Transcript Dia 1

Europe: after the crisis
reaction to the lecture of Charles A.E. Goodhart
Duisenberg School of Finance
Opening Academic Year
September 7, 2011
Wim Boonstra
Chief Economist
Rabobank,
Content
• Charles Goodhart’s conclusions
• Some comments
• Some recommendations: common funding of public deficits
• Concluding remarks
Charles Goodhart’s conclusions
• A monetary union needs some minimal centralisation of power.
• Current account balances are important!
The new Excessive Imbalance Procedure correctly shifts the focus
from public finances to the external sector
• The enforcement of the EIP is misguided
• Interaction between banks and public sector debt is the most severe
problem. There really is no good way to resolve this.
• There is a case for building up a sizeable euro-zone sovereign
wealth fund for use in emergencies
Some comments
•
I agree with Charles Goodhart on almost everything he has said.
•
“For a country like Japan, with a huge public debt but a CA surplus and a
positive NIIP its debt is entirely its own concern”. Is it? Or does it need capital
controls in the end?
•
The corrective arm of the EIP is misguided. Financial sanctions do not make
sense. But would an ‘enforced credit rating downgrade’ have a different effect?
•
What we need is ex ante agreed and automatic political sanctions. Such as:
•
To summarise, we need:
•
Creation of a wealth fund is a good idea, but it is not enough
– (temporary) loss of voting rights in the ECB board
– (temporary) loss of voting rights in the council of ministers
– (temporary) loss of European Commisioner
– measures that hurt politicians, not their electorate
– measures that are easy to implement
On average, EMU public finances are relatively good.
Financial markets’ binary discipline: a case for eurobonds?
The eurobond cacophony
• There are many so-called eurobond proposals. They have one thing
in common: the word ‘eurobond’. The differences are huge.
• Succesfull eurobonds should bring:
–
–
–
–
Stability in the markets
Improved fiscal discipline (supported by a more effective SGP)
Clear benefits for all countries (weak and strong)
A self-financing and pro-active crisis mechanism (via an insurance
premium)
• Most proposals bring at best some benefits for the weaker countries
• Benefits for strong countries might be:
– Lower funding costs due to liquidity premium. This is strongly
–
dependent on the exact design. Here things can go seriously wrong
Self-financing crisis mechanism  Goodhart’s SWF
Central funding via the EMU fund
• EMU fund issues (euro)bonds and pays market rates
• Redistributed to the member states
• Countries pay spread over funding costs, depending on fiscal
performance
Member state
• Self-financing mechanism
(‘insurance premiums’)
• Cross-guarantee essential
(not partial guarantees)
Member state
Member state
EMU Fund
Borrowing by EMU-fund
Payments by EMU Fund
(redemtion plus interest)
Global financial markets
Redemption plus interest, incl.spread
Amount borrowed by member state via EMU-Fund
Pros and cons of this approach
•
Advantages
– Flexibility in debt management (maturities etc.)
– Diverging fiscal policies translate into diverging funding costs (restoration of
failing market discipline)
– Countries are sheltered from sudden swings in market sentiment
– Creation of huge and liquid pan-EMU bond market
– Weaker countries pay premium to EMU Fund, instead of higher interest rates
to markets  financial buffer against future problems  Charles Goodhart’s
SWF?
– Using cross-guarantee  the average counts, not the problem in the margin
 lower funding costs
•
(Possible) problems
– Potential tensions with no-bail out clause  we already have crossed this
line
– Difficulties in calculation of spread  see below
– Practical implementation
– Lack of political willingness  voluntary participation
– We can start without Germany. Any pair of countries can start and scale up.
Computing the spread
• A simple straightforward formula will suffice:
• R(i) =  [O(i) - O(m)] +  [S(i) – S(m)]
• Where:
– R(i) = the margin payable by country i over the funding costs of the
–
–
–
–
EMU fund
O(i) = the government deficit of country i, as a % of GDP
S (i) = the government debt of country i, as a % of GDP
The variables O(m) and S(m) represent the acceptable levels for debt
and deficits. They could be the criteria from the SGP.
The parameters  and  are coefficients, used to determine the weight
of the relative performance on government deficit and government debt
respectively in setting the mark-up.
Concluding remarks
•
A monetary union needs some minimal centralisation of power.
•
Eurobonds can change the interaction between banks and the national public
sector debt
•
There is a case for building up a sizeable euro-zone sovereign wealth fund
for use in emergencies  a well-designed eurobond scheme can bring this
forward
•
If fragmentation of EMU’s national public bond markets is not eliminated,
EMU will remain vulnerable and may in the end not survive. Some
centralisation is essential
•
A well-designed eurobond scheme can bring advantages for all participating
countries:
– Deeper markets bring increased liquidity  lower funding costs
– Weaker countries benefit from cross guarantee
– Self-financing insurance mechanism  no need for additional rescue packages
Thank you
More information: www.rabobank.com/kennisbank