The Eurozone Crisis and Target2

Transcription

1 The Eurozone Crisis and Target2 Aaron Tornell UCLA December 2012 Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

2 Eurozone Crisis combines elements of old crises: The Tragedy-of-the-Commons Multiple Equilibria Nominal Rigidities Systemic Bailout Guarantees Policies that only address multiple equilibria and nominal rigidities: Exacerbate the Tragedy-of-the-Commons Make the eventual crisis more severe Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

3 Sudden-Stop and Current Account Adjustment Current Account / GDP 15% 10% 5% Thailand (T=1997) Korea (T=1997) 0% Mexico (T=1994) -5% -10% T-3 T-2 T-1 T T+1 T+1 T+2 Current Account = National Income - Expenditure 1

4 Insufficient Adjustment in GIPS Billion Euro Current Account -50 of GIPS

5 45 Mexico in the Run-up to the Tequila crisis US Dollars Billion International Reserves Domestic Credit Q Q Q Q Q Q Q4

6 Credit of National Central Banks Billion Euro to Domestic Institutions GIPS FGLN Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2005Q 2005Q 2005Q 2005Q 2006Q 2006Q 2006Q 2006Q 2007Q 2007Q 2007Q 2007Q 2008Q 2008Q 2008Q 2008Q 2009Q 2009Q 2009Q 2009Q 2010Q 2010Q 2010Q 2010Q 2011Q 2011Q 2011Q 2011Q 2012Q 4

7 Euro (Billions) Target2 Net Liabilities and NCB Domestic Credit Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q Target2 Net Liabilities Domestic Credit (narrow definition) 5

8 The exponential path of the red line is not the design of a central planner Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

9 The exponential path of the red line is not the design of a central planner It results from decisions by national authorities Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

10 The exponential path of the red line is not the design of a central planner It results from decisions by national authorities National Central Banks, not the ECB in Frankfurt, have the power over credit to domestic banks Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

11 Full allotment tenders. as it can at a given i. Any bank can borrow from its NCB as much Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

12 Full allotment tenders. Any bank can borrow from its NCB as much as it can at a given i. To borrow from a NCB, a bank must be: Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

13 Full allotment tenders. Any bank can borrow from its NCB as much as it can at a given i. To borrow from a NCB, a bank must be: Solvent Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

14 Full allotment tenders. as it can at a given i. To borrow from a NCB, a bank must be: Solvent Have eligible collateral Any bank can borrow from its NCB as much Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

15 Full allotment tenders. as it can at a given i. To borrow from a NCB, a bank must be: Solvent Have eligible collateral Any bank can borrow from its NCB as much Countries, not the ECB, have supervisory power to: Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

16 Full allotment tenders. as it can at a given i. To borrow from a NCB, a bank must be: Solvent Have eligible collateral Any bank can borrow from its NCB as much Countries, not the ECB, have supervisory power to: Decide whether a bank is solvent Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

17 Full allotment tenders. as it can at a given i. To borrow from a NCB, a bank must be: Solvent Have eligible collateral Any bank can borrow from its NCB as much Countries, not the ECB, have supervisory power to: Decide whether a bank is solvent Determine quality of collateral Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

18 Full allotment tenders. as it can at a given i. To borrow from a NCB, a bank must be: Solvent Have eligible collateral Any bank can borrow from its NCB as much Countries, not the ECB, have supervisory power to: Decide whether a bank is solvent Determine quality of collateral Collateral Rules have been relaxed signi cantly since Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

19 Double Common-Pool Problem in EZ Within-country Several interest groups with power to extract resources from the sc. Sub-national Governments, Unions, Industrial Groups Banks & connected-lending Across-countries Occurs mainly at the Eurosystem of Central Banks Supported by Target2 Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

20 N Powerful Groups Borrow from banks g it, consume c it and invest abroad Group i gross debt to domestic banks Group i "safe assets abroad" d i,t = 1 + ρ t 1 di,t 1 + g i,t 1 b i,t+1 = [1 + β] b i,t + g i,t c i,t Objective function U i (s) = t=s 1 δ t s log(c i,t), δ 1 + r Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

21 Domestic Banks. Controlled by the groups; Make loans to the groups. Fund loans by selling one-period bonds (that promise 1 + ρ t ) to foreign investors or by borrowing from the NCB. Foreign Investors. Competitive risk-neutral agents with an opportunity cost r. National Central Bank (NCB). Provides systemic bailout guarantees to foreign bond-holders and to domestic banks. Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

22 Systemic bailout guarantees. If a majority of domestic banks is at risk of bankruptcy, the NCB extends credit to them so that: (i) they honor the promised repayment on all their outstanding bonds and (ii) they fund new loans to the groups. If a majority of domestic banks is not at risk of bankruptcy, the NCB does not make any loans to any bank. Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

23 Systemic bailout guarantees. If a majority of domestic banks is at risk of bankruptcy, the NCB extends credit to them so that: (i) they honor the promised repayment on all their outstanding bonds and (ii) they fund new loans to the groups. If a majority of domestic banks is not at risk of bankruptcy, the NCB does not make any loans to any bank. Two states of the world: Good state. Investors roll over bonds Bad state. Investors do not roll over bonds The bad state is absorbing. Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

24 The NCB s Budget Constraint D a t = Tg2 t IR t Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

25 The NCB s Budget Constraint D a t = Tg2 t IR t "NCB s shadow domestic credit" is the contingent bailout obligation of the NCB: D t = n d i,t i=1 Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

26 The NCB s Budget Constraint D a t = Tg2 t IR t "NCB s shadow domestic credit" is the contingent bailout obligation of the NCB: D t = n d i,t i=1 There is an upper bound D t on D t. Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

27 The NCB s Budget Constraint D a t = Tg2 t IR t "NCB s shadow domestic credit" is the contingent bailout obligation of the NCB: D t = n d i,t i=1 There is an upper bound D t on D t. D t evolves over time D t+1 D t = λ D t D t + rdt, λ 0 Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

28 Dynamic game across groups. Groups share a common-pool resource: "available NCB domestic credit" L t D t D t 0 The NCB s dynamic constraint L t = [1 + λ]l t 1 n i=1 g i,t 1 (1) Group i. Given the strategies of the other n 1 groups, select fg i,t, c i,t g t=s to maximize U i t subject to NCB s dynamic constraint (1) Private assets eqn b i,t+1 = [1 + β] b i,t + g i,t c i,t Upper bound g i,t 2 [0, gl t ] Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

29 b1 c1 U1 g1 L g2 b2 c2 U2 6

30 Markov Perfect Equilibrium There is a MPE if and only if β < λ < β + (1 + β)(n 1) The MPE is unique c i = r ĝ i = λ n β 1 L t 1 + β [L t + b i,t ] 1 + r Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

31 Intuition: Suppose for a moment that ĝ j (L t, b j,t ) is linear in L t : ĝ j (L t, b j,t ) = γ j L t From group i s private perspective: RoR on the common-pool asset: λ ˆγ j, j6=i RoR on the private-asset abroad: β. group i compares the return on both assets! β = λ ˆγ j j6=i This condition must hold for all i = 1,..., n! the equilibrium is unique & must be symetric ĝ i,t = λ n β 1 L t Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

32 Stylized fact Before the Sudden-stop GIPS interest rates were almost as low as German interest rates. Gross private capital in ows into GIPS were booming Following the Sudden-stop GIPS NCB s credit to domestic banks grow exponentially GIPS Target2 liabilities mirror NCB s credit to domestic banks Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

33 Greece: Cumulative CA & Private Capital Inflows Cumulative CA, Serie 1 Cumulative PKF, Serie Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q3 Greece: Cumulative CA & Target2 Imbalances Cumulative CA, Serie 2 Domestic Credit broad, Serie 2 Target 2 balances, Serie

34 Bailout guarantee ) Investors set interest rate ρ t = r Buy banks bonds up to PV of maximum bailout F t F t D t+1 n i=1 g i,t 1 1+r Domestic banks debt to foreign investors [1 + r] Ft F t = 1 + n i=1 g i,t 1 if S t = good 0 if S t = bad NCB credit to domestic banks 8 0 if S t = good >< Dt a = >: [1 + r] F t 1 + n g i,t 1 if S t = bad & S t 1 = good i=1 [1 + r] Dt a 1 + n g i,t 1 if S t = bad & S t 1 = bad i=1 Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

35 In equilibrium Groups save abroad even if β < r. " National gross debt coexist with " private assets abroad. The Current Account CA t = β n i=1 b i,t rd t 1 n i=1 c i,t Private assets abroad of each group 1 + β t ˆb i,t = [b i,0 + L 0 ] δ 1 + nβ λ t L 0 n 1 National debt 1 (Υ/δ) ˆD t = δ t 1 t Γ L 0, Υ 1 + nβ λ n [λ β], Γ 1 Υ/δ n 1 n 1 Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

36 E ects of ECB Policies The ECB can indirectly relax the constraints on periphery NCBs: Authorizing the purchase of bonds in the secondary market (SMP). Further relax the criteria for "acceptable collateral" and in this way allow an NCB to grant more credit to banks. Emergency loans agreements (ELAs) can be authorized when there is no more eligible collateral Outright monetary transactions (OMT) Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

37 E ects of Greater ECB Generosity In an interior equilibrium, without conditionality The bene ts from an ECB policy shift that increase λ are squandered " λ! " groups borrowing scal appropriations and results in lower growth of L t Neither groups consumption possibilities nor welfare increase Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

38 E ects of Greater ECB Generosity In an interior equilibrium, without conditionality The bene ts from an ECB policy shift that increase λ are squandered " λ! " groups borrowing scal appropriations and results in lower growth of L t Neither groups consumption possibilities nor welfare increase "What leaves one aghast is the irresponsibility of those who think of xing themselves when the house is still burning" M. Monti, FT Dec11, 2012 Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

39 Direct e ect: " λ! " growth of L, NCB available credit to banks Indirect e ect: " λ! " groups loan demand ĝ i,t λ = 1 n 1 L t > 0 Net e ect: # growth of L ˆL t+1 /ˆL t λ = 1 n n 1 = 1 n 1 < 0 Neither groups consumption nor utility increase V i = δ log(l 0 + b i,0 ) β δ 1 δ 1 log δ Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

40 Policy OMT: Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

41 Policy OMT: Promise open-ended intervention to cap interest rates Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

42 Policy OMT: Promise open-ended intervention to cap interest rates Provided the country accepts "conditionality" Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

43 Policy OMT: Promise open-ended intervention to cap interest rates Provided the country accepts "conditionality" Right on Target! OMT avoids a crisis & tries to block scal indiscipline Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

44 Policy OMT: Promise open-ended intervention to cap interest rates Provided the country accepts "conditionality" Right on Target! OMT avoids a crisis & tries to block scal indiscipline BUT it eliminates Central Bank independence as we know it. Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

45 Policy OMT: Promise open-ended intervention to cap interest rates Provided the country accepts "conditionality" Right on Target! OMT avoids a crisis & tries to block scal indiscipline BUT it eliminates Central Bank independence as we know it. What if " i and country cannot accept conditionality? Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

46 Policy OMT: Promise open-ended intervention to cap interest rates Provided the country accepts "conditionality" Right on Target! OMT avoids a crisis & tries to block scal indiscipline BUT it eliminates Central Bank independence as we know it. What if " i and country cannot accept conditionality? Will ECB blink or...? Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

47 Policy OMT: Promise open-ended intervention to cap interest rates Provided the country accepts "conditionality" Right on Target! OMT avoids a crisis & tries to block scal indiscipline BUT it eliminates Central Bank independence as we know it. What if " i and country cannot accept conditionality? Will ECB blink or...? Mr. Rajoy "We will only use the mechanism if it s needed to defend the interests of Spaniards and if it isn t, then we won t use it" Dec Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

48 Policy OMT: Promise open-ended intervention to cap interest rates Provided the country accepts "conditionality" Right on Target! OMT avoids a crisis & tries to block scal indiscipline BUT it eliminates Central Bank independence as we know it. What if " i and country cannot accept conditionality? Will ECB blink or...? Mr. Rajoy "We will only use the mechanism if it s needed to defend the interests of Spaniards and if it isn t, then we won t use it" Dec Mr. Hollande "France s rating, the one we can check every day on the markets, is the yield on its debt, which has been falling since I have been in charge," Dec 2012 Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

49 Policy Centralized supervison of largest Banks by ECB. Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

50 Policy Centralized supervison of largest Banks by ECB. Right on target: it helps eliminate the common-pool problem in the Eurosystem Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

51 Policy Centralized supervison of largest Banks by ECB. Right on target: it helps eliminate the common-pool problem in the Eurosystem It tries to eliminate a pillar of the "red line" Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

52 Policy Centralized supervison of largest Banks by ECB. Right on target: it helps eliminate the common-pool problem in the Eurosystem It tries to eliminate a pillar of the "red line" BUT it exposes the ECB governing board to direct political pressure from powerful groups Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

53 Target2 It is necessary for smooth functioning of the monetary union Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

54 Target2 It is necessary for smooth functioning of the monetary union Also, Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

55 Target2 It is necessary for smooth functioning of the monetary union Also, It supports " NCB doemstic credit Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

56 Target2 It is necessary for smooth functioning of the monetary union Also, It supports " NCB doemstic credit It provides a mechanism for systemic bailout guarantees Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

57 Target2 It is necessary for smooth functioning of the monetary union Also, It supports " NCB doemstic credit It provides a mechanism for systemic bailout guarantees Reduces pressures for capital ight Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

58 Target2 It is necessary for smooth functioning of the monetary union Also, It supports " NCB doemstic credit It provides a mechanism for systemic bailout guarantees Reduces pressures for capital ight Target2 is NOT the source of the EZ problem, just a symptom. Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

59 Target2 It is necessary for smooth functioning of the monetary union Also, It supports " NCB doemstic credit It provides a mechanism for systemic bailout guarantees Reduces pressures for capital ight Target2 is NOT the source of the EZ problem, just a symptom. Can eliminate Target2 imbalances, and still have an EZ problem Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

60 Target2 It is necessary for smooth functioning of the monetary union Also, It supports " NCB doemstic credit It provides a mechanism for systemic bailout guarantees Reduces pressures for capital ight Target2 is NOT the source of the EZ problem, just a symptom. Can eliminate Target2 imbalances, and still have an EZ problem BUT, political limits will be hit. Target2 cannot grow forever. Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

61 What share of Target2 is a bailout? Back-of-the envelope calculation Between 2009:I and 2012:I " Target2 GIPS liabilities {z } e680bn # G&F banks claims on GIPS {z } e280bn {z } CA de cit {z } # gross PAA gips {z } e370bn {z } e5bn {z } Bailout Excess Spending-Income Private Repay Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

62 Structural Reform ECB policies open a window of opportunity for reform Do reforms that a ect powerful groups happen in good times or during severe crises? Ranciere & Tornell (forthcoming) Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 24

63 Conclusion A teacher of many of us said: Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 2

64 Conclusion A teacher of many of us said: "Very rich countries can do very bad things for a very, very long time" Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 2

65 Conclusion A teacher of many of us said: "Very rich countries can do very bad things for a very, very long time" Rudi Dornbusch Aaron Tornell UCLA () The Eurozone Crisis and Target2 December / 2