1. Fiscal Policy and Financial Regulation in EMU: The Prisoners Dilemma when not all players are Ordoliberals Ray Barrell Brunel University, London

2. The Design of EMU Currency barriers were seen as the last impediment to the Single Market in Europe Trade and risk sharing capital flows would increase, output would be higher Financial Regulation remained national in a Single Financial Market Strong belief that the Great Moderation would continue and crises had been abolished No recognition that the total quantity of risk in the system was a consequence of institutions

3. Do we need Institutional change After the 2007-08 financial crisis output fell, and growth has been weak There is a negative output gap in Europe This can be closed by leaving it to the market, or using monetary and fiscal policy Fiscal policy constrained by high debt levels Europe has deflation partly because of oil price falls, and demand is weak Do we need to move to full fiscal and political union in EMU

4. The Political Economy of Budget Deficits in Europe Understanding the Prisoners Dilemma game is central to understanding the SGP constraints and discussion on QE Simple game of looking at payoffs and defaulting if it is beneficial Reputation matters, it constrains games Rule guided (moral) behaviour matters as Ordoliberals believe breaking ‘rules’ matters Debates on default are about politics, and the risk of default is endogenous to the design of institutions

5. Debts and Default in Europe A (partial) default on debt held at home is a tax on wealth and has to be compared to other taxes The Single Market in Financial Services and EMU led to major foreign holdings of debt within the Union

6. Foreign Holdings of Government Debt end 2009

7. General Government net debt (%GDP)

8. Why did bonds become internationalised in Europe Formation of EMU supposedly removed currency risk from foreign EMU bonds Basel II required capital was held to cover 8% of risk weighted assets The weighting meant own currency sovereign bonds had a zero risk weights. Domestic holders of Greek debt had a more realistic perception of risks, so returns looked high to banks elsewhere

9. Limiting Fiscal Risk As long as fiscal policy is national, the risk of government debt should stay largely within national borders. Without greater centralized control on national public finances, Germany and other northern member countries will always be reluctant to be on the hook for the debt of their more profligate partners. QE will ease financing conditions and help keep government funding rates at low levels, including for high debt countries.

10. Banking Union in EMU Banking Union is emerging slowly Over the next decade bank support will remain largely with national governments The scale of the bail out fund is limited Good resolution regimes should be in place The design avoids the need for fiscal and political union but there is a fiscal backup Further problems for debt could emerge in Insurance related solvency problems