This problem is a deep challenge to schemes for delegation of macroeconomic policy-making to autonomous non-political institutions, as their influence depends on the responses of their financial market "audience". The markets failed to punish Greece in the upturn; now they persecute her to destruction in the downturn. The Commission and Eurostat were ignored by the markets in good times, and now they are unable to reassure the markets in bad times.
Thus our central argument is that the authority of the fiscal framework has to come from the disposition of control over funds: However, as we indicated above, even these arrangements are likely to be cyclically asymmetric, with no effective sanctions to fiscal profligacy in good times. Access to the Eurobond will not have much leverage if spreads are small.
The pronounced cyclicality of spreads in the eurozone has drawn attention to the role of the rating agencies. Until the crisis, they gave all eurozone members similar ratings; now, the range of ratings has widened and so have spreads. The cyclicality of ratings worsens the cycle, because it raises costs when borrowers are at their most stressed.
The policy effects on governments are profound, since borrowing costs are a key determinant of the fiscal position. The rating agencies can potentially make self-fulfilling prophecies, pushing costs up if they assess the policy effort as inadequate and thereby ensuring that further retrenchment will be needed. The rating agencies' own accounts of their policies emphasise that ratings should not be cyclical. They seek to establish long-term ratings for sovereign borrowers based on structural factors such as legal institutions and political stability, but they have difficulty withstanding cyclical pressures to downgrade borrowers.
One explanation is that they cannot undertake a macroeconomic analysis but must view each borrower as if its policies will not affect the outcome for the system as a whole. Of course this is justified for the purpose of rating, even if it is perverse for system demand management, but it produces a distinctly anti-Keynesian bias in country policy assessments. The agencies also have their own "herd" tendencies, often making their announcements on the same days and preserving their reputations by ensuring that their ratings do not deviate too much.
For example, Moody's initially rejected moves to downgrade Greece, telling investors on 2 Dec that "investor fears of a liquidity crisis in Greece are overdone", but on 22 Dec it followed the others in lowering its rating, albeit remaining two notches higher than its rivals. Why do ratings matter so much in Europe at the moment? With no financial resources of their own, European fiscal authorities are particularly susceptible to the mood of the financial markets. At present, the European Commission is producing fiscal policy assessments which are almost identical to those of the rating agencies.
All use the same phrases: One could say that the agencies are finally taking note of the authoritative data and analysis issuing from Brussels, but a less flattering interpretation is that the Commission is trying to establish a reputation with the markets by telling them what they expect to hear. By contrast, the IMF can afford its recent bout of Keynesian delinquency 9 , as it has the financial resources to back up its position. The creation of Eurobonds could go some way to establishing a more independent-minded approach to fiscal policy, less dependent on market approval.
But a further problem is that ratings are embedded in the monetary governance of the eurozone. Most strikingly, the ECB's acceptance of a wide range of collateral at its discount window has gone along with passive use of ratings. As Austria's central bank governor, Ewald Nowotny, has argued, it is "unacceptable" that the ECB's acceptance of Greek debt rests on the judgment of the rating agencies. It could make more active use of margins and fees, to the detriment of SGP non-compliant governments, but it should not hide behind the rating agencies in doing this.
By making its own judgments, it could contribute to countercyclical policy-making; by abdicating, it magnifies the procyclicality of rating agencies' judgments. Other regulatory policies could also be disentangled from reliance on ratings. Instead of using ratings to determine capital requirements, banking regulations could return to the pre-Basel II practice of differentiating between classes of debt on other criteria.
The new Eurobond would belong to the most privileged class of debt, while country issues could be graded according to debt ratios and trends. Such changes could be part of making more active use of capital ratios as a countercyclical instrument. Through regulatory means, the market signals that failed to materialise in the early years of the euro could be engineered. The difficulty of achieving political agreements in the eurozone has contributed to the creation of a fiscal framework that lacks fiscal instruments and a monetary policy framework that is detached from fiscal monitoring.
But the effect is an abdication of power that leaves too much to be dictated by the financial markets, as politicians from Greece to Germany are now realising. Delegation to the market may look like a way of avoiding political conflict, but it also reduces the policy-making space available to governments.
This did not bother economists in the era when governments were seen as the primary cause of macroeconomic instability, but it is a huge problem when financial markets themselves are the cause. The financial sector has been allowed to set the terms of fiscal responsibility because the alternative might be that Germany sets the terms for Greece. But Europe is surely by now a sufficiently wide and deep polity that such costly political abdication can be replaced by more robust regulation by the fiscal and monetary authorities. It is time for the public face of international finance to be seen a little more clearly.
Why should we believe the market this time? It is better to have explicit rules for bail-outs, in: Financial Times 16 March , p. Belated Insight or Smokescreen? De Grauwe , W. A Proposal for a Common Euro Bond, in: As is well known, classical Greek tragedies are about insoluble conflicts. They are intended to deeply touch spectators, make them think about it all and eventually come to a purification of their minds Greek: The present crisis of the European Monetary Union EMU emphatically reveals many problems, some of which have to do with Greece, and hopefully all of which can be resolved.
It might, however, be a good idea to follow the ancient tradition and let the discussion of the problem clear our minds to gain deeper insights into the problem. Dramatically increasing public deficits and debts made investors hesitant to give new loans because they feared a state bankruptcy, especially in the case of Greece. Rising interest rates and premiums for loan default insurance are indicators of those fears. For several days at the end of January , the interest rate on Greece's government bonds was nearly basis points above that of Germany's.
In addition, the prices of credit default swaps CDS have increased dramatically in recent months. The government bonds of the countries in question again primarily Greece are being watched by the markets with great anticipation. In response to this situation, politicians and others quickly demanded that speculation be brought to an end and that Greece ought to receive financial assistance, either bilaterally or from the EU.
Otherwise the EMU could break apart, and the present crisis could be aggravated because German, French and other banks holding a good deal of Greece's public debt would encounter significant difficulties. Therefore, it would be in the interest of the other EMU members to help Greece. The main challenge seen by the proponents of assistance is choosing the most appropriate instrument.
Currently, issuing common euro bonds, creating a European Monetary Fund EMF and introducing an economic government for EMU are under discussion, in addition to direct transfers from the EU or bilaterally. Remarkably, most of those proposals were initially made without considering that the Stability and Growth Pact SGP and the Maastricht Treaty strictly forbid financial assistance to a member state of the EMU due to the no-bailout clause of Article In addition, it is clearly stated that the European Central Bank ECB is independent, and therefore monetary policy cannot be made subject to coordination within a European economic government.
After these critiques were voiced, an additional challenge was seen in finding ways to bypass those rules. The real challenges presently facing the EMU, however, go beyond just these. Since the problems are more deeply rooted, the challenges are different and much bigger. They pertain to the governance of the EMU, and the question has to be raised whether the EU will be able to manage it or will wreck it. In spite of the European treaties, there is no real agreement on the fundamental principles ruling the EMU that is fully accepted by the member countries.
The reason for this is that either the rules agreed upon in the treaties are not fully understood or that they are not wanted and, therefore, not accepted. In any case, questions were raised early and often regarding these rules but never really taken seriously. This is especially true with regard to the public budget rules and the independence of the ECB in striving primarily for price stability. The results of this ambiguity are the present problems facing the EMU and some of its member states in particular.
They have not been caused by the worldwide financial and economic crisis per se so much as by the general disrespect for the rules agreed upon in the European treaties. The present crisis merely exposes the failures and omissions of the past. In the Maastricht Treaty, the decision was made to create rules and institutions for the EMU which very much resembled the German ones: Thus, monetary policy has clearly been tasked with the goal of maintaining price stability. The ECB is thereby removed from everyday politics and cannot be made responsible for the achievement of other goals, e.
Furthermore, its independence is safeguarded by the SGP with its well-known budget deficit and debt rules and the no-bailout clause, which clearly states that no government can hope for financial assistance from the EU or other EMU member states if it allows its public budget to drift into an unsustainable position. In case of violations, a formal deficit procedure must be initiated which can result in the imposition of sanctions. All this should guarantee that European monetary policy remains oriented towards price stability.
When seeking assent for the Maastricht Treaty among its fellow citizens, the German government repeatedly assured the public that this arrangement of rules would make the euro as stable as the Deutsche Mark DM that it was replacing. This assurance was necessary for the acceptance of the new currency, given that Germans had lost nearly all of their savings twice within one generation due to two big inflations in the last century. As a result, the stable DM had become a symbol for reconstruction after the war. In the Maastricht Treaty, the other Europeans accepted the adoption of the German model to a great extent in the design of the new European monetary constitution.
At least it appeared that way initially. All parties declared their preference for a stable euro brought about not by currency competition but rather by more or less the adopting of a German model that had proven its ability to achieve a very stable currency. The Delors report recommended this as the best available alternative. If all parties had followed what they had agreed upon in the treaties, the completion of the single market and consolidated public budgets in all member countries would soon have followed.
In addition, because of the highly intensified systems competition within the EMU, urgently needed structural reforms would have been carried out and wages and prices would have become more flexible. This would have enhanced the adaptability of the European economies. The present crisis, the problems of aging societies and adjustments to the needs of globalisation could have been coped with much more effectively.
The problems of Greece and other countries are, therefore, the result of failures and omissions in the past. The challenge therefore is not to hide them but to avoid repeating them in the future. It must be remembered that when the Maastricht Treaty was agreed upon, Germany and the Netherlands were the only member countries with independent central banks.
In some EU countries, the monetary financing of public deficits was allowed and routine. In addition, the economic policy style was different. The acceptance of binding rules for public budgets was mostly unknown. To the French for example, it must have been quite new and perhaps strange that the president of the republic and the parliament would no longer have full command over the public budget and such an important instrument as monetary policy. Therefore, President Mitterand, in the decisive final debate on French television before the referendum, did not dare to tell the truth about the independence of the ECB.
He claimed, contrary to the rules of the Maastricht Treaty, that the European Council would make the basic monetary policy decisions, not the ECB, which would only execute them and conduct the daily business. After the referendum which resulted in the well-known decision in favour of France joining the EMU, intellectuals in France initiated a major debate over the EMU when they realised the true contents of the Maastricht Treaty. This debate is still ongoing. It just did not seem acceptable to them for the EMU to be based on binding and sanction-equipped rules.
It does not seem to suit the French policy style, which considers policy only to be discretionary action and not rule adherent. The latter style is pejoratively referred to as technocratic, in contrast to political. Although the rules and obligations in the Maastricht Treaty suit the German policy style much better, even Germany turned away from its original position. The Kohl government still cared very much for the essentials - like independence of the ECB, price stability orientation etc.
The deficit procedure initiated by the European Commission against Germany in after its violation of the budget deficit criteria was not accepted by Germany. Together with other countries, particularly France, rule changes aiming at a dilution of the pact were pushed through. The now "reformed" SGP prolonged the periods of adjustment and allowed for all kinds of exceptions, watering down the political pressures for public budget discipline that it had originally intended.
With this move, Germany - as a "custodian" of the original construction of a stability-oriented EMU - finally lost its credibility and vanished in that respect. This also happened to the true custodian of the European treaties, the European Commission. It had already lost part of its credibility in the first round of admissions to the EMU in because its examination of countries' compliance with the convergence criteria was quite lax.
Even then countries were allowed to join which were far from fulfilling the standards of the Maastricht Treaty. Italy and Belgium were admitted even though they had debt quotas of nearly double the allowed 60 per cent. But even Germany did not meet all the standards, because its debt quota was slightly above 60 percent and was increasing. As no justification for this can be found in the treaty, Germany should not have been admitted either.
This shows that the EMU rules were being twisted from the start. This occurred to a much greater extent during the second round in which Greece was admitted in The Commission cannot have been very thorough in its examination of the Greek figures since it failed to uncover that the figures had been forged. Indeed, this lack of thoroughness was fairly constant, since it turned out that Greece had not complied with the SGP rules for even a single year since it joined the EMU.
This was only possible because the Maastricht criteria were not taken seriously by the European Commission or by the member states. A typical indication for the former is a comment by the then president of the European Commission, Romano Prodi, in an interview with Le Monde in October one year after the admission of Greece!
One could ask if he also meant the independence of the ECB, the single market rules or other rules in the European treaties. After such a comment, one could hardly expect that the SGP criteria would be examined thoroughly by the Commission. Perhaps it preferred not knowing exactly what was happening.
This is also most likely true for the other member states, since they often found themselves in similarly difficult budget positions. Thus, it appears that, for opportunistic political reasons, nobody really took responsibility for ensuring adherence to EMU rules. All actors were eager to widen their scope for discretionary policy action. However, if this tendency is not stopped at once, the EMU could soon break apart.
If every member country acts as it pleases and chooses when, and when not, to comply with common rules, then there will no longer be any economic convergence within the EMU. Not only Greece but also additional member states could face bankruptcy. It quite simply would be neither fair nor sustainable for Germany and a few other EMU members to have to foot the bill.
How can a government explain to its voters bailouts of other countries that chose not to follow the rules agreed upon in the treaties? Voters would become even wearier of Europe and might ultimately reject European integration in general. Therefore, what is most urgently needed now is an immediate and substantial turnaround and the credible commitment by the European Council and all EU member states to strictly adhere to the rules with respect to the EMU without any ifs, ands or buts. To begin with, this requires that Greece must not be assisted by the EU or the member states, in keeping with the no-bailout clause.
It should instead be referred to the IMF, which is very experienced in cases like this, can set strict conditions in exchange for its loans and is able to ensure that these conditions are met.
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This, however, is the plain truth that cannot be hidden from the world. The attempt to do so by assisting Greece against all common agreements in one way or another would cause the EU to lose its credibility. Furthermore, it would make good governance within the EMU much more difficult if not impossible in the future.
Therefore, what appears to be helpful in the short run could do great damage to the EMU in the medium and long terms. This applies to some of the recent proposals. If common Euro bonds were issued to help Greece immediately 1 , this could initially calm down speculation and create more favourable conditions for the country to finance its public debt. But the costs of this measure would show up later, because good intentions do not necessarily produce good results. What incentives will there be for Greece and other member countries to struggle to consolidate their public budgets in the medium to long term?
Since Germany and other assisting states would take on more liability, they would have to pay higher interest rates for their debt. The bad governance of the EMU would thus damage the competitiveness of all EMU countries, even those which comply with the rules. This would most probably end in permanent conflicts, making the EMU less and less attractive.
Challenges for Economic Policy Coordination within European - download pdf or read online
As said before, French politicians disliked the rules of the Maastricht Treaty from the start. The idea of an economic government is intended to weaken or to replace important rules previously agreed upon in the European treaties with discretionary action. Since this is seen as a potential counterpart and counterweight to the ECB, it would endanger its independence. Instead of the clear assignment of pursuing a monetary policy that leads to price stability, it calls for coordination in general.
This, however, would only make sense if all policy instruments were made responsible for all economic goals - a definite contradiction of the Maastricht Treaty.
What is the Economic and Monetary Union? (EMU)
A taste of future interventions and quarrels along those lines was delivered in recent remarks by Christine Lagarde, the French Minister of Finance. Besides the disregard for rules this exhibits, it is also inconsistent with the Lisbon strategy, which aims at making EU countries more competitive internationally. Thus, an economic government could result in permanent conflicts, inconsistencies and bad governance that damage the attractiveness of the EMU and put its sustainability at risk.
This also applies to the proposal of a European Monetary Fund EMF , which was made with the good intention of forcing countries violating the budget criteria of the SGP to contribute to that fund.
EconPapers: Challenges for Economic Policy Coordination within European Monetary Union
In this way, incentives would be set in place for an early and fast consolidation of public budgets. The necessary adjustments within countries in need would be supported by the financial assistance of the EMF but only if the countries had made their required contributions. As former chief economist of the ECB Otmar Issing 5 and others have said, this would be like opening Pandora's box, for one does not know what one would receive in exchange. Bargaining and ratifying a new treaty takes about ten years, and the result cannot be foreseen.
Therefore, it could and most probably would end up with conditions for financial assistance much less strict than the authors had in mind. The probability is very high that loans would be provided much more easily than originally intended, either based on a compromised original agreement or - as was shown before - in practice. The danger, therefore, is that the EMU would turn into a transfer union without being a political union.
This again would endanger the support of the people for European integration in general and for EMU in particular. It would thus be better not to touch existing rules and to agree instead on a European consolidation pact as proposed by the German Council of Economic Advisors. It is intended to strengthen budget discipline by seeking binding commitments from all EU countries for a swift consolidation of their public budgets. At the moment, there are various attempts to change the EMU rules that were agreed upon in the treaties without following the appropriate procedures.
This could backfire and lead to worse governance and even the dissolution of the EMU. The big challenge now is to fully accept and maintain the rules that make the EMU sustainable in the long run. Money is a much too serious matter to be left to everyday politics. De Grauwe and W. Frankfurter Allgemeine Zeitung, 18 March , p. Towards a Euro pean Monetary Fund, in: The crisis that started in Greece culminated into a crisis of the eurozone as a whole. There is no doubt that the major responsibility rests with the Greek authorities who mismanaged their economy and deceived everybody about the true nature of their budgetary problems.
The solution to the problem will therefore necessitate drastic changes in Greek economic and budgetary policies. That being said, there is more than one villain in this story. The financial markets and the eurozone authorities also bear part of the responsibility for letting this crisis degenerate into a systemic crisis of the eurozone. The destabilising role of financial markets has been dramatically illustrated again. Periods of euphoria alternate with periods of depression, amplifying movements in asset prices that are unrelated to underlying fundamentals.
This is not new, of course, but the speed with which this has occurred is baffling. Just a year ago the sovereign bond markets were gripped by a bubble leading to record low levels of long-term interest rates at a time when governments added unprecedented amounts of new bonds to the market. In a few weeks time the situation turned around dramatically and bond markets in a number of countries crashed. It is a repeat of a sad story: The rating agencies take a central position in the destabilising role of the financial markets.
One thing that is clear about these agencies is that they systematically fail to foresee approaching crises. And after the crisis erupts, they systematically overreact, thereby intensifying it. This was the case two years ago when the rating agencies were caught completely off guard by the credit crisis. It was again the case during the last few months. The sovereign debt crisis started in Dubai. Only after Dubai had postponed the repayment of its bonds and we had all read about it in the Financial Times did the rating agencies realise there was a crisis and downgrade Dubai's bonds.
Having failed so miserably in forecasting a sovereign debt crisis, they went on a frantic search for other possible sovereign debt crises. They found Greece, which of course was a natural target. They did not limit their search to Greece but "visited" other countries as well - mostly Southern European countries - and started the process of downgrading. This in turn led to a significant increase in government bond rates in these countries. Hesitation and ambiguities by both the eurozone governments and the ECB also abetted the crisis as it unfolded.
The eurozone governments failed to provide a clear signal about their readiness to support Greece. The failure to do so resulted mainly from disagreements among member state governments concerning the appropriate response to the Greek crisis. The ECB, in turn, created ambiguities about the eligibility of Greek government debt as collateral in liquidity provision.
As is well-known, the ECB relies on ratings produced by American rating agencies to determine the eligibility of government bonds as collateral. Prior to the financial crisis, the minimal rating needed to be eligible was A- or equivalent. At the end of , however, the ECB announced that it would return to the pre-crisis minimal rating from the start of on. No wonder many dumped Greek government bonds, precipitating the crisis.
Similar uncertainties about the future ratings of other eurozone government bonds hang as a sword of Damocles over the Greek government bond market and more generally over the government bond markets of the weaker countries in the eurozone. The Greek government debt crisis must be stopped. There are at least three reasons why it is imperative that this crisis be put to an end. First, allowing the Greek crisis to lead to default risks leading to a contagion that will affect other government bond markets in the eurozone.
Second, and following up on the previous statement, such a contagion to other government bond markets will affect the banking sector in the eurozone. Many banks have started to recover from the banking crisis by arbitraging the yield curve, i. The steepness of the yield curve has been an important source of profits for banks. A crisis in the government bond markets, i. A third reason the Greek government bond crisis must be resolved is at least as important.
If it continues unchecked, the crisis will lead to increases in government bond yields in a significant number of eurozone countries. This will put pressure on the governments of these countries to sharply contract fiscal policies, leading to deflationary effects and risking pulling down the eurozone economies into a double-dip recession. Such an outcome would not only be bad news for the unemployed, but would also make it even more difficult for the eurozone countries to reduce their budget deficits and debt levels.
The choice the eurozone authorities face today is between two evils. The first one arises from moral hazard. Bailing out Greece is bad because it sends the signal that irresponsible behaviour will not be punished. The second evil arises from the contagious effects on the banking system and the macroeconomic policies in the eurozone that would result from letting Greece default. Authorities have to choose for the lesser evil, which in this case is the former one. This is also what they did when they bailed out the banks that had been at least as irresponsible as the Greek government.
While there can be little doubt that the crisis must be stopped now rather than later, much doubt has been cast on whether the European Union, or for that matter the member countries of the eurozone, have the means to do so. Doubts have been raised regarding the legal authority and the financial capacity of the union to organise a bail-out. The legal sceptics argue that the no-bailout clause in the Treaty forbids the member states of the union to provide financial assistance to another member state. But this is a misreading of the Treaty. The no-bailout clause only says that the European Union shall not be liable for the debt of governments, i.
But this does not preclude the governments of the EU from freely deciding to provide financial assistance to one of the member states. There can be equally little doubt that the eurozone member countries have the financial capacity to bailout Greece if the need arises. It would not cost them that much. One can conclude that the member countries of the eurozone have the legal and financial power to bailout Greece.
Up to now the only obstacle has been political, i. The agreement reached at the European Summit of 25 March goes in the right direction. However, ambiguities remain, in particular with regard to the interest rate the Greek government will have to pay in a future financial aid package. The agreement stipulates that this will be the market interest rate.
This leads to the problem that if the market pushes up the interest rate on Greek government bonds, eurozone countries may step in to "help" Greece using a punitively high interest rate. This surely would not help the Greek government. The Greek government of course has the key to eliminate the obstacle by providing a credible budget cutting policy.
This seems to be the case now after the latest round of budget cutting measures. Despite the agreement of 25 March, it is unclear whether the other EU countries are willing to hold up their end of the deal. Fortunately, the ECB announced on 25 March that it will continue to accept Greek government debt as collateral, independent of the ratings concocted by the agencies.
This is a major contribution by the ECB to stabilising the Greek government bond market and to reducing the risk of spillovers to other markets. The experience we have had with ECB policy regarding the eligibility of government bonds as collateral in liquidity provisions leads to the conclusion that there is an urgent need for the ECB to change this policy. More precisely, the ECB should discontinue its policy of outsourcing country risk analysis to the American rating agencies, which have a dismal record in this field. As argued earlier, they have made systematic mistakes, underestimating risks in good times and overestimating risks in bad times.
Relying on these agencies to decide such crucial matters as the selection of government bonds is simply unacceptable. It helps to destabilise the financial markets in general and the eurozone in particular. Surely, the ECB should not be a primary source of financial instability in the eurozone. Indeed, the ECB is better positioned to analyse the creditworthiness of eurozone member countries than the rating agencies are. It has a pool of highly skilled analysts who are equally if not more capable than the analysts working for the rating agencies.
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The Role of Fiscal Policy. Understanding Growth and Poverty: Theory Policy and Empirics. Nallari Raj; Griffith Breda. Common Currency, Uncommon Challenges. The Financial System Under Stress. Download e-book for kindle: Within the minimal salary and exertions industry results, Christopher Flinn argues that during assessing the results of the minimal salary in the U. Flinn develops a task seek and salary bargaining version that's in a position to producing hard work marketplace results in step with saw salary and unemployment length distributions, and in addition can account for saw alterations in employment premiums and wages after a minimal salary switch.
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