International finance The functioning of the euro area- current problems

International finance Lecture outline  The functioning of the euro area- basic rules  The effects of the single monetary policy  Public finance crisis  Potential solutions and perspectives

International finance Monetary policy  Single monetary policy  ECB- supranational institution  ESBC  Eurosystem

International finance EBC and ESBC  Creation of the ECB  the necessity to set its rules  Different conditions than for NCB’s  The euro area- small degree of opennes  Monetary impuls transmission  The necessity to build credibility

International finance Monetary policy strategy  2 pillars  Control of the monetary base  Other economic and financial values

International finance Exchange rate policy  The aim- price stability  EBC and the EU Council (Ecofin)  Ecofin can unanimously set the rules of the euro area exchange rate system vs. other countries

International finance Exchange rate policy  ERM II- ER stabilisation vs. The currencies of EU countries which are not euro area members  Euro area extension plans  Counteracting high ER volatility within the EU market

International finance ERMII  Amsterdam summit 1997  Agreements between ECB and NCB of countries which are not euro area members  ER approaches the band limit  NCB is obliged to conduct automatic and unlimited interventions  ECB support- conditional

International finance Fiscal policy  The Werner plan 1970  The MacDougall report 1977  Assumptions of fiscal centralisation

International finance Fiscal policy  The Maastricht Treaty  The prohibition to finance fiscal deficits by ECB  No bail out clause  Thresholds concerning the fiscal balance and governement debt

International finance Fiscal policy  Stability and Growth Pact 1997  The reform of the Pact 2005  Middle term surplus or balance requirement

International finance Current problems  Single monetary policy vs. differences  The Stability and Growth Pact and the problem of public finance imbalance  Monetary integration and political integration

International finance The effects of the single monetary policy  Different growth rates in the euro area countries  Potential Balassa-Samuelson effect  Differences in reference i% according to Taylor rule  Differences in inflationary pressures e.g.:  Labour market flexibility  Product market flexibility  The role of labour unions

International finance The effects of the single monetary policy  The lack of national monetary aggregates  Inflation as a monetary phenomenon- analysis only on the euro area level  Monetary transmission- national level

International finance Monetary transmission- national level  Angeloni et al  The interest rate channel  The role of banks in the transmission process

International finance Monetary transmission- national level  Christiano et al  Comparison of ECB and FED monetary policy  The role of labour market structure in the transmission mechanism

International finance The crisis of public finance  The crisis in several member countries (PIIGS)  Procyclical economic policy  The effects of the financial crisis

International finance The crisis of public finance  „Transfer union”- the possibility to finance deficits of other member countries  violation of the Treaty regulations  Loans vs. transfers??  ECB support- the purchase of governement bonds

International finance The crisis of public finance  Assessment by financial markets participants  No implicit information abot who can support whom, when and on what conditions  information discrepancies

International finance The crisis of public finance  Propositions to create a European Monetary Fund  Euro area bonds

International finance The case of Spain Long term nominal interest rate in Spain and in the euro area Ameco database, European Commission

International finance The case of Spain Long term real interest rate in Spain and in the euro area Ameco database, European Commission

International finance The effects of the interest rates decrease  Credit boom  Increasing investments  Investments raising/ not raising labour productivity  Productivity growth vs. inflation

International finance The real exchange rate in Spain Ameco database, European Commission

International finance Current account ,9-4-3,9-3,3-3,5-5,3-7,4-8,9-10,1 Goods ,2-6,4-5,7-5-5,1-6,4-7,6-8,5 Services ,3 3,43,132,62,52,32,1 Eurostat

International finance Inflationary pressures Years Unit labour cost 3,23,0 2,72,82,73,1 Labour productivity 2,51,21,41,61,92,31,8 Eurostat

International finance The crisis in Spain  The collapse of the bubble on the housing market  Increase of market interest rates  Recession as a consequence of the lack of antycyclical monetary policy?

International finance The crisis in Spain  Antycyclical banking supervision instead od antycyclical monetary policy  Proposition to diversify the minimum reserve requirement in the euro area  Proposition to diversify capital requirements

International finance Euro area desintegration?  Arguments contradicting this scenario:  Economic arguments- the single European market  Political arguments

International finance Euro area desintegration?  Eichengreen 2007  Large long term economic costs of disentragtion  Large technical costs

International finance Euro area desintegration?  Credibility of the euro area- diversified risk premia in different countries  ECB as a lender of last resort  Does the crisis change the balance of benefits and costs of the EMU creation???

International finance Summing up  The current problems of the euro area are mainly a consequence of the finacial crisis but also of the procycylical economic policy in some member countries

International finance Summing up  Conclusions from the case study- the necessity to introduce antycyclical tools which could replace the antycyclical monetary policy

International finance References  Auszüge aus Presseartikeln, Deutsche Bundesbank, 51-54/2010  B. Eichengreen, The breakup of the euro area, NBER Working Paper, 2007  I. Angeloni et al., Monetary transmission in the euro area: does the interest rate channel explain it all?, NBER Working Papers 2003  M. Woodford, How important is money in the conduct of monetary policy?, NBER Working Paper,2007