Transcript Europäische Geldpolitik

European Monetary Policy
3.2. The Monetary Transmission
Mechanism
1
3.2.1. The Quantity Theory



Describes the effects of monetary policy on
inflation, i.e., how the growth of the money
stock affects prices without reference to
interest rates (Monetarism)
Does not explain why and how monetary
policy affects prices
Plays an important role in the announced
strategy of the ECB
2
Implications drawn by the ECB
“Inflation is ultimately a monetary phenomenon. The
Governing Council therefore recognised that giving
money a prominent role in the Eurosystem’s strategy
was important. Money constitutes a natural, firm and
reliable “nominal anchor” for monetary policy aiming at
the maintenance of price stability. The important role
played by money in the overall stability oriented strategy
also emphasises the responsibility of the Eurosystem for
the monetary impulses to inflation, which a central bank
can control more readily than inflation itself. To signal the
prominent role it has assigned to money, the Governing
Council has announced a quantitative reference value
for monetary growth as one pillar of the overall stability
oriented strategy.”
ECB Monthly Bulletin, January 1999, p.
3
When does the quantity
theory apply?



Historically: gold and silver discoveries in 16th
and 17th century lead to a huge in the money
supply (composed of gold and silver). This in
turn led to inflation.
At present: financing of public sector
expenditures by printing banknotes is the
most important cause of high inflation in
developing countries
IMF stabilisation programmes: reduce public
sector expenditures in order to put a halt to
monetary financing
4
Relationship between M3 and
inflation (HICP) in the Euro area
10
Wachstumsrate von M3
HVPI
9
8
M3 growth
7
6
5
4
3
Inflation
2
1
04
3
Ja
n-
Ju
l-0
03
2
Ja
n-
Ju
l-0
02
1
Ja
n-
Ju
l-0
01
0
Ja
n-
Ju
l-0
00
9
Ja
n-
Ju
l-9
99
8
Ja
n-
Ju
l-9
98
7
Ja
n-
Ju
l-9
97
6
Ja
n-
Ju
l-9
Ja
n-
96
0
5
Reasons for the weak
relationship

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M3 is mainly used as store of value, and not as
means of payment as dictated by the quantity
theory
Inflation is determined by aggregate demand
(which in turn depends on interest rates), by
wages and by commodity prices
There is no financing of public sector deficits by
printing money
The relation between M3 growth and inflation is
to be interpreted as a “medium run” relation (in
the terminology of O. Blanchard)
6
3.2.2. Stages in the transmission of
monetary policy (ECB)

The process through which monetary policy
decisions affect the economy, and the price level,
is known as the transmission mechanism of
monetary policy.

The individual links through which monetary
policy impulses (typically) proceed are known as
transmission channels.
7
3.2.2. Stages in the transmission of
monetary policy (ECB)
8
3.2.2. Stages in the transmission of
monetary policy (ECB)


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The (long) chain of cause and effect linking monetary
policy decisions with the price level starts with a change
in the official interest rates set by the central bank
Given its monopoly over the creation of base money, the
central bank can fully determine the interest rates on its
operations.
Through this process, the Central Bank can influence and
steer money market interest rates which has impact on
interest rates set by commercial banks on short term loans
and deposits.
9
3.2.2. Stages in the transmission of
monetary policy (ECB)
10
3.2.2. Stages in the transmission
of monetary policy (ECB)
11
Stages in transmission of monetary
policy (interest rate pass-through): 1988-98
12
3.2.2. Stages in the transmission of
monetary policy (ECB)
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Monetary policy can affect other financial variables such
as asset prices (e.g. stock market prices) and exchange
rates.
Changes in interest rates and financial asset prices in
turn affect the saving, spending and investment
decisions of households and firms and the supply of
credits… (Why?)
…leading to a change of demand for goods and services
relative to domestic supply. When demand exceeds
supply, c.p. upward pressure on prices is likely to result.
13
3.2.2. Stages in the transmission of
monetary policy (ECB)
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The exchange rate pass-through: three effects of
exchange rates on domestic prices
Direct effect through prices of imported goods
If these imported goods are used as inputs into
the domestic production process
The effect of domestic competitiveness
(appreciation makes domestic goods less
competitive abroad).
14
3.2.2. Stages in the transmission of
monetary policy (ECB)

Anchoring inflation expectations: If a central bank
enjoys a high degree of credibility in pursuing its
objective, powerfully influence price
developments by guiding economic agents’
expectations of future inflation and thereby
influencing their wage and price setting behavior
15
3.2.2. Stages in the transmission of
monetary policy (ECB)
16
3.3. Fiscal Policy in the EU
The Reform of the Stability and
Growth Pact
17
Stability and Growth Pact

Origins of the Pact (to caricature a bit)

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French considered ESCB statutes a
necessary evil to bring Germany into a
monetary union
France wanted a strong countervailing
power
Germany refused a monetary union
without some economic convergence
Germany wanted rules to maintain fiscal
discipline once monetary union achieved
18
The Macroeconomic Role of Fiscal
Policy. The Stabilisation Role

Automatic Fiscal Stabilisers (no gov’t action required).

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Discretionary Fiscal Policy.
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A rise in output increases tax revenues and decreases
government expenditures. This dampens the increase in
output.
A fall in output lowers tax revenues and raises government
expenditures. This increases output.
Policy changes in gov’t. expenditures and/or revenues.
Cyclically Adjusted Budget Deficits (CAB).

Actual budget deficits minus the automatic changes.
19
Why Fiscal Rules?

Historical Background
 In the 1980s, there was a large
accumulation of government debt in
most OECD countries, which was
unprecedented in peacetime.
 As a consequence, fiscal sustainability
became the main fiscal policy issue, and
major reforms of the fiscal policy
framework were undertaken in nearly
all OECD countries.
20
21
The Stability and Growth Pact (SGP)

Legal Basis
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Article 99 of the EC Treaty - multilateral surveillance
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Article 103 of the EC Treaty – “no bail out” clause
Article 104 of the EC Treaty - Excessive Deficit Procedure
(EDP)
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through monitoring of economic policies and the publication
of Broad Economic Policy Guidelines
procedures for establishing existence of, and taking effective
action against, excessive deficits and debt levels.
Protocol on EDP annexed to the Treaty

definition of reference values for excessive government
budget deficit and debt; and other details.
22
The Stability and Growth Pact (SGP)

Relevant texts

Council Regulation 1466/97 on the strengthening of the
surveillance of budgetary positions and the surveillance and
coordination of economic policies [the “preventive arm”]

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aims, through regular surveillance, at preventing budget deficits
going above the 3% reference value. Requires the submission of
stability and convergence programmes.
imposes a medium-term objective of a government budget close to
balance or in surplus
 measured in cyclically adjusted terms (see Code of Conduct)
Council Regulation 1467/97 on speeding up and clarifying the
implementation of the EDP [the “dissuasive arm”]

in the event of the 3% reference value being breached, requires
Member States to take immediate corrective action, and, if
necessary, allows for the imposition of sanctions. Council can
provide an “early warning” of an eventual deficit.
23
Stability and Growth Pact
(SGP)

Art. 104.1 Member States shall avoid
excessive deficits
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exception: UK (shall endeavour to avoid
excessive deficits)
Art. 104.2 specifies the meaning of
excessive deficits. An excessive deficit
exists if
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the ratio of the planned or actual
government deficit to GDP exceeds a
reference value
the ratio of government debt to GDP
exceeds a reference value
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Stability and Growth Pact

The reference values are specified in a
protocol to the Treaty
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3% for the ratio of the planned or actual
government deficit to GDP at market prices
60% for the ratio of government debt to
GDP at market prices.
The concepts are defined statistically in
Regulation 3605/93 (revised by
regulations 475/2000 and 351/2002)
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Stability and Growth Pact

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Art. 104.3 to 6 concern the procedure for
identifying situations of excessive deficit
Art. 104.7 to 11 concern the procedure for
ensuring the correction of excessive deficits
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Art 104.7 and 8 apply to all EU Member States
Art 104.9 to 11 apply only to Euro-area Member
States
Art 104.12 concerns the abrogation of the
EDP when the Member State is deemed to
have corrected its excessive deficit.
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Stability and Growth Pact
Council Regulation 1466/97
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also known as the “preventive arm”
Euro-area MS must submit a pluri-annual
“stability programme” updated annually
the other MS must submit a pluri-annual
“convergence programme” updated
annually
the contents are identical
the programme should lay down how the
MS plan to respect the norms laid down in
the excessive deficit procedure
27
Stability and Growth Pact


The programme must
 include the medium-term objective for a
budgetary position which is close to
balance or in surplus
 indicate the adjustment path towards this
objective.
The Council will decide whether to approve
the stability programme or to invite the
member state to adjust it.
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Stability and Growth Pact

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The
Council
will
also
monitor
its
implementation
and
may
issue
recommendations in this context.
The Council may issue an “early warning” to a
Member State before an excessive deficit
occurs.
Article 104.2 of the Treaty allows the ratio of
the planned or actual government deficit to
gross domestic product to exceed the
reference value only if this situation is
exceptional and temporary
29
Stability and Growth Pact


Council Regulation (EC) 1467/97 defines what
is to be understood by “exceptional and
temporary”.
In particular, it states that an excess over
the reference value resulting from a severe
economic downturn will be considered
exceptional only if there is an annual fall of
real GDP of at least 2%.
30
Stability and Growth Pact

A smaller decline can only be considered
exceptional by the Council,
 on the initiative of the Member State
concerned,
 when there is supporting evidence on the
abruptness of the downturn or on the
accumulated loss of output relative to past
trends.
 Annual falls of less than
0.75% will not
be considered as severe
31
Stability and Growth Pact

The procedure laid down in Article 104 of the EC
Treaty to be followed for establishing an excessive
deficit is further specified in Regulation (EC) 1467/97
which lays down

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that decisions are taken by (a majority of two thirds of the
votes of) the Council, excluding (the votes of) the
representative of the Member State concerned, and acting
on a recommendation from the Commission.
the deadlines that are to be observed
the rules for monitoring and assessment of the corrective
actions taken
and the eventual application of sanctions if corrective action
is not taken or deemed unsatisfactory
 sanctions are applied only to Euro-area members
 in the event of persistent excessive deficits
32
Stability and Growth Pact

Sanctions
 in the first year of sanctions, the MS
concerned must pay a non-interest bearing
deposit equal to
 fixed component: 0.2% of GDP, plus
 variable component: 10% of difference
between deficit and the 3% reference
value
 a ceiling of 0.5% of GDP is set.
 in
subsequent years only the variable
component is paid
33
The Stability and Growth Pact in Action

The SGP entered into force with the start of monetary
union
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In the lead up to monetary union:
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1 July 1998 for Regulation 1466
1 January 1999 for Regulation 1467
there was a great effort made towards “fiscal
consolidation”
in order to qualify for membership in the monetary union
Since the start of monetary union

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there has been a steady relaxation in the effort
so that now we appear to be back in 1991 re: fiscal
consolidation
34
The Stability and Growth Pact in Action

Portugal
 30 January 2002: Commission proposes that an “early warning”
be issued to Portugal (and Germany) under Regulation 1467/97.
 12 February 2002: Council decides not to do so: Portugal profits
from heavy pressure exerted by Germany.
 16 October 2002: Commission issues an opinion that an
excessive government deficit exists in Portugal. [Art. 104 (5)]
 5 November 2002: Council declares that an excessive deficit
exists in Portugal and recommends action. [Art. 104 (6) and (7)]
 Portugal acts to remove the excessive deficit
 Excessive deficit procedure against Portugal was abrogated this
spring (2004)
35
The Stability and Growth Pact in Action

Germany
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30 January 2002: Commission proposes that an “early warning”
be issued to Germany (and Portugal)
12 February 2002: Council decides not to do so under heavy
pressure from Germany (pre-election period).
8 January 2003: Commission issues an opinion that an excessive
government deficit exists in Germany [Art. 104 (5)]
21 January 2003: Council decides that an excessive deficit exists
in Germany and recommends action [Art. 104 (6) and (7)]
18 November 2003: Commission issues an opinion that Germany
has not acted on the recommendation and proposes legally
binding measures [Art. 104 (8) and (9)]
25 November 2003: Commission recommendations do not
obtain the required qualified majority. Council proceeds further
(see below) and adopts a set of conclusions put forward by the
Italian Presidency.
36
The Stability and Growth Pact in Action

France
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21 January 2003: France receives an “early warning” from the
Council
7 May 2003: Commission issues an opinion that an excessive
government deficit exists in France [Art. 104 (5)]
3 June 2003: Council decides that an excessive deficit exists in
France and recommends action [Art. 104 (6) and (7)]
21 October 2003: Commission issues an opinion that France has
not acted on the recommendation and proposes legally binding
measures. [Art 104 (8) and (9)]
25 November 2003: Commission recommendations do not
obtain the required qualified majority. Council proceeds further
(see below) and adopts a set of conclusions put forward by the
Italian Presidency.
37
The Stability and Growth Pact in Action

Three elements in the Council proceedings on 25 Nov. 2003:

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1. It did not accept the Commission’s Recommendations under
Article 104 (8) and 104 (9): no qualified majority in favour.
2. It used the voting procedure of Article 104 (9) to vote in a
new set of conclusions.
3. These conclusions were in the nature of a new
recommendation.
The Commission sued the Council before the ECJ which concluded
(in substance) on 13 July 2004 that:


The lack of a qualified majority effectively held the “excessive deficit
procedure” in abeyance till the Commission proposed a new
recommendation
The Council acted illegally in proposing a new recommendation (a
prerogative of the Commission)
38
Reforming the Stability and Growth Pact
Relevant texts

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“Strengthening Economic Governance and Clarifying the
Implementation of the Stability and Growth Pact”, Communication of
the Commission of 3 September 2004, COM(2004)581 final.
“Improving the Implementation of the Stability and Growth Pact”,
Council report agreed by the ECOFIN Ministers at their extraordinary
meeting of 20 March, and endorsed by the European Council of
22/23 March 2005.
Proposal for a Council Regulation amending Regulation (EC) No
1466/97 on the strengthening of the surveillance of budgetary
positions and the surveillance and coordination of economic policies,
(presented by the Commission), COM(2005) 154 final, Brussels,
20.4.2005
Proposal for a Council Regulation amending Regulation (EC) No
1467/97 on speeding up and clarifying the implementation of the
excessive deficit procedure (presented by the Commission),
COM(2005) 155 final, Brussels, 20.4.2005.
39