Euro exchange rate.

The continuous appreciation of the Euro since the Fall of 2000 and the uncertainty surrounding its future course are obscuring the prospect for growth in Europe. When one looks in retrospect to the evolution of the euro (reconstituted from 1979), an important fact shows up: since the beginning of the nineties the evolution of the exchange rate has been procyclical . It is expected to continue to be so. Whatever the story one can devise to explain this phenomena, the main message of this paper remains: overreaction or not, the movements of the exchange rate of the dollar are prima facie contributing to the stabilisation of the American economy, but those of the exchange rate of the euro – whether bilateral or effective – are rather destabilising for the European economy. It is as if, absent an exchange rate policy of the euro area, the movements of the exchange rate of the euro are simply the reflection of the exchange rate policies of the rest of the world, and thus can’t correspond generally to the needs of the European economy. If we look at some determinants of the movements of the (real) exchange rate – growth differentials, inflation differentials, long term interest rates differentials – it does not seem that they can explain very much, although interest rates differential may go a long way to explain at least qualitatively the direction of the change. Asset prices and bond yields did not evolve in such a way that one can infer that the appreciation of the euro was the consequence of capital inflows, and it was not. Investment in Europe, on the contrary, decreased in 2003. On all accounts – the appreciation of the euro, the pathological evolution of labour productivity, wage moderation and the deepening of the output gap – time has come for the ECB to cut the interest rate.

rationale for or against expanding central bank eligible collateral in times of distress.

The current crisis is testing the capacity of policy makers to give adequate answers to the possibility of a major financial meltdown. The crisis began in the subprime sector, a relatively small segment of the mortgage industry. It is thanks to an insufficiently regulated system of financial innovations that it spread to the balance sheets of all financial institutions around the world. The briefing paper does not deal with the issue of what regulatory framework we should design. It rather focuses on the short run policy response to the crisis. I will conclude that most of the burden in this specific moment falls on fiscal policy, monetary policy having reached a liquidity trap situation. Nevertheless, monetary policy still has an important role (that it played already in the past months) in providing liquidity to the markets, and in facilitating the task of fiscal policy. In this perspective, I agree with Anne Sibert’s BP of March 2008, in considering appropriate a wider definition of acceptable collateral, to include also “troubled assets”. This should be done in the short run, though, and a number of medium term consequences, notably on the coordination between strictly interconnected fiscal and monetary policies, should be evaluated.

Diverging Tendencies of Competitiveness.

This item has no abstract

Payroll tax reductions for the low paid.

A review of different theoretical models confirms that economists of opposing beliefs find themselves agreeing about the usefulness of employment subsidies. In a country with a relatively high wage floor, they reduce the cost of labour for firms. In countries where wage floors are low, subsidies can increase the net real wage of workers. In both cases, employment is likely to rise. Generally, allowing the price system to perform its allocative function while pursuing distributive objectives through the tax system is welfare enhancing. It is therefore surprising that such a remedy has not yet been implemented on a large scale in all countries suffering from labour market problems. One reason is that there may be a problem of transition. Empirical evidence suggests that reductions in taxes on labour will not solve employment and distribution problems, but will, in the long run, promise progress in both.

fiscal stance and economic coordination in Europe.

No abstract is available for this item.

Monetary Policy, the Promotion of Growth and the SGP in an ageing society.

Economic theory tells us that even when mainly concerned with price stability, a central bank should target economic activity. This because on one side the effects of monetary policy on prices pass through economic activity, and on the other economic activity is a good indicator of expected (and future) inflation. Hence, I believe that there is room for a more proactive policy on the part of the ECB. This would also help to cancel the feeling of inertia that the public has about past monetary policy. A more flexible interpretation of the Stability Pact would increase the room for manoeuvre of fiscal policy to counteract country specific shocks and asymmetric effects of the unique monetary policy of the EMU. As such, it would help balance the European policy mix, that today places too much emphasis, and consequently too much burden on the ECB. If part of the job of stabilizing the economy is done by fiscal policy, the pressure on the ECB will decrease. On the contrary, in the present situation when a strict application of the SGP call for a procyclical fiscal policy, monetary policy has to act both to reshuffle the economy and to compensate for the restrictive fiscal policy, which may be impossible at a too low rate of inflation. Finally, it is hard to tell, in present circumstances, how monetary policy will be affected by the problem of ageing society in Europe. It may be that inflationary pressures will be dominant, calling for a more restrictive role by the ECB; but it may as well be that, if mass unemployment persists, ageing of the society will have deflationary effects. We have to conclude that monetary policy today should aim, even more convincingly, to full employment.

Assessment of ECB Action.

An assessment of the conduct of monetary policy in Europe must necessarily be made along two distinct and complementary lines. The first is a comparison with the policies followed in the past. The second line has to assess whether monetary policy is adapted to the new conditions that came into existence with the inception of the Euro. The picture with respect to these two criteria is mixed. Monetary policy has certainly improved with respect to the policies followed in the 1990s, during the run up to the euro. In fact, the ECB proved to be much more growth friendly than its predecessors. On the other hand, though, the challenges posed by the new environment, the management of a large open economy, have not been internalized by the ECB, that was less reactive than the Fed, and too focussed on current inflation. The tightening of monetary conditions in the euro zone, mainly due to the euro appreciation, was not sufficiently cautioned by monetary policy. Especially considering the poor economic performances of the euro zone in the past few years, we must conclude that monetary policy was not helpful in fostering growth recovery in the euro area. The ECB did not fully recognise its new responsibility of conducting the monetary policy of a “big country”.

Fiscal Indiscipline: Why no reaction yet by the markets?.

Two stylized facts emerge as we observe the evolution of public finances in the past few years. The first is a general trend towards a deterioration of fiscal positions, mainly due to cyclical factors (the persistently deceiving growth performance of the Euro zone). The second, a remarkable lack of reaction of financial markets (long term rates) to this deterioration. This is a puzzling set of findings, as the theory tells us that long term rates should react to larger deficits either because they indicate future tightening of monetary policy, or because they require a risk premium. A first explanation of this puzzle is straightforward: markets have perceived the system as well designed in spite of the latest development and hence did not react to the worsening of fiscal position, seen as temporary and harmless; such an interpretation nevertheless may be dismissed on the ground that if the system was perceived as good and well functioning, its very recent modification (March 2005) should have triggered a negative reaction that until now did not materialize. A more convincing explanation recognizes that markets do not focus on public finances alone, but look at more general conditions concerning Saving and Investment. With such a global perspective in mind, long term sustainability does not seem more at risk today than it were a few years ago; hence, the lack of reaction of markets is all but paradoxical, but may simply reflect the lack of credibility of the current formal fiscal framework for Europe.

Stability (and Growth) Pact and Monetary Policy.

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