Without the basics in place, Financial engineering can only delay the inevitable.
We have argued that various recent proposals aimed at stabilising the euro area via financial engineering do not eliminate the inherent instability of the sovereign bond markets in a monetary union. During crises this instability becomes systemic, and no amount of financial engineering can stabilise an otherwise unstable system.
The proposals made by the French and German economists (Bénassy-Quéré et al. 2018) have clearly be inspired by concerns about moral hazard. These concerns are very intense among German economists and have left their mark on the reform proposals of the Franco-German group of economists. Moral hazard means that agents consciously take too much risk because they expect others to bail them out. It is very unlikely, however, that the sovereign debt crisis had much to do with moral hazard. It stretches the imagination to believe that the Greek, Irish, Portuguese, or Spanish governments decided to allow their debt levels to increase in the expectation that they would be bailed out by the governments of Northern euro area countries.
Our hypothesis that the sovereign debt crisis erupted as a result of a boom that led private and public agents to disregard risk makes more sense. But even if moral hazard was a cause of the crisis, those who took on too much risk will have learned that the punishment for being bailed out by Northern euro area governments is severe. It should by now be clear that no government would wish to be bailed out by these governments.
Stabilisation via financial engineering will not work. Real stabilisation of the euro area goes through two mechanisms.
The first is the willingness of the ECB to provide liquidity in the sovereign bond markets of the euro area during times of crisis. The ECB has set up its Outright Monetary Transactions (OMT) programme to do this. However, OMT is loaded with austerity conditions, which will be counterproductive when used during recessions (which is when crises generally occur). That is why a second mechanism is necessary. This consists in creating Eurobonds that are based on joint liability of the participating national governments. Without such joint liability, it will not be possible to create a common sovereign bond market. The creation of such a common bond market is the conditio sine qua non for long-term stability the Eurozone.
The political willingness to go in this direction, however, is non-existent today. There is no willingness to provide a common insurance mechanism that would put taxpayers in one country at risk of having to transfer money to other countries. Under those conditions, the sovereign bond markets in the euro area will continue to be prone to instability.
The danger of financial engineering proposals is that they create a fiction allowing policymakers to believe that they can achieve the objective of stability via some technical wizardry without having to pay the price of a further transfer of sovereignty.
Hmm..
March 29, 2018 at 12:01 pm |
Governments and central banks main task is to act as anti economic trend stimulators. In EU they still have to establish a proper instrument for this purpose. Today’s major threat to EU is from Italy, with it’s limited capacity to cope with their sovereign debt, that became a whole Eurpean problem. At the end European Central Bank will have to Europenize all the sovereign debts above Mastrich criteria level, otherwise the separate countries will have no tools to react to deflationary trends and situations. The price will be probably additional step towards whole Eurpean Central Bank and budget department. At the end if the corridor is the creation of direct taxation of all European citizens.