Presentation on theme: "The ECB to the rescue? Filling the Lacunae in Euro Area Governance Gabriel Glöckler * European Central Bank Edinburgh, 1 June 2012 * The views expressed."— Presentation transcript:
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
ECBs institutional context EMU rests on four fundamental constitutional pillars Price stability orientation of the central bank Independence of the central bank Monetary financing prohibition No bail-out clause EMU
8 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) Q11999 Q12000 Q12001 Q12002 Q12003 Q12004 Q12005 Q12006 Q12007 Q12008 Q12009 Q12010 Q12011 Q Euro areaGermanyFranceItalySpain NetherlandsBelgiumAustriaGreeceIreland FinlandSlovakiaLuxembourgPortugalSlovenia CyprusMalta
9 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 supervisionNo 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 sector Short-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 14
Bluntness of debt markets as disciplining devices Observed payout distribution of debt and equity contracts
The fiscal-financial nexus in the euro area… …. has been strong since the beginning of 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. 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
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 volatilityCDS 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 Market-based inflation indicators euro 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 EFSF Basiert auf Eurogruppe, EIB, ECB, … ESM Vorsorge- Kreditlinien Secondary Market Purchases Primary Market Purchases 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
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? 31