LUISS

Program

 

IMPORTANT NOTICE FOR STUDENTS ON THE LESSONS OF EUROPEAN ECONOMICS
Differently from the information I gave during the past lesson of October 26th, the lesson planned for November 8th at 10:30 a.m. will be postponed to November 10th 5.00 p.m.-7.00 p.m.(at Aula blu). Hence the course of European Economics will restart on November 9th at the expected time (11.00 a.m. -1.30 p.m.). I apologize for the previous wrong information.
Marcello Messori

Jean-Paul Fitoussi and Marcello Messori

EUROPEAN ECONOMICS (2016-’17)

 

Part 1: Prof. Jean Paul Fitoussi

The first part of the course is aimed at providing a critical evaluation of European fiscal and monetary policy. The first lesson focuses on the globalization path and its theoretical rhetoric while providing some basic facts for assessing the reality of this process. In this context, the economic cost of a non-political Europe is assessed.  In the second lesson, the achievements of the European Union and possible scenarios for its future evolution are explained. Four possible scenarios are presented, starting from a simple extrapolation of current trends, which will lead to increasing imbalances, lack of cohesion, and severe costs of a missing political union. The second and third scenarios consider a possible worsening of the current situation due to increasing regional inequalities, particularly between capital cities and rest of the country, or to low growth and rising income inequalities that might lead to risks for the democratic process. A positive scenario is discussed where increasing cooperation is backed by the provision of basic public goods at the European level, among which scientific research and cooperation among universities is seen as the key to the development of a virtuous and prosperous society.

The following lessons will provide a critical assessment of the economic themes at the root of the European architecture and policy approach. We will start by reviewing the Neo-Classical synthesis and the IS-LM model. We will then discuss the role of rationale expectations and real business cycle fluctuations. Within these models, the time consistency of economic policies and the difference between rule-based and discretionary policies is provided.

The last lessons will discuss European monetary and fiscal policy. We will start by discussing the structure, nature, and objectives of the European Central Bank, as well as the revision of the ECB strategy in 2013. The final lesson will discuss the Stability and Growth Pact (SGP), the theoretical arguments in favor of constraints on budget policy, and the European Union’s fiscal rules. After discussing these foundations and providing some criticism and evaluation of European fiscal policy, suggested changes to the SGP are provided.

 

Part 2: Prof. Marcello Messori
The second part of the course has two objectives: (i) providing a description of the European sovereign debt crisis and the illiquidity or insolvency crisis of the European banking system, which started at the beginning of 2010; (ii) analyzing the reforms of the European Union’s (EU’s) governance that were implemented or defined over the past five years and are currently underway.
After the outbreak of the Greek crisis and the ineffectiveness of the bilateral financing contracts between Greece and other EU Member States (March 2010), the EU and the European Economic and Monetary Union (EMU) launched two temporary mechanisms in May 2010—the European Financial Stability Facility (EFSF) and the European Financial Stability Mechanism (EFSM)—to deal with the sovereign debt crisis in some peripheral Member States. In December 2010, the European Council decided to substitute the EFSF and EFSM  with a permanent fund (the European Stability Mechanism, ESM) by mid-2013. The framework of the ESM was officially proposed in the meeting at the end of March 2011. However, the dramatic worsening of the European sovereign debt crisis and banking activity during the summer and fall of 2011 induced the European Council to suggest a mid-2012 start date for the ESM and to change some of its features (see the meetings of July and December 2011).
The new ESM Treaty became operative after authorization from the German Constitutional Court in mid-September 2012. The ESM can act as a purchaser, on both primary and secondary markets, of public bonds which are issued by Member States enrolled in a traditional aid program; by definition, the latter are under the control of the so-called ‘troika’ (European Commission, European Central Bank – ECB, and International Monetary Fund – IMF). Moreover, thanks to decisions suggested by the European Council of June 2012 and adopted by the EU Council the following July, the ESM can perform two additional tasks. First, the ESM can help Member States meeting the EU’s fiscal rules but under temporary market strain that are ready to reach a ‘light’ aid agreement with the European institutions; in these cases, the ESM can support the allocation of public bonds on the market at proper price conditions. Second, the ESM can finance European banks with liquidity (but not insolvency) problems through public balance sheet of their home country or, when the Banking Union process becomes effective (see below), directly (i.e., without increasing the public debt of the home country).
The workings of these aid mechanisms was complemented 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 budget policies to be implemented by each Member State, became operative at the beginning of 2011. Moreover, in the second half of 2010, the European Commission proposed a reform of the “Stability and Growth Pact” (SGP), as well as stronger macroeconomic coordination to reduce national imbalances within the EMU and EU areas. These advances were refined by a number of European bodies in March 2011 and were transformed into three possible pillars of new European governance by the European Council at the meeting of March 24th and 25th: (i) the new SGP, (ii) new procedures for the prevention and correction of macroeconomic imbalances (MIP), and (iii) the “Euro Plus Pact” (EPP). By the end of the same year, pillars (i) and (ii) were mostly implemented through approval of the so-called “Six Pack”, which is based on five European regulations and one European directive.
At the beginning of 2012, in accordance with the ESM Treaty, the main changes to European governance in the fiscal area were embodied in the “Fiscal Compact” Treaty, which took the form of an international agreement. The Fiscal Compact introduces minor substantial innovations but major institutional changes relative to the Six Pack. Then, during the spring of 2013, the so-called “Two Pack” was approved, which strengthens the ex-ante European control on national budget policies and a number of fiscal and macroeconomic policies decided by EMU Member States.
I stated that the European crisis, which started in late 2009 and possibly ended 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 six years, there were several governance innovations in the ECB’s interpretation of its role and in the architecture of financial market supervision.
In order to mitigate the Greek crisis in the first half of 2010 and tackle the contagion of Italy and Spain during the summer of 2011, the ECB launched a program to purchase public bonds issued by EMU Member States in difficulty on the secondary markets (Securities Markets Program, SMP). In the meantime, the ECB eased its open market operations in favor of European banks by lowering the interest rates on its financing and the quality of acceptable collateral. However, these initiatives and the reproduction of the aid programs in favor of Greece, Ireland, and Portugal appeared insufficient for preventing the vicious circle between the European sovereign debt crisis and European banking crisis from flowing into a wipe-out of the euro area, which collapsed the inter-bank market and caused a dramatic credit crunch in the fall of 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 late-February 2012) for the European banking system, with the aim of overcoming its risk of illiquidity. The ECB offered an unlimited amount of loans, guaranteed by collateral of even poor quality, at a specific and very low interest rate (around 1%).
Despite their significant impact (more than €1,000 billion), the two LTRO operations were not designed to solve the European crises but only to “buy time”.  Hence, also as a consequence of the fiscal initiatives described above, in the late spring of 2012, the sovereign debt problems and the risks of illiquidity in the banking system regained strength. The aforementioned European Council of June 2012 and the parallel Euro-summit tried to regain control of the European situation through four initiatives: the Report of its President “Towards a genuine economic and monetary union” (better known as the four Presidents’ Report), which is a “road map” to gradually build a fiscal and political union; the launch of the process of Banking Union; the just mentioned enlargement of the ESM’s competencies; and a sketch of a Growth compact to complement the Fiscal compact.
The four Presidents’ Report inspired a ‘blue print’ for the European Commission in the fall of 2012 and was translated into a ‘road map’ by the European Council of December 2012. Moreover, in the first half of 2015, it was reappraised by means of an Analytical Note (February) and evolved into the Five Presidents’ Report (June), which, in turn, inspired a Communication of the European Commission in October 2015. Despite this long evolution, the initiative did not flow into actual decisions. On the other hand, the process of Banking Union was quite effective. New rules and new supervision architecture for the financial markets were first defined in the second half of 2010 and became effective on January 1st, 2011. However, the launch of the Banking Union process (June 2012) and the definition of its first steps (from December 2012 to February 2014) marked a crucial break in the European framework of financial regulation. The ECB and the system of EMU (and, on a voluntary basis, EU) national central banks played the role of unique supervisor for the European banking sector since November 2014; moreover, a European resolution mechanism for financial intermediaries in bankruptcy, based on the so-called bail-in principle and the European resolution fund, became operative from the beginning of January 2016. The Banking Union process fed the starting of the Capital Markets Union in mid-February 2015. The latter process aimed to actually build a single European financial market, but it is still taking its first steps.
The new evolution of European economic governance, launched by the European Council of June 2012, did not prevent a new crisis in July 2012. Even in this case, the temporary solution was offered in the form of a new ECB initiative. After a strongly worded statement by its President (Mario Draghi) in support of a watertight euro at the end of July 2012, the ECB launched the OMT (Outright Monetary Transactions) program at the beginning of September to safeguard the functioning of monetary policy channels. Through it, the ECB can buy (on the secondary markets) the public bonds of EMU Member States suffering from an abnormal spread that can, and actually do, sign the mentioned ‘light’ agreement with the ESM.
All these initiatives and the end of the economic recession in April 2013 lowered the risk of a euro area breakdown. However, the decision made in a special meeting of the European Council (February 2013) to reduce the EU’s budget for 2013-2020, the fruitless discussions (over the past two years) on the possible implementation of the so called “growth compact”, the difficulties of introducing a “golden rule” to exempt national funding of European investments from the calculation of public deficits, and the failure in the implementation of the so-called contractual arrangements hindered the implementation of a robust expansionary policy. Hence, in the first half of 2014, the euro area was characterized by a growing risk of deflation, and then its economic perspectives worsened again.
In the fall of 2014, the launch of the Juncker Plan, a new LTRO (the T-LTRO), and a light form of a non-conventional monetary policy (the first ‘quantitative easing,’ QE1) were not enough to stop this negative trend. However, the situation dramatically improved at the beginning of Winter 2014-15. The euro area was positively hit by an external shock (a decrease in the prices of energy products) and by a series of initiatives made by the European institutions that led to the euro’s depreciation relative to other international currencies. In  particular, the ECB implemented a stronger form of ‘quantitative easing’ (QE2) centered on a large monthly purchase on the secondary markets of public bonds issued by EMU countries, and a Communication of the European Commission offered a flexible interpretation of a number of important fiscal rules.
Unfortunately, in the last fifteen months, the EMU’s promising path of growth was threatened by a number of negative events: the new Greek crisis, which led Greece to the brink of a traumatic exit from the euro area and found a precarious solution in August 2015 through the launch of a new aid program; the social and human drama of refugees, which worsened the flows of migration towards the euro area and strengthened the populist parties in several European countries; the crisis of four small Italian banks in Fall 2015, which made evident the fragility of a large part of the Italian banking sector and the unexpected impact of the new European rules on bank resolution processes; the consequent difficulties in handling the excessive stock of non-performing loans on the balance sheets of Italian banks during the first half of 2016; the result of the UK referendum (June 2016), which will lead the UK to abandon the EU. This impressive list of negative events did not elicit a reaction from the European institutions due to another unplanned contingency: the impressive chain of referendums and political elections to be held in the EU and the euro area from September 2016 to Fall 2017. This long ‘political cycle’ is leading to a stalemate in the workings of European and national institutions.

References
The analysis of very recent or current issues means 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 made available to students in advance (three days before).
However, in order to have a general and analytical view on the economic workings of the Euro area, you can refer to:
P. De Grauwe, Economics of Monetary Union, Oxford: Oxford University Press, 2016 (Tenth edition).
A stimulating analysis of the evolution of EU governance since the creation of the Euro area is offered in:
C. Bastasin, Saving Europe, Brookings Institution Press, Washington, 2015 (Second edition).
For an overview of 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.

 

 

 

Rules and organization of the Exam

 

Following LUISS’ rules, the standard Sessions of the exam relating to the course European Economics are three:

Winter Session

Summer Session

Fall Session.

The Session immediately following the classes (in the case of European Economics, the Winter Session) allows for three specific rounds of exam (First, Second, and Third Round: the so-called “Appelli”). The other Sessions select a single date.

The course of European Economics adopts additional rules. In this respect, it must be noted that:

  • Relating to the Session structured in three rounds, any student would not be allowed to repeat the exam in the next round of this same Session, if she/he failed the proof (grade below 18/30) in the current round. This means that a student who attended the exam in the first round of the Winter Session (the so-called “Primo Appello”) and got the grade “Fail”, is forbidden to attend the exam in the second round of this same Session (the so-called “Secondo Appello”); and a student who attended the second round of the Winter Session (the so-called “Secondo Appello”) and got the grade “Fail”, is forbidden to attend the third round of this same Session (the so-called “Terzo Appello”).
  • Still relating to the Session structured in three rounds, any student would be allowed to repeat the exam in the next round of this same Session, if she/he passed the proof (grade equal or higher than 18/30) in the current round but decided to repeat the exam to improve her/his performance. This means that a student who attended the first round of the Winter Session and got a grade ≥ 18/30, will be allowed to attend the second round of this same Session if she/he aims at improving her/his performance; and a student who attended the second round of the Winter Session and got a grade ≥ 18/30, will be allowed to attend the third round of this same Session if she/he aims at improving her/his performance.

The organization of each of the exams will be the following:

  • The exam will be a written test;
  • The test will be divided in two parts:
  • An open question on a specific but important issue of the program, with an answer space of – more or less – twenty-five lines and a maximum score of 10 points;
  • Eleven multiple-choice questions (one question/four answers; just one answer fully correct); a right answer gives a score of two points, a no-answer gives a 0-score, whereas a wrong answer gives a – 0,25 points.

The maximum final grade of this type of Exam is, obviously, equal to 30/30 + distinction.

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