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We study consumption-portfolio and asset pricing frameworks with recursive preferences and unspanned risk. We show that in both cases, portfolio choice and asset pricing, the value function of the investor/ representative agent can be characterized by a specific semilinear partial differential equation. To date, the solution to this equation has mostly been approximated by Campbell-Shiller techniques, without addressing general issues of existence and uniqueness. We develop a novel approach that rigorously constructs the solution by a fixed point argument. We prove that under regularity conditions a solution exists and establish a fast and accurate numerical method to solve consumption-portfolio and asset pricing problems with recursive preferences and unspanned risk. Our setting is not restricted to affine asset price dynamics. Numerical examples illustrate our approach.
We build on previous work on operational performance evaluation of private equity portfolio companies as we are able to at least partially decrypt the black box consisting of restructuring tools these investors use and the corresponding impact on their portfolio companies. Beyond answering whether private equity improves operating efficiency we figure out which of the typical restructuring tools drive operating efficiency. Using a set of over 300 international leveraged buyout transactions in the last thirty years we find that while there is vast improvement in operational efficiency these gains vary considerably. Our top performing transactions are subject to strong equity incentives, frequent asset restructuring and tight control by the investor. Furthermore, investors experience has a positive and financial leverage a negative influence on operational performance.
Homestead exemptions to personal bankruptcy allow households to retain their home equity up to a limit determined at the state level. Households that may experience bankruptcy thus have an incentive to bias their portfolios towards home equity. Using US household data from the Survey of Income and Program Participation for the period 1996-2006, we find that especially households with low net worth maintain a larger share of their wealth as home equity if a larger homestead exemption applies. This home equity bias is also more pronounced if the household head is in poor health, increasing the chance of bankruptcy on account of unpaid medical bills. The bias is further stronger for households with mortgage finance, shorter house tenures, and younger household heads, which taken together reflect households that face more financial uncertainty.
Using fiscal reaction functions for 3a panel of actual euro-area countries the paper investigates whether euro membership has reduced the responsiveness of countries to increases in the level of inherited debt compared to the period prior to succession to the euro. While we find some evidence for such a loss in prudence, the results are not robust to changes in the specification, as for example an exclusion of Greece from the panel. This suggests that the current debt problems may result to a large extent from pre-existing debt levels prior to entry or from a larger need for fiscal prudence in a common currency, while an adverse change in the fiscal reaction functions for most countries does not apply.
Trust in policy makers fluctuates signi
cantly over the cycle and affects the transmission mechanism. Despite this it is absent from the literature. We build a monetary model embedding trust cycles; the latter emerge as an equilibrium phenomenon of a game-theoretic interaction between atomistic agents and the monetary authority. Trust affects agents' stochastic discount factors, namely the price of future risk, and through this it interacts with the monetary transmission mechanism. Using data from the Eurobarometer surveys, we analyze the link between trust and the transmission mechanism of macro and monetary shocks: Empirical results are in line with theoretical ones.
This paper presents a theory that explains why it is beneficial for banks to engage in circular lending activities on the interbank market. Using a simple network structure, it shows that if there is a non-zero bailout probability, banks can significantly increase the expected repayment of uninsured creditors by entering into cyclical liabilities on the interbank market before investing in loan portfolios. Therefore, banks are better able to attract funds from uninsured creditors. Our results show that implicit government guarantees incentivize banks to have large interbank exposures, to be highly interconnected, and to invest in highly correlated, risky portfolios. This can serve as an explanation for the observed high interconnectedness between banks and their investment behavior in the run-up to the subprime mortgage crisis.
We document and study international differences in both ownership and holdings of stocks, private businesses, homes, and mortgages among households aged fifty or more in thirteen countries, using new and comparable survey data. We employ counterfactual techniques to decompose observed differences across the Atlantic, within the US, and within Europe into those arising from differences in population characteristics and differences in economic environments. We then correlate the latter differences to country-level indicators. Ownership across the range of the assets considered tends to be more widespread among US households. We document that shortly prior to the current crisis, US households tended to invest larger amounts in stocks and smaller ones in homes, and to have larger mortgages in older age, even controlling for characteristics. This is consistent with the high prevalence of negative equity associated with the current crisis. More generally, we find that differences in household characteristics often play a small role, while differences in economic environments tend to explain most of the observed differences in ownership rates and in amounts held. The latter differences are much more pronounced among European countries than among US regions, suggesting further potential for harmonization of policies and institutions.
Regulation of investor access to financial products is often based on product familiarity indicated by previous use. The underlying premise that lack of familiarity with a product class causes unwarranted participation is difficult to test. This paper uses household-level data from the ‘experiment’ of German reunification that (exogenously) offered to East Germans access to capitalist products (exogenously) unfamiliar to them. We compare the evolution of post-unification participation of former East and West Germans in financial products, controlling for relevant household characteristics. We vary familiarity differentials by considering (i) both unfamiliar ‘capitalist’ products (stocks, bonds, and consumer credit) and ones available in the East (savings accounts and life insurance); and (ii) cohorts with different exposure to capitalism. We find that East Germans participated immediately in unfamiliar risky securities, at rates comparable to West Germans of similar characteristics. They phased out disproportionate participation in previously familiar assets as familiarity with capitalist products grew. They were more likely to use consumer debt, partly to catch up with richer new peers. We find no signs of abrupt participation drops that could suggest mistakes or regret related to lack of familiarity.
In this paper we investigate the implications of providing loan officers with a compensation structure that rewards loan volume and penalizes poor performance versus a fixed wage unrelated to performance. We study detailed transaction information for more than 45,000 loans issued by 240 loan officers of a large commercial bank in Europe. We examine the three main activities that loan officers perform: monitoring, originating, and screening. We find that when the performance of their portfolio deteriorates, loan officers increase their effort to monitor existing borrowers, reduce loan origination, and approve a higher fraction of loan applications. These loans, however, are of above-average quality. Consistent with the theoretical literature on multitasking in incomplete contracts, we show that loan officers neglect activities that are not directly rewarded under the contract, but are in the interest of the bank. In addition, while the response by loan officers constitutes a rational response to a time allocation problem, their reaction to incentives appears myopic in other dimensions.
In this study prepared for the ECON Committee of the European Parliament, Gellings, Jungbluth and Langenbucher present a graphic overview on core legislation in the area of economic and financial services in Europe. The mapping overview can serve as background for further deliberations. The study covers legislation in force, proposals and other relevant provisions in fourteen policy areas, i.e. banking, securities markets and investment firms, market infrastructure, insurance and occupational pensions, payment services, consumer protection in financial services, the European System of Financial Supervision, European Monetary Union, Euro bills and Coins and statistics, competition, taxation, commerce and company law, accounting and auditing.
This paper contributes to the ongoing debate on the relationship between austerity measures and economic growth. We propose a general equilibrium model where (i) agents have recursive preferences; (ii) economic growth is endogenously driven by investments in R&D; (iii) the government is committed to a zero-deficit policy and finances public expenditures by means of a combination of labor taxes and R&D taxes. We find that austerity measures that rely on reducing resources available to the R&D sector depress economic growth both in the short- and long-run. High debt EU members are currently implementing austerity measures based on higher taxes and/or lower investments in the R&D sector. This casts some doubts on the real ability of these countries to grow over the next years.
The implications of delegating fiscal decision making power to sub-national governments has become an area of significant interest over the past two decades, in the expectation that these reforms will lead to better and more efficient provision of public goods and services. The move towards decentralization has, however, not been homogeneously implemented on the revenue and expenditure side: decentralization has materialized more substantially on the latter than on the former, creating "vertical fiscal imbalances". These imbalances measure the extent to which sub-national governments’ expenditures are financed through their own revenues. This mismatch between own revenues and expenditures may have negative consequences for public finances performance, for example by softening the budget constraint of sub-national governments. Using a large sample of countries covering a long time period from the IMF’s Government Finance Statistics Yearbook, this paper is the first to examine the effects of vertical fiscal imbalances on fiscal performance through the accumulation of government debt. Our findings suggest that vertical fiscal imbalances are indeed relevant in explaining government debt accumulation, and call for a degree of caution when promoting fiscal decentralization.
We develop a model of managerial compensation structure and asset risk choice. The model provides predictions about how inside debt features affect the relation between credit spreads and compensation components. First, inside debt reduces credit spreads only if it is unsecured. Second, inside debt exerts important indirect effects on the role of equity incentives: When inside debt is large and unsecured, equity incentives increase credit spreads; When inside debt is small or secured, this effect is weakened or reversed. We test our model on a sample of U.S. public firms with traded CDS contracts, finding evidence supportive of our predictions. To alleviate endogeneity concerns, we also show that our results are robust to using an instrumental variable approach.
We develop a model of managerial compensation structure and asset risk choice. The model provides predictions about how inside debt features affect the relation between credit spreads and compensation components. First, inside debt reduces credit spreads only if it is unsecured. Second, inside debt exerts important indirect effects on the role of equity incentives: When inside debt is large and unsecured, equity incentives increase credit spreads; When inside debt is small or secured, this effect is weakened or reversed. We test our model on a sample of U.S. public firms with traded CDS contracts, finding evidence supportive of our predictions. To alleviate endogeneity concerns, we also show that our results are robust to using an instrumental variable approach.
The Eurozone fiscal crisis has created pressure for institutional harmonization, but skeptics argue that cultural predispositions can prevent convergence in behavior. Our paper derives a robust cultural classification of European countries and utilizes unique data on natives and immigrants to Sweden. Classification based on genetic distance or on Hofstede’s cultural dimensions fails to identify a single ‘southern’ culture but points to a ‘northern’ culture. Significant differences in financial behavior are found across cultural groups, controlling for household characteristics. Financial behavior tends to converge with longer exposure to common institutions, but is slowed down by longer exposure to original institutions.
This is a chapter for a forthcoming volume Oxford Handbook of Financial Regulation (Oxford University Press 2014) (eds. Eilís Ferran, Niamh Moloney, and Jennifer Payne). It provides an overview of EU financial regulation from the first banking directive up until its most recent developments in the aftermath of the financial crisis, focusing on the multiple layers of multi-level governance and their characteristic conceptual difficulties. Therefore the paper discusses the need to accommodate cross-border capital flows following from the EU internal market and the resulting regulatory strategies. This includes a brief overview of the principle of home country control and the ensuing Financial Services Action Plan. Dealing with the accommodation of cross-border capital flows and their regulation necessarily require an orchestration of the underlying supervisory structures, which is therefore also discussed. In the aftermath of the financial crisis of 2007-09 an additional aspect of necessary orchestration has emerged, that is the need to control systemic risk. Specific attention is paid to microprudential supervision by the newly established European Supervisory Authorities and macroprudential supervision in the European Banking Union, the latter’s underlying drivers and the accompanying Single Supervisory Mechanism, including the SSM’s institutional framework as well as the consideration of its rationales and the Single Resolution Mechanism closely linked to it.
On January 29, 2014, EU Commissioner Barnier published a draft law proposing a ban for proprietary trading by big banks in Europe. In this opinion piece, published in a German newspaper on 30 January, 2014, Jan Pieter Krahnen, who was a member of the Liikanen Commission, argues that the proposal could prove to be effective in preventing systemic risk.
In the wake of the Global Financial Crisis that started in 2007, policymakers were forced to respond quickly and forcefully to a recession caused not by short-term factors, but rather by an over-accumulation of debt by sovereigns, banks, and households: a so-called “balance sheet recession.” Though the nature of the crisis was understood relatively early on, policy prescriptions for how to deal with its consequences have continued to diverge. This paper gives a short overview of the prescriptions, the remaining challenges and key lessons for monetary policy.
n a contribution prepared for the Athens Symposium on “Banking Union, Monetary Policy and Economic Growth”, Otmar Issing describes forward guidance by central banks as the culmination of the idea of guiding expectations by pure communication. In practice, he argues, forward guidance has proved a misguided idea. What is presented as state of the art monetary policy is an example of pretence of knowledge. Forward guidance tries to give the impression of a kind of rule-based monetary policy. De facto, however, it is an overambitious discretionary approach which, to be successful, would need much more (or rather better) information than is currently available. In Issing's view, communication must be clear and honest about the limits of monetary policy in a world of uncertainty.
This European Policy Analysis discusses the need to strengthen the institutions underpinning the euro and makes several policy recommendations. The Stability and Growth Pact must be reinforced, have greater automaticity and entail graduated sanctions. Fiscal surveillance must be improved through the establishment of a European Fiscal Stability Agency. Finally, the European Financial Stability Facility must be made permanent.
How to be a good European...
(2010)
Unter der Überschrift "Ich kaufe griechische Staatsanleihen weil..." sollten Persönlichkeiten aus Politik, Wirtschaft und Kultur kurz begründen, warum sie griechische Staatsanleihen gekauft haben bzw. kaufen werden--idealerweise unter Nachweis ihres finanziellen Engagements. Zum jetzigen Zeitpunkt kaufe ich keine griechischen Staatsanleihen...
At the upcoming G20 meetings the issue what can be done to avoid a repetition of the current deep financial crisis will again be debated. Much attention and criticism will be directed to central banks. That is unavoidable: central banks must never again permit the development of financial imbalances that are large enough to lead to the collapse of major parts of the financial system when they unwind. In the future, policy makers must “lean against the wind” and tighten financial conditions if they perceive that imbalances are forming, even if there is little hard data to rely on. And they must be mindful that the costs of acting too late can dwarf those of acting too early.
In the event of a Greek exit from the Eurozone, the stronger members of the monetary union, especially Germany, face at least two risks: First, the debt of the Greek National Bank vis-à-vis the Eurosystem of central banks will most likely be lost. Secondly, the large flow of capital from Greece and other periphery countries to Germany will accelerate inflation.
We investigate the relationship between anchoring and the emergence of bubbles in experimental asset markets. We show that setting a visual anchor at the fundamental value (FV) in the first period only is sufficient to eliminate or to significantly reduce bubbles in laboratory asset markets. If no FV-anchor is set, bubble-crash patterns emerge. Our results indicate that bubbles in laboratory environments are primarily sparked in the first period. If prices are initiated around the FV, they stay close to the FV over the entire trading horizon. Our insights can be related to initial public offerings and the interaction between prices set on pre-opening markets and subsequent intra-day price dynamics.
he observed hump-shaped life-cycle pattern in individuals' consumption cannot be explained by the classical consumption-savings model. We explicitly solve a model with utility of both consumption and leisure and with educational decisions affecting future wages. We show optimal consumption is hump shaped and determine the peak age. The hump results from consumption and leisure being substitutes and from the implicit price of leisure being decreasing over time; more leisure means less education, which lowers future wages, and the present value of foregone wages decreases with age. Consumption is hump shaped whether the wage is hump shaped or increasing over life.
This paper provides a systematic analysis of individual attitudes towards ambiguity, based on laboratory experiments. The design of the analysis allows to capture individual behavior across various levels of ambiguity, ranging from low to high. Attitudes towards risk and attitudes towards ambiguity are disentangled, providing pure measures of ambiguity aversion. Ambiguity aversion is captured in several ways, i.e. as a discount factor net of a risk premium, and as an estimated parameter in a generalized utility function. We find that ambiguity aversion varies across individuals, and with the level of ambiguity, being most prominent for intermediate levels. Around one third of subjects show no aversion, one third show maximum aversion, and one third show intermediate levels of ambiguity aversion, while there is almost no ambiguity seeking. While most theoretical work on ambiguity builds on maxmin expected utility, our results provide evidence that MEU does not adequately capture individual attitudes towards ambiguity for the majority of individuals. Instead, our results support models that allow for intermediate levels of ambiguity aversion. Moreover, we find risk aversion to be statistically unrelated to ambiguity aversion on average. Taken together, the results support the view that ambiguity is an important and distinct argument in decision making under uncertainty.
The idea of appointing a non-national as Central Bank Governor remains surprisingly controversial. Nevertheless, given the skills required by the Governor in order to manage what no doubt are increasingly complex institutions, considering non-nationals makes good sense for at least two reasons. First, increasing the pool of candidates to include those with broader skills and backgrounds makes it easier to find a suitable person for the job. Second, non-nationals are less likely to be beholden to domestic pressure groups and could help better insulate the central bank from political pressures.
The exceptional circumstances in which the ECB has been operating in the past years are testing not only the currency union itself, but also its institutional design. While the Governing Council of the ECB was designed to mainly set interest rates optimally for the union as a whole, the recent crisis has expanded the tools of the ECB to include unconventional monetary policy actions that potentially increase the risk exposure of its balance sheet. Since each country would contribute to the losses according to its capital key, a different voting mechanism that takes into account the single country’s contribution to the ECB’s capital could be advisable.
SAFE Newsletter : 2014, Q2
(2014)
The European Commission's Green Paper "Audit Policy: Lessons from the Crisis" raises 38 questions regarding how the audit function could be enhanced in order to contribute to increased financial stability. The authors comment on these 38 questions, arguing that the general level of audit quality can be enhanced by extending the duties of care and by tightening the regulations on liability.
This article discusses the effects of the countercyclical premium discussed in insurance supervision in the context of Solvency II. While the basic principle of introducing countercyclical elements into Solvency II is endorsed, the authors argue for a system based on market scenarios which would enforce stricter capital requirements in boom times and less strict requirements in times of crisis.
The European Commission's Green Paper "The EU corporate governance framework" raises 25 questions in order to assess the effectiveness of the current corporate governance framework for European companies. The authors contribute to the EU's consultation, respond to the 25 questions and comment on the suggestions set out in the Green Paper.
We study consumption-portfolio and asset pricing frameworks with recursive preferences and unspanned risk. We show that in both cases, portfolio choice and asset pricing, the value function of the investor/representative agent can be characterized by a specific semilinear partial differential equation. To date, the solution to this equation has mostly been approximated by Campbell-Shiller techniques, without addressing general issues of existence and uniqueness. We develop a novel approach that rigorously constructs the solution by a fixed point argument. We prove that under regularity conditions a solution exists and establish a fast and accurate numerical method to solve consumption-portfolio and asset pricing problems with recursive preferences and unspanned risk. Our setting is not restricted to affine asset price dynamics. Numerical examples illustrate our approach.
We study self- and cross-excitation of shocks in the Eurozone sovereign CDS market. We adopt a multivariate setting with credit default intensities driven by mutually exciting jump processes, to capture the salient features observed in the data, in particular, the clustering of high default probabilities both in time (over days) and in space (across countries). The feedback between jump events and the intensity of these jumps is the key element of the model. We derive closed-form formulae for CDS prices, and estimate the model by matching theoretical prices to their empirical counterparts. We find evidence of self-excitation and asymmetric cross-excitation. Using impulse-response analysis, we assess the impact of shocks and a potential policy intervention not just on a single country under scrutiny but also, through the effect on cross-excitation risk which generates systemic sovereign risk, on other interconnected countries.
Exit strategies
(2014)
We study alternative scenarios for exiting the post-crisis fiscal and monetary accommodation using a macromodel where banks choose their capital structure and are subject to runs. Under a Taylor rule, the post-crisis interest rate hits the zero lower bound (ZLB) and remains there for several years. In that condition, pre-announced and fast fiscal consolidations dominate - based on output and inflation performance and bank stability - alternative strategies incorporating various degrees of gradualism and surprise. We also examine an alternative monetary strategy in which the interest rate does not reach the ZLB; the benefits from fiscal consolidation persist, but are more nuanced.
We study the behavioral underpinnings of adopting cash versus electronic payments in retail transactions. A novel theoretical and experimental framework is developed to primarily assess the impact of sellers’ service fees and buyers’ rewards from using electronic payments. Buyers and sellers face a coordination problem, independently choosing a payment method before trading. In the experiment, sellers readily adopt electronic payments but buyers do not. Eliminating service fees or introducing rewards significantly boosts the adoption of electronic payments. Hence, buyers’ incentives play a pivotal role in the diffusion of electronic payments but monetary incentives cannot fully explain their adoption choices. Findings from this experiment complement empirical findings based on surveys and field data.
After initial temporary measures in support of Greece prooved insufficient to end the sovereign debt crisis, extensive countermeasures have ensued. The heads of state of the euro group have agreed to permanent support mechanims over the course of the past two years. In addition, the European Central Bank (ECB) has become involved in the assistance program. The article provides an overview of the various support mechanisms installed and cautions against the connected legal problems.
Prodigal Italy Greece Spain?
(2011)
Contrary to widely held perceptions, workers in the southern European states that are most afflicted by the sovereign debt crisis work hard. However, labor productivity in these countries lags far behind the EU average. Structural reforms to boost productivity should be at the top of the reform agenda.
In its decision of December 13, 2011, the Constitutional Court of the state of North Rhine-Westphalia ruled that a State Court of Auditors is granted by the constitution a broad scope of powers not only to control the immediate state administration but also entities outside the direct state administration, as far as they exercise financial responsibility for the state. This ruling may have serious implications for the capital guarantees extended by EU Member States to the newly established institutions on the European level, as for instance the European Stability Mechanism (ESM).
This contribution draws on two recent publications in which the macroeconomic model data base (www.macromodelbase.com) is employed for model comparisons. The comparative approach is used to base policy analysis on a systematic evaluation of the different implications that a certain economic policy can have when submitted to different modeling approaches. In this manner, policy recommendations are more robust to modeling uncertainty. By extending the comparative approach to forecasting, the authors investigate the accuracy of different forecasting models and obtain more reliable mean forecasts.
Reforms or bankruptcy?
(2011)
Almost 20 Greek academic economists from renowned universities in Europe and the US have prepared a one-page statement regarding the Greek crisis. In their statement the economic experts call upon the Greek public to accept the economic program of structural reforms, privatization, efficient tax collection, and shrinking of the public sector proposed and financed by the EU partners and the IMF. Among the signatories are this year's Nobel Prize winner Christopher Pissarides and Michalis Haliassos, Director of the Center for Financial Studies and Professor for Macroeconomics and Finance at the House of Finance.
The bail-in puzzle
(2011)
Under the current conditions of a global financial crisis, notably in Europe’s banking industry, the governance role of bond markets is defunct. In fact, investors have understood that bank debt will almost always be rescued with taxpayers’ money. The widespread practice of government-led bank bailouts has thus severely corrupted the bond market, leading to the underestimation of risk and, as a consequence, the destruction of market discipline. Any feasible solution to the bank-debt-is-too-cheap problem will have to re-install true default risk for bank bond holders.
This note proposes a new set-up for the fund backing the Single Resolution Mechanism (SRM). The proposed fund is a Multi-Tier Resolution Fund (MTRF), restricting the joint and several supranational liability to a limited range of losses, bounded by national liability at the upper and the lower end. The layers are, in ascending order: a national fund (first losses), a European fund (second losses), the national budget (third losses), the ESM (fourth losses, as a backup for sovereigns). The system works like a reinsurance scheme, providing clear limits to European-level joint liability, and therefore confining moral hazard. At the same time, it allows for some degree of risk sharing, which is important for financial stability if shocks to the financial system are exogenous (e.g., of a supranational macroeconomic nature). The text has four parts. Section A describes the operation of the Multi-Tier Resolution Fund, assuming the fund capital to be fully paid-in (“Steady State“). Section B deals with the build-up phase of the fund capital (“Build up“). Section C discusses how the proposal deals with the apparent incentive conflicts. The final Section D summarizes open questions which need further thought (“Open Questions“).
Securities transaction tax in France: impact on market quality and inter-market price coordination
(2014)
The general concept of a Securities Transaction Tax is controversial among academics and politicians. While theoretical research is quite advanced, the empirical guidance in a fragmented market context is still scarce. Possible negative effects for market liquidity and market efficiency are theoretically predicted, but have not been empirically tested yet. In light of the agreement of eleven European member states to implement an STT, this study aims to give a comprehensive overview of the effects of the STT, introduced in France in 2012, on liquidity demand, liquidity supply, volatility and inter-market information transmission. The results show that the STT has led to a decline in liquidity demand, has had a detrimental effect on liquidity supply and negatively influences the inter-market information transmission efficiency. However, no effect on volatility can be observed.
In the United States, on April 1, 2014, the set of rules commonly known as the "Volcker Rule", prohibiting proprietary trading activities in banks, became effective. The implementation of this rule took more than three years, as “proprietary trading” is an inherently vague concept, overlapping strongly with genuinely economically useful activities such as market-making. As a result, the final Rule is a complex and lengthy combination of prohibitions and exemptions.
In January 2014, the European Commission put forward its proposal on banking structural reform. The proposal includes a Volcker-like provision, prohibiting large, systemically relevant financial institutions from engaging in proprietary trading or hedge fund-related business. This paper offers lessons to be learned from the implementation process for the Volcker rule in the US for the European regulatory process.
Financial innovation is, as usual, faster than regulation. New forms of speculation and intermediation are rapidly emerging. Largely as a result of the evaporation of trust in financial intermediation, an exponentially increasing role is being played by the so-called peer to peer intermediation. The most prominent example at the moment is Bitcoin.
If one expects that shocks in these markets could destabilize also traditional financial markets, then it will be necessary to extend regulatory measures also to these innovations.
This policy letter provides an overview of the strengths, weaknesses, risks and opportunities of the upcoming comprehensive risk assessment, a euro area-wide evaluation of bank balance sheets and business models. If carried out properly, the 2014 comprehensive assessment will lead the euro area into a new era of banking supervision. Policy makers in euro area countries are now under severe pressure to define a credible backstop framework for banks. This framework, as the author argues, needs to be a broad, quasi-European system of mutually reinforcing backstops.
This article discusses the recent proposal for debt restructuring in the euro zone by Pierre Paris and Charles Wyplosz. It argues that the plan cannot realize the promised debt relief without producing moral hazard. Ester Faia revisits the Redemption Fund proposed in November 2011 by the German Council of Economic Experts and argues that this plan, up to date, still remains the most promising path towards succesful debt restructuring in Europe.
On November 8, 2013, several members of the British House of Lords’ Subcommittee A conducted a hearing at the ECB in Frankfurt, Germany, on “Genuine Economic and Monetary Union and its Implications for the UK”. Professors Otmar Issing and Jan Pieter Krahnen were called as expert witnesses.
The testimony began with a general discussion on the elements considered necessary for a functioning internal market. Do economic union and monetary union require a fiscal union or even a political union, beyond the elements of the banking union currently being prepared? In this context, also the critique of the German current account surplus and the international expectations that Germany stimulate internal demand to support growth in crisis countries, were discussed.
With regard to the monetary union, the members of the subcommittee asked for an assessment of how European nations and the banking industry would have fared in the banking crisis that followed the Lehman collapse, had there not been a common currency. Given the important role that the ECB has played in the course of the crisis management, the members further asked for an evaluation of the OMT-program of the ECB and also if the monetary union is in need of common debt instruments, in order to provide the ECB with the possibility of buying EU liabilities, comparable to the Fed buying US Treasury bonds. Finally, the dual role of the ECB for monetary policy and banking supervision was an issue touched on by several questions.
In many cases, the dire situation of public finances calls into question the very soundness of sovereigns and prompts corrective actions with far-reaching consequences. In this context, European authorities responded with several measures on different fronts, for instance by passing the "Fiscal Compact", which entered into force on January 1, 2013. Of critical importance in this framework is the assessment of a country’s situation by way of statistical measures, in order to take corrective actions when called for according to the letter of the law. If these statistics are not correct, there is a risk of imposing draconian measures on countries that do not really need it.