Thomakos et al (eds ) a financial crisis manual; reflections and the road ahead (2015)

Palgrave Macmillan Studies in Banking and Financial Institutions Series Editor: Professor Philip Molyneux The Palgrave Macmillan Studies in Banking and Financial Institutions are international in orientation and include studies of banking within particular countries or regions, and studies of particular themes such as Corporate Banking, Risk Management, Mergers and Acquisition The books’ focus is on research and practice, and they include up-to-date and innovative studies on contemporary topics in banking that will have global impact and influence Titles include: Elena Beccalli and Federica Poli (editors) BANK RISK, GOVERNANCE AND REGULATION LENDING, INVESTMENTS AND THE FINANCIAL CRISIS Domenico Siclari (editor) ITALIAN BANKING AND FINANCIAL LAW SUPERVISORY AUTHORITIES AND SUPERVISION INTERMEDIARIES AND MARKETS CRISIS MANAGEMENT PROCEDURES, SANCTIONS, ALTERNATIVE DISPUTE RESOLUTION SYSTEMS AND TAX RULES Dr Fayaz Ahmad Lone ISLAMIC FINANCE Its Objectives and Achievements Valerio Lemma THE SHADOW BANKING SYSTEM Creating Transparency in the Financial Markets Imad A Moosa GOOD REGULATION, BAD REGULATION Elisa Menicucci FAIR VALUE ACCOUNTING Key Issues Arising from the Financial Crisis Anna Omarini RETAIL BANKING Business Transformation and Competitive Strategies for the Future Yomi Makanjuola BANKING REFORM IN NIGERIA FOLLOWING THE 2009 FINANCIAL CRISIS Ted Lindblom, Stefan Sjogren and Magnus Willeson (editors) GOVERNANCE, REGULATION AND BANK STABILITY FINANCIAL SYSTEMS, MARKETS AND INSTITUTIONAL CHANGES Gianluca Mattarocci ANOMALIES IN THE EUROPEAN REITS MARKET Evidence from Calendar Effects Joseph Falzon (editor) BANK PERFORMANCE, RISK AND SECURITIZATION BANK STABILITY, SOVEREIGN DEBT AND DERIVATIVES Josanco Floreani and Maurizio Polato THE ECONOMICS OF THE GLOBAL STOCK EXCHANGE INDUSTRY Rym Ayadi and Sami Mouley MONETARY POLICIES, BANKING SYSTEMS, REGULATION AND GROWTH IN THE SOUTHERN MEDITERRANEAN Gabriel Tortella, Ruiz García and Luis José SPANISH MONEY AND BANKING A History Caner Bakir BANK BEHAVIOR AND RESILIENCE Jill M Hendrickson FINANCIAL CRISIS The United States in the Early Twenty-First Century Dimitris N Chorafas HOUSEHOLD FINANCE Adrift in a Sea of Red Ink Mario Anolli, Elena Beccalli and Tommaso Giordani (editors) RETAIL CREDIT RISK MANAGEMENT Palgrave Macmillan Studies in Banking and Financial Institutions Series Standing Order ISBN: 978–1–403–94872–4 (outside North America only) You can receive future titles in this series as they are published by placing a standing order Please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address, the title of the series and the ISBN quoted above Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England A Financial Crisis Manual Reflections and the Road Ahead Edited by Dimitrios D Thomakos Professor of Applied Econometrics, University of Peloponnese, Greece Platon Monokroussos Group Chief Economist and Deputy General Manager of Eurobank Ergasias S.A., Greece and Konstantinos I Nikolopoulos Professor of Decision Sciences, Bangor Business School, UK Selection and editorial matter © Dimitrios D Thomakos, Platon Monokroussos and Konstantinos I Nikolopoulos 2015 Individual chapters © Contributors 2015 Softcover reprint of the hardcover 1st edition 2015 978-1-137-44829-3 All rights reserved No reproduction, copy or transmission of this publication may be made without written permission No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6–10 Kirby Street, London EC1N 8TS Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988 First published 2015 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010 Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries ISBN 978-1-349-55232-0 ISBN 978-1-137-44830-9 (eBook) DOI 10.1057/9781137448309 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data A financial crisis manual : reflections and the road ahead / edited by Dimitrios D Thomakos, Professor of Applied Econometrics, University of Peloponnese, Greece, Platon Monokroussos, Group Chief Economist and Deputy General Manager of Eurobank Ergasias S.A., Greece, Konstantinos I Nikolopoulos, Professor of Decision Sciences, Bangor Business School, UK pages cm — (Palgrave Macmillan studies in banking and financial institutions) Finance, Public – European Union countries Monetary policy – European Union countries Debts, Public – Law and legislation – European Union countries I Thomakos, Dimitrios D., editor II Monokroussos, Platon, 1965– editor III Nikolopoulos, Konstantinos I., 1974– editor HJ1000.5.F563 2015 336.94—dc23 2015026343 To my family, Anthi, Olympia and George, for their ever-present love but also for their patience of endlessly listening about the crisis and always responding, “cheer up, it’s the economists’ limelight!” Dimitris To my lovely parents and sister, my nieces Lydia and Kyveli and to Lilian for all the love and encouragement they have given me in editing this volume Platon To Nina, Ilias, Polyanna and Spyros for all the time I’ve stolen from them; and for all the love and inspiration they have given me Kostas This page intentionally left blank Contents List of Figures ix List of Tables xii Acknowledgments xiv Disclaimer xv Notes on Contributors xvi Introduction Dimitrios D Thomakos, Platon Monokroussos and Konstantinos I Nikolopoulos Part I The Industry Perspective A Retrospective on the Great Recession: Causes, Effects and Prospects Inachos Lazos 11 European Public Finances through the Crisis Fabrice Montagné 24 ECB Monetary Policy and the Euro during the Crisis Athanasios Vamvakidis 39 The Repression of Financial Markets Ralph Sueppel 58 Chasing the Tail of Financial Stability? Solutions to the Last Crisis Are the Seeds for the Next One Marcel Kasumovich Part II 81 The Case of Greece An Empirical Study on Greece’s Current Account Determinants Before and After the Outbreak of the Global Financial Crisis Platon Monokroussos and Dimitrios D Thomakos vii 105 viii Contents Greek Fiscal Multipliers Revisited: Government Spending Cuts vs Tax Hikes and the Role of Public Investment Expenditure Platon Monokroussos and Dimitrios D Thomakos The Challenge of Restoring Debt Sustainability in a Deep Economic Recession: The Case of Greece Platon Monokroussos The Case for a New Reprofiling of Greek Public Debt and Why a Relaxation of the Bailout Program’s Future Fiscal Targets May Prove to Be a Self-Financing Policy Shift Fokion Karavias and Platon Monokroussos 130 170 189 10 External Debt Evolution When Global Financial Markets Are Incomplete Alexis Anagnostopoulos and Gregorios D Siourounis 201 11 Foreign Direct Investment, Innovation and Brain Drain in Greece: Turning a Problem into an Opportunity Constantina Kottaridi 225 Part III Crisis Economics and the Road Ahead 12 Globalized Finance in Disarray Shanti P Chakravarty 257 13 The Elephant in the Euro Room Alex Patelis 281 14 From the Euro-Crisis to a New European Economic Architecture Michael G Arghyrou 308 Afterword: The road Ahead Dimitrios D Thomakos, Platon Monokroussos and Konstantinos I Nikolopoulos 329 Index 331 List of Figures 2.1 Levels and changes in spending composition across countries (% of GDP) 2.2 (a) Public sector investment (% of GDP) and (b) private sector investment (% of GDP) 3.1 Eurozone monetary policy stance (policy rate – Taylor rule) 3.2 Monetary policy stance: spread from a Taylor rule (policy rate – Taylor rule) 3.3 Monetary policy stance (policy rate – Taylor rule) 3.4 Performance since the global crisis and inflation in G10 economies 3.5 Eurozone 5y5y inflation swap rate 3.6 Unemployment and the euro 3.7 Core inflation and the euro 3.8 FED vs ECB balance sheet and EUR/USD 3.9 ECB vs Fed monetary policy stance and EUR/USD 3.10 Eurozone current account balance (€bn) 3.11 Eurozone trade of goods and services with the rest of the world (€bn) 3.12 Eurozone current account balance (four-quarter moving sum, €bn) 3.13 Eurozone balance of payments (6M moving sum, €bn) 3.14 Share of EUR reserves and EUR/USD 3.15 Bank sector claims (BIS data, % of EZ GDP) 3.16 EZ equity flows from non-EZ (four-week average, % of AUM) 5.1 US financial integration much deeper than trade 5.2 Bank deleveraging substantial and ongoing 5.3 China-led EM V-shaped recovery 5.4 Rapid capital inflows into emerging markets ($bn) 5.5 US Treasury buying dominated by central banks 5.6 US corporate financing needs low, debt issuance surges 5.7 Fixed income demand much stronger in this cycle 5.8 EM bond funds have a steep discount to asset value 6.1 Greece’s current account (CA) deficit (ppts of GDP) ix 31 33 42 43 44 45 45 49 49 50 50 51 52 53 53 54 55 56 84 86 89 90 92 93 94 96 115 320 Michael G Arghyrou all private depositors which took place in Cyprus in 2013 beyond the 100,000 euros threshold This contributes towards the maintenance of intra-EMU financial fragmentation through capital flight from periphery to core EMU countries, which, in turn, undermines the growth prospects of crisis-hit countries through liquidity and credit shortages Finally, although all EMU member-states automatically become parts of the EBU, EU countries that have not yet joined the euro are not obliged to so, although they have the option to join the EBU, if they wish Obliging non euro EU countries to participate in the EBU would have been politically impossible, and would also involve its own economic/ financial risks (see Pisani-Ferry et al., 2012) Nevertheless, the self-exclusion of countries such as the United Kingdom and Sweden from the EBU maintains the possibility of regulatory arbitrage in the European continent; and, given the ECB’s clout, tilts the balance of power in the field of banking regulation at the EU level against non-EMU member countries Both factors can prove a source of intra-EU tensions with unpredictable consequences for the EU’s future integrity 3.3 European fiscal union The onset of the Greek sovereign bond market in autumn 2009 and its fall-out it through the EMU made abundantly clear that the SGP’s no-bail out clause was not only (as discussed above) non-credible ex ante, but also, ex-post time-inconsistent, as allowing a country to fiscally collapse could cause negative externalities at the union level exceeding any credibility gains following its enforcement Realization of these facts highlighted the necessity of introducing effective backstop mechanisms stabilizing investors’ expectations at a crisis’ early stages (see Arghyrou and Tsoukalas, 2011) The first response to that direction came in May 2010 in two shapes First, on the fiscal side, granting Greece an ad hoc financial rescue program for €110bn, in exchange for commitments on behalf of Greece to implement fiscal and structural reforms Second, on the monetary side, the introduction by the ECB of the Securities Markets Programme (SMP), involving the purchase of sovereign bonds of crisis-hit countries in the second market These steps produced limited results The Greek financial program failed to stabilize the Greek bond market and had to be supplemented by a second rescue program in July 2011 for €130bn and, following that, in February 2012, the imposition of losses on private holders of Greek debt to the amount of €110 (in face-value terms) in the context of the Greek Private Sector Involvement (PSI) program The SMP had some initial success in stabilizing EMU sovereign bond yields (see A New Perspective of Eurozone 321 Afonso et al., 2015) but, due to its ex ante limited scope, this proved to be only temporary In light of the above, EMU authorities undertook institutional initiatives of permanent nature The first was the creation of the European Financial and Stability Fund (EFSF) in June 2010, upgraded to the European Stability Mechanism (ESM) in October 2012 The EFSF/ESM facilities put in place a formal mechanism of fiscal assistance, based on the principle of conditionality, which subsequently funded packages of financial assistance to Ireland, Portugal, Cyprus and the Spanish banking sector These, however, failed to achieve the intended market stabilization effects, with the sovereign bonds of periphery countries, including those of Italy and Spain, remaining under market pressure for the best part of the 2010–2012 period This led to a second institutional innovation, namely the introduction on behalf of the ECB of the Outright Monetary Transactions (OMT) program in July 2012 Within the context of the OMT the ECB has committed to intervene with unlimited, if necessary, liquidity in the secondary bonds market (do “whatever it takes”, as the ECB president famously put it), to stabilize the prices of bonds of countries under pressure, provided that the latter have previously agreed a program of economic adjustment with their international creditors The OMT’s announcement has so far operated as a game-changer in the EMU crisis, as it seems to have provided a previously non-existent lender of last resort for sovereigns in the EMU area, equivalent to the one offered by the ECB to the European banking sector during the financial crisis of 2007–2008 This, combined with the availability of ESM funds, offered a credible fiscal anchor stabilizing market expectations, leading to a significant drop in EMU government bond yields (see De Grauwe and Ji, 2014) Despite this success, however, the effectiveness of the combined ESM/OMT fiscal backstop mechanism has been questioned, on various grounds To start with, the availability of potentially unlimited funds for fiscal rescues in the context of the OMT, as well as the fiscal backstop offered by the offered by ESM, have been criticized as leaving considerable scope for moral hazard discouraging necessary reforms in crisis-hit EMU countries (see Coeuré, 2013; Sinn, 2014) Furthermore, the funds available to the ESM (700 billion) may be enough to finance rescue programs for small and medium-size countries, such as Greece and Portugal, but would not suffice to assist a large country such as Italy (whose debt has a face value of €2.1tn), if this became under intense market pressure Hence, without the extra funds 322 Michael G Arghyrou offered by the OMT, the ESM on its own does not provide a complete insurance mechanism against all fiscal shocks This renders the OMT as the primary element of the existing fiscal backstop mechanism, posing two significant problems First, in a monetary union like the EMU maintaining fiscal decentralization, the single monetary policy cannot deliver optimal stabilization in the event of fiscal shocks, as discussed by Coeuré (2015) Second, the OMT maintains the element of conditionality, as its operation requires countries under pressure to agree with its creditors a suitable program of economic adjustment before the OMT is activated From that point of view, it is does not offer a lender of last resort facility in the classic sense; rather, it has put in place a European IMF-type mechanism, enhanced by a monetary source of financing As there is no guarantee that future fiscal crises will not cause spillover effects such as those observed in 2010–2012, there is also no guarantee that the ECB will actually let an EMU country that is reluctant to agree to an unpopular adjustment program, to fail, if this failure threatens the stability of the union as a whole Therefore, the conditionality clause of the OMT may well be subject to the same ex ante limited credibility/ex-post time inconsistency problems to which the SGP was subject to, especially if its application is required not for a big country Overall, although the fiscal backstops put in place post-2010 have delivered higher stability in the EMU area, they cannot be regarded a complete insurance mechanism against fiscal shocks This motivates a drive towards a higher degree of fiscal integration, explicitly acknowledged in the new euro-governance blueprint provided by the van Rompuy report, potentially leading to a full fiscal union The latter’s establishment is proposed to be a gradual process involving the following steps (see Fuest and Peichl, 2012) First, the adoption of common fiscal-policy rules and central supervision of their application This step has been concluded by the adoption of the Fiscal Compact Second, putting in place a unified fiscal-crisis resolution mechanism The ESM and OMT can be seen to perform this function, albeit with the efficiency caveats discussed above Third, mutualization of national fiscal liabilities through joint-debt issuance, a scheme known as Eurobonds This could reduce government bond yields for crisis-hit countries, which could contribute significantly to their recovery; and produce positive externalities benefiting all EMU member-states These could take the form of increasing the depth of EMU’s bonds market causing lower liquidity premia; and promoting the A New Perspective of Eurozone 323 use of the euro as a global reserve currency, thus upgrading the ability of the ECB to collect seignorage revenue (see De Grauwe, 2012) Fourth, create a centrally controlled fiscal equalization mechanism, leaving national expenditure and tax collection systems in place, but involving cross-country fiscal transfers in the event of asymmetric shocks (see Luque et al., 2014) Finally, the creation of a central EMU fiscal authority which, in addition to organizing fiscal transfers across EMU member states, would also be able to raise taxes at the union level and determine compulsory changes in national fiscal policies (see Marzinotto et al., 2011; Sapir and Wolff, 2015) These proposals represent valuable contributions in the public debate on the Eurozone’s future economic architecture However, they face opposition on two interrelated grounds: First, objections based on moral hazard arguments (see e.g., Issing, 2009) To address these reservations, proponents of Eurobonds have proposed schemes incentivizing market discipline for higher levels of borrowing, as the blue/red Eurobonds plan by Delpha and von Weizsäcker (2014) and differential fees for countries participating in Eurobonds’ issues, increasing with the country’s level of indebtedness (see De Grauwe, 2012) These plans, however, have so far not gained ground enough to overcome the reservations of the Eurobond’s opponents Second, objections based on grounds of democratic accountability and legitimacy, as acknowledged by the van Rompuy Report itself These are extremely difficult to address without moving towards some form of political union As, however, popular support towards the latter is at present limited, further steps fiscal integration additional to the ESM/ OMT framework currently in place are unlikely to be taken in the foreseeable future Summary and concluding remarks This chapter discussed the pre-crisis euro-governance framework and critically reviewed the emerging new European economic architecture designed to address the former’s shortcomings I argued that the roots of the European fiscal and banking crises lay in significant supply-side divergence among the EMU member-states preceding the euro’s creation, which were further reinforced following the euro’s launch in 1999 These problems were respectively due to the shortcomings of the Maastricht Treaty to put in place the conditions necessary for the successful operation of the EMU; the failure of the Stability and Growth Pact and other 324 Michael G Arghyrou EMU monitoring mechanisms to enforce sustainable national fiscal and macro-policies; and the lack of market pressure on countries with a deteriorating macro-profile, consistent both with deviations from the market efficiency paradigm and the existence of perceived fiscal guarantees I argued that the economic downturn observed in euro periphery countries following the global credit crunch of 2007–2008 was to a large extend an unavoidable equilibrium-restoring phenomenon This, however, took explosive dimensions due to the lack of credible backstops at the union level able to stabilize market expectations by giving effective reassurances that no extreme negative outcomes (e.g., national banking system collapses, unilateral sovereign defaults, and forced euroexits) would occur In the light of this experience, since 2010 European authorities have been putting in place the building blocks of a new European architecture, pursuing three main targets: First, create a more effective macro-prudential institutional framework preventing the accumulation of fiscal, external and financial imbalances This is pursued through the Fiscal Pact, the Euro Plus Pact and the introduction of a single banking supervision mechanism The latter allows banks following excessively risky business models to have their operations’ license withdrawn, while the two pacts postulate that countries not complying with fiscal and other macro targets may eventually face financial fines Second, if a national banking and/or fiscal crisis does occur, put in place effective backstops containing the extent of the crisis nationally and preventing it from spreading to other countries On the banking front, this objective is pursued by deciding bank resolutions at the union level and having in place harmonized national deposit guarantee schemes On the fiscal front, the new framework allows for financial support through programs of financial assistance provided by the European Stabilization Mechanism (ESM) and potentially unlimited ECB intervention in the secondary market for sovereign bonds through the Outright Monetary Transactions (OMT) program Third, the new euro-governance framework must achieve higher market discipline being imposed on banks and sovereigns As far as the former is concerned, bank resolution is governed by the principle of bailing-in bank shareholders and creditors; with regards to the latter, no explicit mechanism exists Overall, set against the targets mentioned above, the post-2010 institutional reforms have gone some way towards addressing the shortcomings of the pre-crisis euro-governance system Nevertheless, this A New Perspective of Eurozone 325 progress is limited and does not provide a full response to the latter: although the new framework limits (through single supervision) the scope for banking crises, it maintains considerable national discretion in other significant policy areas (fiscal and macro) Theoretically, this is limited by the provisions of the Fiscal Compact and the Euro Plus Pact However, like the Stability and Growth Pact, these maintain the element of political discretion in the process of imposing fines against countries in violation of the pacts’ provisions This, combined with the fact that the new framework allows for fiscal financing at the union level, of national banking losses and national fiscal liabilities, implies that banking institutions and national authorities still operate under not entirely binding inter-temporal budget constraints As a result, the moral hazard problem is not eliminated and the imposition of marketimposed discipline is undermined The first-best solution to address these risks would be to eliminate the sources of idiosyncratic shocks by means of complementing the monetary union with a full fiscal union, as envisaged by the van Rompuy Report, and granting the ECB officially the role of lender of last resort These objectives, however, are politically impossible for the foreseeable future The second-best solution is to achieve a higher degree of fiscal co-ordination/harmonization, which however is also strongly resisted on moral hazard terms and, also, raises important questions regarding democratic accountability/legitimacy, which only a high degree of political integration (if not a fully political union) can resolve Therefore, my final verdict is that, compared to the pre-crisis regime, the progress so far achieved towards building a new European economic/ financial architecture is limited and the scope for future crises of magnitudes similar to the present one remains non-negligible Given the current political constraints, it appears that the most feasible/effective way forward is to explore channels increasing further the markets’ ability to exercise pressure on national authorities towards delivering sustainable economic outcomes This sets a challenging agenda for academics and policy-makers alike Notes The Treaty requires a country’s budget deficit not to exceed 3% of the country’s GDP and a structural deficit of 0.5% for countries with debt-to-GDP ratio in excess of 60%; and 1% for countries whose debt-to-GDP ratio is below the 60% The FC has been signed by all EU member-states except from the UK, Hungary and Croatia Non EMU-countries, however, are not subject to fines if they violate its provisions 326 Michael G Arghyrou The Czech Republic, Hungary, Sweden and the UK have not signed the EPP Areas covered by the EPP include nominal wage setting arrangements and indexation schemes, public sector wages and structural reforms enhancing productivity There are also measures geared towards increasing employment, financial stability and fiscal policy sustainability, as well as tax policy co-ordination Non-EMU EU countries that have signed the EPP are not subject to such fines This set of rules is composed by the Capital Requirements Regulation (CRR), the Capital Requirements Directive (CRD IV) and the Bank Recovery and Resolution Directive (BRRD) The implementation of the SRB is the responsibility of the European Banking Authority (EBA) and applies to the whole of the EU countries A future task of the SSM is to create a European Supervisory Rating System for the harmonization of risk assessments The directive sets time frames for the payment of guarantee payouts following bank failures, with the present payoff deadline of 20 working days scheduled to gradually fall to seven days as from January 2024 In exceptional circumstances, the Commission may approve a lower target level, but not lower than 0.5% of covered deposits References Acharya, V.V., Drechsler, I., and Schnabl, P (2014) “A Pyrrhic victory? 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Is it possible to maintain the single currency and maintain growth at the same time, for all involved? Can we play “chicken” (or any other game for that matter) when the lives and well being of millions is at stake? Should a leader punish or reform those that follow him? (How does such reform take place?) Is there any meaning to the voices of “alternative” economics, or are we finally done with backwardlooking social experiments? Can the markets take any more punishment from the policy applications of “self-proclaimed” economists? Do the markets care or not about countries like Greece? Should Greece be in the monetary union? All in all, can we please see some common-sense solutions implemented without political/ideological argumentation? Let us start from the last question: It has been made abundantly clear that policy-making by those who have attached the code-name “economist” to whatever they truly are has been mostly a failure in crisis times Such times require, as the US example has clearly shown, the application of textbook-case, standard and ultra-aggressive policy scenarios for the quick revival of the economy, the stabilization of financial markets and a return to growth The EU is suffering from a lack of such policies, in its battle against the Greek crisis in particular and the European crisis in general This pervades the discussion in all parts of this book: from a market perspective, which suggests that the solutions implemented are the seeds of the next crisis; to the role of European monetary policy; 329 330 Dimitrios D Thomakos, Platon Monokroussos and Konstantinos I Nikolopoulos to the (grossly) miscalculated Greek fiscal multipliers; to the role of Germany during the crisis; to the need for more integration in Europe As our contributors have woven their arguments about the crisis, and bearing the recent events in Greece in mind, one cannot but infer several other points of interest The huge policy reversal of the new Greek government, and its subsequent economic failures, crashed the largest fiscal adjustment ever made in an economy after the Great Recession, obliterated the return to positive growth and almost led to Greece’s exit from the Eurozone – with many having their sights on politics and economic speculation and failing to see the grave implications of such an event for global markets Markets cannot operate on a foundation of hay; they cannot take more punishment and are currently unable to function properly, due to the lack of sensible, growth-oriented policies It is now understood that alternative views on what makes a country go backwards are bad for everyone: alternative policies cannot stop a global financial system in disarray – they only lead to more chaos Keeping Greece in the Eurozone while altering the policy mix is the only way forward We should be able to put our money where our mouth is: if we are to gamble, we should at least it by the textbook rules It is not possible to move forward without: (a) a horizontal cut in all tax rates across Europe (Greece especially) to signal to the markets that Europe is a place where investors and citizens can thrive again, (b) a policy objective that links debt repayments with real economic growth, and (c) a monetary policy that serves the union and not one country alone These three simple suggestions should, in principle, restore the faith of citizens and markets that governments not penalize their citizens in order to maintain endless transfer payments (not just to Greece but within the huge bureaucratic system, that diverts funds for everything and subsidizes almost everyone); they will show that governments are willing to serve the common good of the union by taking a small amount of growth proceeds and using it to maintain the welfare state – not by taking existing wealth and redistributing it as subsidy money without a long-term growth plan This is a mandate that all countries, not just European ones, should actively pursue At the same time, Europe should pursue its, so-much-needed, deeper fiscal and financial integration of countries into the Eurozone Should policy-makers decide not to follow this, or some other reasonable mandate, there is a rather high probability that next time things go wrong there will be no room for negotiation Index accounting standards, 69 asset backed securities (ABS), 48, 64 asset bubbles, 17, 100 asset classes, 19, 99 asset markets, 6, 22, 111, 213 asset-backed securities, 64 asset-related risk, 64 asset-tracking vehicles, 95 asymmetric policy, 281, 284–5 Augmented Dickey Fuller test, 117, 212 austerity, 131, 145–6, 158, 216, 220, 283, 300, 310, 312, 318 automatic stabilizers, 13, 51, 49, 194 back-loading, 29 bailout, 215–16, 220, 283, 300, 310, 312, 318 balance of trade, 206 bank intermediation, 82, 111 bank liquidity, 39, 48, 82 banking Shock, 91 Banks for International Settlements (BIS), 32 bond yield term premiums, 62 boom-bust cycles, 85 brain drain effect, 226, 239 breton woods era, 60 bubble-zones, 13 capex, 34 capital account management, 23 capital expenditure, 12, 32 capital flight, 13, 14, 17, 36, 240–1, 246–7, 320 cointegration, 1, 105, 118 collateral policies, 64 competitiveness, 106–8, 117, 119, 124, 145 complete markets, 201–3, 205, 207–8, 209, 214, 220 consumer price index (CPI), 111 consumption smoothing, 112, 114–15, 136, 140 corruption, 257, 272–6 Council’s reaction function, 63 counterfactual, 1, 77, 81, 179 credit crunch, 257–9, 261, 264, 270–2, 276, 324 credit default swaps, 88, 91 cross-border capital, 60 crowding-out effect, 34 currency dissolution, 13 current account, 105–26, 206, 208, 281–5, 287, 293–6, 299, 306–7, 311–12 current account deficits, 282, 293, 296, 312 current account surplus, 281–5, 287, 293–6, 306–7 cyclical deficit, 25 cyclical risk assets, 20 Cyprus, 225, 230, 281, 308, 319–21 debt crisis, 201, 297, 308, 310–11, 313–14, 319 debt dynamics, 171 debt metrics, 38 debt stock, 58–9, 61, 172, 174, 190 debt sustainability, 170 debt-to-GDP ratio, 36, 88, 91, 172–3, 174, 178, 181–3, 190, 277 deficit, 106, 110, 113, 116, 119, 124–5, 137–8, 144, 171–2, 176, 178, 181, 216, 220, 228, 268–9, 274–5, 282–4, 293, 296, 311–12, 314–15, 325 derivatives markets, 59 discount bonds, 206 disposable income, 106, 110 domestic consumtion, 201, 209, 277 domestic investment, 109, 110, 112, 122, 124 downside risk, 66 331 332 Index economic spiral, 14 emerging market (EM), 88 equiproportional improvement, 191 equity repurchase programs, 92 EU bilateral loans (GLF), 61, 89, 197 Euro area, 3, 5, 7, 11, 15, 18, 20, 22–8, 31–2, 36–8, 59, 60, 63–4, 68, 105–6, 108–9, 114, 145, 228, 281–2, 284–8, 290–9, 304, 306–7, 309, 311, 316–17 Euro crisis, 281, 298, 314 European Central Bank, 12, 14, 18, 22, 63, 100, 308 European Commission (EC), 11, 24, 73, 318 European Fund for Strategic Investments (EFSI), 35 European Investment Bank (EIB), 35 European Monetray Union (EMU), 91, 308 European Stability Mechanism (ESM), 47, 308, 318, 321 Eurosystem, 63–4, 309 Eurozone, 201–4, 215, 226–7, 231, 270, 274–5, 308, 313, 319, 323 Eurozone crisis, 39, 46–7, 54, 274 Eurozone equities, 55 Eurozone institutional infrastructure, 15 excessive deficit procedure (EDP), 27 exchange rate, 107–8, 113–14, 118–19, 135, 221, 274, 281–3, 293, 294–5, 307 external assets, 294, 296–7, 300, 303, 307 external balance, 284, 299 external debt, 201–3, 207–10, 212–16, 220–1 external deficits, 18 external imbalances, 105 Federal Reserve, 14, 16, 22, 60, 62–4, 66, 73, 75–6, 95 financial assets, 21 financial autarky, 221–2 financial crisis, 105–6, 109, 114, 131, 136, 138, 215, 225, 230, 239, 243–4, 248, 263, 272, 277, 293, 296–7, 308, 312, 316, 321 financial globalization, 202 financial integration, 1, 10, 122 financial intermediation, 70 financial liberalization, 111, 116, 125 financial markets, 107, 114, 171, 174–6, 182–3 financial repression, 59, 60–1, 67, 77 financial stability, 41, 66 financial turmoil, 201 fiscal acounts, 17 fiscal adjustment, 15, 37, 38, 191 fiscal buffers, 39, 58 fiscal consolidation, 5, 15, 24, 26, 28–9, 34, 37–8, 147, 170–7, 180–3, 188, 191, 198 Fiscal costs, 34 fiscal deficits, 19, 106, 125, 284 fiscal framework, 3, 61, 87, 199 fiscal levy, 36 fiscal management, 11 fiscal multipliers, 27, 34, 130–1, 133–4, 136–8, 140, 158, 170–1, 173–4, 177, 184, 186, 194 fiscal policy, 110, 125, 130, 132, 138, 170 fiscal shocks, 130–1, 134–5, 142 fiscal stabilization, 60 foreign capital scarcity, 203 foreign currency denominated debt, 202 Foreign Direct Investment (FDI), 226, 228, 235, 237–9, 244, 248–9 frontloaded, 15, 16 G10 economies, 44 GDP, 208, 215, 225, 228–9, 231, 257, 259, 270–1, 275, 277, 288, 293, 295–7, 315, 317 GDP growth, 203 general equilibrium model, 201–3, 221 general government primary balance, 106–7, 119, 125 generalized impulse response, 143–4, 149, 150, 154 Germany, 109, 114, 138, 228, 240, 242, 268, 270, 275–7, 281–2, 284–8, 290–300, 304–7, 311, 330 global debt, 12, 19 government debt, 202, 305 government spending, 130–1, 133, 135, 137, 139, 149, 153 Index Great Moderation, 12 Great Recession, 11, 17 Greece, 105–9, 114–17, 122, 124–5, 144, 157, 170, 201, 203–4, 215–16, 220, 225–8, 230–1, 240–2, 244–6, 248, 275, 277–8, 281, 283–4, 288, 295, 308, 311–13, 321 Greek crisis, 13, 48, 313, 329 hedge funds, 19, 22, 71 high-liquidity assets, 67–8, 70 human capital, 226, 230, 232–41, 244, 246–7, 249 hysteresis effect, 1, 86, 18, 91, 91, 194 idiosyncratic risk, 204, 215, 222 impact multipliers, 6, 181, 189, 197 Im-Pesaran-Shin test, 212 impulse response, 130, 141, 202, 216 income per capita, 107–9 incomplete markets, 201–2, 215–16, 220 indebtedness, 6, 17, 58, 83, 115 indexed debt, 202 inflation, 257–8, 261–3, 268, 269, 276, 281–2, 285, 287–8, 290–2, 294–6, 307, 319 inflation volatility, 107, 112 innovation, 215, 221, 226, 229–37, 239, 243–5, 249, 268–9, 314–15, 321 institutional assymetries, 11 institutional paralysis, 72 interest rate, 111, 113, 134–5, 137–8, 172–86, 203, 259, 269, 271, 277, 291–3, 296, 311 international business cycles, 214 international financial architecture, 203 international financial markets, 201–4, 208, 215, 220, 312 intertemporal budget constraint, 1, 71, 182 Ireland, 201, 203–4, 215–16, 225, 228, 230, 259, 268, 281, 283–4, 288, 295, 308, 321 Japan Government Bonds (JGBs), 65 less developed economies, 203 Levin-Lin-Chu test, 211 liquidation death spiral, 19 333 liquidity buffers, 83, 87 long-term equilibrium, 281, 307 Long-term Refinancing Operations (LTROs), 47 macroeconomic outlook, 24, 38, 315 macroeconomic performance, 66 macroeconomic uncertainty, 112 macro-prudential level, 14 macroprudential regulation, 60 MADF test, 211 market failures, 34 market incompleteness, 202, 214–15 monetary expansion, 20 monetary union, 281, 285, 288, 296–7, 308, 322, 325 moral suasion, 60 mortgage, 62, 82, 83, 85, 87, 98, 269, 270, 296 multivariate threshold autoregression, 1, 30, 141 mutual funds, 82, 98 net balance sheet, 64 net exports, 206, 220 net external asset position, 208 net portfolio flows, 52–3 nominal exchange rate, 294 nominal growth trade-off, 15 non-conventional monetary policy, 66, 70 off-balance-sheet, 90–7, 269 Okun factor, 41 OTC derivatives, 68 output gap, 107 output growth, 106, 112, 122, 125, 201–2, 215–16, 220–1, 270 Outright Monetary Transactions (OMT), 47, 308, 324 over-the-counter (OTC), 98 paradox of thrift, 18 pension funds, 60, 67–9 per capita GDP, 208 population, 111–13, 123, 126 Portugal, 201, 203–4, 215–16, 225, 228, 230–1, 242, 275, 281, 284, 288, 295, 308, 321 334 Index post-GFC, 87, 89, 97 precautionary savings, 110, 112, 135, 136 primary deficit, 58 private consumption, 134, 137, 140 private savings, 107, 111, 119 pro-cyclical risk allocation, 97 productivity shocks, 201–2, 213, 220–1 public debt, 110, 146, 167, 170–2, 176–7, 182–3, 187 public finances, 24–5, 30 public investment, 112, 130, 133, 151, 155–7, 159, 160 Public Private Sector Engagement (PPE), 34 public resources, 32, 230 purchasing power, 23, 108, 119, 262 quantitative easing, 4, 15, 20–2, 39, 43, 56, 61, 65, 79, 91, 257, 270, 309 rational expectations hypothesis, 263 real exchange rate, 107–8, 119, 281, 294–5, 307 rebound, 2, 12, 28, 292 regime-dependent, 1, 30, 141 regulatory arbitrage, 69, 75, 320 repo transaction, 64 risk premiums, 22, 61, 65, 97, 99, 100 risk warehousing, 67, 70 risk-weighted assets, 67 savings glut, 13, 84, 276 Securities Markets Program (SMP), 47, 308, 320 self-defeating fiscal consolidation, 191 self-fulfilling, 13, 19 shadow banking, 70, 74–5 smart debt engineering, 192 solvency crisis, 227 sovereign bonds, 47, 64, 68, 308–9, 312, 320–1, 324 sovereign debt, 25, 106, 125 sovereign debt crisis, 308, 310–11, 313 sovereign default, 5, 145, 324 Spain, 225, 228, 230–1, 242, 268, 284, 288, 295, 321 speculative capital, 19, 20 Stability and Growth Pact (SGP), 24, 26–8, 37, 170, 310, 314 stagnation, 225, 242, 257 stock-flow adjustments, 190 supranational, 15 surplus, 268–9, 275–6, 284, 293–4, 296, 298–9, 306–7 systemic fallout, 73 tail risks, 39, 71 taper tandrum, 73 Targeted Long-Term Repo Operations, 63 tax avoidance, 36 tax cuts, 135, 137, 153 tax evasion, 144 tax hikes, 130–1, 154 tax revenue, 132–3, 135, 150, 153–4, 158–9, 258 Taylor rule, 41–2 three-pillar strategy, 37 Total Factor Productivity (TFP), 221, 236 trade openness, 112–13, 123, 126 Treasury bond, 16 trench war, 20 trust funds, 60 twin deficits, 17, 106, 110, 119, 125 unempolyment rate, 225, 227, 249, 281, 284, 287 unit root, I(1) process, 117–18, 208–9, 211, 213, 215, 222 US subprime, 11 Us treasury market, 62 VaR shocks, 71 Vector Error Correction Model (VECM), 105, 118, 123–4 world economy, 225, 235, 257 world oil prices, 113 zero interest rate policy (ZIRP), 65 ... spent almost two years in the Global FX Strategy team at Barclays Capital as global head of quantitative research He has published papers in democratization, reserve allocation, capital markets and. .. Oxford IMA Journal of Management Mathematics and Supply Chain Forum: An International Journal He is co-originator of the Theta forecasting method and the ADIDA temporal aggregation method-improving... Stefan Sjogren and Magnus Willeson (editors) GOVERNANCE, REGULATION AND BANK STABILITY FINANCIAL SYSTEMS, MARKETS AND INSTITUTIONAL CHANGES Gianluca Mattarocci ANOMALIES IN THE EUROPEAN REITS MARKET