Prof. Volker Wieland, IMFS
Presentation of the Annual Report of the German Council of Economic Experts

The risks of the European Central Bank’s (ECB) low interest rate policy were in the focus of the lecture of Professor Volker Wieland during a joint event of SAFE and the IMFS. At the moment, the economic growth in Germany was sustained by domestic consumption and based on high employment and high increases in real wages, Wieland warned. However, this growth was not independent from the development abroad. Regarding the euro area, Wieland pointed out special factors as the lower effective exchange rate, which led to a higher demand. Looking at the economic growth in euro area countries that started early adopting structural reforms like Ireland or Spain it becomes clear that those countries benefitted from a faster economic recovery. Altogether, economic growth was driven by monetary policy and thus “not sustainable”, Wieland said.

The Council of Economic Experts remained critical regarding the expansive monetary policy of the ECB and did not see any reason for another monetary easing in December. Instead, the experts worry about risks for financial stability. Especially for banks and insurance companies, the low interest rate monetary policy poses risks for the business model and could lead to distortions. This effect would be even more serious the longer the low interest rate monetary policy went on, Wieland warned. If the central bank started to tighten its monetary policy again, this could entail serious problems. Furthermore, Wieland criticized the slackening reform efforts by the governments in the euro area. If the monetary policy of the ECB made the governments push their reforms into the future, this would be a problem, he pointed out.

Concerning the challenges posed by refugee arrivals Wieland rejected too optimistic projections as formulated by the European Commission that assumes an economic growth of 0.3 percent by 2017 in the euro area. The integration of immigrants on the labor market was a long process, Wieland emphasized. In the Council’s opinion, Germany was economically going into the wrong direction. Therefore, the experts named their 2015/16 Annual Report “Focus on Future Viability”. Obstacles for economic growth such as the so-called “mother pension”, the minimum wage or rent control, which the Council had identified in earlier reports, were no longer in the center of interest. However, they had not lost importance.

Prof. Katharina Pistor, Columbia Law School, New York
"The Legal Code for Global Capital"

The way how finance is coded in law Professor Katharina Pistor of Columbia Law School, New York, presented in her lecture on December 9. Building on her legal theory of finance, Pistor who was honored with the Max Planck award in 2012 for her research at the intersection between law and finance examined the way law is needed to enforce certain rights on financial markets, especially in times of bankruptcy or financial crises.

Given the need to avoid a run on entities or markets, “how is global finance sustained without a global state and global law?” Pistor asked. By outlining a deal of mortgage-backed securities based on home-owners in California, she described the different international banks and trusts involved and their respective property rights. Financial transactions of this kind, graphically shown as the “spaghetti bowl of derivatives” include two legal systems of law at the same time: on the one hand, the official system, which is subject to regulation, and on the other hand, the shadow banking system that is organized around private contracts and where the governing law is chosen depending on where the entity is based. According to Pistor, this leads to “regulatory competition” with the players trying to “create contracts that get around the rules without violating them”.

When these systems collide in case of bankruptcy of an entity, “who decides who gets to hold the joker?” Pistor formulated as the key question. “That has always been the game”, she said, pointing out that this was nothing new. However, in her opinion, what had changed were the scale and scope of this phenomenon and its implications in a world with a very complex legal system “where we have ceded some rights to others”. As New York and England are the two legal systems that cover most financial claims and counter-claims, “these two systems hold the key to change the whole system”, Pistor concluded.

To the slides (PDF, 1,24 MB)

Prof. Stavros Gadinis, University of California at Berkeley
"Three Pathways to Global Standards: Private, Regulator, and Ministry Networks"

Why do some international standards get adopted as law although they are not binding? This was one of the questions Stavros Gadinis, Assistant Professor of Law at the University of California at Berkeley, elaborated on in his lecture in the Working Lunch series. Based on his findings in “Three Pathways to Global Standards: Private, Regulator, and Ministry Networks”, Gadinis offers a roadmap for understanding how international networks organize their operations and which mechanisms of network standard setting they apply.

Analyzing the adoption of international accounting standards, Gadinis distinguishes between private market professionals, national regulators, and ministry executives. These networks work according to different mechanisms. “As private firms can’t mandate standards, they try to get market professionals to adopt standards like IFRS”, Gadinis explained. In order to achieve this, private firms "have to convince others that they do what is best for the industry”. As for the regulators, Gadinis recognizes reciprocity as the underlying mechanism. In this case, regulators are looking for others that are similarly affected. On the ministry level, the mechanism is determined by government influence.

Comparing the development of these networks, Gadinis found out that the networks grow at a different pace. By calculating the relative likelihood that a network will adopt a set of standards at a particular point of time, Gadinis comes to the conclusion that private networks promote stricter standards but at a slow speed whereas regulator networks can fight misconduct but privilege better-resourced regulators. Ministry networks, on the other hand, can promote their objectives fast. Here, the preferences of powerful countries are reflected.

Dr. Emanuel Mönch, Deutsche Bundesbank
"In Search of a Nominal Anchor: What Drives Inflation Expectations?"

According to many central bankers, successful monetary policy relies on anchored inflation expectations. The stability of long-run inflation expectations is no inherent feature of the economy, though. In his lecture, Emanuel Mönch, head of research at the Bundesbank, investigated the conditions under which inflation expectations remain anchored. In a joint paper Mönch and his co-authors Carlos Carvalho, Stefano Eusepi, and Bruce Preston have developed a model of expectation formation based on learning.

In the model, price-setting agents act as econometricians who update their beliefs about long-run inflation. They set prices according to their views about future inflation, generating a feed-back between inflation expectations and actual inflation. “If agents observe that they make systematic mistakes in the short run, they update their views about long-run expectations,” Mönch explained in his lecture. Thus, long-term inflation expectations react to a series of short-term inflation surprises.

By using actual inflation data and short-run inflation forecasts from surveys for the United States, Japan and various European countries, Mönch demonstrated how long-run inflation expectations can become unanchored. As he pointed out, except for Japan, the model implied that all countries considered had anchored inflation expectations as of 2014. “The model captures quite well the rise and decline of long-term inflation expectations that we have seen in the U.S. over the last few decades, and also the development in Japan since the 1990s,” Mönch concluded.

To the slides of the presentation (PDF, 668 KB)

Ludger Schuknecht, Federal Ministry of Finance
"Stability in the Eurozone: Challenges and Solutions"

The triangle of stability in the eurozone, consisting of the real economy, the fiscal side and financial markets, were in the focus of the lecture of Dr. Ludger Schuknecht during the Working Lunch on July 15. The Chief Economist and Director General for Economic and Fiscal Policy Strategy and International Economy and Finance in the Federal Ministry of Finance explained how deficit rules, national structural reforms and smart regulation contribute to achieve sound public finances, a competitive real economy and robust financial markets.

Starting his analysis with the fiscal side, Schuknecht argued that the public debt ratio in the eurozone countries was much higher after the crisis than at the start of the monetary union. After a peak in 2014, however, it was beginning to decrease. “We do not know exactly what the sustainable debt ratio is”, Schuknecht pointed out. Nevertheless, this was not a desirable situation to remain in. “The challenge consists in regaining resilience”, he said, advocating a risk-based approach in public finances. Like households, governments should hold expenditures in line with income growth.

Regarding the second area of challenge in the triangle of stability, Schuknecht commented on macroeconomic imbalances endangering the real economy. Although the unique labor costs in crisis countries like Spain had gone down after the crisis, in other countries the size of the productive sector had shrunk significantly like in France. Taking a look at the current account imbalances, “crisis countries show a much higher export orientation than before the crisis with Ireland being the great success story”, Schuknecht said. Unemployment as another indicator also showed a development in the right direction.

With regard to the financial markets as the third part of the triangle, Schuknecht, who had worked at the International Monetary Fund, the European Central Bank and the World Trade Organization earlier, demonstrated that many countries in the eurozone still had a private debt overhang by presenting statistics that showed numbers well above 160 percent of outstanding debt of gross domestic product (GDP) for households and nonfinancial corporations. In France private debt was almost 180 percent in 2014, in Spain 182 percent and in Portugal 209 percent. In his view, the nexus between banks and governments was too tight as shown by the share of sovereign bonds held by domestic banks, which was up at 29 percent in Spain or 24 percent in Portugal in April of this year. “We further need to strengthen the institutional framework”, Schuknecht concluded.

To the slides of the lecture (PDF, 404 KB)

Tobias Adrian, Federal Reserve Bank of New York
"Global Pricing of Risk and Stabilization Policies"

To what extent is the impact of the global pricing of risk on countries’ risk and growth altered by monetary, fiscal and macroprudential policies? This was the main question of the IMFS Working Lunch lecture by Tobias Adrian, Federal Reserve Bank of New York, on 1 July. In his lecture Adrian, who is Associate Director of the Research and Statistics Group, introduced a new framework of thinking about economic policies.

As a starting point, Adrian referring to a paper with his co-authors Daniel Stackman and Erik Vogt looked at the global risk appetite as reflected by the volatility index VIX for the S&P 500. “Since most people delegate their asset allocation to financial institutions constraints of those institutions impact the global pricing of risk,” Adrian pointed out. According to their findings, volatility forecasts future returns in a highly nonlinear fashion, capturing the impact of global institutions on the pricing of risk. Countries’ exposure to this key state variable measures its respective riskiness. Based on data from 27 countries Adrian, who is also an IMFS research fellow, showed correlations between output, inflation, policy rate, and equities across countries demonstrating that there was a risk-return tradeoff. “Countries with higher exposure to the global economic cycle and the pricing of risk have a higher growth but also higher volatility”, Adrian said.

In a last step, he investigated how economic policies interact with the pricing of risk and made evident that there was a relationship between the macro risk-return tradeoff, global risk exposures, and stabilization policies. Economic policies can mitigate the impact of the global pricing of risk on the domestic risk-return tradeoff Adrian concluded. Based on these stylized facts he suggested rethinking economic policies in the light of global financial institutions’ role in the transmission in the pricing of risk.

The presentation is available for download (PDF, 1,0 MB).

Michael Haliassos, Goethe University and Center for Financial Studies
"The Greek Crisis: Where to Next?"

In his lecture Prof. Michael Haliassos, Chair of Macroeconomics and Finance at Goethe University and Director at the Center for Financial Studies, presented the political origins of debt buildup in Greece and proposed some simple reforms that could ensure the viability of the country in the eurozone.

Looking at the political process during the last 30 years, Haliassos described how a state-dependent private sector was built and, at the same time, the public sector became highly inefficient and tax evasion was encouraged. The debt crisis hit Greek banks much harder than the average Eurozone country, Haliassos stated who is an advisor to the European Central Bank on the construction of the Eurozone Survey of Household Finances and Consumption. Greece was the most home-biased country in the Eurozone. Consequently, solvency problems of the Greek banks spilled over to the Greek state and vice versa, Haliassos explained. Since 2010 Haliassos is one of the editors of the policy blog “Greek economists for reform”. Whereas the standard measures in a fiscal crisis as well as the adjustment program controlled by the troika rather concentrated on the reduction of government spending and the increase of taxes, the creation of a repayment potential has been neglected. Prof. Haliassos warned that “very little has been done since the beginning of the crisis in terms of creating productive potential”.

Thus, he sees an enormous scope for reforms and large exploitable margins. As far as the legal framework in Greece is concerned, enforcing a contract takes 1300 days whereas in OECD countries this is 529 days on average, Haliassos gave as an example. He also denounced the missing support for excellent research in the country. “85 percent of the Greek scientists of high reputation live and work outside Greece”, Haliassos pointed out. Regarding the exportation of Greek goods, he cited the National Bank of Greece estimating that export revenues from olive oil could be enhanced significantly if oil was not exported in bulk and bottled in Italy but standardized and branded in Greece. “Simple measures can make a big difference but they are not done”, Prof. Haliassos concluded.

To the photo gallery of the lecture
To Michael Haliassos' lecture as opinion piece at the World Economic Forum

Helmut Siekmann, IMFS
"Legal limits for the outright purchase of sovereign debt by the ESCB"

Outright purchases of sovereign debt by the European System of Central Bank (ESCB) has been a topic of debate among legal scholars since the ECB (European Central Bank) started to purchase covered bonds with underlying sovereign debt. The controversies increased when the ECB publicized its decision to install Outright Monetary Transactions (OMT). New legal questions arose when the ESCB started its debt purchasing program which is known under the name Quantitative Easing (QE). Since its start in March 2015 the ECB has purchased just over 85 billion euro in government and agency bonds by the end of April. But what is the legal framework the ECB is moving in?

In the Working Lunch on April 27, IMFS Professor Helmut Siekmann gave an overview about the history of different programs announced by the ECB, reminding that the powers transferred to the ECB were strictly limited. “Not all the competences of the monetary union are transferred to the ECB”, he pointed out. With the judgment of the European Court of Justice (ECJ) on the ECB’s OMT still pending, he delineated the legal limits for the outright purchase of sovereign debt.

Regarding one of the major holdings against the OMT, the transgression of the so-called mandate, Prof. Siekmann explained that the designation mandate was not used in the primary law and even had a completely different meaning. From a legal point of view, the ECB has competences instead of a mandate. Furthermore, the disruption of the monetary policy transmission mechanism as another major justification was rather irrelevant, he said. Since there was a vast amount of imaginable disruptions this could lead to handing power to the ECB, Prof. Siekmann warned.

Although the ECJ was widely expected to act in favor of the ECB after the opinion of the Legal Counsel was published in January 2015, Prof. Siekmann remained rather critical on this. “The document is not as clear as it appears at first sight”, he added, claiming it would not give plain power to the ECB. “The limits to the ECB could be even closer than the ECB thinks”.

Hence, Prof. Siekmann made clear that there were distinctive differences between OMT and the new QE program, the Expanded Asset Purchase Programme (EAPP), as QE featured no special selection of member states and it was not conditionally tied to measures of economic policy.

The slides of the lecture are available for download here.
Further information:

  • IMFS Working Paper No 89, Helmut Siekmann
    "The Legal Framework for the European System of Central Bank" (<link file:2043 download herunterladen der datei>PDF, 480 KB)
  • IMFS Working Paper No 90, Helmut Siekmann"The Legality of Outright Monetary Transactions (OMT) of the European System of Central Banks" (PDF, 324 KB)
Tobias Tröger, Goethe University
"How special are they? Targeting systemic risk by regulating shadow banking"

In the Working Lunch on February 25, IMFS Affiliated Professor Tobias Tröger shared his insights on how financial stability concerns associated with shadow banking could be addressed. In his lecture, Prof. Tröger doubted the underlying consensus of regulation, putting into question that rule-makers have to close loopholes in the existing framework by coming up with ever more detailed specifications. In his view, shadow banking can be described in part as a reaction to regulation or “a race between a hare and a tortoise”, making use of regulatory arbitrage. This quest for regulatory arbitrage opportunities engages talent in an unproductive endeavor, Prof. Tröger, Chair of Private Law, Trade and Business Law and Jurisprudence at Goethe University, warned.

As an example for the loopholes of regulation, Prof. Tröger cited asset-backed commercial paper conduits, which could be treated as off-balance-sheet exposure with ‘full risk’ or ‘low risk’ depending on the maturity. Since a maturity up to one year entailed a classification as ‘low risk’, financial instruments were designed according to these specifications with a maturity of 364 days.

Instead of this, Prof. Tröger endorsed alternatives that pay close attention to the policy rationales that underpin existing regulation and leave discretion to supervisors in dealing with individual cases by way of a more normative interpretation of prudential rules and standards. By preferring a normative approach rather than a legalistic one, the need to permanently update and amend the regulatory framework was limited, he explained. “The normative approach does not demand knowledge of the ultimate risks for the financial system and the cost of compliance are identical.” However, there were also limits and drawbacks, Tröger warned as the normative approach required engaging skilled and courageous personnel. Furthermore, it did not necessarily cover all occurrences of alternative credit intermediation.

  • The slides and the <link en news-media details news imfs-working-paper-on-regulating-shadow-banking.html _blank external-link-new-window externen link in neuem>paper are available for download.
  • To the <link en events _blank external-link-new-window externen link in neuem>photo gallery of the Working Lunch
Michael Binder, Goethe University
"Determinants and Output Growth Effects of Debt Distress"

The recent developments in the euro area have put public debt levels back into the limelight. During the IMFS Working Lunch on January 29, Prof. Michael Binder analyzed the relationship between public debt levels and sovereign default but also between public debt levels and output growth. Together with Sebastian Kripfganz, Goethe University, and Tihomir Stuĉka of the World Bank, Binder investigated these relations for more than 50 developing and emerging market countries over 38 years.

As a starting point, Binder and his colleagues looked at whether a country had been in debt distress: “We asked what are the driving forces of the probability of debt distress?” In this regard, debt distress was defined either as years in which the sum of arrears exceeds five percent of total public and publicly guaranteed external debt outstanding or in which a country receives balance-of payments support from the International Monetary Fund (IMF) in excess of 50 percent of the country's IMF quota or receives a debt-relief from the Paris Club.

Estimating probabilites of debt distress, Binder and his colleagues found that factors such as the public external debt burden and the policy and institutional track record strongly contribute to explaining cross-country differences in debt distress probabilities, but that inertia is the single-most important factor for debt distress. In this sense, there was psychology in the markets according to Binder.

Turning to the relationship between public debt levels and output growth, standard models encompass only one equation to measure the strength of this relationship, Binder and his colleagues used two equations: Having estimated the probability of debt distress in their first equation, the second equation can shed light on how much rises in the level of external public debt affect output growth, simultaneously accounting for the implied changes of the probability of debt disstress. Binder warned. In contrast to the well-known findings of Carmen Reinhart and Kenneth Rogoff, Binder and his colleagues found that there was not a single threshold beyond which changes in the public debt level would be detrimental for output growth. “The story starts at much earlier levels of external public debt”, Binder emphasized.

While there were relatively small or insignificant direct effects of increases in the public external debt burden on output growth even in episodes of debt distress, there was an overall significant effect when increases in the debt burden notably increased the probability of debt distress. According to Binder and his colleagues, the magnitude in the overall effects is country-specific, depending beyond the level of external public debt inter alia on the policy and institutional track record.

Being asked what their findings implied for Greece, Binder cautioned against directly transferring the numbers from his study to the case of Greece. He nonetheless conjectured that for Greece "there is a very long road ahead". Even if Greece was implicitly or explicitly granted further debt relief, financial markets would see any subsequent increase of debt as a significant threat, and it would be essential for Greece to run primary budget surpluses.