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Fiscal, economic and financial vulnerabilities implications for Euro area surveillance

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This article was downloaded by: [UNIVERSITY OF ADELAIDE LIBRARIES]On: 08 December 2013, At: 22:48Publisher: Routledge

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Applied Economics

Publication details, including instructions for authors and subscription information:http://www.tandfonline.com/loi/raec20Fiscal, economic and financial vulnerabilities:implications for Euro area surveillance

Christian Kastrop, Sarah Ciaglia, Werner Ebert, Sibylle Stoßberg & Stefanie Wolff-Hamacher

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German Federal Ministry of Finance, D-10117 Berlin, GermanyPublished online: 29 Nov 2013.

To cite this article: Christian Kastrop, Sarah Ciaglia, Werner Ebert, Sibylle Stoßberg & Stefanie Wolff-Hamacher (2014) Fiscal,economic and financial vulnerabilities: implications for Euro area surveillance, Applied Economics, 46:6, 603-615To link to this article: http://dx.doi.org/10.1080/00036846.2013.861588PLEASE SCROLL DOWN FOR ARTICLE

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Vol.46,No.6,603–615,http://dx.doi.org/10.1080/00036846.2013.861588

Fiscal,economicandfinancial

vulnerabilities:implicationsforEuroareasurveillance

Downloaded by [UNIVERSITY OF ADELAIDE LIBRARIES] at 22:48 08 December 2013 ChristianKastrop*,SarahCiaglia,WernerEbert,SibylleStoßbergandStefanieWolff-Hamacher

GermanFederalMinistryofFinance,D-10117Berlin,Germany

Soundpublicfinancesarenecessaryforthefunctioningandeconomicprosperityofacommoncurrencyunion.Thefinancial,economicandEuropeansovereigndebtcrisesrevealedthatfinancialstabilityandeconomicgrowthalsoserveasprerequisitesandthatallthreeinteractinthisrespect.ThishasmadeclearthatcontainingrelatedvulnerabilitiesandrisksinordertoeffectivelypreventseriouscrisesiscomplexandnotsufficientlyaddressedbythecurrentinstitutionalframeworkoftheEuroarea.Substantialinstitutionalshortcomingsarenowbeingaddressedbyreforms.However,inthisarticle,wearguethatfurtherinstitutionalreformsareneededinordertointegratevulnerabilityandriskanalysesintosurveillanceprocesses.Aboveall,weproposesettingupaninde-pendentexpertcouncilthatischargedwiththeevaluationofallsurveillanceprocesses.

Keywords:Euroarea;institutions;macro-prudentialsurveillance;fiscalpolicyJELClassification:E62;F36;F55;H77;H87

I.Introduction

Sustainablepublicfinancesandstablefinancialmarketscanbeseenasvitalpreconditionsforgrowth(Baumetal.,2012;KumarandWoo,2013).Thefinancial,economicandEuropeansovereigndebtcriseshaverevealedthatexistingEUsurveillanceprocesseswere–conceptuallyandinstitutionally–notcapableofdetectingandreducingfiscal,financialandrealeconomicvulnerabilitiesandrisksatanearlystage.Asaresult,internationalinstitutionsaredevelopingmethodstobettercapturesuchvulnerabilitiesandrisks1(seeIMF,2010;EC,2011;ECB,2012).Therecentlyimplementedmechanismstocopewiththecrisesaresupposedtorespondinanadhocmannertothecurrentchallengesasriskshavealreadymaterialized,andatthesametimeseektocorrectsevereinstitutionalflaws.

Inordertopreventfuturecrises,‘financialstability’2isgenerallydeemedtobeatthecentreofsurveillancepro-cesses,particularlysinceitissupposedtobethebasisforanyeconomicandfiscalactions.AstheECBputsit,

*Correspondingauthor.E-mail:Christian.Kastrop@bmf.bund.de1Weusetheterm‘vulnerability’todescribeacharacteristicshortcomingofaninstitution,actororsituationthatmaybeinherentorself-made.AbankhavingadisproportionalamountofsovereignbondsofcountryXisvulnerabletoX’sfinancialsituation.However,aslongasthiscountryrunssustainablepublicfinances,thebank’sliquidityandsolvencyriskswouldstillbelow.Hence,astheIMFsummarizes,avulnerabilityisa‘necessary,butnotasufficient,conditionforacrisis’(IMF,2010,p.8).Ariskthendescribestheextenttowhichavulnerabilitymaymaterializeunderspecificconditions,ase.g.X’spublicfinancessustainabilitydecreases(cf.ECB,2010,p.139).2AstheECB,weusetheterm‘financialstability’todescribea‘conditioninwhichthefinancialsystem–whichcomprisesfinancialintermediaries,marketsandmarketinfrastructures–iscapableofwithstandingshocksandtheunravellingoffinancialimbalances’(ECB,2012,p.5).

©2013Taylor&Francis603

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‘systemicrisk’is‘theriskthatfinancialinstabilitybecomessowidespreadthatitimpairsthefunctioningofafinancialsystemtothepointwhereeconomicgrowthandwelfaresuffermaterially’(ECB,2010,p.138).Hence,monitoringfocussesonthefinancialsystematamacro-levelwithrespecttomicro-levelfinancialsupervisionandmacroeconomicdevelopments.Wearguethattheimplica-tionsoffinancialstabilityandtherealeconomyonpublicfinancesalsoneedtobeconsidered.Theaimistointegratealloftheseaspectsinasurveillancemechanismcapturing‘systemicrisks’(BIS,FSBandIMF,2011,p.4).Also,someinstitutionalstepshavebeentaken,asforexamplethestrengtheningoftheFinancialStabilityBoard(FSB),theestablishmentoftheEuropeanSystemicRiskBoard(ESRB)andthefosteringofEuropeanfiscalandmacro-economicsurveillance.However,anintegratedframe-workanalysingfiscal,financialandrealeconomicvulnerabilitiesandriskscomprehensivelyfortheEuroareahasthusfarbeenmissing.Thisarticleaddressesthisgapbyproposingsomeinstitutionalreforms.WeaimatdetectingtowhatextentvulnerabilitiesandrisksarealreadyconsideredandwhatflawsneedtobeaddressedbyfurtherinstitutionalreformsintheEuroarea.Specifically,weasktowhatextentvulnerabilityandriskconceptscouldbeintegratedintheEuroareasurveillanceframeworktoimproveit.

Theremainderofthisarticleisorganizedasfollows.First,wereviewmethodstodetectvulnerabilitiesandrisksconsideredbytheIMF,theECandtheECB.Second,wepresentanoverviewofthecurrentfiscal,macroeconomicandmacro-prudentialsurveillanceprocessesintheEuroarea.Finally,wedevelopideasonhowtointegratevulner-abilityandriskanalysesintotheEuroareasurveillanceframework.Sincetheassessmentofvulnerabilitiesandriskshasbecomeincreasinglyimportantalsotothepoli-ticalsphere,wederiveourassessmentsandproposalsfromapolicy-orientedpointofview,whichisnecessarilymorepracticalandpoliticaleconomyorientedthananacademicone.

II.VulnerabilityConceptsandIndicatorsTheIMF’scontributiontotheIMF–FSBEarlyWarningExercise

Inreactiontothe2008/2009financialcrisisandattherequestoftheG20,theIMFandFSBcreatedanEarlyWarningExercise(EWE;IMF,2010).TheIMF’scontri-butiontotheEWEisbasedonbothqualitativeandquan-titativeanalyses.Initsquantitativeanalyses,theIMFusesavarietyofvariables,indicators,andmodelstomeasuremacroeconomicandfinancialvulnerabilitiesandrisksinindividualcountries(cf.Table1).Inordertoreachanoverallassessmentofacountry’svulnerabilities,theIMF

C.Kastropetal.

Table1.Variables,indicatorsandmodelsusedbytheIMF’sEWE

AEsEMs

Medium-termvariablesRealGDPgrowth✓Houseprices✓Stockprices✓Privatecredit

✓ConstructionsectorcontributiontoGDPgrowth✓FinancialsectorcontributiontoGDPgrowth✓

Near-termvariablesExternalsector

Reservecoverageofshort-termdebtandprojectedcurrentaccountdeficit✓✓Currentaccount/GDP✓✓Externaldebt/GDP

✓Externaldebt/exportsofgoodsandservices✓Realexportgrowth

✓Realeffectiveexchangerateovervaluation✓CGERcurrentaccountnormdeviation✓PrivatesectorexternaldebtPublicsector

Generalgovernmentbalance/GDP✓✓Primarygap

✓Generalgovernmentgrossdebt/GDP✓Publicdebtexposedtocurrencyrisk✓Publicdebtexposedtorolloverrisk✓Governmentrevenue,percentchange✓FinancialsectorInflation

✓✓Capitaladequacyratio(banks)✓✓Returnonassets(banks)

✓✓Nonperformingloans(in%oftotalloans)✓

✓AnnualchangeinprivatesectorcredittoGDPratio

✓Dummyforinstitutional/structuralweakness✓Bankcross-borderinflows(percentchange)✓Loan/depositsratio✓

Corporatesector

Black–Scholes–Mertondefaultprobability(corporate)

✓✓Returnonassets(corporate)✓✓Price/earningsratio(corporate)✓

✓Interestcoverageratio✓Debt/assets✓Householdsector

Housepriceacceleration✓✓

Stockpriceacceleration✓Householdliabilities/GDP

✓Interaction(householdliabilities)x(medium-termhousepriceincrease)✓Interaction(householdliabilities)x(housepriceacceleration

Source:IMF(2010)

Notes:AEs:advancedeconomies;EMs:emergingeconomies.

usestheso-called‘signallingapproach’(Kaminskyetal.,1998;KaminskyandReinhart,1999).Inthisapproach,historicaldataisusedtodeterminecriticalthresholdvaluesforasetofvariablesthathaveinthepastbeen

Downloaded by [UNIVERSITY OF ADELAIDE LIBRARIES] at 22:48 08 December 2013 Fiscal,economicandfinancialvulnerabilities

linkedtoanupcomingcrisissituation(cf.EC,2011,p.7).Vulnerabilitiescanbeidentifiedbycomparingthesethresholdvalueswithactualvalues.Themethodologyconsistsofthreesteps.First,pastcrisisepisodesareiden-tifiedbyapplyingasetofpredefinedcriteria.3Additionally,anumberofvariablesandindicatorsareselectedthataredeemedtohavebeenrelevantduringtheonsetofpastepisodesofthisparticulartypeofcrisis.Second,thresholdvaluesfortheseindicatorsaredeter-mined.4Third,thresholdvaluesarecomparedtoactualvalues.Anaggregatedindicatoriscalculatedforeachcountryforeverysector,andfinallyanoverallcountryvulnerabilityindicator.

SincetheEWEtriestocoverasmanyoftheIMF’smembersaspossible,datalimitationsrestrictthechoiceofvariablesandindicatorstoanalysevulnerabilitiesandrisksinindividualsectors.TheEWEisstillatanearlystageandwillbefurtherdeveloped.AnexampleofhowtheIMFfurtherdeepensitsanalysesisitsworkonfiscalvulnerabilities,andinparticulartheso-called‘RiskOctagon’(Cottarelli,2011,cf.Fig.1andTable2).This‘RiskOctagon’wasfurtheroperationalizedinthefollow-ingworksoftheIMF.5Onestrandofworkfocussedontheselectionofsuitablevariablesandindicators.Forexample,Baldaccietal.(2011a)haveextendedthelistofbasicfiscal

Table2.RiskoctagonaccordingtoCottarelli(2011)

605

Downloaded by [UNIVERSITY OF ADELAIDE LIBRARIES] at 22:48 08 December 2013 Basicfiscalvariables

Short-andmedium-termtrends:

CyclicallyadjustedprimarybalanceGrossgovernmentdebt

DifferentialbetweeninterestrateonpublicdebtandthegrowthrateofGDP

Long-termtrendsinthefiscalvariables(belongingtothefirstdimension):

PensionspendingtrendsHealthcarespendingtrendsAssetandliabilitymanagement:MaturityofgovernmentdebtSovereignbondrollovers

Uncertaintyaroundthebaselineprojections(describedinthefirstthreedimensions)

Contingentliabilities(contractualobligationsand

noncontractualcommitmentssuchasthosearisingfromthefinancialsector)

Macroeconomicassumptions(growthrate,interestrate,exchangerate)

FiscalpolicydeviationsOtherfactorsNonfiscalvariables

CurrentaccountbalancePrivatedebt

MarketsentimentorriskappetiteSource:Cottarelli(2011).

Shocksaffecting thebaseline

Macro shocks

Contingentliabilities

Long-termfiscal trends

Shocksaffecting fiscal

policy

Nonfiscalvulnerabilities

Marketsentiment

A&Lmanagement

Projectedfiscal vari-ables usingbaselineassumptions

Basic fiscalvariables

Other factors

Fig.1.RiskoctagonaccordingtoCottarelli(2011)Source:Cottarelli(2011).

Thesecriteriavarydependingonthetypeofcrisisthatisatthecentreoftheanalysis.Forexample,inordertoidentifyafiscalcrisisinadvancedeconomies,Baldaccietal.(2011b)takeintoaccountfourcriteria:ahighyearlyinflationrate,theoccurrenceofpublicdebtdefaultorrestructuring,therealizationofalarge-scaleIMF-supportedprogrammeandalargedeviationofsovereignbondyieldspreads.4Twowaystoidentifythesethresholdsareusedintheliterature:oneistominimizetotalmisclassifiederrors,i.e.theweightedsumoffalsepositivecrisissignals(typeIerrors)andfalsenegativecrisissignals(typeIIerrors).Anotheristomaximizethesignal-to-noiseratio,i.e.theratioofthepercentageoftruepositivesignals(1–typeIIerrors)tothepercentageoffalsepositivesignals(typeIerrors)(cf.Baldaccietal.,2011b).5Cottarelli’s(2011)approachhasalsobeenusedintheIMFFiscalMonitorsasof2011;duetodatalimitations,however,thisapproachhassofaronlybeenappliedtocountrygroups,notindividualcountries.

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Table3.Fiscalmonitoringindicators

Basicfiscalvariables(short-andmedium-termfiscaldevelopments)

Generalgovernmentgross/netdebt(%GDP)

Cyclicallyadjustedprimarybalance(%potentialGDP)Projectedgrowth-adjustedinterestrate(r-g;5or10yearaverage)

Long-termfiscaltrends

Totalfertilityrate(deviationfrom2.1)Oldagedependencyrationprojections

Long-termprojectionsofpublicpensionexpenditure(%GDP)Long-termprojectionsofpublichealthexpenditure(%GDP)Assetandliabilitymanagement

Currentgrossfinancingneeds(%GDP)

Shareofshort-term(public)debtasaratiooftotal(public)debtDebtdenominatedinforeigncurrencies(%totaldebt)Debtheldbynonresidents(%totaldebt)

Weightedaveragematurityofoutstandinggeneralgovernmentdebt(years)

ForEMEsonly:Short-termexternaldebt(%grossinternationalreserves)

Source:Baldaccietal.(2011a).

C.Kastropetal.

developmentsdifferingfromthoseobservedforpreviouscrises.Whileitcanthusveryeffectivelyserveasafirst‘screening’inasurveillanceprocess,itshouldalwaysbeaccompaniedbyfurthersurveillancetools.TheEC’sreportonpublicfinancesinEMU

Inits2011reportonPublicFinancesinEMU,theECanalysespossibletoolstostrengthenitscapacitytodetectfiscaldistressinmemberstatesatanearlystageandtothereforecomplementitswell-establishedlong-termfiscalsustainabilityanalysis(EC,2011).8OneoftheapproachesoutlinedinthereportinvestigatesthepotentialimpactofthebalancesheetsituationofbanksonpublicfinancesbasedontheSYMBOLmodel(SYstemicModelofBankingOriginatedLosses).9SYMBOLwasdevelopedbytheECandateamofacademicexpertsonbankingregulationandisalreadyusedtoassesstheimpactofregulationpolicyproposalsaimedatincreasingfinancialmarketstability(cf.Campolongoetal.,2011).Themodelfollowsabottom-upapproach:Basedontheestimationofdefaultrisksofbankobligors,thedefaultprobabilityofindividualbanksandsubsequentlytheprobabilityofaggregateindividualbanklossesaredeterminedforeachcountry.Oncetheprobabilitydistributionoflossesofacountry’sbankingsystemasawholehasbeenestimated,thepossibleriskstopublicfinancesderivingfromtheselossesarededucted.Thisiscarriedoutundertheassump-tionthatthegovernmentwouldcoveralllossesthatneitherthebank’scapitalnortheexistingtoolsofthefinancialsafetynet,suchasdepositguaranteeschemes(DGSs)andbankresolutionfunds(BRFs),areabletoabsorb.Calculationsarecarriedoutfordifferentregula-toryframeworkscenarios10andanumberofsustainabilityindicatorsaredetermined.Oneoftheseindicatorslinksthisapproachtothelong-termfiscalsustainabilitymetho-dologyusedbytheECinitsSustainabilityReports(cf.EC,2009).Itistheprobabilitythatacountry’slong-termsustainabilitygap(S2indicator)11exceeds6%ofGDPduetolossesinthebankingsystemandthereforeclassifiesashighrisk(EC,2011).

Overall,theSYMBOLmodelcouldbeausefultooltocomplementtheEC’straditionaldebtsustainabilityassessmentwithafocusonaspecific,highlyrelevantriskfactor,i.e.thefinancialsector.Oneofitsbenefitsis

Downloaded by [UNIVERSITY OF ADELAIDE LIBRARIES] at 22:48 08 December 2013 variablesandthenidentified13suitableones(cf.Table3).Schaechteretal.(2012)haveaddedfurthervariablesandindicatorsfromotherdimensionsoftheRiskOctagon.Inparticular,theyalsoconsidermacroeconomicshocksvis-à-visthebaselinescenarioandtheyincludemarket-basedriskvariablesandindicatorsaswellasindicatorsforspill-overrisks(cf.Table4).6Anotherstrandofworkfocussedonassessingtheoverallvulnerabilityofacountry.Inparticular,Baldaccietal.(2011b)proposethesignallingapproachasanappropriatemethod.7TheIMFhasthusdevelopedanumberofpotentiallyusefultoolsthatcouldalsobeusedforvulnerabilityandriskassessmentsintheEuroarea.Inparticular,thesignal-lingapproachcouldserveasamethodologicalframeworkofaEuroareaEarlyWarningSystem.Amajoradvantageofthisapproachisthatitsmethodologyisinternationallypractisedandrelativelyeasytohandle.However,therearealsoanumberofmethodologicaldrawbacks.First,itisneitherpossibletotestindividualvariablesfortheircon-ditionalstatisticalsignificancenortoaccountforcorrela-tionsbetweenvariables(cf.Baldaccietal.,2011b;EC,2011).Anothershortcomingisthattheanalysisisbasedonhistoricaldata.Afuturecrisismaybeprecededby

67TheIMFplanstoextendthis‘toolkit’toincludetheinvestorbasis,thecurrencyinwhichdebtisdenominatedandcontingentliabilities.Foradetaileddescriptionoftheunivariatesignallingapproachtoidentifyfiscalsustainabilityrisks,refertoBaldaccietal.(2011b).Comparedtoearlierworks,Baldaccietal.(2011a)usethebroaderdefinitionoffiscalcrisesintroducedbyCottarelli(2011).8Overall,fourapproachesarepresentedinthe2011reportonpublicfinancesinEMU.OnlytwowillbediscussedinthisarticleastheyarealreadyusedorplannedtobeusedbytheECforvulnerabilityassessment.9DetailsonthemethodologyarelaidoutinDeLisaetal.(2010).10Theregulatoryframeworkscenariosvarywithrespecttotheunderlyingcapitalrequirements,withrespecttowhetherdepositguaranteeschemesandbankresolutionfundsareinplacetoabsorbbankinglosses,whetherabail-inruleofbondholdersandnoncovereddepositorsexists,andwhethercontagioneffectsaretakenintoaccount(cf.EC,2011).11TheS2-Indicatorexpressesthe‘permanentadjustmentintheprimarybalancenecessarytomeettheintertemporalbudgetconstraintoveraninfinitehorizon’(EC,2009,p.34).

Fiscal,economicandfinancialvulnerabilities

Table4.ToolkitforassessingfiscalvulnerabilitiesinadvancedeconomiesaccordingtoSchaechteretal.(2012)

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Downloaded by [UNIVERSITY OF ADELAIDE LIBRARIES] at 22:48 08 December 2013 Short-termfinancingpressures

Grossfundingneeds(short±mediumterm)

Needforlargenewissuanceofdebttofinanceafiscaldeficit+needtorefinancelargeamountsofmaturingdebtCurrentstockofgeneralgovernmentdebt/averagedebtmaturityMarkets’perceptionofsovereigndefaultriskaCreditdefaultswap(CDS)spreadsRelativeassetswap(RAS)spreadsDistressdependenceamongsovereigns

probabilityofsovereigndistressinonecountrygivendefaultinanothercountryMedium-andlong-termpressures

Medium-andlong-termadjustmentneedstoensurefiscalsustainability

Cyclicallyadjustedprimarybalancethathastoberealizedby2020andmaintaineduntil2030toreachadebtlevelof60%ofGDPby2030bPrimarybalancein2016thatwouldbeconsistentwithstabilizingthedebtlevelintheverylongrun,inordertosatisfytheintertemporalbudgetconstraintInterestrate–growthdifferential

Growthshocks(e.g.realGDPgrowth–1ppcomparedtobaseline)Interestrateshocks(e.g.interestrates+100bpsoverthemediumterm)Stochasticsimulations:riskstopublicdebttrajectoriescSource:Schaechter,A.etal.(2012).

Notes:aTheIMFnotesthatcautionisneededwheninterpretinghigh-frequencyfinancialmarketindicatorslikeCDSandRASspreads.Inparticular,therisksmeasuredbytheseindicatorsdependnotonlyonfiscalvulnerabilitiesbutalsoonglobalandfinancialfactors.bIfthedebtlevelinthestartingyearislessthan60%ofGDP,thatlevelissetasthe2030-target.Forcountrieswithlargefinancialassetsnetdebttargetsareassumed.cThecomputationofpublicdebttrajectoriesreliesonarisk-basedapproachtodebtsustainability.

thatitsresultscanalsodirectlyfeedintothelong-termsustainabilityanalysisalreadycarriedoutbytheEC.However,severalissueswouldneedtobeaddressedbeforeimplementation,suchasquality,coverageandtimelinessoftheunderlyingdata.Furthermore,themodeldoesnotconsidertheimpactofdifferentmacro-economicscenariosandsomesimplifications,suchastheassumptionthatallbankassetsareloans,weakenthestrengthoftheresults(cf.EC,2011).

TheEC(2011)alsopresentsafiscalcrisisriskmodelbasedonthesignallingapproachandisconsideringincludingthemodelinitsupcomingSustainabilityReport2012inordertoassessrisksforshort-termfiscalsustainability.ThemethodologyismainlyadoptedfromrecentIMFresearchworkonassessingfiscalstress(cf.Baldaccietal.,2011b),butisadjustedtotheEuropeancontext.TheECchoosesanumberoffiscalvariables,buttakesonabroaderperspectivebyalsousingmacro-finan-cialvariables.Whencalculatingoptimalthresholds,theECanalysesthesamefourcriteriatoidentifyanepisodeoffiscaldistress.12Theauthorscalculatecross-countryresultsfortheindividualandthematiccompositeindica-tors(fiscalvs.financial-competitiveness)andacompositeindicatorofallvariables(cf.Table5).Overall,theEC’sconsiderationsshowthatthesignallingapproachcanbeusedflexiblywhensettingupanearlywarningsystem,

12adaptedtoaspecificregionalcontextandallowsforset-tingdifferentanalyticalpriorities.TheECB’sfinancialstabilityreview

TheECBisintenselyworkingon‘developingtoolsandmodelswhichcanbeusedtomonitor,identifyandassesspotentialthreatstothestabilityofthefinancialsystem’(ECB,2011a,p.141;seealsoECB,2011b,149ff.).Amongthese,theECB’sFinancialStabilityReviewisoneofthefewpublicallyavailablemacro-prudentialstu-dies.TheECBanalysesthecurrentstateoftheEuroarea’sfinancialstabilityanditsimpactonrealeconomicdevel-opments.Inafirststep,thereportanalyses‘macrorisks’(ECB,2012,15ff.),suchasinternationalfinancialspill-oversandgeographicalriskaccumulationsaswellasoilprices.Thefocusliesonassessingtrendsandtracingabroadpictureofthegeneralglobalfinancialsituation.Inordertoassessmacrorisks,theECBemploystwomodelsaimingatdetectingacountry’soraregion’scontributiontoglobalfinancialmarketstress.Inasecondstep,theECBanalyses‘creditrisks’(ECB,2012,27ff.)atthegloballevelinmoredetail.Creditdemandandsupplyforhouse-holdsandthecorporatesectoraswellaspublicfinancesandtherelatedmacroeconomicoutlookareatthecoreoftheanalysis.Then,theECBlooksatthefinancialsystemspecificallywithregardtotheEuroarea.Afterhaving

SomeminordifferencesexistasBaldaccietal.(2011b)setdifferentthresholdsforemergingandfordevelopedeconomieswithregardtotheinflationrate,whiletheEC(2009)approachonlyconsidersdevelopedeconomies.

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Table5.Variablesusedinthe2011ReportonPublicFinancesinEMUforthecompositionofthefiscalindexandthefinancial-competitivenessindex(EC,2011)

FiscalIndexBalance,%GDP

Primarybalance,%GDP

Cyclicallyadjustedbalance,%GDPStabilizingprimarybalance,%GDPGrossdebt,%GDP

Changeingrossdebt,%GDP

Short-termdebt,government,%GDPNetdebt,%GDP

Interestrate–growthdifferential

Changeinexpenditureofgeneralgovernment,%GDP

Changeinfinalconsumptionexpenditureofgeneralgovernment,%GDP

Old-agedependencyratio20yearsahead

Averageyearlychangeinprojectedage-relatedpublicexpenditureas%ofGDPoverthenext30yearsFinancial-competitivenessIndex

Netfinancialassets,totaleconomy,%GDPNetsavingsofhouseholds,%GDP

Netsavingsofnonfinancialcorporations,%GDPPrivatesectordebt,%GDP

Netacquisitionoffinancialassets,privatesector,%GDPLeverage,financialcorporations

Short-termdebt,nonfinancialcorp.,%GDPRealshort-terminterestrateConstruction,%valueaddedCurrentaccount,%GDP

Averagegrowthrateofrealeffectiveexchangerate,basedonexportsdeflator,ref.35countries

Averagegrowthrateofnominalunitlabourcostsoverthelast3years

RealGDPgrowth

GDPpercapitainPPP,%ofUSlevelSource:EC(2011).

C.Kastropetal.

focussesonfinancialmarketactorsandonlyconsiderspublicfinancesandtherealeconomywithregardtotheirimpactonthem.Amoredetailedanalysisofspecificproducts,especiallywithregardtotheirvolume,regionalandfinancialsectorrelateddispersion,mightbehelpfulingettingabroadviewonfinancialstability.

Inconclusion,eachofthethreeconceptsfollowsadifferentapproach.WhiletheIMFconsidersabroadrangeofvariablesinordertoissueearly-warningrecom-mendationsinitscontributiontotheEWE,theECspeci-ficallylooksatdifferentfiscalvulnerabilityassessmenttools.TheECBfocussesonfinancialstabilitywhileusingsomemacro-stress-testingmodelsandfinancialsta-bilityindicators.Whatismissingsofararesubstantivecontagionmodelsandadeeperintegrationofrealecon-omyandpublicfinancesdevelopmentsintotheanalysis.Also,theseapproachesshouldbeusedinsurveillanceprocessestoactuallypreventvulnerabilitiesandrisksfromincreasingandmaterializinginacrisis.

Downloaded by [UNIVERSITY OF ADELAIDE LIBRARIES] at 22:48 08 December 2013 III.Fiscal,macroeconomicand

macro-prudentialsurveillanceprocessesintheEuroareaAlthoughfiscal,financialandrealeconomicdevelop-mentsarealreadysubjecttosupervisioninEurope(cf.Fig.2),theirsurveillanceisnotascomprehensiveasnecessarytopreventcrises.Mostimportantly,thedifferentbranchesarenotconsideredinaninterconnectedframe-work.Overthelastfewyears,economiccooperationinEuropehasbeenfostered,surveillanceofpublicfinancesintheEuroareahasbeenstrengthened,surveillanceoffinancialmarketshasbeenimprovedandamacro-pruden-tialsupervisorybodywasestablished.Takingstockofthesesurveillanceprocesses,wefocusongapsregardingtheidentificationofvulnerabilitiesandrisksandweiden-tifyelementsthatneedtobeimproved.13●FiscalsurveillancebytheStabilityandGrowthPact

(SGP)includingthecorrespondingsustainabilityanalyses,theEuropeanSemesterandtheFiscalCompact,

●EconomicsurveillancewithintheMacroeconomic

ImbalanceProcedure(MIP)and

●Macro-prudentialsurveillancebytheESRB.

tracedthisbroadpicture,thereportexaminesfinancialinstitutionsintheEuroareafocussingontheprofitability,liquidityandfundingstructureofLCBGs,banksandinsurancecompanies.Moreover,theirinter-linkageswitheachotheraswellassovereignandrealeconomyfundingareconsideredinordertoassesstherelatedsectoralandregionalresilienceofthesefinancialinstitutionsandthepossibleregional,sectoralorspill-overeffectswithinthefinancialsector.

IncontrasttothepresentedmethodsoftheIMFandtheEC,theECBmainlylooksatdescriptivestatisticsandonlyusessomeindicatorsandsimulations.Thereport

TheEuro-Plus-PactandtheEurope2020Strategywillnotbeconsideredherealthoughonemightalsomakeuseoftheselessinstitutionalizedprocessestoimprovesurveillanceofvulnerabilitiesandrisks.Moreover,wedonotconsidermicro-prudentialsuper-visoryagenciesandtheFSBasitisnotpartoftheEuroarealevelinstitutionalsetting.Also,wedonotconsiderfinancialsupportprogrammeagenciesastheyareclearlysupposedtobetemporary.Foranoverviewandgeneralassessmentoftherecentreformpackages,cf.KastropandEbert(2009,2012).

13Fiscal,economicandfinancialvulnerabilities

ThereformedSGP

Whenassessingthecurrentreformpackagelabelled‘SGP3.0’(cf.Fig.3),14itbecomesobviousthatmajorinstitu-tionalgapsregardingthemonitoringofvulnerabilitiesandriskshavenotbeenclosed,notevenbytheFiscalCompactsignedinMarch2012bytheHeadsofStateandGovernmentasaninternationaltreaty.However,thereissomeimprovementunderthenewSGPregime,asthepublicdebtreferencevalueof60%ofGDPisnowtrans-parentanditscomplianceisenforcedbysanctions.Countrieswithdebtlevelsabovethatthresholdneedtoreducethedifferencebetweentheactualdebtlevelandthe60%-referenceby1/20peryear.ThisrequirementisbackedbytheFiscalCompactobligingtheEUMemberStates(MS)toimplementthatruleintheirnationallaws.Nationallawscanbeappealedatacourtandarenotsubjecttopoliticallog-rolling,e.g.intheECOFINCouncil.Theprincipleofabalancedbudgethasbecomecompulsoryandwillbebackedbysanctionsoverthemediumterm.Aviolationofthereferencevalueoraninsufficientreductionofthedebtlevelleadstoanexces-sivedeficitprocedure(EDP)andmoreeasilytosanctions(seeFig.3).

609

BesidespoliticaleconomicamendmentsdesignedtoimprovecompliancewiththeSGP,thequestionisinwhichrespectthecriteriaforsoundpublicfinancesandtheassessmentbytheECandtheCouncilaresufficienttocapturevulnerabilitiesandrisks.Publicdebtasapast-relatedconceptsumsuphistoricaldeficitsandinthatrespectrevealsthevulnerabilityofpublicfinancestointerestratedevelopmentsonfinancialmarkets.ThathasbeenstressedbytheIMF(Schaechteretal.,2012)andcancurrentlyberecognizeddailyinhigh-debtEuroareacoun-tries’publicfinances.Thepublicdeficitasadynamicconceptindicatestheshort-termpublicfinancerecordofanMSatthepresentandintheverynearfutureandinthatrespectcapturespublicfinancerisksonlytoalimitedextent.

However,themonitoringoftheMaastrichtreferencevaluesperseisnotsufficienttoavoidcrises,i.e.thematerializationofrisks:itisinprinciplenotpossibletocaptureallrisksforpublicfinancesinthepublicbudgetsandfiscalplansinadeterministicmanner.Withaninher-entelementofuncertaintyinprojections,thedeficitanddebtschedulessubmittedbytheMSincorporaterisks,explicitlyorimplicitly,onlytoalimitedextent(risksstemmingfromtheeconomy,financialmarketsorpublic

Downloaded by [UNIVERSITY OF ADELAIDE LIBRARIES] at 22:48 08 December 2013 Euro Area Surveillance Processes

Public Finances

Fiscal Compact

SGP

European Semester

Real Economy

MIPEuro-Plus-PactEurope 2020

Financial System

European System of Financial Supervision, ESFS

Micro-level

NaƟonal Supervisory

Agencies

EIOPAEBAESMAJoint CommiƩee of

ESAs

Macro-level

ESRBInternaƟonal Co-operaƟon: FSB

Financial Support Programmes (EFSF, EFSM, IMF, ESM)

SGP: Stability and Growth Pact; MIP: Macroeconomic lmbalance Procedure; EIOPA: European Insurance and OccupaƟonal Pensions Authority; EBA:European Banking Authority; ESMA: European SecuriƟes and Markets Authority; ESA: European Supervisory AuthoriƟes; ESRB: European SystemicRisk Board; FSB: Financial Stability Board

Fig.2.Euroareasurveillanceprocedures–institutionaloverviewSource:Owndesign.

‘Six-Pack’:Regulation(EU)No1173/2011;Regulation(EU)No1174/2011;Regulation(EU)No1175/2011;Regulation(EU)No1176/2011;CouncilRegulation(EU)No1177/2011;CouncilDirective2011/85/EU;‘FiscalCompact’:TreatyonStability,CoordinationandGovernance;‘EuropeanSemester’:ECOFIN-CouncilPressRelease13161/10,07/09/2010,Foradetailedassessmentcf.KastropandEbert(2012).

14610

New Fiscal and Economic Surveillance System

More effecƟve SGP

Besides the deficit criterion, the debt criterion becomes obligatory

Obligatory reducƟon of debt, by 1/20 per year of the difference between theactual debt level and the debt level criterion

Budget must be balanced or in surplus (over the business cycle), defecƟons can besancƟoned (although the deficit is below the 3%-criterion; ‘prevenƟve arm’)Euro area countries need to submit an interest free deposit 1 month aŌer theopening of an EDP (COM’s recommendaƟon can be rejected by the Council’s OM)Besides fees, the Council can cut off a country’s funding from EU funds

NaƟonal planning and reporƟng cycles synchronised; the MS’s budgets and policiesare reviewed over 6 months in order to idenƟfy emerging imbalances

New process to monitor and correct macroeconomic imbalances (focus on currentaccount balance), similar to SGP

C.Kastropetal.

EarlierQuickerMore complex

Downloaded by [UNIVERSITY OF ADELAIDE LIBRARIES] at 22:48 08 December 2013 Europ. Semester

MIP

SGP: Stability and Growth Pact; MIP: Macroeconomic Imbalance Procedure

Fig.3.NewfiscalandeconomicsurveillancesystemintheEuroareaSource:Owndesign.

finances).Also,theyarerarelycalculatedinaprudentmanner,e.g.withrespecttopossiblespill-overeffectsfromtherealeconomy.ThisconceptuallackisnotlimitedtothenationalbudgetoftheindividualMemberStatebutisalsovalidfortheprojectionsoftheEC.NeithertheMSnortheECshowasufficientdegreeofprudencewhencalculatingGDPfiguresorpublicdeficits.Thatabsenceofaprudentcalculationnecessarilyincorporatesanelementofvulnerabilityofthepublicfinancesagainstnegativeshocksaspublicbudgetslackadequateroomforman-oeuvreincaseofrisksmaterializing.

Fromtheperspectiveofpoliticaleconomy,thesurveil-lanceframeworkshowssevereweaknessesastheobliga-tiontomakerisksexplicitisnotestablishedandbudgetarysurveillancelacksclearincentivestocalculate‘prudently’.AlthoughtheEuropeanSemesterstream-linedprocessesandgivestheECmoreindicativepowerinthenationalbudgetarycalculations,itisfarfromclearinwhichrespectrisksforpublicfinancesoftheindivi-dualMShavetobemadeexplicitorhowsafetymarginshavetobecalculatedintheprojections.TheoverrulingpoweroftheCouncilhasbeenreducedbythenewvotingrequirementofreversedqualifiedmajority;thustheECisnowinchargeofenhancingthepreventivemonitoringofnationalbudgetpolicies,e.g.byaskinganMStoresub-mitabudget.

Inthecorrectivearm(EDP),MemberStatesarerequiredtocommittodetailedconsolidationandadjustmentmea-sures,whichcontainelementsofprudenceagainstrisks,withcompliancebeingmonitoredbytheECandthe

MIP and the Excessive Imbalance Procedure (EIP)

Warning

Deepenedanalyses

COM analyses risksmore specifically,taking SGP reportsand ESRB

recommendaƟonsinto account

Result

In case of excessive imbalances:

EIP opening by COM and the ECOFIN CouncilCorrecƟve AcƟon Plan (CAP)

plan and implementaƟon is monitored byCOM and the ECOFIN Council

more than two defecƟons to the deadlinesor requirements will lead to sancƟons (SGP-like procedure)

Scoreboard:

idenƟfy countrieswhich indicatorvalues are higher orlower than the EUaverage; COM’sreport need to beapproved by theECOFIN Council

Fig.4.MacroeconomicsurveillanceandtheexcessiveimbalancesprocedureSource:Owndesign.

Fiscal,economicandfinancialvulnerabilities

Council.Assanctionsimposedonindividualstateswillbetriggeredinamore‘automated’way,theinstitutionalset-upshouldsubstantiallylimittheleewayforagenerousinter-pretationoftheprovisions.Nevertheless,asimilarbindingprocedureatanearlystage,wheretheriskofanegativefiscaltrackrecordcanbeavoided,isstillmissing.ThisiswhytheEuropeanHeadsofStateorGovernmentlaunchedtheFiscalCompact:buildinganinstitutional‘fortress’againstexactlythesepoliticaleconomyproblemsandasastepforwardtowardsafiscalunioninthespiritofastabilityunion.BasedonthemodelofGermany’sconstitutional‘debtbrake’,theEurocountriescommittedtoimplementarrangementsforbalancedbudgetsintheirnationallaws.Infuture,thecyclicallyadjusteddeficitisnotallowedtoexceed0.5%oftheGDP.Thisshouldensurebudgetsclosetobalancewhilefiscalpolicycanactcounter-cycli-callyandthusreduceeconomicvulnerabilities.

Takingalong-termperspective,themonitoringofrisksforfiscalsustainabilityispartlycoveredintheEUpro-cesses.Adetailedreportingframeworkhasbeendevel-opedbytheEconomicPolicyCommittee(EPC)oftheEUtogetherwiththeEC,andtheageingaspecthasbeenintroducedintothemedium-termobjective(MTO)frame-work.Thelong-termpressureonpublicfinancesisaddi-tionallytriggeredbyarecurringno-containingeffectineconomicupswings.WhatwasconceptuallycorrectedinGermanybytheintroductionofacyclicallyadjustedMTO(despitestillopenissues,cf.Ebert,2013)hasunfortu-natelynotbeenimplementedinEuropecredibly.TheestablishmentofMTOsandtheirstrictenforcementoverthecycleremaininawayunfinished.Theintegratedmacroeconomicsurveillance

UnsustainableeconomicdevelopmentsintheEuroareademonstratedthateconomicgovernanceinEuropecannotsolelyrelyonfiscalmonitoring.Aspartoftheso-called‘Six-pack’,theCounciltogetherwiththeECaddressedthatproblemanddevelopedanewprocessforpreventingandcorrectingmacroeconomicimbalances,takingupele-mentsoftheSGPinthedesignoftheMIP(seeFig.4).15ThenewsurveillanceandenforcementmechanismisbasedonArt.121.6oftheEUTreaty.Theprocessisframedandtriggeredbytheso-called‘alertmechanism’,whichaimsatdetectingpossiblyharmfulimbalancesandtheneedforpreventiveorcorrectiveactions.TheMIP’spreventivearmallowstheECandtheCounciltoadoptrecommendationsatanearlystage,beforeimbalancesbecomeexcessive.TheExcessiveImbalancesProcedureasthecorrectivearmcopeswiththeproblematiccases.AnAlertMechanismReportisdiscussedintheEurogrouporintheCouncilfollowedbycountry-specificin-depth

1516611

reviewsbytheECasonepartoftheintegratedsurveil-lanceundertheEuropeansemester.Atthecoreofthenewprocedureisascoreboardof10indicatorswiththresholdsindicatinginternalandexternaleconomicproblems(cf.Table6).Twoindicatorsaimatmonitoringexternalposi-tions,threecaptureeconomiccompetitivenessandthesubsequentfivereflectinternalimbalances(EC,2012).16Basedontheaverageofpastdata,anin-depthanalysisrevealsifimbalancesarepresentorlikelytooccur.

Theflawsoftheseprocessescanbeseeninthefactthatthemacroeconomicsurveillanceisbydefinitionback-wardlooking.Thereisnoexplicitfuture-orientedviewonmacroeconomicdevelopmentsalthoughthealertmechanismissupposedtodetectimbalancesthathaveaclearlong-termdimensionearlyenoughtocounteract.And,whilethescoreboardcoverseconomic,fiscalandfinancialsectordevelopments,thespill-oversbetweenthethreespheresaremostlyneglected.Furthermore,thereisnocommonunderstandingofhowthelinkbetweenfinancialandmacroeconomicissuesshouldbeaddressedbysurveillanceprocesses.Finally,wefaceaseriousimplementationgapas,despitethesevereeco-nomicturbulencesintheEuroarea,theMIPinitsfirstyeardidnotclassifyanycountryashavingexcessiveimbalances.SuchweakpoliticalpressureatthestartoftheprocedureraisesthequestionwhethertheMIPframe-worktrulyhasthenecessarybite.

Macro-prudentialsurveillance–theroleoftheESRBAccordingtotheregulationestablishingtheESRB,

[t]heESRB’staskshouldbetomonitorandassesssystemicriskinnormaltimesforthepurposeofmitigatingtheexposureofthesystemtotheriskoffailureofsystemiccomponentsandenhancingthefinancialsystem’sresiliencetoshocks.(Regulation(EU)No1092/2010,whereas(10))

Downloaded by [UNIVERSITY OF ADELAIDE LIBRARIES] at 22:48 08 December 2013 TheESRBanalysesthecurrentmacro-financialsituationandadvisesEuropeanandnationalbodiesonhowtofosterfinancialstabilityintheEU.TheBoardconsiderspublicfinancesandrealeconomicaspectsforthispurposeaswellasnegativeeffectsofthefinancialsystemontherealeconomy.TheESRBistheEU’smacro-prudentialsuper-visorybody.ItgathersEuropeanandnationalsupervisoryauthorities,centralbanks,theEC,theEuropeanSupervisoryAuthorities(ESAs)andtheEconomicandFinancialCommittee(EFC).TheECB’spresidentisalsotheChairoftheESRB.TheECBplaysastrongrolewithintheESRB,althoughtheESRBissupposedtoconsidernotonlytheEuroareabutthewholeEU.TheESRBisdesignedtoworkindependently,thusmustnotdemand

Notallnewelementsofthatprocesscanbereviewedhere;wefocusontheelementscapturingrisksandvulnerability.Thescoreboardandinparticulartheissueofcurrentaccountsurplushadbeendiscussedintenselyamongpoliticians.

612

Table6.CoreindicatorsoftheMIP’sScoreboard(EC,2012)Three-yearbackwardmovingaverageofthecurrentaccountbalance,%GDP,threshold+6%to–4%

Netinternationalinvestmentposition,%GDP,threshold–35%Five-yearpercentagechangeofexportmarketsharesmeasuredinvalues,threshold–6%

Three-yearpercentagechangeinnominalunitlabourcost,thresholdsof+9%forEuroareacountriesand+12%fornon-Euroareacountries

Three-yearpercentagechangeoftherealeffectiveexchangeratesbasedonHICP/CPIdeflators,relativeto35other

industrialcountries,thresholdsof±5%forEuroareacountriesand±11%fornon-EuroareacountriesPrivatesectordebt,%GDP,threshold160%Privatesectorcreditflow,%GDP,threshold15%

Year-on-yearchangesinthehousepriceindexrelativetoaEurostatconsumptiondeflator,threshold6%Governmentsectordebt,%GDP,threshold60%

Three-yearbackwardmovingaverageoftheunemploymentrate,threshold10%Source:EC(2012).

ortakeonorders.TheESRBprovidestheESAswithrelevantmacro-prudentialinformationandreceivesrele-vantdatafromtheEuropeanandnationalsupervisoryauthorities.Beyondthat,theESRBcollectsmacro-leveldataonregionalandsectoral(e.g.betweenfinancialmar-ketactors,products,markets,theeconomyandpublicfinances)interlinkages(cf.DeutscheBundesbank,2012,29ff.).TheESRBformulatesrecommendationsandtherespectiveaddresseeneedstoinformtheESRBandtheEuropeanCouncilaboutstepstaken.TheESRB’smainworkisconfidential.AlthoughtheESRBissupposedtobeasupervisoryagency,itmainlyservesasanadvisorybodysinceitdoesnothaveanyenforcementinstrumentsatitsdisposal.

IV.InstitutionalFeaturesofanImproved

SurveillanceFrameworkfortheEuroAreaAsthecrisesmadeclear,vulnerabilityandriskanalysesarecrucialtodetectingunfavourabledevelopments.Europeaninstitutionsaretryingtofillconceptualgapsbymoderatelyintegratingvulnerabilityconceptsintotheexistingsurveillanceprocesses.Whilefiscal,economicandfinancialstabilityhavebeenaddressedbytherefinedandnewlyintroducedprocesses,theystillhaveconceptualshortcomingsandtheyarenotsufficientlyconnected.Thefollowingconceptualelementsandinstitutionalexten-sionswouldimprovethesurveillanceprocessesanalyti-callyandincreasetheireffectiveness.Conceptualelements

TheshortcomingoftheSGPandtheMPIcouldbeaddressedbyindividuallyextendingeachoftheprocesses

C.Kastropetal.

bydeeperanalysesandbyconsideringthemcomprehen-sivelyandtogetherwithmacro-prudentialsurveillancetools.

Medium-termprojections.Both,theSGPandtheMIP,workintheshortterm,whereassustainabilityreportingislong-termoriented.Inordertocapturecurrentvulnerabil-itiesandriskswithregardtofutureprobabledevelop-ments,anadditional,medium-term-orientedstrategyisneeded.Onewaytouncovertherisksfacingfiscalsustain-abilityinstitutionallycouldbebycreatingareportingandmonitoringframeworkinadditiontotheSGPframeworkandthesustainabilityanalysis.Suchaforward-lookingmedium-termanalysiscoveringaperiodof10–20yearswouldhavetheadvantageofbeingmorepolicyorientedthantheverylongtermsustainabilityreportingandamoreeffectiveearlywarningtoolthantheveryshorttermorientedSGP.TheECisplanningtoincorporateamed-ium-termprojectionintoitssustainabilityreport.However,integratingitintoasurveillanceprocess–andnotjustreportingaboutit–mightfosterthesurveillance’s,foremosttheSGP’s,effectiveness.

Safetymargins.Themedium-termprojectionscouldberefinedbyintroducingsafetymargins.AnambitiousshiftoftheSGP’sanchor,theMTO,fromdeficittosurplusrequirementsseemsindispensable.Fiscalrisks–notonlystemmingfromageingsocieties–callforaprudentsafetymargintoincreasetheresilienceofpublicbudgetsagainstfuturechallengesandshocksandinordertoaddressthefiscalchallengesofthedemographicchangeahead.TheMTOshouldbeorientedtowardsacyclicallyadjustedbalancedbudget.Notonlypublicdeficitsbutalsodebtlevelscouldbeassessedmakinguseofsafetycon-siderationsdependingontheindividualcountry’scontext.Forexample,the60%-Maastrichtreferencevaluemightbetooweak.Safetymarginstothis60%-thresholdbasedondetaileddebtsustainabilityanalysesmayresultinallowinglowerdebttoGDPratios.Inserioustimes,adjustmentsshouldrequireevenstructuralsurplusesinordertodecreasethepublicdebtlevelatleasttotheSGP’sandFiscalCompact’s60%-threshold,toregaincredibilityandincreasescopeforactiontoprepareforfuturechallenges.Thatistrueevenmoreasthemajoreconomieswillfaceadramaticpressureonpublicdebtevenundersignificantbudgetconsolidationscenariosfol-lowingthecurrentSGPrules(DBResearch,2011).Inthatcontext,itshouldbeensuredthateconomicandfiscalforecastsareconductedbymoreprudentcalculations(lowerconfidencebounds,referredtoassafetymargins).Anearlywarningmechanism.Thetwoproposalscouldtranslateintoanearlywarningmechanism.ThismechanismcouldbuildontheworktheECundertakesregardingfiscalvulnerabilitiesandtheenhancementofthe

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IMF’sEWEforEuropeanpurposes.FiscalsustainabilityshouldbeatthecoreofthenewmechanismtoeffectivelycomplementtheEC’scurrentsurveillancemandateforpublicfinancesandeconomicimbalances.Themechan-ismcouldaddfinancialandrealeconomicindicatorstotheanalysesinordertoassessvulnerabilitiesandrisksstem-mingfromtheseareasforthepublicfinances’sustainabil-ity.Also,themechanismcouldbeenrichedbycontagionandspill-overmodelssimulatingthematerializationofrisksinspecificcases,andbymodelsthatcarryoutamoreprofoundriskanalysisforcertainimportantriskareas,suchasthefinancialsector.Acountry-specificapproachbytheECcouldalsoinfluencethedeterminationofcountry-specificsafetymarginsandcountry-specificmaximumdebtlevelsallowedintheSGP.Hereby,theECshouldespeciallydifferentiatebetweenthedifferentchallengesandresponsibilitiesofthosecountriesthathavetheEuroincontrasttothosewhohavenot.Itcouldbediscussedwhetherresultsshouldbemadepublicornot.Ontheonehand,someofthedatausedareconfidential;ontheotherhand,onlypublishedinformationwilleffectivelyworkaspeerpressure.

Copewithspill-overs.TheEuroareaeconomiesfacestrongspill-overeffects,notonlyfromtherealeconomybutevenmorefromtheeffectsofthefinancialsectoronthegeneraleconomyandonthefiscalsector.Therefore,itiscrucialtoimplementmechanismsthatexplicitlyaddresstheseaspects.Inordertokeepaclear-cutmandate,theSGPisnotsupposedtoincorporatesuchanalyses.TheMIPalreadytriestoassesseconomicspill-overeffects.However,itfocussestoomuchoncurrentaccountimbal-ances.Sofar,spill-overeffectsbetweenthethreemen-tionedareasarehardlycaptured;anearlywarningmechanismandrelatedsimulationscouldmakeupforpartofthat.Further,aprocessshouldbeestablishedthatlinkallindividualprocessesconductedbythedifferentinstitutions,includingmacro-andmicro-prudentialsuper-vision.UndertheEuropeanSemester,representativesoftherespectiveinstitutionsshouldconductstresstestingandcontagionmodelsimulationsonaregularbasis.Resultsshouldtranslateintoinstitution-andcountry-specificrecommendations.Inordertokeepresultsandrecommendationsasfrankaspossible,resultsshouldnotbemadepublic.Whetherrecommendationshavebeentakenintoaccountshouldbeevaluatedintheindividualsurveillanceprocesses.

Institutionalreformcomponents

Europeancommitteeonsupervisorydataanalysis(supervisorycommittee).Theconceptuallackofcon-sideringspill-overeffectsismirroredbytherespectiveinstitutionalshortcomings:whileproceduresandrelatedinstitutionsavoidtakingspill-overeffectsintoaccount,

613

onlyanintegratedapproachconnectingallsurveillanceprocesseswouldbeabletoaddressvulnerabilitiesandrisksintheEuroareaservingasa‘fortress’againstfuturecrises.Therefore,aEuropeanCommitteeonSupervisoryDataAnalysisshouldcomplementallsurveillancepro-cessesasatechnicaladvisorycommittee,conductingtherelevantanalysesandsupportingtherespectiveinstitu-tionsasanadvisorycommittee.Thecommitteeanditsmembersshouldbepoliticallyindependent.Membersbeingappointedfor,e.g.sixyears(max.twoterms),bytheresponsibleEuropeaninstitutionsshouldhaveastrongdataanalysisbackgroundandbesupportedbyanade-quatelylargestaffedsecretariat.

TheCommitteewouldconductdifferenttypesofana-lysesonfiscalsustainability,bothshort-andlong-term.MostofitsworkwouldtargetanalysesregardingEuropeanlevelsupervisoryschemesliketheSGPandMIP,buttheCommitteecouldalsobechargedwithmacro-prudentialanalysessupportingtheESRBorwithexamin-ingEuropeangoalssuchasoftheEurope2020strategy.Thereby,asregardsthestructureinFig.2,theCommitteeshouldbeinstitutionallyindependentfromexistingpro-cessesbutcansupportallofthembydataanalyses.Itwouldbeasimpleadvisorybody,hence,therespectiveEuropeaninstitutionswouldkeeptheresponsibilitytodecideupontheuseoftheanalyses’resultsandthefor-mulationofrespectiverecommendations–e.g.regardingtheSGPandMIPandthedefinitionofexcessivedeficitsandimbalances.Nonetheless,theCommitteeshouldmakeresultspublic(e.g.SGPandMIPforecasts)andtherebyimplicitlyputpressureontheECandthenationalgovern-mentstotakethemintoaccount.Onlypublishedinforma-tionorthethreatofinformationbecomingpubliccoulddisciplinecountriestoactaccordingtotherules.Inordertodevelopthenecessarydesignfeaturesofsuchanewsurveillanceinstitution,wecanbenefitnotonlyfromtheexperiencesobtainedinHungary,whereanindependentFiscalCouncilwaschairedbyGeorgeKopits(2012;cf.DebrunandTakahashi,2011;Nyikos,2013),butalsofromotherindependentbodies,suchasintheNetherlandsorSweden,whichhelptocontrolpublicexpenditure.Integratedsurveillanceframework.Aspointedoutinthesectionabove,anintegratedapproachisneededtoeffectivelycapturespill-overeffectsandtherelatedthebuild-upofvulnerabilitiesandrisks.Therefore,allrele-vantinstitutionsshouldconveneonaregularbasisandexchangeinformationandevaluationsoftheirrespectivefieldsofaction.TheEuropeanSystemofFinancialSupervision(ESFS)couldserveasanexample.Moreover,tocomplementthesupervisionrelatedtofinan-cialvulnerabilitiesandrisks,amicro-prudentialsupervi-sorybodyaspartofapossiblebankingunioncouldbeestablished.Also,thiswouldprovidemoreinformationonrealeconomicdevelopmentsandregionaldispersionsofa

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financialinstitution’srisksduetofundingofpublicbodies.Thiscouldfostertheassessmentofspill-overeffectsbetweencountriesandamongthefiscal,financialandeconomicfieldsandhelptodetectcontagionchannelsandrelatedvulnerabilitiesandrisks.Suchanintegratedframework,atleastwhenitcomestoassessingfuturerisks,couldleavetheestablishedcorrectivearmsuntouchedasitmightbeappropriatetoleavetheprocessesseparatewhileassessingpossiblefuturerisksinamorecomprehensivemanner.

V.Conclusion

TheEuropeanconcepts,institutionsandprocesseshavetoensurethatnotonly‘expectedrisks’butalsounlikelyorunknownrisksassociatedwithaglobalized,highlyinte-gratedworldorrapidlyevolvingcontagionriskscanbedealtwith.Thecrucialtaskofsuchanextremescenariotreatment,prominentlydescribedbyTaleb(2010),istobuildrobustsystemsandbeingabletoexploitpositiverisks.Asthefinancialandsovereigndebtcrisishasshown,financialmarkets,therealeconomyandnottheleastpublicfinances,areveryvulnerabletohazardousBlackSwaneventsandexposedtowelfarelossesbeyondthosepredictedinstandardmodels.

Atthesametime,itisquiteobviousthattherewillneverbeacomprehensiveearlywarningframeworkoverseeingallfactorsandtheirinterplaythatpreventsfinancial,macroeconomicandsovereigndebtcrises.However,thecurrentframeworkcanbeimproved,andtherearenowelementsavailablethatcouldservemuchbetterasearlywarninginstruments.WhentheSGPwasdesignedinthelatenineties,itsdesignwassolelyfocussedonfiscalstability.Somecountrieschosethispathsuccessfully,butonlyuntilthecrises.Thebasicthinkingwasthatrequiringfiscalstabilitywouldmotivaterelatedpolicies,suchasstructuralreforms.Consideringonlythedeficitcriterionandneglectingthedebtcriterionandothermacroeco-nomicandfinancialmarketindicators,shapedanarrowunderstandingofwhatinfluencesfinancialstability.Atleastnow,politiciansknowthatallthementionedele-mentsplayarole,andthatthesettingofallthreediffersbetweencountries.Accordingly,thecurrentEMU’sinsti-tutionalframeworkhastobeenhancedbysomeinstitu-tionalelements.Apartfromthat,methodsandmodelsshouldbecontinuallyassessedandimproved.Betterwaystoassessdataandtodefineindicatorsneedtobefound.Considerationofpoliticaleconomyandeffectivecommunicationdemandsthatmethodsandprocessesbekeptsimpleandtransparent.Inanycase,methodologyshouldnotsticktoanideologicalschool–suchasneo-classicalorKeynesianconcepts–butshould‘useanyrodtocatchthefishnotdiscussingwhethertherodhastobewoodorKevlar’.Furthermore,itwouldbeenrichingto

C.Kastropetal.

findawaytokeeptheinstitutionaldesignopen,asa‘self-learning’structure,sothatitadaptseasilytochanginginitialconditionswhilestayingthesameduringdifferent‘seasons’.Alotmorework,especiallyregardinginstitu-tionaldesigns,shouldbeundertaken.

Acknowledgements

TheauthorsthanktheparticipantsoftheBdFconferenceandinparticularAntónioAfonso,RüdigervonKleistandWilliamBruntonforfruitfulcommentsonthesubject.Theopinionsexpressedinthisarticlearetheauthors’personalonesanddonotnecessarilyreflectthepositionsoftheGermanFederalMinistryofFinance.

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