The Euro Crisis Banking Crisis Debt Crisis Economic Crisis Crisis of Confidence Bertram Wieland Representative of the Deutsche Bundesbank

The Euro Crisis

Banking CrisisDebt Crisis

Economic Crisis

Crisis of Confidence

Bertram WielandRepresentative of the Deutsche Bundesbank

17.12.2013 Higher School of Economics 2

Same crisis, different perspectives

❙ sovereign debt crisis (high public and/or private debt)

❙ lack of competitiveness

❙ current account imbalances

❙ weaknesses in the monetary framework

❙ weaknesses in the financial system


The Euro Crisis

(1) Consolidation of public debts

(2) Regaining competitiveness

(3) Target2 – symptom of the imbalances

(4) Monetary policy of the ECB

(5) European Banking Union

(6) An alternative view: the Austrian business cycle theory


Solving the crisis on a country level

... by addressing underlying deficiencies:

❙ public debt above 100 % of GDP

(Greece, Portugal, Ireland, Italy)

❙ loss of competitiveness since introduction of the euro:

Greece –12 %, Spain –14 %, Italy –8 %


(1) Public debt and deficit in per cent of GDP

Public debt in per cent of GDP in 2007, 2010 and 2013

Budget deficit in per cent of GDP in 2007, 2010 and 2013


(1) Public debt in per cent of GDP in the Eurozone


(1) Public debt in per cent of GDP in G7 countries


(1) Instruments of choice for sustainable growth

❙ governments need to consolidate public finances• Germany strongly supported the initiative of the Russian

G20 presidency to reach a debt agreement as a more ambitious follow-on to the plan agreed to in Toronto in 2010

• but up to now no G20 agreement on specific debt to GDP targets

❙ ... and to embark on structural reforms


(2) Loss of competitiveness in Southern Europe

European labour markets in comparisonunit labour cost development annual average wage cost changes

2000-2010 2000-2010


(2) Regaining competitiveness since 2009 in Ireland, Greece, Spain and Portugal ...

Since 2009 competitiveness has improved in crisis countries:nominal unit labour costs declined in Ireland and Greece by 12%, in Spain by 6%, in Portugal by 5%

Unit labour cost development since 2000


(2) ... but no improvements in France and Italy

Unit labour cost development since 2000


(2) Development of competitiveness in Europe


(3) TARGET2 imbalances:Symptom of the balance of payments crisis


(3) What is TARGET2?

❙ Target2 is the Real-Time-Gross-Settlement system operated by the Eurosystem

❙ Target2 has to be used for• all payments involving the Eurosystem,• the settlement of operations of all large-value net

settlement systems and• securities settlement systems handling the euro.


(3) How does TARGET2 work?

❙ The total Target2 payments and settlements system is a closed system, in an accounting sense:

• every Target2 transaction by the ECB and the 17 NCBs that make up the Eurosystem is entered once as a credit and once as a debit

• Because of this double-entry bookkeeping feature, the net Target2 balance of the consolidated 17 euro area NCBs and the ECB is zero.

❙ It is important to note that the net credit position of any NCB under Target2 are claims against the ECB


(3) TARGET2 flows before the crisis

commercial banksin Germany

commercial banksin Greece

trade related flows

Greek importersGerman exporters

private financial flows

Deutsche Bundesbank ECB Bank of Greece


(3) German banks exposure to peripheral EuropeChange from Q1 2008 to Q2 2012 in billions of Euro


(3) TARGET2 flows during the crisis

commercial banksin Germany

commercial banksin Greece

trade related flows

Greek importersGerman exporters

private financial flows

Deutsche Bundesbank ECB Bank of Greece


(3) Net credit position of the Bundesbank

❙ In the monetary union the net credit position of the Bundesbank vis-à-vis Target2 can be interpreted as the equivalent of official foreign exchange reserve claims vis-a-vis the other euro area member states held by the Bundesbank (in a hypothetical fixed exchange rate regime)

❙ The change in the net credit position of the Bundesbank vis-a-vis Target2 can be interpreted as the surplus of the German balance of payments accounts vis-à-vis other euro area member states

❙ Target2 imbalances can therefore be driven by• current account deficits of an euro area country• private financial account deficits (capital account deficits)


(3) Target2 imbalances

❙ As a matter of accounting logic Target2 imbalances are not necessarily driven by current account deficits

❙ Experience suggests that drivers of changes in Target2 imbalances are movements in the private financial account (capital account).

❙ These private capital flows out of the euro area periphery into Germany and other core countries have their counterpart in the accumulation of Target2 net credit balances by the Bundesbank and other core countries’ NCBs.

❙ That would have been increases in official foreign exchange reserve claims of the Bundesbank on the periphery member states had there still been 17 distinct national currencies in the euro area


(3) Balance sheet of the Deutsche Bundesbank

Assets (€ billion) 2012 2011

1 Gold and gold receivables 138 133 2 Claims on non-euro-area residents in foreign currency 51 52 3 Claims on euro-area residents denominated in foreign currency 3 18 4 Claims on non-euro-area residents denominated in euro – – 5 Lending to euro-area credit institutions related to monetary policy 73 56 6 Other claims on euro-area credit institutions denominated in euro 1 9 7 Securities of euro-area residents denominated in euro 68 72 8 Claims on the Federal Government 4 4 9 Intra-Eurosystem claims 668 476

9.1 Participating interest in the ECB (2) (2)9.2 Claims transfer of foreign reserves to the ECB (11) (11)9.3 Claims related to the allocation of euro banknotes (–) ( –)9.4 Other claims within the Eurosystem (net) (655) (463)

10 Items in course of settlement 0 011 Other assets 19 18

Total Assets 1,025 838


❙ The Deutsche Bundesbank's TARGET2 claims:

❙ peak in August 2012 with751,4 bn €

❙ lowest level since August 2012 in October 2013 with 561,5 bn €

(3) Traget2 Net Balances


(3) Redistribution effects of Target2 imbalances

❙ The quasi-fiscal actions of the Eurosystem since the beginning of the crisis have redistributed resources between debtors, investors, tax payers and beneficiaries of public spending across the periphery and the core countries of the euro area

❙ The scale and scope of these redistributions has been large: the Eurosystem balance sheet has more than doubled in recent years

❙ Again: Target2 imbalances do not represent a separate risk exposure; they indicate the balance of payment crisis and the capital flight within the euro area

❙ As the balance sheet size and the exposure of the Eurosystem grow, the ECB needs to review the range of eligible collateral


(4) Government Bond Spreads over German Bund Yields before and after Launching Monetary Union


(4) ECB Securities Market Programme (SMP)

♦ weekly purchases of government bonds (right in bn €)▌ECB stock of government bonds (left in bn €)


(4)


(4) Does the ECB’s OMT Programme prevent contagion?

❙ OMT (outright monetary transactions) means the implicit mutualization of debt in contrast to an explicit mutualization of debt by introducing euro bonds.

❙ The announcement of a possible larger-scale debt mutualization through the central banks’ balance sheets calmed the markets.

❙ Calm markets might be treacherous; concerns relate to reforms both at the national and at the European level.

❙ The crisis is not over.


(4) Why does the Bundesbank have reservations against the ECB’s OMT Programme?

❙ Diverging interest rates within the euro region aren’t necessarily something the ECB should fix.

❙ Different effects of monetary policy within the euro area: not necessarily a malfunctioning to be addressed by monetary policy

❙ Rising sovereign bond yields: not necessarily an explanation for a disturbance of monetary policy transmission.

❙ distortion in yield developments for sovereign bonds may be ...• due to fundamentally justified causes• potential exaggerations, irrationalities, inefficiencies

❙ ECB bond purchases under OMT would be different from those of other central banks (eg the Fed)

• Fed targets only top rated government assets• ECB targets assets of poor credit quality (more risks for ECB)


(4) Should the ECB prevent a country’s Eurozone exit?

❙ Emergency Liquidity Assistance (ELA): liquidity disposal from the Eurosystem to cover financial needs of Greece and Cyprus through access to ELA is particularly problematic:

• takeover of fiscal responsibilities by monetary policy’s authorities

• ECB has taken an extremely high risk, as Greece’s and Cyprus’ exit from the Eurozone cannot be considered impossible

❙ The ECB’s main task:• to guarantee the currency union as a stability union• not to guarantee the composition of the Eurozone


(4) Private sector in crisis stricken countries is lacking access to bank loans – should the ECB react?

General bank lending has been falling, but

the Eurozone’s banking system credit to the government has exploded even as credit to the private sector has weakened.

In short, government borrowing has taken the slack from the private sector.


(4) Diverging interest rates on loans to companies – should the ECB react?

Higher refinancing costs for the private sector reflect higher national fiscal risks and the deterioration in the banks’ situation in peripheral countries. That is not a development for monetary policy to address, but rather a direct consequence of national fiscal policy.

Credit supply: interest rates for new corporate loans (terms: up to 1 million euro, 5 years)


(5) Financial Stability: European Banking Union

❙ Three pillars• Single Supervisory Mechanism (SSM)• Single Resolution Mechanism (SRM)• Single Depositor Guarantee Scheme (SDGS)

❙ SSM will be composed of the ECB and the supervisory authorities in the member states

❙ Germany adopted law on SSM; paving the way for SSM regulation (operational not before 2014)

❙ When an effective SSM is established, the ESM could recapitalise banks directly (currently only by member states)

❙ Legal foundation of SRM still under discussion❙ SSM without the SRM means liability and control are temporarily

out of balance.❙ SDGS only with fully integrated financial systems (fiscal union)


(6) An alternative view of the crisis:

Austrian Business Cycle Theory (Austrian School of Economics)

❙ Natural rate of interest (reflects the return on investment)

❙ Market rate of interest (reflects the borrowing costs of funds charged by the banks)

❙ Market rate is below the natural rate:companies borrow to invest and the economy expands

❙ Market rate is above the natural rate:investment is reduced and the economy contracts


(6) Austrian Business Cycle


(6) Why are artificially low interest rates bad for the economy?

❙ No incentive to save due to devaluation of savings; resources are channelled into consumption; capital stock is neglected

❙ Encouragement of investments that turn out to be profitable only at low interest rates; vicious circle to ever lower rates

❙ Moral hazard, as the central bank is committed to low interest rates; market participants take more risks; increasing risk of speculative bubbles and mal-investments

❙ Artificially low interest rates mean subsidizing inefficient production and preservation of unprofitable structures


(6) The failure of the Great Moderation*

[* Great Moderation: pro-active use of monetary policy by the Fed under Greenspan to fine-tune economic developments]

❙ The financial crisis since 2007 uncovered the Great Moderation as a great illusion.

❙ Old reflexes of crisis solution led to the combined deployment of monetary and fiscal policy

❙ excessive leverage needed to be unwound: the crisis moved from the US sub-prime mortgage sector to the money markets, the banking sector and to the public sector

❙ principle: to shift the unbearable burden of debt from weaker to stronger shoulders and to lower debt service costs through monetary policy induced interest rate cuts


The crisis triggered by massive de-leveraging is not yet under control

(6) Stages of the Crisis


(6) Lessons from Austrian Business Cycle Theory

❙ Economic policy cannot fine-tune the business cycle❙ It is unhelpful to pro-actively manipulate the market rate to

achieve certain economic growth objectives❙ Policy makers should try to create conditions for a steady

development of credit by allowing the market rate to closely follow the natural rate

❙ Banking system must be capable to satisfy the demand for credit• Regulation can help, but needs to realize its limits.• Regulation can create a false sense of security, unless there

are incentives to follow sound business practices.• The best incentive for sound business practices is to make

failure possible (effective resolution regimes for financial firms are indispensable).

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Documents

The Euro Crisis Banking Crisis Debt Crisis Economic Crisis Crisis of Confidence Bertram Wieland Representative of the Deutsche Bundesbank