Transcript Presentation_Barrell_ppt

Fiscal Policy and Financial
Regulation in EMU: The Prisoners
Dilemma when not all players are Ordoliberals
Ray Barrell
Brunel University, London
The Design of EMU
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Currency barriers were seen as the last
impediment to the Single Market in Europe
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Trade and risk sharing capital flows would
increase, output would be higher
Financial Regulation remained national in a
Single Financial Market
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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
Do we need Institutional change
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After the 2007-08 financial crisis output fell,
and growth has been weak
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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
The Political Economy of Budget
Deficits in Europe
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Understanding the Prisoners Dilemma
game is central to understanding the SGP
constraints and discussion on QE
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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
Debts and Default in Europe
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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
Foreign Holdings of Government
Debt end 2009
General Government net debt
(%GDP)
140
120
100
80
60
2013
40
2014
2015
20
0
-20
-40
-60
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
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Limiting Fiscal Risk
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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.
Banking Union in EMU
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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
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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
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