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QE + permanent debt purchases + fiscal expansion = helicopter money: recipes for the Eurozone

Biagio Bossone's picture

Is Quantitative Easing the solution for the Eurozone?[1]

Considering Quantitative Easing (QE) to be an effective way to save the Eurozone from deflation, De Grauwe and Ji (2015) argue that a QE programme can be so structured as not to pose a risk on German taxpayers – this risk being seen as the main obstacle against active policies by the ECB. However, they seem to miss some important points. 

First, they fail to recognize that there is little convincing evidence that QE has any significant effect on consumer price inflation: QE does not buy-up ordinary goods and services, and consequently it does not create consumer price inflation. QE has delivered positive effects only when it has been implemented in conjunction with decisive fiscal stimulus, since it has counteracted the interest rate rises that deficit and debt growth would have otherwise caused. Giavazzi and Tabellini (2015) note that an accompanying fiscal expansion is critical to QE’s effectiveness. Yet fiscal expansion does not appear to be an option in the Eurozone, especially in already largely indebted countries, as it would trigger offsetting effects linked to Eurozone members having issued debt in a non-sovereign currency, which would neutralize the action of QE combined with fiscal expansion.

Using administrative data to measure impact: an example from a business tax reform in Georgia

Miriam Bruhn's picture

Policymakers and researchers would often like to measure whether reforms have their desired effects, but it’s not always feasible to collect survey data to shed light on this issue. Here, administrative data, that is being collected in any case, can help. Administrative data has no additional cost and may be readily available, particularly in countries that digitize the information they collect.

The ‘safety trap’ and Eurozone secular stagnation

Biagio Bossone's picture

The ‘safety trap’ hypothesis and secular stagnation 

Noting that Eurozone inflation has been declining for almost a year, and constantly undershooting forecasts, Landau (2104) suggests that underpinning those evolutions, including the lack of growth, might be one factor: an excess demand for ‘safe assets’. Essentially — Landau argues — agents have responded to extreme risk aversion by developing a strong inclination for holding liquid and safe assets (typically money and government bonds). In order to accumulate more of these assets, they have reduced consumption and investment, thus depressing aggregate demand. When inflation is low and the economy hits the zero lower bound (ZLB), interest rates cannot reach their (negative) equilibrium levels and the economy falls into what Landau refers to as a ‘safety trap’, with cumulative disinflation, increasing real interest rates, and depression setting in. This sounds as a plausible explanation for secular stagnation in the Eurozone.

Call for Papers for the IMF / CFD conference: Financing for Development

Asli Demirgüç-Kunt's picture

The Financing for Development conference, organized by the IMF and the CFD, will take place at the Graduate Institute, Geneva, on April 16-17, 2015. The objective of the conference is to discuss new and enduring questions in development finance for Low-Income Developing Countries. The conference will include paper presentations, a policy panel, and a keynote address by Professor Jeffrey Sachs (The Earth Institute, Columbia University). A selection of papers will be published in a special issue of the Oxford Review of Economic Policy. Read more about the call for papers and the conference.

Banking union in Europe—are we there yet?

Thorsten Beck's picture

November 4 marked an important milestone in the Eurozone — the ECB took on direct supervision for the 120 largest banks and indirect supervision for all other banks. This came after a rigorous one-year examination of these banks’ books and subjecting their financial situation to different stress scenarios.1 Compared to the discussions right after the onset of the Global Financial Crisis in 2008, this is quite some progress. Six year ago, economists suggesting that the EU or Eurozone would need a single financial safety net were laughed out of the room by lawyers who pointed to the need for a treaty change and the political impossibility to do so. Six years and no treaty change later, the step towards a single supervisory mechanism can therefore be seen as quite an achievement towards a banking union matching the idea of a Single Market in Banking in Europe. On the other hand, the single supervisory mechanism has not been matched with similar progress on the resolution of weak banks on the European rather than national level, and there has been no move on connecting or joining the deposit insurance schemes across the Eurozone. A banking union on one and half pillars compared to the ideal of three pillars; a glass half full or half empty?

How does financial development affect firm lifecycle?

Asli Demirgüç-Kunt's picture

In a new paper, we address this question using detailed manufacturing census data from India. India offers an ideal laboratory for testing the role of institutions on firm lifecycle given the large persistent differences in institutions, business environment, and income across different regions. Specifically, we examine the relationship between plant size, age, and growth and ask: how does local financial development influence the size-age relationship? Are there differences in the size-age relationship across different industry characteristics and between the formal and informal manufacturing sector and does this vary with the extent of local financial development? Does the role of local financial development on firm lifecycle vary with major regulation changes in India such as financial liberalization, changes in labor regulation, and industry de-licensing?

Insulating Foreign Bank Subsidiaries from Shocks to Their Parents

Maria Soledad Martinez Peria's picture

Since the late 1990s, the importance of multinational banks has grown dramatically.  Between 1999 and 2009 the average share of bank assets held by foreign banks in developing countries rose from 26 percent to 46 percent. The bulk of the pre-global crisis evidence analyzing the consequences of this significant transformation in bank ownership suggests that foreign bank participation brought many benefits to developing countries, especially in terms of bank competition and efficiency.

The recent global financial crisis, however, highlighted the role of multinational banks in the transmission of shocks across countries. Most of the research has focused on transmission through the lending channel – how foreign bank lending behaved during the crisis. A number of papers, including some before the recent global crisis, have documented that lending by foreign bank affiliates declines when parent banks’ financial conditions deteriorate.

Enlarging the Contracting Space: Collateral Menus, Access to Credit, and Economic Activity

Mauricio Larrain's picture

One of the main obstacles that firms in developing countries face is lack of access to credit. A key factor that restricts access is insufficient collateral. Interestingly, banks in less-developed countries usually lend only against real estate; they rarely lend against other assets such as machinery, equipment, or inventory. The problem is that assets such as machines and equipment often account for most of the capital stock of small and medium-size firms. In this context, these assets become “dead capital”: they lose their debt capacity and only serve as inputs in the firms’ production processes.

While it’s true that machines and equipment are less redeployable than real estate, banks in developed countries do lend against these types of assets. In a recent study with Murillo Campello, we argue that the root of the problem lies in weak collateral laws. The law makes a clear distinction between two types of assets: immovable assets (e.g., real estate) and movable assets (e.g., machinery and equipment). Developing countries have weak collateral laws regarding movable assets, which makes its very difficult to pledge these assets as collateral. This shrinks the contracting space, since the menu of collateral becomes smaller, which limits access to credit. Moreover, since movable assets lose debt capacity, firms under-invest in technologies intensive in movable assets.

Credit Information Sharing Reforms and Firm Financing

Maria Soledad Martinez Peria's picture

According to the most recent World Bank Enterprise Survey Data, firms in developing countries report that access to finance is the biggest obstacle for the growth of their operations. Across all regions, 17 percent of firms report that access to finance is the biggest obstacle. In some regions, access to finance is an even larger obstacle. For example, in Sub-Saharan Africa close to a quarter of the firms report access to finance to be the top obstacle.

An important impediment to firm financing is asymmetric information: a firm seeking to borrow from a lender in the credit market has better information about its financial state and its ability and willingness to repay the loan than the lender. Asymmetric information can lead borrowers less seriously intent on repaying loans to be more willing to seek out loans (adverse selection) and borrowers to use loaned funds in ways that are inconsistent with the interest of the lender (moral hazard). Seminal work by Stiglitz and Weiss (1981) shows that under asymmetric information the equilibrium interest rate is such that demand for credit exceeds supply - even borrowers willing to pay the market equilibrium interest rate are not able to get a loan (credit rationing).

Correlated Trading by Pension Fund Managers

Alvaro Enrique Pedraza Morales's picture

Despite the common perception that institutional investors herd, it is difficult to identify the reasons for correlated trading. For example, managers might buy into or out of the same securities over some period due to correlated information, perhaps from analyzing the same indicator. Alternatively, a manager might infer private information from the prior trades of better-informed managers and trade in the same direction. Also, managers might disregard their own information and trade with the crowd due to the reputational risk of acting differently from other managers. Finally, managers might simply have correlated preferences over certain types of securities.

In a recent paper, I study correlated trading by Colombian pension fund managers in the presence of a peer-based underperformance penalty known as the Minimum Return Guarantee (MRG). The MRG resembles a reputational risk, in that the manager might be penalized for having lower returns than her peers. With the MRG, the risk is explicit as the manager will be penalized financially if returns are below the maximum allowed shortfall relative to the peer benchmark. The rationale for the MRG, which is a common piece of the regulation in defined contribution pension systems, is to discourage excessive risk taking by pension fund managers.

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