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Posts Tagged ‘Asymmetries Eurozone’

A proposal for Target2 reform and a capped mutualisation debt scheme in Europe

‘Under a monetary union, fiscal and monetary discipline have to go hand in hand if macroeconomic stability is to be maintained. The question is how to set up the right institutions to achieve this stability in a credible manner. This policy brief proposes a new institutional arrangement for the euro area to restore fiscal discipline. It places the responsibility for compliance entirely on the shoulders of the member states. It also provides for the mutualisation of 30% of the member states’ debt-to-GDP ratio.
This would help to maintain a stable currency and to limit the risk of contagion should another crisis occur in the future. However, this comes at a cost. Under the fiscal scheme proposed, member states, which would be fully fiscally sovereign, would need to run long-term sound fiscal policies to benefit from euro membership. In addition, this brief proposes a reform of Target2 under which overspending economies would have to pay the financial cost of accessing extra euros, which would deter the accumulation of internal imbalances within the euro area. All this is expected to change the current fragility of the architecture of the euro, provide member states with the right incentives to abide by sounder economic principles and make them fully responsible for the policies they adopt.’

The above is the abstract of a research report I have just written on the reforms needed to undertake to re-balance the eurozone economy, published by the Wilfried Martens Centre for European Studies. As you will read in the report, I don’t favour more centralisation of fiscal competences to the ‘federal’ level (be it Brussels or Frankfurt), but instead to abide by the subsidiarity principle as much as possible; and thus to make Member States (MSs) fully responsible for their own macroeconomic policies and public finances. The euro is a sort of a ‘monetary club’ (some will claim, and quite rightly, that it is much more than that) with benefits and costs of membership. As to the benefits, these are particularly evident for those economies with a poor inflation record in the running of their own national currencies in the past; for which the euro has provided a strong monetary anchor and therefore greater  price stability and lower borrowing costs. As to the costs, these were more subtle before the Eurozone crisis (and indeed less publicised at the time of the launch of the euro), and have become much more evident since then: simply put, MSs do not have access to their own (national) monetary policy anymore in order to ‘alleviate’ the costs of adjustment to a crisis, and also have limited sovereignty over their fiscal policy.

The reforms introduced during and after the recent crisis have confirmed the direction of change in the eurozone towards ever more co-ordination of macro policies; and therefore more and more conditions and criteria are now in place to closely monitor and eventually fine MSs for the running of (severe) fiscal and also macroeconomic imbalances (see the the new ‘Fiscal Compact’ and the new ‘Macroeconomic Imbalances Procedure’ for more details). If anything, the experience of how the excessive public deficits and public debt by different MSs were handled by the eurozone institutions before the crisis is not very promising; even less so now that the complexity and degree of macroeconomic integration and regulation are even greater. The approach I adopt in this report is quite different.

In a nutshell:

(1) I put forward a (capped) debt mutualisation scheme, so those MSs running sound fiscal policies and sustainable budgets can benefit from it; and those in excess of the annual debt threshold will have to issue their own bonds, backed only by their own national revenues and credibility. The scheme, once launched, is communicated to the MS and it is not negotiable; the scheme also decreases in the coverage of the MSs public debt for the current levels down to a 30% ratio of the GDP in ten years. With this scheme, the MSs will have the incentives to meet the pre-announced annual targets, as their debt will be covered under the debt mutualisation programme, and thus will benefit from much lower borrowing costs. And, crucially, there is no need to monitor nor regulate further the fiscal or macroeconomic performance of the MSs.

(2) I also propose a major reform of Target2, which has accumulated (particularly since 2008) enormous imbalances among MSs (see the latest balances across MSs at the ECB website here): On the one hand, Italy holds a debit position amounting to approx. 30% of its GDP while Spain’s is 25% of its GDP; on the other hand, Germany holds a credit position close for the value of nearly 30% of its GDP. The reform proposed in the report would consist of setting a price for access to credit (if only the ECB policy rate), so overspending economies find it more and more costly to keep on borrowing and thus accumulate further imbalances. A way to settle the existing balances cross MSs must be also addressed.

(3) There are other key elements in the report for the proposals above to be effective, such as the return to the ‘no bailout clause’ of MSs, and the possibility of an errant economy to leave the eurozone (or be temporarily suspended). More details in the report.

 

Juan Castañeda

Full text of the report at: https://www.martenscentre.eu/publications/rebalancing-euro-area-proposal-future-reform

Feedback most welcome.

 

 

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How has the Euro performed? Are the economies of the Eurozone countries more homogeneous today than in 1999?

The 2017 optimality index 

Professor Pedro Schwartz and myself have conducted a research to (1) assess the trend in macroeconomic imbalances within the Eurozone since 1999 and (2) compare it to those in the US dollar monetary area. This is an extension of the research paper published last year in Economic Affairs (October, 2017), ‘How Functional is the Eurozone? An Index of European Economic Integration Through the Single Currency’. We have collected 10 different economic indicators per country (that is, for the 19 Eurozone Member States and 50 US states plus Washington DC) to measure how homogeneous or asymmetric the Eurozone Member States’ economies are, and calculated an overall index of economic dispersion, as well as four separate sub-indices to measure for asymmetries as regards (1) cycle synchronicity, (2) public finances, (3) competitiveness and (4) monetary and credit growth. The overall index can be interpreted as a measure of macroeconomic dispersion and thus of the asymmetries existing within the currency area.

In a nutshell, what the calculations and indices tell us is the following:

  1. Overall, the economies of the Eurozone Member States are less homogeneous today than in 1999. Integration did deteriorate even during the ‘good years’ (the expansionary phase of the cycle; specifically, a 86% accumulated increase in macroeconomic asymmetries from 1999 to 2006.
  2. During both the Global Financial Crisis and the Eurozone Crisis asymmetries escalated, in particular those regarding differences in competitiveness across Member States. Since 2015 the overall index of dispersion had shown a slight recovery: the new fiscal measures adopted at the EU level, along with the adjustment in costs and prices in those Member States mostly affected by the crises, seem to have been effective. In addition, the new programme of Quantitative Easing by the ECB, which began in 2015, has also helped, by reducing monetary growth dispersion across the Member States.
  3. However, this positive trend has been reversed in 2017, due to a deterioration in the competitiveness and monetary dispersion indices. This raises concerns about the stability of the Eurozone, since it shows that the return to macroeconomic stability and integration to something like pre-crisis levels is not an easy task even in times of economic growth. It also shows that the changes introduced in the euro architecture during the crisis have not been as effective as hoped.

For further details, you can access the summary of our project here: https://www.mv-pt.org/staff-research. You can also access the tables and figures with the comparison with the indices of dispersion in the USA here. These indices are now part of the research agenda of the Institute of International Monetary Research (IIMR) and an update with new figures will be published every year.

Note: Euro-12 and Euro-19 overall index of dispersion, 1999=100  (https://www.mv-pt.org/staff-research). The higher the value of the index the greater asymmetries are.

A full academic article by Pedro Schwartz and myself with further explanations on the figures and the calculations will follow soon. As always, comments most welcome!

Juan Castañeda

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