Assets

tend to overreact— and this calls for
a well-tuned intervention.
TI: For the Euro zone as a currency union,
what do you think about the European
quantitative easing (QE) policy? Does the
current monetary policy increase inflation
risk and create bubbles for the next crisis?
MB: It depends on what kind of underlying
problem one tries to solve and what the
alternatives are. If the underlying problem
is that real wages are too high in the
peripheral countries (and hence they are
not competitive), then the solution for
this problem is to meet the inflation
target at least in core countries such as
Germany. So any central bank intervention
should primarily be targeted at the core
countries.
If the underlying problem is peripheral
countries suffering from balance sheet
impairment, then QE can subsidize the
peripheral countries. It can help the
balance sheets of peripheral countries by
pushing down the interest rates. In this
sense, QE is redistributive— but might
ultimately help the whole euro area.
After one has identified the underlying
problem, it is not obvious that QE is the
best instrument to tackle the problem.
For example, if the underlying problem is
the difference in competitiveness, then
an alternative policy comes to mind: for
example, an active communication policy
by the central bank that tries to impact
the wage bargaining, say, in Germany.
Central banks should “talk up wages” in
core countries. This would help close the
real wage gap between the peripheral
countries and the core countries. This is
essentially the opposite of what central
banks did in the 1970s when they tried
to “talk down” inflation during a high
inflation period.
TI: Do you think the peripheral countries
have incentives to be over-indebted?
How should the currently high public
debt ratio in these countries be reduced?
Will austerity measures alleviate or
worsen the current situation?
MB: Over the next decades the debt
ratio can come down. If you look at the
debt-to-GDP ratio, you can reduce this
ratio by either increasing GDP or decreasing
debt. It is important that government debt. They are safe in nominal terms
debt will increase by less than GDP.
because the central banks can always
print money to pay off the debts. Within
Austerity is usually associated with two a currency union, however, one cannot
things: a reduction in expenditures and do this anymore. Individual sovereigns
implementation of structural reforms. cannot print Euros. The sovereign debts
However, both measures are independent are as if foreign-denominated sovereign
of each other. A smart approach would debts. Thus, sovereign debt in the EU has
provide some reward for growth-enhancing
structural reform. Knowing that
default risk and liquidity risk.
structural reform measures are contractionary
in the short-run and only yield a asset for Europe, which can be treated as
The idea of ESBies is to create a really safe
higher GDP growth rate in the intermediate
and long run, politicians are reluctant the risky sovereign debts, banks can hold
safe assets for banks. Instead of holding
to undertake them. To encourage
ESBies, which are not risky at all. The way
structural reform for the long-term
that ESBies work is to pool (up to a limit)
growth, our fiscal rules should be such the sovereign debts in Europe, and to issue
that they provide compensation for senior and junior bonds such that the
short-term growth costs in the form junior bonds protect the senior bonds.
of a small stimulus program.
So the senior bonds are very safe and the
risk is all concentrated in the junior bonds.
TI: You proposed, together with the The senior bonds are held by banks and
Euro-nomics group 1 , European Safe Bonds the junior bonds are held outside of the
(ESBies) as a way out of the Euro zone banking sector. Whenever there is a
crisis. What are the advantages of ESBies? negative shock, the senior bonds are
always safe and the banks do not suffer
MB: ESBies are not a panacea, but they from the double diabolic loop. That is the
solve two specific problems. The double first advantage of ESBies: to switch off the
diabolic loop between the financial sector diabolic loop, which reduces overall risk
and the sovereign risk is at the center and makes the junior bond also less risky.
of the Euro Crisis. When sovereign debts
lose in value, banks that hold a significant The second advantage of ESBies is to
amount of sovereign debt on their balance redirect the cross-country capital flow.
sheet suffer capital losses. This lowers Right now, as the crisis intensifies, capital
their equity, leading them to scale back flies across borders to the core countries
their activities and grant fewer loans to since the safe asset is asymmetrically
the rest of the economy. As a consequence,
the real economy is slowing down junior bonds to senior bonds. Both bonds
supplied. With ESBies, capital flows from
and tax revenue declines. As tax revenues are European bonds; and the safe asset is
decline, sovereign debt becomes less a European asset but not a German asset.
sustainable and, in turn, riskier. That is the So there is no cross-border capital flow,
first diabolic loop. At the same time, there which stabilizes the whole system.
is a second diabolic loop at work. When
banks lose value, the bailout probability TI: Does your new book with Harold James
also goes up. This, in turn, makes the
and Jean-Pierre Landau, entitled “The Euro
sovereign debts riskier and lowers their and the Battle of Ideas”, describe the
prices— which in turn hits banks and ESBies?
increases the probability of a costly
bailout. Both of these amplification
MB: Yes, indeed. Readers interested in
mechanisms enable a small negative learning more about this subject should
shock to have large implications.
read our forthcoming book. It will be
available from the end of August onwards.
To solve this double diabolic loop, one However, the book is much broader in
needs safe assets that are truly safe. scope than ESBies. It explains how
Typically, the safe assets are government different economic philosophies, primarily
1 Euro-nomics is by a group of nine European academic economists, whose objective is to provide concrete,
carefully considered, and politically feasible ideas to address the euro area's current problems.
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