Lecture 14. EUROPEAN POLICY RESPONSE: Economics 1490 THE WORLD ECONOMY: GROWTH OR STAGNATION? with Professor Dale W. Jorgenson Lecture 14. EUROPEAN POLICY RESPONSE: THE EURO October 17, 2017 Harvard University Department of Economics Fall 2017

THE WORLD ECONOMY: GROWTH OR STAGNATION? A. Comparing Economies B. U.S. Crisis and Recovery C. European Slowdown D. Asian Economic Miracles E. Sustainability of Economic Growth F. World Economic Outlook

EUROPEAN SLOWDOWN 11. U.S. Growth Resurgence  12. Global Trade Slowdown  13. Europe 2020 and the Single Market  14. European Policy Response: The Euro  15. European Policy Response: Brexit

TWO ECONOMIC CRISES IN EUROPE The U.S. Crisis Was Transmitted Internationally by the Collapse of Inter-Bank Lending. This Was Followed by the Collapse of Trade in Late 2008 and Early 2009. Bank Bailouts Were Handled by Local Authorities – Governments and Central Banks. The Sovereign Debt Crisis in Europe Began with the Greek Bailout in May 2010.

THE SECOND PHASE OF THE CRISIS Signs of Financial Distress Emerged in Europe in 2011. European Bank and Sovereign CDS Prices Revealed Possible Solvency Problems European Central Bank Broadened Its Support of Sovereign Debt Recovery from the Second European Crisis Has Taken Hold in 2017, Supported by Domestic Demand

TIME LINE FOR EUROPEAN SOVEREIGN DEBT CRISIS

A GLOSSARY OF EUROPEAN INSTITUTIONS ALPHABET SOUP: A GLOSSARY OF EUROPEAN INSTITUTIONS

EUROPEAN SYSTEM OF FINANCIAL SUPERVISORS (ESFS)

LONDON SPEECH Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough. Mario Draghi, President of the European Central Bank, London, July 26, 2012.

MARIO DRAGHI: BIOGRAPHICAL HIGHLIGHTS Born: Rome, Italy, 1947. Ph.D., MIT, 1976. Professor of Economics, University of Florence, 1981-1994.  Fellow, Institute of Politics, Kennedy School of Government, 2001. Governor, Bank of Italy, 2006-2011. Chairman, Financial Stability Board, 2009-2011. President, European Central Bank, 2011-

EUROPEAN CENTRAL BANK POLICY December 2011: Expanded Long Term Refinancing Operation for Banks September 2012: Outright Monetary Transactions 2012-2013: Lowered Policy Rate in Steps to 0.25%

EUROPEAN POLICY RESPONSE TO THE SOVEREIGN DEBT CRISIS European Union Participated in Sovereign Debt Bailouts Through the EFSF and EFSM.   The EFSF and EFSM Were Superseded by the ESM EFC Strengthened the Stability and Growth Pact ECB Provided Support for Banks through Conventional And Unconventional Monetary Policy

EUROPEAN BANKING UNION Four Essential Components: Single Supervisor, Single Regulator, Single Resolution Mechanism, Single System of Deposit Insurance October 2014: ECB Examination of Balance Sheets of 130 European Banks with 85% of EU Deposits November 2014: ECB Provides Single Supervisory Mechanism (SSM) for 130 Largest Banks. January 2016: Single Resolution Mechanism by ECB.

SHARES OF GOVERNMENT BONDS HELD BY DOMESTIC BANKS

INTEREST RATES ON LOANS TO BUSINESSES IN SELECTED COUNTRIES OF THE EURO AREA

BANK CDS SPREADS CLUSTER ALONG COUNTRY LINES DURING CRISIS

CHANGE IN CROSS-BORDER BANK HOLDINGS, 2008Q-2012Q4

TOTAL FACTOR PRODUCTIVITY GROWTH

UNEMPLOYMENT RATE

GDP

INFLATION 4. Headline inflation has picked up, but core inflation remains stubbornly low (Figure 2). International Monetary Fund (2017), Euro Area Policies, 2017 Article IV Consultation: Staff Report, Washington, DC, International Monetary Fund, July, pp. 4-37. http://www.imf.org/en/Publications/CR/Issues/2017/07/25/Euro-Area-Policies-2017-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by-45121

ANNEX. MONETARY POLICY TRANSMISSION CHANNELS

SUPRANATIONAL CONSTRAINTS AND RULES ON FISCAL AGGREGATES

TIMELINE OF THE ECB’S COMPREHENSIVE ASSESSMENT

TOTAL DEBT-TO-GDP

FISCAL CONSOLIDATION, 2013-2022

DEBT-TO-GDP

THE EURO AREA GROWTH PROBLEM

LOANS TO NON-FINANCIAL CORPORATIONS AND HOUSEHOLDS

THE FINANCIAL CRISIS IN EUROPE The U.S. Financial Crisis Was Transmitted to Europe by the Collapse of Interbank Lending in 2008. The Sovereign Debt Crisis in Europe Emerged in 2010, Beginning with the Greek Bailout in May. The policy response was more diffuse in Europe Recovery from the Second European Crisis Has Taken Hold in 2017

THE SECOND PHASE OF THE CRISIS Indications of Renewed Financial Distress in Europe Began to Emerge in 2011. This Involved Bank Debt and Sovereign Debt, Especially in the Periphery Countries. The ECB Responded by Providing Financial Support for Sovereign Debt. Initially This Was Indirect Support through Bank Lending, but Became Direct with the OMTs in 2012

CONTINUATION OF THE EUROPEAN SLOWDOWN The European Recovery of 2017, While Supported by Domestic Demand, Is Weaker Than the U.S. Recovery. Europe Is Developing a New Framework for Financial Regulation. A Fiscal Union Has Been Discussed, but Little Progress Has Been Made. Structural Reforms Like a Single Market in Services Appear to Be on Hold.