. However, itcaneasilybecome asignificant inconvenience ifitcreates recessionary anunnecessary policy that monetary respect, thefact ‘gets inallthecracks’ ofthefinancialsystem was seenasanadvantage by tool to respond shouldbethemainpolicy toMacroprudential thebuild-upoffinancial imbalances.In this policy intervention applyingthemethodologydevelopedintervention by LarsSvensson to theeuro area conclusion isthatMy thecosts of againstthewind’‘leaning are likelyto exceed benefitsasIillustrated ina recent financial crises. credibility ofthecentral bankregarding itsinflation objective, whileonlymarginally reducing theprobability of occurs.crisis The ofthisapproach risks are andhinderthe to increase fluctuations theamplitudeofbusinesscycle help prevent potentially larger deviations from over price stability the medium-to long-term, once thefinancial move to medium-term, ofafutureIts benefit asaprecautionary againsttherisk financialcrisis. wouldbeshort- to More precisely, againstthewind’‘leaning requires intentionally producing deviations from over price stability the intertemporal trade-off inachievingprice stability trade-off intertemporal cycles, synchronisation offinancialandbusiness leaningagainstthewind due towould posean the imperfect usedto shouldbenormally prevent policy the build-upoffinancialimbalances.monetary The main reason isthat, tool to respond to financialimbalances withwhat iscalled‘leaning againstthewind’ policy. Idonotbelieve that Let meemphasisehowever, interest policy rates that thisconclusion are doesnotimplythat monetary thebest now agree that thetightening decisioninDecember 2005was appropriate. similar recommendation was issuedby theOECDinNovember 2005 11 . 10 . With thebenefitofhindsight, mostobservers 12 . 13 . www.worldcommercereview.com boost thebubblycomponent ofstock prices, orincrease houseprice imbalances through debtdeflation effects Indeed, someinfluential authorshavecould, insomecases, policy pointed even outthat atightening ofmonetary been severely impaired asaresult ofexcessive pressures. market 2007 and mid-2012,thesize Between oftheECB’s sinceintervened 2010withpurchases transmission had ofgovernment policy bondsofcountries where monetary increase inbankreserves. This was accentuated by theeffectsofSMPprogramme underwhichtheECB boldly ECB balance sheet. The increase infinancialinstitutions’ demand led to aprogressive,for ECBliquidity andsizable, provision ofeasedliquidity to was themarket increase implicationA direct oftheactivity inthesize ofthe that emerged thecrisis. during expanded to easethe shortages sector’sexacerbating mismatch the maturity onthebanking balance sheet. The listofeligible collateral was also at that point. For example, was provided liquidity at muchlongermaturities thanusualto helpalleviate tensions The operational approach was to calibrate eachmeasure to address impairment prevailing thespecificmarket and keptuntil thisday. by replacingprovision thefixed sector auctions to thebanking rate fullallotment regime was introduced October in bankruptcy, rates were subsequently cutthree timesto alevel ofliquidity of2.5%inDecember 2008.Abroad policy took thecontroversial rate decisionto increase to thepolicy 4.25%.Following thedramatic effectsofthe Lehman However, inJuly2008,overreacting to areading of4%inheadlineinflation related to oilprice developments we of Lehman BrothersSeptember of2007,andespeciallyitsintensificationcrisis in2008. thebankruptcy after The third policy. anabruptchangeineuro canbeidentified phasemarks asa arearesult ofthefinancial It monetary The ThirdGreat Phase:globalfinancialcrisisand Recession (2008-2013) financial stability. This requires inorder strong to macroprudential achieve policy bothprice policiesto and complement monetary 14 . www.worldcommercereview.com forecasts outto whichturned beexcessively optimistic. Blanchard andLeigh, whoalsopoint outthat many other above 2%andwithinflation attaining 2.75%inthesecond quarter. We were also overly influenced by growth Those rate increases came onthewake ofdevelopments inthe firsthalf2011,showing economic growth slightly double dipingrowth therefore comment. deserve further rate it from increases ofthetwo 1%to policy criticism 1.5%. andJulyof2011,taking inApril This episodeandthe in 2012andapossiblelinkto therecession andlow inflation that period followed. This viewis compounded by the theopposite concerns direction, In were alsovoiced intheECB’s aboutthereduction balance sheetsize beginning inflation. increase insize oftheECBbalance sheet, theproblem intheeuro area remains oneoftoo low, rather thantoo high, inflation. This assessment has beenvindicated by subsequent developments. Almost ten theinitial years after a shockto moneydemandthat totally disrupted any potential aggregates relationship between monetary and aggregates didnotincrease inresponse third, to theexpansion ofcentral thatimplied thecrisis bank liquidity; aggregates baseandthebroad thatmonetary monetary isunstable and,during period infact, the monetary ofinflation isdirectly related withthe no theory central bank’s balance sheet;second, the relationship between baseasasignal offuture highinflationrisks. ECB monetary These fears obviously disregarded three things:first, the highlong-runcorrelation between inflation andmoney growth, theyinterpreted thehuge growth inthe commentatorsSome were concerned by nevertheless theincreasing size oftheECBbalance sheet. Basedon adverse effects. improving inmid-2012,theECBbalance started sheetslowly sector beganto contract withoutanyin thebanking measures, to Indeed,asthefundingsituation themarket. butrather function theresult ofthelenderlastresort balance sheet more thandoubled. Clearly, thelarger balance sheetwas ofournon-standard thennottheobjective www.worldcommercereview.com to cumulative deviations from thebaselinegrowth in2011-2013from 8%inGermany to 18%inGreece paperpublishedbyengaged. theEuropean Aworking Commission estimated that collective fiscal consolidation led responsible for therecession of2012/2013was thecoordinated fiscal consolidation inwhichallmemberstates rates cannotberesponsible ofpolicy reductions for episodeofthat period. therecessionary What really was effects, itisobvious policy that thequicksuccession ofincreases viewofthelonglagsmonetary and In year. Programme (SMP). The two consecutive rate hikeswere reversed quickly inNovember andDecember ofthat same that ledto asecondand Italy round inthesovereign ofinterventions Market undertheSecurities bondmarkets weakened thesummer, after markedly onthewake oftheacute pressures market onthesovereign debtofSpain With hindsight, itisnow clearthat increasing interest rates thisphasewas during premature. The economy announced 2010. inearly multipliers, effectsofthefiscal ledto consolidation whichinturn anunderestimation plans ofthecontractionary validation ofthishypothesis intheir2013paper forecasting institutionsmaderecurring errors oneuro area growth thisperiod, during makeanindependent This measure ofthetwo andthecorrection rate hikescontributed to attenuate ofthe2012recession theseverity longer-term refinancing operations implementedDecember in 2011 and 2012 amounting to EUR 1 trillion. February continued to helpthesituation policy when,at theendof2011,ECBintroduced two three-year Monetary become an important sourcebecome ofmacroeconomic animportant uncertainty. The programme facilitated aneaseoftension inall preventing aneven worse deterioration ofeconomic conditions by removing whichhad redenomination risk, The announcement Monetary oftheOutright contributed programmeTransactions to in2012further (OMT) paper findsalossdeviation from baselinebetween 14% to 20%, for theeuro area thesameperiod GDPduring 15 . The authorsargue that thisisdueto anunderestimation offiscal 16 . Another 17 . 18 . www.worldcommercereview.com including: a cut in policy rates andanegativeincluding: acutinpolicy rate; depositfacility two assetpurchase programmes for assetbacked 2013, falling under 1%, a comprehensive package of expansionary measures 2013, fallingunder1%,acomprehensive ofexpansionary package rates at prevailing orlower levels ‘for oftime’. period anextended As inflation continued to decelerate fromOctober ECB hadalready introduced offorward guidance, thenon-standard policy indicating itsintention to keepinterest July2013,inresponseIn to thecontagion ofincreased bondyieldsresulting from the tantrum’‘taper intheUS, stance at rates apoint where policy hadreached policy their lowerease themonetary bound. standard policieswere notmerely to expected undoany remaining impairments, financialmarket but to further standard measures was launched, includingincreasing thebalance sheetwithassetpurchases. The newnon- stance. response policy In to thesedevelopments,required monetary anewphaseinnon- amore expansionary intheface ofinsufficient priceMaintaining stability aggregate demand and downward pressures inflationary possibly theconsequence ofweakened economic sentiment two recessions after thenegative turn, In demandshockcould bethedelayedshock. tightening result since 2010,or ofthefiscalpolicy output andinflation suggested that the renewed economicwas driven weakness by anegative aggregate demand years, financialdisruptions could nolongerbe responsible for theeconomic slowdown. The coincident of reduction with aprogressive fallofinflation towards levels significantly below 2percent. In contrast withthe previous five spite oftheultra-lowhad notyet In gainedtraction. level ofinterest rates,risks emerged renewed deflationary intheeuro area.2013,theeuro policy In area recovery andcurrentThis meto brings phaseofmonetary thefourth The Fourth Phase:ultra-low inflation andQE(2014-today) OMT announcement, theECBputanendto theeuro area acute existential crisis. Altogether, withthesecond round ofsovereign bondpurchases suppliedat end-2011andthe in2011,theliquidity financial markets, which was accompanied by aslow, butprogressive ofspreadsreturn towards levels. normal 20 was announced inJune2014 19 . www.worldcommercereview.com APP critics andthosewhoclaimeditwasAPP critics unnecessary eliminated ofprolonged therisk deflation. isincontrovertible This fact andshouldbeadmitted by boththeearly decline. From asimplerperspective, we canstate today that threeassetpurchases yearshave oflarge-scale APP announcement ofinflation contributed by expectations reversing to are-anchoring theirpreviously observed central banks. Improving ourunderstandingoftherelativefor priority strength effectsisalsoanimportant ofthesedistributional time, theAPPincreased thevalue offinancialassetsandthusled to capitalgains for theholdersofthoseassets. especially beneficial for thoseindividualswho, asa result, being unemployed.found ajobafter At thesame accommodation, theAPPledto policy anincrease ineconomic activity,an instrument ofmonetary whichwas ofQEprogrammes aspect that needsto beinvestigatedA particular regards effects. itsdistributional further As bound constraint willbehitmore frequently. that nominalinterestpossibility rate willbemore persistently low inthefuture, andthusthat theeffective lower theoretical research for understandingofQEremains central animportant priority banks, especiallyinviewofthe understood andtheydo notrelate progress tostill imperfectly technical Ithinkthat monetarism. making inour weNevertheless, shouldremain aware that theprecise channelsoftransmission ofQuantitative Easing(QE) are spreads assetsandthereby onlong-maturity boosting inflation and growth A growing ofAPPsuggestthat theprogramme numberofstudiesabouttheimpact was effective inlowering sovereign bonds. assetpurchase programme(TLTRO). 2015,thelarge-scale (APP) wasto January extended includepurchases In of contingent onbankcredit supplybehaviour, whichwe refer to astargeted longer-term refinancing operations (ABS)securities andcovered bonds(CBPP), to provide andafacility longer-term fundingto banksfor newloans, 22 . 21 . These studiesalsohighlight that the www.worldcommercereview.com Stochastic General Equilibrium (DSGE)modelsthat prevailed before thecrisis, are by now quite well known withthefirstquestion.Let mestart ofmainstreamDynamic macroeconomicsThe shortcoming type of andofthe Implications for theory macroeconomics andmonetary bereflected inachangeof learnt inthejourney central banks’ strategies? policy monetary decisions, orshould thesebechanged? shouldlessons strategy: The second questionrelates policy to themonetary analysis: were themainstream macroeconomic modelsusedbefore appropriate thecrisis to help guidepolicy The that ECBjourney Ihave recalled here cangive to rise two obvious questions. The firstone relates to economic Implications for thefuture recovery, thesamepositive outcome took place to withrespect wealth distribution. reduced income inequality. Furthermore, asaresult ofhousingprice increases associated withtheeconomic Federal Reserve’s FRB/USmodelhasbeenadopted macroeconomy to astance term onthetheoretical premia, fundamental withouttaking debate abouthow theyare linkedto the approach allows andfinancial variables, usto goingfrom modelawiderange ofbanking banklendingspreads representation that isconsistent withdifferent theoretical micro-foundations. This more flexible, semi-structural to provide soundquantitative predictions. When introducing financialfrictions, we have relied ona reduced form had a disproportionately positive impact onlow-income positivehad adisproportionately impact households Ongoing work at the ECB suggeststhat the declineinunemployment that followed theintroduction oftheAPP expected toexpected have thesametight as structure models’ ‘theory from thepremise that, modelstarting inthewordsCountry ofOlivierBlanchard, ‘policy models’ cannotbe theECBdecided DSGEmodelstoto develop linkages, extending includemacro-financial Multi- Besides a new 27 . 26 . We cantherefore putmore emphasisonthemodel’s ability 25 . A semi-structural approach. Asemi-structural alongthelinesof 23 . The netoverall ofAPPhastherefore impact 24 . www.worldcommercereview.com shocks orinertia”.shocks and fiscalrationallypolicy. changesinmonetary to andexpected actual two-way gamehasno This forsupply room respond andothers. expectations, andexpectations onforward-looking Inflationdepends recently by andGertler Galì fork intheroad evolution, ofthepost-1975 features anapproach developed by Kydland, Prescott andmore andSargent, interpretation oftheinfluence ofpastinflation as generalized inflation. reflecting expected Theright ratherthan inertia long-run neutrality thePhillips upordown, andanexplicitrole Curve inshifting together withan ofsupplyshocks in theroad,… thatincorporates istheresurrection model ofKeynesian economics intheformofa….Phillips(PC) Curve empirical modelofinflationempirical that faces several estimation problems variables asitusesseveral unobservable whichrequiresA crucialtheoretical aspect improvement isrelated to thePhillips themostcommonly curve, used In thelateIn 1970s, two different researchGordon approaches emerged, Robert thuscharacterised by doubtfully deemedto bethesame. AcceleratingRate long-term (NAIRU)are NARU, Inflation what isobtainedinstead oftheunobservable which are aggregatesvia monetary for Friedman orwithinterest rates, asbelieved today. practice, In estimates ofaNon- Inflationinflation. wasan — excess demandphenomenonand couldbe policy controlled by monetary used asproxy for demandpressure seenasthemaintheoretical ofgoodsandservices, causeof inthemarket The difference unemployment andthislong-term between actual unemployment rate becamethe variable (NARU), determined onlyby supplyfactors, to whichtheeconomy would tend inthelong-term. relationship. Jointly withthischange, Friedman addedtheconcept ofafixedRate Natural ofUnemployment 1967-8,Phelps andFriedmanIn introduced thepreviously asavariable that shifted expectations considered stable asarelationship between wagestarted growth andunemployment andlater, prices orinflation substituted wages. 29 “The left fork left : “The 28 . It . It www.worldcommercereview.com NKPC, since Roberts asithighlights oneofthepuzzlesfound inthesecond important approach ofthe isparticularly This lastaspect stable.” inflationandtheunemployment notdecline between gapdoes by halformore asinthe recent literature, butinstead is of lagged inflation,predict the2013 value ofinflation percentage towithin0.5 point.ofthePC Theslope relationship estimate coefficients up to1996andthenina16-year-longactual dynamicsimulation, withnoinformationonthe values lags ofinflation were (1999) NKPC to createhybrid introducedGertler theso-called Galì and by inordertried even to makeitwork, whentheydidnotconform to thepure theoretical paradigm ofthemodel. First, Many wellThe empirically ad-hocremedies from problem have thestart. isthat theNKPCdidnotperform been coefficient. itisnatural thatspecified Roberts, thelowby inflation environment shows oftheperiod upinadecliningslope supply-side variables, assumes inflation lags with coefficients that add to1,and a constant NAIRU, asintheNKPC expected, thevalue ofthat coefficient dependsonthe entire specification ofthe regression. Whenitdoesnotuse to obtain very goodresults inflationto inpredicting out-of-sample obtain very determined by asimplestochastic process. To thisday, usingthisso-called approach’,‘triangle Gordon continues NAIRU represented inertia bydepend ondemandandsupplyfactors), longlagsofinflation andatime-varying Gordon andothersforged aheadwiththefirst approach, adding variables representing supplyshocks(asprices control demandandtherefore inflation. oftheDSGEmodels, where theinterest andisacrucialpart the outputgapandexpectations rate to isall-powerful This second approach produces that basicallyfocuses what iscalledtheNewKeynesianPhillips (NKPC) on Curve has faced many inflation difficultiesin with predicting acceptable accuracy, evenwhenembedded inDSGEmodels. 31 obtainedtheresult ofa50%declineintheslopecoefficient fortheUSin2006. Asis tobe 30 . In 2013,Gordon shows. In that hismodel“can 32 . This hybrid model www.worldcommercereview.com DSGE modelsto forecastIn theirencompassing inflation. survey, Mavroeidis, Plagborg-Møller andJ Stock (2014) and chosenvariables, althoughtheytend to agree onthetimingofpeaksandtroughs. usual measure ofunemployment substantially (standingat across 8%).Usual measures methods ofslackcanvary be obtainedwhenthebroad concept ofunemployment isused(eg. U6,whichisat 16%for euro area) instead ofthe underestimation oftheslackineconomy. This isillustrated that we by thefact better ofinflation predictions can oftheunder-prediction ofinflation in and theNAIRU.recent part years may An important bethe result ofan source ofthePhillipsAn important curve’s canbethemis-measurement oftheoutputgap poorperformance of theliteratureGordon seem some to haveconvergence. identified Robert by undertaken rationale ismicrofounded ofDSGE modelswhere to everything rational andsubject expectations. The two strands especially for core inflation. This specification isquite distant from theinitial pretensions oftheNKPCand from coefficients andNAIRUs are alsoused. Time-varying So, pragmatically adjusted, NKPCscanbemade hybrid to work, some estimates, isintroduced theprice asanad-hocelement ofoilorthefull price ofimports withintheparadigm. As Imentioned inanotherintervention significant declineofthoseULCs”. (2013) andRossi Kisacikoglu Gürkaynak, costsor unitlabour donotcapture the models thatthelast15years donotshow aco-movement ofinflationwiththe take expectations fromtake expectations orprofessional consumer surveys forecasters, whichofcourse are notmicrofounded is to focus oncore Another approach may inflation is onwhichthemissingsupplyfactors belessimportant. to Many othertransformations have beenattempted better. to make variants ofthehybrid modelperform Oneway analysis”.the results to usefulforpolicy be also conclude that, are “we unableto pindown intheinflationprocess therole ofexpectations sufficiently accurately for 33 : “As andWatson King (2012) 34 highlight when using the labour income highlightwhenusingthelabour share 35 alsoillustrateof thesubparperformance 37 . In . In 36 , www.worldcommercereview.com -3% for thoseyears average, anestimate whichisconsiderably more negative thanmostofficial estimates, hovering between -2and The bestvariant from impliesthat thisperspective the outputgapwas as large as-6%in2014 and2015,on positive growth trend, implying awideroutputgap, are theonesthat produce better inflation forecasts. togap isto forecast check their ability outthatIt turns the variants associated inflation. witha continuation ofa they getdifferent measures oftheoutputgap. One way to discriminate amongdifferent estimates oftheoutput inflation was used but with the inclusion of import prices, taken laggedinflationinflation and expectations from surveys was usedbutwiththeinclusionofimport recentIn ECBwork aboutunderstandingthelow inflation environment, a variant ofthe NKPC hybrid for core decomposition of real activity variablesandcoredecomposition ofreal inflation activity dynamic modelsto estimate it. For atrend/cycle instance, modelthat performs ECBstaffusedadynamicfactor ismultidimensionalsuggeststhat there that might economicThe beadvantages activity fact inusinglarge the NKPCfor 21countries andthe TKPC for 7countries estimations oftheNon-Accelerating Wage ofUnemployment Rate (NAWRU), theEuropean Commission hasused forecasting tools. EitherNKPCor canachieve that.Traditional For instance, KeynesianPhillips (TKPC) intheir Curves anyIn case, what matters isthat itispossibleto findspecifications that goodinflation canbeusedasfairly involving theNAIRU. the estimation oftheoutputgap, thesamebeingtrueaboutconcept ofanunemployment gapmore directly already closeto zero by several asreported international institutions. This points to behind thegreat uncertainty the endcontribute to achieve ourinflation goal. increasing inrecent years. This isasource ofconfidence that ourpolicy, having contributed to the recovery, willin Using that pragmatic specification, acceptable forecasting results are obtainedand we findthat theslopehasbeen 39 . Results for. Results 2017still continue to show aquite negative meaningful outputgap, instead ofone 40 . 38 . Using different setsofandtrendvariables assumptions, 41 . www.worldcommercereview.com economic viewpoint. However, it, suchasthe decreased employability of appearsto support somemicro-evidence demand. Unfortunately, this difficult to detect hypothesis onempirical itisvery grounds from anaggregate various transmission channelsthat due may of economicto aggregate fluctuations induce along-lastingimpact while instillingahighdegree ofdoubtandcautioninitsuse. The mainargument behindhysteresis isthat there are Recently, Blanchard even questionedwhethertheNRHshouldberejected whichintheendherefrains from doing challenged, for example inthehysteresis hypothesis proposed by Blanchard andSummers forward by Friedman. This viewofseparating trend from orsupplyfrom cycle demandshockshasrepeatedly been determined exclusively by supply-side factors. This would correspond to the natural rate hypothesis (NRH)put to isthat underline itisdifficultA second to aspect accept that estimated NAIRUs are long-term constants decisions. estimates policy for strict estimates ofNAIRUbutwe canrely that theyare quite normally large. This recommends cautioninusingNAIRU concluded that thesewere large very theirseminalpaper,In Staiger, Stock and Watson (1997)estimated standard deviations for theNAIRUand canbedangerous. policy one numberto conduct calculation ofpotential budgetdeficitwithallitsimplication output andthestructural for fiscalpolicy. Trustingjust decisions: for value instance, asameasure unemployment ofstructural that usingthat enters particular into the institutions that rules, shapemarket etc. This viewthenendorsestheuseofestimated NAIRUs for several policy rateterm structural ofunemployment totally dependent likedemography, onsupply-side factors technology, iscommon from tothe NAIRUthat seeitasequivalent it. canbeextracted It to theFriedman’s NARU, along- Another questionrelated to thePC,beyond theforecast ofinflation, refers to theinterpretation anduseof 42 . The standard deviations are notusuallycalculated and/ordisclosedin 43 . www.worldcommercereview.com unemployment. Already in1998,Estrella andMishkin The major point behind theprevious discussion isthat estimated NAIRUs are notgoodproxies ofstructural quipped “a natural rate thatwanders isnotnatural, permanently isepiphenomenal”. which cannot falsified be by any setofobservations, iscloser to religion thanscience.” thesamevein, In Solow once of unemployment varies over time. theNRHhasnopredictive like content. Intheabsence this, ofsuch atheory Atheory time varying. ButIamunaware whichprovides us, ofany theory inadvance, withanexplanationofhow thenatural rate to mightchoose respond toHypothesis theseempirical findings by arguing thatthenatural rate ofunemployment is updated studyoftheEuropean anearlier to Commission illustrate (EC) thispoint. The studyrelates the European developments characteristics. labourmarket ECBstaffhave rather instructural thanby shifts recently replicated and concept, theNAIRUestimates since 2007,for instance, seem,to alarge extent, to bedriven by macro-economic consequences, eitherinusingto calculate potentialBeing ashort-term budgetdeficit. outputor thestructural Indeed, thecasualidentification oftheNAIRUwithlevel unemployment oflong-term structural haspernicious it asatarget, incorrect isboth andmisguided”. to move theeconomy authoritiesshouldtry concept towards impliesthatthemonetary theNAIRU, thus to sometreating rate ofunemployment…something thatisnottypically doneintheliterature. Furthermore, …theviewthatthe NAIRU critically onredefiningconcept NAIRU anddistinguishing itfrom asashort-term along-term concept like thenatural these time-varying NARUs andNAIRUs, Farmerthese time-varying refuses thewhole concept much more sluggish thanwhat usedinestimates isnormally ofNAIRUthat even show yearly changes. About One changeintheNARUlong-term assumptionisto accept that itchangesover time, albeitslowly andindeed recessions. long-term unemployed, andmorale, andinvestment astheyloseskill orthedeclineinR&Dactivities during offirms 45 showed that the NAIRU use in monetary policy “… policy showed that theNAIRUuseinmonetary depends 44 “Defenders oftheNatural: “Defenders Rate www.worldcommercereview.com Figure 1.Changes inNAIRU andcontributions 2007-2016 www.worldcommercereview.com Unemployment (SUR)to Rate substitute the NAWRU Confirming this, an Economic Paper published by the European Commission usesa concept of Structural unemployment. NAIRU levels. This meansthat theestimated NAIRUfrom isnotagoodrepresentation Phillips curves ofstructural andnotby anincrease cycle unemployment ofstructural asallegedlyindicated high the macro-economic by very Overall, inunemployment thisevidence suggeststhat theshifts ratessince 2007were observed mostlytriggered by broader setofvariables isHeimberger etal . indicators appear to explain thebulkofitsvariation. Another paper, reaching thesameconclusion andusinga indicators ofthechangesinNAIRU, thestructural explain onlyasmallfraction chart, whereas themacro-economic unemployment, exclusively macro above policy accelerates whichexpansionary inflation. is theideathat there isauniqueidentifiable level ofunemployment, corresponding to alevel ofstablestructural indicating that strong growth ofaggregate demand, given time, willincrease inflation. What shouldbe refused asapureimply abandoningtheideabehind thePhillips forecasting curve device withapositive slopecoefficient long-term stableconcept decisions. that canbeestimated from andusedinpolicy Phillips curves This doesnot ofdropping consider viewofalltheuncertainty, shouldseriously thepossibility theNRHasa In policy-makers stance indicators when on fiscalpolicy compared withtheprevious straight estimates of NAWRUs. are therefore andlesssensitive cyclical to lesspro- data corrections subsequent DiscussionPaper integrated ofanchorintheestimation ofNAWRUs, theconcept ofSURasasort that (total factor productivity growth, productivity (total factor theshare inGDPandthereal ofconstruction interest rate) rates, labourtaxwedges, uniondensity, indicators policies)andthree labourmarket andactive macro-economic Commission’ sNAIRUestimates to four indicators labour market (unemployment structural benefits, replacement 47 in the calculation of the structural budgetdeficit. A inthecalculation ofthestructural 48 . These analyses produce changes meaningful 46 . As shown inthe www.worldcommercereview.com 2017 to aquestionabouttheletter to theFederal signed by 22prominent Reserve economists American to asproposed amildcorrection by many economists. issimilarto reaction what My Janet Yellen replied inJune of managing thetransition withoutlosingcredibility. this, Notwithstanding Iwould have notheoretical objections Regarding proposals to increase inflation targets, Ithinktheyare ingeneral problematic, inviewofthe difficulties should undergo amore complete overhaul, status quo rather thaneventually returning to thepre-crisis change central banks’ strategies. policy Many commentators monetary have discussingwhetherthese started While ourquestfor better analyticaltools continues, abroader questionconcerns whetherthere isaneedto also strategy policy inthefuture Monetary observe insomecountries”observe before proceeding withthisradical proposal, even ifdigitalisationmaygainground andfinallyprevail to –as we start of increasing theinflation target: “…this isoneofourmostcritical decisions and onewe are attentive to evidence and shocks negative, andahigherinflation target to reduce thelikelihoodofhittinglower boundeven large, after adverse whichprevents ratescontext includetheabolitionofcash,to from eliminate policy going thearbitrage opportunity A substantial overhaul ofcurrent strategies would intheendbenecessary. Options that have beenproposed inthis ever againinthefuture. view isthat itwould cruciallyrequire reducing to literally zero thelikelihoodofhitting theeffective lower bound rates reach theireffective lower bound, central banksare, defacto, powerless. The inconvenient truthbehind that really betheonly available tool to achieve price stability. otherwords, In we would conclude that, once interest measures. non-standard policy If measures weremonetary considered to beineffective, theninterest rates would I thinkthat thepositionto take inthisdebate hingesontheassessment oftherecent experience withnon-standard 50 . In my. In view, ontheissueofabolishment ofcash,“a prudent policy-maker cautious would adviseto very be 51 . 49 52 . infavour www.worldcommercereview.com Reserve An interesting alternative proposal hasrecently beenmadeby Bernanke, theformer ofthe Federal chairman much forward look to seeingresearchvery by economists thatwillhelpinformourfuture decisionsonthis.” around theworld inthefuture. policy we questionsfacing And monetary would saythatthisisoneofthemostimportant outside thinking. It’s onethatwe reconsidering willbe atsomefuture time. needsto abalanced be …It assessment. ButI central bankbalance sheetsandthetargeting ofovernight rates, money market for anumberofreasons. canremain effective policy just by goingback to thetraditionalsmall approachdoubtful that monetary of very stressful ofinstruments to situations. addresstoolkit particular Even outsidethosespecialconditions, itissomewhat operations of asset purchases to negative rates, andIamgladthat theynow permanentlybelongto theECB’s I have apositive assessment oftheexperience withnon-standard measures, from large scaleopenmarket central bankinthefuture. and thepublicfrom fullyunderstandingit, whichmay maketheproposal anunrealistic optionto beadopted by a would Iamnotsure difficultiesofimplementingNevertheless, thepolicy prevent whetherthepractical markets the central bankwould continue to target theinflation rate alsofacilitates communication withthepublic. below trend would have to becompensated. Relative to otherproposals, that for thefact mostofthetime, The mainadvantage ofthisproposal isthat communicates itclearly thehorizon over ofinflation whichaperiod objective. high inflation rather thaninflation, andittherefore ensures that any low-inflation episodeis compensated of byaperiod relatively rates effective lower boundisbinding. Underaprice level target, the central bankaims to stabilisetheprice level, 53 . In anutshell,. In theideaisto price switch level to target atemporary episodesinwhichtheinterest during 54 . Outside thezero. Outside lower bound, thecentral bankwould continue to target astandard inflation www.worldcommercereview.com for repo operations againstcash of aprogramme liketheFed’s reverse repo programme (RRP)where itsstock ofgovernment isavailable securities These developments are behind proposals to keep central bank’s balance sheet with significant size to allow the use andthemanagement ofmarkets of collateral.assets that affectsthefunctioning in arbitrage; thegrowing relevanceview ofimperfections ofmarket-based finance; andfinally, thescarcity ofsafe ofabroad rates setofmarket theimportance secured beyond transactions; moneymarket theovernight rate, in Second, changesinthefinancialsystem inthis otherstructural context: theincreased are alsoimportant role of unnecessary. unsuccessful attempts by thefinancialsystem to engineer ‘safer’ private assets, as we saw before thecrisis would be albeit muchsmallerthanthepresent levels creates safe assets. short-term This the would foster financialstability: inEuropean markets.similar pass-through Furthermore, imperfections by keepingasignificant balance sheet, thepass-through tohampering long-term interest from short- rates. Recent internal work at theECBalsodetects interest rates, thereby policy, contributing to abetter transmission inviewofthelimitsto ofmonetary arbitrage represented 37%oftotal debtfinancing(or60%,ifnetofintra-sectoral financing) only 28%oftotal debtfinancing(or45%,ifnetofintra-sectoral Before financing). crisis, the backin2007,bankloans same year, ifonlythestock ofdebtinstruments isconsidered (excluding sources), equity bankloansrepresented just above 12%(or15%,ifintra-company loansandtrade credit are excluded from financing). total external For the in 2007to 44% last year. The percentage ofbankloansinthetotal stock offirms’ financingin2017 was external onset ofthefinancialcrisis. Total assetsofinvestment fundsinpercentage of total bankassetsincreased from 16% There hasbeenadramatic change, asnon-bankfinancingsources have since become the muchmore important First, includingintheeuro hasdeclined ofbanksinfundingnon-financialfirms everywhere, area. theimportance 56 . The programme would beusedto involve andaffectseveral more counterparties 55 . www.worldcommercereview.com needs to bemanagedthrough common decisions. However, instruments indomainsotherthan itlackspowerful Yet, agreat dealstillremains to beachieved. The euro area isahighlyintegrated economic andfinancial area which optimism for theimmediate future. The euro area ismuchmore resilient financialshocks to possible external inflationwith underlying at just1%. The ongoing robust thatrecovery the euro isasourcezone is experiencing of the second halfof2017andtherecent levelsMarch, ofheadlineinflation: 1.4%in following 1.1%in February, accommodation.cautious withdrawal ofmonetary The cautionisjustified by thesubduedinflation dynamicssince These are, however, questionsfor policy. thelong-term future At ofmonetary present, we haveavery started rates transmission. to target to policy ensure aneffective monetary andthechoice for eligibility ofmoneymarket decisionsaboutfuture thecentral counterparty bankwhenmaking demandforsame timeasmarket that collateral hasincreased. Nonetheless, understandingthesedrivers iscrucial discount is, ofcourse, alsoattributed to theAPPwhichhasreduced collateral theavailability ofhighquality at the access to central bankfacilities–are accepting interest rates rate below thedepositfacility intheirrepo activity. The thisdiscount rates. moneymarket isexplainedfor by non-banks’ part, short-term In that –nothaving activities collateral,by highquality have traded several rate, timesbelow theECBdeposit facility sets afloor whichnormally Such aconsideration isnotneutral for rates market intheeuro area. Securedrates, moneymarket whenbacked take aneven greater role uniondeepensandbroadens asthecapitalmarkets in financialmarkets Europe. non-banksareNevertheless, beginning to play agreater role intheEuropean financiallandscape, andare likely to Central bankshave traditionally operations granted exclusively policy access to to monetary credit institutions. targeting abroader setofinterest rates. Another related dimensionrefers to central bankcounterparties. normalisation phase. amuchsmallerbutstillsignificant Maintaining balanceto allow sheetmay benecessary careful arguments thepresentBoth consideration after deserve for policy thedesign offuture monetary 57 . www.worldcommercereview.com market. market. The from influence ECBmadethejourney ofthesimplemonetary acentral bankstillunderthepartial transmission by inthesovereign intervening policy addressing bond theimpairment ofthesinglemonetary From now on,theECBwillhave noexcuse notto fulfil itsmandate, eitherinfighting againstdeflation orin to beusedwhenever toolkit necessary. policy belong now to themonetary crisis. These newunconventional instruments, alongwithforward guidance, negative rates andreverse repos deployment oflarge scaleassetpurchase programmes isthemostrelevant since thefinancial changeobserved policy.have the Likeinotherjurisdictions, how ofmonetary hasaffected described thefinancialcrisis the conduct myIn remarks, Ihave reviewed since theintroduction oftheeuro the different and policy phasesofmonetary Conclusion adjustments. Governments now needto andtakeadvantage institutional act oftheongoingrecovery to makethenecessary require that willthenneed willcertainly thehelpofstrongto beinplace. fiscalpolicy policy point. Monetary episode that inthecontext shouldcomeThis ofarecessionary at some situation isnot sustainable, particularly policy. monetary contributing to economic stabilisation. Until now, theburden ofcountercyclical to stabilisation hasbeenmainlyleft fiscalpolicies to ensureco-ordinated that the stanceoverall issufficiently fiscalpolicy countercyclical, thereby repeated sothat we donotsuffer from avoidable doubledip cycle,recessions.Over thebusiness we alsoneed The creation ofsuchinstruments would mistakesmadein2011-12 alsoensurewould notbe that thefiscalpolicy strong centralised shocks. andsymmetric to deal withasymmetric fiscalstabilisation function policy, rangingmonetary from unionwithaEuropean private inatruecapitalmarkets sharing risk safe asset, to a www.worldcommercereview.com Euro Area: A Case for Monetary Indicators?”,Euro ACase Area: forMonetary NBERWorking Paper No. 8025,publishedlater ofMonetary intheJournal contains future littleinformationabout inflation”.See,Gerlach, SandLEO Svensson (2000), “Money andInflationinthe strategy,6. Already andSvensson inits(ECB)monetary in2000,Gerlach prominent hadconcluded “first pillar” that“the percentages. year-on-year 5. December Economics, ofMonetary EditionHandbook 1,Volume 3,Chapter 22,pp1237-1302. inflation targeting, see Svensson, LEO, (2010),“Inflation Targeting,” BenjaminM in: Michael Friedmanand Woodford (ed.), oftheECB”, policy monetary ECB(2011),“The 4. See third edition,May. For adetailedreview ofthetheoretical features of the 4 Issing,3. See ECB’s O. (2006),“The Policy Strategy: Why didwe Pillar atwo Monetary choose Approach?”, contribution to general way, doctrinal visionoftheway market referring aparticular to about economies asetofbeliefs work. aggregate precisely calibrated to achieve thedesired level ofinflation. The wordbeen usedinamore Monetarismhas 2. Iusetheexpression “technical monetarism” to designate theoperational approach relying onatarget foramonetary strategy” policy instagethree: elementsofthemonetary policy singlemonetary EMI(1997)“The 1. See Endnotes Vítor Constâncio is Vice-President oftheECB effectivemodern, andprepared union.■ central thegoalsofmonetary bank to serve inaworld inwhichmarket-based financestability isever more complexIn sum,theECBisnow anddominant. a for ofprice stability euro areathe priority citizens, whilecontributing to favourable growth conditions andfinancial targeting regimes andassetpurchases asnon-standard measures. istherefore It prepared to continue to deliver on aggregates approach, to usingflexible ofcentral inflation jointhecommunity banksofothermajorjurisdictions th ECBCentral Conference, Banking Frankfurt, November. . www.worldcommercereview.com 16. See Veld,16. See J(2013),“Fiscal consolidations and spillovers andcore”, intheEuro area periphery EUCommission European 117-20. 15. Blanchard, OandDLeigh (2013),“Growth Forecast Errors andFiscal Multipliers”, American Economic Review, 103(3): the Wind”, Economics, ofMonetary 90:193–213. Journal Economic Macroeconomics Journal: 2015,7(1):233–257;Svensson, LEO(2017),“Cost-BenefitAnalysis of Leaning against onStock MarketSome Policy ofMonetary Evidence”, Bubbles: Effects (2015),“The JandLGambetti Galì, 14. See American sponsored by theFederal BankofStLouis. Reserve Household Financial theGreat research after Recession: Why Household Balancesymposium Stability SheetsMatter” 13. Stein, J(2013),“Overheating inCredit Markets: Origins, Measurement, andPolicy Responses”, atthe“Restoring speech area”, Watchers attheECBandIts speech XIXConference, Frankfurt amMain,14March 2018. applied benefits to theeuro area see Constâncio, V(2018),“Financial intheeuro risksandmacroprudentialpolicy stability Analysis of Benefit Leaning againstthe Wind”, Economics,Journal ofMonetary 90:193–213. For a calculation of costs and Framework forComparison ofResults,” International ofCentral Journal 13:385-408.Svensson, Banking LEO(2017),“Cost- 12. Svensson, LEO(2017c),“Leaning Against theWind: Debt, Costs on andBenefits,Effects LeaninginModels,DSGE anda candidate explanations”, mimeoBundesbankandECB. 212-226; Schüler, Y, andIJaccard PHiebert (2017),“Contrastingcycles: and Stylized facts financialandbusiness Rünstler,11. See GandMVlekke (2018),“Business, HousingandCredit Cycles”, Econometrics, ofApplied Journal 33(2): Vol.10. OECDEconomic Outlook, 2005,Issue2. 9. IMFWorld 2005. April Economic Outlook, Grauwe, forinstance De 8. See wolf oneurozone P(2005),“Monetarists cry inflation” 7. Svensson, LEO(2008),“Inflation targeting”, in The New of Economics,PalgraveSecond Edition, 2008. Dictionary euro area M3abandoningus?”. a reassessment”, Banco dePortugal, mimeo, 2004,later developed December into aWorking Paper No. 20,2007“Isthe Economics also, 50(2003)1649-1672.See Alves, NandCRMarques (2004),“Money intheECB’s strategy: policy monetary , Opinion, Financial, Opinion, Times. www.worldcommercereview.com Conference, Frankfurt 2017. amMain25-26September Constâncio, analysis incentral27. See forpolicy models V(2017),“Developing banks”, attheAnnual speech Research 96-42,Board ofGovernorsEconomics Series oftheFederal Discussion System. Reserve 26. Brayton, FandPA Tinsley (1996),“A guideto FRB/US: amacroeconomic oftheUnited model States”, Finance and International Economics RealTime Economic IssuesWatch, 2017. 12January NeedforDifferent ClassesofMacroeconomic Blanchard, Models”,25. See O(2017),“The Peterson Institute for thewholeissueofThe Oxford ReviewofEconomic24. See Policy Volume 34,Issue1-2,Spring-Summer 2018. intheeuro oninequality area”,unconventional policy monetary mimeo, European Central Bank. Economic 22August Lisbon 2017.Basedonwork Association, by Lenza, of effects MandJSlacalek (2017),“The Constâncio,23. See and macroeconomic V(2017),“Inequality policies”, attheAnnual speech Congress oftheEuropean by Jürgen Stark forinstance thearticle 22. See ECB’s assetpurchase programme: anearlyassessment”, ECBWorking Paper 1956. Series the euro area”, ECBWorking Paper No1864;Breckenfelder Fiore, J,FDe PAndrade, PKaradi andOTristani (2016),“The eg.21. See Altavilla,C,GCarboni and RMotto (2015), “Asset purchase programmes andfinancialmarkets: lessonsfrom measures, 2014. policy Frankfurt 6October standard monetary Constâncio,20. See V. (2014),“A newphaseoftheECB’s policy” monetary inwhichadropmodels inconsumer sentimentcan leadto demandshocks. Lorenzoni,19. See G(2009),“A Shocks”, ofDemand Theory American Economic Review, 99:2050–84asanexample of tool: The ECB’s non-standard measures thefinancialcrisis”, after Journal ofInternational Moneyand Finance, 80:15-34. Unconventional Central BankLiquidity”, DandOTristani mimeo;Quint, policy provision (2017),“Liquidity asamonetary forinstance Jasova18. See M,CMendicinoandDSupera (2018),“Rollover andBankLending Risk Evidence Behavior: from consolidation from 2011to 2013:aquantitative assessment”, IMKWorking Paper 156. 17. Rannenberg, andJStrasky, A,CSchoder Union’s macroeconomic ofthe effects European Monetary (2015), “The fiscal Economy Paper, Economic Papers 2013,Table 506,October 5,pages10and11. , former member oftheECBboard., formermember , intervention attheECBworkshop, intervention onnon- www.worldcommercereview.com 40. See European Commission (2014), “The production function methodology forcalculating methodology function production potential growth European rates Commission40. See (2014),“The & ofMoney, intheJournal Working Paper article Credit 1966,forthcoming andBanking. Mand MLenza Jarociński, 39. See (2016),“An inflation-predicting measure oftheoutputgapineuro area,” ECB ofMoney, intheJournal Working Paper article Credit 1966,forthcoming andBanking. MandLenza Jarociński, 38. See (2016),“An inflation-predicting measure oftheoutputgapineuro area,” ECB Disinflation”,Missing American EconomicJournal: Macroeconomics, 7(1):197-232. 37. Coibion, OandYGorodnichenko, (2015),“IsthePhillips Alive Curve andWell andthe All?InflationExpectations after Keynesian Phillips Curve”, ofEconomic Journal Literature 52(1):124-188,March 2014. 36. Mavroeidis, S,MPlagborg-Møller andJStock (2014),“Empirical Evidence intheNew onInflationExpectations Models?”, Paper, CEPRDiscussion July2013. 35. Gürkaynak, RS,BKisacikoglu, DSGE Forecast Models andBRossi(2013),“Do More Accurately thanVAR Out-of-Sample 34. King, Rand MWWatson (2012),“Inflationandunitlabour costs”,Journal ofMoney, Credit andBanking, 44(s2):11-149. Economic Policy Symposium, Federal BankofKansas City. Reserve Constâncio,Policy,” andMonetary 33. See Dynamics V(2015),“Understanding Inflation Annual panel remarks atthe Keynesian Phillips Curve”, Economics, ofMonetary 52:1107-18. Journal andDLópez-Salido (2005),“Robustnessoftheestimates ofthehybrid new J,MGertler 44:195-222; seealsoGalì, astructural (1999),“Inflationdynamics: econometric analysis”, JandMGertler 32. Galì, Economics.Journal ofMonetary Policy andinflationdynamics”, JM(2006),“Monetary Roberts, 31. See InternationalJournal of Central :193-230. Banking Working Paper 19390. isalive Phillips andwell: curve inflationandtheNAIRU duringtheslow Gordon, R(2013),“The recovery”,30. See NBER Economica 78(309):10-50. ofthePhillipsconsensus Curve: andbifurcation”, history theinsightfuldescriptionby Gordon,29. See R(2009),“The Hutchins Center InstitutionWorking atBrookings Paper No.33. 28. For aninsightfulreflection frompolicy-maker, a see ofinflation” withoutatheory policy Tarullo, D(2017), “Monetary www.worldcommercereview.com “The future of monetary policy frameworks” policy 49. For future discussionseeConstâncio, ofmonetary amore V(2017),“The in-depth 069. European Commission48. See (2017),“NAWRU estimationusingstructural market labour indicators”, Paper Discussion cyclical andthefiscal position stance”, Economic 552. Papers European Commission47. See (2015),“Structural unemployment vs. NAWRU: implications fortheassessmentof Commission’s NAIRU estimates”, ICAE, ofLinz,Working University Paper No47. Kapeller, (2016),“What’s ‘structural’ andBSchütz unemployment about inEurope: onthedeterminants of the European that European Commission estimates oftheNAIRU are proxy ofstructural notagood unemployment isHeimberger, P, J Countries”, European Commission Economic Papers 455.Usingabroader setofvariables, thatillustrates anotherpaper 46. This regression approach follows F(2012),“Structural theanalysisinOrlandi, Employment inEU anditsDeterminants formulation anduncertainty”, Federal BankofNewYork. Reserve theimplications ofmodel policy: therole ofNAIRU (1998),“Rethinking 45. Estrella, inMonetary AandFMishkin R Farmer (2002),“Natural rate doubts” ECBWorking Paper 121. Beyer, Q3,pp244-256, 2013;seealsoanearlierpaper Bulletin,September No. 19267andBankofEnglandQuarterly Aand Working Paper 17/14;Farmer, Natural ideapastitssell-by Rate An date”, Hypothesis: R(2013),“The NBERWorking Paper 44. Blanchard, O(2017),“Should we rejectthenatural rate hypothesis?”, Peterson Institute forInternational Economics implications”, policy monetary ECBForum onCentral onInflationandUnemployment Banking in Europe, Sintra 2015. Annual, Vol. 1.andBlanchard, O,two explorations ? ECerutti andtheir andLSummers(2015), “Inflationandactivity 43. Blanchard, OandLSummers(1986),“Hysteresis andtheEuropean Unemployment Problem”, NBERMacroeconomics Perspectives 11:33-49. 42. Staiger, ofEconomic Journal D, andMWWatson policy” JHStock, NAIRU, unemployment andmonetary (1997),“The Paper No. 181. Ciccarelli,41. See (ed) MandCOsbat (2017),“Low inflationintheeuro area: Causes and consequences”,Occasional ECB output gaps”, Economic Papers 535,page7. , lecture atthe www.worldcommercereview.com 57. See Constâncio,57. See V(2017),“Growth, adjustment andresilience intheeuro area”, attheForum Villa d’Este, Cernobbio, 2 presented attheAnnual Economic Policy Symposium, Federal BankofKansasCity. Reserve Greenwood, Federal R,SHanson andJStein (2016), “The Reserve’s balancetool”, sheetasafinancialstability both (2016), Krishnamurthy 56. Duffie, “Pass-through DandA inthe efficiency setting” policy and FED’s newmonetary Parliament, Remarksby Vítor Introductory Constâncio, Vice-President oftheECB, Brussels, 2018. 9April 2017to the Committee Affairs onEconomic presentation ofthe oftheECBAnnualEuropean Report andMonetary 55. See B.E. ofMacroeconomics, Journal 11(1). Working cost channel, Paper indeterminacy, S(2011),“The 818;Schmidt, andprice-level versus inflation stabilization”, The and Banking, 31(3):277-295. Gaspar, V, FSmetsandDVestin forprice (2007),“Isthetimeripe level pathstability?”, ECB 54. Svensson, LEO(1999),“Price-Level Targeting versus Inflation Targeting: A Free Lunch?”,Journal ofMoney, Credit Institute forInternational Economics, 2017. 12-13October 53. Bernanke, Policy inaNewEra”, B(2017),“Monetary conference Macroeconomic onRethinking Policy, Peterson target. 52. 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Svensson, LEO, (2010),“Inflation Targeting,”Benjamin M. in: Michael Friedman and Woodford (ed.), of Handbook www.worldcommercereview.com architecture, would theprovision render ofsafe unnecessary level, combined withanambitiousreform oftheeurozone Grégory Claeys argues thatGrégory soundpolicies at the national Are SBBS really the safe assets intheeuro area viapotentially hazardous SBBSs asset theeuro area is looking for? looking www.worldcommercereview.com T rapidly. status resultedThe lossofthesafe-asset intwo mainproblems: enjoyed thisstatus –butseveral theeuro ofthemlostitduring crisis, andspreads bondsincreased withGerman From unionthrough to thecrisis, theestablishment mostofthebondsfrom ofthemonetary euro area countries finances are considered sound by themarkets. play thisrole, inadvanced countries inparticular, –aslongpublic andsimplicity thanksto theirhighliquidity Several assets canplay sucharole: cash,central bankreserves, bankdeposits, etc. Sovereign also debtsecurities for ameanstolooking invest theirforeign exchange reserves. generally to postcollateral inmany financialoperations; andfrom abroad, from emerging economies market wealth for thefuture; from domesticfinancialinstitutions to satisfy capital requirements, ratios liquidity andmore ( A safe assetisaliquidthat credibly stores adverse during value systemic at alltimes, crises inparticular included inSBBSif, intheend, theyare advantage putat aregulatory vis-à-vis individualbonds. they might changeincentives for governments to default, andtheycould poseaproblem to individualbondsnot Caballero etal.2017). There ishighdemandfor ofasset: from thistype savers inneedofavehicle to store their recession, and to1) thesecountries putinplace lostthepossibility countercyclical fiscalpolicies at low the cost during sovereigns andbanks. Buttheywillnotgive governments ameansto maintainaccess market crises, during a massive scale, theymight increase thesupplyofsafe assetsingoodtimesandloosenthelinkbetween (SBBS).However,bond-backed securities SBBSdonotfullyfulfiltheiroriginal promises.If introduced on he European Commission ispushingto create asynthetic euro area-wide safe assetintheform ofsovereign www.worldcommercereview.com how to create synthetic euro area-wide safe assetshave emerged (seeLeandro andZettelmeyer, 2018 , for agood Given ofsomeeuro theinability area sovereign bondsto play therole ofsafe thecrisis, assetsduring ideason several countries. of thesebonds, having beendrained already by andtheburstofhousingbubblesin theglobalfinancialcrisis 2) thefallinsovereign bondprices putanadditionalstrain onEuropean banksholdingasignificant amount bond markets of the eurozone the of markets bond such a drastic change could entail for the sovereign sovereign the for entail could change drastic a such are afraid of the unintended consequences that that consequences unintended the of afraid are management agencies in many euro area countries countries area euro many in agencies management controversial. Policymakers and public debt debt public and Policymakers controversial. The SBBS idea remains untested and politically politically and untested remains idea SBBS The www.worldcommercereview.com Originally, theESBiesproposal hadthree mainobjectives: to anyresorting mutualisation ofdebtbetween countries. Eurobonds orbluebonds/red andvon bonds(Delpla Weizsacker, 2010)–that itwould create safe assetswithout mezzanine/junior ‘risky’ assets. This hastheadditional(political)advantage over otherproposals –suchas to provide cashflows issuedinseveralfor securities tranches, withdifferent senior seniorities: ‘safe’ assets, and the ECB’s capitalkeys, i.e. more orlessthesize ofeacheconomy intheeuro area) to usethemascollateral and The mainideabehindESBies/SBBSisto poolsovereign bondsfrom to alleuro-area countries (inproportion What are SBBSandwhy would we needthem? strengthen the euro architecture. and 2018b developed inmore detailby theEuropean Systemic Board High-Level Risk Task Force onSafe Assets (ESRB, 2018a sphere.by etal.(2011,2017)–hasrecently Brunnermeier inthepolicy As gainedsometraction aresult, ithasbeen ofthemainproposals).overview The SBBSproposal –originating from theEuropean Safe (‘ESBies’) Bonds proposed banks by providing themwithaneasyway themmore to diversify immuneto theirportfolios, thusmaking thecrisis.loops during Introducing SBBScould helpreduce thedomesticbiasinsovereign bondholdingsof 2) To helpbreak thelinkbetween euro area sovereigns andtheirdomestic banks, which resulted indoom the form ofsenior SBBS. thanks to poolingandtranching, could increase thesupplyagainby offering aeuro area widesafe assetin status thecrisis, during thisreduced significantly of thequantity European safe assetsincirculation. SBBS, 1) To ensure alarge supplyofeuro area safe assets. As somecountries oftheeurozone losttheirsafe-asset ) and is supported by theEuropean) andissupported Commission (2017a,2017band2018),whichseesitasaway to www.worldcommercereview.com to theformer. SBBS over individualbondswould give anincentive to theeuro area’s banksto switch, at leastpartly, from thelatter also becrucialto encourage financialinstitutions to usethemas collateral. Such adrasticadvantage regulatory for A changeintheECB’s refinancing operations and haircut valuation to give apreferential treatment to SBBS would sovereign bondsto more complex SBBS). sovereign bondsasproposed by theCommission might notbesufficient topush investors toswitch from simple aligning treatment theregulatory of individualsovereign ofSBBSwiththat of bondswould bepenalised(just would require significant changessothat SBBS could betreatedregulatory risk-free asa asset, whiletheholding However, even fortwo thefirst objectives to bemet, SBBS would need to beintroduced onamassive scale. This to maintain access market intimesofcrisis. between banksandsovereigns, butitishard to imagine how theywould provide away for euro area governments practice,In itispossiblethat SBBSwould helpincrease thestock ofsupplyfor safe assetsandbreak thelink Would SBSSreally helpachieve thesethree objectives? asymmetric shocks.asymmetric policy,cannot rely on their own independent exchange monetary rate oronafederal budgetto respond to in ordercrisis to be able to put in place countercyclical fiscal policies, which are needed as euro area countries the worst moment. unionmaintainaccess SBBScould market helpcountries intimesof from themonetary 3) To avoid intra-euro area flights to safety crises, during which reduce thefiscalspace ofsome countries at ofsafetype assetavailable savers) to ordinary safer thebanks, by issuersofthesedeposits, making safer. oftheirsovereign.the defaultrisk An additionaladvantage isthat itwould alsomakebankdeposits(another www.worldcommercereview.com by flights to safety butalso to flights tosimplicity. Asthefinancialpanicof2007 showed, runsonasset-backed instress correctly assurance periods. that inSBBSwillfunction themarket These episodesare characterised often than someofthecollateralised debtobligations (CDOs) produced before theglobalfinancialcrisis. Butthisisnotan the low level istruethat SBBSwould oftheseassets. ofcomplexity andtransparency belesscomplex It andrisky Proponents ofSBBSargue that there would be investors interested inbuying bothseniorandjuniortranches, given stress periods. junior SBBSinbadtimeswould become crucialasthiswould ofissuingany limitthepossibility SBBSat allduring of countries access losingmarket willnotbeincludedinthepooling. Second, for othercountries, findingbuyers for to rely afalsepromise, oninbadtimes–thisisclearly for two reasons. First, theESRBinsiststhat sovereign bonds Turning to thethird of SBBS–to objective offer aflow of ‘safe liabilities’ (asput byCoeuré, 2017)for governments become morebonds could actually problematic. As treatment theregulatory would have changed, puttingthemat adisadvantage againstSBBS,fundingfor these Spanish, Belgian, French, Portuguese, Austrian andotherbondsfrom theEMUthat would notbeincludedinSBBS. some point andDutch by levels German ofdebt. This meansthat there would beasignificantItalian, share of themaximumissuancedeviate ofSBBS from wouldbe quickly), constrained theofficialECBcapitakeys at very countries likeLuxembourg ratios orEstonia, whichhave (andwhichwould low debt-to-GDP force very SBBSto The issuance ofSBBSwould beconstrained by lower debtlevels prevailing insomecountries. Putting aside would highto have needto bevery on banks’ asignificant impact balance sheets. However, theextent to whichthisprobability would bereduced would dependonthedevelopment ofSBBS. This This would result insomediversification and thus reduce oftheirportfolios theprobability ofadoomloop. www.worldcommercereview.com increasing. That iswhy theuseofhistorical data inSBBSsimulations isgenerally hard to justify. with modifiedincentives related risk ofdefaulton to theintroduction ofSBBS, the European debts could endup countries oftheeuro area (Germany, France, andSpain),thanksto theuseofECBcapitalkeys weights Italy –and Coupled withthelow diversification being invested ofSBBS–almost80%portfolios inthe four biggest instress times.quickly Star Movement –correlations between sovereign bondprices of theeuro area have to increase hadatendency and Portugal, following theannouncement ofthecoalition agreement between inItaly The League andtheFive introducing SBBS.As highlighted by Grauwe De andJi(2018) –butalsoby therecent increase inspreads inSpain additionto notfulfillingoneofitsmainobjectives,In there could beotherunintended consequences of not entailany built-inpromise to offerastablesource offinance for governments duringacrisis” . Caballero etal.(2017)putit, which would notbe thecasewithSBBS. That’s why theESRBconcludes that “SBBS do role ofsafe assets, needto securities beinformation-insensitive –ie. theyneedto be“simple incomplex times”, as This isanissue because, inafinancial crisis, even abitof canmaketheseassetsvulnerable.complexity To play the lowermarket, liquidity, andlesstransparency. matters worse by creating ofSBBSwithdifferent avariety compositions, resulting inthelackofahomogenous (whether becausetheyare access losing market or, onthecontrary, becausetheirdebtistoo low) would make froze completely. The samecould addition,theideato happento exclude SBBS.In somecountries from thepool This general panicaboutABSmadenewissuances impossibleeven for markets simpleproducts, whilesecondary ( (ABS)securities were indiscriminate, anddependedneitherontheircomplexity norontheirintrinsicperformance Covitz etal.2009). www.worldcommercereview.com sovereign credit defaultswaps (CDS) oftheCDSislow). risk for instance (aslongasthecounterparty tranches ofSBBS,butthesamewould betrueiftheywould hedgethemselves againstsovereign defaultby buying for banksifthey onlyholdsenior istrue that SBBS,in additionto diversification,It also result insomede-risking by themselves. not indispensablefor concentration this task; charges, asproposed by aslongbanksareInsurance Scheme biasedintheirexposures towards theirown sovereigns). However, SBBSare union from (becausesomecountries apoliticalperspective willbereluctant to accept aEuropean Deposit se inorder to share between countries, risk to avoid doom loopsituations, andto beablecomplete thebanking course,Of even are ifotherobjectives notfulfilled, thediversification ofeuro area banks’ isdesirable per portfolios become illiquidassets). could bevulnerable to panicsdueto their(even limited) complexity, could markets freeze andSBBScould quickly times,crisis nordo theyincrease theflow ofnewsafe assets to whichinvestors could turn to inbadtimes(asSBBS sovereigns. However, SBBSdonotseemto provide agreater for possibility governments to finance themselves in good times–whichcould appearto beagoodthing, asitwould helpthemdiversify away from theirdomestic Overall, SBBScould leadto anincrease inthestock ofEuropean safe for assets, available banksduring inparticular introduction. SBBS are not“build to fail” ora“precursor to debtrestructuring”, incentives to defaultmight beaffected by their the goalsintended) and countries might have anincentive to defaultmore Although theESRBinsiststhat often. abroad by (whichisoneof non-systemic sector institutions, thedomesticbanking adefaultwould notimpact changes.regulatory For instance, ifdomesticbanksonlyholdseniorSBBSand, ifthejuniorSBBSwere onlyheld Indeed, theincentives ofgovernments to defaultcould becompletely altered by theintroduction ofSBBSand Véron (2017),shouldbeableto play that role www.worldcommercereview.com This article was originallypublished onBruegel This article ClaeysGrégory isaResearch Fellow at Bruegel hazardous SBBSs. ■ eurozone architecture. This would theprovision render ofsafe unnecessary assetsintheeuro area viapotentially times. This canbeachieved through soundpoliciesat thenational level, combined withanambitiousreform ofthe the mostdesirable way to increase thesupplyofsafe assetsandavoid intra-euro area flights to safety bad during inthecurrentdistraction debate. alleuro area Instead, making sovereign bondssafe again–andfor good– remains Moreover, asargued inanotherpost unintended consequences that suchadrastic changecould entail for thesovereign oftheeurozone. bondmarkets controversial. Policymakers andpublicdebtmanagement agenciesinmany euro area countries are afraid ofthe can contribute to diversify butfaces risks numerous drawbacks. The SBBSidearemains untested andpolitically The keyto beconsidered asafe assetis, ofcourse, policy. soundfiscalandstructural Apoolofeuro area bonds Conclusions ESRB) might nothave thisproperty. sell theirbondsto investors at alltimes. However, asdiscussedabove, SBBS (at least intheversion proposed by the introduce concentration charges ontheirbanks’ that theycould rely portfolios onthisnewinstrument to beableto The proposal from theCommission to pursueSBBScould beseenasaway to convince countries reluctant to , themostcompelling argument againstSBBSisthat theyrepresent a www.worldcommercereview.com phase. George Papaconstantinou attempts a ‘what if’ experiment The policy discussion oneuro areaThe policy reform hasentered acritical based ontheproposals intherecent CEPRPolicy Insight assessing proposals for A ‘what if’ approach to euro area reform www.worldcommercereview.com T reform proposals already implemented before theeuro area onpreventing crisis outbreak thecrisis ormitigating it context ofa ‘what if’ counterfactual. This ofhaving etal.’s consists Bénassy-Quére ex ofexploring posttheimpact As acontribution to thedebate engendered by etal.,Iwould Bénassy-Quére liketo offer somethoughts inthe political climate would seemto bebeyond reach. an acceptable compromise. Andor etal.(2018)instead sketch outabolderandbroader that direction inthecurrent attempt to influence debate theongoing oneuro areaFranco-German reform by presenting what could constitute mistake to settlefor marginal changes. Where theydiffer isintheirscope andintent. etal.explicitlyBénassy-Quére addressed to date.partly And bothbelieve notonlythat thestatus quoisnottenable but alsothat itwould be a point to oftheeuro bothisthebuilt-in institutional weaknesses area andtherecognition that thesehave beenonly These two contributions share anumberofcommon views onthestate ofaffairsandthe way forward. The starting democratic renewal oftheEurozone (Andor etal.2018). backgrounds,economists withdiverse academicandpolicy anopinionpiece Ico-signed onaBlueprintfor institutionally withitsown ‘roadmap’ proposals. to thePolicy together Insight, withanumberofother Reacting contribution to thediscussionwhichEuropean isanimportant off Commissional. 2018)standsout. It kicked Among these, therecent important. discussion have et CEPRPolicy (Bénassy-Quére become Insight particularly discussiononeuro areaThe policy reform hasentered phase, acritical andanalyticalcontributions informing that ormitigatingof thecrisis itonce itwas underway. been implemented at andexamines theirpotential theoutset ofthecrisis role inpreventing theoutbreak FocusingInsight. caseofsuchproposals ontheGreek having case, already itlooksat thecounterfactual on euro area reform, attempts a ‘what if’ experiment basedonthe proposals intherecent CEPRPolicy discussiononeuro areahe policy reform hasentered phase. acritical ofthe This column, part VoxEU debate www.worldcommercereview.com conclusions on the adequacy ofpreventiveconclusions ontheadequacy andstabilisation mechanisms inplace. had to rely loans onemergency oftheGreekcharacteristics are crisis notrepresentative orfullyreplicated intheothereuro area countries which once itwas underway. point IwilltaketheGreek andasmainfocus, caseasmy that the starting infullknowledge systemic in nature in systemic avoid the Greek crisis spreading and becoming becoming and spreading crisis Greek the avoid et al et Bénassy-Quére in proposals Turning to the final issue of contagion, many of the the of many contagion, of issue final the to Turning 1 . Nevertheless, itisby. Nevertheless, examining theoutlierGreek casethat onecanbestdraw . would have helped helped have would . www.worldcommercereview.com rules ofthepreventive andGrowth oftheStability arm Pact (SGP)failedto properly monitor. This assumeseffective targetterm debtreduction could have avoided increase thesharp inexpenditures ofthe2005-8 period, whichthe definitive answer to thisquestionisobviously impossible. But following asimple expenditure ruleguided by along- Would prevention thecrisis proposals etal.(2018)have inBénassy-Quére helpedGreece avoid thisoutcome? A financing became gradually more expensive, leading creationto theinextremis ofthebailoutarrangements. in understandingthat inthecaseofGreece, were markets effectivelyfor aguarantee looking Market ofnodefault. exacerbatedThe by situation was thelongdelay further ofEUcountries months andinstitutionsintheearly of2010 government. figures pronouncements of correctivewere policy severelyby thenewGreek mademarkets wary underreported account. deficitinthe external At thesametime, the 15% ofGDPandadouble-digit realisation that thedeficit deficit, andoneofdeficit, wasrunningapublicdeficit an confidence.inexternal In2009,the country excessof withtheinitialtrigger,Starting at theroot oftheGreek economic deficit:afiscal andfinancialcrisis was atriple worse thanitcould have been;and(iii)allowed contagion to othereuro area countries. different proposed which(i)triggered (ii)madeit reforms thecrisis; etal.(2018)onthefactors Bénassy-Quére in IwillofferNevertheless, onthe some reflections of’ ‘what ofthe atthepotential question impact bylooking proposals.result ofhaving policy implemented certain historical eventsactual whichwould arguably nothaveenvironment happenedinapolicy vastly different asa setup additionto from theinfluenceIn isinseparating oftheinevitablehindsight, onedifficulty the counterfactual are by natureCounterfactuals difficult tosketch outandespeciallydifficult to interpret in order to draw conclusions. www.worldcommercereview.com would andlesssevere have anearlier observed anESMprogramme debtcrisis, triggering withhigherchances of If, however, thegovernment had ignored theexpenditure rulebuthadstillissuedjunior bonds, hebelieves one been averted. Greece’s fiscalbalance in2009 would have beenpositive, asopposed to a15%deficit;hencecrisis the would have the rainy day fund. Herunssimulations andconcludes that ifthegovernment hadfollowed theexpenditure rule, union,sovereignbanking concentration charges, theregime for debtrestructuring, easyaccess to ESMliquidity, ‘counterfactual’ for Greece, assumingallrecommendations hadbeeninplace by 2001:theexpenditure rule, anunpublishedcompanion noteIn etal.(2018),Jeromin to Bénassy-Quére Zettelmeyer attempts sucha andtheIMF.partners tempered thecontinuous jog’‘bank 2010whichprecipitated ofearly theneedfor financingfrom Greece’s EU thecrisis. theirpositionduring Simultaneously,undermined acommon depositinsurance would have at least testmarket whenissuingdebtandthereby reduced thelarge exposure ofGreek banksto thesovereign, which introduction ofsovereign concentration charges for bankswould have to effectively acted introduce atighter Similarly, system whichroutinely initspublicdebt-financing useditsdomesticbanking exercise, inacountry the when assessingtheGreek situation. that ofthepoliticaldecisionmakerwould alsohave addedto thecredibility ofEUinstitutionsvis-à-vis themarkets financing market could have been avoided.Separating the role ofanindependent fiscal watchdog atEUlevel from deficitdata which contributed andactual between reported to thelossof suchasituation, thehugediscrepancy In level institution, providing theearly-warning inpractice. signs whicheludedCommission services monitoring, withtheproposed independent national fiscal watchdog, by anindependent euro area- supervised www.worldcommercereview.com action ondebt restructuring action political realities amongsteuro area countries thantheresult ofrobust economic design, to thedelay intaking andinternal.both external The former stretch from aninitialprogramme design whichwas more achildof At thesametime, thetwo additionalprogrammes theinitial2010bailoutare after testimony to offailures, aseries account theadverse initialconditions. cumulative drop inreal isfarinexcess thisperiod GDPduring ofwhat shouldhave beennecessary, into even taking account,balance theexternal would underany circumstances causeasteep recession; however, thealmost30% economicenormous andsocialcost. The drastic fiscal consolidation, together withtheinternal devaluation to Passing from prevention to mitigation, itisclearthat once intheassistance programme, Greece suffered an aversion result could alsohave beentheoutcome in Greece. the monitoring tools inplace at thetimemore effectively, itisnotunreasonable to suggestthat thesamecrisis- the decadeleadingto thecrisis. Had thegovernment simplyfollowed theSGPrules, withtheEUinstitutionsusing This would berelevant injudging theeffectiveness ofthe expenditure rule versus simply following the SGPrulesin institutional framework at thetime? And shouldthenonenotalsocompare sucha ‘what if’ withthealternative offullimplementation oftheexisting in terms ofhow muchoftheinitialenvironment theyassumeto bealtered by ‘full implementation’ oftheproposals. These conclusions are reasonable; theypoint however especially to theinherent ofsuch counterfactuals, difficulty in 2012,againwithhigherchances ofsuccess. there would likelyhave beenabailoutin2010,butoncondition ofdebtreprofiling, followed by debt restructuring success. Finally, iftheGreek government haddisregarded boththeexpenditure ruleandthejuniorbondissue, 2 . implementationThe deficit, latter the or includesanimportant result oftheinability www.worldcommercereview.com debt restructuring ofGreekdebt restructuring officialdebt. they beeninplace at thetime, would have helpedeuro area countries arrive faster at decisionsontheinevitable bonds, andFrench butalsoGerman ones), together with better stabilisation tools and aeuro area safe asset, had banks’Reducing exposure to anindividual sovereign (notonlyGreek banksinthecaseofgovernment-guaranteed through conditional lending. crisis adjustment costs. istheframework involving It sovereign-debt cannotberestored whensolvency restructuring theproposals etal.(2018),however, inBénassy-Quére Of onehasahighrelevance to mitigating someofthe systems andinfrastructure could have madeadifference. competitiveness example andinstitutionalchallenges. where investments Greece isaperfect ineducation, legal are proposalsEqually important for anew form ofcohesion andconvergence for countries policy with shocks, suchasa euro area-level unemployment insurance scheme, inthisrespect. are important recognising Proposals oftheseaspects. theimportance for astronger macro stabilisation intheevent ofextreme The second ofthetwo contributions referred to inthebeginning ofthispiece (Andor etal.2018)comes closerto inpopulism. and rise the economic downturn isnotconverted into aneconomic andsocialcollapse, withtheassociated politicalfallout required politicaleconomy discussionwhichshouldhave accompanied thebailoutarrangements to ensure that The proposals etal.(2018)donotaddress inBénassy-Quére issuesofprogramme the design, orequallyimportantly reforms.necessary unwillingness ofsuccessive Greek governments andoftheentire Greek politicalsystem to takeownership ofthe www.worldcommercereview.com Deauville Deauville ‘walk onthebeach’, whicheffectively precipitatedIreland and into assistance programmesPortugal implemented’, theywould have 2010 rendered thedecisionstakenat indeedinprinciple theOctober unnecessary Conversely, itisharder to state ofthesovereign-debt definitively proposals. theimpact restructuring ‘Fully had theybeeninplace thecrisis, during would have contributed to financialstability. large economic disruptions, oraeuro area safe assetoffering investors analternative to national sovereign bonds, avoid theGreek spreading crisis andbecoming systemic innature. Aeuro area fundassistingcountries to absorb Turning to thefinalissueof contagion, many oftheproposals etal.(2018)wouldBénassy-Quére in have helped impossibleandrendering the2012assistance programme unavoidable.re-entry redemption”, butonedriven by creditors rather thanGreece market –weighed ontheadjustmentbymaking effort The two-year delay inexecuting theprivate involvement sector etal.calla“gamble –what Bénassy-Quére of robust system. place whentheGreek woes triggered thebroader euro area crisis, theywould undoubtedly have madefor amore between politicsandeconomics whichhasalways attempts characterised to reform theeuro area. Hadthey beenin conclusion, theproposals etal . (2018)areIn inBénassy-Quére awelcome contribution to that delicate dance forcein fact itsbroader thanintended use. difficultacting asastabilisation togaugewhether mechanism,the existence rather than ofthemechanism would mechanism could instead well have to ledmarkets assumethat Greece was simplythefirstofmany Itis to fall. muchbe would situationssustainability insuchcrisis very ‘in theeye ofthebeholder’. The mere existence ofthe environment, vulnerable to pressures thepoliticalandmarket ofthemoment. Even withoutDeauville, debt Full implementation, however, isnotnecessarily theright yardstick; we are implementation always inapartial 3 . www.worldcommercereview.com Independent EvaluationIndependent (2016),The IMFandtheCrisesinGreece, Office Ireland, Evaluation An andPortugal: by the constructive approach to euro area reform” Rey, ISchnabel, NVéron, BWeder diMauro, andJZettelmeyer (2018),“Reconciling risksharingwithmarket discipline:A A,MBrunnermeier,Bénassy-Quéré, HEnderlein, EFarhi, MFratzscher, CFuest, JPisani-Ferry, Gourinchas, P-O PMartin, H Andor, Letal.(2018), “Blueprintforademocratic renewal oftheEurozone” References assistance programmes. For amore skeptical viewonthis, (2014). seeMody private creditors, andasaresult drove spreads higher, arguably forcing andIreland thehandofPortugal inrequesting decision”3. The “Deauville preannounced thatinfuture, sovereign bailoutswould require on imposed thatlossesbe attempted to provide Evaluation analysis;seeIndependent anexpost (2016). Office thisisbroadly2. While recognised by academics andpolicy-makers alike, theIMFis oneoftherare institutionsthathas 1. For aninsider’s account oftheGreek crisis, seePapaconstantinou (2016). Endnotes Transnational Governance oftheEuropean University Institute George Papaconstantinou isaformer Greek Finance Professor andpart-time Minister at of theSchool outcome, thedefiningdifference may lie in thepolitical economy ofthesituation. ■ mitigated itsimpact. tools inplaceThe at any policy given moment are obviously butfor critical; theeventual isunclear,It however, whetherby themselves theycould have avoided theoutbreak orseriously ofthecrisis , CEPRPolicy InsightNo. 91. , Politico, 2February. www.worldcommercereview.com VoxEU.org This intheVoxEU column isaleadcommentary “Euro Debate Reform.” Area was originallypublishedon This article Papaconstantinou, oftheGreek Crisis”, –The InsideStory G(2016),“Game Over Papadopoulos Publishing. Mody, ghostofDeauville” A(2014),“The EvaluationIndependent Office , Washington DC. , VoxEU.org, 7January. www.worldcommercereview.com Jérémie Cohen-Setton andShahin Vallee write that the recent CEPR Policy Insight missed an opportunity to recent CEPR Policy missedanopportunity Insight cannot ignore the Euro area reform monetary realm monetary provide abalanced reform package www.worldcommercereview.com T In ourview,In thefollowing four shouldguidesuchrethinking: principles Principles for improving the Eurosystem improve inareformed function EMU. thelenderoflastresort (Farhisurprising 2018).Butthere should bebroad agreement andMartin aboutways onsomebasicprinciples to have different andtheirpreferred views policy ontheappropriate choice ofinstruments stance isnot ofmonetary the role oftheECBandnational central banksintheprovision whenneeded. ofliquidity That 14economists would from crises”risks connected theauthors’ andcredibility (Butietal.2018)results to acute liquidity inpart silence on The viewthat theproposals etal.(2018)would inBénassy-Quéré increase rather thandecrease “redenomination outside ofdebates aboutthefuture architecture ofEMU. provision.but alsoenhance liquidity The responsibilities andoperating procedures oftheEurosystem cannotstay to provide abalanced reform thatan opportunity would notonlyincrease package risk sharing, fiscaldisciplineand members. Butby refusing to complement theirproposals realm, withrecommendations theymiss inthemonetary alternative anchorthanthecurrent system offiscalrulesandfinancialpenalties todisciplinefiscallywayward The etal.2018)are authorsofCEPRPolicy 91(Bénassy-Quéré right to Insight argue that theeuro area needsan reform that would notonlyincrease package risk sharing, fiscaldisciplineand provision. butalsoenhance liquidity recommendations in the monetary realm, the authors have missed an opportunity to realm, providerecommendations theauthorshave abalanced inthemonetary missedanopportunity of the VoxEU debate oneuro area reform, argues that by not complementing theirproposals with system offiscalrulesandfinancialpenalties to disciplinefiscallywayward members.part This column, he authorsoftherecent CEPRPolicy argue Insight that theeuro area needsanalternative to thecurrent www.worldcommercereview.com analysis, whichwould bedoneby theESM,to ofgovernment determine eligibility bondsinrefinancing operations. delays anduncertainty. (2018)recently Claeys andGoncalves Raposo proposed relying onadebtsustainability ECB, dominance. itisshared itcreates If between several ofmonetary arisk institutions, itcreates ofindecision, risks thisjudgement iscompletely toIf governments, left itcreates offiscaldominance. arisk If itis completelyto the left necessarily requires drawing andsolvency. adifficultlinebetween liquidity Monetary of Outright conditionalTransactions onaEuropean (ESM)programme Mechanism Stability – (OMT) foran unconditional solvent lenderoflastresort governments theactivation 2014) –instead (Mody ofmaking considers that panicked investors are threatening (Eichengreen the integrity ofthesinglecurrency 2016).Being The central ableto union shouldbe backstop financialmarkets bankofamonetary insovereignbonds ifit with fiscal and political authorities political and fiscal with conduct of monetary operations and its interactions interactions its and operations monetary of conduct monetary union without profound reforms in the the in reforms profound without union monetary There can be no such thing as the completion of the the of completion the as thing such no be can There www.worldcommercereview.com remove theECBfrom canbeinterpreted apositionwhere itsactions asattempts to disciplinegovernments OMT. Butoptionsalongtheselinesshouldbeexplored to improve ofthesovereign predictability backstop andto Under thecurrent intergovernmental oftheESMwithunanimity, structure thisapproach seemsunsuitablefor political support of the monetary authority. ofthemonetary political support matter notbecausethenotionofcentral makessense, banksolvency butbecausetheyreveal thesovereign’s andthepotential associated risks actions withthem. This would makeclearthat recapitalisation arrangements Alternatively, itcould bereplaced by amore from blanketstatement European ofsupport governments for ECB the fiscalauthority. replaced by aFiscal suggested Carveout,as by Tucker (2018),whichwould specifyhow losseswould becovered by . functions lender oflastresort The onfinancialindependence shouldbe currentrevised and ECBdoctrine Balance sheetconsiderations shouldnotconstrain acentral bank’s and itsmonetary to ability perform 1999). [national central bank]would reluctantto be buildupclaimsindefinitely onsomeothernational central (Kenen bank” effectiveness andincreased redenominationrisks by suggestingthat there could be“conditions […]inwhichone Purchase Program) istroubling andshouldberemoved. The renationalisation ofthesepolicieshaslimited their framework (Additional assetpurchases Credit programme Claims),anditsmostimportant (thePublic-Sector ofitscollateral Assistance),governing Liquidity someaspects (Emergency theprovision liquidity ofemergency (Draghi, 2018)stillexist intherisk-sharing arrangements oftheEurosystem policy” national sovereignty inmonetary operations andliquidity fullycentralised shouldbe policy andmutualised.ThatMonetary “remnant[s] of 1 . www.worldcommercereview.com to banks[…][but]there theirmember isdefinitely anobligationonthe FederalGovernment to reimburse the12 regional thewordsIn ofPresident Franklin DRoosevelt, “it [was] madeby inevitablethatsomelossesmaybe theFRBsinloans but by theUS respective districts Treasury. losses–would1933 that nothave FRBs–iffaced withimportant to berecapitalised by thememberbanksoftheir unifiedwhenthe 12 individualbalance sheetsonlybecamedefacto federal government eventually in clarified operations did notoccur automatically. what was stilladecentralised fact, In system ofregional central bankswith (FRBs) owned by commercial banksintheirrespective risk-sharing ofprofits districts, andlosses linked to monetary theFederalBecause of1913created Act Reserve adecentralised system of12regional Federal Banks Reserve failures becameobvious the Great during Depression. oftheUSFederal System,history Reserve whoseinitialdesign was alsoproblematic andwas onlycorrected its after As we argue inarecent paper(Cohen-Setton and Vallée lessonsfrom draw the 2018),theseprinciples onimportant How theGreat Depression changedtheFederal System Reserve decisions.eligibility problems ex ante would rather thanex alsohelpavoid post. It politicisedinits oftheECBappearing therisk A more robust, andcountercyclical predictable framework could, however, bedesigned to dealwiththese haircuts, andexpanding thecollateral pool(Cohen-Setton etal.2013, Wolff 2014). of itscollateral relaxed theECB hasoften framework, theseconstraints ex postby introducing waivers, lowering that have beendestabilising(Claeys 2018). andGoncalves Raposo To counter someofthebuilt-in procyclicality private credit-rating agenciesto andhaircuts. determine eligibility This reliance has ledto abruptswingsinhaircuts The operational framework shouldnotreinforce. Since loops doom 2005, theECBhasrelied onratings madeby www.worldcommercereview.com provide somelevel ofbackstop to thesovereign bondmarket. movedclearly somedistance andto to complement function itsframework andenhance itslender-of-last-resort The initialdesign oftheEurosystem isstronger thanthat oftheinitialFederal System. Reserve The ECBhasalso Governors oftheFederal System Reserve 1937). decreasingmay be because ofadownward turninthenation’s businessandadecrease inthenationalincome” (Board of a newregulation specifyingthat credit beinstead liberally extended “at times whenthevalue ofassetsheldby banks excess collateral” 1960)againstthedeterioration ofeconomic (McKinney activity, theFederal Board adopted Reserve Recognising, for example, theprocyclical biasofacollateral framework that “require[ed] substantialamountsof transforming theFederal into afully-fledged lenderoflast Reserve resort. Together withtheseinstitutionalchanges, technical improvements initsoperational framework were in alsocritical and itssovereign was clarified, did regional considerations eventually becamesubordinated to national ones. Only when regional monetary autonomyOnly whenregional was eliminated monetary state bankholidays 1987). that Holiday culminated (Wigmore withtheNational Banking refusing theNew York Fed’s request to rediscount government securities, theChicagoFed precipitated acascadeof attack againsttheNew York Fed’s hadledto ofitsgoldratio goldreserves areduction towards limit. In thestatutory uncooperative mannersto protect theirown leading(Eichengreen 1933,aspeculative reserves early 1992).In thepreceding fact, weeksIn hadillustrated theextent to whichautonomous regional FRBscould behave in shall asktheCongress to indemnifyany ofthe12FRBsforsuchlosses” (Silber2009). FRBs forlosseswhichtheymaymake powers. onloans madeundertheseemergency Idonothesitate to assure you thatI 2 , and when the compact between thecentral, andwhenthecompact bank www.worldcommercereview.com 25 April. Buti, M,GGiudice, andJLeandro EMU Requires aCoherent (2018),“Deepening andWell Package” Sequenced 15-17. Bulletin,October: Reserve Board ofGovernors oftheFederal System Reserve (1937),“RegulationonDiscounts, by Federal Banks” Reserve constructive approach to euro area reform” Rey, ISchnabel, NVéron, BWeder diMauro, andJZettelmeyer (2018),“Reconciling risk sharingwithmarket discipline:A A,MBrunnermeier,Bénassy-Quéré, HEnderlein,EFarhi, MFratzscher, CFuest, JPisani-Ferry, Gourinchas, P-O PMartin, H References market inopen policies. operations andintheirlenderoflastresort participating reforms oftheFed 1913andtheNewDeal 2. Between regional Feds enjoyed autonomy insettingdiscount rates, in 1. For introika thissamereason, we programmes. thinkthattheECBshouldnolongerparticipate Endnotes Shahin Vallee isaPhD candidate at theLSEEuropean Institute Jérémie Cohen-Setton is a Research Fellow at the Peterson Institute for International Economics, and operations anditsinteractions withfiscalandpoliticalauthorities. ■ monetary unionwithoutprofoundThere canbenosuchthingasthecompletion reforms ofthemonetary of intheconduct thatnew institutionalrisks needto beaddressed inthecontext ofreforms ofthearchitecture oftheeuro area. Yet thisremains incomplete andtherenationalisation ofitsoperational framework ofsomeaspects have generated , CEPRPolicy Insight No. 91. , VoxEU.org, , Federal www.worldcommercereview.com 739–55. Wigmore, (1987),“Was theBankHolidayof1933Caused BA by aRun ontheDollar?”, 47(3): ofEconomic Journal History May. Tucker, political economic ofthecentral P(2016),“The bank balance sheetmanagement”, atColumbia Speech University, Tucker, Power, P(2018),Unelected Princeton Press. University FDR’s Did Silber, (2009),“Why WS BankHolidaySucceed?”, Economic Policy Review15(1). McKinney, GW(1960),The Federal Discount Window: Administration Reserve intheFifth Rutgers Press. University District, forEMU.Eastern Outlook Economic Journal”,Kenen, PB(1999),“The Eastern Economic 25(1):109-115. Association RoleoftheECBinReformProposalsFarhi, inCEPRPolicy Insight91”, (2018),“The E, and PMartin VoxEU, 19April. Approaches, BBVA Group. European Central FromEichengreen, B(2016),“The Bank: Problem to Solution”, forEurope: inThe Search Contrasting from theU.S.,Cambridge Press. University System”,Reserve inMBCanzoneri, VGrilli,andPRMasson(eds), EstablishingaCentral IssuesinEurope andLessons Bank: aCentralEichengreen, B(1992),“Designing Tale Bank forEurope: ACautionary from The Early Years oftheFederal Mody, ECB’s A(2014),“The BridgeToo Far”, Project Syndicate, 11February. Dialogue Draghi, M(2018), Committee Affairs onEconomic Monetary andMonetary EuropeanDeGrauwe, Central P(2011),“The BankasaLender ofLast Resort” ECB Watchers, 24July. Cohen-Setton, J,EMonnetandSVallée theECBcollateral (2013),“Deconstructing framework: assessmentandoutlook” to theEuropean Commission. Report andtheEuropean CentralReserve Bank” Cohen-Setton, J,andSVallée (2018),“Federalizing aCentral AComparative Bank: StudyoftheEarly Years oftheFederal SovereignArea Bonds?” Claeys, GandIGoncalves Raposo (2018),“IstheECBCollateral Framework StatusofEuro- Compormising theSafe-Asset , BruegelBlog, 8June. , inJFKirkegaard andASPosen (eds), Lessons forEUIntegration from US History, , VoxEU.org, 18August. , European Parliament, 26February. , www.worldcommercereview.com VoxEU.org This intheVoxEU column isaleadcommentary “Euro Debate Reform.” Area was originallypublishedon This article Authors’ note: theauthorsthankMadonaDevasahayam, Adam Posen, andJeromin Zettelmeyer forusefulfeedback. 204/14. Wolff, GB(2014),“Eurosystem Collateral and Policy Framework: Was itUndulyChanged?”, Bruegel Contribution Policy www.worldcommercereview.com When thinking aboutwhat and willdetermine theprosperity When thinking central. Guntram Wolff Insightconsiders theCEPR and Policy well-being ofcitizens living intheeuro area, five issuesare Europe needsabroader argues that itleaves asidesomeofthemostcrucial ones discussion ofitsfuture www.worldcommercereview.com W many years to come. necessary, unemployment willbehigherandhysteresis canlower effectsinlabourmarkets growth potential for a proper macroeconomic stabilisation. Without proper macroeconomic policy, recessions willbedeeperthan hitsthezero lower policy inensuring bound, becomesthat more whenmonetary the role important offiscalpolicy tofor theeuro runasensiblefiscalpolicy areaIt is asa whole.well establishedinstandard macroeconomic models macroeconomic ofthe euroOne ofthekeyreasons area for performance hasbeenitsinability thedissatisfactory bound 2. Ensuringthat stance thefiscal of theeuro is at the zone isappropriatepolicy zero lower whenmonetary stage don’tbut unfortunately pursue. To my mind, thepoliticaldebate rightlyputsastrong focus ontheseissues at this Moreover, play publicgoodsoften arole inmacroeconomic etal.acknowledge stabilisation asBénassy-Quéré depends onthem.And withoutpoliticalcohesiveness, thefoundations oftheeuro willbemore fragile thanever. One may argue that suchpublicgoodsare to connected notdirectly theeuro. Yet, politicalcohesiveness crucially thought leadership. areMarket topics lacking often protection, fundimmigration, how to dividenational andEuropean competences orhow to advance theSingle will provide European publicgoods. Yet How to provide thedebate superficial. ontheseissuesisoften border The well-being ofcitizens willdependonwhetherEuropean institutions, together withnational institutions, 1. Providing adequate publicgoods 1 . contribution to two ofthembutIfindit overall unbalanced. Let metakethefive issuesinturn. area, five issuesare central. etal.2018)makesanimportant paper(Bénassy-Quéré The Franco-German aboutwhat andwell-being willdetermine theprosperity ofcitizenshen thinking livinginthe euro www.worldcommercereview.com fiscal space when monetary policy is at the zero policy lowerfiscal space bound when monetary (Claeys etal.2016). debate. For example, onecould propose to amendtheexpenditure ruleandincrease expenditure incountries with topic aside anddonotconfront to shapethe thesignificant political resistance ontheissue–amissedopportunity Attempts to address have thisinstitutionalweakness gonenowhere. Unfortunately, etal.putthe Bénassy-Quéré stronger countries to contribute more to fiscalstabilisation inthe recession years. deficits makessense for theeuro area asawhole.International institutionssuchastheIMFhave repeatedly asked The EU’s institutionalset-up ignores thisissueandthere isnomechanismto ensure that thesumofnational fiscal and therefore shared responsibilities shared therefore and that a shared currency comes with many spill-overs spill-overs many with comes currency shared a that future. The starting point needs to be an understanding understanding an be to needs point starting The future. Europe needs to discuss the broader horizons of its its of horizons broader the discuss to needs Europe www.worldcommercereview.com is well thought through andwould reduce thelinkbetween banksand sovereigns withoutcreating majorfinancial The union. mostconvincing isthat onbanking section The idea ofsovereign concentration charges 2017) (Veron 4. Completing unionandadvancing markets capital banking union academic debate, whichIhadhopedmy 14colleagues would bring. crises, nomatter what isachieved asacompromise onhow to dealwithsovereign debt. These issuesdeserve address any weak oftheseissueswillmean astructurally euro area that remains fragile andsusceptible to further government expenditure, growth itslow productivity ofitsinstitutions. andItaly andtheweakness Failing to that Germany remains addresses akeypriority itslowIt investment, France itsoverly high andinefficient for theeuro area asawhole. Germany, that andmacroeconomic national structural policiesmatter notonlyfor thedomesticeconomy butalso macroeconomic policiesat thenational level. requires It anacceptance inthenational politicaldebates, includingin Addressing thesesignificant divergences andwithalessereconomic morecost quickly requires and boldstructural inflation environment isdifficultandpainful. consequence, thedebtburden increases, oneconomic Debt-deleveraging performance. inalow- weighing further relative price adjustment more painful, forcing somecountries to becloseto deflation. As real ratesrise asa Adjustment isongoing, butat alow inflation rate andslowly. The low inflation rate oftheeuro area hasmade adjusted to theeuro area’s core. Butthedivergences between Germany, France, remain amajorliability. andItaly different countries. The pastdivergence inthesmaller countries oftheeuro area hasbeenaddressed astheyhave One ofthekeyfragilities oftheeuro that area prices andwages have isthefact diverged sosubstantially across 3. Ensuringthat macroeconomic imbalances weaknesses andstructural are addressed www.worldcommercereview.com complemented withstrong steps that would etal.2018). unionareality (Sapir make capitalmarkets increase oftheeuro thefinancialstability area andshouldtherefore unionshouldbe bepursued. Banking Still, unionwithsuchdeposit insurance completing andfiscalbackstop banking to the resolution fund would and willmaketheirpoliticalinfluence heart. when thedebtiswidelyspread inthesystem, butinfluential owners ofdebt inmany countries would beaffected morerestructuring difficultthough. Thefinancial system maybe more easilyable to copewiththe restructuring terms ofpoliticaleconomy,In thespreading ofsovereign debtacross euro area countries may makedebt havestrings beenattached. insurance introduced. Overall, itshouldnotbeconsidered a substantial concession to theweaker countries asmany incentivesusefully preserve to politicalcondition improve to may get institutions. alsobethenecessary It country (Wolff 2016).deposit financing This differences would cement funding-cost forbanks across countries, butit would Unfortunately, italsomeansthat banksincountries withweaker institutionswillcontinue to face highercosts of just simple, good-senseeconomics. issuesareIntroducing addressed insurance legacy andallowing after for differentiated risk is fees dependingon Yet, oneshouldnotclaimthat introducing suchinsurance isamajorconcession by stronger to weaker countries. policiesmatter for union. country banksdespite beinginabanking for theinsurance according would that we characteristics sensiblyacknowledge remain to country aunioninwhich loansare addressed problems –isalso sensible. withnon-performing and legacy Differentiating the fee structure instability. The introduction ofaEuropean depositinsurance scheme–once exposure to sovereign debtisreduced www.worldcommercereview.com associated withsteep outputcosts. yield spreads exclusion. ofcapitalmarket andlongerperiods Trebesch andZabel(2016)findthat hard defaultsare Cruces and Trebesch involving (2013)findthat restructurings higherhaircuts are associated withsignificantly higher authors somehow butdo notseemto lightly muchonitsmajor reflect discussdebtrestructuring consequences. Second, Imissedamore comprehensive inamajorcountry. discussionoftheimplications ofdebtrestructuring The which itisusedcould render theeuro area more fragile. mentioning inthiscontext). andnotmentioning Removing OMT constructive ambiguity andtheconditions under OMT oratruesafe assetwould besusceptible to problems. badequilibria (A smallrainy-day fundishardly worth this creates animbalance where isexplicit whileOMT debtrestructuring isat bestimplicit. Yet, aeuro area without isnotablethat Monetary theOutright programmeTransactionsIt isnotexplicitly mentioned. (OMT) Willingly ornot, panicisalikelyresult.market canmore easilycalculatemean that participants whenandhow market to speculate againstacountry. Earlier thatcriteria would remove would current onwhensuchrestructuring happen. constructive ambiguity This would I have two mainworries inthissection. The firstisthat withclear thepaperis explicit aboutdebt restructuring andweak oftheproposals to appeartoo managesuchfall-out. half-hearted the otherparts sufficient toensure ofamajordebt wouldbemanageableand that restructuring the economic andpoliticalfall-out needed to manage theconsequences particular, of majordebtrestructuring. In unionwould notbe banking main concern isthat thepaperisnotsufficiently courageous in arguing thecase forsignificant integration steps takesupastrand of work contribution. that was firstadvanced It perhaps important by theGlieneckeGruppe.My The core ofthepaperisabouthow to reconcile disciplineandhere withmarket sharing thepaper makesan risk 5. Dealingwithsovereign debt www.worldcommercereview.com 1. See forexample1. See Emmanuel Macron’s orMarkRutte’s attheSorbonne speech inBerlin. speech Endnotes Guntram WolffDirector ofBruegel is intohouse inorder account butalsoabouttaking effectsonneighboursofone’s own policies. ■ comesshared withmany currency andtherefore spill-overs shared responsibilities. isaboutkeepingone’s It own Europe needsto discussthebroader horizons ofitsfuture. point needsto beanunderstanding that a The starting major politicaldecisionswould beneededto stability. preserve currentlyconstructive ambiguity prevents unwarranted ithadto speculation. happeninamajorcountry, market If ESM treaty does foresee and lastresort itandbondspreads Butitisameasure currently ofvery doprice risk. the fact, In All cannotandshouldnotbeameasure of thisdoesnotmeanthat debtrestructuring oflastresort. excluded from ESBies. difficulties. onESBies(ESRB2018) that even acknowledges countrieslosingmarket access TheESRB report wouldbe The proposals to experiment withasynthetic safe assetwould alsonothelpinproviding in fundingto acountry OMT andinthe absence oftheIMF. Contagion erode oftheESM. effects to other thecapacity countries may further several may years arestructuring bemore after limited thantheauthorsassume, at leastintheabsence oftheECB’s neededto reduce ontheeconomy. theimpact support Yet, for oftheESMto fundamajorcountry theability The authorssuggestthat theESMcould ensure thefundingfor andthe thebasicprovisioning ofpublicservices www.worldcommercereview.com org This intheVoxEU column isaleadcommentary “Euro Debate Reform”. Area Committee Public Hearingof23May. Wolff, Insurance“TheDeposit European Scheme”, G(2016), statement prepared forthe European Parliament’s ECON European Parliament inthecontext ofEconomic withthePresident Dialogues oftheEurogroup inECON, November. Veron, N(2017),“Sovereign Concentration Charges: ANewRegime forBanks’ Sovereign Exposures” Trebesch, outputcost ofhard sovereign andsoft CandMZabel (2016),“The default”, European Economic Review. Sapir, A,NVéron, GBWolff ofEurope’s areality (2018), “Making capital markets union” Stiftung, March. Berlin, Netherlands attheBertelsmann Rutte, M(2018),“Underpromise andoverdeliver: fulfillingthepromise of Europe”, speech by the Minister ofthe Prime Macron, E(2017),“Initiative forEurope”, by speech thePresident oftheFrench September. RepublicatSorbonne, Leclercq, A(2018),“(How) could European constructed?”, assetsbe safe presentation atBruegelevent, March. Glienicke Group (2013),“Towards aEuro Union”, Zeit, Die October. ESRB (2018),“Sovereign bond-backed study” securities:afeasibility 5(3): 85–117. Cruces, JandCTrebesch (2013),“Sovereign defaults: theprice ofhaircuts”, American Economic Macroeconomics Journal: Contribution. andALeandroClaeys, G,ZDarvas (2016),“A proposal to revive theEuropean fiscal framework”, Bruegel Policy constructive approach to euro area reform” Rey, ISchnabel, NVéron, BWeder diMauro, andJZettelmeyer (2018),“Reconciling risksharingwithmarket discipline:A A,MBrunnermeier,Bénassy-Quéré, HEnderlein,EFarhi, MFratzscher, CFuest, JPisani- Ferry, Gourinchas, P-O PMartin, H References , CEPRPolicy InsightNo. 91. , January. This article was originallypublished onVoxEU.This article , Bruegel policy contribution. , Bruegelpolicy , Studyprovided to the www.worldcommercereview.com opportunity for reform intheeuroopportunity area. Andrew Watt discusses There iscurrently both aneconomic andapoliticalwindow of the strengths ofrecent andweaknesses proposals andmakes 'A constructive approach Analysis oftheproposal: recommendations for andalternatives extensions to euro area reform' www.worldcommercereview.com A rates resulting from differences ininflation rates. between thememberstates are too weak given mechanismofprocyclical differences thepowerful in real interest Second, themechanismsto avoid competitive andcorrect and macroeconomic (current account) imbalances therequiredother central banksin taking measures. are, at And, best, weak. showed, asthecrisis theECB, facingamultitude offiscalactors, hasmore than difficulty aggregate demandinlinewithpotential. The mechanismsto setandenforce anappropriate aggregate fiscalstance two fundamental problems. At theeuro area level, first, there crisis in timesof tokeep isaninsufficient capacity oftheeuro asthemainweaknesses area.stabilisation capacity While ofthe valid, thisdoesnotgetto theheart systems doomloopbetween andsovereigns national banking identifies theso-called andalackof The report to ransom. partners of rulesbecausetheyreduce contagion to from others, onecountry andthusprevent from holdingits acountry risk-sharing measures to enabletheimposition canminimisemoral hazard benecessary issues andmay actually impossible(identifiedcrises asthe view’).‘German The authorsargue that, provided theyare carefully designed, (identified asthe ‘French disciplinethat andrulesmarket ensure view’) ‘sound’ domesticpolicies that make The isto orcollective abalance insurance basicphilosophy sharing strike between risk thereport underlying Underlying philosophy andproblem analysis make recommendations for andalternatives. extensions area. Following ofthepaperitself, thestructure Idiscussstrengths of theproposals andweaknesses and initiative. There for iscurrently reform bothaneconomic andapoliticalwindow intheeuro ofopportunity rather comprehensive proposal for reform oftheeuro area etal.2018). (Bénassy-Queré This isawelcome group of14prominent economists, seven eachfrom France andfrom Germany, hasissuedadetailedand www.worldcommercereview.com scheme with country-specific experience ratingscheme withcountry-specific –occupy aprominent positionintheproposals. governmentincluding bail-insofbankbondholders, bonds, de-privileging andacommon depositinsurance given to linewiththeimportance thedoomloopbetween banksandsovereigns,In financial-sector reforms – The financialproposals effectively combat crises. other national policies, includingwage setting, difficult tostabilise national makeitvery economies and rapidlyand alackofeffective cooperation andthemultipleactors responsible short, between In centralfor fiscaland monetary feasible the euro area, internally coherent, and politically politically and coherent, internally area, euro the package of measures that is effective in stabilising stabilising in effective is that measures of package be congratulated for the attempt to put together a a together put to attempt the for congratulated be The team of French and German economists is to to is economists German and French of team The www.worldcommercereview.com medium run. What isneededto achieve anappropriate fiscalstance inaggregate, butalsoineachmember While thisiscorrect, theauthorsretain thebasicphilosophy oflimitingpublicdeficitsand reducing debtsinthe policy. point isthat thefiscalrulesareThe badlydesigned, unenforceable. starting complex, andvirtually reformThe proposals mostimportant are to befound inthearea ofpublicfinances andthegovernance offiscal The proposals fiscal etal. 2017). Union(CMU) oftheCapital Markets may posedetabilisation (Theobald risks heart properties. There isgoodreason to besceptical, however 2017). Indeed,thesecuritisationschemesat (Dullien the abeliefthatreflect diversification internationalprivate portfolio and capital flows have substantial stabilising The measures to increase geographical assetsand diversificationto develop Union ofbanking Markets Capital loan issuesare required withacleanslate. to enablecountries to start –weaker ofthecrisis countries. legacy At to aminimum,somecollective non-performing efforts resolve thelegacy seeks to address moral hazard (andpoliticalobstacles), butitalsoimposeslonger-term costs onalready –asa The recommendation to differentiate premiums to thedepositinsurance scheme perceivedto risk reflect country real thesource economy; notthesymptom ofthisproblem needsto beaddressed. problems sector insomecountries are consequencebanking adirect ofprolonged contraction orstagnation ofthe appear to takeaccount that, rather ofthefact thanimproper regulation oranexcessively closebank-sovereign link, restoring economic growth (whichisacondition sector).Theauthorsdonotsufficiently for stabilisingthebanking risks, though:ifretail investors suffer severe counterproductive canbe losses, very impact the for real-economic resolution regime steps in stabilisingtheeuro would area beimportant financialsystem. has The bail-inprinciple Achieving anadequately backstopped (ie. through theESM)common depositinsurance andaharmonised www.worldcommercereview.com – aswiththejuniorbondsproposed asaneffective inthepaper–itcould serve controlrisk sharing If mechanism. itisappliedonly to newgovernmentIf spendingthat isincontravention ofagreed (andbroadly sensible)principles howeverimpacts, (Lindner2018, Watt 2017). it. Imposing ‘market discipline’ ongovernment bondswithoutabackstop haspotentially massively destabilising As such,thedifferentiated stickandcarrot has, approach inprinciple, setoutinthe much report to recommend in federal states), whiletheywould beeffective,at thecurrent juncture. apoliticalnon-starter are almost certainly a progressive competences takeover inthecaseofrepeated ofnational policymaking floutingofagreements (as The ex postpunishment regime hasindeedfailed. Far-reaching federalisation policy orat leastrulesproviding for 2016). golden rule(Truger differentiating spendingcategories soas productiveto privilege investment, ie. combining itwithsome version ofa inflation countries need to runtighter fiscalpolicy. Itshouldalso be considered the expenditure toenrich rule by GDP growth, implyingmore space for government spending. Yet isthat lessonofthecrisis higher- animportant Care mustbetakenusing nominalGDPsoasto avoid procyclicality. Ahigherinflation rate implieshigher nominal constrained to expand aggregate demandandallow upward adjustment ofnominalwages andprices. current-account-surplus, low-inflation andsymmetry; targets that emphasisecounter-cyclicality countries mustbe the focus onconvergence target shouldbedownplayed debt-to-GDP infavour to anarbitrary ofnationally specific expenditure canbereadily At measured, leastnon-cyclical is perfect. andisundergovernment control. However, The from proposed afocus shift adjusted) deficits on(cyclically to an expenditure ruleis welcome. Nofiscalrule way.symmetrical canbe Deficits too low (orsurpluses too high). state. For thelatter, theoutputgapandcompetitive positionare decisive andthesemustbeanalysed ina www.worldcommercereview.com some point transgress againsttheexpenditure rule, measures, willloseaccess to andwillbe thevarioussupport the exaggerated concern withmoral hazard that leadsto risk countries aserious gettinginto difficultieswill at can freely issuebonds(whichcanbepurchased by theECBto theextent that itsinflation mandate allows). Again, states are notlikehouseholdsorfirms. An ESMcredit linewithappropriate conditionality would suffice, iftheESM in therecent crisis. There isnoobvious reason why collectively, suchafundshould bepre-financed; themember restrictive, however. Differentiated contribution rates will(here too) penalisethe countries whohave suffered most The authors accept theneedfor aeuro area fiscalcapacity. This is welcome. The version proposed isunnecessarily measure, ofwhichare thepracticalities barely discussed. measures inthefuture.policy leastitseemsthat degree adisproportionate At thevery offaithisplaced inthis possible stabilisingrole for theECBandwhether ESBieswould beatool for quantitative easingorothermonetary to getaseniortranche that isbothsafe andlarge, given asmall numberofmutuallycorrelated –norofa securities ‘skittish’ forces market destabilisingcountries. There isnodiscussionofthesize –specificallyhow oftheESBmarket into is by ESBies. nomeansclearthat suchuntested It collateralised financialproducts would really guard against seemsthat theonlyprotection forIt outstandingandnewbondswillbeto theextentthat theyare securitised thus greater possibilitiesfor restructuring. That would behighlydestabilising. is ambiguousonthispoint. impliesincreased clausesand onfinancialmarkets The useof action collective section soasto markets keepspreadsthe ECBshouldbeableto purchase withintight limits. themonsecondary The paper issued withintheagreed limits, theyshouldcontinue to are restructuring; to notsubject have zero weighting and However, suchanapproach shouldonlybeconsidered iftheexisting stock ofsovereign debt, andalsonewbonds disciplineneedto introduction ofmarket be weighed againstthoseofpossiblealternatives.partial hastois extended, besomereliable there way certainly to constrain national fiscalpolicy. Any drawbacks of the www.worldcommercereview.com common currency will continually be in doubt (Watt 2017). willcontinuallycommon beindoubt (Watt currency with the question of whether they are not better autonomy. off regaining their own monetary Thus thefuture of the comparatively unscathed willnotbesoencumbered. Countries facinghigher costs will constantly beconfronted countries hithardest by willstruggleto thecrisis develop, whilethosethat have emerged from thecrisis imposedonthem(suchashigherinterestUnder thevarious strictures rates andfundcontributions), those the crisis. latter. The excessive concern with ‘moral hazard’ issuesinanumberofareas prevents aclearlinebeingdrawn under approaches oftherisk-sharing theclaimto anddisciplinarian beamarriage –infavournotwithstanding ofthe At thesametime, itfailsto adequately issuesandtheproposals address are someimportant skewed – manifestly notworked, withoutfar-reaching federalisation, whichseemspoliticallyinfeasible. attempts to overcome package The proposed policy the ‘discipline through punishment’ approach, whichhas inherent to competitive tendency andcurrent account imbalances (‘rotating slumps’) shortcoming. isaserious problem oftheunderlying Much analysis iscorrect, althoughinsomeareas itislimited. The downplaying of the needsto oradapted. beextended package order andany mustrecognise critic thescaleofchallenge. To conclude, Ifocus onsuggestionsasto where the of measures that iseffective instabilisingtheeuro area, internally coherent, and politically feasible. That isatall The team ofFrench economists isto andGerman becongratulated for theattempt to puttogether apackage Overall assessment andproposals fundamentally unstable. willinducefaced anticipative with debtrestructuring. ofthisfact Knowledge unionis speculation. Suchacurrency www.worldcommercereview.com Hans-Böckler FoundationHans-Böckler Andrew Watt isHeadEuropean Economic Policy Director, &Deputy Macroeconomic Policy Institute, including notably: theproposals would changesandextensions If are beneeded, to betakenasapoint important ofdeparture, • • • • • disciplinary measures inspired bydisciplinary afear ofmoral hazard. ■ This approach emphasisesthepreventive rather thancorrective approach, andwould reduce theneedfor growth andmutuallyconsistent stances. andstability-oriented ofagreed Ownership targets isincreased. national central banks. Fiscal, incomes andmacroprudential policiescanbethusbetter aligned towards to theeuro area andnational levels. andthe Alongside fiscalpolicy, inthesocialpartners theMEDbrings for theexisting Macroeconomic andextending macroeconomic Dialogue(MED) at theEUlevel expertise also and (2017) andHorn Watt (2017)propose developing boards thenewnational into productivity aplatform vis deficitandsurplus countries anditsapplication to theentire mix.Kolland macroeconomic policy Watt To thisenditisvitalto reform theMacroeconomic Procedure Imbalance to ensure vis-à- itissymmetrical level. stances counter-cyclical at symmetrical nationalensuring level andthustheircoherence at theaggregate National fiscalstances mustbesetwithmuch greater regard to safeguarding publicinvestment and to destabilising speculation. government bondsandnewissuesunderthespendingruleare risk-free andthusremoved from thethreat of Any creation ofjuniorbondsmustgohandin handwitheffective measures to ensure that existing The European shouldnottakethe fiscalcapacity ofa form rainy-dayby theESM. fundbutalendingcapacity withacollective element. sectors needtoSolutions befound issuesinvulnerable national banking to legacy www.worldcommercereview.com This article originallypublishedonVoxEU.orgThis article Watt, Schäuble’s A(2017),“Wolfgang to theEuro gift Area” parting poisoned IMK Working Paper 168. Truger, goldenruleofpublicinvestment andsufficient reform oftheEUfiscal –anecessary A(2016), “The framework?”, No.weiterentwickeln, 121. IMKReport Theobald, T, STober andBLojak 2016.Regulatorischen (2017),IMKFinanzmarktstabilitätsreport Fortschritt Lindner, fürStaaten wäre F(2018),“EinInsolvenzverfahren schlecht fürEuropa” governance, Europe Publishing, Social pp. 335-352.e convergence intheEuro Area” Koll, WandAWatt (2017),“A feasibleconceptual andinstitutionalreform agendaformacroeconomic coordination and Paper 059. Horn, GandAWatt (2017),“WagesandNominalRealUnitLabour Cost DifferentialsinEMU” No. 2. sharingby financialmarkets S(2017),“Risk Dullien, infederal systems.What do we really measure?”, FMM Working Paper constructive approach to euro area reform” Rey, ISchnabel, NVéron, BWeder diMauro, andJZettelmeyer (2018),“Reconciling risksharingwithmarket discipline:A A,MBrunnermeier,Bénassy-Quéré, HEnderlein,EFarhi, MFratzscher, CFuest, JPisani-Ferry, Gourinchas, P-O PMartin, H References Editors’ note: This isanabridgedandrevised version thatappeared inEnglishhere ofatext here andinGerman This intheVoxEU column isaleadcommentary “Euro Debate Reform” Area , inHHerr, JPriewe andAWatt (eds), theEuro: Saving RedesigningEuro economic Area , CEPRPolicy InsightNo. 91. , €-Vision, 11October. , Herdentrieb, 31January. , DG ECFIN Discussion , DGECFINDiscussion . www.worldcommercereview.com A planto save theeuro productively substantial improvements inits operation For theeuro area to bestableandmove forward are required, argues Jeffry Frieden www.worldcommercereview.com T the EUdropped from over 70% before to thecrisis barely it(eg. 20%during Foster andFrieden 2017,Frieden 2016). citizens’ debtor-country existing politicalleadersto andefficiently: manageitfairly confidence intheinstitutionsof closertopopulation, andwas 70%.However, typically Europeans have of littlefaithinthewillingness orability Even unionnever inthemostheavily affected debtor nations,fell belowfor monetary 50%ofthe support residents1. Most ofthe euro area union. remain positive themonetary about There ifwe are want several making to understandthecurrent points worth politicaleconomy ofeuro area reform. reformmeaningful hasto address inorder to besuccessful. to understandthepoliticalneedfor reform, important andthepoliticalconditions any alsomakesitparticularly It reform theeuro area inaway that theysay etal.2018). combines discipline(Bénassy-Quéré risk-sharing andmarket to evaluate important theproposal from 14leadingFrenchThis makes itparticularly economists to andGerman is unlikelythat liketheonefrom theeuro anothercrisis whichitisjust(barely) could survive emerging. For theeuro area to bestableandmove forward productively requires substantial improvements initsoperation. It surveys). that challengetheeuro, andEuropean integration more generally (seeAlgan etal.2017for oneamongmany hascontributedThe ofthisbungledcrisis economic mightily to andsocialimpact ofpopulistmovements therise debt problem into adecadeofeconomic stagnation, socialupheaval, andpoliticalprotest. policies, amanageable turned and politicalconflict contradictory integration. misguidedaction, Inaction, he mismanagement oftheeuro area hasbeenthegravest debtcrisis ofEuropean failure inthehistory www.worldcommercereview.com crisis, likemostotherdebtcrises, there was Citizens alsoadomesticaxisofconflict. ofdebtor countries battled over debtors wanted creditors inhelpingreduce to play thepoliticalandsocialcosts ofausterity. theirpart And inthis the pain.Creditors wanted payments; debtors tofor prompt makethesacrifices necessary andfulldebtservice As inalldebt crises, hasbeenbetween debtor amajoraxisofconflict andcreditor countries over how to distribute adjustment burden. 2. The central failure ofcrisismanagement was to theinability arrive at areasonable distributionofthe in both the core and periphery of the euro area euro the of periphery and core the both in towards addressing the legitimate concerns of citizens citizens of concerns legitimate the addressing towards catastrophic crisis and that they would go a long way way long a go would they that and crisis catastrophic are necessary if the euro area is to avoid another another avoid to is area euro the if necessary are ... the proposals in the recent CEPR Policy Insight Insight Policy CEPR recent the in proposals the ... www.worldcommercereview.com member states attempted to shift the burden of adjustment onto others, missing opportunity after opportunity member states attempted opportunity theburden after to ofadjustment shift onto others, missing opportunity However, itwas firstand foremost thememberstates that cameclose to destroying theeuro. turn, At almostevery more positive role at buteventually, theoutset ofthecrisis; reasonably well. 2012,itperformed after of theeuro area that istruethat euro faileditspeople. theprincipal area It institution,theECB, could have played a ofthecrisis. However,deepened theimpact theinstitutionalinadequacies hitit, was whenthecrisis notprimarily Certainly, oftheeuro issuesunresolved, theconstruction many area left important andtheeuro’s inadequacies institutions. 3. The principalculpritsinthemismanagement ofthecrisishave national been governments, notEuropean region. progress intheeuro area, and–notincidentally ofdangerous –oftherise strains ofpopulismthroughout the the likelihoodoften years ofstagnation that ensued, oftheviciouspoliticalstandoffs that continue to hamper restructuring, withcreditor thesacrifice withdebtor financialinstitutionssharing nations, might well have reduced isthat muchofthissuffering,And the sadfact andmuchofthisbitterness, was avoidable. Prompt debt use oftaxpayer moneyfor never purposes madeclearto them. quite reasonably, having beenlargely misledby theirgovernments aboutthetruenature ofthecrisis, resent the that lenderswerethe fact at leastasresponsible for theaccumulation ofbaddebts. Citizens ofcreditor nations, Citizens ofthedebtor nations, quite reasonably, resent thelion’s bearing share oftheburden ofadjustment, despite (Greecerestructuring was anexception, itsdebtascontracted). given ofservicing theclear impossibility oftheadjustment was doneby thevastout, inthisdebtcrisis majority thedebtors, andthere wasdebt noserious taxpayers, financialinstitutions, orothers would pay whatever price there might be for asettlement. As itturned who would make themostsacrifices to satisfy creditors; and withincreditor countries, thedispute was over whether www.worldcommercereview.com and that future willberesolved crises inamore timely andequitablemanner. thatensuring thecreditor – to winduptheongoingcrisis nations takeonat leastsomeofthesacrifice necessary euro area theothermemberstates their legitimate –and, –willtakeseriously most important, concerns. This means Any reform serious needs to prove that theinstitutionsof to citizens oftheindebted, periphery crisis-ridden What, andpoliticaltasksfaced then,are by theeconomic thememberstates? policy union. There issometruthinboth setsofbeliefs; but, ofcourse, bothare misguided. mechanism to force themto sendtheirmoneyto dissolute Europeans, southern to theeuro turn area into atransfer from adecadeofirresponsible lending. For citizens ofthecore, theirpart, creditor nations seetheeuro area asa their massive bargaining power to force onto alloftheburden theborrowers ofdealingwiththefallout virtually see theeuro area onthem. asamechanismto imposeausterity They believe that thecreditor countries have used What are theprincipal, legitimate, concerns oftheeuro area’s citizens? Those intheperipheral, debtor countries euro area that itwillbemanagedmore responsibly inthefuture. union’smonetary itneeds to and, provide more construction; perhaps important, assurances to thecitizens ofthe recovery –andthereform ofeuro area institutions. This reform needsto address gaps inthe someoftheprincipal hampers boththeresolution oftheremaining debtoverhang –whichcontinues to adrag ontheregion’s exert For theeuro area to move forward, itsmemberstates have to overcome theexisting stalemate. The gridlock states. resolution withmore ofthe crisis have burden-sharing would almostcertainly beenintheinterests ofallmember is that themore delayed theseconflicts policies,constructive themore the costs ofthecrisis rose. Aquicker nation states resisted stubbornly attempts to find cooperative strategies to address thedebtproblem. The tragedy for alesscostly resolution ofthecrisis. Almost from themoment broke, thecrisis thegovernments oftheprincipal www.worldcommercereview.com European integration. anti-European populiststo point to the disastrous mismanagement asevidence ofthe crisis for of their rejection legitimate concerns ofcitizens oftheeuro area, core andperiphery. This would of inturn helplimitthe ability anothercatastrophicmove crisis. forward withoutrisking And theywould goalongway towards addressing the thereformSo proposals are eminently reasonable. They are, more iftheeuro to area thepoint, necessary isto union. ESM, to play inmonitoring theoperation amore ofthemonetary consequential part sovereign borrowing. This would complement areform ofrelevant euro area institutions, firstand foremost ofthe and banks;amore reasonable –hence credible –system offiscalanddebt oversight would limit excessive On theotherhand, sovereign concentration behaviour charges by would debtor sovereigns limitopportunistic creditors offailingbanks, would aswell. allgointhisdirection more equitablyshared. union,ofcommon regulation, Astrengthening ofthebanking and ofmechanismsto bailin insurance scheme, would helpguarantee that inherent therisks inlendingamongeuro area memberswould be would. The proposals for mechanismto ameaningful restructure troubled debts, alongwithacommon deposit Would themeasures suggested by thecurrent reform document accomplish thesetasks? To alarge extent, they and unjustifiedborrowing andspending. commitment unioninorder not to abusethecommon to poolcomponents engageinuncontrolled ofamonetary avoid arecurrence ofthecurrent disaster. acredible This that meansensuring theperipheral nations undertake reform serious of theeuro area theothermemberstates measures –and, –willundertake to mostimportant, thesametoken,By any reform serious needsto prove to citizens ofthecore, creditor nations that theinstitutions www.worldcommercereview.com VoxEU.org This intheVoxEU column isaleadcommentary “Euro Debate Reform” Area Albuquerque Tavares (eds), After the Crisis:Reform,Recovery, andGrowth inEurope, Oxford Press. University crisis,Frieden, thepublic, and thefuture ofEuropean J(2016),“The integration”, inF Caselli, MCenteno, andJ European UnionPolitics 18(4):511–535. Foster, C,andJFrieden (2017),“Crisis ofTrust: ofEuropeans’ Determinants Confidence Socio-Economic Government”, in constructive approach to euro area reform” Rey, ISchnabel, NVéron, BWeder diMauro andJZettelmeyer (2018),“Reconciling risk sharingwithmarket discipline:A A,MBrunnermeier,Bénassy-Quéré, HEnderlein,EFarhi, MFratzscher, CFuest, JPisani-Ferry, Gourinchas, P-O PMartin, H Papers onEconomic Activity, Fall: 309-382. Algan, Y, SGuriev, EPapaioannou, European andEPassari Trust (2017), “The ofPopulism”, CrisisandtheRise Brookings References Jeffry Frieden is ProfessorGovernment of University at Harvard lead to its collapse inthefuture. ■ Progress to bedesired. iscertainly inthisdirection Failure to move forward withareform oftheeuro area now may administration willleadto agreater amongtheEU’s senseofsolidarity memberstates. sides ofthebargaining table. Perhaps, also, thecontinuing threats andescalating economic from policy the Trump Whether thesereform proposals are politicallyfeasible isanothermatter. Perhaps onall growth hearts willsoften , CEPRPolicy Insight No. 91. . This article was originallypublished on . This article www.worldcommercereview.com address anumberofcentral problems ofEMUarchitecture Sebastian Dullien argues Dullien thatSebastian therecently publishedCEPR Policy leaves Insight too many questions openandfailsto Blind spotsofthe14 economists’ Policy Insight www.worldcommercereview.com A In short, theypropose thefollowing short, measures:In Germany andFrance. prevention),and crisis andthat reforms needto makeprogress onbothfronts inorder to beacceptable to both The authors makethebasicpoint that theeuro mitigation (orcrisis reduction area andrisk sharing needsbothrisk as well asthe ‘German view’ and, politically, from economists aswell from asfrom theleft thosefrom theright. ofreformtheir package proposals into ascompromise accounts papertaking concerns ofboththe ‘French position’ of reference. The authors, andFrench agroup German of14well-known andwell-connected economists, present For thisdebate, beamajorpoint therecently etal.2018)willcertainly publishedCEPRPolicy (Bénassy-Quéré Insight • • • • Reform offiscalrules:nominal expenditure rulesinstead ofdeficitrules;spending overshoots will have tobe of sovereign bonds government bonds;creation ofEuropean Safe credit (ESBies),structured Bonds basedonaportfolio products Reform ofthetreatment ofsovereign bondsinbanks’ balance sheets:regulations to limit banks’ exposures to Completion ofthe Capital Union requirements incasesofbankrestructuring. the ESMasabackstop; removal ofobstaclesfor cross-border bankmergers; strengthening ofthebail-in andbankresolution;framework establishment for ofacommon depositinsurance banksupervision with Union:cleanupofbanks’Completion ofthe Banking balance sheets;streamlining andstrengthening the thus to start inearnest. thus to start government.a newworking With adelay ofalmosthalf ayear, thedebate onthereform oftheeuro area is months oftediousfter negotiations Germany between itsmainstream hasfinallymanaged to get parties, www.worldcommercereview.com no-brainer. deposit insurance. Also, streamlining thedecisionprocedures andstrengthening thecompetencies oftheESMisa burdened loans, by theESMinto large norturning amounts afiscalbackstop ofnon-performing for a common Many ofthepackage’s elements still makesense. sectors Noonecanreally oppose thecleaningupofbanking • • • transfers to national budgetsincaseofdeeprecessions Fiscal for capacity theeuro area: afiscalstabilisation scheme(orunemployment reinsurance) offering one-off Reform ofESMgovernance ofjuniorbonds’extensions receives maturitieswhenacountry anESMloan Facilitating sovereign automatic changesinvoting debtrestructuring: rulesto makeholdoutslesslikely; covered by juniorsovereign bondswhichwillberestructured firstintimesofpayment difficulties hopefully not be taken at face value by politicians by value face at taken be not hopefully ... the package contains a lot of good ideas, it will will it ideas, good of lot a contains package the ... www.worldcommercereview.com construction sector ofthesecountries expanded sector strongly,construction andwages andconsumption increased. The goodlabour played acentraland-bust-cycles role. SpainandIreland experienced Both areal estate to boomprior thecrisis. The asin allcountries affectedThis logicby theeuro isimportant (maybe crisis withthe exception ofGreece), boom- with overheating boomsandlong recessions orat ofstagnation. leastperiods increase thereal interest rate andprevent aquickrecovery. Overall, thisleadsto longeranddeeperbusinesscycles, into alower real isinarecession, interest acountry inflation willfall. rate, fuelling theboom.If further This will willpickupandthe common nominalinterest isinaboom,inflation inthis country acountry rateIf willtranslate will always betoo low for somecountries andtoo highfor others. to live withthesamenominalcentral bankinterest rate. are cycles notcompletely If synchronised, thisinterest rate countries havemight union,allparticipating have ledto amonetary longeranddeepernational businesscycles. In withtheproblem Let ofboom-and-bust-cycles. usstart doesnotaddress theargumentThe package that EMU problemsThe three are mostimportant that thepackage: failsto address anumberofcentralpackage problems ofEMUarchitecture. isnotconvincing. asawhole,Nevertheless, thepackage theend, In too many questionsremain open,andthe • • • policy space.policy proposes fiscalrulesand for sovereignrisk of whichrunthe reducing governments’ debt restructuring governments and inasensibleanddesirable way; puts anexcessive offinancialmarkets to stabilisenational economies trustintheability and to discipline does notaddress intheeuro the issue ofboom-and-bustcycles area; www.worldcommercereview.com its sovereign From bondmarket. 2007to 2016,Spanishpublicdebtincreased by €723billion. The fiscal cost of iseven union,Spainwould questionableifunder acompleted haveIt banking dodgedthe confidence in crisis Spain according to thenewruleswould have prevented thedeepdownturn thesecountries have experienced. able to permanentlyprevent real estate bubbles. Moreover, itisunlikelythat aresolution ofbanksinIrelandand in thefuture. Historically, inmajoreconomies, even reforms, after regulation andoversight banking hasnotbeen Yet, itishighlyquestionablewhetherallthissufficient to preventcycles atthe deepboom-and-bust national level of default. canbesolved crises by resolutionbanking andrecapitalisation withoutpushingnational governments to thebrink bubbles again.Moreover, inthefuture, European institutionswill provide fundssothat even severe national The implicit hopehere inthefuture seemsto bankswillnotfuelreal bethat underbetter estate supervision, The paper by the14economists addresses thisproblem for Union. onlyby thecompletion asking oftheBanking seen asresponsible into for turned crisis asovereign bailingoutbanks, thebanking debtcrisis. they cutbacklending. Consumption, employment andtaxrevenues imploded. And asnational governments were bubble deflated. Suddenly, banks were loansand, faced withlarge asa consequence, amounts ofnon-performing Problems andtheSpanisheconomies emerged intheIrish whentheboomcameto anendandthereal estate (or appropriate) competitiveness size, deteriorated. export might have.the boomran muchlongerthanitotherwise grew sector While theconstruction farbeyond itsnormal tonot react theoverheating oftheseeconomies (buthadto setitsinterest rate withregard to thewhole euro area), situationmarket attracted immigrants, increased real estate thedemandofwhichfurther prices. As theECBcould www.worldcommercereview.com moral hazard inatransfer system, theyhave shrunkitto alevel at whichitdoesnotyieldany real benefitsanymore. One getstheimpression that the14economists here have thrown outthebaby withthebathtub. afraid Being of transfers would hardly have madeany difference in ofdebtsustainability.terms ofthisproposed scheme.dropped seestheinadequacy Again, by the about€70billion,or 7%ofGDP),onequickly oneputsthesenumbersintoIf comparison withthedrop intaxrevenues (Spain’s annualtaxrevenues 2007 after GDP. case, Spainwould have received atotal ofabout1.3%GDP (roughly €14billion),and Irelandoflessthan1% would nothave mademuchdifferenceIreland.Over inthecaseofSpainand period, thewholecrisis inanideal calculation withtheparameters proposed by the14economists yieldsthat thisscheme A simplerule-of-thumb prevent thefundhaving to gointo debt. number ofcountries gointo arecession are simultaneouslyandreserves notsufficient, are scaled pay-outs down to to have asignificant impact. areFirst, pay-outs supposed amount,to becappedabove andsecond, a ifa certain However, becomes clearthat theproposed itquickly schemeismuchtoo smallto uponcloserinspection, beable of percentage points (theypropose athreshold oftwo percentage transfer. points) would receive aone-off According to theirproposal, countries inwhichunemployment ina single year rises number by more thanacertain The authorsofthePolicy might claimthat Insight theirproposed fiscalstabilisation scheme could have helped. wouldmarkets have againstSpaineven turned €40billionofadditionalpublicdebt. withoutthisextra inSpainhaslastbeenestimatedbank restructuring to have isplausiblethat beenslightly more than€40billion.It www.worldcommercereview.com large debt-to-GDP ratios.large debt-to-GDP expenditure into path account isto besettaking potential growth rates, andwould belower for countries with getsanESMloan. automatically ofwhich isextended easily berestructured ifthecountry andthematurity The and interest rate) nominalpublicexpenditure above path hasto acertain befinanced by juniorbondswhichcan The ideaofthe14economists underlying isthat publicexpenditure (except costs for cyclical unemployment place. makesovereigncould actually more debtcrisis likely, notlesslikely, relative to thestatus quowithESMandOMT in The third problematic which point andtheautomatic extension isthefacilitation ofdebtrestructuring maturity might cutofffinancingindiscriminately. tendmarkets to lendto governments irrespective ofimbalances (astheydidto Greece), whileinbadtimes, they prohibit thisborrowing iffundsare wasted. Yet, aswe have to seenprior theeuro crisis, ingoodtimes, financial expenditure withjunior bondsisthat willallow markets suchborrowing ifthe fundsare put to good useand economies disciplinegovernments. andcorrectly The central ideaofforcing governments to finance overshooting This many linksto thesecond In the14economists aspects, majorcriticism. count onfinancialmarkets to stabilise foreign capitalpropped upreal estate bubbles. up.When dried hit, theseflows thecrisis quickly evidenceempirical points to cross-borderIn therun-up to theeuro crisis, capitalflows being pro-cyclical. extremely integration popular, asastabilisation tool isvery 2017).Instead, questionable (seeDullien most itisempirically when domesticinvestors andbankscutbacklending. Yet, whilethehypothesis ofcross-border financialmarket hope here isthat more cross-border system might help financingoutsidethebanking to bolster growth intimes economistsSome might claimthat theproposed completion unionwould ofcapitalmarket dothetrick. The www.worldcommercereview.com has better chances ofbeingimplemented. However, ifthecompromise isstruckat theexpense ofaddingsome politicians. Acompromise andFrench between thearchetypical German that position might it have thevirtue So, contains alotofgoodideas, inconclusion, whilethepackage itwillhopefullynotbetakenat face value by push for level aquickreturn of60%issensible. to adebt-to-GDP given that demandfor thefact government bondsoverall remains strong, itisquestionablewhether suchastrong inherent biasto cutpublicinvestment). Given that publicinvestment intheeuro area isalready at arecord low, and with expenditure ruleslike thePAYGO system an intheUSplace the1990sshows during that theserulescarry might argue that countries could stillincrease taxes to finance more publicinvestment, evidence butempirical (Theconsiderations, 14economists cuts to publicinvestment. itislikelythat thiswillfirstbeseeninfurther expenditure growth would meanyears ofconstrained publicexpenditure, andbecauseofpolitical economy has beenarbitrary. Pushing highlyindebted countries towards today quickly thisthreshold by limitingpublic However, whetherthisleadsto intheeuro better area economic policy isquestionable. The 60%threshold always Maastricht Treaty would finallybeenforced. maketheexpenditureactually path ahard boundary. Hence, over threshold time, ofthe the60%debt-to-GDP As aresult, more onecould expect frequent, smaller-scale sovereign intheeuro debtrestructurings area which make theESMprogramme necessary, thefear andturn into ofdebtrestructuring aself-fulfillingprophecy. these bonds, pushinguptheinterest rate andpotentially cuttingcountries offfrom access. market This might then ‘default’. Hence, iffears ofanESMprogramme grow theywillhave participants, amongmarket anincentive to dump incentives for speculation. According to standard procedure, rating agencieswould as count extension amaturity However,be lesspro-cyclical. creates that therisk itactually new carries theautomatism extension ofmaturity principle, thepublicexpenditureIn rulehastheadvantage over mostlikely thecurrentwould rulesthat fiscalpolicy www.worldcommercereview.com This column was originallypublishedonVoxEU intheVoxEU isaleadcommentary “Euro Debate Reform” Area sharingby financialmarkets S(2017),“Risk Dullien, infederal systems”, FMM Working No.Paper 2. constructive approach to euro area reform”, CEPR Policy InsightNo. 91. Rey, ISchnabel, NVéron, BWeder diMauro, andJZettelmeyer (2018),“Reconciling risksharing withmarket discipline: A A,MBrunnermeier,Bénassy-Quéré, HEnderlein,EFarhi, MFratzscher, CFuest, JPisani- Ferry, Gourinchas, P-O PMartin, H References Policyand Senior Fellow at theEuropean Council onForeign Relations is Professor Dullien Sebastian – University Berlin of International of Applied Sciences, Economics at HTW implementing it. ■ elements to theeuro area architecture whichwillweaken thealready wobbly structure, itmight notbeworth www.worldcommercereview.com Steinberg with argue that canonlybetackled this risk Rafael Doménech, Miguel Otero IglesiasandFederico Otero Miguel Doménech, Rafael level, whose mere existence willreduce notonlyits common instruments andpoliciesat the European magnitude consequences butalsoitsasymmetric Beyond risk sharing Beyond sharing risk and risk reduction and risk www.worldcommercereview.com T would towards makethelongjourney trust deepereconomic andpoliticalintegration easier andhelpre-establish and well-sequenced package,. Ashared avoiding steps andclearvisionontheeuro’s unsafe inthedark” endgoals thisvein,gradually run.In Butietal.(2018)have withconsistent steps stressed intheshort theneedfor a “coherent listconstitutesthe above-mentioned indispensablelong-term goals, andthenbuildastrategy to achieve them That iswhy, from thepoliticalpoint ofview, itwould beagreat achievement if allEMUcountries could agree that However, thiscannotbeachieved overnight. European onlymoves construction forward insmall, gradual steps. andcoordination,surveillance intheoverall andgreater legitimacy governance structures” . mechanism to break banksandsovereigns, thelinkbetween ensuringfinancialstability, more effective macroeconomic andaneffective formacro area,joint facility stabilisationwithinthecurrency anunconditional lenderoflastresort As fiscal themanifesto pointscoordination needsto out, further anddisciplinea inthelongrun“there be runbutnotenoughinthelongterm. backstop, inthe short bothnecessary unionandusingtheESMasabank beyond ofjustcompleting thenarrow thebanking viewinsomequarters (Almunia etal.2018),contributes20 Spanishexperts to thisdebate, emphasisingtheneedofdeeperintegration disciplinehavemarket revitalised anintense debate oneuro area reform. Arecent manifesto, signed by more than proposal by 14French etal.2018)onhow economists (Bénassy-Quére to and German reconcile with sharing risk The European Commission’s paper reflection for deepeningEMU(European Commission 2017)andthe recent to advance towards amore genuinemonetary, fiscal, economic, andpoliticalintegration. that we more2015). Much cannotafford needsto bedone, andtheJunesummitisanopportunity to miss achieved inthe lastyears, itspresent architecture andBlyth (Matthijs cannotensure itslong-term survival he euro remains progress Despite avulnerable theenormous construction. inimproving itsgovernance www.worldcommercereview.com to proceed simultaneously. theinterconnection fact, between theeuro In area countries’ economies issointense We share withtheFrench economists’ andGerman need proposal reduction andrisk theviewthatsharing risk 2016). andMaes be lost(Dyson between thememberstates. otherwords, In of theprinciple ‘ever closerunion’ ofthefirstarchitects ofEMUcannot economic union but with very asymmetric costs asymmetric very with but union economic exposed to the risk of an incomplete monetary and and monetary incomplete an of risk the to exposed simultaneously. In fact, all euro area countries are are countries area euro all fact, In simultaneously. risk sharing and risk reduction need to proceed proceed to need reduction risk and sharing risk have carried out all their domestic reforms, both both reforms, domestic their all out carried have Deepening of EMU cannot wait until all countries countries all until wait cannot EMU of Deepening www.worldcommercereview.com appointment to ensure democratic legitimacy. euro andthat anewlycreated Committee for EMUaffairsinthe European Parliament specifically ratify his/her That iswhy we suggestthat itspresident beproposed by theEurogroup to become theCommissioner for the issue joint debt. We understandthat thisinstitutionwillnotfiteasilyin thecurrently existing governance structure. thelongrun,euroIn area needsacentral (CFA) fiscalauthority withits own sources of revenue to andtheability The needfor acentral authority fiscal (2018) tend to underestimate. EMU institutions, rules and governance are notimproved (BiniSmaghi2018). This etal. that isarisk Benassy-Quéré advances inrecentDespite alltheimportant years, theredenomination islikelyto risk remain amajorproblem if with theredenomination ofnational risks currencies andthepotential union. breakup ofthecurrency 2010, whentheeuro area experienced suddenstops, financialfragmentation, andsovereign debtcrises coupled 2017) have noted, thedifferences inthe response crisis betweenafter the USandEMUappearedto thefinancial their effects. As Lane(2012)andmany others(eg.González-Páramo and Doménech and Philippon Martin 2017, withcommon instruments at theEuropeanonly betackled level, whosemere existence would reduce and therisks thecaseofEMU,In asthesovereign highlighted, debtcrisis problems mostofthechallengesandstructural can particular, andtheimprovement oftheirinstitutionsandgovernance. have significant economic, social, andpolitical consequences. They require aproper response by theEUandEMUin globalisation, protectionism, digital revolution, demography, immigration orclimate change, amongothers)may that theyalready share many risks, buttheydonotyet share thecosts. Many (geopolitics, oftheserisks terrorism, www.worldcommercereview.com Parliament. measurescountercyclical shouldbeapproved support by theCommittee for EMUaffairsofthe European states. Moreover, crucialonessuchthoserelated to debtlimits, sums destinedto pan-European or projects Given itsbroad mandate, decisionsby theCFA oftheeuro should be takenby area qualified majority member a viewto anadequate ensuring stimulusinrecessions periods. andconsolidation inexpansionary break therulesdonot. The president oftheCFA would settheoverall fiscalstance for theeuro area asawhole, with –countriesstructures that abideby indownturns, therulesreceive but fiscalsupport countries that counter-cyclical CFA would taketheultimate politicaldecisionsonthesematters underthefollowing incentive andgovernance The FSBwould, therefore, beincharge ofthetechnical analysis ofmacroeconomic andfiscalstability, whilethe andlegitimacy.both decisionmaking We needacommon European approach, notthat of19European countries. beyondGoing theexisting intergovernmental oftheEurogroup structures andtheESMwithinEMUwould facilitate union. monetary isinsufficientadherence toguarantee to necessary) andstable fiscalrules(whichisclearly a well-functioning ofcountriesof willingness to orinability comply withtherules. experience Nevertheless, shows that even strict consolidation as muchaspossible. There isstillawidespread viewinEurope that themainproblem isthelack Despite significant progress infiscalandmacroeconomic governance, countriesstill have incentives todelay fiscal BoardStability (FSB)that would thecurrent absorb ESMandintegrate itinto EUlaw. more credible, andshouldbemonitored at atechnical andindependent level by areformed Fiscal European macroeconomic rules. These rules, whichshouldbesimplified, assuggested etal.,haveBénassy-Quéré by to be euro euro finance minister area headinganembryonic treasury, would be responsible for enforcing fiscaland at theEuropean becausetheCFA’s legitimacy levelInput isimportant president, the whowould beinfact www.worldcommercereview.com constructive ambiguity. therisk-free Questioning inthebond nature ofinstability therisk ofpublicdebtcarries thecurrent optionandpreserving last-resort ECB, asavery ofpublicdebtrestructuring leaving thepossibility shocks, alleuro area sovereign bondsshouldcontinue to beconsidered risk-free assets, implicitlybackedby the We thinkthat, aslongthere isnolarge euro withasizablebudgetcapableto area dealwithasymmetric treasury close different countries are challenging to theirfiscallimits(Leeper and very Walker 2011). are difficult tomeasure and toimpose systematically uponall countries. makequantifying Allthesefactors how that anduncertainties tocommitment honouritspublicdebtdependsonpoliticalandsocialfactors ofacountry automatically.would insolvency nottrigger There is aneedfor somediscretionality since, at theendof day, the may beusefulto assessthepotential ofdebtsustainability. risks However, itshouldalsobeclearthat theserules As Wolff (2018)points currently out, ambiguity preventsconstructive unwarranted speculation. market ESMrules would contribute to create theconditions for financialinstability. methodthat canbereproduced basedonadata-driven restructuring andcheckedby thepublic, becausethat Moreover, we disagree withtheirproposal oftransparent andconsistent across countries for ESMcriteria debt that countriesshould notraise someofthepresent expectations willinevitablyberestructured. debtsofhigh-debt We option.However, agree shouldbepossibleasalast-resort etal.that debtrestructuring with Bénassy-Quéré this thedoomloopbetween banksandsovereigns aimedat breaking run, alimited package would beagreat success. backstop, ultimately provided by theCFA mentioned above. As Schnabeland Veron (2018)have argued, intheshort convergence laws,mechanism, further union,andacredible deepeningthecapitalmarket inbankruptcy fiscal We alsoagree with otherproposals intheneedto Unionwithacommon complete depositguarantee theBanking unionandtherole oftheECB Banking www.worldcommercereview.com monetary area. monetary basis sothat theireconomies are sufficiently flexible, innovative, andsociallyinclusive to live withinasingle positive incentives needto reforms beputinplace for unpopularstructural onanongoing countries to undertake Finally, there isaneedto promote more economic convergence between different euro area countries. Therefore, Economic convergence reforms andstructural EMU affairsofthe European Parliament. monitoring andimplementing theadjustment scrutiny programme oftheCommittee under theparliamentary for of itssovereignty. The CFA, drawing ontheindependent technical work oftheFSB, would thenbeincharge of finances andnegotiate understress, amemorandum ofunderstanding withthe country which would losepart However, intheevent ofamemberstate, ofanofficialinsolvency the CFA wouldtake control ofitspublic the sovereign bondmarket. theexperienceafter ofthesovereign debtcrisis, theECBhasnoexcuse notto fulfilitsmandate in by intervening countries that might suffer panicsorspeculative market attacks. As Constancio (2018)has recently emphasised, provider ofunconditional liquidity, sovereign through thesecondary debtmarkets, for circumstantially illiquid sector.banking Buildingonitscurrent Public Purchase Sector Programme (PSPP),theECBhasto betheultimate states stressed by butnotunderaCFA financialmarkets programme ofdebt asitdoes restructuring, for the We therefore for thinkthat illiquidbutsolvent asthelender oflastresort theECBneedsto beableto act member turmoil. markets, worsening thecurrent financialfragmentation andthreatening to create anotherepisodeofmarket www.worldcommercereview.com more sovereignty at thesametimeas it strengthens EMUgovernance). to ceaseless aworld technological subject In (which leaves theeuro andrecurrent exposed weaknesses to structural andgreater crises) integration (whichpools each ofthemembercountries. Euro area citizens needto begiven areal choice between continued fragmentation Such reforms ofthepeople, require expressed inthelongrun thesupport intheapproval of thetreaty changein sovereign canmakeEMUlastfor centuries, asinthecaseofUS. the elites andthepublicat large. Ultimately, theeuro area needsto create itsown sovereignty, for onlyaEuropean we believe for theyare theeuro’s necessary long-term sustainability. This istheconsensus inSpain,bothamong sovereignty from memberstates to European institutions, someofwhichwillrequire atreaty change. However, andaccountability.democratic legitimacy We are fullyaware that ourproposals implyasignificant transfer of course,Of thisunavoidable level ofdeeperintegration willrequire agreater degree ofpoliticalunionto provide reformsstructural andreduce ofdeflation. therisk the CFA to helpstabilisetheireconomies cyclically. This conditional mechanismwould facilitate politicallydifficult problem ofmoral hazard, onlycountries that commit to reforms should beableto receive from financialsupport pressure onlyworks inexceptional circumstances. order In to provide theadequate incentives andavoid the reformsimplement thestructural neededto maketheireconomies more flexible and convergent, andthat external The euro area experience hasshown unionhave that countries joiningthecurrency insufficient incentives to designing anintelligent incentive structure. European recommendations Semester anditscountry-specific could beuseful, but theyneed to beenforceable by the digital transformation, reforms andcountry-specific that are essential for thearea asawhole. The ofthe work control explained above), could provide finance for pan-European publicgoods, suchassecurity, border protection, The CFA, to issuejoint withitscapacity debtandraise itsown fiscal resources (underthe supranational democratic www.worldcommercereview.com Future” Rand JMGonzález-PáramoDoménech, (2017),“Fiscal Policy inEurope: Lessons from forthe theCrisis and Options FutureColloquium on“The ofCentral Banking”, 16-17May. Constâncio, union” V (2018),“Completing journeyoftheEuropean monetary theOdyssean VoxEU.org,org/article/deepening-emu-requires-coherent-and-well-sequenced-package], 25April. Buti, M,GGiudice, JLeandro EMUrequires acoherent (2018),“Deepening andwell-sequenced package” [https://voxeu. Bini Smaghi,L(2018),“A stronger euro area through stronger institutions” constructive approach to euro area reform” Rey, ISchnabel, NVéron, BWeder diMauro, andJZettelmeyer (2018),“Reconciling risk sharingwithmarket discipline:A A,MBrunnermeier,Bénassy-Quéré, HEnderlein,EFarhi, MFratzscher, CFuest, JPisani-Ferry, Gourinchas, P-O PMartin, H view ofEMUreforms” BRomana,FSteinberg,Rocha, RTorres, JTugores andDVegara thecan (2018),“Quit kicking down theroad: aSpanish Andrés, AGarcía-Herrero, Carretero, MAHidalgo, EOntiveros, JMMartín MOtero-Iglesias, APalacio, JPiqué, Mdela Almunia, J,ÁAnchuelo, JFernández JBorrell, RDoménech, FFernández, GdelaDehesa, Albertos, DFuentes, GGarcía References Elcano Royal Institute at theUniversity of Valencia, OteroIglesiasandFederico andMiguel Steinberg are Analysts Senior at DoménechisHead ofMacroeconomicRafael Analysis ofBBVA Research andProfessor ofEconomics proverbial canmuchlongerdown theroad isnolongeranoption.■ transformation andrevived geopoliticaltensions, amongthegreat the withincreased powers, rivalry kicking , BBVA Research. , Elcano Royal Institute. 8May. , CEPRPolicy Insight No. 91. , VoxEU.org, 9April , RemarksattheECB www.worldcommercereview.com VoxEU.org This intheVoxEU column isaleadcommentary “Euro Debate Reform” Area Wolff, G(2018),“Europe needsabroader discussionof itsfuture” VoxEU.org, 16May. Schnabel, IandNVeron (2018),“Completing Europe’s thebank-sovereign Unionmeansbreaking Banking viciouscircle”, Sapir, A,NVéron andGWolff ofEurope’s areality (2018),“Making capital markets union” FutureMatthijs, MandBlyth (2015),“The oftheEuro”, Oxford Press. University 30(1),33-47. and policy Leeper, EM,&Walker, TB(2011),“Fiscal limits inadvanced economies”, Economic Papers: Ajournalofappliedeconomics European sovereignLane, PR(2012),“The debtcrisis”, ofEconomic Journal Perspectives, 26(3),49-68. COM(2017) 821,6December. European Commission (2017),“Further steps towards completing Europe’s Union:aROADMAP” Economic andMonetary Press.University KandMaes, I(2016),“ArchitectsDyson, Union”, oftheEuro: ofEuropean Intellectuals intheMaking Monetary Oxford , VoxEU.org, 4May. . This article was originallypublishedon . This article , Bruegel policy contribution. , Bruegelpolicy , www.worldcommercereview.com Make euroMake area sovereign euro Claeys area. argues that Grégory animproved euro area architecture would makealleuro area sovereign bondssafer A recent CEPRPolicy suggestsintroducing Insight sovereign bond-backed securities tobond-backed securities play the role ofsafe assetinthe bonds safe again www.worldcommercereview.com T are fulfilled:1)the country’s issustainable;and2)its central bankstands fiscalpolicy ready toplay abackstop role Thanks andsimplicity, to theirhighliquidity sovereign canplay debtsecurities that role aslongtwo conditions from for emerging economies meansto market looking invest foreign exchange reserves. from domesticfinancialinstitutions to satisfy regulations and to post collateral infinancialoperations, as wellas There isahighdemandfor ofasset: from thistype savers inneedofavehicle to store theirwealth for thefuture, A safe assetisaliquid assetthat credibly stores adverse during value systemic at alltimes, crises. andinparticular What isasafe asset? sovereign (SBBS)to bond-backedsecurities play therole ofsafe assetintheeuro area. considered asasafe assetintheeuro area. This positionisexemplified inthe group’s inclination to introduce However, oneproblematic element ofthe ‘Franco-German’ isthe implicitviewonwhat shouldbe package stabilisation tool to dealwithlarge shocks, asymmetric andreform theEuropean (ESM). Mechanism Stability UniontoCapital increase Markets private sharing, risk reform theEuropean buildaeuro fiscalframework, area Basically, unionmore to Union,develop resilient, complete to a makethemonetary theBanking itisnecessary made inapaperpublishedlastyear (Claeys 2017). various pieces complement eachother. Actually, themainproposals ofthepaperare broadly similarto theonesI Overall, mostofthemeasures advocated inthepaperare sensibleandform acoherent inwhichthe package position between economists from thetwo largest euro area countries andfrom abroad politicalspectrum. from France etal.2018),constitutes andGermany (Bénassy-Quéré atimelyattempt to buildaconsensus he proposal for how union’s to complete themonetary architecture, madeby agroup of14economists www.worldcommercereview.com sovereigns at acrucialmoment (from 2010to 2012). issues, andsolvency ofdisentangling liquidity preventedthe difficulty theECB from abackstopoffering to solvent public finances before interpretation financing, and2)astrict oftheprohibition thecrisis; coupledwith ofmonetary However, intheeuro area, these two conditions have notalways beenfulfilled:1)Greece didnothave clearly sound (ie.value ofthecurrency low inflation andstable foreign exchange rate). in thesovereign incaseofaself-fulfillingcrisis, debtmarket whilehaving animpeccable record inmaintaining the backed securities unnecessary securities backed untested and potentially disruptive sovereign bond- sovereign disruptive potentially and untested and thus make the provision of safe assets through through assets safe of provision the make thus and long run, make all euro area sovereign bonds safer, safer, bonds sovereign area euro all make run, long ... an improved euro area architecture would, in the the in would, architecture area euro improved an ... www.worldcommercereview.com ready to play abackstop role crisis. inaliquidity twofulfil conditions, theymusthave 1)sustainablefiscalpolicies;and2)a credible (inflation-targeting) central bank What would ittakefor all euro area bondsto beconsidered safe again?As mentioned earlier, sovereigns needto increase thesupplyofsafe assetsandavoid intra-euro area flights to safetybad times. during current debate. alleuro area Instead, making sovereign bondssafe again,andfor good, isthemostdesirable way to But inmy view, themain argument andrepresent againstSBBS isthat they are inthe unnecessary adistraction oftheeuromarkets area. countries are afraid oftheunintended consequences that suchadrastic changecould entail for thesovereign bond andpublicdebtmanagement Board agenciesinmany (ESRB)andtheCommission,Risk euro policymakers area However, theidearemains untested andpoliticallycontroversial. oftheEuropean Systemic Despite thesupport needing them. tranches ofdifferent seniorities, inorder to supplysafe assets (seniorSBBS)inlarge quantities to economic agents sovereign bondsfrom alleuro area countries andusingthemto provide cashflows issuedinseveralfor securities how to create synthetic euro area-wide safe assetsemerged. particular, In proponents ofSBBSsuggested pooling Given ofsomeeuro theinability area sovereign bondsto play therole ofsafe thecrisis, assetsduring ideason Which assetshouldplay that role intheeuro area? from doingso, ie. to putinplace thepossibility countercyclical fiscalpolicies at low cost during recessions. programme. This putsomeeuro area countries at adisadvantage to themainbenefit issuesafe assetsandextract it takes” promise inthe summerof2012anditsformalisation Monetary astheOutright Transactions (OMT) thedooropento self-fulfillingsovereignthis left insome debtcrises countries – at least until Draghi’s “whatever union, financingisjustified toWhile theprohibitionavoid unsustainablefiscalpoliciesinthemonetary ofmonetary www.worldcommercereview.com that theimplementation ofanOMT programme inanESMprogramme. would beconditional onparticipation toante justify anOMT that programme. debtissustainablethusnecessary To solve that problem, theECBdecided to aself-fulfillingissueandnotlinked to fundamentals, this could lead to moral hazard. A strong presumption ex were usingtheOMT in allcaseswhichyieldsincrease significantly, withoutbeing confident that they are related The problem oftheOMT programme isthat issues. itisdifficult IftheECB todistinguishliquidity from solvency The reform necessary oftheESM proof intheEMU. isthusessential to reformIt theESM/OMT framework to makesovereign genuinelyliquidity-crisis- debtmarkets remains fragile for andcould limitthepossibility someeuro area sovereign bondsto qualifyassafe assetsinacrisis. programme place inseveral was crucialto taking endtheself-fulfillingcrises countries in2012.However, itssetup convincing solutionto fulfilthesecond condition. Even thoughit was never activated, thecreation oftheOMT This corresponds to someoftheproposals etal.(2018).However, inBénassy-Quéré theauthorsdonotoffer a Union (EMU)itisalsoessential ensureto have: soundpublic finances inthelongrun EconomicMonetary and reformed expenditure rulewould beastep However, intheright direction. goodfiscalrulesare notsufficient. To to bedrastically improved to play theirrole –ditching theflawed deficitruleand structural replacingitwitha For publicfinances intheeuro area to besustainable, fiscalrulesisnecessary. respecting Butcurrent rulesneed • • • and aeuro area stabilisation instrument to dealwithlarge shocks. asymmetric European andacredible Insurance Scheme Fund); Deposit SingleResolution Uniontoa completed makeEuropean Banking sovereigns (thanksto crises the immuneto domesticbanking they burst; effective macroprudential policies to avoid bubblesthat endup weighing heavily onpublicfinances when www.worldcommercereview.com terms” practice, crisis., whichmight could In thecriteria notbethecaseinaliquidity beinterpreted looselyand Moreover, for thecriteria accessing credit linesisoverly restrictive asitrequires “market access onreasonable conditional onthesignature ofUnderstanding. ofaMemorandum countries credit could applyto lineinstead anESMprecautionary ofafullprogramme, butcredit linesare still forof multipleequilibria which itmight bearlittleresponsibility. principle, today, In to beeligible for the OMT, might beforceda country to implement policiesto access anOMT programme solelybecauseofaproblem the country’s to repay capacity itsEuropean Onthecontrary, partners. thecurrent situation isproblematic because Conditionality would notbeneededbecausethere would noESMloansinvolved andtherefore noneed to ensure the ECB’s OMT programme, withoutany conditions attached orany debtrestructuring. 1. Atrack for ‘pure’ crises, liquidity inwhichtheESMwould validation usedasapolitical justbe device for (2017), there ESMtracks: shouldbethree distinct should bedifferentiated crises. dependingonwhether orsolvency countries faceAs Iproposed liquidity inClaeys highly problematic iftheOMT ever needsto beused. Thus, therole anditsfunctions oftheESMmust beclarified However, thecurrent optionsavailable at theESMare notappropriate to solve crisis, whichwould aliquidity be for theECBtonecessary act. lend to countries (whichisrelatively small)butbecauseitprovides thepoliticalvalidation ofthedebtsustainability is sustainable. The ESMthusplays afundamental role inthecurrent setup, to becauseofitscapacity notprimarily programme, thismeansthat there mustbenotonlyatechnical assessment butalsoapoliticalagreement that debt given that theESMboard –composed ofthefinance ministers ofthememberstates –needs to approve the requesting helpissustainable,of thecountry before theESMprogramme canbeapproved. More importantly, This impliesthat theCommission, inliaison withtheECB, would have to assess firstwhetherthepublicdebt www.worldcommercereview.com and withoutany conditionality, neitherex postnorex ante. This track is, inmy view, essential iffinancial markets restructuring. Unfortunately, theydonotgoasfar introducing anoptionsimilarto track 1,ie. withoutESMloans ex conditionality post),andto track 3withabasicESMprogrammelight policy conditional onsovereign debt two tracks broadly similarto (for track 2withaflexible ESMfacility countries withgoodpolicies ex ante andwith etal.makesomesuggestionsto reformBénassy-Quéré that theESM inadirection would leadto aset-up with provide oflosingmarket aloanto theshock smooth helpthecountry access. by private institutions, whichwould alsoenhance market disciplineex ante. that In case, theESMwould macroeconomic/fiscal/financial adjustment programme ofthe andonthesovereign restructuring debt held 3. Atrack for clearsolvency crises, inwhichtheESMwould provide fundingconditional onafull restructuring, to avoid full-blown andlast-minute crises decisions. disentangle. ofprogrammeThis type could beactivated at stagewithlight anearlier conditionality, andnodebt trajectory. issuesare andsolvency difficult to usefulinthecaseswhichliquidity This track willbeparticularly eligible forcountry OMT once there isnodoubtremaining ofthecountry’s onthesustainability newdebt The ESMwould credit offer lineunder aprecautionary relatively light conditions, which would alsomakethe 2. Atrack for situations inwhichcountries could be ‘at riskofinsolvency’ inthefuture. being used. track would toa liquidity increase theESMtoolkit thecredibility oftheOMT andreduce the likelihoodofitever need ofanOMT programme might bereluctant to applyto theESMfor fear oflosingeconomic sovereignty. Adding technically andpoliticallyvalidated). countries andin theabsence facingaself-fulfillingcrisis ofsuchatrack, In the Governing Council would betheoneultimately theassetpurchases activating is once debtsustainability to crises liquidity ‘authorise’ OMT programmes by theECB(thecentral bankwould retain itsindependence as light. But, could forconditionality bevery thesakeofclarity, itisbetter to create anewtrackfor reserved pure www.worldcommercereview.com des Arts etMétiers des Arts ClaeysGrégory isaResearch Fellow at BruegelandAssociate Professor at theConservatoire National unnecessary. ■ thecrisis.during This would maketheprovision ofsafe assetsthrough untested andpotentially disruptive SBBS long run,makealleuro area sovereign bondssafer andthus limitdrastically theintra-EMU flight for safety observed improved fiscalrules, aeuro area stabilisation instrument, anda reformed ESM/OMT framework – would, inthe Overall, animproved euro area architecture Union,effective –withacompleted macroprudential Banking policies, Conclusions defence, etc.). andintherealmarkets economy through theprovision ofsafety netsandessential publicgoods(health,education, concentration charges), given thecrucialroles played by memberstates indomestic financial asabenchmark is difficult to believe canbepainless(even that publicdebt ifbanks restructuring are more thanksprotected to fiscal policies(whileESMloans would notbesizeable enough to compensate accessfor market Second, loss). it frequent would debtrestructuring makeitimpossiblefor countries to borrow inbadtimesto runcountercyclical More generally, intheeuro thenorm area debtrestructurings could have making dangerous implications. First, to access theESMandthusOMT. compulsory conditionality such atrack intheirproposal to reform theESMisproblematic and/orpolicy becauseitmakesdebtrestructuring were to calltheECB’s bluffoneday needs andtheOMTto beused to solve actually crisis. aliquidity The absence of www.worldcommercereview.com VoxEU.org This intheVoxEU column isaleadcommentary “Euro Debate Reform.” Area was originallypublishedon This article Pieces Missing oftheEuroClaeys, Architecture” G(2017)“The constructive approach to euro area reform” Rey, ISchnabel, NVéron, BWeder diMauro, andJZettelmeyer (2018)“Reconciling risksharingwithmarket discipline:A A,MBrunnermeier,Bénassy-Quéré, HEnderlein,EFarhi, MFratzscher, CFuest, JPisani-Ferry, Gourinchas, P-O PMartin, H References , CEPRPolicy InsightNo. 91. , BruegelPolicy Contribution No 2017/28. www.worldcommercereview.com The recent proposals for euro area reform have initiated specific insolvency risk ofeuro areaspecific insolvency membershipisthe main risk thatmain risk shouldbecovered by joint sharing risk No dealisbetter than an intensive debate. Peter argues Bofinger that the a baddeal www.worldcommercereview.com A (‘original sin’). oftheirnational central theycannolongerrely acrisis bank. onthesupport In member states are inasimilarsituation asemerging economies market whichcanonlylendinaforeign currency currency. adoptstheeuro,When acountry itsdebt isredenominated from into thenational theeuro. currency Thus, exposes itsmemberstates to aninsolvencyrisk whichisabsent for similarcountries which have anational theuniqueandexistential union crisis. Butthisneglects banking riskofeuro area. Monetary membership want to beshared. Their proposals focus ofidiosyncratic onthe risk ofanational demandshocksandtherisk Given thefocus on ‘risk sharing’, that theauthorsdonotexplicitly explain itissurprising whatrisks they specific The insolvency riskofeuro specific area membership step by allowing at leastsomedebtfinancingofpublicinvestments withinthefiscal framework oftheeuro area. slavishly adopted. For aproductive compromise between France andGermany, sidehasto takethefirst theGerman target, for 60%value oftheMaastricht sensible debt-to-GDP whichthecompletely arbitrary Treaty shouldnotbe expenditure asitfocuses rulehas itsmerits onatarget whichgovernments cancontrol effectively. Butit requires a far,So there islittleevidence that financialmarkets could play astabilising role intheeuro area. The proposal for an discipline,market could thisrisk even beincreased. authors’ modestproposals for apublicandprivate are sharing risk insufficient inthis regard. Withastrengthening of risk ofeuro areaspecific insolvency risk that membershipisthemain shouldbe covered by ajointrisksharing. The While several ofCEPRPolicy Insight91have shortcomings already beendiscussed, inthiscolumn Iargue that the (Bini Smaghi 2018, Micossi 2018,Butietal.Pisani-Ferry(Bini Smaghi2018,Micossi andZettelmeyer 2018). changer fortheeuro area”et al.2018). (Benassy-Quéré Their proposals have initiated anintensive debate team ofprominent French economists have andGerman presented apaperwhichtheyregard as“a game www.worldcommercereview.com exchange domesticbonds into bondsofothermemberstates withoutanexchange rate risk. ‘currency wall’ isdifficult to surmount. Withinthe euro area this wallhasbeen removed sothat investors can instead, For itisconfronted risk. withacurrency institutionalinvestors that are required to holdsafe assets, this a Japanesepensionfundisnolongerwillingto holdJapanesegovernment bondsanddecidesto holdUStreasuries Thisrisk isaggravated specific by aneasyexit provides optionthat thesinglecurrency for investors. If, for example, vis-à-vis the other member states member other the vis-à-vis German manufacturing against exchange rate shocks shocks rate exchange against manufacturing German the integrity of the euro area. The euro has protected protected has euro The area. euro the of integrity the Above all, Germany must have a strong interest in in interest strong a have must Germany all, Above www.worldcommercereview.com lender of last resort would beabletolender oflastresort stabilisethesystem effectively. uncorrelated. In ‘large, systemic crises’ are risks correlated, andtheschemebreaks down. Thus, onlytheECBas systems) would banking soonreach itslimits.participating An insurance schemeiseffectiverisks are onlyif providedBut insuchasituation, sharing therisk by theEDIS(withatarget size of0.8%covered depositsof compartments”. Common fundsshould beprovided only“in large, systemic criseswhichoverburden oneorseveral national It also risks. requires country-specific that firstlossesshouldbeborne bythe relevant national compartment. The proposal for aEuropean (EDIS)envisages Insurance Scheme Deposit insurance premiums whichare pricing Two effective notvery proposals risksharing political for and von Weizsäcker 2011)are Council alsonotdiscussed. 2010,German ofEconomic Experts sharing’ would ButasthePolicy not even Insight address mention it, thisrisk. proposals for (Delpla sharing suchrisk vis-à-vis othercountries. Thus, that aproposal oneshouldexpect andFrench by German economists for ‘risk would Mark haveDeutsche thantheeuro, beenastronger currency sothat theprotection hasalsobeeneffective againstexchangemanufacturing rate shocksvis-à-vis theothermemberstates. Onecanalsoassumethat the Above all, Germany musthave astrong interest intheintegrity oftheeuro area. The euro hasprotected German would require more politicalintegration to become astablebuilding. unionisabuildingwhichnotyetIt finished. that themonetary isdueto thefact etal.seeit. It Benassy-Quéré to note that isnotdueto thisrisk “a isimportant maintained. It designedfiscal poorly andfinancial architecture”, as it takes”, whichwas regarded oftheeuro could thestability asanimplicitinsurance area be againstthisrisk, which hasmanifested itselfintheeuro Draghi’s crisis. OnlywithMario commitment to save theeuro “whatever The withtheeasyexit combination optionleadsto risk adenomination(BiniSmaghi2018) oftheinsolvency risk www.worldcommercereview.com and French banksin the years 2000-2007,which contributed to thecrisis. More generally, itisnotclearhow bond the ‘currency wall’ for investors. portfolio And itwas anexcessive cross-border banklending,above allby German already possibleundercurrent institutionalarrangements. As already mentioned, hasremoved thesinglecurrency in instrumentswhosereturns are ofunemployment independent andoutputdeclinesintheir homecountry.” Butthisis andCapital Marketof theBanking Union:“Euro area citizens andcorporations ableto shouldbe holdtheirsavings etal.proposeBenassy-Quéré market risksharingasanotherstabilisingfactor. Oneelement isthecompletion The limitsofmarket risksharing fires. of hugefires. But at thesameitisdesigned withsuchlimited capacitiesthat itwillnever beable to dealwithsuch forms resembleBoth sharing ofrisk theideaofestablishingafire whichcanonlybeactivated inthecase brigade problems. cyclical without major deficitonthecapitalmarket itshouldbepossibleto finance a an idealcountry temporary unlikely. thisis recommendations. largewith thecountry-specific very shock, In asituation witha And very for such As aspecifichurdle, access to thefund requires that amember state complies notonlywith thefiscalrulesbutalso addition,dueto thelimitedIn size ofthefundshockmustnotaffect too many memberstates simultaneously. better off ifitishit by theshockwithinfirst five yearsofthe existence ofthefund 4 percentage transfer points, ofonly0.5%national GDPisenvisaged. aone-time only Butthismakesacountry recession would receive acountry rather limited transfers. For an increase ofthenational unemployment rate by area GDP, thesize ofthefundislimited asaborrowing isexplicitly excluded. possibility As aresult, even inasevere states”. The authorscompare itto a“catastrophic lossinsurance” . With total annualcontributions of0.1%euro The second proposal envisages aEuropean forcapacity fiscal “large oneorseveral downturns affecting member www.worldcommercereview.com lack offiscaldisciplineinGreece camemuchdelayed inthe year 2010,andthenthe was sosuddenand reaction The oftheeuro developments have since thestart confirmed thisprediction. to thechronicThe market reaction cameto thefollowing assessment: Report this seemsoutofquestion.Butalmost20years agotheDelors this raises thequestionofwhether ‘market discipline’ canberegarded asastabiliserat all. For etal. Benassy-Quéré The pillarsfor authors regard theeuro disciplineascomplementary andmarket sharing area risk architecture. But Market discipline:governments underthecontrol ofmarkets? ofthe area inthesituation risk whenthefundamental becomes insolvency exactly manifest. to findbuyers forthejuniortranches otherwords, intimeofcrisis” . In theirschemefor would sharing risk fail market access since thistriggers exclusion from thecollateral ofnewissues.” pool that And theyseetherisk “it difficult maybe of changesinmarket sentiment.” Buttheyalsoadmitthat thisisonlythecase“so longassovereigns donotlosemarket a “safe assetintheeuro area would create asource ofdemandforeuro area sovereign debtthatisnot‘skittish’ intheface The isthecreation second sharing element risk ofmarket ofeuro area safe assets(ESBies). The authorsbelieve that effective insurance risk ofunemployment.for the member states. For littleornofinancial wealth at all, householdswithvery Unioncannotprovide Market Capital an canprovide markets of and equity distribution significant asymmetric wealth inthe risk sharing given the very imposed byimposed market forces too slow might either be and weak ortoo suddenanddisruptive.” borrowersofficial tend tochangeabruptlyand resultintheclosure of access tomarket financing. The constraints Rather thanleadingto agradual adaptationofborrowing costs, of market thecreditworthiness viewsabout that access to alarge capital market mayforsometimeeven facilitate thefinancingofeconomic imbalances. “ […]experience suggests thatmarket perceptions donotnecessarily provide strong andcompelling signalsand www.worldcommercereview.com A third isanewframework element for ofthereport fiscalpolicy. The proposal is basedontheassessment that the An expenditure rule setby wisemenandwomen future, thislooksmuchlikeanescapeclausefor theFrench economists. unlikelyfor […]”.Asare to sustainablewithhighprobability suchasituation be theforeseeable widelyexpected isvery time whenthedebtsofalleuro area countries onmarket thatdepend thoseofhighdebtcountries access – –particularly But how should thetransition bemanaged? The authorspropose that the newregime shouldbeintroduced “at a crisis ontheway –needsto firmly be recognised andaddressed inproposals to raise market discipline”. problem’‘transition –gettingto astate ofmore effective market disciplineandhigherstability, withouttriggering a The authors are aware mainlessonisthat the ofthisproblem, buttheyregard “The itasatransition problem only: fundamental ofinsolvency, risk thestrengthening disciplinehasthepotential ofmarket to even increase thisrisk. isnotconvincing.elements sharing risk While donotaddress theelements sharing ofrisk theeuro area’s most sum,thewholeconceptIn ofstabilisingtheeuro area by combining enhanced discipline withhomeopathic market areespecially questionableasfinancialmarkets dominated playersby mighty Sachs orBlackrock. Goldman like of thegovernments. disciplinecalls for Market governments that are underthecontrol ofmarkets. This concept is markets onitshead. thepastthere In was aconsensus amongeconomists that mustbeunderthecontrol markets aremarkets assigned adiscipliningrole over states. This thetraditional turns relationship between state and itmay sector have unionitimpliesthat thecontext ofthebanking itsmerits,In butinthecontext ofthemonetary addition,onemustaskwhether In ‘market discipline’ isanadequate concept for theorganisation oftheeuro area. the economists’ almostunscathed. thefinancialcrisis disciplinecould trustinmarket survive disruptive that thesystem could onlybesaved Draghi’s by Mario More intervention. generally, that itissurprising www.worldcommercereview.com follows: case for economics. David evidence-based Eddy (1990),whocoined theterm ‘evidence-based medicine’, putsitas (2010) andRogoff to derive atargetattempt scientifically failed. by Renowned Reinhart economists have madethe fiscal policy. MaastrichtFor the Treaty it was derived asthe average debtlevel ofthememberstates at that time. The addition,itisfarfromIn obvious that the60%target for thedebtlevel isasensiblemedium-term target for the debt target andthecorresponding expenditure path. of economics. Thus, for the thenominationcouncil has astrong ofspecific experts influence on theoutcome of the have biaseswhichinfluence thejudgements ideological that mustbemade given thelimitations ofthescience councilclear why andnotby government anelected theruleshould besetby anexpert orparliament. Economists There isnodoubtthat expenditure ruleshave astheyare theirmerits easierto follow than deficitrules. Butitisnot year. exceeds acountry thetarget If path allexcessive spendingmustbefinanced by juniorsovereign bonds. aconsistent medium-term expenditurechart path, andusethisto setanominalexpenditure ceiling for thecoming national-level fiscal shallproposecouncil shallbeestablished. arolling It target, medium-term debtreduction objective” operational ruleto andanexpenditure-based reach thistarget. For thispurpose, anindependent, The approach authorspropose withalong-term debttarget atwo-pillar “such as60%ofGDP, oramore bespoke fiscal discipline. andtheUSonother,and ofJapan,theUK, themuchlower deficitsofmemberstates speak for apronounced member states thisnot soobvious. Comparing thefiscalbalancesGermany, of France,Italy ontheonehand and fiscal rules“have notworked well”. While thisistruefor Greece, statistics, whichpublishedincorrect for thelarge anchoring apolicy, not to current butto evidence. practices experimental must ofexperts, orthebeliefs The policy to evidence. thepolicy Consciously andtying to“[E]xplicitly describingtheavailable apolicy evidence thatpertains www.worldcommercereview.com Source: IMFWorld Economic Outlook. Figure 1.Fiscal balances oflarge states member compared withJapan, theUKandUS(%of GDP) www.worldcommercereview.com envisage withlarge projects euro area (infrastructure, externalities defence, research, policy, industrial environment) that at leastalimited debtfinancingofpublicinvestments would bepossible. As anotherstep one forward, could concerning the zero’.‘black This would allow more room for andGrowth thegolden ruleintheStability Pact so For aproductive compromise, Franco-German sidemustmake afirststep theGerman by allowing some flexibility excuse explicit what for isreally notmaking required to stabilisethearchitecture oftheeuro area. thecurrentIn situation progress towards integration likely. afiscalpolicy isnot very But for economists thisisnotan would beenforced by ademocratically legitimised euro area finance minister andnot by myopic financial investors. With thetransfer responsibilities to thesupranational offiscalpolicy level, fiscaldisciplineofthememberstates debt mutualisation whichwould removerisk of euro area thespecificinsolvency membership. Thus, theonlyway to makeitstableisto goaheadwithpoliticalintegration. This would allow acomprehensive and19independent national fiscal policies. policy anunfinishedbuildingwithasupranationalreflects monetary oftheeuroThe instability area architecture isnotdueto a“poorly designedfiscal andfinancial architecture” . It The way forward US could fundamentally changetheperception ofthe financialsoundnessofthememberstates. for thememberstates. Substitutingthe60%target by atarget whichiscloser, say, level ofthe to thedebt-to-GDP strategy that to tries maketheeuro area more stableshouldentail anintensive analysis ofanadequate debttarget evidence (for example, intheUKlong-term historical average from 1700to 2016is99.5%;Figure 2). Thus, any The 60%target Maastricht isobviously anditlacksany basedoncurrent andbeliefs pertinent practices ofexperts The policymakers must determine whether the policy isjustified The must policymakers by theevidence.” determine whetherthepolicy by evidence evidence. must consistent identified,be be withand supported The described, pertinent andanalysed. www.worldcommercereview.com Source: BankofEngland, “A millenniumofmacroeconomic data”. Figure ratio, 2.UKDebt-to-GDP 1700-2016 www.worldcommercereview.com German Council of Economic Experts (2011),“European Council Redemption Pact”,German ofEconomic Experts 2011/12. inAnnual Report Eddy, D(1990),“Anatomy of aDecision”, oftheAmerican Journal Medical 263(3). Association Jandvon WeizsäckerDelpla, Proposal”, BlueBond (2010),“The Bruegel Policy Brief, May April Buti, M,GGiudice, JLeandro EMUrequires acoherent (2018),“Deepening andwell-sequenced package”, VoxEU.org, 25 Bini Smaghi,L(2018),“A stronger euro area through stronger institutions”, VoxEU.org, 9April constructive approach to euro area reform” Rey, ISchnabel, NVéron, BWeder diMauro, andJZettelmeyer (2018),“Reconciling risk sharingwithmarket discipline:A A,MBrunnermeier,Bénassy-Quéré, HEnderlein,EFarhi, MFratzscher, CFuest, JPisani-Ferry, Gourinchas, P-O PMartin, H References Wuerzburg Peter is Bofinger Professor International and Monetary EconomicsPolicy for at theUniversity of discipline’. The proposal could indeedbea ‘game changer’, butinto thewrong ■ direction. only by theestablishment ofindependent fiscal councils andbutalso by exposing governments to more ‘market of fiscalrulesand“sovereign concentration charges” . And itreduces thescope discretion for not national policy discretion”rules withpolicy . But it presents a framework that limits the scope for demand policies by the introduction CEPR Policy Insight91callsfor “a intheeuro shift area’s approach to reconcile fiscal prudencepolicies, withdemand and targets for publicdebtto helpful. GDPwould bevery which are financed by bondswithajoint liability. Finally, athorough andopen-mindedanalysis oftheadequate , CEPRPolicy Insight No. 91. www.worldcommercereview.com VoxEU.org This intheVoxEU column isaleadcommentary “Euro Debate Reform”. Area was originallypublishedon This article CMandKS (2010), Rogoff “GrowthDebt”, ina Reinhart, Time of American Economic Review100(2):573-78 misrepresentation”, CEPSCommentary, 19February. Pisani-Ferry, JandZettelmeyer (2018),“Messori andMicossi’s reading oftheFranco-German isa 7+7paper crux ofdisagreement oneuro area reform”,Micossi, S(2018),“The VoxEU.org, 5April www.worldcommercereview.com well-sequenced package significantrisks, and could lead to more, not fewer, rescues Marco Buti, Gabriele GiudiceMarco andJoséLeandro Buti,Gabriele argue that requires acoherent and the recent CEPR proposals seemunbalanced andcarry Deepening EMU Deepening www.worldcommercereview.com T loans (NPLs), as also acknowledged by the Eurogrouploans (NPLs),asalsoacknowledged have inFebruary 2018.Several packages beentabledand surpass, theECOFIN Council’s June2016roadmap for non-performing planto the BUandJuly2017Action tackle should bemore recognised. clearly Achievements at boththeEUandnational level are inlinewith,andsometimes point, the progressAs astarting madeinreducing inEurope risks –inparallel with,oraheadofmore – sharing risk Building ontheprogress made risks. policies, andare aggregated to withoutappropriate contain macroeconomic sequencingnecessary andfinancial and credibility acutecrises. liquidity As such, the proposals are mainly geared at increasing pressure market on fiscal as macroeconomic imbalances andadjustments withintheeuro area andtheredenomination to connected risk proposals significant seemsunbalancedrisks. andcarries The diagnosis ofthecrisis overlooks crucial issuessuch etal.putforward severalBenassy-Quéré attractive ideasonhow to reform EMU. At thesametime, themixof Commission’s initiatives (European Commission 2017b). indispensable components ofacomprehensive reform thesubsequent ofEMU(seeButietal.2017)andunderpins Commission’s May 2017Reflection Deepening EMU(EuropeanPaper on Commission 2017a)whichidentified – where thebiggest divisionslie. Their initiative overlaps andwithmuchofthesubstance inspirit oftheEuropean etal.2018)istherefore(Benassy-Quéré timely. suggestsways It for reconciling discipline risk-sharing withmarket The debate onEMUdeepeningisentering stage. acritical The contribution of14French economists andGerman fiscal risks fiscal could lead to financialdistress, ultimately more, requiring not fewer, rescues. attractive, significant themixseemsunbalancedrisks. andcarries The focus oftheproposals on reducing Area Reform debate argues that whiletheproposals inarecent CEPRPolicy are Insight bothtimelyand he debate ondeepening EMUisentering stage. acritical This column, contributing to VoxEU’s Euro www.worldcommercereview.com objective. A country not respecting itsfiscaltargets notrespecting objective. Acountry would face heightened pressure, market asultimately it would the etal.aimat making Benassy-Quéré ‘no-bailout’ 125 clause(Article TFEU) more credible, which isadesirable isoftheutmostimportance financialstability Preserving prevent theirresurgence loans(see progress theongoingfallinnon-performing reflecting Figure 1)and and risk to support in reduction, improve frameworks, insolvency andsecond chances, restructuring to defineamore gradual path risk sharing to are reinforce beingimplemented to further banks’ prudential management andstrengthen discipline, market to unsafe steps in the dark the in steps unsafe coherent and well-sequenced package, avoiding avoiding package, well-sequenced and coherent is a need to advance without delay, but with a a with but delay, without advance to need a is After all the effort to regain financial stability, there there stability, financial regain to effort the all After 1 . www.worldcommercereview.com Figure countries 1.Evolution loansinselected andtheEU ofnon-performing www.worldcommercereview.com Source: European Central Bank Figure countries 1.Evolution loansinselected andtheEU ofnon-performing www.worldcommercereview.com systems, whichexplains why they enjoy arisk-free status across alladvanced economies. treatment theregulatory If Sovereign role bondshave infundingpublicexpenditure for andasbenchmarks aparticular national financial the financialsystemMaking more resilient ex anteclarifying ‘who’would bearthecost ofagovernment default. to suchadefaultevent (seebelow); (2)improving theEMUarchitecture and (3) to makedefaultseven lesslikely; inevitable intheeuro area. This alternative approach would involve: thefinancialsystem more (1)making resilient economic, financial, andpolitical costs inthe andunlikelycasethatextreme asovereign debtdefaultbecomes As costless defaultsare anillusion,rather thanforcing defaultsitwould makemore senseto work to reduce the financial markets. prophecies, withuneven to reactions changesinperceptions market andcredibility ofgovernments, destabilising spillovers across assetsissuedby acountry, andacross jurisdictions. These proposals could generate self-fulfilling theproposals concern onlytheflowWhile showed in theory ofdebt, thecrisis thatfailwithcritical markets significant questions narrowcredit tranche onavery ofnational risks debt. This would takeEurope waters into and raises uncharted (overreaction) lines. andvertical neglect) The proposals by etal.concentrate Benassy-Quéré and bothliquidity forcesBut market mustbehandledwithcaution.Financial tend markets to operate alonghorizontal (benign requirecountry support. ESMcrisis their expenditure targets would issuejuniornational debt, whichwould beautomatically restructured shouldthe the equivalent orSDRM(Corsetti ofaSovereign Mechanism, etal.2016):governments Restructuring Debt missing be forced into outrightdefault. They focus therefore ondefining‘when’ or‘how’ defaultshouldtakeplace, through 2 . www.worldcommercereview.com analysts, academicsandsovereign debtmanagershave highlighted, are even barriers removed. ifregulatory the supplyofsafe assets, are unlikely to ofagenuine fulfilall the objectives European safe asset, as many market Sovereign etal.2016,ESRB2018),whileincreasing (Brunnermeier bond-backedsecurities diversification and change to theEUtreaties. and von Weizsäcker 2010),whileappealing, have at andwould limited thisjuncture politicaltraction require a across theEuro area. bonds(Delpla solutionssuchasEurobonds Mutualised Grauwe (De andJi2018)orBlue-Red it would increase thetotal supplyofEuropean andglobalsafe would assets. therefore It improve debtdynamics it would replace sovereign bondsonthebanks’ balance sheets, hence mitigating thesovereign-bank loop;and would avoid ‘sudden stops’ andreduce the financialfragmentation policy; that blunts thetransmission ofmonetary A genuineEuropean safe assetwould create alarge, homogenous, andhence liquideuro area-level it bondmarket; A stone that could hitmany birds shouldbeconsidered assoonpossible.package asset. This shouldnotbeseenasaway to delay progress butrather asanargument that alltheseelements ofthe progressing towards Unionandreaching theCapital Markets anagreement to launchagenuineEuropean safe etal,butonkeysteps toBenassy-Quéré Union, improve offinancial markets: completing Banking thefunctioning package. The rightsequencingwould dependnotjustonhaving adealonthedepositinsurance, asproposed by financing,indirect butonlyifsuch reform were implemented wisely, gradually, ofa well-sequenced andaspart reduce ofgovernment theimpact defaults, improve incentives for governments andavoid any of possibility reformA regulatory to reduce excessive concentration ofsovereign bondsinthebanks’ balance sheetscould the consequences could bematerial for andunpredictable financialstability. of banksovereign exposures were to bechangedinisolation, orwithaninappropriate combination orsequencing, www.worldcommercereview.com risks) andthefocusrisks) oftheproposals onreducingrisks fiscal could rather lead to financialdistress ultimately create risks. The diagnosis overlooks ofEMU(internal imbalances, somekeyaspects flows, liquidity redenomination sequencingishowever thepaper exact In unclear, elements are covered, notallnecessary andsomeproposals takesplace.sharing ofreforms. hastowithin apackage reduction continue, Risk butone shouldavoid changing thegoalpostbefore risk there isaneedto strengthen EMUthrough sharing, andrisk parallel reduction risk complementing each other The proposals etal.(2018)are inBenassy-Quéré welcome andthemainmessageshouldbeheard loudandclear: Conclusion insurance andthe backstop, whileitmay oftheECB’s alsosmoothenthereduction balance sheet. implementation ofconcentration charges, ofwhichcould theprospect helparapid agreement onboththedeposit that othersmay backtrack onagreed reforms (seeFigure introduction would facilitate 2).Its aprogressive significant common issuance discipline withmarket could overcome the reciprocal fear among memberstates Against thecurrent lackoftrustamongEuropean countries, anoptionbalancingandindissolublybinding marginal cost ofsovereign debtissuance, withoutraising theaverage costs for lower-rated borrowers). from thecommon issuer, whichmay well fiscaldiscipline(by betheESMorEIB–could exert directly raising the 61-65, Junckerand Tremonti 2010)–whereby thewholenational debtissubordinated to any fundingreceived would makethem more 2010: (Monti E-Bonds immuneto defaults. Among thenon-mutualisedoptions, so-called mutualisation insufficient quantities to replace theeuro area banks’ current holdingsof sovereign bonds, which A recent paper(Leandro andZettelmeyer 2018)concludes that safe assetscould beproduced without dangerously fragment even bondmarkets more. addition,introducingIn SBBSalongsideAccountability bonds, asproposed by etal,would Benassy-Quéré also www.worldcommercereview.com Source: Butietal. (2017). Figure 2.Possible forms for aEuropean safe asset www.worldcommercereview.com Bénassy-Quéré, A,MBrunnermeier,Bénassy-Quéré, HEnderlein, EFarhi, MFratzscher, CFuest, JPisani-Ferry, Gourinchas, P-O PMartin, H References European Commission. Authors’ note: The authorsare capacity attributed writingintheirpersonal andtheiropinionsshouldnotbe to the This intheVoxEU column isaleadcommentary “Euro Debate Reform” Area price (something thatwe alsoexperienced duringthelastcrisis)? thinmarket? to wouldwill itbe issuetheminavery Who enforce theirissuance? ifthere happens isnobuyer What at any are bonds meantto issuedonlyrarely If be policies? (ascountries would normallystickto thefiscal targets), how easy iffiscal happens 2. Suchas:What targets arebecause missed offorecast errors orsurpriseelements, rather thanwrong European Commission1. See (2016,2017c, 2018). Endnotes European Commission Policy, Strategy andCommunication, Directorate General for Economic andFinancial Affairs, at the EMU DeepeningandtheMacroeconomy oftheEuro Area (DGECFIN),andJoséLeandro for isDirector Marco General, ButiisDirector DGEconomic andFinancial Affairs,GiudiceGabriele isHeadofUnit, delay, butwithacoherent andwell-sequenced avoiding package, unsafe ■ steps inthedark. requiring more, notfewer, rescues. to After alltheeffort regain financialstability, there isaneed toadvance without www.worldcommercereview.com This article was originallypublished onVoxEU.comThis article Barroso. Monti, M(2010),"A newstrategy forthesinglemarket", to thePresident oftheEuropean Report Commission Manuel José Leandro, search Asset”, foraEuro Aand JZettelmeyer Safe Area (2018),“The PIIEWorking Paper 18-3. andGTremontiJuncker J-C would (2010),“E-bonds endthecrisis”, Financial Times, 6December. Level Task Force Assets. onSafe European Systemic Board (ESRB)(2018),Sovereign Risk bond-backed study, securities:afeasibility ofthe High- Report European Commission (2018),“Commission measures to address therisksrelated to NPLs”, 14March 2018,IP/18/1802. European Commission (2017c),“Completing Union”, theBanking COM(2017) 592,11October. ROADMAP”, COM(2017) 821,6December. European Commission (2017b),“Further steps towards completing Europe’s Union:a Economic andMonetary 291, 31May. European Union,” Commission ofthe (2017a),“Reflection Deepening EconomicAnd Monetary onthe Paper COM(2017) strengthenEuropean theresilience Commission ofEUbanks”, (2016),“Reformsto further 23November. Jandvon WeizsäckerDelpla, Proposal”, BlueBond (2010),“The BruegelPolicy Brief, May. Grauwe,De asset?”, PandYJi(2018),“How isasafe safe CEPSPolicy InsightNo. 2018-08. protecting society” anopen Corsetti, G,LFeld, RKoijen, LReichlin,RReis, HReyandBWeder diMauro (2016),“Reinforcing theEurozone and tranches”, ESRBWorking Paper No. 21. Brunnermeier, M,SLangfield, M Pagano, RReis, S Van Nieuwerburgh andD inthe VayanosSafety (2016),“ESBies: Buti, M,SDeroose, LLeandro, andGGiudice (2017),“Completing EMU” constructive approach to euro area reform” Rey, ISchnabel, NVéron, BWeder diMauro, andJZettelmeyer (2018),“Reconciling risksharingwithmarket discipline:A , VoxEU.org, 27May. , CEPRPolicy InsightNo. 91. , VoxEU.org, 13July. www.worldcommercereview.com Roel Beetsma and Martin Larch dilemma argue that thepolicy andMartin Beetsma Roel around acentral canonlybe overcome fiscalcapacity if fiscal Risk reduction and risk and risk reduction Risk risk sharing and risk reduction advance reduction andrisk inparallel sharing risk sharing inEUfiscal sharing policymaking www.worldcommercereview.com T smooth functioning of a monetary union pre-dates theeuro by crisis particular, quite of abit. In unionpre-dates thetheory ofamonetary smooth functioning area hasbeen.However,currency acentral the insightwould be ofhow fiscalcapacity (CFC) important for the drastic reminderThe ofhow euro incomplete of2011-2012was crisis aparticularly thearchitecture ofthesingle Completing EMUordefending thestatus quo? accompanied to strengthen by effort aserious existing elements risk of fiscal reduction. suchasa risk sharing central willonlybepoliticallyof fiscal fiscalcapacity feasibleand economically if effective andparcel ofany mustbepart reduction viablereform proposal. essence, In establishingnewarrangements willbeofcrucialimportance. reduction andrisk balance sharing between risk We are convinced thatrisk fiscal We share thisview. thiscolumn we In dimensionsandargue focus that findingtheappropriate onfiscalpolicy areboth fronts reduction andrisk complements, sharing –risk notsubstitutes. be won neitheronthebattleground ofthefirstbestnoronmoral high ground. Progress requires movement on apologists for ledby sharing France. risk etal.(2018)convincingly Bénassy-Quéré underscore that thedebate can had beenheldhostageby opposedcamps:theadvocates diametrically ledby reduction ofrisk Germany andthe long-lasting debate onhow to reform theeuro offers area. a It convincing synthesis in a discussionwhichuntil then The CEPRPolicy by Insight 14French acrucialstagein etal.2018)marks economists (Bénassy-Quéré andGerman fiscal rulesneed to receive more attention. canonlybeovercomecapacity advancerisk and inparallel.risk sharing reduction iffiscal Therefore, reform ofEU column, adding to VoxEU’s Euro Area Reform debate, dilemmaaround argues acentral that the policy fiscal consistently paying mistakesofothers, for ofamoral whileotherssee themselves diktat. policy victims This be whetherwe canprogress withintegration inacontext where somecountries perceive themselves as Unionseemsto debate steps for onthenext he keyquestioninthepolicy theEconomic andMonetary www.worldcommercereview.com integration hasbecome aeuphemismfor footing mistakesmadeby others. more billsofpolicy They are notat additional integration docitizens andtheirpoliticalrepresentatives really want. some euro In area countries, more Therefore, questionisnotwhetheraCFCneededto theunderlying complete theEMU;rather, how much more relevant thanever before. areas thecrisis by around andfiscal optimum currency 50 federalismyears. pre-date insightsYet, are theseearly risk reduction versus risk sharing risk versus reduction risk by diametrically opposed views on the need for for need the on views opposed diametrically by Progress with EMU deepening has been hampered hampered been has deepening EMU with Progress www.worldcommercereview.com on compliance withcommonly agreed fiscalrules. Hence, strengthening theEUfiscal framework andsettingup a There are several ways to access address concern, to theunderlying butonestandsout:making theCFCconditional governments lessattentive towards prudent fiscalpolicymaking? The debate. prominently lastone features inthepolicy How canwe particularly ensure aCFCdoesnotmake How should itbefunded–transfers, borrowing, abudget?And how should themoral hazard problem betackled? judgement? triggered –automatically orwithexpert Which shocksshoulditaddress orasymmetric? –symmetric The design ofaCFC raises many questions:what shouldittarget –unemployment orinvestment? How shoulditbe etal.(2018). Beetsma etal.(2015),Carnot et al.(2017),Abraham etal.(2015),Dolls contributionsearlier etal.(2017),and suchasBeblavý thatet al.2018)hasrecently isshared by many confirmedfor aCFC,support itsstrong others, support including call for aCFCaimed at dealingwith majoradverse shocks, theIMF(Berger isbecoming etal.2018,Arnold louder: To beclear, we are strongly infavour ofaCFC;we believe itisacrucialelement ofacomplete EMU. And indeed, the Two sidesofthesamecoin integration, becausethat’s where intheform citizens oftaxes impact seethemostdirect andtransfers. integration.areas ofeconomic andmonetary We weight inrelation would particular addthat to itcarries fiscal when puttingforward reform proposals. Clearly, etal.(2018)appliesto allpolicy thiskeymessageofBénassy-Quéré The current impassecanonlybeovercome ifwe accept ofbothcampsandtaketheminto thereservations account moral intransigence oftheothercamp. contrast underscore thebenefitsofmore fiscal integration forthe oftheEMUandbemoan overall stability all convinced integration that thebenefitsoffurther outweigh its costs, Other especiallyfiscalones. countriesin www.worldcommercereview.com system simplification isthemagic hasputoffalmosteveryone word. Almostall proposals put inthe recent forward There convergence hasbeenasurprising ofviews onhow to overhaul theSGP. Since thecomplexity ofthecurrent making. realm offiscalpolicy elements ofdiscretion economic are contingencies, lessusedto tackle butto solve problems that lieoutsidethe more ‘intelligent’. The outcome isanexcessively complex setofrulesthat few understandand where themany Initially, thepredicament was blamedonthe ‘stupidity’ oftherules, butthingsdidnotimprove asrulesbecame consolidation measures hadto beimplemented,pro-cyclical giving to rise misgivings. accumulated sufficient buffers tolet automatic stabilisersdampenthedeclinein aggregate demand. Painfuland member states to takeadvantage ofeconomic goodtimes. Whenever adownturn arrived, somecountries hadnot oftheSGP hasnotbeenimpressive. we assessment,If adjustfor theimpact didnotpush intheshifting thecycle It and debt. unions, whichinclude acentral fiscalinstrument andonesinglesovereign canafford bondmarket, higherdeficits the US,Japan,orUKare inaworse shape. What thisviewoverlooks isthat complete economic andmonetary argumentA typical to substantiate therosier appraisal isto say suchas that publicfinances inotherjurisdictions assessment by EUinstitutionshasbecome more sanguine:theSGPisagainconsidered to have worked. attempts were now, madeto Right amendshortcomings. several after years ofsolideconomic growth, the nicely. hadbroken After thecrisis outanduntil recently, theconsensus was that theSGPhadfailed, andvaliant The assessment ofhow theSGPhas worked pattern. exhibits aclearcyclical The post-2007 illustrates crisis this not work. CFC mustbeseenasonepackage. Trying to push aheadwithaCFCwithoutimproving thecommon fiscalruleswill www.worldcommercereview.com As aresult, anindependent assessment willgaininimportance its original role oftheguardian ofthe Treaty to amore conventional executive branch that takespolitical decisions. decision maker. economic andpolitical integrationWith further theEuropean executive willinevitably move from theassessment assessment, public itenhancesshould provide andby theaccountability making ofthe animpartial decision willandshouldfollow prevailing isthe politicalmajorities. It ‘watchdog’ rather thanthe ‘prosecutor’ who the EUfiscalsurveillance In ‘judge’ democratic isthedecisionmakerendowed legitimacy, withthenecessary andits interpretgenerally meant thelaw to impartially inlight oftheavailable evidence. While we share theideaofseparating roles, we findthe expressions ‘prosecutor’ and ‘judge’ misleading. The ‘judge’ is steps are to betakenundertherules. etal.(2018)refer Bénassy-Quéré to therole ofthe ‘prosecutor’ andthe ‘judge’. developmentsassessment vis-à-vis offiscalpolicy commonly agreed rulesandthepoliticaldecisiononwhether oftheEFB(EFB2017). andthethinking a proposal that isinlinewithourthinking The proposal isto separate the key questioniswhoshouldexercise etal.(2018)raise it. this fundamental Bénassy-Quéré questionandadvance judgement the isinevitableintheapplication offiscalrules, asitisinallareasExpert ofeconomic policymaking; with thisviewisthat itisstuckinthefallaciousparadigm ofthecomplete contract. in order (Bini-Smaghi2018). to consistency produce sensibleresults cross-country andensureThe strict problem measures, andmuchmore)details andspecialcircumstances that need to betakeninto (thecycle, one-off account doubtsimplification they thinksimplification will isanillusion,becausetherework; observers Some are toomany parsimonious useofescapeclauses(to account for unforeseen contingencies). (reducingobjective government debt),oneoperational rule(cappingexpenditure growth, for example), anda past, includingby the European Fiscal Board (EFB) 1 , are organised around thesamebasicelements: onemain 2 . www.worldcommercereview.com country is ineconomic bad times.country reversed – to a rainy-day qualifiedmajority fund to beused–againbasedona timethe Council decision–thenext of EUexpenditure allocated to that memberstate would betransferred to adecisionofthe Council –subject with For aslonga memberstate isfound to runafoul ofkeyelements ofcommonly agreed rules, a given percentage mechanismcouldunderlying beasfollows. not beingconsistent, butby thesupranational institution.Different designs are imaginable inpractice, butthe with commonly agreed rules. The charge would notbeimposedby themarkets, whichhave atrack record for An alternative to theissuance ofjuniordebtcould bea charge’‘budgetary leviedat theEUlevel for non-compliance junior debt? debt (realise inasmooth that donot way). financialmarkets react Third, how canonelegallyenforce theissuance of may high–markets bedisruptedif theexisting seniordebtstock iftheyare isvery reluctant to accept thejunior compliance withtheexpenditure involves benchmark judgement. Second, placement ofjuniordebtmay berisky to beableto unambiguouslyestablishthat thethreshold itsissuance activating hasbeenexceeded – assessing Junior debtmay indeedfulfilauseful role inthis regard. However, risks we alsosee to itsissuance. First, oneneeds would encourage fiscaldiscipline. imposed by theSGP’s expenditure withjuniordebt. benchmark The higheryieldonjuniorthanseniordebt Quéré etal.(2018)putforward anovel ideawhereby euro area countries shouldfinance newdebtin excess oflimits markets. Since institutionshave failed, argument theunderlying goes, itistimefor to markets step in.Bénassy- commentaries, etal.(2018),have includingBénassy-Quéré emphasisedthepotentially increased role offinancial has proved erratic, onfiscalpolicymaking Although thediscipliningeffect ofthefinancialmarkets recent The role ofmarket discipline www.worldcommercereview.com 1. The EFB has outlined its proposals for simplification in its first Annual Report 2017. Other prominent proposals, in 2017. 1. The EFBhasoutlineditsproposals forsimplification Annual initsfirst Report Endnotes Secretariat at theEuropean Fiscal Board Business, University ofAmsterdam, oftheEuropean Member Fiscal Larch isHeadof Board, andMartin is MN Professor Beetsma Roel of Pension Economics and Vice-Dean of the Faculty of Economics and attention. ■ to theCFCismadeconditional onaneffective fiscal framework. Consequently, fiscalrulesneed to receive more aswe fact, haveIn for argued, aproperly designed politicalsupport central willonlyemerge ifaccess fiscalcapacity asaprerequisite sharing risk to makeprogress withthefiscalarchitecture ofEMU. common ground to break thedeadlock. We agree with thisapproach andview an exchange and reduction ofrisk betaken. should actually The contribution by etal.(2018)contains Bénassy-Quéré welcome suggestionsfor finding versus sharing. risk stepsThere ofintegration debate isincreasing aboutwhether further doubtinthepolicy Progress withEMUdeepeninghasbeenhampered by opposedviews diametrically ontheneedfor reduction risk Concluding remarks would haveIt to beintroduced withtheoverhaul ofthefiscalframework. the reasons mentioned above, charge would unlikelybeeffective thebudgetary withthe current setoffiscalrules. for Financial the2021-2027Multiannual Framework even aimsat itto extending areas suchastheruleoflaw. For Conditionality onEUexpenditure isnotnewandhasslowly grown over theyears. The recent Commission proposal www.worldcommercereview.com Claeys, G, Z Darvas andALeandroClaeys, G,ZDarvas (2016),“A proposal to revive theEuropean fiscal framework”, Bruegel Policy No. ofEconomics 17/025,Solvay andManagement. Brussels School andGMourreCarnot, (2017),“Fiscal N,MKizior Asimulation stabilisation intheEuro-Area: exercise”, CEB Working Paper, Bini-Smaghi, L(2018),“A stronger euro area through stronger institutions” Policy Paper.Research Department Berger, H,GDell’Ariccia (2018),“RevisitingtheEconomic andMObstfeld Case forFiscal UnionintheEuro Area”, IMF constructive approach to euro area reform” Rey, ISchnabel, NVéron, BWeder diMauro andJZettelmeyer (2018),“Reconciling risksharing withmarket discipline: A A,MBrunnermeier,Bénassy-Quéré, HEnderlein,EFarhi, MFratzscher, CFuest, JPisani- Ferry, Gourinchas, P-O PMartin, H world trade”, ECBWorking PaperNo. 2137. R,SCimaandJCimadomo(2018),“ABeetsma, minimalmoral hazard central stabilisationcapacity fortheEMUbasedon No.Document 401. Beblavý, M,DGros andIMaselli(2015),“Reinsurance ofnationalunemployment schemes”, benefit CEPS Working Note,Discussion 18/03. Arnold, N,BBarkbu, ETure, HWang andJYao (2018),“A central fiscal stabilization forthe Area”,Eurocapacity IMFStaff Insurance Mechanism”, mimeo, EUIandUPF. Abraham, A,JBrogueira ofaEuropean RMarimonandLMayr(2017),“On Unemployment theDesign deSousa, References is essentialto make asimplification work inpractice. 2. Interestingly, notalladvocates ofaradical simplification ofthe SGP thematisetheseparation of roles, which believewe al. (2018). addition to thoseincludedinCEPRPolicy InsightNo. 91,includeEyraud andWu (2015),Claeysetal. (2016) andEyraud et , CEPRPolicy Insight No. 91. , VoxEU.org, 9April. www.worldcommercereview.com This intheVoxEU column isaleadcommentary “Euro Debate Reform” Area andwas originallypublishedVoxEU.org on flexibility, andenforceability, DiscussionNotesNo. IMFStaff 18/04. Eyraud, Pattillo LledoandCA AHodge, fiscal (2018),“Second-generation VDuarte L,XDebrun, rules:balancingsimplicity, Eyraud, LandTWu (2015),“Playing by therules:Reformingfiscal governance in Europe”, IMF Working Paper, No. 15/67. European Fiscal 2017. Board (2017),Annual Report of different alternatives usingmicro data”, CESifo Working Paper, No. 5581. M,CFuest,Dolls, DNeumannandA.Peichl (2014),“An unemployment insurance schemefortheEuro Acomparison Area? Contribution, No. 2016/07.