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Current Issues and Policies

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Modern Financial Crises

Part of the book series: Financial and Monetary Policy Studies ((FMPS,volume 42))

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Abstract

This chapter deals with current issues and policies regarding the updated developments of the three crises dealt with in this book: in Argentina, USA, and Europe. Argentina restructured its debt in 2005 with a significant reduction, which was accepted by 76 % of the creditors and resumed payment to them. In 2010 a second debt swap was offered which was accepted by another 17 % of the creditors. Anyway the terms of the debt exchanges left some open questions. In the USA the consequences of the Dodd–Frank Act are analyzed. Finally, in the EMU, a near-defaulting situation for Greece still remains unsolved, while the recent quantitative easing monetary policy implemented by the ECB succeeded to calm financial markets and created the right environment necessary to promote a new European economic recovery.

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Notes

  1. 1.

    Edwards (2015) uses data on 180 sovereign defaults to analyze what determines the recovery rate after a debt restructuring process. Why do creditors recover, in some cases, more than 90 %, while in other cases they recover less than 10 %? He finds support for the Grossman and Van Huyk (1985) model of “excusable defaults”: countries that experience more severe negative shocks tend to have higher “haircuts” than countries that face less severe shocks. Edwards discusses in detail debt restructuring episodes in Argentina, Chile, Uruguay, and Greece. The results suggest that the haircut imposed by Argentina in its 2005 restructuring was “excessively high.” The other episodes’ haircuts were consistent with Grossman and Van Huyk’s model.

  2. 2.

    The Dodd–Frank Act implements changes that, among other things, affect the oversight and supervision of financial institutions, provide for a new resolution procedure for large financial companies, create a new agency responsible for implementing and enforcing compliance with consumer financial laws, introduce more stringent regulatory capital requirements, effect significant changes in the regulation of over-the-counter derivatives, reform the regulation of credit rating agencies, implement changes to corporate governance and executive compensation practices, incorporate the Volcker Rule, require registration of advisers to certain private funds, and effect significant changes in the securitization market. Further comments on the Dodd–Frank Act from an economic point of view are exposed by Acharya et al. (2010).

  3. 3.

    To end the euro crisis and return the Eurozone countries to healthy growth rates of income and employment, Feldstein (2015) proposes to adopt revenue neutral fiscal incentives by the individual Eurozone countries, while Alesina et al. (2015) show that fiscal adjustments based upon cuts in spending appear to have been much less costly, in terms of output losses, than those based upon tax increases, and the difference between the two types of adjustment is very large.

  4. 4.

    Forni and Pisani (2013) assess the macroeconomic effects of a sovereign restructuring in a small economy belonging to a monetary union by simulating a dynamic general equilibrium model. In line with the empirical evidence, they make the following three key assumptions: first, sovereign debt is held by domestic agents and by agents in the rest of the monetary union; second, after the restructuring the sovereign borrowing rate increases and its increase is fully transmitted to the borrowing rate paid by the domestic agents; and third, the government cannot discriminate between domestic and foreign agents when restructuring. They show that the macroeconomic effects of the restructuring depend on (a) the share of sovereign bonds held by residents in the country as compared to that held by foreign residents, (b) the increase in the spread paid by domestic agents, and (c) its net foreign asset position at the moment of the restructuring. Their results also suggest that the sovereign restructuring implies persistent reductions of output, consumption, and investment, which can be large, in particular if the share of public debt held domestically is large, the private foreign debt is high, and the spread paid by the government and the households does increase.

  5. 5.

    “Eurogroup statement on Greece,” approved on 20 February 2015.

  6. 6.

    “Greece and the euro: Doing the splits,” The Economist, February 28, 2015.

  7. 7.

    Friedman (2014) argues that one of the two forms of hitherto unconventional monetary policy that many central banks have implemented in response to the 2007 financial crisis—large-scale asset purchases or, to put the matter more generically, the use of the central bank’s balance sheet as a distinct tool of monetary policy—is likely to become part of the standard toolkit of monetary policymaking in normal times as well. As intended, these purchases have lowered long-term interest rates relative to short-term rates and lowered interest rates on more-risky compared to less-risky obligations. Moreover, their introduction fills a conceptual vacuum that has long stood at the heart of monetary policy analysis and implementation. In contrast to the last century or more of monetary theory, which has focused on central banks’ liabilities, the basis for the effectiveness of central bank asset purchases turns on the role of the asset side of the central bank’s balance sheet. The implications for monetary theory are profound.

  8. 8.

    Anyway, Neri and Ropele (2015) share the opinion that the accommodative monetary policy stance of the ECB helped to moderate the negative effects of the sovereign debt tensions.

  9. 9.

    The ECB’s Qe program, which will encompass the asset-backed securities purchase program and the covered bond purchase program, both launched in 2014, as just mentioned in the text, will amount to €60 bn monthly. Starting on March 2015, it will be carried out until at least September 2016, for a total of bond purchases of €1140 bn. This figure compensates the ECB’s withdrawal of about €1.000 bn out of the Eurozone economy as the result of banks repaying loans they had taken during the last 2 years of the debt crisis.

  10. 10.

    Further details on the technicalities of ECB’s Qe can be found in the articles by Bird (2015), Bird and Pozzebon (2015), ECB (2015b), Lynch (2015), WP (2015).

  11. 11.

    See https://www.ecb.europa.eu/stats/money/long/html/index.en.html.

  12. 12.

    Some examples are illustrative: Italian bonds long-term interest rates (10-year government bond yields) decreased from 3.87 % in January 2014 to 1.70 % in January 2015, Ireland bonds from 3.39 % to 1.22 %, Spain bonds from 3.79 % to 1.54 %, Portugal bonds from 5.21 % to 2.49 %, France bonds from 2.38 % to 0.67 %, and Germany bonds from 1.76 % to 0.39 %. Only Greece bond yields augmented their 10-year rate of return from 8.18 % to 9.48 % in the same period. Anyway, Turner (2013) advises that an extended period of very low long-term interest rates and high public debt creates financial stability risks. Interest rate risk in the banking system has grown, and some institutional investors face significant exposures. Central banks in the advanced economies now hold a high proportion of bonds issued by their governments, most of which have so far failed to arrest the rise in the ratio of government debt to GDP. Implementing an effective exit strategy will be difficult. According to Turner, current policy frameworks should be reconsidered, with a view to clarifying the importance of the long-term interest rate for monetary policy, for financial stability, and for government debt management.

  13. 13.

    Fochmann et al. (2014) use a controlled laboratory experiment with and without overlapping generations to study the emergence of public debt. Public debt is chosen by popular vote, pays for public goods, and is repaid with general taxes. With a single generation, public debt is accumulated prudently, never leading to over-indebtedness. With multiple generations, public debt is accumulated rapidly as soon as the burden of debt and the risk of over-indebtedness can be shifted to future generations. Debt ceiling mechanisms do not mitigate the debt problem. With overlapping generations, political debt cycles emerge, oscillating with the age of the majority of voters.

  14. 14.

    According to Guiso et al. (2015), entering a currency union without any political union, European countries have taken a gamble: will the needs of the currency union force a political integration (as anticipated by Jean Monnet) or will the tensions create a backlash, as suggested by Nicholas Kaldor, Milton Friedman, and many others? They try to answer this question by analyzing the cross-sectional and time series variation in pro-European sentiments in the EU 15 countries. They conclude that 1992 Maastricht Treaty seems to have reduced the pro-Europe sentiment as does the 2010 Eurozone crisis. Yet, in spite of the worst recession in recent history, the Europeans still support the common currency. Europe seems trapped: there is no desire to go backward and no interest in going forward, but it is economically unsustainable to stay still.

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Authors and Affiliations

  1. University of Belgrano and University of Buenos Aires, Buenos Aires, Argentina

    Victor A. Beker

  2. Department of Economics and Business, University of Cagliari, Viale San Ignazio 17, 09123, Cagliari, Italy

    Beniamino Moro

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  1. Victor A. Beker
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  2. Beniamino Moro
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Correspondence to Victor A. Beker or Beniamino Moro .

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© 2016 Springer International Publishing Switzerland

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Beker, V.A., Moro, B. (2016). Current Issues and Policies. In: Modern Financial Crises. Financial and Monetary Policy Studies, vol 42. Springer, Cham. https://doi.org/10.1007/978-3-319-20991-3_11

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