The European Economy - Slides Set.pdf

The European Economy. MIM – Economics and the Global Environment Fall 2024 Term Prof. Jordi Vives – [email protected] Prof. Josep Comajuncosa – [email protected]  EUROPEAN UNION AND EUROPEAN MONETARY UNION EUROPEAN MONETARY UNION...

The European Economy. MIM – Economics and the Global Environment Fall 2024 Term Prof. Jordi Vives – [email protected] Prof. Josep Comajuncosa – [email protected]  EUROPEAN UNION AND EUROPEAN MONETARY UNION EUROPEAN MONETARY UNION  THE EURO AREA Foundations on the European Union Major world economies by GDP per capita (2016)  EFTA EU EMU EU: European Union EMU: European Monetary Union (Euro Zone) EFTA: European Free Trade Agreement  EFTA Norway Swisland EU Iceland Liechtenstein EMU Germany Irlanda France Poland Slovenia Txec Rep Italy Slovakia Spain Hungary Malta Rumania Netherlands Cyprus Belgium Bulgaria Estonia Croatia Luxembourg Latvia Portugal Lithuania Greece Austria Finland (United Kingdom) Denmark Sweden What is the European Union? Supranational Political, Economic and Monetary Union of 27 Sovereign States Economic Union Single Market (since 1993) Free movement of: goods services Economic Union Customs Union Application of a common external tariff on all goods entering the single market. Once goods have been admitted into the market, as they travel internally: no customs duties no discriminatory taxes no import quotas, as they travel internally Political Union EU Operates through system of supranational and intergovernmental decision-making institutions. Under Principles: Conferral: act only within the limits of the competences conferred on it by the treaties Subsidiarity: act only where an objective cannot be sufficiently achieved by the member states acting alone Political Union 7 Main Decision Bodies. European Parliament European Council Council of the European Union (or Council of Ministers) European Commission European Central Bank Court of Justice of the European Union European Court of Auditors Political Union 7 Main Decision Bodies. European Parliament (legislative body) European Council Council of the European Union (legislative body) European Commission (executive body) European Central Bank Court of Justice of the European Union European Court of Auditors Fundamental Values Requirements for member countries: Human Rights Democracy Rule of Law Freedom and Equality European Union Four Freedoms. Free movement of: goods services people (labor) capital Ampliación de 6 a 28 países. Hoy permanecen 27. EU, EFTA, Eastern Partnership  EURASIAN ECONOMIC UNION What is the Eurasian Economic Union? Supranational Economic Union of 5 Sovereign States Single Market + Customs Union After the existing Eurasian Economic Community (2000-2014) What is the Eurasian Economic Union? Created on 1 January 2015 Member states: Armenia Belarus Kazakhstan Kyrgyzstan Russia. Eurasian Economic Union  FIRST TEN YEARS OF EUROPEAN MONETARY UNION 1999-2008 THE EURO THE EURO THE EURO MONETARY POLICY EUROPEAN CENTRAL BANK (ECB) ECB Tower, Frankfurt, Germany The Statute established both the ECB and the European System of Central Banks (ESCB) as from 1 June 1998. The ECB was established as the core of the Eurosystem and the ESCB. The ECB and the national central banks together perform the tasks they have been entrusted with. WHO OWNS THE EUROPEAN CENTRAL BANK –ECB?  MONETARY POLICY The European Central Bank (ECB) – Executive Board MONETARY POLICY The European Central Bank (ECB) – Dimension of Monetary Policy MONETARY POLICY The European Central Bank (ECB) – Dimension of Monetary Policy Annual consolidated balance sheet of the Eurosystem MONETARY POLICY The European Central Bank (ECB) – The Price Stability Goal MONETARY POLICY The European Central Bank (ECB) – Dimension of Monetary Policy MONETARY POLICY The European Central Bank (ECB) – Dimension of Monetary Policy MONETARY POLICY The European Central Bank (ECB) – Official Interest Rates MONETARY POLICY The European Central Bank (ECB) – Official Interest Rates MONETARY POLICY The European Central Bank (ECB) – The EUR/$ Exchange Rate FISCAL POLICY  FISCAL POLICY The European Union 2023 Annual Budget  FISCAL POLICY The European Union Recovery Plan  FISCAL POLICY The European Union Recovery Plan  FISCAL POLICY The European Union Recovery Plan  FISCAL POLICY The European Union 2024 Annual Budget  FISCAL POLICY The Response to COVID-19 Pandemic  FISCAL POLICY The 2021 Stability Programs  FISCAL POLICY 2022 Draft Budgetary Plans FISCAL POLICY EU Fiscal Rules These goals include reducing public deficits to below 3% of GDP and public debt to below 60% of GDP. However, countries will be required to adjust their budgets by a minimum of 0.5% of GDP annually until they reach the 3% deficit limit. "The objective is therefore a gradual reduction of public debt over 4 or even 7 years for countries above the limits, with a country-specific approach," Paolo Gentiloni the European Commissioner for Economy told Euronews. "On the other hand, reduced fines would be effectively applied in case of non-compliance with the rules.” It is expected that 14 countries, including Italy, France, Romania, Spain, and Malta, will exceed the 3% deficit limit in 2023. FISCAL POLICY EU Fiscal Rules  FISCAL POLICY The Energy Market – Costs of the War  FISCAL POLICY The Energy Market – Costs of the War  FISCAL POLICY The Energy Market – Costs of the War  FISCAL POLICY The Energy Market – Costs of the War  FISCAL POLICY The Energy Market – Costs of the War  FISCAL POLICY The Energy Market – Costs of the War FISCAL POLICY Costs of the War  THEORY OF OPTIMAL CURRENCY AREAS  Optimal Currency Area: When a number of countries are better off by merging their currencies and creating a new currency. EUROPEAN MONETARY UNION  EFTA EU EMU EU: European Union EMU: European Monetary Union (Euro Zone) EFTA: European Free Trade Agreement  EFTA Norway Swisland EU Iceland Liechtenstein EMU Germany Ireland France Poland Slovenia Czech Rep Italy Slovakia Spain Hungary Malta Rumania Netherlands Cyprus Belgium Bulgaria Estonia Luxembourg Latvia Portugal Lithuania Greece Croatia Austria Finland Denmark Sweden EUROPEAN MONETARY UNION Stability and Growth Pact: Under normal circumstances, the government deficit must no exceed 1% of GDP. In recession, it must not exceed 3% of GDP. Sanctions: States that fail to comply will pay a fine equal to 0,25% of GDP per point in excess. This will take the form of a non-interest-bearing deposit in the ECB that will be paid back after two years if the state has solved its deficit problem. EUROPEAN MONETARY UNION Stability and Growth Pact: It was created to avoid free-riding of small states that are not used to budgetary discipline. It turned out to be very inflexible. Germany and France unilaterally broke it without paying sanctions (2004) Reform needed. Will it be credible?  Why a Fiscal Pact is necessary? ZE If a country decides: G TR t And increases its public deficit … THE EURO Advantages: No exchange rate uncertainty Elimination of transaction costs It favors price stability and low interest rates It favors economic and financial integration More budgetary discipline It guarantees stable markets for the more developed economies THE EURO Disadvantages: Loss of monetary policy. Loss of exchange rate policy. Highly restricted fiscal policy. Possible asymmetric shocks. ZE This country receives a negative asymmetric shock. Policies: Monetary Policy? Exchange Rate Policy? Protectionist Policy? Fiscal Policy? USA This State receives a negative asymmetric shock. Policies: Monetary Policy? Exchange Rate Policy? Protectionist Policy? Fiscal Policy? USA Federal G TR t This State receives Government a negative asymmetric shock. Federal Government: Fiscal Policy: USA L Federal G TR t This State receives Government a negative asymmetric shock. Factor Mobility: L Labor , Capital  USA: Exists risk sharing due to fiscal transfers made by central federal government. When a state in the U.S. is in recession, every $1 drop in that state’s GDP would have an offsetting transfer of 28 cents.  Theoretical Framework: Theory of Optimal Currency Areas (Robert Mundell) –The initial formulation of what should determine the geographical coverage of a currency. Mundell, R. A. (1961). "A Theory of Optimum Currency Areas". American Economic Review.  Theoretical Framework: Theory of Optimal Currency Areas (Robert Mundell) –The initial formulation of what should determine the geographical coverage of a currency. –First condition: integration in the trade of goods and services. Mundell, R. A. (1961). "A Theory of Optimum Currency Areas". American Economic Review.  Theoretical Framework: Theory of Optimal Currency Areas (Robert Mundell) –Either, there are no negative asymmetric shocks –Or there exists fiscal integration, financial integration and Labor and Capital Mobility. Mundell, R. A. (1961). "A Theory of Optimum Currency Areas". American Economic Review.  Theoretical Framework: Theory of Optimal Currency Areas (Robert Mundell) Criteria: – Labor mobility – Capital mobility – Similar Business Cycles – Risk sharing mechanism (fiscal transfers)  Robert Mundell (1932-2021) Nobel Prize in Economic Sciences, 1999 BANKING UNION  Assets Balance Sheet of a Bank Liabilities Created by Reserves all the bancs in the EZ Loans Public Bonds Deposits Corporate Resolution Bonds Mechanism Other Assets Liquidity $ $ $ $ $ $ $ $ $  Governments in EZ Assets Balance Sheet of a Bank Liabilities In case of Reserves systemic crisis Loans Public Bonds Deposits Corporate Resolution Bonds Mechanism Other Assets Liquidity $ $ $ $ $ $ $ $ $ LARGER FISCAL INTEGRATION FISCAL INTEGRATION ◼ Fiscal Union: ◼ Set of fiscal rules and arrangements. ◼ Possibility of (permanent) cross-country transfers. ◼ Some (total) debt mutualization. ◼ Scope can vary significantly. FISCAL INTEGRATION ◼ Deeper Fiscal integration can correct architectural weakness. ◼ Reduce the incidence and severity of future crisis. ◼ Give long term credibility to the crisis measures in train. FISCAL INTEGRATION ◼ Cross border fiscal supervision and transfers raise difficult political issues Degrees of Fiscal Integration: Fiscal Sovereignity Fiscal Union of each territory Sovereignity Risk Sharing  Increase Fiscal Integration: EZ Fiscal now Sovereignity Fiscal Union of each territory Transfer Union FISCAL INTEGRATION ◼ The crisis has made clear that there are architectural gaps in the design of the ESC: ◼ Whereas it was believed that country specific shocks would be moderate ◼ But there have been large and idiosyncratic shocks ◼ Also, idiosyncratic policies (with important spillovers) ◼ Many countries did not build sufficient fiscal buffers in good times FISCAL INTEGRATION ◼ Fiscal Integration can be useful to solve these gaps: ◼ Risk Reduction (fiscal discipline) ◼ Risk Sharing (insuring against country-specific risk) FISCAL INTEGRATION ◼ Minimal elements of a larger fiscal integration (that would make a future crisis less severe) (1) Better supervision and stronger incentives for sound national fiscal policies. (2) Some system of temporary transfers or provision of public services (organized by a central budget). (3) Finishing the fiscal link in the banking union. (4) Some public debt mutualization. FISCAL INTEGRATION ◼ Minimal elements of a larger fiscal integration (that would make a future crisis less severe) (1) Better supervision and stronger incentives for sound national fiscal policies (to build fiscal buffers, and ensure common concerns are addressed) (2) some system of temporary transfers or provision of public services (organized by a central budget) FISCAL INTEGRATION ◼ Minimal elements of a larger fiscal integration (that would make a future crisis less severe) (3) Credible euro zone wide backstops for the banking sector to break the loop between sovereign and bank risk in financial system. (4) Some form of common issue of public bonds (backed by common revenue). it would reduce the potential for large portfolio shifts between public bonds of different countries by providing a safe asset. FISCAL INTEGRATION (1) Better Supervision: Fiscal Policy Design: Structural fiscal targets (instead of headline, or annual). Independent forecast about the position of the economy in the economic cycle. Binding medium term fiscal plans: any accommodation to the cycle in downturns must be accompanied with plans to offset this in the medium term. Fiscal transparency and accountability (independent Fiscal Councils). FISCAL INTEGRATION (1) Better Supervision: Enforcement: Needs to be “center-based” in the beginning, with stronger involvement in national fiscal decisions. Fiscal rules included in national legislation and ruled by national courts. In case of larger central budget, transfer from it could be dependent on compliance with rules Veto power from the center when spending or borrowing do not comply common rules (it would require treaty changes and loss of fiscal sovereignty). FISCAL INTEGRATION (1) Better Supervision: Political Accountability: Large role for the center raises questions of political and democratic accountability. Existing fiscal unions are political unions (in EZ deeper fiscal integration may not be posible without changes in political organization of the union). Necessary to ensure that decisions are taken according to EZ collective interest rather than that of individual states. FISCAL INTEGRATION (2) Temporary Transfers or provision of public services: Rainy Day Fund: providing transfers to countries to deal with adverse shocks. The fund should collect revenues from EA members at all times and make transfers to countries when they experience negative shocks. Size difficult to say: 1.5%-2.5% of GDP (EFSF and ESM have used 7.5%) FISCAL INTEGRATION Rainy Day Fund: Pros: Provides ex-ante support (before shocks have turned into funding crises) Easier to manage than a full-fledged EZ Budget Provides insurance agains idiosyncratic shocks and allows for EZ wide counter-cyclical fiscal policy (contributions saved in good times and paid out to countries in tough times) FISCAL INTEGRATION Rainy Day Fund: Cons: A challange is correctly detect the events warranting the activation of transfers (difficult to measure shokcs and to know whether permanent or temporary, exogenous or policy shocks. “Free-riding” is always a risk, with countries less inclined to build fiscal buffers at national levels FISCAL INTEGRATION (2) Temporary Transfers or provision of public services: Common Unemployment Insurance: move some amount of provision of unemployment benefits to EZ level provides insurance against individual income risk across the union. Should imply and harmonization of labor market arrangements across countries FISCAL INTEGRATION Common Unemployment Insurance: Pros: Highly related to the economic cycle. Common social security fund more understandable and acceptable to the public. Cons: Given large variation in long-term unemployment rates, the focus should be restricted to short term benefits (directly connected to negative shocks) In long term benefits, it would imply redistribution of income instead of risk-sharing. FISCAL INTEGRATION (2) Temporary Transfers or provision of public services: Euro Area Budget: It would allow for risk sharing both through revenues (countries with adverse shocks contribute less) and through spending (countries with negative shocks would benefit from the same amount of centrally-provided public services) Providing some specific public services at euro wide level. FISCAL INTEGRATION Euro Area Budget: Pros: The extent of risk sharing would increase with the extend of centralization of fiscal revenues and spending It would facilitate the coordination of fiscal policy. Cons: Implies a large loss of fiscal sovereignty (implies shifting taxation and spending to the center). Currently, public opinion and electorates would not support this move. Transfer Union: “Automatically” richer territories make fiscal transfers to other territories: to “equalize” the quality of public services and the standards of living. Transfer Union: Actually, a central government, or a central fiscal authority, makes these transfers. Although “automatic”, the government can change them. Normally, the government does not directly decide the transfers between territories, these are just the result of fiscal decisions about G, TR and t. Risk Sharing: When a territory experiences a negative asymetric shock, the other territories make a fiscal transfer to help the one with problems. This can be done by a central government by changing the amount and direction of G, TR and t. Risk Sharing: Or can be done with a Fund created with this goal. Fund Risk Sharing: Or can be done with a Budget which provides certain public service. Budget Risk Sharing: In the good years all territories must contribute to the Fund. Fund FISCAL INTEGRATION (3) Common backstop for the banking union: FISCAL INTEGRATION (4) Issuing Public Debt from the center: ◼ EZ debt instrument backed by the revenues of a central Budget (Common Bonds) ◼ It would require the creation of a central entity able to issue debt on its own behalf Deuda Pública en la Zona Euro: Bonos Alemania € Bonos Francia Mercados € Bonos Italia € Bonos España € Deuda Pública en la Zona Euro (crisis para Italia): Bonos Alemania € Bonos Francia Mercados € Bonos Italia € Bonos España € Deuda Pública en la Zona Euro Mutualizada: Bonos Alemania € Bonos Francia Mercados € Bonos Italia € Bonos España € El responsable último de pagar los bonos es Autoridad Fiscal de la ZE-UE una institución europea Deuda Pública en la Zona Euro Mutualizada (crisis): Bonos Alemania € Bonos Francia Mercados € Bonos Italia € Bonos España € El inversor no teme que el gobierno italiano Autoridad Fiscal de la ZE-UE no le pueda devolver el dinero Deuda Pública en la Zona Euro Mutualizada y QE del BCE: Banco Central Europeo Bonos € Bonos Alemania Alemania € Bancos Bonos de la ZE Francia € Bonos Italia € Mercados Bonos España € Autoridad Fiscal de la ZE-UE NEXT GENERATION –EU FUND Deuda Pública en la Zona Euro: Bonds Alemania € Bonds Francia € Mercados Bonds Italia € Bonds España € Bonds Next Generation - EU € Deuda Pública en la Zona Euro: Bonds Alemania € Bonds Francia € Mercados Bonds Italia € Bonds España € Bonds Next Generation - EU € Deuda Pública en la Zona Euro: Bonds Alemania € Bonds Francia € Mercados Bonds Italia € Bonds España € Bonds Next Generation - EU € CRISIS COVID-19 ◼ Next Generation EU (NGEU): ◼ Agreed on 21 July 2020 by the European Council ◼ An exceptional temporary recovery instrument. ◼ To give a coordinated European fiscal response to economic crisis from the covid-19 pandemic. CRISIS COVID-19 ◼ Next Generation EU (NGEU): ◼ It is a joint funding model to support government spending and reform in the EU. ◼ In 2008 the European Economic Recovery Plan was only intended to coordinate national stimulus packages to be financed by each Member State. CRISIS COVID-19 ◼ Next Generation EU (NGEU): ◼ NGEU has been authorized to raise up to €750 billion on the capital markets on behalf of the EU (5% of EU GDP). ◼ This funds can be used to provide loans of up to €360 billion and grants to up to €390 billion. ◼ These will be disbursed up to the end of 2026 and repaid by 2058 at the latest. CRISIS COVID-19 ◼ Next Generation EU (NGEU): ◼ The loans will be repaid by the beneficiary Member States. ◼ The European Council will reform the own resource system and ensure that grant repayments by: ◼ gross national income-based contributions. ◼ New EU own resources. CRISIS COVID-19 ◼ Next Generation EU (NGEU): ◼ The Recovery and Resilience Facility (RRF) is 80% of NGEU: ◼ Support investment and reform in MS to pave the way for: ◼ Sustainable, resilient recovery while promoting EU green and digital priorities. ◼ Other 20% to reinforce EU-wide spending programs under Multiannual Financial Framework (standard EU Budget) CRISIS COVID-19 ◼ Next Generation EU (NGEU): ◼ To receive financial support MS need to prepare national recovery and resilience plan for 2021-23, outlining national investment and reform agendas to: ◼ Strengthen the growth potential, job creation and economic and social resilience. ◼ Meet the green and digital transitions. CRISIS COVID-19 ◼ Flagship Areas: 1. Power Up - The frontloading of future-proof clean technologies and acceleration of the development and use of renewables. 2. Renovate - The improvement of energy efficiency of public and private buildings. 3. Recharge and Refuel - The promotion of future-proof clean technologies to accelerate the use of sustainable, accessible and smart transport, charging and refuelling stations and extension of public transport. CRISIS COVID-19 ◼ Flagship Areas: 4. Connect - The fast rollout of rapid broadband services to all regions and households, including fiber and 5G networks. 5. Modernize - The digitalization of public administration and services, including judicial and healthcare systems. CRISIS COVID-19 ◼ Flagship Areas: 6. Scale-up - The increase in European industrial data cloud capacities and the development of the most powerful, cutting edge, and sustainable processors. 7. Reskill and upskill - The adaptation of education systems to support digital skills and educational and vocational training for all ages. CRISIS COVID-19 ◼ Next Generation EU (NGEU): €750 billion is 5% of EZ GDP Fully committed by the end of 2023 And disbursed over period 2021-2024 CRISIS COVID-19 CRISIS COVID-19 ◼ Next Generation EU (NGEU): NGEU will imply a debt-based fiscal expansion of around 1% of GDP on average over 2021-2024. Key point: must be deployed for productive spending and accompanied by growth enhancing- reforms. Then: it will help recovery but also increase the resilience and growth potential of MS economies. CRISIS COVID-19 ◼ Recovery & Resilience Facility: Core of the NGEU: all the loans and 80% of the grants The agreed distribution of funds will imply net financial support for countries that face biggest economic and fiscal challenges after the pandemic. Greece is largest net recipient relative to GDP. Italy and Spain will get large size help (they are expected to be most heavily affected economies).