4 Lectures on the €uropean
crisis
Lecture 4: The philosophy of the EMU economic
polices; fiscal policies of the monetary union; fiscal
governance; the debate on the fiscal multipliers
The “philosophy” of the EMU economic policies
• Independent CB  monetary policy is ineffective in the long run;
price stability is the predominant target
• Budget deficit crowds out private investment. So balanced budget
rules  Maastricht Treaty and Stability and Growth Pact reinforced
by most recent measures (six and two packs; fiscal compact)
• Full employment pursued at national level through market and
(mainly) labour market flexibility.
• A full anti-Keynesian program; no ex-ante coordination of budget
and monetary policies.
• Otmar Issing  no need for ex ante coordination. If countries follow
the rules there will be an ex post coordination by he market.
Alternative view
• Monetary policy is effective; of course, expansionary policies raise
inflation, but a “natural unemployment rate” defined at a zero (or
very low) inflation rate is a fiction useful to keep wages under
control. Income policy should be used to keep inflation under
control.
• Fiscal policy does not crowd out private investment which are, in
general, not at full employment level
• Coordination between fiscal and monetary policy at an international
level is necessary in order to permit fiscal expansions, when
necessary, at low interest rates.
• Full employment is an international question, not a national one!
International coordination is necessary.
• There is not a potential output at which, with price and wages
flexibility, the economy tends to; potential output depends on long
term aggregate demand and if AD is depressed, productive
capacity is lost.
The European economic governance
http://europa.eu/rapid/press-release_MEMO-13979_en.htm
• Crisis prevention: Fiscal policy regulated by the GSP (Amsterdam 1997)
and by a baroque number of new regulations approved in the last years.
• The Stability and Growth Pact was established at the same time as
the single currency in order to ensure sound public finances.
However, the way it was enforced before the crisis did not prevent
the emergence of serious fiscal imbalances in some Member States.
• It has been reformed through the Six Pack (which became law in
December 2011) and the Two Pack (which entered into force in May
2013), and reinforced by the Treaty on Stability, Coordination and
Governance (which entered into force in January 2013 in its 25
signatory countries).
• The new rules (introduced through the Six Pack, the Two Pack and
the Treaty on Stability, Coordination and Governance) are grounded
in the European Semester, the EU's policy-making calendar.
• Crisis management
• EFSF and ESM
The European economic governance: Growth and
stability pact
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The SGP contains two arms – the preventive arm and the corrective arm. The
preventive arm seeks to ensure that fiscal policy is conducted in a sustainable
manner over the cycle. The corrective arm sets out the framework for countries to
take corrective action in the case of an excessive deficit.
The cornerstone of the preventive arm is the country-specific medium-term
budgetary objective (MTO), defined in structural terms (i.e. in cyclically adjusted
terms and net of one-off and other temporary measures). Member States outline
their medium-term budgetary plans in stability and convergence programmes
(SCP), which are submitted and assessed annually in the context of multilateral
fiscal surveillance under the European Semester.
The corrective arm is made operational by the Excessive Deficit Procedure (EDP), a
step-by-step procedure for correcting excessive deficits that occur when one or
both of the rules that the deficit must not exceed 3% of GDP and public debt must
not exceed 60% of GDP (or at least diminish sufficiently towards the 60%) defined
in the Treaty on the Functioning of the EU (TFEU or Treaty) are breached.
Non-compliance with either the preventive or corrective arms of the Pact can lead
to the imposition of sanctions for euro area countries. In the case of the corrective
arm, this can involve annual fines for euro area Member States and, for all
countries, possible suspension of Cohesion Fund financing until the excessive
deficit is corrected.
The European economic governance: the European
semester
• The European Semester represents a yearly cycle of EU economic policy
guidance and country-specific surveillance. Each year the European
Commission undertakes a detailed analysis of EU Member States'
programmes of economic and structural reforms and provides them with
recommendations for the next 12-18 months.
• Within the European semester the European authorities intervene in the
formulation of national fiscal policies (ex ante coordination)
• (e.g. the Commission in November had reservations about the Italian
budget )
The European semester: some relevant dates
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October: Euro area Member States submit draft budget plans for the following year
to the Commission (by 15 October). If a plan is out of line with a Member State's
medium-term targets, the Commission can ask it to be redrafted.
November: The Commission publishes its opinions on draft budget plans. The Alert
Mechanism Report (AMR) screens Member States for economic imbalances.
December: Euro area Member States adopt final annual budgets, taking into
account the Commission's advice and finance ministers' opinions.
February/March: It is around this time that the Commission publishes in-depth
reviews of Member States with potential imbalances (those identified in the AMR).
April: Member States submit their Stability/Convergence Programmes (mediumterm budget plans) and their National Reform Programmes (economic plans),
which should be in line with all previous EU recommendations. Eurostat publishes
verified debt and deficit data from the previous year, which is important to check if
Member States are meeting their fiscal targets.
June/July: The European Council endorses the CSRs, and EU ministers meeting in
the Council discuss them. EU finance ministers ultimately adopt them in July.
Six pack
• Entered into force on 13 December 2011;
• Five Regulations and one Directive (that is why it is called six-pack);
• Applies to 27 MS with some specific rules for euro-area Member
States, especially regarding financial sanctions;
• The six-pack does not only cover fiscal surveillance, but also
macroeconomic surveillance under the new Macroeconomic
Imbalance Procedure.
• In the fiscal field, the six-pack strengthens the Stability and Growth
Pact (SGP). According to the SGP Member States' budgetary
balance shall converge towards the country-specific medium-term
objective (MTO) - so-called preventive arm - and the general
government deficit must not exceed 3% of GDP and public debt must
not exceed 60% of GDP (or at least diminish sufficiently towards the
60% threshold). The six-pack reinforces both the preventive and the
corrective arm of the Pact, i.e. the Excessive Deficit Procedure
(EDP), which applies to Member States that have breached either the
deficit or the debt criterion.
Six Pack
– The six-pack ensures stricter application of the fiscal rules by
defining quantitatively what a "significant deviation" from the
MTO or the adjustment path towards it means in the context of
the preventive arm.
– Moreover, the six-pack operationalizes the debt criterion, so that
an EDP may also be launched on the basis of a debt ratio above
60% of GDP which would not diminish towards the Treaty
reference value at a satisfactory pace (and not only on the basis
of a deficit above 3% of GDP, which has been the case so far).
– Financial sanctions for euro-area Member States are imposed in
a gradual way, from the preventive arm to the latest stages of the
EDP, and may eventually reach 0.5% of GDP. The six-pack
introduces reverse qualified majority voting (RQMV) for most
sanctions, therefore increasing their likelihood for euro-area
Member States. (RQMV implies that a recommendation or a
proposal of the Commission is considered adopted in the
Council unless a qualified majority of Member States votes
against it.)
Treaty on Stability, Coordination and Governance (TSCG)
• Entered into force on 1 January 2013.
• The fiscal part of the TSCG is referred to as "Fiscal Compact".
Requires contracting parties to respect/ensure convergence towards
the country-specific medium-term objective (MTO), as defined in the
SGP and Six Pack (e.g. convergence to 60% at the pace of 1/20 per
year).
• Lower limit of a structural deficit (cyclical effects and one-off
measures are not taken into account) of 0.5% of GDP; (1.0% of GDP
for Member States with a debt ratio significantly below 60% of GDP).
• These budget rules shall be implemented in national law through
provisions of "binding force and permanent character, preferably
constitutional". ( this is the real novelty of the TSCG). Compliance
with the rule should be monitored by independent institutions
• European Court of Justice (CoJ) may impose financial sanction
(0.1% of GDP) if a country does not properly implement the new
budget rules in national law and fails to comply with a CoJ ruling that
requires it to do so.
Two Packs
• Approved 13 May 2013. Reinforces the role of the Commission in the
evaluation of national budgets
• As part of a common budgetary timeline, euro-area Member States
shall submit their draft budgetary plan for the following year to the
Commission and the Eurogroup before 15 October, along with the
independent macro-economic forecast on which they are based.
• This builds on the Stability and Growth Pact (SGP), under which
Member States present the main characteristics of their mediumterm public finance plans to the Commission and the Council in
spring (in Stability or Convergence Programmes). The exercise in
autumn introduced by the two-pack allows monitoring and sharing
information on MS budgetary policies closer to their adoption. The
Commission analyses if the draft budget is in line with the SGP and
the recommendations from the European Semester (which the
country has received in May/June).
• If the Commission assesses that the draft budgetary plan shows
serious non-compliance with the SGP, the Commission can require a
revised draft budgetary plan.
Macroeconomic Imbalance Procedure (MIP) (Included in the Six Pack)
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The Macroeconomic Imbalance Procedure (MIP) is a surveillance mechanism that aims to identify
potential risks early on, prevent the emergence of harmful macroeconomic imbalances and correct
the imbalances that are already in place.
The alert mechanism consists of an indicator-based scoreboard complemented by an economic
reading thereof presented in an annual Alert Mechanism Report (AMR).
On this basis, the Commission decides for which countries it will prepare
country-specific in-depth reviews.
In the preventive arm this is part of the integrated package of
recommendations under the European semester. If the Commission instead
considers that there are severe or excessive imbalances that may
jeopardise the proper functioning of the Economic and Monetary Union, it
may recommend to the Council to open an Excessive Imbalance Procedure
(EIP) which falls under the corrective arm of the new procedure.
In case the in-depth review points to severe or excessive imbalances in a
Member State that may jeopardise the proper functioning of the Economic
and Monetary Union, the Council may declare the existence of an excessive
imbalance and adopt a recommendation asking the Member State to
present corrective actions within a specified deadline.
Scoreboard indicators: a boring and expected list with few (limited)
exceptions
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3 year backward moving average of the current account balance as
percent of GDP, with thresholds of +6% and -4% ;
net international investment position as percent of GDP, with a
threshold of -35%;
5 years percentage change of export market shares measured in values,
with a threshold of -6%;
3 years percentage change in nominal unit labour cost, with thresholds of
+9% for euroarea countries and +12% for non-euroarea countries;
3 years percentage change of the real effective exchange rates based on
HICP/CPI deflators, relative to 41 other industrial countries, with thresholds
of -/+5% for euroarea countries and -/+11% for non-euroarea countries;
private sector debt (consolidated) in % of GDP with a threshold of
133%;
private sector credit flow in % of GDP with a threshold of 15%;
year-on-year changes in house prices relative to a Eurostat
consumption deflator, with a threshold of 6%;
general government sector debt in % of GDP with a threshold of 60%;
3-year backward moving average of unemployment rate, with a threshold of
10%;
year-on-year changes in total financial sector liabilities, with a threshold of
16.5%.
Limits: bad Economics and morality play
• Why the asymmetry +6%/-4% CA surpluses?  CA surpluses are a
vice from the international economy point of view. Stop the morality
play in Economics.
• Why only a negative NIP is sanctioned? Huge positive NIP must as
well.
• Why in case of imbalances action must be taken at national level only?
This is again a morality play (YOU are guilty) and bad Economics:
• “In case the in-depth review points to severe or excessive imbalances
in a Member State that may jeopardise the proper functioning of the
Economic and Monetary Union, the Council may declare the existence
of an excessive imbalance and adopt a recommendation asking the
Member State to present corrective actions within a specified deadline.
Then, …, the Member State is obliged to present a corrective action
plan (CAP) setting up a roadmap to implement corrective policy
actions. The CAP should be a detailed plan for corrective actions with
specific policy measures and implementation timetable. As regards the
content of the CAP it is clear that the policy response to
macroeconomic imbalances has to be tailored to the circumstances of
the Member State concerned and where needed will cover the main
policy areas, including fiscal and wage policies, labour markets,
product and services markets and the financial sector. Moreover,
efficiency and credibility derive from consistent approaches across
policy strands.”
Macroeconomic Imbalance Procedure for Germany: much
ado about nothing
• Daniel Gros argues that the 13 November announcement of the
European Commission that Germany is running an excessive
current account surplus appears to be much ado about little. All the
Commission can, and will, do is to start an ‘in depth analysis’. This
might lead to strong political reactions and an enormous echo in the
media. But nothing of concrete substance is likely to follow.
(http://www.ceps.eu/book/macroeconomic-imbalance-procedure-and-germany-whensurplus-%E2%80%9Cimbalance%E2%80%9D)
The mysterious Golden rule: Let us (Letta’s) have a dream
• In principles “well behaved” countries, those not under a EDP, will be
able to exclude the following year some public investment from the
deficit. Spain and France decided not to well behave, and are in
principle subject to the EDP. But they grew (or better, they declined
less) than Italy. In spite of huge austerity Oli Rehn (I refrain from
defining its intelligence) said no. We do not trust Italy’s efforts. They
asked more austerity! They are right not to trust the Italian
government. The question is that all the European policy framework
is mad.
European acronymia: EFSF and ESM
• The European Financial Stability Facility (EFSF) was created by the
euro area Member States following the decisions taken on 9 May
2010 within the framework of the Ecofin Council. The EFSF’s
mandate is to safeguard financial stability in Europe by providing
financial assistance to euro area Member States within the
framework of a macro-economic adjustment programme.
• To fulfill its mission, EFSF issues bonds or other debt instruments on
the capital markets. The proceeds of these issues are then lent to
countries under a programme. The EFSF may also intervene in the
primary and secondary bond markets, act on the basis of a
precautionary programme and finance recapitalisations of financial
institutions through loans to governments.
• EFSF was created as a temporary rescue mechanism. In October
2010, it was decided to create a permanent rescue mechanism, the
European Stability Mechanism (ESM). The ESM entered into force
on 8 October 2012.
• From this date onwards, the ESM will be the main instrument to
finance new programmes. In parallel to the ESM, the EFSF will
continue with the ongoing programmes for Greece, Portugal and
Ireland.
EFSF
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The Facility act after a support request is made by a euro area Member State and a
country programme has been negotiated with the European Commission and the IMF
and after such a programme has been accepted by the euro area finance ministers
and a Memorandum of Understanding (MoU) is signed. This would only occur when
the country is unable to borrow on markets at acceptable rates.
any financial assistance to a country in need is linked to strict policy conditions which
are set out in a Memorandum of Understanding (MoU) between the country in need
and the European Commission.
Following the increase of guarantee commitments to €780 billion, EFSF’s effective
lending capacity is intended to be €440 billion. This is explained by the credit
enhancement structure which includes an overguarantee of up to 165%
On 28 November 2010, the ECOFIN Ministers concurred with the European
Commission and the ECB that providing a loan to Ireland was warranted to safeguard
the financial stability in the euro area and the EU as a whole. The total lending
programme for Ireland is €85 billion.
Following the formal request for financial assistance made by the Portuguese
authorities on 7 April 2011, the Eurogroup and ECOFIN Ministers agreed to grant
financial assistance on 17 May. The financial package of the programme will cover
financing needs up to €78 billion.
At the euro zone summit held on 26 October 2011, euro zone Heads of State or
Government agreed to a second financial assistance programme for Greece. The
details of this programme were agreed by the Eurogroup on 21 February 2012. As
part of the second bailout for Greece, the loan is shifted to the EFSF, amounting to
€164 billion
ESM
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The European Stability Mechanism is the permanent crisis resolution mechanism for
the countries of the euro area. The ESM issues debt instruments in order to finance
loans and other forms of financial assistance to euro area Members States.
The decision leading to the creation of the ESM was taken by the European Council
in December 2010. The euro area Member States signed an intergovernmental treaty
establishing the ESM on 2 February 2012. The ESM was inaugurated on 8 October
2012.
For this purpose, the ESM is entitled to raise funds by issuing financial instruments
or by entering into financial or other agreements with ESM Members, financial
institutions or other third parties.
All financial assistance to Member States is linked to appropriate conditionality.
The ESM may provide stability support by:
-providing loans to countries in financial difficulties,
purchasing bonds of an ESM Member State in primary and secondary debt markets,
providing precautionary financial assistance in the form of a credit line,
financing recapitalisations of financial institutions through loans to governments
including in non-programme countries.
The ESM’s maximum lending capacity is €500 billion. During the Eurogroup meeting
held on 30 March 2012, it was decided that the EFSF would continue to fund the
existing Facility Agreements for Portugal, Ireland and Greece.
ESM
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Stability support loans within a macro-economic adjustment programme. The
objective is to assist ESM Members that have significant financing needs but have to
a large extent lost access to market financing, whether because they cannot find
lenders or because lenders will provide financing only at excessive prices that would
adversely impact the sustainability of public finances.
Precautionary financial assistance The objective of ESM precautionary financial
assistance in the form of credit lines is to support sound policies and prevent crisis
situations by allowing ESM Members to secure ESM assistance before they face
major difficulties raising funds in the capital markets. Precautionary financial
assistance aims at helping ESM Members whose economic conditions are still
sound to maintain continuous access to market financing by reinforcing the
credibility of their macroeconomic performance while ensuring an adequate safetynet.
Primary Market support facility The ESM may engage in primary market
purchases of bonds or other debt securities issued by ESM Members to allow them
to maintain or restore their relationship with the dealer/investment community and
therefore reduce the risk of a failed auction. It would also serve to increase efficiency
of ESM lending.
Conditions would be those of the macroeconomic adjustment programme or
precautionary programme.
As announced by ECB President Mario Draghi on 6 September 2012, Outright
Monetary Transactions, i.e. is the purchase of euro area sovereign bonds on the
secondary market by the ECB, will be considered for future cases of EFSF/ESM
macroeoconomic adjustment programmes or precautionary programmes, provided
that they include the possibility of EFSF/ESM primary market purchases.
ESM
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Secondary Market Support Facility The Secondary Market Support
Facility aims to support the good functioning of the government debt markets
of ESM Members in exceptional circumstances where the lack of market
liquidity threatens financial stability, with a risk of pushing sovereign interest
rates towards unsustainable levels and creating refinancing problems for the
banking system of the ESM Member concerned. An ESM secondary market
intervention is intended to enable market-making that would ensure some
debt market liquidity and incentivise investors to further participate in the
financing of ESM Members.
Bank recapitalisations The aim of a loan for recapitalising financial
institutions is to preserve financial stability of the euro area as a whole and
of its Member States by addressing those specific cases in which the roots
of a crisis situation are primarily located in the financial sector and not
directly related to fiscal or structural policies.
Will the ESM make loans directly to financial institutions?
Currently, the ESM may only lend to euro area Member States. However, at
the euro area summit on 29 June 2012, it was proposed that once an
effective supervisory mechanism is established for banks in the euro area,
involving the ECB, following a regular decision the ESM could have the
possibility to recapitalise banks directly.
ESM
• On 25 June 2012, the Spanish government made an official request
for financial assistance for its banking system to the Eurogroup for a
loan of up to €100 billion.The results of the diagnostic exercise,
commissioned by the Spanish authorities to external evaluators,
indicated that the additional capitalisation needs of the Spanish
banking sector as a whole could be estimated to be in a range of
€51-62 billion. Including an additional safety margin, these capital
needs would remain within the envelope approved by the Eurogroup
of up to €100 billion in total.
• The programme will address the exceptional financial, budgetary and
structural challenges that Cyprus is facing. The total amount of
financial assistance, agreed by the Eurogroup, is up to €10 billion.
Out of this amount, the ESM will provide approximately €9 billion,
and the IMF will contribute around €1 billion.
Comments
• Funds collected by the ESM are guaranteed by the same troubled
states, a vicious circle. Only the ECB can guarantee the ESM.
• The ESM plays the role of the ECB without the printing press!
• Proposals that the ESM functions as a bank, that is uses its capital as
leverage to borrow from the ECB (this is a way to circumvent the
prohibition to the ECB to buy sovereign debt).
• Prohibition to the ESM to lend directly to troubled banks
• Small size in the case of a default risk of a major country. Indeed the
ECB is the only institution that can avoid big defaults. It has always
been so, it cannot be otherwise; CBs have been invented with that
purpose!
The debate on the fiscal multiplier
Y
1
[Ca  I  G  E ( )]
1  c[1  t ]  m( )
• When G falls or t rises, Y will fall. The question is the dimension of the
fall. Strong debate over 2011-13 on the size of the multipliers, that is
on the effects of fiscal austerity (or of the opposite fiscal expansion).
• A multiplier of 1.5, for instance, means that $1 in governmentspending cuts reduces GDP by $1.50; a multiplier of 0.5 means a $1
cut in spending only reduces GDP by 50 cents.
• Keynesians  the multipliers are large
• supporters of expansionary fiscal retrenchment or of Ricardo-Barro
effect  multipliers are low
The conservatives’ viewpoint
• Ricardo-Barro effect: if t falls, Y will remain constant since people
expect more future taxes, so they will save they save all the extraincome they receive via tax-reductions. Likewise, in case of fiscal
austerity if t rises, people will save less expecting to pay less taxes
in the future, so non effects on Y.
• On Ricardo-Barro  during a crisis people consume less than they
like to; so if they get extra-income (through lower taxes or by
getting a subsidy or a job), they will spend more. Conversely  if
during a crisis taxes are increased, people will might save less but
just because they feel impoverished! Or, if they can, they save the
same being afraid of the future.
• Expansionary fiscal retrenchment (Alberto Alesina and Bocconi
boys)  austerity and leads to higher credibility of long-run budget
sustainability and to lower interest rates that help the adjustment in
a virtuos circle
In Europe conservatives have lost in theory but
(unfortunately) prevail in practice (they have not won in
Germany)
• Further and further empirical estimates of the fiscal multipliers have
shown that they are larger than 1, often much larger; they are large
in depressions, when capacity and labour are under-utilised; they
are larger if monetary policy is cooperative keeping interest
payments low.
This is from Krugman
References
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http://ec.europa.eu/economy_finance/articles/governance/2012-0314_six_pack_en.htm
http://ec.europa.eu/economy_finance/economic_governance/
http://ec.europa.eu/economy_finance/economic_governance/macroeconomi
c_imbalance_procedure/index_en.htm
http://www.efsf.europa.eu/attachments/EFSF%20FAQ%2001072013.pdf
http://www.esm.europa.eu/pdf/FAQ%20ESM%2022102013.pdf
Gerhard Illing*, Sebastian Watzka, Fiscal Multipliers and Their Relevance in
a Currency Union – A Survey, German Economic Review, 2013.