Maastricht revisited Of stocks and flows

Bernhard Winkler*, European Central Bank

Conference in Honour of Mike Artis EUI, Florence, 17 June 2016

* Views should not be attributed to the ECB.

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Overview

I. Maastricht revisited => Mike was right !

II. Crisis => flow-of-funds themes: 1. sectoral “flow” (im-)balances

2. leverage cycles & “stock” adjustment

3. central banks as “balance sheet of last resort”

Bundesbank for Sale An Economic Analysis of the

Maastricht Treaty Bernhard Winkler EUI, 4 June 1997

Jury: M Neumann, M Artis, S Vassilakis, B Eichengreen

“Words ought to be a little wild, for they are the assault of thoughts upon the unthinking” (JM Keynes)

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I.a “Is Maastricht a good contract?”

1. Of sticks and carrots: incentives for EMU Sharing sovereignty: a European Bundesbank?

2. Co-ordinating EMU: multi-speed convergence Time inconsistency: ex ante vs ex post adjustment?

3. Reputation for EMU: signalling preferences Institutions vs. people vs. structures?

B. Winkler, Journal of Common Market Studies, Vol. 37, No. 1, March 1999, 39-58

The Stability Pact Safeguarding the Credibility of the

European Central Bank Michael Artis and Bernhard Winkler

NIER, January 1998

Jury: MJM Neumann, M Artis, S Vassilakis, B Eichengreen

“Words ought to be a little wild, for they are the assault of thoughts upon the unthinking” (JM Keynes)

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I.b The Stability and Growth Pact

1. Long-term stability vs. short-term stabilisation ensuring safety margins to deal with shocks focus on debt vs deficits role of private assets in (consumption) risk sharing

2. Game of chicken: monetary vs. fiscal dominance role of private vs. public debt? role of financial markets: financial dominance? LOLR for banks and/or governments ?

3. A substitute for/or step towards fiscal union? Fiscal dimension of banking union, ESM, ECB Public sector vs. private sector risk sharing (Capital Market Union)

Artis & Winkler, National Institute Economic Review, January 1998, 87-98

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“… if other economic agents affecting the determinants of inflation (fiscal authorities and wage setters in particular) do not play their part, the ECB will be either induced to accommodate (i.e. accept fiscal dominance) or impose great economic costs in an attempt to reassert its leadership … The Stability Pact can be seen as a (blunt) safeguard to limit the extent to which the ECB will be confronted with this dilemma … as an imperfect substitute for an explicit or implicit coordination mechanism via common institutions or a shared stability culture … to limit the risk that the ECB’s independence is tested or contested too severely.” [p.95]

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“… we believe there is a nexus between Political Union and Monetary Union. Putting a lot of faith in codified rules as in the Stability Pact and statutory central bank independence, is a reflection of the German Ordo-liberal tradition, but may be misplaced … Failing a source of legitimacy the rules risk being ignored or of becoming the object of serious conflict. Monetary stability and political cohesion in Europe may yet become lost in the “Bermuda triangle” between national and European institutions and responsibilities. Here, too, the Stability Pact serves as an important test.” [final para, p.95]

II

Flow-of-funds perspective on the crisis

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“When the crisis came, the serious limitations of existing economic and financial models immediately became apparent. […] Macro models failed to predict the crisis and seemed incapable of explaining what was happening to the economy in a convincing manner. As a policy-maker during the crisis, I found the available models of limited help. In fact, I would go further: in the face of the crisis, we felt abandoned by conventional tools.” Jean-Claude Trichet, 18 November 2010

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New-old uses of Flow of Funds • Financial imbalances & credit cycles (BIS) • Financial intermediation chains, securitisation and

leverage targeting broker-dealers (Adrian-Shin) • Role of credit liberalisation and HH balance sheets for

consumption (J. Muellbauer, R Rajan) • Liquidity trap (Keynes), portfolio balance (Tobin), debt

deflation (Fisher), preferred habitat (Modigliani) • Role of money&credit for inflation and asset prices

(Friedman, Brunner & Meltzer) • Stock-flow consistent modelling (Godley-Lavoie) • Austrians/Minsky endogenous fin. cycles (Radke) => “off the radar screen” in standard (neo-Wicksellian & representative agent) DSGE macro and “state-of-the art” inflation targeting

FoF II.1

sectoral (im-)balances

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EA sectors’ net lending/net borrowing

(4-quarter cumulative flows, % GDP)

Source: Euro area accounts (EAA), ECB and Eurostat. Latest observation: 2015Q3

1. Counterpart of growing euro area external surplus is the unusual financial surplus of NFCs (contractionary)

2. Financial corporations’ surplus reflects recapitalisation needs

3. A recovery requires the return of ‘animal spirits’ of firms, i.e. of a net borrowing position by NFCs

4. Which in turn will accommodate a reduction in the government deficit

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Rationalizing Current Account imbalances

View I - Financial integration supports optimal savings ‘Lawson doctrine’ (private vs public imbalances) ‘End of the Feldstein-Horioka puzzle’ (Blanchard-Giavazzi) (Saving/Investment co-movement tests jointly the integration of goods/labour markets and of capital markets)

View II - External imbalances reflect underlying competitiveness

issues in goods/labour markets - … and sectoral imbalances and asset bubbles fuelled

by easy financing in a monetary union

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Sectoral net lending/net borrowing by country grouping (deficit and surplus countries)

Sources: Eurostat, ECB. Latest observation: 2012Q4. “Surplus countries” (current account): Belgium, Germany, Luxembourg, the Netherlands, Austria and Finland

Surplus countries Deficit countries (% of GDP, four-quarter moving sum) (% of GDP, four-quarter moving sum)

-10

-8

-6

-4

-2

0

2

4

6

8

10

-10

-8

-6

-4

-2

0

2

4

6

8

10

2002 2002 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

governmentfinancial corporationsnon-financial corporationshouseholdstotal economy

-10

-8

-6

-4

-2

0

2

4

6

8

10

-10

-8

-6

-4

-2

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

governmentfinancial corporationsnon-financial corporationshouseholdstotal economy

FoF II.2

credit & leverage cycles

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Money and loan growth (banks vs FoF)

Euro area US

Sources: ECB and Fed. Last observation: 2015 Q3 Note: Annual percentage changes. FoF = Flows of funds from the euro area (respectively US) financial accounts.

Debt-to-GDP ratio in the EA and in the US

Euro area US

Sources: EAA (ECB and Eurostat), US Flow of funds accounts (Fed) and National Economic Accounts (BEA). Note: Debt is defined as loans, debt securities and insurance reserves, net of loans granted within the same sector. Government debt reported in the chart is thus different from the Maastricht public debt definition. Latest observation: 2015Q3.

Debt-to-asset ratio in the EA and in the US

Households NFCs

Sources: EAA (ECB and Eurostat), US Flow of funds accounts (Fed) and National Economic Accounts (BEA). Note: Debt is defined as loans, debt securities and insurance reserves, net of loans granted within the same sector. Latest observation: 2015Q3.

Capital ratios of financial institutions

Capital ratios of financial institutions (other than investment funds) (percentage of total assets)

“Equity” comprises shares and other equity. All assets and liabilities are valued at market value. The “notional net assets to assets” ratio is calculated on the basis of net assets and assets excluding changes in prices of assets and liabilities. Interbank deposits and Eurosystem financing are netted out from assets and liabilities. Last observation 2015Q3

Annual change of debt-to-assets ratio and sectoral contributions

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Leverage cycle: a cross sector view

Source: ECB, Eurostat. Latest observation: 2015Q3 Notes: The leverage ratio is calculated as notional debt liabilities divided by total notional assets. The contributions by sector are calculated as the ratios of each sector debt to total assets of the euro area.

FoF II.3

central bank balance sheet policies

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Leverage and change in notional leverage. Contributions by sector

Eurosystem leverage expanded as private sectors deleveraged

(% of assets; year-on-year changes in the euro area notional leverage ratio, cumulated changes in contributions to the ratio by sector; percentages)

Source: ECB, Eurostat. Latest observation: 2015Q3 Notes: The leverage ratio is calculated as notional debt liabilities divided by total notional assets. The contributions by sector are calculated as the ratios of each sector debt to total assets of the euro area.

Leverage= Debt / Assets

+

−==

1

1

DDAA

DL

A DD−How to increase (decrease

leverage)?: • A. Increase net assets (thus savings):

( )A D S∆ − →

A.1 Some agents have to “accommodate” the increasing savings: government? Rest of the world? A.2 Capital formation

,D A↓ ↓• B. Liquidation of debt: B.1 Asset price decreases, self-defeating leverage loop (Adrian, Shin, 2010), disorderly deleveraging B.2 Consolidation/nonconsolidated

A sectoral perspective on non-standard measures

OMT

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ABSPP

ABSPP

PSPP OMT

OMT

PSPP

/ HH

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Selected references • October 2011 ECB Monthly Bulletin article on flow-of-funds

perspective on the financial crisis • February 2012 MB Box 3 & April 2012 and 2013 ECB Financial

Integration Reports: Special Features on sectoral balances • ECB Working Paper No. 1402 (2011) by Riccardo Bonci on

transmission of monetary policy via FoF • Chapter 7 on cross-checking and the flow-of-funds, in Papademos

and Stark (eds.): Enhancing Monetary Analysis, ECB October 2010 • “Flow-of-funds perspective on unconventional monetary policy”, The

Journal for Money and Banking, Vol. 63, No. 11, Nov. 2014, B. Winkler • Cour-Thimann and Winkler, “Central banks as balance sheets of last

resort: ECB’s monetary policy in a flow of funds perspective”, in David Cobham (ed.): Monetary Analysis at Central Banks, 2016.

• ECB Working Paper No. 1528 (April 2013) by Cour-Thimann and Winkler, “The ECB’s non-standard monetary policy measures: the role of institutional factors and financial structure” (cf. OxREP 2012)

• Giron and Rodriguez-Vives (forthcoming), “Leverage interactions: a national accounts approach”, ECB Statistical Working Paper Series

THANK YOU, Mike