EMU Governance: Monetary Policy Francesco Saraceno MPA - 2012
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Where were we?…The Eurozone
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The Long Road to Maastricht and the Euro
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From Delors to Euro Notes June 1999 the European Monetary Institute is replaced by the European Central Bank (ECB)
June 1989 Establishment of the EMU timetable at the Madrid European Council 1990 1991
1992 1993
1994 1995
July 1990 1st stage of the EMU : free movement of capital January 1994 2nd stage of the EMU : entry into force of the European Monetary Institute
1996 1997
1998
1999 2000
May 1998 11 countries qualified to participate in the euro - fixing of parities
February 17, 2002 Final withdrawal of national currencies
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2002
January 2002 Release of euro banknotes and coins
January 1999 3rd stage of the EMU : entry into force of the euro in 11 countries (Greece 2002)
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The Maastricht Treaty 9 A firm commitment to launch the single currency by January 1999 at the latest. 9 A list of five criteria for admission to the monetary union. 9 A precise specification of central banking institutions. 9 Additional conditions added later on (e.g. the excessive deficit procedure).
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The Maastricht Convergence Criteria 9 Inflation:
not to exceed by more than 1.5 per cent the average of the three lowest inflation rates among EU countries.
9 Long-term interest rate:
not to exceed by more than 2 per cent the average interest rate in the three lowest inflation countries.
9 ERM membership:
at least two years in ERM without being forced to devalue.
9 Budget deficit:
deficit less than 3 per cent of GDP
9 Public debt:
debt less than 60 per cent of GDP 6
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Convergence Criteria: Inflation 10.00
5.00
0.00 1991 France Spain Belgium Greece
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1993
1994
1995
1996
1997
1998
Italy Germany Portugal average of three lowest + 1.5%
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Convergence Criteria: Interest rates and ERM
9 Long-Term Interest Rate Rationale: easy to bring inflation down in 1997 and then let go again. LTR are an indicator of markets’ long term expectations 9 Exchange Rate Mechanism Membership Rationale: sufficient period of stability of exchange rate, to make sure that the chosen parity is good
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A Tour of the Acronyms 9 N countries with N National Central Banks (NCBs) that continue operating but with no monetary policy function. 9 A new central bank at the centre: the European Central Bank (ECB). 9 The European System of Central Banks (ESCB): the ECB and all EU NCBs (N=27). 9 The Eurosystem: the ECB and the NCBs of euro area member countries (N=17).
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The System
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How Does the Eurosystem Operate? 9 Objectives: What is it trying to achieve? 9 Instruments: What are the means available? 9 Strategy: How is the system formulating its actions?
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Objectives 9 The Maastricht Treaty’s Art. 105.1: ‘The primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community […].’ 9 Article 2. The objectives of European Union are a high level of employment and sustainable and non-inflationary growth.
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Objectives - II
9 Does the Eurosystem have a target? “In the pursuit of price stability, the ECB aims at maintaining inflation rates below, but close to, 2% over the medium term.” 9 Chosen by the Eurosystem 9 Leaves room for interpretation: Where below 2 per cent? (Eurosystem says: between 1.5 and 2%) What is the medium term? (Eurosystem says: 2-3 years horizon)
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Instruments 9 What are the channels of monetary policy:
Long run interest rates Credit Asset prices Exchange rate.
9 These are all beyond central bank control. 9 Instead, it can control the very short-term interest rate: European Over Night Index Average (EONIA).
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Instruments - II
9 The Eurosystem controls EONIA by establishing a ceiling, a floor and steering the market in-between. 9 The floor: the rate at which the Eurosystem accepts deposits (the deposit facility). 9 The ceiling: the rate at which the Eurosystem stands ready to lend to banks (the marginal lending facility). 9 In-between: weekly auctions (main refinancing facility REPO).
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1/ 1/ 99 1/ 7/ 99 1/ 1/ 00 1/ 7/ 00 1/ 1/ 01 1/ 7/ 01 1/ 1/ 02 1/ 7/ 02 1/ 1/ 03 1/ 7/ 03 1/ 1/ 04 1/ 7/ 04 1/ 1/ 05 1/ 7/ 05 1/ 1/ 06 1/ 7/ 06 1/ 1/ 07 1/ 7/ 07 1/ 1/ 08 1/ 7/ 08 1/ 1/ 09 1/ 7/ 09 1/ 1/ 10 1/ 7/ 10 1/ 1/ 11 1/ 7/ 11 1/ 1/ 12 1/ 7/ 12 7
ECB Target Rates and Interbank Short Rate.
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Euro Marginal Lending Rate
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REPO
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Euro Deposit Rate Interbank 1 Week Rate
Source: Datastream
0
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The Two-Pillar Strategy 9 The Eurosystem’s interest rate decisions (every month) rest on two pillars. 9 Economic analysis: broad review of economic conditions: growth, employment, exchange rates.
9 Monetary analysis: evolution of monetary aggregates (M3, etc.).
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Comparison With Other Strategies 9 The US Fed: legally required to achieve both price stability and a high level of employment does not articulate an explicit strategy.
9 Inflation-targeting central banks (Czech Republic, Poland, Sweden, UK, Hungary): announces a target (e.g. 2% HICP in the UK), a margin (e.g. ±1%) and a horizon (2–3 years) compares inflation forecast and target, and acts accordingly.
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Independence and Accountability 9 Arguments for central bank independence: 9 governments tend not to resist to the ‘printing press’ temptation 9 Independence removes central banks from such pressure. 9 the Bundesbank has set an example. But… 9 Misbehaving governments are eventually punished by voters. What about technocratic institutions? 9 A democratic deficit? 19
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Redressing the Democratic Deficit 9 In return for their independence, central banks must be held accountable: to the public to elected representatives.
9 Example: the Bank of England is given an inflation target by the Chancellor. It is free to decide how to meet the target, but must explain its failures (the ‘letter’)
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The Eurosystem’s Weak Accountability 9 The Eurosystem must report to the EU Parliament. 9 The Eurosystem’s President must appear before the EU Parliament when requested, and does so every quarter. But… 9 The EU Parliament cannot change the Eurosystem’s independence and has limited public visibility.
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The Record So Far 9 A difficult period:
An oil shock in 2000 September 11 in 2001 Oil prices to record level Food prices fluctuations The crisis of 2007-20??
9 Result: Inflation almost always above 2% but close to target and lower than perceived
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Inflation record: eurozone 5
%
ECB Refinancing Rate
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CPI Inflation 3
2
CPI Core Inflation
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0
9 9 9 9 0 0 0 1 0 1 2 1 1 2 2 3 3 4 5 4 6 5 7 6 8 7 8 /9 7/9 1/0 7/0 1/0 7/0 1/0 7/0 1/0 7/0 1/0 7/0 1/0 7/0 1/0 7/0 1/0 7/0 1/0 7/0 1/0 7/0 1/1 7/1 1/1 7/1 1/1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 -1
Source: ECB
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Growth Record Before the Crisis
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Q
19 9 2 8 19 Q 99 4 19 Q 99 2 20 Q 00 4 20 Q 00 2 20 Q 01 4 20 Q 01 2 20 Q 02 4 20 Q 02 2 20 Q 03 4 20 Q 03 2 20 Q 04 4 20 Q 04 2 20 Q 05 4 20 Q 05 2 20 Q 06 4 20 Q 06 2 20 Q 07 4 20 Q 07 2 20 Q 08 4 20 Q 08 2 20 Q 09 4 20 Q 09 2 20 Q 10 4 20 Q 10 2 20 Q 11 4 20 11
Q 4
Exchange rate: from too weak to too strong?
1.6 155
1.5 145
1.4 135
125
1.3
$/€ 115
1.2 105
1.1
1
Effective (21 Currencies) 95
85
0.9 75
Source: ECB
0.8 65
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Asymmetries
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Lasting inflation differentials 9 Issue of lasting inflation differentials Lower than average in: Germany, France and Finland Higher than average: Ireland, Spain, Portugal, Netherlands, Greece and Italy
9 Possible causes:
Catching up in productivity levels Wrong starting conversion rates Autonomous wage and price setting Policy mistakes, such as fiscal expansion Asymmetric shocks, such as oil price effects 27
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New EU members and EMU 9 Obligation to meet the 5 convergence criteria 9 Yearly publication of ‘Convergence Reports’ to assess how they meet the convergence criteria 9 Whilst Estonia, Slovenia, Malta, Cyprus and Slovakia are members, Lithuania was rejected and the rest are still to meet criteria
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Not Everything is so Nice… 9 Fitoussi is rather critical 9 Three (or two?) periods 1999-2002 2002-2008 2008-2010
9 In the first period policies were even more appropriate than during the 1990s
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9 Since 2002: inertia 9 The US Fed was much more reactive to changing economic conditions 9 This is also true in the current crisis. Think of the difference between Draghi on September 6 and QE3 announcement
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Monetary Policy: Interest Rates 7 %
Fed Funds Euro Refinancing Rate
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1
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Y/Y variation. Source: OECD, Fed, ECB
09 08 10 04 11 09 08 07 03 02 01 07 05 10 04 03 02 01 06 06 05 00 00 11 99 99 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
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A Small Country Legacy? 9 The ECB did not seem able to meet the challenge posed by Its new capacity to influence global variables like the exchange rate The constraints on fiscal policy in the EMU that leave monetary policy as the only union- wide tool to sustain growth
9 The Fed Statute is not hazardous 9 The exclusive focus on inflation, may be seen as a “small country” legacy
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