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The ECB to the rescue?
Filling the Lacunae in
Euro Area Governance
Gabriel Glöckler *
European Central Bank
Edinburgh, 1 June 2012
* The views expressed are those of the author and do not necessarily reflect the position of the ECB.
• Conceptual Framework
• Designing EMU
• The response to the crisis
• Filling the ‘gaps’ in economic governance
• Toward economic and financial union?
2
Fiscal and financial dominance?
• Classic notion of fiscal vs. monetary dominance
(see Sargent and Wallace: 1981, Jeanne: 2012)
• Morgan Stanley, Oct 2011: “The name of the game:
fiscal dominance […] the inability or unwillingness of
governments to rein in debts and deficits becomes a
binding constraint on monetary policy and may well
collide with the objective of price stability.”
• See also ECB Monthly Bulletin July 2012 (forthcoming)
3
• Conceptual Framework
• Designing EMU
• The response to the crisis
• Filling the ‘gaps’ in economic governance
• Toward economic and financial union?
4
Designing EMU
• Economic basis
– ‘Sound money sound finances consensus’ (McNamara: 1998)
“ [A single currency] would imply a common monetary policy and require a high
degree of compatibility of economic policies…, in particular in the fiscal field”; “In
particular, uncoordinated and divergent national budgetary policies would undermine
monetary stability….” (Delors report 1989)
• Legal basis (Maastricht Treaty)
– Art. 101 monetary financing prohibition
– Art. 102 prohibited privileged access to governments
– Art. 103 (1) no bailout clause
– Art. 104c, 109j and protocol annexed in the Treaty outlined
the ‘Maastricht criteria’
5
clause
‘No bail-out’
Monetary
financing
prohibition
of the central bank
Independence
orientation
of the central bank
Price stability
ECB’s institutional context
EMU rests on four fundamental constitutional pillars
EMU
Designing EMU: positive feedback
mechanisms
Monetary Financing
Prohibition
SGP
No Bailout Clause
Policy
consequences
internalised
‘Keep own house
in order' principle
Financial Market
Discipline
Source: Yiangou, Glöckler, O’Keefe (forthcoming)
7
What went wrong (I)? – despite early warnings
• Weak implementation of fiscal rules
• Insufficient monitoring of imbalances
Unit labour costs in selected euro area countries, nominal
“..[T]he access to a
(index 1998 Q4 = 100, relative to Germany, based on sa data)
large capital market
Euro area
Germany
France
Italy
Spain
Netherlands
Belgium
Austria
Greece
Ireland
Finland
Slovakia
Luxembourg
Portugal
Slovenia
may for some time
Cyprus
Malta
even facilitate the
financing of economic
imbalances.”
(Delors report, 1989)
• Low pricing of
sovereign risk
145
145
140
140
135
135
130
130
125
125
120
120
115
115
110
110
105
105
100
100
95
95
1998 Q11999 Q12000 Q12001 Q12002 Q12003 Q12004 Q12005 Q12006 Q12007 Q12008 Q12009 Q12010 Q12011 Q1
8
What went wrong (II) ? – despite early warnings
• Missing elements
• “…Rather than leading to a gradual adaptation of borrowing costs,
market views about the creditworthiness of official borrowers tend to
change abruptly and result in closure of access to market financing.The
constraints imposed by market forces might either be too slow and weak
or too sudden and disruptive.” (Delors report)
– No crisis resolution mechanism
– No responsibility for financial stability at euro area level
– Contagion channels not adequately understood
Risk of fiscal dominance
9
What went wrong?: ‘Gaps’ in the financial
governance framework
• Two trilemmas:
(1) Financial trilemma
Financial integration
Financial stability
National supervision
Source: Schoenmaker (2011)
(2) The new impossible trinity
Sovereign-bank interdependence
No monetary financing
National fiscal policies
Source: Pisani-Ferry (2012)
• Increasing financial fragmentation due to bank
sovereign nexus:
also a risk of financial dominance
10
• Conceptual Framework
• Designing EMU
• The response to the crisis
• Filling the ‘gaps’ in economic governance
• Toward economic and financial union?
11
Financial sector debt transferred to public sector
Short-term fiscal impact of crisis- general government
debt
Source: Commission Services
12
Sovereign spreads on the rise
Spreads compared to 10 yr German Bund, in basis points
Source: Bloomberg
13
But do markets get it right?
25
150
GR 10yr Yield
GR Govt Debt/GDP %
140
16
120
IRE 10yr Yield
IRE Govt Debt/GDP %
14
100
20
130
12
80
10
15
120
8
60
110
10
6
100
40
4
5
0
20
90
2
80
0
0
2000-2011
2000-2011
6
100
5
90
4
3.5
240
JAP 10yr Yield
JAP Govt Debt/GDP %
220
3
4
80
200
2.5
3
70
2
60
2
180
1.5
160
1
1
0
50
US 10yr Yield
US Govt Debt/GDP
%
2000-2011
40
140
0.5
0
120
2000-2011
Source: Bloomberg
14
Bluntness of debt markets as disciplining devices
Observed payout distribution of debt and equity contracts
http://ineteconomics.org/sites/inet.civicactions.net/files/turner-frankfurt-slides.pdf
The fiscal-financial nexus in the euro area…
…. has been strong since the beginning of 2010
Euro area
US
300
800
700
250
10Q1
10Q2
10Q3
10Q4
11Q1
11Q2
11Q3
11Q4
500
400
300
200
10Q1
10Q2
10Q3
10Q4
11Q1
11Q2
11Q3
11Q4
200
Bank CDS
Bank CDS
600
150
100
50
100
0
0
0
100
200
300
400
Sovereign CDS
500
600
700
800
0
50
100
150
200
250
300
Sovereign CDS
Source: Thomson Reuters and ECB calculation. Latest observation: 31 Dec 11.
Note: Sovereign CDS euro area average calculated as country CDS weighted by ECB capital key. Banks CDS euro area average is calculated taking the
largest bank of each available country and aggregating using ECB capital key. Each dot represents the pair (av. sovereign CDS, av. bank CDS) at a certain
day in the respective quarter.
16
Market segmentation and the fiscal-financial nexus
Increased risk aversion and retrenchment behind
national borders
17
The risk of re-fragmentation of markets
Cross-border holdings of EU MFIs
(% of total holdings)
Share of cross border collateral used
in Eurosystem credit operations
Quelle: ECB Financial Integration Report, April 2012
18
Could the ECB break that feedback loop?
• In the absence of common supervision,
resolution or fiscal backstop:
– Deploy “bazooka” via the ECB operations?
– Unlimited commitments? Yield targets?
• Major problems:
– Legal prohibition
– Incentives
– Accountability and democracy
19
The SMP in a comparative context
1400
1200
Fed change in Treasury holdings ($, bn, since QE announcement)
ECB SMP purchases (EUR, bn)
1000
800
600
400
200
0
Mar-09
Sep-09
Mar-10
Sep-10
Mar-11
Sep-11
Mar-12
20
3 year LTRO as ‘the Big Bertha’
Two 3-year operations
(1) € 489 bn, 523 counterparties;
(2) € 529 bn, 800 counterparties
Exceptionally serious situation in late 2011
• panic and complete drying-up of
inter-bank markets;
• Dangers of a credit crunch;
• perceptions of the “inevitability”
of a catastrophe
•21
Impact on money markets
Reduced tensions in money
markets
•Euro area money market spread and volatility
Reduced credit risk
•CDS for financial and non-financial corporations
•Note: The vertical green line denotes the announcement on 8 December 2011 of the two three-year LTROs. The two vertical red lines mark
the allotment of the two LTROs on 21 December 2011 and 29 February 2012 respectively. Source: ECB Monthly Bulletin, march 2012
First impact on credit provision
Quelle: ECB Bank Lending Survey April 2012
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Addressing the criticisms
No real help for real economy?
• 800 banks – of which 500 German (i.e. many of those
which are closest to SMEs)
Excessive risks for the Eurosystem balance sheet?
• strikt und differentiated risk management framework
• loss only through double default
• dynamic balance sheet as part of normal central bank
functions (i.e. when intermediation breaks down)
24
The ‘breathing’ Eurosystem balance sheet
Quelle: ECB, Letzte Daten: 26..März 2012
25
Sowing the seeds of future inflation?
Market-based inflation indicators
euro area (%.)
• Different concepts of liquidity
• Till now no significant increase
in monetary aggregates
(M3 +3.2% March 2012)
• Inflation expectations securely
anchored
• Eurosystem can re-absorb
liquidity (e.g. via minimum
reserve requirements)
Sources: Bloomberg, BoE, Fed staff calculations, Reuters, Euro MTS, and ECB. Note: market-based inflation expectations (break-even inflation rates).
Latest observation: 30 August 2011.
26
• Conceptual Framework
• Designing EMU
• The response to the crisis
• Filling the ‘gaps’ in economic governance
• Toward economic and financial union?
27
2. A robust rescue mechanism
Supportive
Primary
Secondary
Funding
Market
Market
EFSF
Purchases
Basiert auf Eurogruppe, EIB, ECB, …Purchases
Funds to
recapitalize
banks
“...a ‘
Other
uses –
genuine
ESM
EMF?
VorsorgeKreditlinien
Precautionary
Facilities
’ in all but name?” (Sarkozy)
28
3. Progress in financial supervision and resolution
• New supervisory framework (since Jan 2011)
• EBA, gradual progress towards single rulebook –main
role still played by national supervisors
• EU Bank Recovery & Resolution Directive (COM proposal)
• Harmonised powers for early interventions, new
resolution tools, framework for cross-border cooperation
•
Deposit Guarantee Schemes Directive (text in trialogue)
• Harmonisation of levels (at EUR 100,000)
Enough to secure monetary dominance ?
What now?
29
Further governance reform is needed
• “…to operate smoothly and to be more resilient to
crises, the Economic and Monetary Union has to
become a true financial union.” B Coeure, March 2012
• “Increasingly, it seems that it is not too bold to consider
a European finance ministry, but rather too bold not to
consider creating such an institution” J.C. Trichet,
October 2011
• “Financial market union”, “fiscal union”, and “political
union” J. Asmussen, May 2012
30
Toward financial/banking union?
– Strengthened micro and macro prudential
regulation of risk
• Strengthened EBA?
• New Authority with mandate for cross border
supervision?
– Harmonised deposit guarantee scheme
– Recapitalisation of financial institutions
• Direct recapitalisation of banks by the ESM
– Resolution
• Network of resolution funds? Common fund
financed by the industry?
31
Thank you
For further questions
Email:
[email protected]
Or visit:
www.ecb.europa.eu