Le Cercle des Économistes and Friedrich Ebert Stiftung Berlin, 23 June 2017 Can the euro still be saved? Threats to monetary robustness of the euro area Stefan Kooths Kiel Institute for the World Economy, Forecasting Center Business and Information Technology School (BiTS), Berlin 1
Monetary policy: Overloaded Quelle: FAZ, 26th October 2011, p. 11 2
The core problem: Lack of monetary consensus Consensus Institutions 3
Stuck in the middle: The worst place to be Maastricht 2.0» Rules» No bail-out» Fiscal discipline via capital markets» Decentral macro stabilization by solvent member states» No monetary government financing, hard currency Diversity, competition Fiscal union» Discretion» Mutualized debt» Conditionality of fiscal support» Macro stabilization on EMU level» Monetary government financing, soft currency Harmonization, deepening Critical rationalism Rationalistic constructivism 4
The myth of conditionality (bail-out vs. structural reforms) Key insight for successful reform processes: Ownership matters. 5
Historically high public debt levels, historically low government financing cost Gross Government Debt Germany France Italy Spain EMU Government Bond Yields (10-year) Germany France Italy Spain EMU 140 Percent 8 Percent 120 7 6 100 5 80 4 3 60 2 40 1 20 0-1 0 2005 2007 2009 2011 2013 2015 2005 06 07 08 09 10 11 12 13 14 15 16 17 Annual Data. In relation to nominal GDP; EMU: Average. Monthly data. EMU: Averrage. Data source: Eurostat, European Commission. 6
Buying time did not work Low refinancing cost: Consolidation and reform efforts wane. 7
Diagnostic failure: Predominance of macro-managment thinking Shock absorption Risk sharing Mobilizing fiscal space EMU-budget» Expenditure-side (EMU-specific collective goods)?» Cyclical vs. structural problems? 8
Interest, capital, and production structures Interest rates just another instrument for macro-management? or the key price relation within the market system?» Time preference» Coordinating savings and investment» Component of all prices for goods and services (relative prices)» Impact on capital/production structure Capital gives money time to cause trouble. (Garrison) 9
Two types of mal-investments Idiosyncratic: Entrepreneurial ventures» Wrong expectations of one market participant» Happens every day, no systemic risk» Liquidation, reallocation of resources Pervasive: Expansionary monetary policy» Systematically wrong expectations of all market participants» Financial crisis (debt crisis = flip-side of heavy capital stock distortion) Fragile financial system Excess debt positions destabilize monetary system 10
Three options of coping with debt-crises Public bail-outs» Shifts private debt to public sector» Private debt crisis sovereign debt crisis» No solution for fiscally distressed countries Inflating the debt away» Takes a long time, promotes zombification» Puts the currency at risk» Not targeted towards non-performing loans Liquidation» Tough (cold turkey) in the short-run» but targeted (and root cause oriented)» Puts capital at second (now first) best use Anti-capitalist approach (harms principle of accountability, creates moral hazard risks) Capitalist approach (in line with free market principles) 11
Flip-side of not liquidating (= buying time ): High debt positions hamper credit channel Gross Private Sector Debt Protugal Italy Spain Greece Ireland Non-Performing Loans Portugal Italy Spain Greece Ireland 350 Percent 40 Percent 300 35 30 250 25 200 20 150 15 100 10 50 5 0 2000 2002 2004 2006 2008 2010 2012 2014 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 Annual Data. In relation to nominal GDP. Annual data. Share of total loans. Data source: Bank for International Settlements, World Bank. 12
Hard to solve: The Legacy-restart-nexus Restart (new framework) requires resolution of legacy problems Resolution of legacy problems (debt overhang) requires consensus on new framework 13
Radical monetary strategy: Regime change instead of policy renormalization Buying risks upfront instead of lowering risk free yields» More private sector securities» Distortion of risk premia and related cost of capital Targeting non-performing assets» Monetary bail-out» Turning the Eurosystem into a bad bank Helicopter money» Bypassing the credit channel to inflate the debt-overhang away» Transforms the Eurosystem into a pure fiat money system Hardly in line with ECB s mandate, radical consequences Chicago plan 2.0 requires credible post-resolution design 14
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