LUISS

Programma

Program of the first part of the course

The first part of the course has two objectives: (i) the description of the European crisis of sovereign debt and that of illiquidity or insolvency crisis of the European banking system, which started at the beginning of 2010; (ii) the analysis of the reforms of the European Union’s (EU’s) governance which have been implemented or defined during the past five years or are still under way in the current year.

After the outburst of the Greek crisis and the ineffectiveness of the bilateral financing contracts between Greece and other EU’s Member States (March 2010), in May 2010 the EU and the European Economic and Monetary Union (EMU) launched two temporary mechanisms (the European Financial Stability Facility: EFSF; and the European Financial Stability Mechanism: EFSM) to deal with the crisis of sovereign debt in some peripheral Member States. At December 2010, the European Council decided to substitute a permanent fund (the European Stability Mechanism: ESM) for the EFSF and EFSM by mid 2013; and it approved the ESM’s organization in the meeting of the end of March 2011. However, the dramatic worsening of the European crises of sovereign debt and banking activity during the summer and fall 2011 induced the European Council to anticipate the ESM’s starting at mid 2012 and to change some of its features (see the meetings of July and December 2011).

The new ESM Treaty has become operative after the authorization of the German Constitutional Court in mid September 2012. The ESM can act as a purchaser on the primary and secondary markets of public bonds, issued by Member States which are enrolled in a traditional aid program and – hence – are under the control of the so-called ‘troika’ (European Commission, European Central Bank – ECB, International Monetary Fund – IMF). Moreover, thanks to the decisions taken by the European Council of June 2012, the ESM can perform two additional tasks. First, the ESM can help Member States which meet the EU’s fiscal rules but are under a temporary market strain and are ready to reach a ‘light’ aid agreement with the European institutions; in these cases, ESM can support the allocation of the public bonds on the market at proper price conditions. Secondly, the ESM can finance European banks with liquidity (but not insolvency) problems through the balance sheet of their home country or, when the Banking Union process will become effective (see below), directly – that is without increasing the public debt of the home country.

The working of these aid mechanisms has been matched by the introduction of new governance institutions in the fiscal and macroeconomic fields. The so called “European Semester”, which implies an ex ante and stricter coordination of the budget policies to be implemented by each Member State, has started at the beginning of 2011. Moreover, in the second half of 2010, the European Commission and a Committee led by the President of the European Council (van Rompuy) proposed a reform of the “Stability and Growth Pact” (SGP) as well as a stronger macroeconomic coordination to reduce national imbalances within the EMU and EU areas. These advices were refined by a number of European bodies during the month of March 2011, and were transformed in three possible pillars of the new European governance by the European Council at the meeting of March 24th and 25th: (i) the new SGP, (ii) a new regulation on the prevention and correction of macroeconomic imbalances (RMI), (iii) and the “Euro Plus Pact” (EPP). At the end of the same year, pillars (i) and (ii) have been largely implemented by means of the approval of the so-called “Six Pack”, which is based on five European regulations and one European directive.

At the beginning of 2012, in concurrence with the ESM Treaty, the main changes of the European governance in the fiscal area have been embodied in the “Fiscal Compact” Treaty, which has the form of an international agreement. The Fiscal Compact introduces minor substantial innovations but major institutional changes with respect to the Six Pack. Then, during the Spring 2013, it was approved the so-called “Two Pack” which strengthens the ex ante European control on national budget policies and on a number of fiscal and macroeconomic policies, decided by the Member States of the EMU.

I stated that the European crisis, which started in late 2009 and had its possible end in the last quarter of 2013, is based on a vicious circle between the sovereign debt crisis and the crisis of the banking sector. Hence, during the last four years, there were also several governance innovations in the ECB’s interpretation of its role and in the architecture of financial markets’ supervision.

In order to mitigate the Greek crisis in the first semester of 2010 and to face the contagion of Italy and Spain during the summer of 2011, the ECB launched a program of purchases of the public bonds, issued by EMU’s Member States in difficulties, on the secondary markets (Securities Markets Program: SMP). In the meantime, the ECB eased its open market operations in favor of the European banks by lowering the interest rates on its financing and the quality of the accepted collaterals. However, these initiatives and the reproduction of the aid programs in favor of Greece, Ireland and Portugal appeared insufficient to avoid that the vicious circle between the European sovereign debt crisis and the European banking crisis flowed into the wipe-out of the euro area, the collapse of the inter-bank market, and a dramatic credit crunch during the fall 2011. Hence, at the end of November 2011, the ECB decided to launch a new initiative: the LTRO (Long Term Refinancing Operation). This new program was based on two generous refinancing operations (Mid-December 2011, and end of February 2012) of the European banking system with the aim of overcoming its risk of illiquidity. The ECB offered an unlimited amount of loans, guaranteed by collaterals of even poor quality, at a given and very low interest rate (around 1%).

Despite their significant impact (more than 1,000 billions), the two LTRO operations were not designed to solve the European crises but just to “buy time”.  Hence, in the late spring of 2012 the sovereign debt problems and the risks of illiquidity of the banking system won back their strength. The already mentioned European Council of June 2012 tried to regain control on the European situation by means of four initiatives: the Report of its President “Towards a genuine economic and monetary union” which is a “road map” to gradually build up a fiscal and political union; the launch of the process of Banking Union; the analyzed enlargement of the ESM’s competences; and a sketch of a Growth compact to complement the Fiscal compact. However, the European governance really improved thanks to a new initiative of the ECB. After a sharp statement of its President (Mario Draghi) in support of a watertight euro at the end of July 2012, at the beginning of September the ECB launched the OMT (Outright Monetary Transactions): in order to safeguard the working of the monetary policy channels, the ECB is ready to buy (on the secondary markets) the public bonds of EMU’s Member States which suffer an abnormal spread and can and actually does sign the mentioned ‘light’ agreement with the ESM.

New rules and new supervision architecture for the financial markets were defined in the second half of 2010 and have become effective at January 1st, 2011. However, the launch of the Banking Union process (June 2012) and the definition of its first steps (since December 2012 to February 2014) mark a still more important break in the European framework of financial regulation. In the next future the ECB and the system of EMU’s (and – on a voluntary basis – of EU’s) national central banks should play the role of unique supervisor for the banking sector; moreover, there will be a European resolution mechanism for financial intermediaries in bankruptcy based on a European resolution fund.

All these initiatives have lowered the risk of a euro breakdown. Now the European institutions are more and more concerned with the problems caused by the competitiveness gaps between the central and the peripheral Member states, and with the lack of growth in the peripheral part of the Euro area. These two factors have complex links. During the last years there was a significant reduction of the macroeconomic imbalances inside the EMU; however, these adjustments are mainly due to the deep recession that affected the Member states with severe deficits in their current accounts, and to the consequent decrease in their import flows. The expectation is thus that any significant economic recovery in the peripheral part of the Euro area would produce a new increase in the European macroeconomic imbalances.

This expectation can explain some of the constraints that hinder the launch of an expansionary policy in the euro area. The decision taken by a special meeting of the European Council (February 2013) to reduce the EU’s balance sheet for the period 2013-2020,  the fruitless discussions (all along the past year) on the possible implementation of the so called “growth compact”, the difficulties to introduce a “golden rule” to exempt the national funding of European investments from the calculation of public deficits show that EU’s institutions have still a lot of difficulties to find the right way to implement an expansionary policy.

Since October 2013 there was an attempt to overcome the possible vicious circle between the expected dynamics of the European imbalances and the stimuli to the economic growth of peripheral countries by means of the so called “contractual arrangements”. In principle, the latter are based on a contractual bilateral agreement between each Member state which engages itself to implement specific structural reforms, and the European Commission which offers incentives for these reforms. However, the German attempt to launch the contractual arrangements during the European Council of December 2013 has been unsuccessful. At this moment, it is still unclear if these agreements are voluntary and/or involve the peripheral as well as the central Member states; moreover, it is still unclear which are the actual incentives that the European Commission is ready to offer.

The first part of the course analyzes the main components of the EMU’s and EU’s new governance. In particular, this part focuses on five topics: (1) the European semester, the reform of the SGP, the implementation of the “Six Pack” and of the “Fiscal compact”, and the discussion on the “Two Pack”; (2) the consequent management of the European sovereign debt; (3) the new rules and supervision of the European financial markets, including the analysis of the process to implement the Banking Union; (4) the RMI as well as their impact on competition and disequilibria in the EMU’s internal market; (5) the possible launch of European policies for growth and competitiveness, including the analysis of the possible impact of the contractual arrangements.

The program of the first part of the course will be the following one:

Topics covered in Marcello Messori’s lessons:

  • The general framework of the international financial crisis and of the European crisis;
  • The new European governance and its main problems before the LTRO;
  • The innovations of the European governance since December 2011 to June 2012;
  • The most recent initiatives: banking union and road map;
  • The policies for growth and competitiveness.

References

The analysis of new issues also implies that it is impossible to refer to a specific textbook. The references for the final exam are based on a set of slides. The slides, referring to a given lesson, will be placed at students’ disposal in advance (three days before).

However, in order to have a general and analytical view on the economic working of the Euro area, you can refer to:

P. De Grauwe, Economics of Monetary Union, Oxford: Oxford University Press, 2012 (Ninth edition).

An overview of the evolution of the EU governance since the creation of the Euro area to the end of 2012 is offered in:

R. Giordano, “The Reform of the EU Economic Governance: the Stability and Growth Pact, mimeo (see the current web page).

In order to have an overview on the evolution of the international crisis (2007-’09), you can refer to:

M. Messori, The Financial Crisis: Understanding it to Overcome it, www.assogestioni.it, 2009.

Handout A.A. 2014/2015

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