Download Evaluating the responses to the EZ crisis

Evaluating the responses to the
EZ crisis
Lecture to 3rd yr undergrad ‘Current
Economic Problems’, Bristol, Spring
2015
Tony Yates
Overview (of the still-unfolding
disaster!)
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Central bank interest rate policy
Bail-outs, debt forgiveness and the Troika
SMP, OMT
Conventional fiscal policy
Banking union
Macro prudential policy
Unconventional monetary policy
Unemployment in EU
Large disparity in
unemployment experiences
of the main creditor and the
debtor program countries.
Normal currency union wd
entail large fiscal transfers.
But this was not what was
signed up to.
And instead we got small
transfers with tight
conditionality, aimed at
creditor interests.
Source: Orphanides
Youth unemployment
Lots of evidence that
protracted youth
unemployment leaves
permanent scars on earnings.
A lost generation in some of
these program countries.
The extremeness of this
situation threatens legitimacy
and therefore continuity of
mixed economy welfare state
capitalism.
As manifest in some views of
Syriza/Podemos.
US vs EA recovery
Prompt and
decisive action,
and fiscal solidarity
led to strong and
prompt US
recovery.
Not so for the
Eurozone, which is
still languishing.
Source: Orphanides
CONVENTIONAL INTEREST RATE
POLICY
ECB rate appears to fall later, and not as far as rates in other countries?
Interest rate policy
• ECB relatively slow to respond?
• Large, unwieldy committee
• Hampered by conservative self-defined ‘clarification’ of
price stability mandate: ‘close to, but below 2%’
• In turn hampered by conservative view of mon pol role in
smoothing real activity.
• View that easy monetary policy lets govts ‘off the hook’ on
structural reform.
• More understandable failure to see depth and length of
demand weakness.
• Qualification: monetary policy not that strong an
instrument to correct financial/sovereign dysfunction
IR relative to a ‘Taylor Rule’
Suggests rates responding relatively promptly. Source: Brugel blog, 2103
Perils of the Taylor rule
• Matched Fed rates during era of good
performance but without financial crisis
• Theoretical studies confined to macro models
without financial sector, spreads, crisis.
• Taylor rule takes as inputs lr natural rate, and
output gap, both of which hard to measure.
• So not a ringing endorsement.
SOVEREIGN BAIL-OUTS
Troika bail-outs
• ECB-IMF-EU bails outs for Portugal, Ireland,
Greece, Cyprus
• Debt relief staged in return for structural
reform and austerity.
• Happened despite assumption that EU
treaties implied no bail outs.
• And because otherwise countries forced out
of EMU.
Why Euro exit looms if no bail-out
• No legal mechanism to withdraw or to be
pushed out.
• Happen de facto if member govt ran out of
money. Print own money to pay ongoing
spending needs [civil service pay, benefits].
• Tension between cutting loose a badly
behaved and irredeemable polity, and setting
precedent that increases speculation another
will leave, ultimately self-fulfilling.
Troika bail outs
• German politics: hard to sell bail-outs to
German electorate.
• Forced to the table partly because of exposure
of German banks to Greece, or to wider
problems caused by messy G/P/I exit.
• Tricky issue of larger precedents for
Spain/Italy.
• They could be next for a hand-out, or next for
EMU exit.
Critiques of the bail-outs
• Priority to protect French-German banks,
exposed to troubled sovereign debt.
• Debt-forgiveness would have left their own banks
needing a bail out they didn’t want to pay for.
• Also uppermost were political concerns, and
selling crisis solutions to electorates with a strong
moral narrative about the crisis.
• Hopelessly optimistic projections eg of Greek’s
ability to service debt without major write-down.
‘Structural reform’
• Privatisation: Southern med states running
inefficient and corrupt state organisations.
• Procurement.
• Tax collection/simplification.
• Labour market reform to reduce hiring/firing
costs.
• Entitlements – pensions.
• Product market competition; business
regulation.
Troika conditionality
• Conditionality necessary to sell to Northern
electorates, and to minimise moral hazard:
– If we forgive debt now without being sufficiently
harsh, another cycle of borrowing and default will
ensue
• But became seen as wrongful undermining of
national sovereignty by recipients, especially
in Greece.
‘Private sector initiative’
• Principle that private sector creditors to a
sovereign take a haircut before other member
states help even a solvent but illiquid
government.
• Introduced extra credit risk and arguably
increased the risk of a self-fulfilling run on
bonds.
• Orphanides views Ireland as the first victim of
this.
Orphanides on Cyprus
• Cyprus bail out fell below even low standards
of solidarity exhibited in other programs
• Insistence Cypriut depositors take a haircut as
a precondition for a loan.
• Combined with forced sale of operations to
reduce size of banking sector, to Greece, on
preferential terms.
• Simple transfer from Cyprus to Greek
state/Piraeus Bank.
SECURITIES MARKET PROGRAM,
OUTRIGHT MONETARY TRANSACTIONS
Securities Market Program [SMP]
• Introduced May 2010.
• Reached 210bn at peak. Purchases of bonds
on secondary markets, to be ‘sterilised’ to
avoid increase in money supply.
• Replaced by OMTs.
• It was not deemed enough by markets –in
sense that spreads on Spanish and Italian
bonds widened again.
SMP purchases
Source: Fawley+Neely
Outright Monetary Transactions
• August 2012: Draghi explains ECB will ‘do
whatever it takes’ to save the euro.
• Promise to buy unlimited quantities of shortterm bonds [1-3 yrs] off secondary market.
• Provided country accepts intervention by
ESM/EFSF [money for structural reform].
• Idea to kill off possibility of self-fulfilling run
on sovereign bonds.
• ECB becoming lender of last resort [sort of]
OMTs: bluff that worked
• Exposes ECB to unlimited capital losses, and
thus, if seigniorage not to be used to make
good, exposes ECB shareholders [=member
states’ taxpayers].
• No political support for tolerating such losses.
• Hence, a bluff. [See my blog for more].
• But, it was a bluff that worked.
The effect of OMTs on yields
OMTs sharply and persistently
reduce the yields on Spanish
and Italian bonds.
Markets clearly believe ECB’s
promise to buy unlimited
quantities.
Merkel and OMTs
• Given Merkel/Germany’s antipathy to risksharing, why did she agree to OMTs?
• Political and economic risk of EZ break-up
greater than risk of having bluff called.
• No alternatives.
• Attempting an explicit fiscal backing
impossible, incredible, and could not have
happened fast enough.
Challenge from Germany to ECB ‘fiscal’
actions
• OMT couched as combatting ‘irrational’
‘redenomination’ risk, that broke the
‘transmission mechanism’ of monetary policy
[leading to dispersion of interest rates across
member states]
• German constitutional court initiated challenges
of ECB’s OMT program.
• Objected to definition of it as ‘monetary policy’.
• Authority delegated via German govt and
Bundesbank; not permitted to engage in ‘fiscal
policy’.
ECJ ruling
• European Court of justice largely rejected this
challenge. But for a while many worried about it
limiting the ECBs effectiveness, and that it would
postpone QE.
• Insistence that OMT countries enter program
designed to ensure that there was no fiscal risk
associated with purchases.
• But ECJ argued ECB should not be in business of
monitoring that fiscal program.
• Academically, distinction between monetary and
fiscal is moot. See this post on my blog.
CONVENTIONAL FISCAL POLICY
Stability and growth pact
• Fiscal policy governed by the stability and
growth pact, still, in theory
• Initiatives to clarify possible ‘flexibility within
the existing rules of the SGP’.
• In fact SGP “honoured more in the breach
than the observance”
• Wikipedia table shows no breeches only for
Sweden, Denmark, Finland
• No fiscal transfer union.
• European Financial Stability Fund – European
Stability Mechanism: common pool for bailouts.
• German fiscal policy focused on balanced
budget.
• Italian, French, Spanish fiscal policy already
strained to the limits.
No aggregate sovereign debt crisis
The tragegdy of the
EZ sovereign debt
crisis is that there
isn’t one, in
aggregate.
If all debt was
mutualised, EZ wd
have perfectly
sustainable fiscal
position.
Source: Karl Whelan
US: what a real fiscal union looks like
BANKING UNION
Origin of the sovereign debt crisis
• Recall origin of the sovereign debt crisis:
– Drying up of wholesale funding market for banks,
investment banks and other intermediaries
– …As values of loans and securities held became
uncertain and then dropped precipitously
– Assumption, reality of sovereigns stepping into
avoid collapse turns private liabilities into a public
liability….
‘Banking Union’
• Steps taken to develop common pool of funds to
finance systemically important banks.
• Idea: banking failure in one country need not sink that
country’s sovereign if bail-out can be financed from
common fund.
• Ideally, fund not called on because more secure
sovereign avoids bank failure in the first place.
• Common supervisory standards applied by new
supervising directorate at ECB.
– This is the quid pro quo for having a common fund.
• Single resolution mechanism for banks.
Banking union: drawbacks
• BUT. It’s a very small fund. E55bn.
– Compares to £133bn cash outlay by UK alone, according to
National Audit Office.
• Manifests overly lenient regulatory response to crisis?
• Or, as per ‘freshwater’ critique, just more bailouts,
more regulation, leading to more disaster.
• Some reading:
– Dell’Arricia et al, VoxEU on the banking union.
– Various blogs by Cochrane, + Calomiris writings, on perils
of regulation and bailouts.
CREDIT AND QUANTITATIVE EASING
ECB: LTROs in
the early
phase.
Then SMP
purchases.
Now QE.
Early response:
credit easing +
purchases of
Agency debt.
Then QE.
BoE balance sheet
expansion marked by
2 phases; 1) LTR0s
under the SLS and 2)
QE, outright
purchases of m/l
maturity govt bonds.
‘Credit easing’
• Term coined by Bernanke. Buying risky assets.
Take risk out of private sector, whose pockets are
too shallow to bear it, and put it on public sector,
which can.
• Program to buy ‘covered bonds’ issued by banks,
where banks retain residual risk.
• ECB took troubled peripheral sovereign bonds as
collateral for loans to EZ banks.
– Not normally considered ‘credit easing’, but bearing in
mind position of sovereigns, it is.
Quantitative Easing
• ECB plan to buy 50bn/month.
• No ‘risk-sharing’. I.e. national central banks buy
their own govt bonds, and bear the brunt if their
govt defaults.
• Much wrangling over whether monetary stimulus
is desirable; whether QE is ‘fiscal’
policy/monetary financing, i.e. outside ECB remit.
• Dissent from >1 Governor, inc German, Weidman.
ECB QE: critique
• Program small. Wd take 5 yrs to get to 30% of
nominal GDP, comparable to UK/US schemes.
• Happening when yields already very low
[some –ve] so signalling channel gone, premia
in Northern yields low. No risk sharing.
• Expectations mgt very bad on account of
controversy, signalling lack of commitment.
• Bear in mind QE hasn’t solved problem in UK.
• See my blog on this.
Comment on QE/CE
• In US/UK
– ‘credit easing’ considered further away from
traditional cb function, more ‘fiscal’, and less
desirable.
– QE was the first resort, esp of the BoE.
• In EZ
– QE is the last resort, because of sovereign nature
of the crisis, and worry that this is ‘monetary
financing’.
Dissident freshwater views
• Sovereign debt forgiveness and financial sector
bailouts:
– worsened demand
– and increased likelihood of next crisis and weakened
resolve of peripheral polities to engage in structural
reform.
• Lack of structural reform failed to address route
causes of crisis.
• Low interest rates bloated asset prices and feed
next crisis, inhibiting creative destruction.
‘Zombie firms’.
Dissident views on QE
• Will be hyper-inflationary.
• High profile US critics of Fed QE.
• Based on view that more money always
means higher prices.
• This is true, except at the ZLB. At least in
theory! And, so far, in the data too.
STOP PRESS: THE SECOND GREEK
SOVEREIGN CREDIT CRISIS
2nd Greek crisis, 2015
• Greek economy contracted by 25% peak to trough. 40-50%
youth unemployment.
• Bail out left them with apparent gross govt debt to GDP
ratio of approx 175%
• Commitment to primary surplus [G-T excluding interest
payments] of 4.5%.
• Despite recovering starting in 2014, ‘New Democracy govt
led by Samaras’ lost popularity to Syriza, recently elected.
• Syriza: against the bail-out; officially pro-Euro, but some
dissent from this.
• Origin: union of former Communist factions, but long since
migrated to democratic left.
Syriza’s demands
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End of the scrutiny from the Troika.
‘No more bail outs’
Stay within the Euro
Freedom to set their own domestic policy:
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Reverse public sector staff firing
Progressive benefits [free food, electricity] to poor
Halt/reverse privatisations
New collective bargaining legislation; employment
protection
– Tackle the oligarchs: tax evasion, procurement
Syriza’s bargaining stance
• Syriza demanding things that are not realistic
for the Troika to accept.
• Threat: exit would stimulate contagion in
other economies, forcing Troika to give way.
• Syriza’s hand weakened by:
– Accelerating deposit flight from banks
– Lack of movement in other sovereign or bank
yields : no contagion.
Greece: stay or go?
• Staying: debt servitude and austerity and
inappropriately tight monetary policy?
• Leaving: financial crash and chaos
immediately post-exit
• Not what Syriza voters or population wants.
• Devaluation nice, but long term issue of
guaranteeing sound monetary and fiscal
policy. [What took them into EZ in the first
place].
Eurogroup’s bargaining stance
• Want to avoid moral hazard.
• Have to sell new deal to home electorate, so
must seem fair exchange.
• Spain/Portugal have anti-austerity parties [eg
Podemos] that incumbent govts don’t want to
be encouraged.
• Some poorer EZ members are poorer than
Greece
Dilemma for the Euro
• Two alternative visions of the Euro [see my
blog post]:
– Reputation for preserving enduring membership
come what may.
• If give let one country go, risks presumption that will let
others go
– Reputation for preserving enduring rules of
membership, come what may
• If let one country break the rules, risks presumption
that others will too.
The deal
• Change of name from ‘Troika’ to ‘the
institutions’!
• 4 months extension of funding, conditional on
agreeing new set of reforms.
• Relaxation of demands on primary surplus for
2015.
• Time to negotiate a longer-term deal.
• Some signs of internal Syriza dissent.
EZ policy responses: Recap
• ECB interest rate policy.
• ECB balance sheet policies: Term lending,
SMP, OMTs, QE, credit easing.
• Conditional bail-outs.
• Banking union and banking supervision.
Problems with EZ responses
• Ideal: member states surrender fiscal
sovereignty to enable full fiscal transfer union.
• Reality: those that suffer want fiscal transfers,
but don’t want to surrender sovereignty.
• Solutions partial, and late.
• EZ economy blighted by uncertainty about
resolution of sovereign/bank credit crisis.
• And by inability of uncompetitive polities to
reform themselves.
Expectations management
• Woodford stresses importance of expectations
management in monetary policy.
• Open conflict, uncertainty, wrangling, weighed
heavily on expectations, reducing impact of
almost all policies. [OMT excepted].
Who should bear the costs?
• Unfair distribution of costs of crisis.
• Unsustainable debts are mirrored by
irresponsible loans, yet creditors bearing less
of the cost.
• ‘Debtors pay’ principle went against spirit of
EZ political project.
• And probably worsened outcomes for EZ as a
whole.