1. Duisenberg School of Finance Opening Academic Year September 7, 2011 Wim Boonstra Chief Economist Rabobank, Europe: after the crisis reaction to the lecture of Charles A.E. Goodhart

2. Content Charles Goodhart’s conclusions Some comments Some recommendations: common funding of public deficits Concluding remarks

3. Charles Goodhart’s conclusions A monetary union needs some minimal centralisation of power. Current account balances are important! The new Excessive Imbalance Procedure correctly shifts the focus from public finances to the external sector The enforcement of the EIP is misguided Interaction between banks and public sector debt is the most severe problem. There really is no good way to resolve this. There is a case for building up a sizeable euro-zone sovereign wealth fund for use in emergencies

4. Some comments I agree with Charles Goodhart on almost everything he has said. “For a country like Japan, with a huge public debt but a CA surplus and a positive NIIP its debt is entirely its own concern”. Is it? Or does it need capital controls in the end? The corrective arm of the EIP is misguided. Financial sanctions do not make sense. But would an ‘enforced credit rating downgrade’ have a different effect? What we need is ex ante agreed and automatic political sanctions. Such as: – (temporary) loss of voting rights in the ECB board – (temporary) loss of voting rights in the council of ministers – (temporary) loss of European Commisioner To summarise, we need: – measures that hurt politicians, not their electorate – measures that are easy to implement Creation of a wealth fund is a good idea, but it is not enough

5. On average, EMU public finances are relatively good.

6. Financial markets’ binary discipline: a case for eurobonds?

7. The eurobond cacophony There are many so-called eurobond proposals. They have one thing in common: the word ‘eurobond’. The differences are huge. Succesfull eurobonds should bring: – Stability in the markets – Improved fiscal discipline (supported by a more effective SGP) – Clear benefits for all countries (weak and strong) – A self-financing and pro-active crisis mechanism (via an insurance premium) Most proposals bring at best some benefits for the weaker countries Benefits for strong countries might be: – Lower funding costs due to liquidity premium. This is strongly dependent on the exact design. Here things can go seriously wrong – Self-financing crisis mechanism  Goodhart’s SWF

8. Central funding via the EMU fund EMU fund issues (euro)bonds and pays market rates Redistributed to the member states Countries pay spread over funding costs, depending on fiscal performance Self-financing mechanism (‘insurance premiums’) Cross-guarantee essential (not partial guarantees)

9. Pros and cons of this approach Advantages – Flexibility in debt management (maturities etc.) – Diverging fiscal policies translate into diverging funding costs (restoration of failing market discipline) – Countries are sheltered from sudden swings in market sentiment – Creation of huge and liquid pan-EMU bond market – Weaker countries pay premium to EMU Fund, instead of higher interest rates to markets  financial buffer against future problems  Charles Goodhart’s SWF? – Using cross-guarantee  the average counts, not the problem in the margin  lower funding costs (Possible) problems – Potential tensions with no-bail out clause  we already have crossed this line – Difficulties in calculation of spread  see below – Practical implementation – Lack of political willingness  voluntary participation – We can start without Germany. Any pair of countries can start and scale up.

10. Computing the spread A simple straightforward formula will suffice: R(i) =  [O(i) - O(m)] +  [S(i) – S(m)] Where: – R(i) = the margin payable by country i over the funding costs of the EMU fund – O(i) = the government deficit of country i, as a % of GDP – S (i) = the government debt of country i, as a % of GDP – The variables O(m) and S(m) represent the acceptable levels for debt and deficits. They could be the criteria from the SGP. – The parameters  and  are coefficients, used to determine the weight of the relative performance on government deficit and government debt respectively in setting the mark-up.

11. Concluding remarks A monetary union needs some minimal centralisation of power. Eurobonds can change the interaction between banks and the national public sector debt There is a case for building up a sizeable euro-zone sovereign wealth fund for use in emergencies  a well-designed eurobond scheme can bring this forward If fragmentation of EMU’s national public bond markets is not eliminated, EMU will remain vulnerable and may in the end not survive. Some centralisation is essential A well-designed eurobond scheme can bring advantages for all participating countries: – Deeper markets bring increased liquidity  lower funding costs – Weaker countries benefit from cross guarantee – Self-financing insurance mechanism  no need for additional rescue packages

12. More information: www.rabobank.com/kennisbank Thank you