Transcript Lecture 4

News Analysis Assignment
 Follow news on topics related to EU, EMU (or economic
elsewhere)
• Read newspapers, magazines
• Search the internet
• Articles do not have to be about the same topic; this
time no logic required…
 Based on theories/concepts learned during the course, explain
the economics behind the stories
- Show me that you have learned some economics during
the course!
- See for example group work today on news on ECB’s
interest rates
 Include the news as an appendix in your report
 Report (excluding appendices, cover page and table of
content) should be maximum 10 pages
- DL Mon Nov 2nd, send to [email protected] and [email protected]
- INDIVIDUAL assignment – DO NOT copy text directly (not
from Internet or any other source)
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Is EMU an OCA?
 In groups, collect your findings
- Openness
• Intra-industry trade or specialization?
- Business cycle correlation
• GDP changes
• Inflation
- Financial markets & institutions
- Labor markets
- …
 In your opinion, is EMU above the ”OCA line”?
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Today’s Agenda
 Monetary Policy
- Goals and tools
- Transmission mechanism of monetary policy
 The European Central Bank
- Goals of ECB
- Challenges
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Monetary Policy
= Actions of a central bank to control the supply of
money
 Goals
- Stabilize economy (low inflation)
- Support economic growth
 Tools
- Interest rate
• Open market operations
• Standing facilities
- Minimum reserve requirements
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Transmission Mechanism
 The mechanism through which the central bank’s
actions affect the economy and ultimately the price
level
- Complex
- Time lags
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Transmission Mechanism Illustrated
OFFICIAL INTEREST RATES
Expectations
Money, Credit
Wage &
Price Setting
Bank and Market
Interest Rates
Asset Prices
Exchange
Rate
Supply & Demand in
Goods & Labor Markets
Domestic
Prices
Import
Prices
Shocks from outside
the control of
the central bank
Changes in
global economy
Changes in
fiscal policy
Changes in
commodity prices
PRICE DEVELOPMENTS
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European Central Bank
 ECB, ”Eurosystem”, and ESCB
 Decision-making in ECB
- Governing council and executive board
- General council
- Independence from politics
 Established in the Maastrict Treaty:
- Primary objective to ”maintain price stability”
- Secondary objective to ”support general
economic policies in EU”
• High level of employment, sustainable growth,
high degree of competitiveness
 Comparison to the anglo-saxon model
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Specifying ECB’s Goals
 What is meant by ”price stability”?
- ECB’s definition: Inflation close but not above 2%
 If inflation is bad, why not aim at 0%?
-
Inflation keeps economy going when wages are sticky
Bias in HICP -> true inflation less
Regional differences within EMU
Risk of deflation
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How Are Policy Decisions Made?
 Two pillars strategy
- Economic analysis
- Monetary analysis
 ECB takes actions to ensure price stability in the
medium to long term
- Due to lags, monetary policy cannot react to shocks in the
short term
 Accountability?!
 Transparency and communication of policy
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Challenges for ECB
 ”One policy fits all”
- How to maintain price stability in all regions?
- ECB follows euroarea aggregates -> large countries weigh
more
 Pressures from politicians and other lobbyists
 Credibility and reputation
- How to establish when no track record?
10
Financial Crisis 2008
 Started from the U.S.
- Housing market and subprime loans turned into investment
instruments
- Defaults and declining prices caused huge losses for banks
and investors
 Problem: trust between banks disappeared
- Interbank money market froze
- Banks couldn’t get money so they could not lend it to firms
or consumers
• No invesments, low confidence => recession
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ECB in the Financial Crisis
 ECB took emergency measures
- Acting as an intermediary in the interbank money market
- Longer term financing guaranteed for banks
- Decrease in the interest rate
 New duties for the ECB: regulation of financial
institutions, e.g. ”stress tests” for banks
- Discussion on more regulation of the financial markets
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Debt Crisis since 2011: Implications for
ECB
 Although a problem of national governments, the debt
crisis affects ECB
 Insolvency of one member can affect the credibility of
other members
- Also the credibility of the ECB is at risk: can it maintain price
stability?
 Problems for commercial banks
- Banks use their ”low risk” investments as collateral when
borrowing from ECB
- When banks incur losses, their ability to gain finanancing is
compromised
• Potential liquidity problem similar to the financial crisis
 ECB has had to purchase government bonds to calm the
markets
- The ECB is not supposed to purchase government bonds to
maintain its independence from national governments
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Group Work
 Read the news item from September 2015 from the
Wall Street Journal reporting on the outlook on FED’s
monetary policy
- What is the economics behind the story?
• Why did ECB lower the interest rates?
• What are the current challenges for the ECB?
• What are the effects of the decision?
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Pre-Lecture Assignment
1. How successful has ECB’s policy been?
Evaluate the success of ECB from several view
points.
- Find data on the development of ECB interest
rates, EMU inflation and GDP growth of EMU
countries
- You can read selected parts from ECB’s 10 year
anniversary publication "Special edition of the
Monthly Bulletin". May 2008.
http://www.ecb.int/pub/pdf/other/10thanniver
saryoftheecbmb200806en.pdf
2. What do you think the ECB’s challenges will be
in the near future?
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