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The ECB to the
rescue? Filling the
Lacunae in Euro
Area Governance
Gabriel Glöckler *European Central Bank
Edinburgh, 1 June 2012* The views expressed are those of the author and do not necessarily reflect the position of the ECB.
2
• Conceptual Framework
• Designing EMU
• The response to the crisis
• Filling the ‘gaps’ in economic governance
• Toward economic and financial union?
Fiscal and financial dominance?
• Classic notion of fiscal vs. monetary dominance(see Sargent and Wallace: 1981, Jeanne: 2012)
• Morgan Stanley, Oct 2011: “The name of the game: fiscal dominance […] the inability or unwillingness of governments to rein in debts and deficits becomes a binding constraint on monetary policy and may well collide with the objective of price stability.”
• See also ECB Monthly Bulletin July 2012 (forthcoming)
3
4
• Conceptual Framework
• Designing EMU
• The response to the crisis
• Filling the ‘gaps’ in economic governance
• Toward economic and financial union?
Designing EMU
• Economic basis– ‘Sound money sound finances consensus’ (McNamara:
1998)“ [A single currency] would imply a common monetary policy and require a
high degree of compatibility of economic policies…, in particular in the fiscal field”; “In particular, uncoordinated and divergent national budgetary policies would undermine monetary stability….” (Delors report 1989)
• Legal basis (Maastricht Treaty)– Art. 101 monetary financing prohibition– Art. 102 prohibited privileged access to governments– Art. 103 (1) no bailout clause– Art. 104c, 109j and protocol annexed in the Treaty outlined
the ‘Maastricht criteria’
5
ECB’s institutional context
EMU rests on four fundamental constitutional pillars
Pri
ce s
tab
ilit
y
ori
en
tati
on
of
the c
en
tral b
an
k
Ind
ep
en
den
ce
of
the c
en
tral b
an
k
Mon
eta
ry
fin
an
cin
g
pro
hib
itio
n
‘No b
ail-o
ut’
cla
use
EMU
Designing EMU: positive feedback mechanisms
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No Bailout Clause
Monetary Financing Prohibition
SGP
Financial Market Discipline
Policy consequences internalised ‘Keep own house in order' principle
Source: Yiangou, Glöckler, O’Keefe (forthcoming)
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What went wrong (I)? – despite early warnings
• Weak implementation of fiscal rules• Insufficient monitoring of imbalances
“..[T]he access to a large capital market may for some time even facilitate the financing of economic imbalances.”(Delors report, 1989)
• Low pricing of sovereign risk
Unit labour costs in selected euro area countries, nominal
(index 1998 Q4 = 100, relative to Germany, based on sa data)
95
100
105
110
115
120
125
130
135
140
145
1998 Q11999 Q12000 Q12001 Q12002 Q12003 Q12004 Q12005 Q12006 Q12007 Q12008 Q12009 Q12010 Q12011 Q1
95
100
105
110
115
120
125
130
135
140
145
Euro area Germany France Italy SpainNetherlands Belgium Austria Greece IrelandFinland Slovakia Luxembourg Portugal SloveniaCyprus Malta
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What went wrong (II) ? – despite early warnings
• Missing elements• “…Rather than leading to a gradual adaptation of
borrowing costs, market views about the creditworthiness of official borrowers tend to change abruptly and result in closure of access to market financing. The constraints imposed by market forces might either be too slow and weak or too sudden and disruptive.” (Delors report)
– No crisis resolution mechanism – No responsibility for financial stability at
euro area level– Contagion channels not adequately
understood
Risk of fiscal dominance
What went wrong?: ‘Gaps’ in the financial governance framework
• Two trilemmas:(1)Financial trilemma (2) The new impossible trinity
Source: Schoenmaker (2011) Source: Pisani-Ferry (2012)
• Increasing financial fragmentation due to bank sovereign nexus:
also a risk of financial dominance
10
Financial stability
Financial integration
National supervision No monetary financing
Sovereign-bank interdependence
National fiscal policies
11
• Conceptual Framework
• Designing EMU
• The response to the crisis
• Filling the ‘gaps’ in economic governance
• Toward economic and financial union?
Source: Commission Services
Financial sector debt transferred to public sectorShort-term fiscal impact of crisis- general government debt
12
13
Spreads compared to 10 yr German Bund, in basis points
Source: Bloomberg
Sovereign spreads on the rise
But do markets get it right?
Source: Bloomberg
0
1
2
3
4
5
6
2000-2011
40
50
60
70
80
90
100
US 10yr Yield
US Govt Debt/GDP% 0
0.5
1
1.5
2
2.5
3
3.5
4
2000-2011
120
140
160
180
200
220
240JAP 10yr Yield
JAP Govt Debt/GDP %
0
5
10
15
20
25
2000-2011
80
90
100
110
120
130
140
150GR 10yr Yield
GR Govt Debt/GDP %
0
2
4
6
8
10
12
14
16
2000-2011
0
20
40
60
80
100
120IRE 10yr Yield
IRE Govt Debt/GDP %
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Bluntness of debt markets as disciplining devicesObserved payout distribution of debt and equity contracts
http://ineteconomics.org/sites/inet.civicactions.net/files/turner-frankfurt-slides.pdf
The fiscal-financial nexus in the euro area…
…. has been strong since the beginning of 2010
16
Source: Thomson Reuters and ECB calculation. Latest observation: 31 Dec 11. Note: Sovereign CDS euro area average calculated as country CDS weighted by ECB capital key. Banks CDS euro area average is calculated taking the largest bank of each available country and aggregating using ECB capital key. Each dot represents the pair (av. sovereign CDS, av. bank CDS) at a certain day in the respective quarter.
0
100
200
300
400
500
600
700
800
0 100 200 300 400 500 600 700 800
Sovereign CDS
Bank
CD
S
10Q110Q210Q310Q411Q111Q211Q311Q4
0
50
100
150
200
250
300
0 50 100 150 200 250 300
Sovereign CDS
Bank
CD
S
10Q110Q210Q310Q411Q111Q211Q311Q4
Euro area US
Market segmentation and the fiscal-financial nexus
17
Increased risk aversion and retrenchment behind national borders
18
The risk of re-fragmentation of markets
Cross-border holdings of EU MFIs
(% of total holdings)
Share of cross border collateral used in Eurosystem
credit operations
Quelle: ECB Financial Integration Report, April 2012
19
Could the ECB break that feedback loop?
• In the absence of common supervision, resolution or fiscal backstop:
– Deploy “bazooka” via the ECB operations?
– Unlimited commitments? Yield targets?
• Major problems:
– Legal prohibition
– Incentives
– Accountability and democracy
The SMP in a comparative context
20
0
200
400
600
800
1000
1200
1400
Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12
Fed change in Treasury holdings ($, bn, since QE announcement)ECB SMP purchases (EUR, bn)
•21
3 year LTRO as ‘the Big Bertha’
Two 3-year operations(1) € 489 bn, 523 counterparties;(2) € 529 bn, 800 counterparties
Exceptionally serious situation in late 2011• panic and complete drying-up of inter-bank markets; • Dangers of a credit crunch;• perceptions of the “inevitability” of a catastrophe
Impact on money markets
Reduced tensions in money markets
•Note: The vertical green line denotes the announcement on 8 December 2011 of the two three-year LTROs. The two vertical red lines mark the allotment of the two LTROs on 21 December 2011 and 29 February 2012
respectively. Source: ECB Monthly Bulletin, march 2012
Reduced credit risk
•Euro area money market spread and volatility
•CDS for financial and non-financial corporations
23
First impact on credit provision
Quelle: ECB Bank Lending Survey April 2012
24
Addressing the criticisms
No real help for real economy?
• 800 banks – of which 500 German (i.e. many of those which are closest to SMEs)
Excessive risks for the Eurosystem balance sheet?• strikt und differentiated risk management framework• loss only through double default• dynamic balance sheet as part of normal central bank functions (i.e. when intermediation breaks down)
25
The ‘breathing’ Eurosystem balance sheet
Quelle: ECB, Letzte Daten: 26..März 2012
26
Sowing the seeds of future inflation?
Sources: Bloomberg, BoE, Fed staff calculations, Reuters, Euro MTS, and ECB. Note: market-based inflation expectations (break-even inflation rates). Latest observation: 30 August 2011.
Market-based inflation indicatorseuro area (%.)
•Different concepts of liquidity
•Till now no significant increase in monetary aggregates(M3 +3.2% March 2012)
•Inflation expectations securely anchored
•Eurosystem can re-absorb liquidity (e.g. via minimum reserve requirements)
27
• Conceptual Framework
• Designing EMU
• The response to the crisis
• Filling the ‘gaps’ in economic governance
• Toward economic and financial union?
28
2. A robust rescue mechanism
EFSFBasiert auf Eurogruppe, EIB,
ECB, …
ESM
Vorsorge-Kreditlinien
Secondary
Market Purchas
es
Primary Market Purchas
es
Supportive
Funding
Funds to recapitalize
banks
Other uses – genuine EMF?
Precautionary Facilities
29
3. Progress in financial supervision and resolution
• New supervisory framework (since Jan 2011)• EBA, gradual progress towards single rulebook
–main role still played by national supervisors
• EU Bank Recovery & Resolution Directive (COM proposal)• Harmonised powers for early interventions,
new resolution tools, framework for cross-border cooperation
• Deposit Guarantee Schemes Directive (text in trialogue)
• Harmonisation of levels (at EUR 100,000)
Enough to secure monetary dominance ?
What now?
Further governance reform is needed• “…to operate smoothly and to be more
resilient to crises, the Economic and Monetary Union has to become a true financial union.” B Coeure, March 2012
• “Increasingly, it seems that it is not too bold to consider a European finance ministry, but rather too bold not to consider creating such an institution” J.C. Trichet, October 2011
• “Financial market union”, “fiscal union”, and “political union” J. Asmussen, May 2012
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Toward financial/banking union?
– Strengthened micro and macro prudential regulation of risk•Strengthened EBA?•New Authority with mandate for cross
border supervision?– Harmonised deposit guarantee scheme– Recapitalisation of financial institutions
•Direct recapitalisation of banks by the ESM– Resolution
•Network of resolution funds? Common fund financed by the industry?
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