07a euro book_francestrategie
29
Brunnermeier, James & Landau The Euro & The Battle of Ideas Markus K. Brunnermeier, Harold James & Jean-Pierre Landau France Stratégie Lunch Talk Paris, Sept. 21 st , 2016
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Transcript of 07a euro book_francestrategie
Bru
nn
erm
eier
, Jam
es &
Lan
dau
The Euro &The Battle of Ideas
Markus K. Brunnermeier,
Harold James & Jean-Pierre Landau
France Stratégie Lunch Talk Paris, Sept. 21st, 2016
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Overview
Power shift & watershed moments• 2010, May: EFSF, IMF involvement
• 2010, Oct: Deauville PSI: contagion
• 2012: Draghi’s “Whatever it takes” Speech in London
• 2013: Cyprus Bail-in
• 2016: Brexit
Different economic philosophies• Ideas versus interest
• Interests are interpreted through the lens of ideas ≈models
2
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Overview
Power shift & watershed moments• 2010, May: EFSF, IMF involvement
• 2010, Oct: Deauville PSI: contagion
• 2012: Draghi’s “Whatever it takes” Speech in London
• 2013: Cyprus Bail-in
• 2016: Brexit
Different economic philosophies• Ideas versus interest
• Interests are interpreted through the lens of ideas ≈models
3
Rationale to focus on France & Germany
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Overview
Power shift & watershed moments• 2010, May: EFSF, IMF involvement
• 2010, Oct: Deauville PSI: contagion
• 2012: Draghi’s “Whatever it takes” Speech in London
• 2013: Cyprus Bail-in
• 2016: Brexit
Different economic philosophies• Ideas versus interest
• Interests are interpreted through the lens of ideas ≈models
4
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Overview
Power shift & watershed moments• Rationale for focus on Germany and France
Different economic philosophies• Ideas versus interest
• Interests are interpreted through the lens of ideas ≈models
5
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Overview
Power shift & watershed moments• Rationale for focus on Germany and France
Different economic philosophies• Ideas versus interest
• Interests are interpreted through the lens of ideas ≈models
• Shifts and even reversals are possible
6
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Overview
Power shift & watershed moments• Rationale for focus on Germany and France
Different economic philosophies• Ideas versus interest
• Interests are interpreted through the lens of ideas ≈models
• Shifts and even reversals are possible
Maastricht’s Ghost: Monetary and fiscal stability
Maastricht’s Stepchild: Financial stability
7
Bru
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, Jam
es &
Lan
dau
“French” “German”
1. Discretion Rules
2. Solidarity Liability• Fiscal union No-bailout clause/rule
3. Liquidity/contagion Solvency
4. Keynesian Stimulus Austerity/Reform
Ghost of Maastricht “Rhine Divide”
9
Ideal types (Max Weber) White-black comparison to sharpen contrast
Bru
nn
erm
eier
, Jam
es &
Lan
dau
“French” “German”
1. Discretion Rules
2. Solidarity Liability• Fiscal union No-bailout clause/rule
3. Liquidity/contagion Solvency
4. Keynesian Stimulus Austerity/Reform
Ghost of Maastricht “Rhine Divide”
10
Ideal types (Max Weber) White-black comparison to sharpen contrast
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion vs. RulesStraitjacket commitment Safety/escape valves
Active management ▪ Autonomous - no “ad hocery”
current crisis management ▪ future crisis prevention
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
• Commit to currency peg/not to exit currency unionin order to discourage currency attacks
but consolidate (later)19
“Black-white” Organizing Principle
Bru
nn
erm
eier
, Jam
es &
Lan
dau
“French” “German”
1. Discretion vs. RulesStraitjacket commitment Safety/escape valves
Active management ▪ Autonomous - no “ad hocery”
current crisis management ▪ future crisis prevention
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
• Commit to currency peg/not to exit currency unionin order to discourage currency attacks
but consolidate (later)
Ghost of Maastricht “Rhine Divide”
20
“Black-white” Organizing Principle
Bru
nn
erm
eier
, Jam
es &
Lan
dau
“French” “German”
1. Discretion vs. RulesStraitjacket commitment Safety/escape valves
Active management ▪ Autonomous - no “ad hocery”
current crisis management ▪ future crisis prevention
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
• Commit to currency peg/not to exit currency unionin order to discourage currency attacks
but consolidate (later)
Ghost of Maastricht “Rhine Divide”
21
“Black-white” Organizing Principlein
tern
atio
nal
Bru
nn
erm
eier
, Jam
es &
Lan
dau
“French” “German”
1. Discretion vs. RulesStraitjacket commitment Safety/escape valves
Active management ▪ Autonomous - no “ad hocery”
current crisis management ▪ future crisis prevention
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
• Commit to currency peg/not to exit currency unionin order to discourage currency attacks
Ghost of Maastricht “Rhine Divide”
22
“Black-white” Organizing Principle
Free capital flow
Fixed ex-change rate
AutonomousMonetary Policy
inte
rnat
ion
al
Bru
nn
erm
eier
, Jam
es &
Lan
dau
“French” “German”
1. Discretion vs. RulesStraitjacket commitment Safety/escape valves
Active management ▪ Autonomous - no “ad hocery”
current crisis management ▪ future crisis prevention
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
• Commit to currency peg/not to exit currency unionin order to discourage currency attacks
Manage capital flows!
Ghost of Maastricht “Rhine Divide”
23
“Black-white” Organizing Principlein
tern
atio
nal
Bru
nn
erm
eier
, Jam
es &
Lan
dau
“French” “German”
1. Discretion vs. RulesStraitjacket commitment Safety/escape valves
Active management ▪ Autonomous - no “ad hocery”
current crisis management ▪ future crisis prevention
Commit future to fix current crisis
• Commit not to default some debt restructuringin order to keep current (not official debt)interest rate low
• Commit to currency peg/ floating exchange ratenot to exit currency unionin order to discourage currency attacks
Manage capital flows! Free capital flow
Ghost of Maastricht “Rhine Divide”
24
“Black-white” Organizing Principlein
tern
atio
nal
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion & Commitment Rules
2. Solidarity Liability• Fiscal union No-bailout clause/rule
• Illusion of default free bonds SDRM/insolvency procedures
33
“Black-white” Organizing Principle
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion & Commitment Rules
2. Solidarity Liability• Fiscal union No-bailout clause/rule
• Illusion of default free bonds SDRM/insolvency procedures
34
“Black-white” Organizing Principle
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion & Commitment Rules
2. Solidarity Liability
3. Liquidity/contagion Solvency • multiple equilibria E[NPV]>0, at what discount rate?
“big bazooka”
37
p
“Black-white” Organizing Principle
S
D
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion Rules
2. Solidarity Liability
3. Liquidity/contagion Solvency • multiple equilibria E[NPV]>0, at what discount rate?
“big bazooka”
38
p
“Black-white” Organizing Principle
S
D
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion Rules
2. Solidarity Liability
3. Liquidity/contagion Solvency • multiple equilibria E[NPV]>0, at what discount rate?
“big bazooka”
• amplification/spirals E[NPV bailout]>0
E[PV bailout – PV no bailout]>0
contagion/systemicBail-out/LLR Bail-in
Countries ▪ Fire-walls
Financial Sector
40
p
p
“Black-white” Organizing Principle
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion Rules
2. Solidarity Liability
3. Liquidity/contagion Solvency • multiple equilibria E[NPV]>0, at what discount rate?
“big bazooka”
• amplification/spirals E[NPV bailout]>0
E[PV bailout – PV no bailout]>0
contagion/systemicBail-out/LLR Bail-in
Countries ▪ Fire-walls
Financial Sector
41
p
p
“Black-white” Organizing Principle
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Ghost of Maastricht “Rhine Divide”
“French” “German”
1. Discretion Rules
2. Solidarity Liability• fiscal union No-bailout clause/rule
3. Liquidity/contagion Solvency
4. Keynesian Stimulus Austerity/ReformDemand Supply • Output gap unsustainable credit boom• Reforms in boom Reforms in crisis (political economy)
42
“Black-white” Organizing Principle
Bru
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erm
eier
, Jam
es &
Lan
dau
“French” “German”
1. Straitjacket Safety valvesDiscretion Rules
2. Solidarity Liability• Fiscal union No-bailout clause/rule
3. Liquidity/contagion Solvency
4. Keynesian Stimulus Austerity/Reform
Ghost of Maastricht “Rhine Divide”
44
Ideal types (Max Weber) White-black comparison to sharpen contrast
Free capital flow
Fixed ex-change rate
AutonomousMonetary Policy
inte
rnat
ion
al
Bru
nn
erm
eier
, Jam
es &
Lan
dau
Maastricht’s stepchild: Financial Stability
Why was financial sector ignored?• Large growth EU banks became global banks• Whole-sale funding cross-border funding
Systemic Risk• Liquidity spiral on asset side of banks
Fire-sales, …
• Disinflationary spiral on liability side of banks
“Paradox of Prudence”• Micro-prudent behavior can be macro-imprudent• Like Keynes’ Paradox of Thrift but on risk dimension
Saving lowers other income, and lowers overall savings
46
Bru
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erm
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, Jam
es &
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Role of Government bond
Special MoPo Role as safe assetDefault-free long-term gov. bond
Interest rate policy leads to income/wealth effects(not only substitution effects)
Insurance role for extreme crisis statesDefaultable bond – contingent debt
“French view”• never default
(straitjacket commitment)
• Use diabolic loopbanks as hostageDefault in extreme situations
49
tension
“German view” • Default in tail events
• Limit banks’ sovereign risk taking
• Banks provide insurance
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, Jam
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The two “safe asset challenges”
Challenge 1: Safe asset + sovereign debt restructuring w/o diabolic loop
Challenge 2:No asymmetrically supplied safe asset• German Bund
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French IMF/Anglo-American/German
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Cross-border flight to safety
Today: asymmetric shifts across borders• Value of German debt increases
German CDS spread rises, but yield on bund drops (flight to quality) • Value of Italian/Spanish/Greek… sovereign debt declines
With ESBies: Negative co-movement • Value of ESBies expands – due to flight to quality• Value of Junior bond shrinks – due to increased risk• Asset side is more stable
56
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Solution: ESBies
Today: asymmetric shifts across borders• Value of German debt increases
German CDS spread rises, but yield on bund drops (flight to quality) • Value of Italian/Spanish/Greek… sovereign debt declines
With ESBies: Negative co-movement across tranches• Value of ESBies expands – due to flight to quality• Value of Junior bond shrinks – due to increased risk• Asset side is more stable
57
sovereign bonds ESBies
Junior Bond
A L
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, Jam
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Conclusion & Policy Implications
Towards a European “Ideas UNION”
“Insurance/transfers without Politics” automatic stabilizers
• Specify “tail events”
• Person to person instead of state to state insurance
• No transfer union that leads to rent seeking activities
“race away from the bottom” – firewall emphasis
ESBies as safe asset for Europe• No joint liability & safety valve
Wage bargaining: central bank communication
European Banking charter• Tax revenue for European budget• European bailout
60
