European Economic Integration – 110451-0992 – 2014 VIII European Monetary Union(EMU) Euro area Member States Non-euro area Member States Prof. Dr. Günter S. Heiduk Member States with an opt-out 1 Debating Europe Some thoughts on the EURO “EMU will have a very pervasive impact on the working of the economy. Many different mechnisms will come into play and interact .“ One Market, One Money (1990) “I believe the Euroland is going to run into big difficulties. That's because the different countries have different languages, limited mobility among them, and they're affected differently by external events.“ Milton Friedman (2003) “Policy-makers rushed to negotiate a detailed agreement, having no time for detailed economic analysis.“ Charles Wyplosz (2006) 3 Today‘s Anti-Euro and Pro-Euro Debate “The euro area will hang together, in other words, because the decision to enter is essentially irreversible. Getting out is impossible without precipitating the most serious imaginable financial crisis – something that no government is prepared to risk.” Barry Eichengreen, 2007, http://www.voxeu.org/article/was-euro-mistake IFO Policy Issue: Euro Crisis “The euro rescue plan suspended fundamental principles of the Maastricht Treaty, especially the no-bail-out clause – a ban on mutual credit assistance. These changes had serious economic consequences. The interest rates on government bonds of the various countries that were drifting apart as a result of the new risk assessments were to be artificially kept together. This led to a weakening of the control function of the capital market, which induces cautious behaviour on the part of borrowers and creditors. For Germany the package bears considerable budgetary risks. Moreover, it retards economic growth since the guarantees for the euro partners divert additional capital to the indebted countries which is thus no longer available for investments in Germany. As a result of the crisis the question of structural reform for the currency union has come to the forefront.” Source: http://www.cesifo-group.de/ifoHome/policy/Spezialthemen/Policy-Issues-Archive/Euro-Krise.html “Although the European Monetary Union has survived for 11 years, the current strains within the euro zone show why it may not last for another decade without at least some of its members leaving.” Martin Feldstein, 2012, http://www.economist.com/debate/days/view/5 “I believe that there is still a fighting chance that the monetary union will emerge strengthened, not weakened. But policymakers will have to radically raise their game.” Charles Wyplosz, 2012, http://www.economist.com/debate/days/view/522 Who is the Patient: Euro versus US$ Appreciation of the EURO Depreciation of the US$ 5 Source: Pacific Exchange Service Who are the Patients: PIGS versus G+F Quarterly GDP, Change over Previous Quarter, in %, Selected Countries, Q3-2007 – Q2-2012 6 Source: Own calculations on OECD National Accounts Statistics. What is wrong in the Eurozone? ECONOMICS ? POLITICS ? Mundell‘s Optimum Currency Approach Pareto‘s Policy Priority Approach Countries/regions that are highly integrated by cross-border flows of production factors can fix the exchange rate or introduce a common currency Political integration paves the way toward economic integration, means: common fiscal policy first, monetary union second SOCIETY ? Schmölder‘s Credibility Approach Money is what‘s being generally accepted “Geld ist, was gilt“ 7 ECONOMICS ? POLITICS ? SOCIETY ? Reality Reality Reality Maastricht Treaty: Convergence Criteria EU budget has no fiscal impact Hidden scepticism, but globally still high acceptance of the Euro Increasing function as currency reserve Weakness: Control + sanctions mechanisms didn‘t function after countries joined the Eurozone National competence in all policies which are relevant for budget imbalances between Member States 8 The European way to solve the impossible “trinity“ Source: Mongelli, F P (2008). European Economic and Monetray Integration and the Optimum Currency Area Theory. Economic Papers 302. European Commission. 9 Europe: Home of a Complex, Partly Overlapping System of Institutions Eurozone: Part of a complex system of institutional arrangements http://en.wikipedia.org/wiki/Eurozone 10 Arguments for a single European currency Arguments against a single European currency Cost of Introduction Consumers and businesses will have to convert their bills and coins into new ones, and convert all prices and wages into the new currency. This Transaction Costs Having to deal with only one currency will reduce the cost of converting will involve some costs as banks and businesses need to update one currency into another. This will benefit businesses as well as tourists. computer software for accounting purposes, update price lists, and so on. Non-Synchronicity of Business Cycles No Exchange Rate Uncertainty Eliminating exchange rates between European countries eliminates the Europe may not constitute an "optimum currency area" because the business cycles across the various countries do not move in risks of unforeseen exchange rate revaluations or devaluations. synchronicity. Transparency & Competition The direct comparability of prices and wages will increase competition Fiscal Policy Spillovers across Europe, leading to lower prices for consumers and improved Since there will only be a Europe-wide interest rate, individual countries that increase their debt will raise interest rates in all other countries. EU investment opportunities for businesses. countries may have to increase their intra-EU transfer payments to help Strength The new Euro will be the among the strongest currencies in the world, regions in need. along with the US Dollar and the Japanese Yen. It will soon become the No Competitive Devaluations In a recession, a country can no longer stimulate its economy by 2nd-most important reserve currency after the US Dollar. devaluing its currency and increasing exports. Capital Market The large Euro zone will integrate the national financial markets, leading Central Bank Independence Previously, the anchor of the European Monetary System has been the to higher efficiency in the allocation of capital in Europe. independence of the German Bundesbank and its strong focus on price No Competitive Devaluations One country can no longer devalue its currency against another member stability. Even though the new European Central Bank (ECB) will be nominally independent, it will have to prove its independence. This will at country in a bid to increase the competitiveness of its exporters. the very least incur temporary costs as it will have to be extra-tough on Fiscal Discipline With a single currency, other governments have an interest in bringing inflation. Excessive Fiscal Discipline countries with a lack of fiscal discipline into line. When other governments exert pressure on a government to reduce European Identity borrowing, or even pay fines if the budget deficit exceeds a reference A European currency will strengthen European identity. value, this may have the perverse effect of increasing an existing economic imbalance or deepening a recession. 11 How the Eurozone emerged 12 The Three Stages of Economic and Monetray Union 13 Source: Ibid. Index of Institutional Integration of EU-6 Source: Ibid 14 The Institutional System 15 Monetary System in the European Union The European System of Central Banks (ESCB) • the European Central Bank (ECB) and • the national central banks (NCBs) of all 27 EU Member States. The Eurosystem = The central banking system of the euro • the ECB and • the national central banks (NCBs) of the 17 EU Member States whose common currency is the euro. The Eurosystem is thus a sub-set of the ESCB. Since the ECB's policy decisions, such as on monetary policy, naturally apply only to the euro area countries, it is in reality the Eurosystem, which, as a team, carries out the central bank functions for the euro area. In doing so, the ECB and the NCBs jointly contribute to attaining the common goals of the Eurosystem. ECB.Eurosystem Basic Tasks of the Eurosystem “Monetary policy The Eurosystem is responsible for defining and implementing the monetary policy of the euro area. This is a public policy function that is implemented mainly by financial market operations. Important for this task is the full control of the Eurosystem over the monetary base. As part of that, the ECB and the national central banks (NCBs) are the only institutions that are entitled to actually issue legal tender banknotes in the euro area. Given the dependence of the banking system on base money, the Eurosystem is thus in a position to exert a dominant influence on money market conditions and money market interest rates. Foreign exchange operations Foreign exchange operations influence exchange rates and domestic liquidity conditions; both are important variables for monetary policy. Assigning this task to the Eurosystem is therefore logical, also because central banks have the necessary operational facilities. Secondly, if the central bank carries out this task, it ensures that the foreign exchange operations remain consistent with the aims of the central bank's monetary policy. Promote smooth operation of payment systems Payment systems are a means to transfer money between credit and other monetary institutions. This function places them at the heart of an economy's financial infrastructure. Assigning the task of promoting their smooth operation to the Eurosystem acknowledges the importance of having sound and efficient payment systems - not only for the conduct of monetary policy but also for the stability of the financial system and as such for the economy as a whole. Hold and manage foreign reserves One of the most important reasons for managing the foreign reserves portfolio is to ensure that the ECB has sufficient liquidity to conduct its foreign exchange operations. The ECB's foreign reserves are currently managed in a decentralised manner by the NCBs that opt to take part in operational ECB foreign reserve management activities. These NCBs act on behalf of the ECB in accordance with instructions received from the ECB. Although the NCBs manage their own foreign reserves independently, their operations on the foreign exchange market are, above a certain limit, subject to the approval of the ECB, in order to ensure consistency with the exchange rate and monetary policy of the Eurosystem.” ECB. Eurosystem Decision-Making Bodies of the European Central Bank “The ECB’s mission is to keep inflation low and stable. To achieve this goal, it closely follows economic developments in the euro area and seeks to influence the state of the economy through its decision-making. The ECB is the centre of decision-making in the Eurosystem. Thus, the Governing Council, the Executive Board and the General Council of the ECB each take all the decisions necessary to enable the Eurosystem and the ESCB to carry out their respective tasks. This includes the formulation of policies, such as the monetary policy for the euro area, but also how they should be implemented.” ECB.Eurosystem Decision-Making Bodies of the European Central Bank “Main decision-making body of the Eurosystem. It comprises • all the members of the Executive Board of the ECB, and • the governors/presidents of all the national central banks (NCBs) of the euro area, i.e., those EU Member States that have adopted the euro. Main responsibility • formulating the monetary policy of the euro area by taking the necessary decisions and adopting the Guidelines needed for its implementation.” ECB.Eurosystem Decision-Making Bodies of the European Central Bank “The Executive Board of the ECB is the operational decision-making body of the ECB and of the Eurosystem. It assumes the responsibility for all the decisions which need to be taken on a day-to-day basis. The ECB must be able to react and adapt to quickly changing conditions in the money and capital markets, to address specific cases and to deal with matters of urgency. This function can only be performed by a body whose members are permanently and exclusively involved in the implementation of the ECB's policies. The Executive Board usually meets once a week. Members •the President of the ECB, •the Vice-President of the ECB, and •four other members.” ECB. Eurosystem Division of Labor in the Eurosystem “Except for the statutory tasks that have been exclusively assigned to the ECB, the ESCB Statute does not indicate to what extent ECB policies are to be implemented through activities of the ECB or the NCBs. For the bulk of the Eurosystem's activities, the actual intra-System division of labour has been guided by the principle of decentralisation, with the ECB having recourse to the NCBs, to the extent deemed possible and appropriate, to carry out operations which form part of the tasks of the Eurosystem (cf. Article 12.1 of the ESCB Statute). Thus, the ECB and the NCBs jointly contribute to attaining the Eurosystem's common goals. However, according to Article 9.2 of the Statute, the ECB has to ensure that all tasks are carried out properly and consistently. To ensure this across the euro area, the ECB has the power to issue guidelines and instructions to the NCBs.” ECB.Eurosystem History of European Monetary Integration The 1970s: From Barre Plan to Werner Report In 1969, the European Commission submitted a plan (the "Barre Plan") to follow up on the idea of a single currency because the Bretton-Woods-System was showing signs of increasing strain. Werner Report: published in 1970, proposing to create EMU (European Monetary Union) in several stages by 1980. However, this process lost momentum in a context of considerable international currency unrest after the collapse of the Bretton-Woods- System in the early 1970s and under the pressure of divergent policy responses to the economic shocks of that period, in particular the first oil crisis. To counter this instability and the resulting exchange rate volatility among the currencies, the nine members of the then EEC relaunched the process of monetary cooperation in March 1979 with the creation of the European Monetary System (EMS). Its main feature was the exchange rate mechanism (ERM), which introduced fixed but adjustable exchange rates among the currencies of the EEC countries. Thus it required adjustments in monetary and economic policies as tools for exchange rate stability. Within the EMS framework, the participants succeeded in creating a zone of increasing monetary stability and gradually relaxing capital controls. The 1980s: The Exchange Rate Mechanism The Exchange Rate Mechanism (ERM), established in 1979 which forms the core of the EMS, provides a means for stabilizing exchange rates between member states of the ERM. All then member states of the EU except the UK joined the ERM. Later, Spain followed in 1989 and Portugal in 1992; the UK in 1990, but was forced to withdraw from the ERM, along with Italy, in autumn 1992. The fixed exchange rate system was build around the artificial European Currency Unit (ECU). The ECU served as a payment and accounting unit for payment transactions between central banks. The 1990s: Steps to EMU Stage One: The abolition of all internal barriers to the free movement of goods, persons, services and capital within EU MS. Stage Two started with the establishment of the European Monetary Institute (EMI), the predecessor of the European Central Bank (ECB), on 1 January 1994. Stage Three: On 1 January 1999, the final stage of EMU, started with the irrevocable fixing of the conversion rates of the currencies of the 11 Member States initially participating, and with the introduction of the euro as the single currency. 1st January 2002: Distribution of Euro banknotes and coins 25 Conversion rates Conversion rate to €1 Euro-area Member State Old national currency Belgium Belgian franc (BEF) 40.3399 Germany German mark (DEM) 1.95583 Ireland Irish pound (punt) (IEP) 0.787564 Greece Greek drachma (GRD) 340.750 Spain Spanish peseta (ESP) 166.386 France Italy Cyprus French franc (FRF) Italian lira (ITL) Cyprus pound Luxembourg Luxembourg franc (LUF) Malta The Netherlands Maltese lira (MTL) Dutch guilder (NLG) Austria Austrian schilling (ATS) 13.7603 Portugal Portugese escudo (PTE) 200.482 Slovenia Slovenian tolar (SIT) 239.640 Slovakia Slovak koruna (SKK) 30.1260 Finland Finnish markka (FIM) 5.94573 6.55957 1936.27 0.585274 40.3399 0.429300 2.20371 26 27 Entry Terms 28 Joining the EURO AREA: Conditions for Entry (1) ”The process of building Europe is one of progressive integration. The single market for goods, services, capital and labour, launched in 1986, was a major step in this direction. Economic and Monetary Union and the euro take economic integration even further, and to join the euro area Member States must fulfil certain economic and legal conditions. Adopting the single currency is a crucial step in a Member State's economy. Its exchange rate is irrevocably fixed and monetary policy is transferred to the hands of the European Central Bank, which conducts it independently for the entire euro area. The economic entry conditions are designed to ensure that a Member State's economy is sufficiently prepared for adoption of the single currency and can integrate smoothly into the monetary regime of the euro area without risk of disruption for the Member State or the euro area as a whole. In short, the economic entry criteria are intended to ensure economic convergence – they are known as the 'convergence criteria' (or 'Maastricht criteria') and were agreed by the EU Member States in 1991 as part of the preparations for introduction of the euro. In addition to meeting the economic convergence criteria, a euro-area candidate country must make changes to national laws and rules, notably governing its national central bank and other monetary issues, in order to make them compatible with the Treaty. In particular, national central banks must be independent, such that the monetary policy decided by the European Central Bank is also independent. The Member States which were the first to adopt the euro in 1999 had to meet all these conditions. The same entry criteria apply to all countries which have since adopted the euro and all those that will in the future.” 29 European Commission. Economic and Financial Affairs. The Euro. Who can join and when Joining the EURO AREA: Convergence Criteria (2) To ensure sustainable convergence, the EC Treaty sets criteria which must be met by each EU Member State before taking part in the third stage of EMU. • Budgetary deficit to GDP not exceeds a reference value as 3%. • The ratio of government debt to GDP not exceeds a reference value as 60%. • There must be a sustainable degree of price stability and an average inflation rate, observed over a period of one year before the examination; which does not exceed by more than 1.5 points that of the three best performing Member States in terms of price stability; • There must be a long-term nominal interest rate which does not exceed by more than 2% points that of the three best performing Member States in terms of price stability; • The normal fluctuation margins provided for by the exchange rate mechanism must be respected without severe tensions for at least the last two years before the examination. Monitoring the Maastricht Criteria • Monitoring of interest rates and inflation is not necessary (single policy of the ECB) • On fiscal policy, national governments present „stability programmes“ showing their fiscal policy plans over the next 4 years (goal: Zero-Deficit at the end of the planning horizon) • Deficits above 3 % are allowed if country is in a deep recession (GDP –2%) or hit by severe disturbances not under the influence of fiscal policy • Early warning, when deficit comes close to 3%: Government must propose actions how to reduce deficits (also for non-Euro-states!) • Excessive deficit procedure: When deficit is above 3% of GDP, Ministerial council decides about procedure. If member country fails to meet the deficit criterion, European Council can decide on measures. 30 Joining the EURO AREA: Convergence Criteria (3) What is measured: How it is measured: Sustainable Sound public Price stability public finances finances Consumer Government Government price inflation deficit as % debt as % of rate of GDP GDP Not more than 1.5 percentage points above Convergence the rate of criteria: the three best performing Member States Reference value: not more than 3% Reference value: not more than 60% Durability of Exchange convergence rate stability Long-term interest rate Deviation from a central rate Not more than 2 percentage points above the rate of the three best performing Member States in terms of price stability Participation in ERM II for at least 2 years without severe tensions 31 Joining the EURO AREA: Convergence Criteria (4) ”Who decides if the convergence criteria are met? According to the Treaty, at least once every two years, or at the request of a Member State with a derogation, the Commission and the European Central Bank assess the progress made by the euro-area candidate countries and publish their conclusions in respective convergence reports. On the basis of its assessment, the Commission submits a proposal to the Council which, having consulted the European Parliament, and after discussion in the Council, a meeting among the heads of state or government decides whether the country fulfils the necessary conditions and may adopt the euro. If the decision is favourable, the Council abrogates the derogation and, based on a Commission proposal, having consulted the ECB, adopts the conversion rate at which the national currency will be replaced by the euro, which thereby becomes irrevocably fixed.” European Commission. Economic and Financial Affairs. The Euro. Who can join and when 32 Maastricht criteria as determined by the European Commission in May 1998 Inflation Country Government Budgetary Position HICP (a) Deficit [% of GDP] Jan. 1998 1997 Debt [% of GDP] Exchange Rates Long term interest rates ERM partici -pation (d) March 1998 Jan. 1998 Change from previous year 1997 1997 1996 1995 Reference Value 2.7 3 60 7.8 (f) Belgium Denmark Germany Greece Spain France Ireland Italy Luxembourg Netherlands Austria Portugal Finland Sweden 1.4 1.9 1.4 5.2 1.8 1.2 1.2 1.8 1.4 1.8 1.1 1.8 1.3 1.9 2.1 -0.7 2.7 4.0 2.6 3.0 -0.9 2.7 -1.7 1.4 2.5 2.5 0.9 0.8 122.2 65.1 61.3 108.7 68.8 58.0 66.3 121.6 6.7 72.1 66.1 62.0 55.8 76.6 -4.7 -5.5 0.8 -2.9 -1.3 2.4 -6.4 -2.4 0.1 -5.0 -3.4 -3.0 -1.8 -0.1 -4.3 -2.7 2.4 1.5 4.6 2.9 -9.6 -0.2 0.7 -1.9 0.3 -0.9 -0.4 -0.9 -2.2 -4.9 7.8 0.7 2.9 4.2 -6.8 -0.7 0.2 1.2 3.8 2.1 -1.5 -1.4 yes yes yes yes (h) yes yes yes yes (j) yes yes yes yes yes (k) no 5.7 6.2 5.6 9.8 (i) 6.3 5.5 6.2 6.7 5.6 5.5 5.6 6.2 5.9 6.5 United Kingdom 1.8 1.9 53.4 -1.3 0.8 3.5 no 7.0 Europe Average 1.6 2.4 72.1 -0.9 2.0 3.0 Notes: (a) Percentage change in arithmetic average of the latest 12 monthly harmonized indices of consumer prices (HICP) relative to the arithmetic average of the 12 HICP of the previou period. (b) Council decisions of 26-Sep-94, 10-Jul-95, 27-Jun-96, and 30-Jun-97. (c) A negative sign for the government deficit indicates a surplus. (d) Average maturity 10 years; average of the last twelve months. (e) Definition adopted: simple arithmetic average of the inflation rates of the three best-performing member countries in terms of price stability plus 1.5 percentage points. (f) Definition adopted: simple arithmetic average of the 12-month average of interest rates of the three best-performing member countries in terms of price stability plus 2 percentage points. (g) Commission is recommending abrogation. (h) since March 1998 (i) Average of available data during the past 12 months. (j) since November 1996. (k) since October 1996. Source: European Commission 6.1 33 Members of the EUROZONE 1) Austria 2) Belgium 3) Cyprus 4) Estonia 5) Finland 6) France 7) Germany 8) Greece 9) Ireland 10)Italy 11)Luxemburg 12)Malta 13)Netherlands 14)Portugal 15)Slovakia 16)Slovenia 17)Spain Countries, using the EURO (320 million Europeans) 1) Andorra 2) Austria 3) Belgium 4) Cyprus 5) Estonia 6) Finland 7) France 8) Germany 9) Greece 10) Ireland 11) Italy 12) Kosovo 13) Luxembourg 14) Malta 15) Monaco 16) Montenegro 17) Netherlands 18) Portugal 19) San Marino 20) Slovakia 21) Slovenia 22) Spain 23) Vatican City 34 EU Eurozone (17) EU states obliged to join the Eurozone once they fulfil the entrance criteria (8) EU state with an opt-out on Eurozone participation (UK) EU state with an opt-out which may be abolished by a future referendum (Denmark) States outside the EU with issuing rights (3) Other non-EU users (4) 35 http://en.wikipedia.org/wiki/G-20_major_economies New Member States: Moving toward Convergence? CPI inflation rates in the EMU accession countries, 2004 – 2007 (annual rate in %) Lipinska, A (2008). The Maastricht Convergence Criteria and Optimal Monetary Policy for the EMU Accession Countries. ECB Working Paper Series, No 896. New Member States: Moving toward Convergence? Nominal exchange rate fluctations versus euro of the accession countries, 2006 – 2008 (average monthly change since the EU accession date) Lipinska, 2008. New Member States: Moving toward Convergence? Correlation Coefficient of Visegrad countries‘ currencies and EURO against USD, 1994-2005 Value of 1 = currency area Source: CNB New Member States: Moving toward Convergence? Zloty against Euro and US Dollar, Q1-2000 – Q3-2013 Source: National Bank of Poland Exchange Rate Mechanism II (ERM II) ”The Agreement of 16 March 2006 between the European Central Bank and the national central banks (NCBs) of the Member States outside the euro area layed down the operating procedures for an exchange rate mechanism in stage three of the Economic and Monetary Union (EMU). Participation in ERM II is optional for the non-euro area Member States, but those Member States with a derogation can be expected to join. ERM II ensures that participating Member States orient their policies to stability and convergence, helping them in their efforts to adopt the euro. A central rate is determined between the euro and each participating non-euro area currency, with a standard fluctuation band of 15% above and below that rate. All parties to the mutual agreement on the central rates, including the European Central Bank, have the right to initiate a confidential procedure to reconsider the rates. Decisions are taken by common accord by the ministers of the euro area Member States, the ECB and the ministers and central bank governors of the non-euro area Member States participating in the new mechanism, in accordance with a common procedure involving the Commission and following consultation of the Economic and Financial Committee. Under the Agreement, intervention is, in principle, effected in euro and the participating currencies. The ECB and the NCB or NCBs concerned inform each 40 other about all foreign exchange intervention.” European Commission. Summaries of EU legislation.ERM Monetary Policy 41 Monetary Policy in the European Union: European Central Bank “The primary objective of the Eurosystem shall be to maintain price stability. The Governing Council aims to maintain inflation rates at levels below, but close to, 2% over the medium term.“ ECB. Facts 42 Evaluating ECB‘s Monetary Policy Two levels of evaluation: - Euro area as a whole - Individual member states of the euro area The evaluation has to take into account the external shocks, esp. the 2007 financial crisis. “....monetary policy was too accomodative throughout much of the history of the ECB, particularly during periods of economic expansion. ..To the extent that the New Keynesian framework provides a reasonable representation of the euro-area economy, the ECB monetary policy has been quite appropriate in responding to the changing economic conditions in the euro area, especially over the periods of an economic downturn. Even though monetary policy is found to be appropriate for the euro area as a whole, there is evidence of disparities from the standpoint of individual Member countries. In particular, the ECB appeared to have reacted more aggressively to changing economic conditions in the major “core“ members, such as France and Germany. On the other hand, monetary policy was too loose for some “peripheral“ countries, such as Ireland and Portugal, which experienced relatively high inflation at times. This contrast highlights one of the challenges in implementing monetary policyfor a region with heterogeneous national economic conditions.“ Lee, J and Crowley, P (2010). Evaluating the Monetary Policy of the European Central Bank. Federal Reserve Bank of Dallas. Euro Crisis vs. Global Crisis: Is the ECB Acting Differently to Other Central Banks? Main Characteristics of Central Bank Mandates Source: Pisani-Ferry, J. and Posen, A.S. (2010). From Convoy to Parting Ways? Euro Crisis vs. Global Crisis: Is the ECB Acting Differently to Other Central Banks? The Period 2007-2010 ECB, Fed, BoE; Similarity in interest rate policies after Lehmann shock 45 Source: Pisani-Ferry, J. and Posen, A.S. (2010). From Convoy to Parting Ways?, p. 12. Euro Crisis vs. Global Crisis: Is the ECB Acting Differently to Other Central Banks? “The ECB has consistently rejected the ideas that it either had to go beyond the provision of liquidity to banks, to overcome the zero bound through purchasing of government bonds, or to attempt to influence the shape of the yield curve. The asset purchase programmes it announced (a covered bonds purchase programme in 2009 and a sovereign bonds purchase programme in 2010) were intended to be of limited magnitude and to be sterilized so as to have no impact on aggregate money supply. Consistent with this approach, the ECB’s balance sheet increased expanded by far less than those of the two other central banks. Also credit easing (i.e. specific asset purchase programmes undertaken with the aim of restoring liquidity in asset market segments) was undertaken by all three central banks, but to an uneven degree.The Fed undertook early on to unfreeze clogged market segments such as the commercial paper as well as student loan and other securitization markets. The BoE offered a commercial paper facility, but had few takers. Through the early stages of the crisis, the ECB was satisfied with its liquidity provision measures to the banking system, perhaps because of the greater importance of bank lending versus securities markets in the Euro Area. As indicated already, the ECB did undertake credit easing actions, however, at a late stage after the Greek crisis erupted in early 2010 and it did it with evident reluctance, without having stated its aims, and only for a rather short period.” Source: Pisani-Ferry, J. and Posen, A.S. (2010). From Convoy to Parting Ways? p. 12 ECB‘s conservative asset purchasing program before the Greece crisis emerged Central Bank‘s balance sheet, 01/2007 – 03/2010 47 Source: Pisani-Ferry, J. and Posen, A.S. (2010). From Convoy to Parting Ways?, p. 13. ECB‘s Lack of Quantitative Easing? “For all three central banks, broad money growth went way down after the crisis (less so on this measure for the UK than for the US or Euro Area). In fact, the largest sustained decline in trend monetary growth versus pre-crisis average has taken place in the Euro Area, perhaps as a result of the lack of quantitative easing undertaken by the ECB. Remember, this is broad money so a measure of credit outcomes, not of an instrument like base money which the central bank controls. (Quantitative easing is a substitute for interest rate policy when traditional monetary stimulus has reached its limits and/or been frustrated by financial instability.)” Source: Pisani-Ferry, J. and Posen, A.S. (2010). From Convoy to Parting Ways?, p. 13-14. Summary for the Period 2007 - 2010 “In the end, central bank policy reactions to the crisis demonstrated both remarkable initial convergence in view of dissimilar traditions and institutional constraints across the Atlantic, and significant divergences in policy strategy, the instruments used, and ultimately on the outlook once the worst had passed. Even the sovereign debt crisis of spring 2010 did not prompt greater activism from the ECB beyond immediate and targeted liquidity provision. On the basis of the track record this far and the policy announcements made, we posit that divergences are likely to grow larger in the aftermath of the recovery.” Source: Pisani-Ferry, J. and Posen, A.S. (2010). From Convoy to Parting Ways?, p. 16. “Throughout the first stages of the crisis, similar to other central banks in high income countries, the ECB addressed the unprecidented liquiditiy problems across a broad spectrum of financial institutions by extending the volume and average maturity of its liquidity provision.“ Source: Gabor, D. (2011), The ECB and the European Debt Crisis, p. 4. “The ECB’s actions since the onset of the financial crisis have been bold, and yet firmly anchored within the medium-term framework of our monetary policy strategy.” Former ECB President Trichet, 2009 . ECB: Its Emerging Active Role in Europ. Sovereign Debt Crisis Sept. 2008 Lehman Brothers US Fed, BofE, BofC, BofJ Credit easing (purchase of private assets) January 2010 Onset of European sovereign debt crisis (Greece) November 2010 March 2009 Oct. 2009 US Fed, BofE Quantitative easing US Fed QE completed Feb. 2010 Sept Nov Jan 2009 Mar May Jul Sept Nov IRELAND bailout BofE QE completed (purchase of sovereign assets) Jul 2008 US Fed Second QE round Jan 2010 Mar May April 2011 PORTUGAL bailout Jul Sept Nov Jan 2011 Mar May GREECE bailout ECB Covered bonds program ECB Enhanced credit support ECB Securities Market program (Credit easing) July 2009 (Bank refinancing vs. market interventions) May 2010 ECB October 2008 ECB Announcement CBPP 1year LTRO May 2009 Initiation phasing out LTRO Dec. 2009 ECB ‘Addicted to liquidity’ Sept. 2010 ECB Phasing out 6m and 1y LTRO European Financial Stability Facility June 2010 Source: Gabor, D. (2011), The ECB and the European Debt Crisis, p. 6. ECB Interest rate rise (Separation Principle) SMP Suspended European Stability Mechanism March 2011 ECB and the Crisis: 3 Turning Points Source: Gabor, D. (2012), The ECB and the European Crisis. Point 1, May 2009: strategic appropriation (CBP) Point 2, May 2010: sound money or too little, too late? Implicit analytical recognition that sovereign debt instruments are special Point 3, March 2011: putting politics in its place ESM as crisis resolution mechanism Commitment to LTROs Source: Gabor, D. (2012), The ECB and the European Crisis. ECB and the Crisis: The 4th Turning Point – Outright Monetary Transactions ("OMT") “On 2 August 2012, the Governing Council of the ECB announced that it would undertake outright transactions in secondary, sovereign bond markets, aimed "at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy." The technical framework of these operations was formulated on 6 September 2012. OMT denotes the European Central Bank's purchases in secondary, sovereign bond markets, under certain conditions, of bonds issued by Eurozone member-states. OMT is considered by the European Central Bank once a Eurozone government asks for financial assistance. From ESM and ESFS and through OMT, the Eurozone's central bank can, henceforth, buy government-issued bonds that mature in 1 to 3 years, provided the bond issuing countries agree to certain domestic economic measures - the latter being the so-called term of ‘conditionality’. The aim is to bring bond yields, at the long end of the curve (i.e. 10 years), down to levels that lower borrowing costs for countries that face problems selling debt, and, thus, provide investors with confidence in the euro for them to buy up bonds in a normal market. OTM are not the same as Quantitative Easing operations, since, in the latter, the central banks buy bonds and, by doing so, inject liquidity into the banking system, with the aim of stimulating economic activity. The ECB has made clear1 that the principle of "full sterilisation"3 will apply, whereby the bank will be absorbing back the money pumped into the system ‘by any means necessary’.” Source: http://en.wikipedia.org/wiki/Outright_Monetary_Transactions 54 Source: http://en.wikipedia.org/wiki/File:Long-term_interest_rates_(eurozone).png Summing up:Bank-based and Market based Crisis Measures, ECB, 2008-2011 Gabor, D. (2012), The Power of Collateral: the ECB and Bank Funding Strategies in Crisis, p. 24. ……and the future? ECB: Secret Bailout Strategy Under the EU Rescue Umbrella? 56 Greece Lightening 57 Economist, Nov. 05, 2011.