Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

Evaluate future prospects of the Euro
...
macgillsummerschool
...
It would have to be administered by real federal
bodies
...
The need for
strong democratic oversight will spur the creation of a revitalised European Parliament and directly elected Commision
...

• A European fiscal union, with proper institutions would be able to provide joined-up management of the EU economy
as a whole
...
The trust that responsible EU-wide economic management would
engender will assure markets, draw investment and boost growth, creating a Europe that’s more fair, stable and
prosperous
...
However, the rest of macroeconomic policies have
remained firmly in the hands of national governments, producing idiosyncratic movements unconstrained by the
existence of a common currency
...
The effect of all this is that booms and busts originate at the national level and
have a life of their own at the national level without becoming a common boom-and-bust dynamics at the Eurozone
level
...
The existence of the monetary union can exacerbate booms and busts at the national level
...
Thus, when in Spain, Ireland, Greece the economy started to
boom, inflation also picked up in these countries
...
The opposite occurred in the countries experiencing low
growth or a recession
...
e
...


As we can see a controlled break-up of the euro would be hugely risky and expensive
...

The first is financial: the euro zone needs a region-wide system of bank supervision, recapitalisation, deposit insurance
and regulation
...
Banks sprawl across national borders
...
The answer is to move the supervision and support of banks away from
national regulators to European ones
...
A first step would be to use Europe's rescue funds to recapitalise weak banks, particularly in Spain
...
Politicians will no longer be able to force their
banks to support national firms or buy their government bonds
...

The second is fiscal: euro-zone governments will be able to manage—and reduce—their fiscal burdens only with a
limited mutualisation of debt
...

With regards to the fiscal side: At the political level there is now a gradual recognition that the financial crisis can only be
solved through stronger European (as opposed to national) political representation and control
...
The financial crises experiences led to the realization of the fact that close mutual
control of each other’s fiscal policies, of the functioning of Member States’ internal labor markets and more broadly the
sustainability of Member States’ social welfare systems, is in each country’s national interest
...

Fiscal consolidation can support economic growth in the short term by fostering financial market confidence
...

According to Francesco Nicoli from the European Policy Centre “Any form of fiscal union must accomplish, regardless of
its institutional shape, two basic functions: preventing the emergence of endogenous asymmetric crises, and correcting
acute economic and fiscal crises”
...

● Debt will now be issued in currency over which the ECB has control, thereby protecting countries from the
destabilising effects of liquidity crises
...
This encourages more prudential fiscal policies for these
countries
...
Setting a euro-area wide integrated bond market would offer a safe and liquid
investment opportunity for savers and financial institutions that matches its US$ counterpart in terms of size and
liquidity, which would also strengthen the position of the euro as an international reserve currency and foster a more
balanced global financial system
- Immediate effect even if introduction takes some time, since changed market expectations adapt instantly, resulting in
lower average and marginal funding costs, particularly to those EU member states most hit by the financial crisis
- Eurozone financial system more resilient to future adverse shocks and reinforce financial stability
- Reduce vulnerability of banks in the eurozone to deteriorating credit ratings of individual member states by providing
them with a source of more robust collateral ​
Potential Problem: Illegal - Legal and political reasons: Article 125 of the Lisbon Treaty states explicitly that the European Union and its member
states are not liable for the commitments of other members
...
The root cause of
the debt problems in the EZ can be found in the unsustainable debt accumulation of the private sectors
...
There were two reasons to explain the
boom in govt debt
...

2) Automatic stabilizers set in motion by the recession-induced decline in government revenues
...
e
...

An intergovernmental covenant on the Stability and Growth Pact was considered to be sufficient, until the recent crisis
have highlighted the structural and the deficiencies of the euro achitecture
...

A fiscal union merges the national financial authorities and fiscal policies into one: it amalgamates the government
spending and revenues (taxes)
According to the latest paper published by the IMF survey the following elements are essential for functioning of a fiscal
union:
• Better oversight of national policies and enforcement of rules: With more emphasis on structural fiscal targets and
ongoing reforms to the governance framework, the design of fiscal policy has improved
...
So, provided there is
better disciplining of national fiscal policies, all euro area countries would benefit from cross-country fiscal insurance
mechanisms
...


Arguments For Fiscal Union:
+ Incompatibility between supranational monetary policies and national fiscal policies
...
The
euro-zone is clearly unable to manage its macro-economic imbalances without some sort of federal structure to oversee
revenue collection and expenditure
...
Combining
supranational monetary policies with national fiscal policies is unsustainable
...

+ Raise Europe’s market credibility and eurobonds would rival US treasuries
Unity raises credibility
Unless a strong fiscal element is adopted, predatory markets will be able to pick off the weakest members of the euro
herd
...

US vs EU : The US federal budget is an important instrument of regional distribution: when the income of a US state
declines, the federal budget redistributed back 25%
...

+ A major step towards a true political union due to the need for stronger democratic oversight
Step towards political union?
Fiscal union would be a major step towards a true political union
...
Central tax resources and mutualized debt would become powerful symbols of a united Europe
...

+ Contribute to an orderly, stable and satisfactory arrangement of the union’s finance, and prevent reckless inflate
property bubbles done by the Spaniards or Greeks
Efficiency through joined up management
A European fiscal union, with proper institutions would be able to provide joined-up management of the EU economy as
a whole
...
The trust that responsible EU-wide economic management would
engender will assure markets, draw investment and boost growth, creating a Europe thats more fair, stable and
prosperous
...

● Argument that the current asymmetries reflect underlying, permanent economic differences
● In this case, it is more important that wage markets and prices adjust to bring back stability If this flexibility is not
established, fiscal transfers can actually prevent the adjustment mechanism
● Countries facing negative shocks would receive transfers which slowly become permanent, keeping real wages in the
depressed area too high and preventing required labour movements
● This can create political tensions leading to the collapse of the EZ
http://www
...
org/article/spillovers-why-macro-fiscal-policy-should-be-coordinated-economic-unions
Carlino and Inman (2013, Vox)
Overcome coordination problems (prisoner’s dilemma) of fiscal stabilisation policy
Which level of government manages macroeconomic stabilisation?
EU evidence finding on the significant positive spillovers from expansionary fiscal policies by economic neighbours
raises the important institutional question of which level of government should manage fiscal policy for macroeconomic
stabilisation
...
Though larger economies may find it
beneficial to run their own fiscal stabilisation policies, they will ignore the job and income benefits those programmes
create for their economic neighbours
...

Germany rightly asks: why should we pay for fiscal deficits beyond what is best for Germany? If all states, provinces, or
Eurozone countries think this way, there will be too little use of beneficial stabilisation policies
...
In the
case of a full fiscal and political union such as the US this would be central government deficit financing of temporary
tax cuts, increased transfer payments, expanded unemployment insurance, and perhaps added infrastructure spending
...
One possibility might be a Eurozone-wide unemployment-insurance trust fund specified by the European
Parliament and the Council of Finance Ministers and supervised by the European Commission
...
While some of the insurance against banking accidents should be funded by
the industry, a common backstop for the recapitalization, resolution, and deposit insurance would contribute to reducing
the risk of
Borrowing at the centre
In the long term, when the appropriate governance structures are in place, borrowing by the center—backed by its own
revenues—could help finance risk-sharing vehicles, and reduce the potential for large portfolio shifts between
sovereigns by providing a safe asset
...

Benefits of Fiscal Union is greater than the cost - The benefits (political union, buffer to asymmetric shocks, a credible
market would revive confidence and attract investment) are long term
High debt to GDP ratios in individual nations force national governments to run large budget surpluses to stabilise their
debt
...
These spillovers include:
1) higher interest rates for the union interest rate as a whole (assuming one exists)
2) a higher union interest rate may cause countries to put pressure on the ECB to relax its monetary policy stance,
thereby interfering with the conduct of monetary policy
...

(http://www
...
com/publications/article_pdf/746)
- The cost problem could be solved: Bad performing countries could take advice from other countries; let the public
understand the benefit of fiscal union and what they have to sacrifice for that; introduce credible punishment terms in
the agreement for loose spenders

Arguments Against Fiscal Union:
Locality of national issues - Local Problems need local solutions
As long as the European Union is made up of independent nations with their own elected governments, their problems
are going to be essentially local and they will need local solutions
...

Governments need flexibility to deal with their own problems
...
It’s a recipe for gridlock
...
Setting budgets is a core responsibility of sovereign
parliaments
...

History tells us citizens will not accept taxation without representation
...

2) Budget control is a central role of national parliaments so having policy set by a centralized institution will be
undemocratic
...
The discontent of citizens
over the fiscal union may undermine its stability
...
We’ll all end up paying more
...
” Another blow to Europe’s
competitiveness
...

● The result may be an increase in bureaucratic inefficiency
● Greece or France or Spain wouldn’t accept the shift of economic, political and military power to Germany that this
would entail
A fiscal union would require a homogenization of tax systems and government spending rules
...

Encourages moral hazard; loose spenders will be given an everlasting bailout by virtuous nations, led by Germany
Loose spenders will be given an everlasting bailout fed by virtuous nations, led by Germany
...
The safety net for sinners will lessen their
incentive to tighten belts and push through reforms their economies need
...

This reduces the incentives for these heavy spenders to tighten budgets and implement the reforms their economies
actually need
...
Bailouts,
overspending and free-riding would become serious issues, if the rules are not set up properly
...

Forgone flexibility of national governments in setting tailored fiscal policies to rectify nation-specific problems
...

The EU has limited fiscal powers at the current state:
- A role in deciding the level of VAT and tariffs on external trade
- Stability and Growth Pact intended to coordinate the fiscal policies of member states ( member states report their
economic plans to the European Commission and explain how they are to achieve medium-term budgetary objectives
...
So, it brings to the discussion of a
powerful fiscal influence among member states
...

A political union requires acting together in the decision making process, creating common legal rules and regulations
and also transferring part of the sovereignties to the supranational authorities and finally implementing coordinating
fiscal policies
...
possible to organise fiscal transfers that provide some insurance against asymmetric shocks
...

2
...

3
...

At the moment, the transfer of sovereignty between national governments and the EU government is highly unequal
across sectors: authority regarding agriculture, trade and competition has been largely given over to the European
government, while in spending, social policies and wage policies there has been very little
...
Provision of insurance against asymmetric shocks:
● Makes it possible to centralise a large part of national budgets at the level of the union and then organise systems of
automatic fiscal transfers in response to shocks
...
Increased stability:
● The consolidation of national government debts into a jointly issued union debt would reduce fragility of the union,
allowing it to better withstand movements of distrust afflicting national governments that cannot issue their own money
...
Reduces the risk of asymmetric shock that have a political origin
...
Eurozone citizens therefore will eventually need to choose two of these three
objectives
...
But,
if they want deeper economic, financial, and monetary integration they will have to surrender some national sovereignty
...

Therefore, the ECB must act as a lender of last resort to buy sovereign debt while credibility is not yet restored in order
to prevent a liquidity crisis from turning into a solvency crisis
...

Wren-Lewis argues that market reaction was always more to do with the ECB than the fiscal position of the countries
involved
...

EFSM and ESM have been poor surrogate lenders of last resort → they will never have the necessary credibility to fully
stop contagion as they cannot guarantee cash: even doubling the institutions’ present resources 400bn Euros would not
have this effect
...

Arguments against the ECB stepping in as lender of last resort:
Could encourage moral hazard issues: but just like the banking sector, this should be overcome by effective supervision
at the on the risks taken by governments
...

If it was easy to differentiate between solvency and liquidity crises, the market would easily do so and there would be no
role for the ECB: means ECB will end up supporting insolvent governments → moral hazard risks
...
lse
...
uk/50178/1/blogs
...
ac
...
pdf
Wren Lewis argues that we should not draw conclusions on this question based solely on the example of the Eurozone
...

● There was the mistaken belief that default risk in all countries was the same as Germany
● only in Greece was there really any underlying fiscal excess
● The union should have allowed Greece to default early on, rather than avoid the situation through replacing private
debt with intergovernmental lending
● ECB refusal to act as a lender of last resort
http://whynationsfail
...
html
MAYBE NOT:
We think not
...
What we are seeing now are mostly shortterm fixes, not true solutions to these institutional problems
...

Europe’s underlying problems cannot be tackled by short-term fixes
...
S
...

And yet, there is no realistic plan for true fiscal centralization in Europe
...
It means a European organization with the power to set taxes and harmonize labor,
product and credit market institutions
...

It was crucial that with the U
...
Constitution, political and military power shifted to the federal government
...
wsj
...

Theory of optimal currency areas:
A monetary union in Europe should be accompanied by some centralisation of national budgets
...
It makes it possible to consolidate part of national
government debts and reduces the fragility of monetary union
...
Monetary union alone restricts fiscal possibilities, creating
uncertainty and asymmetry =>national policies affect the EU through monetary effects, but there are no fiscal means to
counter them
...
europa
...
pdf
The most obvious cost of federalism is the loss of autonomy by the central government
...
As a result, in highly decentralized fiscal
federations, central governments might find it difficult to implement coordinated policies and provide federation wide
collective goods
...
Each individual fiscal authority
sees itself as a small player who has little impact on monetary policy
...
An extensive literature has analyzed the existence of independent
fiscal authorities with a single central bank (Dixit and Lambertini 2001, Chari and Kehoe 2004, Uhlig 2002)
...

Shocks/ OCA:
The original OCA approach weighed the benefits of adopting a single currency against the costs of abandoning
independent monetary policy
...
These benefits would be greater the more open and the more
extensive the trade connections are for the economies involved
...
Adjustment to such shocks can be facilitated by flexible wages and prices and by labor
mobility
...
Indeed, the expectation of institutionalized transfers or bailouts following fiscal problems
might well be expected to increase the incentives for bad behavior
...
Fiscal reforms would in the longer run be expected to raise
the rate of growth
...
– a broader European Central Bank (ECB) mandate – the
building of a banking federation – fiscal union with common bonds

---