The Euro Crisis: The Role of Different Economic Traditions · The Role of Different Economic Traditions ... Rules vs. Discretion Time-inconsistency problem btw ... Central split Bank.

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The Euro Crisis:The Role of Different Economic TraditionsMarkus K. Brunnermeier

EEA 2015 Mannheim, August 26th, 2015

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“interests are interpret through the lens of ideas”≈models

• From forthcoming book“The Euro Crisis & the Battle of Economic Ideas”

Brunnermeier, James & Landau

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Watershed Moments/Turning Points

2010: Deauville PSI agreement – Contagion & Power shift

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Watershed Moments/Turning Points

2010: Deauville PSI agreement – Contagion & Power shift

2012: Mario Draghi’s “Whatever it takes” Speech in London

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Watershed Moments/Turning Points

2010: Deauville PSI agreement – Contagion & Power shift

2012: Mario Draghi’s “Whatever it takes” Speech in London

2013: Cyprus Bail-in

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules Discretion

2. Liability Solidarity• No-bailout clause/rule fiscal union

3. Solvency Liquidity/contagion

4. Austerity/Reform Keynesian Stimulus

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“Rhine-divide”

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules vs. Discretion

• “ad hocery” flexible crisis management

• Federal structure central government

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules vs. Discretion

Time-inconsistency problem btw ex-ante ex-post efficiency

Price stability promise not to inflate in the future

Fiscal sustainability promise to spend in recessions (now)but consolidate

Financial stability promise only to provide liquiditybut not to bail-out (redistribute)insolvent institutions

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules vs. Discretion

Time-inconsistency problem btw ex-ante ex-post efficiency

Institutional Design (mechanism design)

• Fiscal dominance

• Monetary dominance

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Fiscal authority

Central Banksplit

Fiscal authority

Central Bank

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules vs. Discretion

Time-inconsistency problem btw ex-ante ex-post efficiency

Institutional Design (mechanism design)

• Fiscal dominance

• Monetary dominance

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Fiscal authority

Central Banksplit

Fiscal authority

Central Bank

Game of chicken

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules vs. Discretion

Time-inconsistency problem btw ex-ante ex-post efficiency

Institutional Design (mechanism design)

• Fiscal dominance

• Monetary dominance

• “Financial dominance”

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Fiscal authority

Central Banksplit

Fiscal authority

Central Bank

Game of chicken

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules vs. Discretion

Time-inconsistency problem btw ex-ante ex-post efficiency

Institutional Design (mechanism design)

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Fiscal authority

Central Banksplit

Fiscal authority

Central Bank

Game of chicken

FinancialSector

recap Redistributive MoPo (i, QE, ….)

2nd Game of chicken

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules Discretion

2. Liability Solidarity• No-bailout clause/rule fiscal union

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules Discretion

2. Liability Solidarity• No-bailout clause/rule fiscal union

• SDRM/insolvency procedure

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules Discretion

2. Liability Solidarity• No-bailout clause/rule fiscal union

• SDRM/insolvency

• ESBies without joint liability Eurobonds with joint liability

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules Discretion

2. Liability Solidarity

3. Solvency Liquidity/contagion• E[NPV]>0 - multiple equilibria

at what discount rate? “big bazooka”

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules Discretion

2. Liability Solidarity

3. Solvency Liquidity/contagion• E[NPV]>0 - multiple equilibria

at what discount rate? “big bazooka”

- amplification/spirals

E[NPV bailout]>0

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules Discretion

2. Liability Solidarity

3. Solvency Liquidity/contagion• E[NPV]>0 - multiple equilibria

at what discount rate? “big bazooka”

- amplification/spirals

E[NPV bailout]>0

E[PV bailout – PV no bailout]>0

contagion/systemic

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules Discretion

2. Liability Solidarity

3. Solvency Liquidity/contagion• E[NPV]>0 - multiple equilibria

at what discount rate? “big bazooka”

- amplification/spirals

E[NPV bailout]>0

E[PV bailout – PV no bailout]>0

contagion/systemicBail-in Bail-out/LLR

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules Discretion

2. Liability Solidarity

3. Solvency Liquidity/contagion• E[NPV]>0 - multiple equilibria

at what discount rate? “big bazooka”

- amplification/spirals

E[NPV bailout]>0

E[PV bailout – PV no bailout]>0

contagion/systemicBail-in Bail-out/LLR

• Countries

• Financial Sector22

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Dimensions of Differences in economic traditions

“German” “French”

1. Rules Discretion

2. Liability Solidarity

3. Solvency Liquidity/contagion

4. Austerity/Reform Keynesian Stimulus• Program=stimulus

• Merkel/Schäuble Hollande, Rajoy, Renzi, Tsipras, …

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“Rhine-divide”