lessons from the ongoing European debt crisis it was easy to pick the subject a few months ago Francesca I thought that this would be a topical you know argument for discussion and indeed there it is we have a trip analyst with the strongest credentials in a powerful mix of academic excellence and polish experience on the subject I would like actually to start thanking them profusely for setting our invitation and being here sometimes taking time from a very busy schedule in the middle also the teaching period so they deserve a warm tanks they need no introduction let me just point to them we have lorenzo pinna smacking to my right now at Alvord he has been as you know in the exact member of the executive board ECB long experience in the central banking a subject on which has written profusely always providing an academic perspective on the policy-making process and especially challenging the academics about coming up with a bien sûr models for the process and to my right i Ken Rogoff and Guillermo Calvo I put them together as the two most one of the most influential matter economies in the last decades that you know I’ve literally shape our way of thinking about many many problems both as academics and for the policymakers the topic discussed today we’ll go from issues from the debt crisis in particular we are interested in knowing how the events in the Europe in the last year’s have change or should change the way we think about sovereign debt crisis both as applied you know a Buddhist academics and policy makers what bit were parts of the intellection foreign policy tool kids we need to revise what are the novel features that we face maybe because of the specific features of the economy’s OECD economy is part of the monetary union or because of fundamental changes in the winter national capital markets are working so this would be our opening salvo and then we’ll go a more specific into the model of adjustment for Europe and perhaps other question about fiscal austerity fiscal compact in other emerging topics the organization of the panel we are one hour and a half I will be strict interrupting questions when i opened the floor because we want to have many questions so please if you have ideas or question keep it short or 22 minutes the most so that we have a wealth of questions and answer I would be tough on the on the panelists to so that I’ll try to keep everybody within the time we’ll have a first a couple of rounds without opening the floor and after the couple of rounds I opened the floor for a further question from the audience and and then we go Guillermo Calvo first who is using some slides and then Lorenzo and can next and we live like a seven minutes of an opening I will I will try to keep you in what let me know when there are two minutes left I’ll handle it okay so our first speaker is again thank you very much and Carlo thank you for inviting me also Francesco caselli I is quite challenging to say in a few words what you think is essential to to the discussion so I had to be a little bit short but hopefully we’ll be able to come back to questions later on so let me let me make some opening shot type of statement the very beginning I mean has no the the word emerging market has become very popular and the idea is that there are new markets they’re very few people seem to realize that that’s what it meant and so if there are new markets you had to be able to model what that means when I look at at Europe and not all countries in Europe but Europe as us

as as an area at this point you also find out that the financial markets have been developing and having held the same problems many of the same problems that were common in emerging markets so that’s why in principle if you would if I want to think if I thought if I would do advise anybody to start thinking about these issues I think it’s a good starting point to begin with a view that you are dealing with an area with emerging markets and maybe you will learn something from many experiences in emerging markets properly speaking and one of the things that is common to the to the standard model that we use is that we assume that the markets are there so if you start that way there’s no way you can really capture the essence of the problems that’s my main say academic message to this now one concept that I think is useful although it’s very elusive very slippery is a concept of liquidity something that mainstream macro obliterated completely if you are familiar with a mainstream say New Keynesian models moneys out there as an appendix is not central to to the shock start with this cut the shocks come from the real sector and not from the monetary or the financial sector so again if you start with those models there is something very important missing when I look at the experiences and I had to just mention this happy to go back and discuss it I see the Brady boss in 1980s as developed in the bond market in emerging markets I see the eurozone and the creation of the of the euro as creating new liquid acid that’s an issue that I don’t think we focus at all because we were obsessed with the optimum currency area as spell out by Mandel many others where the emphasis was on on other aspects nothing to do with the creation of money and say superficially you realize that by inventing the euro all of a sudden the pizzetta banks the leader banks and the drag my bars were able to issue reserve currencies to some extent and on top of that with the support of the European Central Bank and liquids the instruction events like that is the Russian 1998 cases which is very very interesting recommend that you look at it if you haven’t because it’s an accident that happens in the corner of the world and affects everybody so it’s very hard to say because of fiscal deficit or this or that maybe that has something to do with the vulnerabilities of the countries but not necessarily by by with a with a with the origin of the problem and also subprime crisis as we all know where these days he started at the dark corner of the world economy and spread out in ways that are not easy to rationalize if you work in terms of a standard normal now what’s the evidence about the quiddity creation that I can bring up and that requires a lot more research but we have to get ourselves in the mood if you wish of thinking about liquidity creation something that in our models we just have em there it’s already being created we say it’s very difficult to understand but it’s out there and that there is no more discussion but here what central is that liquidity is being created that says an asset that were not liquid or acceptable that means of payments are being greedy so what what can I show that has that characteristic that suggests that something like that is going on is that some of these flows and we talk a lot about flows and southern stops and so on are actually x direction you have outflows and influence which is typical of money if you have money and you divide any any area any city in two parts we see that man is going one way or the other constantly so you have influenced allows us constantly so that is a characteristic the other one is that the flows both the net flows and the gross blows keep increases until the crisis happen so of course you can always rationalize that but saying that the market is deeply irrational well yeah maybe that’s the explanation maybe it’s animal spirits who knows but but but if you think of this as a processing which liquidity is being created then it’s quite possible that it’s becoming more and more popular but the liquid is being created without a lender of last resort and we know from all theory that if you have a situation like that then the

system is proud to have attacks backgrounds and so on I had to to speed up because time is running running short this is evidence this is for many emerging markets and you see the growth flows the net flows go in the same direction and increasing towards the peak where the Graduate takes place and then then collapsing after what is in together for the father for the Eurotas our profile portfolio flows this is when the euro is created and you see the flows increasing in both directions in several countries for the current account again for for here you have Spain and Italy to problem areas you see that it’s being deteriorated towards a in the run-up of the crisis and then going back so so the system is about to have hit without a lender of last resort that we didn’t have to have that kind of very familiar kind of crisis now central bath what have we seen when for emerging market there was no global central bank available and they took many years for this Marcus to go back to normal when you look at the advanced countries now you see that there was a problem yes around Lehman but then central banks came back very quickly so just to show you one graph this is a measure of the risk interbank risk and you see how it shoots up and then it comes back very very quickly when the central vas go back into the action so central banks play a key role here which is what you would expect if liquidity is the problem so so to qualify finishing in one minute I’ve also less so the issues now that we are going to discuss here is easy money tight fiscal this is what we are seeing here in in Europe we know we have bad experience about that in in other countries in Latin America particularly but there is a big difference now is something which is quite intriguing which is that some people have been computing safe assets in the world and showing that actually those safe asses collapsed after after Lehman this is a full of about thirty percent so what does suggest is that maybe there is a scarcity of safe assets that’s why I interest rates in the US and even his ecv interest rates are very low because of scarcity of those types of assets so that if central banks are able to issue those assets that may not be so inflationary as we tend to think when we don’t take into account that there’s been these type of crisis taking place so so maybe there is more room for quantitative easing the some work that Giancarlo has done now about these issues this is the last month problems and tightly fiscal I would be a little bit leery about it because in a situation where you still have a credit crunch student it’s not an aggregate demand issue that I’m going to raise if there is already clear crunch increasing taxes to the private sector set ourselves that don’t have access to credit could deteriorate to see very seriously the situation and with this I finished thank you thank you so much already many things on the table Lawrence well first of all thank you very much for inviting me I’m squeezed between two academics or three academic so I and the first round is about being provocative in order for the others to answer so I’ll try to put a lot of questions to my colleagues on the table and try to explain why we addressed as policymakers and as former policymaker the crisis maybe with not enough tools not enough analytical tools to tackle all the problems we were facing as policymakers and I think the current policy makers also may not have a full understanding of the complexity of what is happening in the euro area which by the way is in the middle of a global financial crisis and many of the problems which we had to address in the euro area were similar to problems that were faced elsewhere and which were the result also have not fully understanding certain issues let me just give you an example we head into euro area parts parts of the euro area affected by bubbles which

were the result of probably prolonged periods of very low interest rates something which we saw somewhere else of course around the world which was the result probably of not fully understanding the impact of protracted low interest rates and the impact on financial markets incentives on risk-taking behavior and so on so forth since then some literature of course has developed but in the context that was certainly not not fully understood probably those who were thinking about the euro area and how it would develop thought that sooner or later some of the problems deriving from lack of competitiveness of some areas unbalanced growth and others kind of disequilibrium that were arising in the US which leads to some problems that would lead to some kind of smooth adjustment or law prolonged adjustment and not many thoughts that this adjustment would have to take place in an abrupt way in the middle of a global financial crisis and on top of that I think something which was probably underestimated is that Europe and your area remained a sum of national economies in particular for the banking system many many who look and compare the u.s. to the euro area often look at the fiscal the fiscal side and the amortization and the absorption of shocks that goes through the fiscal system and the fact that you have a federal fiscal Authority and not many look instead of the impact of the markets and in particular the structure of the banking system which makes it you know the case that if you state in the u.s goes bankrupt the bank’s not necessarily the banks of the state itself and and the banking system in general does not go bankrupt because there was no link between the banking system and the state itself or series of reason and that I think was very much underestimated in the euro area and it was one of the hard lessons to learn and I would like to focus mainly on the current situation right rather than on the past the current situation how to address the crisis and maybe going forward incidentally the first years of EMU led to developments which were rather different from what many experienced I remember discussing with the poor Krugman who was fearful he was fearing that EMU would lead to reduction of growth in the periphery he was taking Finland as the main example have concentration of industries to in the corridor the system in fact if you think about the crisis that we had in Europe it’s a crisis which derived largely from too much growth too much unbalanced growth in the periphery countries like Ireland Spain even Greece unbalanced growth and excessive goes in the catching up labor management which which which came at the midst of a financial crisis so in when it came to managing this crisis many reactions and you have em you try to interpret the reaction of policymakers many reactions were due to the lack of knowledge and the lack of President thinking that this time was different maybe from the past but it’s true that looking at Europe maybe some things are different and let me just give you a couple of examples 1 is was a whole issue about contagion I mean clearly contagion within the euro area with something that we touch every day when something happens in Greece you immediately see spreads moving all over the world of place but to what extent would a catastrophe a local I catastrophe spread to the rest of the euro area that was something very difficult to understand and the Lehman Brothers case of course was an example which led the policymakers in Europe to be very fearful to go to an experiment like letting a bank fail or letting a country out of the euro area so the lack of understanding of and from that point of view are not in the academic world really helped us very much because it’s these markets in which we are living in are just so complicated and you always have to remember that policymakers have to take a decision in one way or the other so if they don’t take a decision by definition they take a decision so the alternative as always to be to be weighted so one of the problems have been the understanding of how financial markets work and how contagion spreads from one case with the other the another

difficulty in addressing the issue in particular in Europe and I think that was one of the problems in our discussion with the many academics is that they looked very often at the experience in Latin America the Latin American debt crisis and how that was sold to the Bradys bonds and other type of measures which were substantially different actually from what happens from the situation in Europe because in Europe large parts of the debt is held within countries so restructuring the debt or even defaulting or even in some cases changing the currency regime has an impact on the country itself more importantly maybe than the countries outside so the problem of Greece for instance and the problem of excess debt of Greece was not so much a problem of German banks or French banks or other banks it was a problem of the Greek banks and the Greek society and do we want to risk having a major economic and social collapse in Greece and that was another concern that policymakers head we should didn’t really know how to address because there were no precedent and of course people looked at Argentina but the analogy between argentina and greece did not always hold the other difficulty of course is to have a major crisis in an advanced economy in a democracy in which many people understand the problem only when they see the crisis looming and in the euro area probably the crisis was perceived and seen by the people much more quickly in Athens in Rome or Madrid than in Berlin because the economy was much better so the understanding of the type of measures which were needed was was much more difficult and that’s a novelty because we are used to think about managing crisis within political entities were creditors and debtors have the similar perception of the problem which was not the case in Europe were clearly creditors and debtors have a different had a different perception because the underlying economic situation in their own place was different so going forward there are still many issues I think that policymakers need to tackle without maybe having many clear answers one of them is the balance for instance between fiscal austerity and monetary expansion I think he ever mention this but we are discussing issues which seemed to imply that multipliers are bigger than one in the sense that a fiscal tightening leads to increase in the debt to GDP ratio and that’s not what at least I learned in the textbook at least in enclosed economies like the euro area is and that’s that’s one of the problems I think on which we need to better understanding clearly it’s easier if you devalue but even without the valuation the balance between fiscal and monetary should entail some kind of restriction if you want to adjust especially if you have lost market access when one second the same for monetary policy I think there is an understanding of the interaction between monetary and fiscal institutional terms that is the the impact of a moral hazard the more the monetary policy does the more it takes away pressure from the fiscal to do the kind of adjustment he needs to take to achieve the kind of sustainable equilibrium and that’s another very complex debate and discussions that policymakers have to solve final issue that anything in my view is underestimated both by policy makers and academics in Europe is the role of banking as long as banking we remain national it would be very difficult for monetary policy to address some of the issues that year Murray mentioned already that is to really implement a single monetary policy which produces its impact on the economy because of the credit risk which is is is there because of the National supervision because of the National Taxpayers which ultimately responsible for national supervision so that’s another complexity in Europe that we need to tackle also through better ideas of how to solve some of the problems I don’t know can you hear me hear me out of yeah this might be once working have a pleasure to be here in Cambridge and to speak on the side just panel on this interesting topic I’m not going to start out on the conjuncture all issues I want to focus in on the academic question of is there a theory of the optimum currency area i have Modell’s paper here it’s called theory

of optimum currency areas and often i saw in the academic literature and others does this region meet the criteria of an optimum currency area and i would say that in fact there’s certainly no consensus theory there are a lot of interesting work this isn’t something that’s been molded that’s been developed to the point where there’s any kind of consensus on what those criteria should be in just to follow the intellectual history the mandela paper in many ways and even if you read it carefully talks about having an optimum currency area not just about reforming currents areas but a way think about exchange rate regimes it was very fresh a little bit impish but very fresh way of looking at things to sort of well if you really think stabilizations of the core of it why are you drawing the line at countries maybe it should be regions within countries maybe it should be across countries and it has a very eloquent discussion of stabilization issue is unemployment inflation which actually has a very modern tone to it it’s really quite remarkable in that respect by the way the idea of labour mobility which is the one criteria that he really hasn’t it actually he cites Mead and Scott oski for saying that of course I was a rude adorned by a student who emphasized me that everything is in mead it’s just you can’t understand it and so my Dell says the problem with me is he takes it too literally it’s not something that’s absolute and he looks at adjustment mechanisms but there’s nothing there it came later on a lot of other issues Peter Kenan maybe eight or ten years later brought in the idea that there’s no risk sharing adjustment mechanism if you don’t have a common government you need some mechanism for fiscal transfer cannon really didn’t take up the point that if the fiscal transfers are big you need political legitimacy across the Union to decide who’s going to make those fiscal transfers others talked about further issues just to name a couple ob’s felled in his graham lecture maybe 20 years after that talks about the lender of last resort and he by the way mentions that garber and folk respondent landau had said something about that earlier as well although he’s talking about lender of last resort for private institutions not necessarily for governments lorenzo talked about regulation that’s clearly something very very important having a common regulation we had an empirical literature trying to play out with sort out these very basic ideas for example sacks and sally martine had an estimate about how important all transfers were within the United States as a burden a risk absorbing mechanism I must say one of the answers that my some of my European colleagues who were somewhat evangelical about the Euro because of the spiritual ideas that under underlie it say that well that’s okay we can do that with capital markets they can provide the cushioning well okay that’s another criteria you could have really really developed capital markets and you can decide if we do there’s a very fine piece of empirical work was by the European Commission this book you’ve probably heard of but maybe not looked at many of you called one market one money it’s if it is a very fine piece of work looking at the state of the art in each of these things but but actually they can’t come up with much they’ve been sat on the task of finding an empirically important reason within what they can find from the optimum currency area literature and the biggest thing in it is that they say well it’s expensive to do accounting in different currencies of course now it is that you just push a button and that’s really not an issue coming back to these ideas you know these intermediate ideas of what does labor is if it’s labor mobility what is that does that mean everyone’s a citizen of Europe they can go anywhere they want take any transfers they want do we talking about China where I’m not going to pronounce it right but you need a Haku to you know go to the city and work except your kids can’t get educated and you can’t get health care what does it mean labor mobility what exactly do we mean by that so I wouldn’t say that we don’t have a literature there’s wonderful papers on this but you know looking from the very theoretical to the more empirical but there certainly wasn’t a consensus now I think maybe everyone knows that but if

you you know if you asked where did it stand in the economic community on should we you know have a single currency are we ready for that I would have said looking at Europe there was big literature and the overwhelming answer was no that it’s premature at least on that broader scale with that many countries and I this is also a forward-looking comment of the challenges ahead and just a couple more points i mean the debt crisis I think Guillermo made a very good point that there’s a way and winter it’s a lot like an emerging market debt crisis in fact I’d say it’s a lot like an exchange rate based Stabilization program works for many years interest rates come down big private credit boom boom blows up I mean it looks an awful lot like that so far I mean a different end game perhaps because the exchange rate can’t appreciate and you know at the same time it’s true with Lorenzo said that the the financial crisis which started in the United States really shook things up europe europe didn’t get time to mature on the other hand a system has to be robust stuff happens you can’t set up a system that’s only works if nothing happens and and you know if it’s it’s it’s a calm year or not if we think about the system going forward I would say just to be provocative I mean you could throw out the periphery countries not that that’s going to happen necessarily but you could throw them out have France and Germany if they don’t form more of a political union much more of a political union than they have with a real finance ministry that create that that has the right to take in a lot of taxes they have voting for people they actually you know care about as being the leaders if Europe there will be other problems really in the next 20 years and it will not survive if they don’t do that I I think Mendell laid out this very interesting and provocative question I think oh it clearly he brought in the idea that a lot of things are in flux we need to you know show the economic side of it but I think it’s very clear that there are these other elements on the political side that require more than more than we have at the moment and that’s I think the challenge going forward very good thank you very good thank you so much there is quite a bit of material on the table so let me start by visiting some reaction immediately before going later to broader audience there is a small question which is in the analogy with emerging market crisis and the European crisis there is one aspect that is interesting the fact that European markets European countries have an original see the issue that in Euros is no longer you know it’s basically foreign currency from the perspective of each country but there is no balance of payment constrain literally so because of the ECB basically as a byproduct of ACB financing the interbank market so I wonder whether you want to comment on that particular difference in the in terms do you want the questions were a pronto would you prefer to go here tomorrow I am the moderator so let me pick up on with more question before we go to the big questions that they can at least at the end raised yeah and and you’re exactly right that the emerging markets faces were a supreme a problem because they didn’t have a lender of last resort that came forward so quickly although they had some helpful from from the IMF and institutions of that sort but it was not the lender of last resort type of help it just came when the crisis was really very serious now that different in a certain way help this country to solve the crisis in a more sweety way because there was nothing they could do the government was part of the problem so they had to abandon the system and as a result the chain rate went up inflation went through the roof and that help to

solve certain domestic problem the real wages for example felt like a rock so there’s no good news for the workers as anybody but from that point of view but from the point of view of fiscal accounts for example the adjustment was the very quick the disadvantage was not having a lender of last resort but that helped to also take care of social benefits for example that inflation just liquidated very quickly let me let me make so inflation and the inevitability of inflation I think tend to solve the problem certainly they have this original same problem which is the one you mention about that win denominated in a foreign currency but after you did after a bit devaluation becomes much easier to argue that you cannot pay back so for some country was obvious and in Argentina 2001 that there was no way you could enforce that especially because there were many domestic debt denominated in foreign exchange so the big mess in a certain sense help to you know focus on on a couple of things and get going and actually a gin Tina since I mentioned it was able to recover without credit actually with the balance of payment with current positive current account all along and he went back through very speedy recovery for other reasons too and to mention another different without a end is that when you look at the emerging market part of the recovery of these countries was help because of the big devaluation but they were facing a well the rest of the world was advanced countries that went through a period of relative boom great moderation and so on so they could hitchhike on the rest of the world and in our sample for example expose increase after the crisis by about twenty-five percent when you look at that in Europe or in the u.s exports are basically flat there is a very nice people re option throw some time ago linking the adjustment problem to the insularity economic in stroller economies I guess you remember in which basically if I remember correctly the issue of smooth adjustment of shocks becomes less less not smooth as a story because less less likely the more economies have you know faulty lines between them that can be for jurisdiction so I actually would like to throw back this question to both of you which is I guess you know you have a skeptical view about the survival the euro but before that there is a question of how which aspect of insularity is going to play a major role now and what kind of adjustment one can think he may happen in the next yeah I wanted to come back to some of the questions that can pose to explain how easier it is to be an academic than a policymaker in the sense that he because he asked you know easy euro-area an optimal currency area and he said the overwhelming literature led to the conclusion that it is not and probably most people would agree but that’s not a question policymakers ask the policymakers ask what is not an optimal but a sustainable exchange rate or monitoring regime for Europe so they’re not cannot look only for the optimal they have to do something concrete in reality and they went to the history and after the Bretton Woods crisis they try to do things and clearly a fully floating exchange rate regime was not optimal either and what probably was less optimal deaths so they went to trying to reduce volatility through this exchange rate mechanism which were not optimal also if you want to liberalize capital movement so the choice of a policy makers is much more complicated for second or third based and clearly crisis come and ensure that it’s not optimal but maybe it’s less worse than others but then I agree with him that in order to make it a bit more optimal or a bit more sustainable or closer to the optimal you need to do things and it’s clear that the euro was born on the assumption that first the only possible crisis would come from the fiscal instead of the real economy and maybe as basically assuming that it would be no crisis so the crisis came and you had to start fixing things in a quite

cumbersome way and it’s true that in order to fix things you need the political integration and unless there is a willingness to take some political decisions in particular to redistribute income and to create a shock absorber you you will fail so the key test is whether Europe is willing to take the kind of political decisions in order to fix the problems but that’s what happened in the u.s. also and to some extent when you say why don’t you throw some countries out it would make life easier I don’t know how things were addressed in the 18th in the 19th century in the u.s. whether they were thinking about throwing away Carolina or other states but it strikes me that for instance the Fed that was created only in 1914 so the you had a monetary union without a central bank now today people would say this is crazy but the learning by doing process is part of the building up of institutions and I think we have to realize in Europe that that’s part of what we are trying to do to learn and by mistakes and of course we could be quicker I would agree with that but without making the mistakes people don’t understand what you need to do certain things I mean some people in the US are putting into question the same existence of the Fed more than nearly a hundred years after which shows how complex it is to build political consensus around institution but I think that’s the kind of exercise we are doing in many many years after and you need crisis i think they created the Fed after a few banking crisis in the US and they realize of course that you need the lender of last resort that’s the same thing we are we’re trying to do here and what i consider just to conclude important is that ultimately the political will to do these things comes ultimately from the people and the people on the ground and the fact that the Greeks ultimately have voted time after time very late of course in with a very complicated process but devoted to stay in the euro is is a testimony of this willingness to progress so I would be a bit more optimistic about the fact that we are trying to do something similar to what the US did 200 years ago in a different way of course because crisis are different and I much more complicated to solve yeah provocative enough again well I mean one obvious thing is I i think that europe’s not nearly there on its political integration and you’re inviting the retort that a much bigger crisis must be coming so that you can have the political union that ultimately would make it stable with either the whole or some subset of states i want to make one other backward-looking comment which is one of the reasons the euro was formed was a dissatisfaction with exchange rate volatility which policymakers never liked but it was also inflation and a feeling is particularly in Italy and in France we haven’t figured out what to do in with inflation the German sure seem to have done it why don’t we just tie ourselves to them and that was the transition the truth of the matter is is I think the advent of independent central banking went a long ways towards solving that problem everywhere and had Europe not adopted the euro but had gone in this other institutional direction I don’t think you’d have high inflation in Italy or France today without the euro and and of course there is the question of the political side of it the Trenton European the cut the common market is a great idea at least you know up to a point and to the extent the euro helped catalyze that that’s fine but you know part of the reason Greece is so enthusiastic about staying in the euro is it’s sort of subtly threatened with being thrown out of the European Union if it leaves the euro which doesn’t need to be the same question but from ultimately their sustainability day you know there is a practical question now that the euro was conceived as you know a way to worse some stronger integration that was a one-point question there was a debate in desi be no boat Marissa will say why do we need the paw you know what is the minion constitutional if I can say you have to go to the people because ultimately is a citizen to the side and when you tell the people we need to create monetary union because we have problems in the exchange rate volatility and so forth in the end they said yes we understand this okay if at the same time you would have said that we’d also fiscal Union most of the people said why

do we need that what kind of our problems are we solving then ken would say yeah but if you don’t do that once you have a crisis you will get into trouble but most people will say well let’s see maybe maybe not now we have a crisis and and you go to Germany and you see several people in Germany who say well maybe we have to think about your bonds we have to think about transfers you know we have a problem to solve and you know let’s solve it I think that’s the way our democracies work they to see the problems in order to solve them most people didn’t think about tarp before the crisis they voted top by the way I think they eliminated now the possibility to make it so easy for the future because also in the US people don’t transport itions but but I think that’s the way our democracies solve problems they need to see the problem they need to see the alternative which is probably disastrous and then they are convinced to take the unpalatable decisions which which are taken in a very cumbersome way but that’s that’s the way I see the progress towards this kind of political union which is which is difficult but it’s happening I see a parallel between Europe this type of discussion and emerging markets in a major market was the issue of sequencing were to open first the trade account of the the capital account more in general should you have a free financial system if you still have problems in the commercial arena say in the in the real part of the economy and and the the experience there was very much against opening at the financial account first and then tried to wheat that I was a hope for a while going looking back to the 1980s was a hope that by opening up the capital account completely then that would sort of discipline the real side of the economy and politicians and then they will open up the rest of the economy well that was much more trickier than than than they thought now the lesson that was learned from that is that if you’re going to liberalize the financial system which is what a GT native a beginning in 2001 then you have to be very careful with the financial system and subject your banks to very strict regulation and that they did actually this is not the place to discuss a case of Argentina that went out of the system very badly but not because of lack of regulation of the back is it there was other problems on top of that and when you look at the recent Lehman episode for example and you examine these countries many of which are somewhat pegged to the dollar what they have done after the crisis that they subjected the the banks too much stricter conditions so you find very few banks in the region that had toxic assets and consequently they could recover they’re actually boom in these days for other reasons too but maybe if it is a lesson that what I would draw from that is that to the extent that you don’t have the real side including the fiscal political arrangement etc maybe you cannot afford to have a very free financial system maybe reserve requirement should be higher maybe bank should be subject to much stricter rules that has all kinds of problem because you have the US on the other side and you may lose competitiveness in the financial sector but maybe that’s the price to pay may take just a minute if you look on 92 93 the largest the last but one crisis in Europe there are remarkable similarities to today we have been a growing imbalance over time a common shock at the time was the German unification a mess for many months maybe perhaps it was the exit was basically coincided with a new macro framework or resolution or framework this country went for that inflation targeting together with Sweden the others went for the euro with the growth and stability pact basically reinforce their what do you think it would be the way forward I mean you have to talk about sabbatical from the euro a or what would be the new macro framework I do you think it is also like an implicit question about the fiscal compact I guess in this what is the hope for Europe to go ahead in the process of you know maintaining the single market maintaining an area of economic prosperity in my view what what’s missing in the current discussion is a recognition that the imbalances were

made mainly due to private sector and in particular the fact that banks the banking systems have remained national and in my view if we want to move forward with a better functioning monetary union economic union we need a European banking system as long as we’d have a national banking system national shocks will become capital account shocks not only current account shocks and it would make it much more difficult to finance them and in order to to have a European banking system you need European supervisory system and you need a European bank resolution system like this within the euro area and that’s an issue on which I would like to see also more work in the academic sector the link between monetary and banking and how complementary they are so that’s I think the progress we need to make because the fiscal punk compact is only one dimension of it and it’s basically a strengthening of the previous stability and growth pact but we are missing the you know what makes a capital account work better i think ken said that the evangelicals were answering to the shock absorber question we will have the capital markets absorb the shock affecting one part of the euro area the point is that we all assume that capital markets always work and we realize in this crisis the capital market sometimes don’t work and so we need to fix that in India where well first I second what Kira mosa I think it may well be that you know in the foreseeable future Europe’s gonna have to rein in its capital markets in or in order to preserve the euro I don’t know that that’s a good trade by the way you know that it depends on how far you have to go that’s a question it certainly wasn’t raised in the optimal currency union literature much till now so I you know I think that’s that’s an important question but if you if you go to talking about having eurobond if you talk about going to have a euro banking system it’s a very hard to do this in a sustainable way without political legitimacy following I don’t see how you can keep 17 independent countries the way they are without having a significantly closer federation than what’s talked about now I mean with the fiscal rules and such which the mazda treaty it’s sort of the mazda treaty reinforced and the monster she is very clever although unfortunately it didn’t look at the private debt it only looked at the public that the private dot often implicitly becomes public and maybe having a european banking system would be a step towards that but you know i just don’t see robustness in the system without going one way if i can take another minute one of my my favorite analogies for this whole thing and forgive me that this is too extreme but you have a couple they can’t decide whether they’re going to want to get married or not so they say let’s open a checking account together to see how it works and actually it doesn’t work so bad so they say well how about my brother and your sister share the checking account and that works and then they start bringing in second cousins third cousins they’ve never met and well you know and maybe they ultimately have to ultimately have to get married because of all the lawsuits against the two of them but it’s it’s very much annex you know that’s extreme but it’s an experiment like the saying you don’t we do this there’s no choice but to get married ultimately we want to go to political union which is part of part of the project but that has to come in I i ah I agree you need crisis to force the public to want that if they want that Britain opted out when they had to at least for a long time when they had their crisis but it’s coming back to the mandela article that I brought a theory of optimum currency area he poses the question does the currency have to have anything to do with the national border and I think that we’re filling in the answer to that which is a resounding yes just to threat to even the playing field if you start from the other end floating exchange rate that’s also very risky I mean we are looking at the experiences recent experiences of the Swiss franc and the norwegian krone and that led me to take a look at what happens in

reserve currencies if you at present international reserves around the world represent around thirty percent of em to supply in Europe and in the United States and even a large share of the short term that in in in those countries so there is a new player in the world the central banks and we have not factored that in and the central bank is a completely different player and they have people who will reshuffle the currencies for for purely financial financial reasons so there could be I don’t know if it break up the Union I don’t know what’s going to happen there could be a southern switch in favor of the of the new euro and therefore a tremendous appreciation and maybe the others will sort of shadow the new Europe so you may end up having a system that since we are dealing with money and we know that from first principles that man is in principle hell no fundamental began so you need some something to to keep them uncle so if we just say we just break up this union and that some of them go we without an ankle and we won’t have an encoding the show run because we don’t know how the new system works you can have a lot of non fundamental in equally that way volatility that may lead to reap egging and he may lead to all kinds of problems having to do with the real sector so I’m a little bit worried about taking this sabbatical oh I’m not advocating the Euro break up i’m making the point that if it’s good we’re not going to have like a much worse crisis you have to go forward to a much deeper union now within that context when you think of a much deeper union I think it does raise the question of how expensive it should be a political decision that’s a cost benefit thing but that questions been carefully kept from the public because they don’t want to particularly in the northern European countries don’t really want to think about the fact that they may need to allow much more fiscal transfers more labour mobility more govern and sharing that they’re not they don’t want that and yet they may not it may not have a choice I don’t know very good so we had the comments for a shadow in some radical rethinking of European policies financial market do they say very solutions of the euro we are now half an hour for open questions there should be microphone somewhere and I’ll ask everybody to be extremely short so that we can collect the number of questions I can actually see I wonder whether you could have some more light in the audience’s oh I can see people raising their hands francesco Cassetti thanks quick question on the auto currency area issue i think the statement that the euro area is not an optimal currency area it’s very hard to deny and to debate so i think we have pretty much all agree on that but i wanted to probe the further statement which I think was implicit in some of the comments that the Greek crisis which is the crisis started is a direct consequences of the failure of the criteria of the alternate currency area sorry I can sit on your faces they cannot quite hear me is that correct statement the implicit statement that the crisis the debt crisis in Greece is stems from failing to meet the criteria of the optimal currency area if you look at just the sequence of events you have a government that for about 10 years can borrow at the same rates as the German government and I think we can all agree that interest rates being higher we will probably have seen a more sustainable fiscal behavior in Greece so then the question becomes why where interest rates so low in Greece over this period and i think the inevitable answer is

that markets were assuming that they would be available in case of a crisis so nothing to do with too much to do with the standard criterion of the ecology areas is more about markets for me an expectation and the transportation then not being realized exposed so the obvious question is what what would happen where would we be now if it had been possible to credibly signal to markets that the bailouts were not to be expected in case of crisis yes so just going back to in a sense what policy is now derma calvo did mentioned the the current policy of fiscal tightness and lots of money printing historically hasn’t had the great results but it does seem to be what everyone’s doing not just in Europe in the US and in the UK so just wondering maybe if one if you’d care to comment a bit more on that but also experience in emerging markets from the Bradys russia one could argue iceland not so much emerging market although maybe again at the moment is that default does work and shouldn’t shouldn’t that be may be encouraged with portugal and italy and spain and so forth as a way to resolve the crisis at the moment do you do you hear me can you hear me yeah did you hear me loud and clear yeah but the question is as us and attempt to solve the liquidity problem the European Central Bank like the Federal Reserve in the US have severely expanded the monetary base could you comment on could you comment on the way out how would the European Central Bank eventually the reserve reabsorb that expansion of the monitor base without raising interest rates start from the point that low inflation and zero growth is far from being an optimal situation given this I wonder to what extent Europe must still understand that public debt is not so different from private debt in a full integrated market so that the idea of bailing out national governments that are indebted should be discarded and in order to remove the constraint that today forces government to apply hyper austerity which leads in my opinion to self within self-defeating zero growth accepting the idea that one public body can issue bonds that are not saved by definition but they have they have some degree of risk much like any other private issue could be an element that helps governments and even central bank to accept the idea that the market is integrated but this does not mean that there is a unique interest rate apply to everybody because the riskier issuer has to pay higher interest rates stop here with this questions anybody which to go first 5 10 I can why don’t I take up a couple and then I could come back so Francesco asked what does Greece problem have to do with the euro and to a first approximation it’s just your basic exchange rate based stabilization problem they could have had their own central bank pegged at the euro interest rates come down they borrow like crazy looks like 25 other countries and it

blows up very common pattern as Guillermo highlighted in this discussion of course it’s in the end game that you have the problem there are differences so there’s of course no exchange rate to depreciate to create competitiveness which is the normal way out of this and I think that is a huge question lurking over Europe and it doesn’t just have to do with debt it has to do with global forces with Asia and other things that have created a very uncompetitive periphery where wages need to adjust your labor needs to be mobile or something and the I think the size of the wage adjustments needed are profound in some of the periphery countries it has to do with the fact that there’s a bigger bludgeon that Greece can be hit with because it can be kicked out of the European Union which is a huge penalty and when we study sovereign default which I think we understand a little better than optimum currency unions that that isn’t usually they’re in the same way you can’t really credibly threaten to cut a country off from trade in a big way and then finally I can remember if it was a dare mo or Lorenzo that mentioned that there’s the contagion issue because there’s always contagion when if Argentina defaults is always contagion but it’s much more because there’s so much symmetry across the problems that countries face Portugal faces very similar problems to Greece less extreme but very similar if you look at the benchmark that Carmen Reinhart and I external that public that Portugal looks good only next degrees I mean it doesn’t look good by historical standards and some of the other European countries don’t don’t look so well either there was a question about this default work yeah i mean i think there’s clearly going to be default here and how much it swept under the table it’s done through financial repression and behind the scenes taxes how much of it is outright restructuring reigns to be seen and it’s different in different situations but certainly if you don’t do outright restructuring and get it over with quickly some way this is going to be painful for a long long time if I just ask this move adding person do you see the full more frequent besides the euro I mean one of the more frequent the gift from the class is the fact that we have an increase in public liabilities explicit and contingent worldwide so this the full question would the full be a less pathological situation apart from the usual because that is enough I mean if the United States would default it would be fantastic for the sales of our book but I don’t I don’t I don’t think it would be I don’t think I don’t think it’s particularly likely I mean there was a technical default for sure in the nineteen thirty three by the way which is sort of written out of the history books to some extent but if you’re looking at the big countries what Carmen and I find in our work and our continuing work and I guess she spoke he recently is slow growth happens after afterwards when debt gets these high levels that but there’s a lot of countries besides the big countries and where data is I certainly don’t think we’re done with saying sovereign defaults here like a sovereign sorry then an interpretation then as the long tangent but I think in the big country is the most likely thing as a long period of slow growth with a mix of different half-baked approaches to it maybe on reserve was a question on the ECB well at least one of the issues of the papers that I found helpful during the crisis he is a pool paper 1968 on our 68 69 I think it helps understanding why central banks have to expand the balance sheet when you have a portfolio shift like the one we experience and how difficult is going to be to reabsorb liquidity in theory it’s not so complicated you just have to issue paper to reabsorb the liquidity to some extent in the ECB case given that the liquidity is provided on demand by the banks the banks will as the economy improves and as the portfolio shift goes back towards risky assets then it will be less demand for central bank money and this will help reabsorb the excess liquidity the question was can you reabsorb without increasing rates why don’t you need to increase rate at a certain point they will be the need to increase rates and this will contribute to reabsorb the excess liquidity so I I don’t see a

problem with having both on the issue of who who should assess the viability of and the risk of public debt I think that we have we wanted a system in which markets would play a role in assessing a national debt risk and it didn’t work and I don’t think it will work and I don’t think it would be a system which is sustainable in political terms and I think in the end if we want to move towards greater political integration I don’t think we can let the markets the burden of assessing whether the debt is sustained of a country sustainable or not I think it has to be the task of the political authorities and that’s what they have not fully understood yet they have not understood that finance ministers when they sit at the table they don’t have only to define their own fiscal position they have to make sure that the fiscal position of the others matters and they have to act in a way that that can change the fiscal policy of the other members of the union if needed and when they started not to do that anymore in particular in 2003 when European finance ministers decided to accept some leeway for Germany and France then they stopped to provide this kind of fiscal discipline which is necessary when the crisis comes to then provide financial assistance because ultimately and that’s the difference with emerging markets at try to understand if a government default the debt of somebody is an asset of somebody else and in our economies the assets are largely held by the banking system and by residence so a default in 1980 bi bi bi latin america was a problem of american banks it was not a big problem for for the Latin American countries except for the to some extent the contagion and except from the loss of market access for a few years but the the wealth effect was largely in the US and that was dealt with through forbearance and other special issues in the case of Greece we have seen that part of the savings that was achieved by through the haircut of the debt had to be compensated by new capital injection Patel injection to avoid the collapse of the financial system in Greece and the same would happen of course in other countries so the redistributive effect that you have through a massive devastating impact of a default is really something that will have a real economy impact so I agree which can we will have low growth in order to absorb but the alternative of default if it is a hard default could be even more devastating and I don’t know to what extent you I haven’t read that in your book but what is the political implication of default and and and the social implication of the fault it’s something which I’m agree is very interesting i don’t know how many democracies survived defaults not not maybe not that many i mean defaults like the ones that that if we were really need to cut that so the issue goes a bit beyond economics in my view if you if you if you have a major social and political disruption in europe then I think we are facing something totally different that we have we to think seriously bounds very much for the printed larezo made about the financial system being the responsibility of everybody in the Union in any Union and and what I would like to point out is that may be something that we should convey to the politicians is that and that part of the over-indebtedness problems that we are facing now I partly due to the fact that they liberalized the financial system they didn’t realize they we everybody mostly did not realize that we were creating a monster that capital was going to Spain and other countries that are in big trouble now partly because it was his liquidity thing that they have this new access to the capital market we view that in fact as a very good development many people thought of that as a better reallocation of capital and so on and so forth and we miss completely the fact

that we were creating that on the basis of something that had very weak bases we didn’t have the structure to sustain it we thought and this have been said several times in this panel that the capital market was going to be our friend that was a lesson that they could have learned from emerging markets but they felt actually I discussed that in Europe before the crisis and it was very clear that many economies very central bank said well this is very different because we have the ACB and so on and so forth and it’s a matter of just issuing a little bit of liquidity and everything would be fine obviously that we are not there so Francesco brought up the case of Greece and I guess your question was partly if they had met the master each conditions for example would we would they be out of this problem I don’t think so because Spain met those conditions and the over-indebtedness took place in the private sector not in the public sector now they have nationalized much as other probably they will doing that in the future so I see that as a result of this new access to to credit with a sort of very very very weak institutional basis at at the heart plus the fact that and sometimes this is not brought to the fore clearly as he should that there were new instruments that have been created like mortgage-backed securities that made transfers and credit to certain sectors than the like real estate magician and that’s why the cost of doing that went down and that can partly explained the real estate boom that obviously collapse when all of these instruments were were attacked so there is an element here that is not just crazy over-indebtedness that taking advantage of a certain condition because I mean there are two take two to tango right as we know from the south and and so Greece or was able to get great at very low rates what were the banks thinking and there was this issue of liquidity if you want to give it at that name trust that I had probably very little to do with Greece but with something else so in this I think it’s a message that politicians should get often so that they they get into action without thinking that in bailing out the country of belly you are our economy you are really giving away something that they don’t deserve now there were some questions connected with that one is about money supply my supply absorption it depends on how you think about it I mean that could be a problem but if you if you take a look at the chart that I showed very briefly here were safe as it seemed to have contracted by about thirty percent and it is a study by Barclays based on a work by golden economies in Yale and they define a concept which is safe assets very close to liquid assets and they claim that there was a contraction of thirty percent and then they look at how that supplier safe assets will increase if the deficit continued that the present levels in the EU and in in the United States and which would create more of those assets and you still find that after I don’t know ten more years you are still below the levels that they have achieved in two thousand and before two thousand eight well that’s an issue for further for modeling what happens when they find out the safe assets aren’t safe well that’s it work that’s exactly what happened that’s why this easier I don’t have an answer but the issue is well so that’s the possibility that they will be an unraveling is there I don’t know where the money is going to go I mean don’t tell me they travel to go out it went to gold but that’s not good enough for for a means of payment in a regular economy to the extent that prices are set in terms of dollars or sentence of viewers now if we change over to a system where prices are set in terms of gold then the dollar and the you will be in trouble so it so that does that’s my opinion my humble opinion

but in any case so that the issue is certainly there is an issue that the sum of those expansions may have to be unraveled if they have in the one answer that I would have looking at this evidence is maybe they don’t have for a long time so as I said I think it’s something that this was conceived but if they have then it’s going to be a mess because it’s not going to happen just in an orderly fashion I mean somebody will invent something all of a sudden and we will shift to a new system now what is the Fed think in these days well they want to pay interest on reserves well once again imagine Marcus is a good example that especially Argentina and Brazil they try that and that’s what’s a kiss of death because if you have a fiscal problem and you start paying interest on money you have dead in the water so and if this happens very sudden and there’s a lot of trust lack of trust in the currency then then you’re in real trouble so if if unraveling should take place I things can be very complicated thank you we are justified for two questions there is a hand up there up in the meanwhile let me just ask a very quick so imagining a world in which indeed we create the European safe asset likely remote talks and we integrate the banks the way on Lorenzo talks and we do the political union and allow for the fiscal transfers like ken asks for we’d still left with an underlying problem Europe of very large productivity differences since two thousand unit labor costs in Germany grew thirty percent less than in Portugal or Spain but that’s actually not a problem of the Euro it’s not a problem of integration of capital markets if you look between 1990 and 2000 yeah you see exactly the same pattern of just a very divergent productivity growth and unit labor costs in Europe is it do we have an answer on how to even have a consumer going back the applicants union but now from the real perspective when we have twenty-third year old and long and perhaps even more productivity differences across different regions that require real exchange rate adjustments and that’ll lead to crisis and they’re floating rates as we had in the 80s and 90s enter crisis under a fixed rate or under thermal currency with that and so on as we had to thousands but how do we handle an awful currency area when we have 30 years long with just very large part of any differences systematically across regions with the system now that it seems to me that I mean that’s an academic issue that you can have two parts of a monetary union with divergent productivity growth rates which are can be sustainable to the extent that wages grow in a different pace which is much more difficult to accept within a country if you have the same Union so that’s not sustainable in a country like Italy maybe where you have systematic fiscal transfers it may be most acceptable say between Italy and Germany but only to the extent that wages in Italy don’t follow wages in Germany but they follow the productivity and so I don’t know if this is consistent from an academic point of view from from analytical point of view but I it seems to me that this would be a problem only if we start having European Union’s negotiating wages but if if the labor markets remain segmented you just need a discipline of which is not easy because unions in the South may be going to look at what happens in the north but but to the extent that you have a lower with a rate of growth of wages that sustainable method I just make an observation when we look at the inflation differentials after the Euro creation of the Europe Greece is 21% relative to Germany Portugal and Spain is fifteen percent and eateries eight percent I could not find any equally large inflation differential for any state in the US etc zona for some reason I don’t know why so implicit in this is first of all I think it’s not not clear to me that relativity financials in the United States may not drift apart but they never translate into such imbalances in prices that we observe from a typical as you can you say the typical problem of the changes based ability shun that in I don’t know what you were thinking in the ACP when

granted the credit risk was underestimated everywhere in the world but when we live for many many years with such a low in interest differential with such different dynamics in prices I don’t know whether the one you know and you must have had some some bell ringing no alarm be frank that was a discussion with finance ministers we were bringing this chart which unit labor costs divergences but they were just simply no there were no reactions and they they were say it’s not a problem yet I mean politicians are used to solve problems if it’s unless it becomes a problem they don’t see it so only when they saw it they realize that this was was a real problem on top of that when you looked at Spain it’s true that Spain was losing competitiveness and so on sorbate was you know the fastest growing economy with budget balance so everything was fine how could you go to Spain and say you’re doing something wrong that’s that’s not the way politicians think there were doing everything right now they realize it lets for another case and maybe this is a lesson I think for for future generations that you have also to work in good times not only bedtimes to maintain the discipline just going to mention that for the euro area would be very difficult for for a regular country that pegs to the currency without a master each type arrangement there are things that you can do from the fiscal side real devaluations that do not require the volume then the Gaussian can help out in the transition now and but i would say that let’s be careful not to extrapolate what we have seen in the area something that is likely to happen in the future because i think what help we have seen it as massive transfer of funds to certain regions in the area because of the development of new financial instruments if we are careful with that maybe we can avoid some of the problem before they stop it’s now one o’clock I guess we should join your big round of applause to thank our and I’m sure will not post it any threat to the UK banking system when many of you will go ahead and divide up your joint account with your current partners you