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  1. Monitoring Global Financial Stability
  2. Monitoring Global Financial Stability – IMF Blog
  3. Working Papers & Publications
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The EU has been trying to address this problem in the context of the coordination of economic policies and repeated recommendations were made to countries with fiscal space to use it for boosting investments. The focus on investments was justified by its impact on growth on both the demand and the supply sides. Fiscal and financial fragilities still pose important challenges to the euro area. Large public debt ratios and non-performing loans NPL in the banking sector in several Member States signal large deleveraging needs in the public and the private sector.

Low interest rates, combined with large NPL stocks, negatively affect bank profitability. However, while the expected increase in interest rates may be welcomed from the point of view of banking profitability, it poses a challenge for countries with high public debt ratios. In those cases, the risk of a snowball effect for debt may return. Taking steps to complete the EMU by Despite a set of policy responses under the crisis, imbalances persist and the EMU is still not showing its full potential. Long term growth remains subdued and the lack of common stabilisation tools will hinder the ability to effectively tackle the next significant downturn.

In the short term, there is a need to avoid the situation where the remaining financial and fiscal fragilities jeopardize the budding recovery. A new synthesis is therefore needed that should rely on three main building blocks as presented in the Five Presidents Report: a Financial Union, a Fiscal Union and an Economic Union. The Financial Union has to be built on a balance between risk-sharing and risk reduction. The Fiscal Union needs to include a strong commitment to sound budgetary policy at the national level and a common stabilisation capacity at the euro area level.

Such stabilisation function would be used in justified cases to help achieving an appropriate fiscal stance for the euro area as a whole and support an orderly policy mix. The Economic Union has to incorporate effective incentives that lead to reform implementation that effectively correct the imbalances. In addition, the governance structures and their legitimacy in the eyes of national constituencies and the population at large will also determine the efficiency and acceptability of the EMU reforms going forward.

These different domains should not be seen in isolation but as complementary. Achieving the Financial Union is key for the good functioning of the EMU, due to the systemic importance of the financial sector. Also, as put forward by the Reflection Paper on EMU, better integration between Fiscal and Economic Unions would improve overall shock absorption capacity of the euro area due to a better combination of private, market-based tools and public mechanisms.

Risk reduction and financial markets in the euro area The European economy has traditionally relied predominantly on bank finance, with total banking sector assets far exceeding those in the US. Not surprisingly then, the banking sector was the main channel transmitting the cross-border shocks during the crisis. Two building blocks of the Banking Union have been already established and are up and running: the Single Supervisory Mechanisms and the Single Resolution Mechanisms, with the Single Resolution Fund being gradually filled in by banking sector contributions.

Nevertheless, there are still two important elements of the Banking Union, which are missing: a common deposit insurance mechanism European Deposit Insurance Scheme also known as EDIS and a common fiscal backstop to the Single Resolution Fund. As to the latter, there is an agreement among the euro area Member States to establish a common backstop, but the discussions have been underway — and are close to a successful conclusion — on the modalities of the backstop. The role of the banking sector in the crisis and its aftermath, when due to structural problems the sector was unable to efficiently provide financing to the economy, highlighted the risks related to excessive reliance on one source of financing.

This has given rise to the Capital Markets Union project, which aims to create a single market for capital in the EU. While being a project for the whole EU, it has particular importance for the euro area as it can provide significant adjustment mechanism. The US serves here as a useful example. Also, CMU would facilitate the recycling of the euro area internal imbalances via equity rather than debt, lifting the negative narrative attached to indebtedness, in particular in some parts of Europe.

Tackling further the sovereigns- banks feedback loop The main rationale behind the Banking Union was to sever the infamous "doom loop" or the "vicious cycle" between the euro area sovereigns and the banks. Indeed, the common banking supervision and the common resolution have already reduced the risks of spill-overs from the banking sector to the sovereigns, compelled to rescue the banks. But the risks stemming from the strong home bias in sovereign bonds holdings by the banks i. As suggested by Brunnermeier et al.

Monitoring Global Financial Stability

At the same time it is recognised that SBBSs will not reach a potential equivalent to US treasuries or Japan's government bonds, which for an area of comparable economic size, comes with opportunity costs. Individual euro area Member States issue bonds with heterogeneous risk characteristics, generating an asymmetric provision of safe assets.

Experience has shown that at times of stress, the current structure of the sovereign bond market has amplified market volatility, affecting the stability of the financial sector. That's why the Reflection Paper advances the idea of a genuine European Safe Asset that could be pursued to complete the financial market architecture and ultimately break the link between sovereigns and banks. A truly European safe asset should preserve the capacity of governments to finance themselves at reasonable costs and with continuous market access, but at the same time should improve the incentives for sound budgetary policies.

Several specific proposals exist of European safe assets with different characteristics. Some models reduce the degree of mutualisation while others are based on joint liabilities European Commission , Buti et al.

Monitoring Global Financial Stability – IMF Blog

First, the lack of a fiscal instrument at the centre, which could support stabilisation role of national fiscal policies and the monetary policy once it ran out of ammunition. Second, in the aftermath of the crisis the coordination of fiscal policies at the euro area level showed its limits in achieving a coherent overall fiscal stance - coherent in terms of its relation to the monetary policy stance and in terms of its breakdown across countries.

These findings have led to calls for a stabilisation capacity for the euro area, first in the Five Presidents Report and then in the Reflection Paper on EMU. The Five Presidents argued that the function should be conceived in such a way that it does not lead to permanent transfers and minimises moral hazard. It should not duplicate the role of the ESM in crisis management and it should fall under the EU framework. Access to the capacity should be strictly conditional on clear objective criteria and sound policies.

The Reflection Paper went one step further and put forward different options for a stabilisation capacity:. One additional benefit of a common stabilisation function is related to the EU fiscal rules, which have over the past grown in sophistication and complexity. One of the reasons for this development was the attempt to marry stabilisation and sustainability objectives of the rules, which initial design was strongly tilted towards sustainability. The establishment of the common stabilisation facility would take some of the stabilisation burden out of national budgets and would thus allow re-focusing EU fiscal rules on sustainability.

This could also lead to their simplification and what follows — transparency and effectiveness. This is why 66 national currencies are currently linked to the U. Were Greece or Portugal or Ireland to exit the euro they would still have to peg their currencies to the euro as many EU non-euro countries currently do, the UK being the only major exception with the result that they would lose the benefits of eurozone membership while not reaping any substantial policy autonomy gains. The only viable alternative open to the small economies of the eurozone is to continue to mount a concerted effort to change its rigid, neo-liberal rules and structures in favour of ones that are far more flexible and growth-oriented.

I oppose Grexit because I reject the three major claims made in support of it. The first is that a return to the drachma would be tantamount to a return to national economic sovereignty. As I have made clear in answer to the previous question, this is a myth. If Greece exits the euro, it would still have to tie its currency to it in order to avoid the potentially catastrophic effects of any exchange rate volatility.

In so doing, it would lose much of its room for policy manoeuvre in any case. The second claim in favour of Grexit is that it would enable Greece to increase its international competiveness thus enabling it to restore domestic economic growth. This claim ignores the fact that there are two dimensions to competiveness: a quantity or physical dimension as well as a price dimension.

For Greece to be internationally competitive to the point where it can actually generate stable, self-reinforcing growth it has to have a material output base that can support such a strategy. The fact of the matter is that this base does not exist. In no industrial or other manufacturing category does Greek domestic production exceed domestic absorption, thus making it generally import dependent.

Indeed, in some manufacturing categories, such as medicines, electronic equipment, motor vehicles and office machinery Greece's import dependence is near total. Now for Greece to turn this situation around, it would need years of investment in education and training and in all of the other business-related areas required for promoting Greece's production and technological base. In the meantime, it would remain heavily import-dependent thus exposing it to serious problems were the drachma to continually depreciate in value against other major currencies including the euro.

The third major claim made in favour of Grexit is that this strategy would help to promote international solidarity. Given that Greece's far right Golden Dawn party are also in favour of Grexit and invoke essentially the same two claims regarding national sovereignty and a restoration of Greece's economic competiveness in support of their policy, the far left in Greece needs to add a third component to their eurosceptic position that distinguishes it from that of the far right.

As the latter never talk of international solidarity but only emphasise national self-interest, this is the obvious distinguishing component. The truth of the matter, however, is that exiting the euro and returning to the drachma would undermine rather than strengthen international solidarity in the area of economic and financial policy. A case in point is the policy for taxing the European financial sector. At the present time, it is eurozone member countries that are leading the fight to impose a uniform tax on this sector.

This task is proving to be difficult even with presence of the euro as a sheltering hub against the storms and pressures of the global currency markets. Take away the euro and return to small national currencies, and the task of implementing a uniform European wide tax on the financial sectors would be near impossible as the countries concerned, struggling to maintain their currencies' exchange rates, would be unlikely to make such a coordinated tax policy their national priority.

What needs to be changed in the euro area to allow economic growth in small countries like Greece? I have already indicated above that for economic growth to take place across the whole eurozone, and not just in the smaller member states, the economic policy direction has to radically change. In particular, the austerity drive led by Germany and as enshrined in the 'debt brake' policies that it has championed has to be challenged far more forcefully than is currently the case.

Central to any growth and job creating strategy must be an increase in public expenditures that can be financed by a number of measures including a coordinated increase in taxes on banks and multinational corporations operating in the eurozone and the issuance of euro government bonds to help finance public investments in infrastructure and other growth generating projects.

Would you recommend that countries such as Turkey or the Czech Republic should join the euro? There is no uniform answer to this question. Whether countries are encouraged to join the euro or not should depend on a case by case basis. I do not think that Turkey is ready for euro membership because its economic structures and institutions are still not robust enough to cope with the constraints of a single currency.

If Greece has found it difficult to survive in the euro, I believe that Turkey will find it even more so. The Czech Republic is another matter. Its currency is already closely tied to the euro, as are several other currencies, and I expect it to eventually become part of the euro. What are the alternatives open to medium sized economies under the current institutional arrangements? Would you recommend a monetary union for these types of economies in Latin America? On the contrary, they need to tie their currencies' exchange rates to a major currency such as the U.

Ideally, small to medium sized economies that co-exist within a given geographical area can collectively increase their policy autonomy by forming a currency union that on account of its size and depth can withstand the stresses of the global forex markets. The problem is that in practice it is extremely difficult to form a currency union because such a strategy requires three sets of criteria to be met: i the economies of the common currency area should be highly integrated in production and trade terms: ii the structures and institutions of the currency area countries should be broadly similar; iii the political and economic priorities of the common currency countries should be broadly aligned.

It just as certainly does not meet the second set of criteria as has always been clear and as has become even more painfully clear when the financial crisis ruthlessly exposed the deep-seated structural differences between countries like Germany on the one hand and countries like Greece on the other.

As concerns the third set of criteria, if the eurozone currently meets these it is only in the highly problematic sense that Germany insists on using its economic weight to impose a dogmatic neo-liberal agenda on just about every other eurozone member country. One might be tempted to say that the current problems of the eurozone should serve as a warning to any other regional group of countries intending to form a currency union.

However, one should not overemphasise this observation as the obstacles standing in the way of other prospective currency unions appear to differ from region to region. The obstacles facing the Southern Cone countries of Latin America illustrate the point. This group may to a certain extent meet the second set of criteria regarding broad equivalence between country structures and institutions. Indeed, the fact that all of the countries in this group share the same language is even more of a bonus in this regard.

However, the external trade relations of countries in this region appear to be heavily towards other geographical regions rather than towards each other, a fact that would then complicate attempts to reach agreement on the type of exchange rate and other macroeconomic policy measures that ought to be prioritised for the whole currency area. The paper shows that the desirability of participating in a monetary union is contingent on the inclusion of fiscal policy considerations. The study, in the spirit of Mundell optimum currency areas, is an important contribution given that it calls attention to the prominent role that fiscal policy considerations have in the cost-benefit analysis of monetary unification.

The structure of the analysis, where the authors show gradually how modifying elements of the model -varying country-size, comparing a flexible exchange rate regime versus a monetary union, adding fiscal policy, and considering different interactions of fiscal and monetary policy- turns out useful to gain insights on the role that each modification has.

Also, the paper derives analytical solutions for employment and inflation in the non-cooperative flexible exchange rate regime and the monetary union, which allows it to present a transparent discussion of the inflation-employment trade-offs to show that a smaller economy's monetary authority faces a steeper trade-off can achieve a larger inflation reduction for a smaller employment loss that is favorable if the monetary authority cares relatively more about inflation than employment , while the fiscal authority faces a flatter trade-off can achieve a higher employment gain for a small price stability loss that is advantageous if the fiscal authority cares more about employment than inflation.

The paper has interesting results, but along the way the authors make several decisions that compromise the generality of the results. The most important decision is the welfare criteria to rank regimes as the model lacks of a well-defined welfare metric in terms of individuals' utility. The results are based on the comparison of the fiscal authority's loss function which is considered to be a function of the volatility of employment, inflation, taxation and nominal exchange rate, however there is no clear reason of why these are the variables the society cares about, neither the relative weights that these variables should have in the loss function.

Even conceding that this welfare criterion was valid, the document does not have analytical solutions to make the regimes comparison transparent and no sensitivity analysis is presented to show that the obtained rankings are not conditioned by the chosen parameters. There are relevant aspects of the strategic interaction of fiscal policies within a monetary union absent from the analysis. Other relevant aspect is related to the usual rules versus discretion debate over policies. For example, Dixit and Lambertini show that allocations are contingent on how both policies are conducted.

Also important are the dynamic interactions among countries and policy institutions as the repeated nature of the decision-making process could affect the optimality of the policy choices. It calls the attention that the fiscal authorities' losses are independent of the country size under the alternative forms of coordination see Table 5.

As explained in the paper, this is consequence of the assumption that the fiscal authority equalizes the tax rate in both economies. This is a useful benchmark to analyze coordination, but it would be interesting to understand what happens under coordination but tax asymmetries. Overall, the paper sets the ground for an important debate on the desirability of fiscal policy coordination for a monetary union. It provides a guideline of some relevant elements to be analyzed in this interaction and when possible derives analytical solutions that eases understanding the ranking of the regimes.

There are several directions to extend the analysis and verify the robustness of the results, but the paper contributes by serving as a catalyzer of this thinking. Is fiscal policy coordination desirable for a Monetary Union? Interactions of commitment and discretion in monetary and fiscal policies.

American Economic Review. Mundell, R. A theory of optimum currency areas. Their analysis makes use of models mainly developed before the recent financial crisis by a literature that focuses on the evaluation of the benefits of alternative exchange rate regimes. The analysis also overlooks the content of two debates. The first deals with the asymmetric working of the international monetary system. This comment discusses the consequence of disregarding these debates. It argues that "the appeal of taking part in a large monetary union from the perspective of small open economies" cannot be evaluated without taking into account their results.

This conclusion makes it difficult to understand why:. A different conclusion is instead achieved if, by taking into account the changes occurred in the financial system since the s, one considers the existence of a liberalised and highly unstable international monetary system, which favours the rich economies at the expenses of the others, and of the different implications for growth and stability of the alternative approaches to the institutional organization of policy coordination.

The comment develops as follows. Section 2 considers how the debate on the asymmetric working of the international monetary system enters in the choices of the euro countries. Section 3 examines the debate on the institutional organization of policy coordination in EMU and the implications for growth and stability of the alternative approaches to this problem. Section 4 concludes. The economies using the euro enjoy a privileged position in an international monetary system.

They can count on a currency allowing them to avoid increasing the ratio official reserve-Gross Domestic Product GDP and other problems that are due to the asymmetric working of the international monetary system. The integration and the size of the international financial markets strengthen the role of the hierarchy existing among the currencies see Patnaik, ; MacKinnon, ; Aguiar de Medeiros, ; Prasad, ; Chapoy Bonifaz, Some of them, considered by the operators of better quality or of class-A , are preferred to others, considered of class-B, whenever uncertainty increases.

According to MacKinnon , "peripheral monies" are held only provisionally because the preference for the "definitive monies" of the richest countries is powerful. As a consequence, large flows of capital move towards the latter countries as soon as uncertainty rises. The asymmetric working of the international monetary system can clarify why the dollar revaluated in while Lehman Brothers was breaking down and the U. This tendency, instead of generating net flows of capital moving from more to less rich countries, as promised before the liberalisations began, has forced the latter to finance the former through the investment of official reserves in high quality assets see Reinhart and Rogoff, Figure 1 shows the data regarding the ratio official reserves-GDP of Central and Latin America countries, confirming that in these countries the ratio has been progressively increasing.

Figure 2 further corroborates the existence of an asymmetric working of the international monetary system by showing that some rich countries [United States of America USA , United Kingdom UK and Canada] have reduced the ratio official reserves-GDP before the crisis.

The accumulation of official reserves for emerging and developing countries raises several problems. It affects the issue of monetary base and makes sterilising interventions by the central banks necessary. Without these interventions, the banking systems would own such a large amount of monetary base as to make the operation of monetary policy impossible. Yet, sterilising interventions can affect the efficient operation of financial institutions see Mohanty and Turner, ; , of the financial system and of the management of the public debt.

The asymmetric working of the international monetary system generates other differences in the behaviour of the economies. Emerging and developing countries do not implement the standard scheme of the Inflation Targeting policy. They fear that sudden speculative attacks can transform small movements in the nominal exchange rate into dangerous devaluations.

For these authors, the interest rate that the central banks set in their policy, not only reacts in different degrees to the inflation and the output gaps, as foreseen by the standard model of Inflation Targeting see Svensson, and ; Svensson et al. The stability of the nominal exchange rate contributes to the control of inflation. Yet, if the inflation rate in the less rich countries is higher than that of the richest ones, a stable nominal exchange rate generates a revaluation of the real exchange rate, which in turn affects the international competitiveness of the economy. What's more, the structure of the interest rates of the emerging and developing countries tends to show a positive difference with that of the richest countries because the central banks of the former tend to choose higher policy rates than those prevailing in the latter in order to avoid the occurrence of net outflows of capital and related devaluations.

Both conditions, which have been prevailing in recent decades, affect the growth of GDP and prevent the economy from fully exploiting its growth potentials. The adoption of the euro has allowed the EMU member States to avoid these problems. Figure 3 presents the data regarding the ratio official reserves-GDP of the twelve countries 26 participating in the monetary union in , of the nineteen countries that are now participating in it 27 and of the Eastern European countries waiting to be admitted.

The data presented in Figure 3 suggest a reason for desiring to be part of the monetary union even in the presence of a policy coordination process in which the monetary authorities act as a Stackelberg leader.

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By entering the euro area, the Eastern European countries can benefit from the opportunity to invest in domestic activities, rather than in other countries' financial assets, the large amount of official reserves that now they have to accumulate. As to Greece's acceptance of the conditions imposed by the European authorities after the striking result of the referendum of the 5 th of July, the previous data suggest that leaving the monetary union would have imposed on this country a heavy toll in terms of official reserves to be accumulated.

This toll would have required a further squeeze on the income distributed to the citizens, unless the country could receive a large foreign loan for the accumulation of official reserves. The absence of this second solution must have influenced the choices of the Greek national authorities.

Some data regarding the interest rates show that, before the debt crisis of , the participation in EMU brought about other benefits to the member countries. Figure 4 compares the interest rates on year government bonds of Germany and other euro countries. It shows that the difference between these rates was large before the introduction of the euro, almost disappeared until the start of the debt crisis in , "burst" with the debt crisis from Spring to Summer , and returned to more tolerable values when some mechanisms of the coordination process were changed by the ECB's decision to introduce the Outright Monetary Transactions OMTs , a programme allowing the Eurosystem to discretionarily purchase sovereign bonds in the secondary markets.

The analysis of the causes of the debt crisis has underlined the role of the faults in the institutional organization of the coordination process between monetary and fiscal policies. The international financial crisis turned the attention of the authorities away from these proposals. They were however necessary and the incapacity of the European authorities to introduce them, together with the changes in the relations among the different participants in the Union that the international financial crisis brought about, can be seen as a major cause of the disruption of the sovereign debt markets see Panico and Purificato, ; Capraro et al.

The debate on the EMU institutional organization developed before the international financial crisis and reached a wide consensus on the inefficient policy outcomes of the existing organization and on need to change it. There was agreement on the fact that it generated policies that are pro-cyclical and unable to take into account the specific needs of the different economies.

There was, on the other side, disagreement on how to reform the coordination process. According to some authors see Canzoneri and Diba, ; Alesina et al. According to the former authors, the main problem of the coordination process is to achieve effectiveness in imposing discipline on the national fiscal authorities in order to minimise their free riding behaviour.

Rather than changing the institutional organization of the coordination process, the reforms they proposed before the international financial crisis regarded the rules of the Stability and Growth Pact and of the Excessive Deficit Procedures. These rules had to adequately punish misaligned behaviours in order to achieve effectiveness in minimising free riding. According to the latter authors, to improve the policy outcomes of the coordination process it was necessary to reform both the institutional organization of EMU and the rules of the Stability and Growth Pact and of the Excessive Deficit Procedures.

Von Hagen and Mundschenk present an analysis of the strategic interaction among the actors of the coordination process to show that the institutional organization set up at the start of the monetary union favours the development of non-cooperative attitudes among the monetary and fiscal authorities and consequently leads to inefficient policy outcomes. Under these conditions, monetary and fiscal policies end up by working as strategic substitutes, rather than as complements: 'If the governments pursue output targets exceeding the level of aggregate demand the central bank wishes to achieve, they will boost public deficits.

Anticipating this, the central bank will tighten monetary policy more than it would otherwise. The result is an inefficient combination of tight monetary and loose fiscal conditions. Cooperative policies could achieve a better policy mix with lower interest rates and smaller deficits' Von Hagen and Mundschenk , p. Von Hagen and Mundschenk recall that the coordination process existing in EMU adopts a "narrow approach", which focuses on monitoring the national fiscal policies in order to penalise those who take decisions that, according to the coordinating authorities, negatively affect the euro area.

Within this approach, "punishment", i. According to von Hagen and Mundschenk, the "narrow approach" generates non-cooperative attitudes among the authorities and must be replaced by a "broad approach", which is based on the use of methods, instruments and incentives favouring the participation of all authorities in the identification and the implementation of common policy objectives.

This proposal underlines the need to create a positive environment through the active participation of all actors in the decision process and the need to introduce a system of incentives based on both penalties and prizes. As in any aspect of human life, a system of incentives only based on "punishment", instead of generating responsible and law-abiding participation, stimulates dishonest and deceiving attitudes. Some outstanding economists of the past underlined the relevance of cooperative attitudes in the management of economic policy.

Entering into a debate between the U. I do not wish to go into the merits of the struggle between the Treasury and Federal Reserve. Let me simply state dogmatically that the Secretary of the Treasury should be just as concerned for the nation's stability as the Central Banker. In particular it is nonsense to believe, as many proponents of monetary policy used to argue, that fiscal policy has for its goal the stabilisation of employment and reduction of unemployment, while monetary policy has for its goal the stabilisation of prices.

In comparison with fiscal policy, monetary policy has no differential effectiveness on prices rather than on output I have already asserted that the Treasury and Central Bank have to be co-ordinated in the interests of national stability, so I am little interested in the division of labour between them' Samuelson, , pp. An example of efficient coordination within EMU can be found in the organization of monetary policy. The Eurosystem too requires a coordination process that guarantees that the super-national decisions, taken in Frankfurt, are correctly executed at the national level.

In this case, the coordination process follows a "broad approach". The National Central Banks NCBs directly participate in the decision process by discretionarily making technical evaluations in order to identify common interests, objectives and actions. Unlike what happens in fiscal policy, monetary policy decisions are not based on rigid rules. Moreover, the system of incentives introduced to coordinate the implementation of monetary policy at the national level is mainly based on prizing the institutional loyalty and the professional merit.

To guarantee the correct implementation of the super-national decisions, the European Treaties and the Statute of the European System of Central Banks and of the European Central Bank also foresee penalties for incorrect behaviours. It is worth noticing that, owing to the efficient working of the system of incentives based on prizes, these penalties have never been used. The analysis of von Hagen and Mundschenk supports the standpoint held by the authors who proposed a reform both of the institutional organization of the EMU coordination process and of the rules of the Stability and Growth Pact and of the Excessive Deficit Procedures.

As to the institutional organization, they recommend the introduction of independent fiscal agencies. According to Wyplosz , the institutional organization of fiscal policy has to follow the positive experience of monetary policy, which achieved satisfactory results when, after acknowledging the failure of rigid rules, such as Friedman's for the growth of monetary aggregates, it moved to institutional reforms and central bank independence. Wyplosz proposed to set up independent 'fiscal policy committees' similar to 'monetary policy committees', arguing that they can generate better results than rigid numerical rules.

A similar proposal can be made for the application of other related policies, concerned with infrastructures, energy, environment, industrial development, etc. As to the rules regarding the incentives for the monetary and fiscal authorities, they should be based on both prizes and penalties and should be directed to create a cooperative environment among the authorities.

These conditions should lead to the restoration of the efficient use of fiscal, industrial and other policies and to the identification of an appropriate policy mix for the euro area. Without pretending to enter into the details of these complex problems, let's suggest here that a European policy focusing on infrastructures or industrial development can provide some prizes for the system of incentives. The policy should be operated by lending the resources collected through euro-bonds issued by the European Commission to an independent Agency and should be designed at the super-national level with the direct participation of all the authorities.

The design of the policy should take into account the loyalty of the national authorities to the European values and decisions. It can prize the loyal authorities and be used to penalise those who do not respect the supernational decisions, having care to avoid damaging the citizens of that country. In the case of violation of the European agreements, for instance, the Agency should have the power to transfer the execution of the projects from the national to a super-national authority, thus hitting the interests of the national politicians involved without affecting those of the citizens.

Indeed, their problem is to identify through maximising procedures which authority should lead the process and which should be obliged to follow. Unlike what happened in the past as the previous reference to Samuelson's position points out , this way of designing the relations among State institutions or among the institutions participating in the governance of an economy, as in the case of EMU is widespread in recent economy literature, particularly after the seminal contribution of Rogoff , which originated the so-called "institutional design literature".

Several outstanding criticisms have been raised against this literature for a review of the criticisms to its application to monetary policy, see Panico and Rizza, Yet, it has to recognise the limitations that it faces in the study of the relations among institutions. As Tobin pointed out, its overlooking of the complex working of governance can generate some serious problems when it is concretely applied to the institutional organization of an economy. Tobin, in particular, expressed some preoccupations for the safeguarding of democracy, which is founded on the respect of procedures and not on the mere achievement of results defined by economic theory as socially optimal.

His preoccupations remind us that the use of the notion of economic rationality in the analysis of individual choices brings about both accomplishments and disappointments. Attention to the notion of "bounded rationality" makes us discover that other elements, such as fears, habits, conventions, etc. The same applies to the study of institutions, in which elements like confidence, cooperation, democratic legitimation and participation, can hardly be disregarded.

Its complex analysis provides interesting insights into this issue. Yet, it disregards elements that are crucial for interpreting the working of a process of regional integration and monetary unification, like EMU. These elements are related to the need to defend the economies and the citizens from the growing instability generated by the working of a large, powerful and internationally integrated financial system and to create a coordination process in which cooperation among the actors and loyalty to shared values play a central role.

Aguiar de Medeiros, C. Aguiar de Medeiros. Financial dependency and growth cycles in Latin American countries. Journal of Post Keynesian Economics. Alesina et al. Alesina, O. Blanchard, J. Gali, F. Giavazzi, H.

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Defining a macroeconomic framework for the Euro Area. Monitoring the European Central Bank Beestma and Debrun, R. Beestma, X. Blanchard and Giavazzi, O. Blanchard, F. London: Centre for Economic Policy Research; Buti et al. Buti, S. Eijffinger, D. Revisiting the Stability and Growth Pact: grand design or internal adjustment?.

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Capraro et al. Capraro, C. Panico, I. Perrotini, F. Chang, A. Is Inflation targeting still on target?. Chapoy Bonifaz, A. Chapoy Bonifaz. On constraining fiscal policy discretion in EMU. Oxford Review of Economic Policy. The Euro and the fiscal policy. Europe and the Euro. Hughes Hallett, R. Frenkel, R. Comparative Economic System. Griffith-Jones et al. Griffith-Jones, M.

Montes, A. Managing capital surges in emerging economies. Short-term capital flows and economic crises. Heidelberg: Physica- Verlag; MacKinnon, MacKinnon, R. The dollar standard and its crisis-prone periphery: New rule for the game. Mohanty and Turner, M. Mohanty, P. Intervention: What are the domestic consequences?. BIS Research Papers. Foreign exchange reserve accumulation in emerging markets: what are the domestic implications?. BIS Quarterly Review. Panico, C. Panico and Rizza, C. Panico, M. Central bank independence and democracy: A historical perspective.

London: Ashegate; Policy coordination in the euro area. Studi Economici. Panico and Purificato, C. Panico, F. Policy coordination, conflicting national interests and the European debt crisis. Cambridge Journal of Economics. Patnaik, P. Globalisation of capital and terms of trade movements. Pisani-Ferry, Pisani-Ferry, J.

Fiscal discipline and policy coordination in the Eurozone: Assessment and proposals. Prasad, E. Reinhart and Reinhart, C. Reinhart, V. Some lessons for policy makers who deal with the mixed blessing of capital inflows. Capital flows and financial crises. Reinhart and Rogoff, C. Reinhart, K. Serial default and the paradox of rich- to-poor capital flows. Rogoff, K. The optimal degree of commitment to an intermediate monetary target. Ros, J. Samuelson, P.

Recent American monetary controversy. Three Banks Review. Svensson, L. Inflation targeting as a monetary policy rule. In March , Germany presented a series of proposals to address the ongoing European sovereign debt crisis. They emphasised that the intention was not to establish a fiscal union in the short term, but to make the monetary union more resilient to crisis.

They argued that the previous Stability and Growth Pact needed to be reformed to become more strict and efficient, and in return a European emergency bailout fund should be founded to assist states in financial difficulties, with bailout payments available under strict corrective fiscal action agreements — subject to approval by the ECB and Eurogroup. A call was also made to enforce the Coordination of economic policies between eurozone members, so that all states take an active part in each other's policymaking.

The envisaged emergency bailout fund European Financial Stability Facility EFSF was the first proposal to become agreed to by the EU member states on 9 May , [20] with the facility being fully operational on 4 August As a part of the proposed reform of the Stability and Growth Pact, Germany also presented a proposal in May that all Eurozone states should be obliged to adopt a balanced budget framework law into its national legislation, preferably at the constitutional level, with the purpose of guaranteeing future compliance with the pacts promise of having a clear cap on new debt, strict budgetary discipline and balanced budgets.

In late , proposals were made to reform some rules of the Stability and Growth Pact to strengthen fiscal policy co-ordination. In March , a new reform of the Stability and Growth Pact was initiated, aiming at strengthening the rules by adopting an automatic procedure for imposing penalties in case of breaches of either the deficit or the debt rules. By the end of , Germany, France and some other smaller EU countries went a step further and vowed to create a fiscal union across the eurozone with strict and enforceable fiscal rules and automatic penalties embedded in the EU treaties.

In that perspective, strong European Commission " oversight in the fields of taxation and budgetary policy and the enforcement mechanisms that go with it could further infringe upon the sovereignty of eurozone member states ". Think-tanks such as the World Pensions Council WPC have argued that a profound revision of the Lisbon Treaty would be unavoidable if Germany were to succeed in imposing its economic views, as stringent orthodoxy across the budgetary, fiscal and regulatory fronts would necessarily go beyond the treaty in its current form, thus further reducing the individual prerogatives of national governments.

On 9 December at the European Council meeting, all 17 members of the eurozone agreed on the basic outlines of a new intergovernmental treaty to put strict caps on government spending and borrowing, with penalties for those countries who violate the limits. Ireland held a referendum on the treaty on 31 May , which was approved by EU countries that signed the agreement will have to ratify it by 1 January Once a country has ratified the Treaty it has another year, until 1 January , to implement a balanced budget rule in their binding legislation.

Although the European Fiscal Compact was negotiated between 25 of the then 27 member states of the EU, it is not formally part of European Union law. It does, however, contain a provision to attempt to incorporate the pact into EU law within five years of its entering into force, i. January The treaty is divided into 6 titles. The first explains that the aim of the treaty is to "strengthen the economic pillar of the economic and monetary union " and that the treaty should be fully binding on Eurozone countries.

Title VI contains the final clauses regarding ratification and entry into force. Finally a tie exists to the European Stability Mechanism , which requires its Member States to have ratified and implemented the Fiscal Compact into national law as a pre-condition for receiving financial support. The fiscal provisions introduced by the Fiscal Compact treaty for those states legally bound by these measures function as an extension to the Stability and Growth Pact SGP regulation. The SGP regulation applies to all EU member states, and has been designed to ensure that each state's annual budgetary plans are compliant with the SGP's limits for deficit and debt or debt reduction.

Compliance is monitored by the European Commission and by the Council. The counter measures will only be outlined in general, identifying the size and the time-frame of the needed corrective action to be undertaken, while taking into consideration country-specific risks for fiscal sustainability. Progress towards and respect of each specific state's Medium-Term budgetary Objective MTO shall be evaluated on the basis of an overall assessment with the structural balance as a reference, including an analysis of expenditure net of discretionary revenue measures.

If a eurozone member state repeatedly breaches its "adjustment path" towards respecting the state's MTO and the fiscal limits outlined by the SGP, then the Commission may fine the state a percentage of its GDP. EU member states outside the eurozone cannot be fined for breaches of the fiscal rules. In December , Finland became the twelfth eurozone state to ratify the treaty, thus triggering its entry into force on 1 January For subsequent ratifiers, entry into force is on the first day of the month following their deposit of the instrument of ratification.

Slovakia became a party to the treaty on 1 February , as did Hungary, Luxembourg and Sweden on 1 June , Malta on 1 July , Poland on 1 September , the Netherlands on 1 November , Bulgaria on 1 February and the last signatory Belgium on 1 April The ratification processes is summarised in the table below. In Cyprus, ratification was performed by a governmental decree without involving the parliament.

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In Ireland, a referendum was held to approve a constitutional amendment that empowered the government to ratify the treaty. After a country has completed its domestic ratification, it must deposit an instrument of ratification with the depositary the General Secretariat of the Council of the European Union to complete the process. If a legal complaint is filed with a constitutional court, this can delay the deposit and ratification, or even stop it if the court upholds the complaint. The list below summarises the progress of the ratification process.

Any non-signatory EU member state may accede to the Fiscal Compact without prior negotiations. The provisions regarding governance Title V are applicable to all signatories since the treaty's entry into force on 1 January For eurozone members that ratify, the treaty applies in full, pursuant to article Non-eurozone countries will automatically become bound by all treaty provisions the moment they adopt the euro.

Prior to that, only Title V applies to them, unless they by their own initiative make a declaration to the depositary "to be bound at an earlier date by all or part of the provisions in Titles III and IV". The applicability of the treaty's provisions to each country is summarized in the table below. The last column of the table reflects the status of compliant implementation laws, and denotes whether the Title III provisions the "balanced budget rule" and "automatic correction mechanism" have been embedded into national legislation through an ordinary law subject to later revisions by simple majority, or also by a constitutional amendment of which later revisions will require a higher constitutional majority.

The first official independent assessment of the treaty compliance of the listed national implementation laws has been scheduled to be conducted by the European Commission in September , for each of the states bound by the fiscal provisions Title III. The European Commission adopted in February a report on the transposition across the 22 Member States concerned [].

The figures stem from the economic forecast published by the European Commission in November , basing its forecast figures on the government's already implemented fiscal budget law and its recently proposed fiscal budget law for Until the MTO has been achieved, all states are obliged to adhere to an adjustment path towards this country-specific target, where the structural balance must improve at least 0. The final country-specific MTO minimum limit will be determined as the one respecting all of the three determined minimum limits note: those non-eurozone states neither having entered ERM-II nor ratified a submission to Title III of the Fiscal Compact, are only required to respect the first two calculated minimum limits , and this final limit will be recalculated by the European Commission once every third year most recently in October [].

Subsequently, and as a final step, each state have the prerogative still to set its MTO at a level being stricter than the one calculated by the European Commission, but can not set it at a limit being worse. Green rows in the table reflect full compliance with the Fiscal Compact criteria, requiring the state to have achieved its MTO for the entire —17 period. The noted ongoing EDPs will be abrogated, as soon as the concerned state for the period encompassing the last completed fiscal year based on final notified data and for the current and next year based on forecast data , succeeds in delivering a general government account in full compliance with the SGP's deficit criteria budget deficit no more than 3.

The deadlines for EDP abrogations will only be extended if extraordinary circumstances occur — like a recession or severe economic downturn. As part of the increased surveillance efforts introduced by the Sixpack , all EDP's are now evaluated three times per year, based upon data from the Commission's economic outlook reports published in February, May and November. The SGP and Fiscal Compact feature identical debt criteria, so they only differ compliance wise for the deficit criteria, where the Fiscal Compact sets the additional structural deficit criteria to be met as a main criteria elevating its importance from the additional but less binding MTO adjustment path criteria.

The debt-criterion has due to transitional reasons been split into three different requirements, being in place since the sixpack reform was implemented in November From Wikipedia, the free encyclopedia. EU members which may accede to the treaty. Further information: European sovereign-debt crisis.

Main article: Stability and Growth Pact. Failing that, a second vote can be held where only one third of each language group, and a majority of the full house, is required for adoption. As the Fiscal Compact was an intergovernmental treaty without provisions requirering a change of the constitution, it was however sufficient to ratify the treaty by votes with simple majority, in both chambers.

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