The functioning of the euro area- current problems

International finance 120181-1165

The functioning of the euro area- current problems


Lecture outline

The functioning of the euro area- basic rules

The effects of the single monetary policy

Public finance crisis

Potential solutions and perspectives


Monetary policy

Single monetary policy

ECB- supranational institution

ESBC

Eurosystem


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


Monetary policy strategy

2 pillars

Control of the monetary base

Other economic and financial values


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


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


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


Fiscal policy

The Werner plan 1970

The MacDougall report 1977

Assumptions of fiscal centralisation


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


Fiscal policy

Stability and Growth Pact 1997

The reform of the Pact 2005

Middle term surplus or balance

requirement


Current problems

Single monetary policy vs. differences

The Stability and Growth Pact and the

problem of public finance imbalance

Monetary integration and political

integration



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



The lack of national monetary aggregates Inflation as a monetary phenomenon- analysis

only on the euro area level

Monetary transmission- national level



Angeloni et al. 2003

The interest rate channel

The role of banks in the transmission

process



Christiano et al. 2007

Comparison of ECB and FED monetary

policy

The role of labour market structure in the

transmission mechanism


The crisis of public finance

The crisis in several member

countries (PIIGS) Procyclical economic policy

The effects of the financial crisis



„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



Assessment by financial markets

participants

No implicit information abot who can

support whom, when and on what

conditions information discrepancies



Propositions to create a European

Monetary Fund

Euro area bonds


The case of SpainLong term nominal interest rate in Spain and in the euro area

Ameco database, European Commission


The case of SpainLong term real interest rate in Spain and in the euro area



The effects of the interest rates decrease

Credit boom

Increasing investments

Investments raising/ not raising labour

productivity

Productivity growth vs. inflation


The real exchange rate in Spain



Current account 1999 2000 2001 2002 2003 2004 2005 2006 2007

-2,9 -4 -3,9 -3,3 -3,5 -5,3 -7,4 -8,9 -10,1

Goods 1999 2000 2001 2002 2003 2004 2005 2006 2007

-5,2 -6,4 -5,7 -5 -5,1 -6,4 -7,6 -8,5 -8,5

Services 1999 2000 2001 2002 2003 2004 2005 2006 2007

3,3 3,3 3,4 3,1 3 2,6 2,5 2,3 2,1

Eurostat


Inflationary pressures

Years 2001 2002 2003 2004 2005 2006 2007

Unit labour cost 3,2 3,0 3,0 2,7 2,8 2,7 3,1

Labour productivity 2,5 1,2 1,4 1,6 1,9 2,3 1,8

Eurostat


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?


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


Euro area desintegration?

Arguments contradicting this scenario: Economic arguments- the single European market

Political arguments



Eichengreen 2007

Large long term economic costs of

disentragtion

Large technical costs



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???


Summing up

The current problems of the euro area are

mainly a consequence of the finacial crisis

2007-2009 but also of the procycylical

economic policy in some member

countries


Summing up

Conclusions from the case study- the

necessity to introduce antycyclical tools

which could replace the antycyclical

monetary policy


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

The functioning of the euro area- current problems

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