the euro & the battle of ideas - bruegel | the brussels...
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The Euro &The Battle of Ideas
Markus K. Brunnermeier,
Harold James & Jean-Pierre Landau
Bruegel Brussels, October 13th, 2016
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Why ideas?
Facts historians
Interests - incentives economists
vs
Ideas - ideologies• Interests are interpreted through the lens of ideas ≈models • Different economic philosophies
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Why France & Germany?
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Why France & Germany?
Power shifts• 2010, May: EFSF, IMF involvement
• 2010, Oct: Deauville PSI: contagion
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Overview
Watershed moments• 2010, May: EFSF, IMF involvement
• 2010, Oct: Deauville PSI: contagion
• 2012: Draghi’s “Whatever it takes” Speech
• 2013: Cyprus Bail-in
• 2016: Brexit
Maastricht’s Ghost: Monetary and fiscal stability
Maastricht’s Stepchild: Financial stability
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Is difference caste in stone? … cultural?
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“German” Federalism
Holy Roman Empire
“French” Absolutism/Centralism
King Luis XIV, XV, XVI 1643-1715, 1715-1774, 1774-1792 A.D.
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… or fickle?
Historic breaks and reversals after World War II
“France” “Germany”
from laissez-faire from cameralism/state tradition
to planisme to Ordo-liberalism
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“French” “German”
1. Discretion Rules
2. Solidarity Liability• Fiscal union No-bailout clause
3. Liquidity Solvency
4. Keynesian Stimulus Austerity/Reform
Ghost of Maastricht “Rhine Divide”
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Ideal types (Max Weber) White-black comparison to sharpen contrast
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“French” “German”
1. Discretion Rules
Active management ▪ Autonomous - no “ad hocery”
Current crisis management ▪ Future crisis prevention
Ghost of Maastricht “Rhine Divide”
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“French” “German”
1. Discretion Rules
Active management ▪ Autonomous - no “ad hocery”
Current crisis management ▪ Future crisis prevention
Straitjacket commitment Safety/escape valves
Commit future to fix current crisis
Ghost of Maastricht “Rhine Divide”
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“French” “German”
1. Discretion Rules
Active management ▪ Autonomous - no “ad hocery”
Current crisis management ▪ Future crisis prevention
Straitjacket commitment Safety/escape valves
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
Ghost of Maastricht “Rhine Divide”
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Bru
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“French” “German”
1. Discretion Rules
Active management ▪ Autonomous - no “ad hocery”
Current crisis management ▪ Future crisis prevention
Straitjacket commitment Safety/escape valves
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
• Commit to currency peg/not to exit currency unionin order to discourage currency attacks
Ghost of Maastricht “Rhine Divide”
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inte
rnat
ion
al
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Bru
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“French” “German”
1. Discretion Rules
Active management ▪ Autonomous - no “ad hocery”
Current crisis management ▪ Future crisis prevention
Straitjacket commitment Safety/escape valves
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
• Commit to currency peg/not to exit currency unionin order to discourage currency attacks
Manage capital flows!
Ghost of Maastricht “Rhine Divide”
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inte
rnat
ion
al
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Bru
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“French” “German”
1. Discretion Rules
Active management ▪ Autonomous - no “ad hocery”
Current crisis management ▪ Future crisis prevention
Straitjacket commitment Safety/escape valves
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
• Commit to currency peg/ floating exchange ratenot to exit currency unionin order to discourage currency attacks
Manage capital flows! Free capital flow
Ghost of Maastricht “Rhine Divide”
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inte
rnat
ion
al
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Bru
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“French” “German”
1. Discretion Rules
Active management ▪ Autonomous - no “ad hocery”
Current crisis management ▪ Future crisis prevention
Straitjacket commitment Safety/escape valves
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
• Commit to currency peg/not to exit currency unionin order to discourage currency attacks
Ghost of Maastricht “Rhine Divide”
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Free capital flow
Fixed ex-change rate
AutonomousMonetary Policy
inte
rnat
ion
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Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion Rules
2. Solidarity Liability• Fiscal union No-bailout clause/rule
• Illusion of default free bonds SDRM/insolvency procedure
• Eurobonds with joint liability Avoid any joint liability (ESBies)(sovereign debt is anyway default free)
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Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion Rules
2. Solidarity Liability
3. Liquidity Solvency • multiple equilibria E[NPV]>0, at what discount rate?
“big bazooka”
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S
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Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion Rules
2. Solidarity Liability
3. Liquidity Solvency • multiple equilibria E[NPV]>0, at what discount rate?
“big bazooka”
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S
D
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Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion Rules
2. Solidarity Liability
3. Liquidity Solvency • multiple equilibria E[NPV]>0, at what discount rate?
“big bazooka”
• amplification/spirals E[NPV bailout]>0
E[PV bailout – PV no bailout]>0
contagion/systemicBail-out/LLR Bail-in
Countries ▪ Fire-walls
Financial Sector
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“French” “German”
1. Discretion Rules
2. Solidarity Liability
3. Liquidity Solvency
4. Keynesian Stimulus Austerity/ReformDemand Supply • Output gap unsustainable credit boom
• Reforms in boom Reforms in crisis (political economy)
Ghost of Maastricht “Rhine Divide”
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Overview
Powershift
Maastricht’s Ghost: Monetary and fiscal stability
Maastricht’s Stepchild: Financial stability
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Maastricht’s Stepchild: Financial Stability
Why was financial sector ignored in early 1990s?• Large growth EU banks became global banks
• Whole-sale funding cross-border funding
Liquidity Spirals, Fire Sales, Spillovers, Systemic Risk• Southeast Asia crisis only occurred in 1997/8
Disinflationary Spiral • Japan experience was not absorbed
Deflation if banks don’t lend to productive firms (only to zombies)
Money multiplier collapses
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Contagion, Spillovers, Systemic Risk
“French” “German”
1. Liquidity & Contagion Solvency • multiple equilibria E[NPV]>0, at what discount rate?
“big bazooka”
• amplification/spirals E[NPV bailout]>0
E[PV bailout – PV no bailout]>0
contagion/systemic risk
Bail-out/LLR Bail-in Countries ▪ Fire-walls
Financial Sector
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Contagion, Spillovers, Systemic Risk
“French” “German”
1. Liquidity & Contagion Solvency • multiple equilibria E[NPV]>0, at what discount rate?
“big bazooka”
• amplification/spirals E[NPV bailout]>0
E[PV bailout – PV no bailout]>0
contagion/systemic risk
Bail-out/LLR Bail-in Countries ▪ Fire-walls
Financial Sector
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p
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Two Diabolic (doom) loop
Government-banking nexus (deadly embrace)
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Gov. debt: safe versus contingent
“French view”• Almost never default
Straitjacket commitment
• No risk weights
• Banks as hostage Default would destroy
banks and economy
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“German view” • Default in tail events
“Safety valve”
• Risk weights on risky s-debt
• Banks as insurance providers
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Gov. debt: safe versus contingent
“French view”• Almost never default
Straitjacket commitment
• No risk weights
• Banks as hostage Default would destroy
banks and economy
• Lowers interest rate chance to get out of crisis,
• Doubling up strategy, but ..
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“German view” • Default in tail events
“Safety valve”
• Risk weights on risky s-debt
• Banks as insurance providers
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Two Challenges
Challenge 1: Safe asset + sovereign debt restructuring w/o diabolic loop
Challenge 2:No asymmetrically supplied safe asset• German Bund
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French IMF/Anglo-American/German
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Solution: ESBies
Across borders
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sovereign bonds ESBies
Junior Bond
A L
Across two European bonds
• Euronomics Group (2011) www.euro-nomics.com
Poo
ling
Tran
chin
g
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Conclusion
Ideas matter! – not only interest/incentives
Powershift in 2010• IMF, EFSF Intergovernmental• Deauville Paris-Berlin
“Rhine Divide”• Ghost of Maastricht Price and fiscal stability
Rules vs. Discretion, Solidarity vs. Solidity/Liability, Liquidity vs. Solvency, Stimulus vs. Reforms
• Stepchild of Maastricht Financial stability Liquidity spiral, contagion, diabolic (doom) loop, … Disinflationary spiral
Proposals• European Safe Bond (ESBies)• Fire-walls & “Race away from the bottom”, … 48