Yuemei Ji

Self-Fulfilling Crises in the Eurozone: An Empirical Test

This paper tests the hypothesis that government bond markets in the eurozone are more fragile and more susceptible to self-fulfilling liquidity crises than in stand-alone countries. We find evidence that a significant part of the surge in the spreads of the PIGS countries (Portugal, Ireland, Greece and Spain) in the eurozone during 2010-11 was disconnected from underlying increases in the debt-to-GDP ratios and fiscal space variables, and was the result of negative self-fulfilling market sentiments that became very strong since the end of 2010. We argue that this can drive member countries of the eurozone into bad equilibria. We also find evidence that after years of neglecting high government debt, investors became increasingly worried about this in the eurozone, and reacted by raising the spreads. No such worries developed in stand-alone countries despite the fact that debt-to-GDP ratios and fiscal space variables were equally high and increasing in these countries.

Mispricing of Sovereign Risk and Macroeconomic Stability in the Eurozone

This article presents evidence that a significant part of the surge in the spreads of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) countries in the eurozone during 2010–11 was disconnected from underlying increases in the debt‐to‐GDP (gross domestic product) ratios, and was the result of negative market sentiments that became very strong since the end of 2010. It is argued that the systematic mispricing of sovereign risk in the eurozone intensifies macroeconomic instability, leading to bubbles in good years and excessive austerity in bad years.

The Fragility of Two Monetary Regimes: The European Monetary System and the Eurozone

We analyze the similarities and the differences in the fragility of the European Monetary system (EMS) and the Eurozone. We test the hypothesis that in the EMS the fragility arose from the absence of a credible lender of last resort in the foreign exchange markets while in the Eurozone it was the absence of a lender of last resort in the long-term government bond markets that caused the fragility. We conclude that in the EMS the national central banks were weak and fragile, and the national governments were insulated from this weakness by the fact that they kept their own national currencies. In the Eurozone the roles were reversed. The national central banks that became part of the Eurosystem were strengthened. This came at a huge price, i.e. the fragilization of the national governments that could be brought down by the whims of fear and frenzy in financial markets.

The Future of the Eurozone

We argue first that the Eurozone crisis has left a legacy of unsustainable government debt levels. These will continue to exert a deflationary dynamics in the Eurozone except if creditor nations are willing to contemplate a debt restructuring. Second, we argue that the institutional innovations since the start of the debt crisis fall short of what is needed to solve the design failures of the Eurozone. In addition, they are not sustainable, mainly because they have led to a situation where bureaucratic institutions have been vested with more responsibilities without a concomitant increase in the democratic legitimacy of these institutions. We conclude that the Euro crisis is not over.

Correcting for the Eurozone Design Failures: The Role of the ECB

Abstract Macroeconomic policies in the Eurozone have been dysfunctional since the eruption of the financial crisis. The failure of these policies to guide the Eurozone out of the crisis has everything to do with the design failures in the Eurozone. In this article, we first remind the reader of the nature of these design failures. We then analyze how these have led to ill-designed macroeconomic policies. We then focus on the role of the ECB on correcting for these design failures. We conclude with some thoughts about monetary and political unification.

Behavioural Economics is Useful Also in Macroeconomics: The Role of Animal Spirits

Dynamic stochastic general equilibrium models are still dominant in mainstream macroeconomics, but they are only able to explain business cycle fluctuations as the result of exogenous shocks. This paper uses concepts from behavioural economics and discusses a New Keynesian macroeconomic model that generates endogenous business cycle fluctuations driven by animal spirits. Our discussion includes two applications. One is on the optimal level of inflation targeting under a zero lower bound constraint. The other is on the role of animal spirits in explaining the synchronization of business cycles across countries.

Booms, Busts and the Governance of the Eurozone

Since the eruption of the sovereign debt crisis in the Eurozone, substantial efforts have been made to create a new form of governance for the Eurozone that will make the Monetary Union more robust in absorbing future economic and fi nancial shocks. Much of the drive to adapt the governance of the Eurozone has been infl uenced by the traditional theory of optimal currency areas (OCA), which stresses the need for fl exibility in product and labour markets . As a result, the Eurozone countries have been pushed towards structural reforms that aim to reduce the structural rigidities in product and labour markets, in the hope that this would lead to a more resilient monetary union capable of withstanding future asymmetric shocks. Figure 7.1 , which presents the OECD product market legislation index, shows that the Eurozone countries have introduced structural reforms at a faster pace than the rest of the OECD countries. Figure 7.2 , which presents the OECD index of employment protection, shows how the Eurozone has signifi cantly reduced its tight employment protection, especially since the sovereign debt crisis in 2010. It is interesting to note that since the early 1990s the nonEurozone OECD countries have followed a reverse trend of increasing employment protection. In this chapter, we ask whether this movement towards structural reform as part of the push for new governance is going in the right direction. We will argue that this is not the case. The main reason is that the nature of the shocks that have hit the Eurozone does not correspond to the pattern of asymmetric shocks that has been identifi ed by the OCA theory to require more fl exibility. We will argue that what is needed in the Eurozone

The EU Debt Crisis: Testing and Revisiting Conventional Legal Doctrine

Controversies surrounding the European sovereign debt crisis loom prominent in the public debate. From a legal perspective, the no-bailout rule and the ban on monetary financing constitute the main principles governing the legality review of financial assistance and liquidity measures. Interpretation of these rules are full of empirical claims. According to conventional legal doctrine, bond spreads only depend on the country’s debt position, largely ignoring other causal factors including liquidity. We test the hypotheses implicit in conventional legal reasoning. We find evidence that a significant part of the surge in the spreads of the peripheral Eurozone countries was disconnected from underlying fundamentals and particularly from a country’s debt position, and was associated rather strongly with market sentiments and liquidity concerns. We apply our empirical findings to the legal principles as interpreted by recent jurisprudence arguing that application of the no- bailout principle and the ban on monetary financing should be extended to capture non-debt related factors. Also, the empirical results suggest taking recourse to alternative legal grounds for reviewing the legality of anti-crisis instruments and allowing for a lender of last resort in the euro zone.

Les conséquences fiscales du programme d'achat d'obligations de la BCE

The perception that the government bond buying program (OMT) announced by the ECB may lead to future tax burdens on countries, in particular on Germany, is based on an erroneous application of solvency principles that apply to private agents, but not to central banks. We argue that the creditor nations? taxpayers, in particular the German taxpayers, will receive tax revenue from the implementation of the OMT. We also measure the size of the bond-buying program that is compatible with price stability. It turns out that this estimate critically depends on whether the Eurozone stays in a liquidity trap situation or not. Today, as the Eurozone is still in a liquidity trap there is no limit to the amount of government bonds the ECB can buy without triggering inflation. Classification JEL: E58, E63, F36, G01.