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2011 9 10
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GDP GDP
GDP
Taylor Rule (comovement ofinterest rate and inflation)
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Types and Sources of Shocks
Productivity shock
Interest rate shock
Financial shock Earthquake, tornado, etc
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FiscalExpansion
tax reduction of 150 bln (1% GDP)in 2008
Two-thirds for private individuals
One-third for firms
Welcomed by IMF and prominent economists
Troubled Asset Relief Program (TARP)Asset purchases from financial institutions to support
the financial sector.
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American Reinvestment and Recovery Act;further 787 billion dollar (5% GDP) of fiscal stimulus tax cuts for both households and business
transfers to households funding for states and infrastructure projects
European Economic Recovery Program Cumulative discretionary fiscal impulse of about 1.5% GDP 1.2% GDP coming directly from the Member States
Potential free-riding problem solved at the European level
Quantitative easing by FED and Securities MarketsProgram of ECB
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What should we do next? Fiscal
Consolidation
Fiscal consolidation is a policy aimed at
reducing government deficits and debt
accumulation.
Composition: increased tax and reduction
of public expenditure
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On the Needs of Fiscal
Consolidation
GDP 10% Acquisitions from financial sector acquisitions from financial sector
Criteria: Maastricht Treaty, deficits < 3% of GDP and debtlevels < 60% of GDP in EMU
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(long-run sustainability): Rise in public spending on pensions, health and long-term care Average is 5.2% GDP
Though wide dispersion In some instances public debt projected to rise above 800%
spill-over from private sectorindebtedness when government is forced to rescue
spill-overs Direct spill-overs via international trade
Bilateral loans and guarantees provided by supranational institutions
increase public good character of consolidation
Stronger linkages private sector financial institutions
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Increase in contingent liabilities
In particular guarantees to the banking sector
Capital injections
Guarantees on bank liabilities
Relief of impaired assets
Liquidity and bank funding support
Add to public debt when they materialise
Adds to uncertainty about sustainability of public
finances higher interest, in particular with lack oftransparency
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Effects of Fiscal Consolidation
GDP , distortionary taxes.
Depending on the fiscal instrument used,
fiscal consolidation may have pronounced
distributional effects
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Channels
Expectation view I: increase in taxes now
means that future increase can be smaller
net present value tax burden stimulates
economy avoid even worse budgetary crisisin future
Expectation view II: positive signals for
international capital market increaseconfidence of investors and lower risk.
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Channels
Labour market view focuses on spending composition
Taxes after-tax wage unions demand higher pre-tax wagesemployment and shadow value capital capital accumulation
and growth
Public employment relaxes labour market and weakens unionpowerreservation utility of union members downwardpressure on equilibrium real wage rate
Unemployment benefits/other transfers similar effects
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Channels
If stabilisation perceived as credible perceived likelihood ofpublic debt default interest burden more secure valueof bond holdings may stimulate consumption.
In addition interest rate charged to firms and consumers may
fall.
Large budgetary cuts resolve uncertainty on specifics ofimpending adjustment precautionary savings
Reductions in social expenditure and wage governmentconsumption are politically difficult to enact signal ofgovernments resolve private sector confidence that fiscalproblems will be overcome
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2004: Greece admitted to have entered euro-zone on
wrong budgetary figures
April 2009: Greek minister of Finance refused to clarify
financial situation
July 2009: projected 2009 deficit was raised from 3.7% to
5-6% GDP
October 21, 2009: update of deficit projection 2009 to12.5%
November 5, 2009 : update of deficit projection 2009 to
12.7%
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May 3, 2010: agreement Greece, EC, ECB and IMF on 3-
year program of economic and financial policies.
May 3, 2010: ECB announces to accept Greek debt ascollateral irrespective of its rating.
May 7, 2010: Spread on Greek debt exceeds 1000 basis
points.
May 7, 2010: Council adopts Decision on conditions for
financial assistance program (110 billion)
Weekend May 8 and 9, 2010: Agreements on European
Financial Stabilisation Facility (EFSF) and European
Financial Stabilisation Mechanism (EFSM)
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GDP still shrinking
Deficits continue to be high and debt still rising rapidly.
Greece is lagging behind the agreed adjustment package
Eventually, restructuring seems inevitable
Systemically relevant banks may need to receive publiccapital injections and need to raise equity.
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Debt restructuring:
Becomes necessary if both capital markets and Europeangovernments refuse to provide further funding
Key questions:
Is there any realistic prospect that additional loans willbe repaid?
If not, should one restructure now or postpone it till
later?
Note extra funding may buy time to work out a solution.
Contracts mostly written under local law legal obstacles
seems manageable
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Types of adjustment: several
optionsVoluntary roll-over of debt (Vienna initiative applied to
Eastern Europe)
Temporary solution only
Pursuasion of sufficient number of creditors
Postpone the maturity date of the debt (reprofiling)
Lower the coupon rate on the debt
Reduce nominal value of debt
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Consequences of debt
restructuringDirect:
Losses on rescue package by other governments
Losses for ECBneeds to be recapitalised
Estimated 50 bln. direct holdings
Estimated 90 bln. as collateral via repos
Banks need to write off some of their assets risk of
bankruptcy (especially Greek banking sector)
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Consequences of debt
restructuringIndirect:
Confidence in support of other vulnerable
countries is undermined borrowing
difficulties spill over to these countries new
demand for support while there is only limited
capacity.
Credit-default swaps may trigger payments
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Europes sovereign debt crisis? EMU : Investors European Resolution Mechanism Guide market expectations effectively about the steps to be taken
during the resolution (so avoid excess volatility in financialmarkets).
Provide governments with a game plan for this situation.
Resolve credibility problem of unconditional no-bail-out clause:need to set clear rules for how default will evolve.
Set clear rules for involving creditors in the resolution.
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Global Imbalance
Increased dispersion in CA balance
Increased persistence in CA imbalance
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Policy issues
Increase domestic spending in surplus
countries. For example, China, Germany,
Japan.
Reduce domestic spending in deficit
countries. For example, US.