macro policy post crisis

8/4/2019 Macro Policy Post Crisis

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2011 9 10


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GDP GDP

GDP

Taylor Rule (comovement ofinterest rate and inflation)


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Types and Sources of Shocks

Productivity shock

Interest rate shock

Financial shock Earthquake, tornado, etc


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FiscalExpansion

tax reduction of 150 bln (1% GDP)in 2008

Two-thirds for private individuals

One-third for firms

Welcomed by IMF and prominent economists

Troubled Asset Relief Program (TARP)Asset purchases from financial institutions to support

the financial sector.


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American Reinvestment and Recovery Act;further 787 billion dollar (5% GDP) of fiscal stimulus tax cuts for both households and business

transfers to households funding for states and infrastructure projects

European Economic Recovery Program Cumulative discretionary fiscal impulse of about 1.5% GDP 1.2% GDP coming directly from the Member States

Potential free-riding problem solved at the European level

Quantitative easing by FED and Securities MarketsProgram of ECB


11/31

What should we do next? Fiscal

Consolidation

Fiscal consolidation is a policy aimed at

reducing government deficits and debt

accumulation.

Composition: increased tax and reduction

of public expenditure


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On the Needs of Fiscal

Consolidation

GDP 10% Acquisitions from financial sector acquisitions from financial sector

Criteria: Maastricht Treaty, deficits < 3% of GDP and debtlevels < 60% of GDP in EMU


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(long-run sustainability): Rise in public spending on pensions, health and long-term care Average is 5.2% GDP

Though wide dispersion In some instances public debt projected to rise above 800%

spill-over from private sectorindebtedness when government is forced to rescue

spill-overs Direct spill-overs via international trade

Bilateral loans and guarantees provided by supranational institutions

increase public good character of consolidation

Stronger linkages private sector financial institutions


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Increase in contingent liabilities

In particular guarantees to the banking sector

Capital injections

Guarantees on bank liabilities

Relief of impaired assets

Liquidity and bank funding support

Add to public debt when they materialise

Adds to uncertainty about sustainability of public

finances higher interest, in particular with lack oftransparency


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Effects of Fiscal Consolidation

GDP , distortionary taxes.

Depending on the fiscal instrument used,

fiscal consolidation may have pronounced

distributional effects


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Channels

Expectation view I: increase in taxes now

means that future increase can be smaller

net present value tax burden stimulates

economy avoid even worse budgetary crisisin future

Expectation view II: positive signals for

international capital market increaseconfidence of investors and lower risk.


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Channels

Labour market view focuses on spending composition

Taxes after-tax wage unions demand higher pre-tax wagesemployment and shadow value capital capital accumulation

and growth

Public employment relaxes labour market and weakens unionpowerreservation utility of union members downwardpressure on equilibrium real wage rate

Unemployment benefits/other transfers similar effects


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Channels

If stabilisation perceived as credible perceived likelihood ofpublic debt default interest burden more secure valueof bond holdings may stimulate consumption.

In addition interest rate charged to firms and consumers may

fall.

Large budgetary cuts resolve uncertainty on specifics ofimpending adjustment precautionary savings

Reductions in social expenditure and wage governmentconsumption are politically difficult to enact signal ofgovernments resolve private sector confidence that fiscalproblems will be overcome


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2004: Greece admitted to have entered euro-zone on

wrong budgetary figures

April 2009: Greek minister of Finance refused to clarify

financial situation

July 2009: projected 2009 deficit was raised from 3.7% to

5-6% GDP

October 21, 2009: update of deficit projection 2009 to12.5%

November 5, 2009 : update of deficit projection 2009 to

12.7%


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May 3, 2010: agreement Greece, EC, ECB and IMF on 3-

year program of economic and financial policies.

May 3, 2010: ECB announces to accept Greek debt ascollateral irrespective of its rating.

May 7, 2010: Spread on Greek debt exceeds 1000 basis

points.

May 7, 2010: Council adopts Decision on conditions for

financial assistance program (110 billion)

Weekend May 8 and 9, 2010: Agreements on European

Financial Stabilisation Facility (EFSF) and European

Financial Stabilisation Mechanism (EFSM)


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GDP still shrinking

Deficits continue to be high and debt still rising rapidly.

Greece is lagging behind the agreed adjustment package

Eventually, restructuring seems inevitable

Systemically relevant banks may need to receive publiccapital injections and need to raise equity.


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Debt restructuring:

Becomes necessary if both capital markets and Europeangovernments refuse to provide further funding

Key questions:

Is there any realistic prospect that additional loans willbe repaid?

If not, should one restructure now or postpone it till

later?

Note extra funding may buy time to work out a solution.

Contracts mostly written under local law legal obstacles

seems manageable


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Types of adjustment: several

optionsVoluntary roll-over of debt (Vienna initiative applied to

Eastern Europe)

Temporary solution only

Pursuasion of sufficient number of creditors

Postpone the maturity date of the debt (reprofiling)

Lower the coupon rate on the debt

Reduce nominal value of debt


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Consequences of debt

restructuringDirect:

Losses on rescue package by other governments

Losses for ECBneeds to be recapitalised

Estimated 50 bln. direct holdings

Estimated 90 bln. as collateral via repos

Banks need to write off some of their assets risk of

bankruptcy (especially Greek banking sector)


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Consequences of debt

restructuringIndirect:

Confidence in support of other vulnerable

countries is undermined borrowing

difficulties spill over to these countries new

demand for support while there is only limited

capacity.

Credit-default swaps may trigger payments


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Europes sovereign debt crisis? EMU : Investors European Resolution Mechanism Guide market expectations effectively about the steps to be taken

during the resolution (so avoid excess volatility in financialmarkets).

Provide governments with a game plan for this situation.

Resolve credibility problem of unconditional no-bail-out clause:need to set clear rules for how default will evolve.

Set clear rules for involving creditors in the resolution.


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Global Imbalance

Increased dispersion in CA balance

Increased persistence in CA imbalance


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Policy issues

Increase domestic spending in surplus

countries. For example, China, Germany,

Japan.

Reduce domestic spending in deficit

countries. For example, US.

macro policy post crisis

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