Monthly Archives: July 2015

The Challenges of the Greek Crisis

The Greek crisis has abated, but not ended. Representatives of the “troika” of the European Commission, the European Central Bank and the International Monetary Fund returned to Athens for talks with the Greek government about a new bailout. This pause allows an accounting of the many challenges that the events in Greece pose to the international community.

The main challenge, of course, is to the Greek government itself, which must implement the fiscal and other measures contained in the agreement with the European governments. These include steps to liberalize labor markets as well as open up protected sectors of the economy. While these structural reforms should promote growth over time, in the short-run they will lead to layoffs and reorganizations. At the same time, Prime Minister Alex Tsipras must oversee tax rises and cuts in spending. The combined impact of all these measures, which follow the virtual shutdown of the financial sector during the protracted negotiations with the European governments, will postpone any resumption in growth that past efforts may have generated.

It is not clear how long the Greek public will endure further misery. Any form of debt restructuring may give policymakers some justification to continue with the agreement. New elections will clarify the degree of political support for the pact. But the possibility of an exit from the Eurozone has not been removed, either in the eyes of Greek politicians or those of officials of other governments.

The Greek crisis, however, is not the only hazard that the Eurozone faces. The Eurozone’s governments have yet to come to terms with the effects of the global financial crisis on its members’ finances. A split prevails between those countries that ally themselves with the German position that debt must be repaid and those that seek with France to find some sort of middle ground. Other European countries with debt/GDP ratios of over 100% include Belgium, Portugal, and Italy. Weak economic growth could push any of them into a situation where the costs of refinancing become daunting. How would the Eurozone governments respond? Would they bail out another member? If so, would the terms differ from those imposed on Greece? Would European banks be able to pass the distressed debt on to their own governments?

In the long-term, the governments of the Eurozone face the dilemma of how to reconcile centralized rule-making with national sovereignty. The ECB, for example, has been granted supervisory oversight of the banks in the Eurozone. It will exercise direct oversight of over 100 banks deemed to be “significant,” while sharing responsibility with national supervisors for the remaining approximately 3,500 banks. The ECB has a Supervisory Board, supported by a Steering Committee, to plan and executes its supervisory tasks, which supposedly allows it to separate its bank supervisory function from its role in setting monetary policy. All these agencies and committees must work out their respective jurisdictions and responsibilities. Meanwhile, the European Commission, which oversees fiscal policies, faces requests for exemptions from its budget guidelines by governments with faltering growth. But if it shows flexibility in enforcing its own rules, it will be derided as weak and ineffective.

The IMF has its own set of challenges. The IMF was sharply criticized for its response to the wave of crises that struck emerging markets in the last 1990s and early 2000s, beginning with Mexico in 1994 and extending to Turkey and Argentina in 2001. Critics charged that the IMF was slow to respond to the rapid “sudden stops” of capital outflows that set off and exacerbated the crises. When the Fund did act, it attached too many conditions to its programs; moreover, these conditions were harsh and inappropriate for crises based on capital outflows.

The global financial crisis gave the IMF a second chance to demonstrate its crisis-management abilities (for a full account, see here). The Managing Director at the time, Dominique Strauss-Kahn, seized the opportunity to redeem the IMF ‘s reputation, as well as reestablish his own political career in France. The IMF lent quickly to its members, attached relatively few conditions to the loans, and allowed the use of fiscal measures to stabilize domestic economies. The result was less severe adjustment, the avoidance of excessive exchange rate movements and a resumption of economic growth. By the time the global economy recovered, the IMF had proven that it could respond in a flexible manner to a financial emergency.

The IMF’s response in 2010 to the Greek debt crisis was very different. The IMF’s loan to Greece was the first to a Eurozone member; moreover, the loan was much larger than any the IMF had extended before, whether measured by the total amount of credit or as a percentage of the borrowing country’s quota at the Fund. To make the loan, the IMF had to overlook one of it own guidelines for granting “exceptional access” by a member to Fund credit. Such loans were to be made only if the borrowing government’s debt would be sustainable in the medium-term. Greece’s debt burden did not pass this criterion, so the Fund justified its actions on the grounds that there was a risk of “international systemic spillovers.”

The IMF’s involvement in the Greek program was also unusual in another sense: the IMF’s contribution, as large as it was, was still smaller than that of the European governments. The IMF was, in effect, a “junior partner.” While it had worked with other governments before (such as the U.S. when it lent to Mexico in 1994-95), this was the first time that the IMF was not in a lead position. This may have initially made it reluctant to disagree with the other members of the troika.

The subsequent contraction in the Greek economy far exceeded the IMF’s forecasts. The IMF later admitted that it underestimated the size of the multipliers for the fiscal policies contained in the program in a paper co-authored by the head of the IMF’s Research Department, Olivier Blanchard (see also here). The failure to properly estimate the impact of these conditions calls into doubt the basic premises of the 2010 and 2012 programs.

More recently, the IMF has challenged its European partners over their projections for the Greek debt, as well as the budget and fiscal targets contained in the latest agreement. The Fund claims that the debt projections are much too optimistic. Greece’s debt will only be sustainable if there is debt relief on a much larger scale than the European governments have been willing to undertake. Moreover, the IMF states that it will not be part of any new programs for Greece if debt relief is not a component.

The public admission of error and the rebukes of the European governments will only partially restore the IMF’s reputation. The generous treatment of Greece as well as Ireland and Portugal reinforces the belief that the European countries and the U.S. control the IMF. The members of the European Union have a total quota share of almost one-third, much larger than their share of world GDP. This voting share combined with the U.S. quota gives these countries almost half of all the voting shares at the IMF. The need for a realignment of the quotas to give the emerging market nations a larger share has long been acknowledged, but approval of the reform measures is mired in the U.S. Congress.

Another aspect of European and U.S. control of the “Bretton Woods twins”—the IMF and the World Bank—has been their selection of the heads of these organizations. All the Managing Directors of the IMF have been Europeans, and until the appointment of Ms. Lagarde, European males. All the heads of the World Bank have been U.S. citizens. Ms. Lagarde’s term expires next July, and the pressure to name a non-European will be tremendous. How the Europeans and U.S. respond to this challenge will go a long way in determining whether these institutions will be shunted aside by the emerging market nations in favor of institutions that they can control.

The last challenge of the Greek crisis comes for the Federal Reserve. Federal Reserve Chair Janet Yellen has been explaining that a rise in the Fed’s policy rate, the Federal Funds rate, is likely to occur later this year. This forecast, however, is contingent on continued economic growth and favorable labor market conditions. These plans could be threatened by any financial volatility that followed a disruption in the latest Greece bailout.

The Federal Reserve is also aware that a rise in interest rates would affect the dollar/euro exchange rate. The euro, which has been depreciating, could fall lower when the Fed raises rates while the ECB keeps its refinancing rate at 0.05%. A further appreciation of the dollar would threaten U.S. exports, thus endangering a recovery.

The Fed also faces concerns about the broader impact of its policy initiatives on the world economy. The IMF is worried about how a rate rise would affect the global economy, and has urged the Fed to hold off on interest rate increases until 20016. Companies that borrowed in dollars through bonds and bank loans will be adversely affected by the combined effects of an interest rate rise and a dollar appreciation.

Greece’s GDP accounts for only 0.4% of world GDP and about 1.3% of the European Union’s total output. But the global financial crisis demonstrated how financial linkages across sectors and countries can disrupt economic activity no matter what their source. The response to these incidents by national and international authorities can risk global stability if they are based on self-interest and organizational agendas. Commitments to cooperation disappear quickly when national concerns are threatened.

(A Powerpoint version of this post is available here.)

International Macroeconomics Conferences

This post is different from my usual writings. It is intended for those who write and present research papers in international finance.

This past year I have kept a list of all the conferences that are held on an annual basis and emphasize research in international macroeconomics. There are, of course, many conferences where a wide range of papers are presented, but I focused on those with an explicit focus on topics in open-economy macroeconomics. There are also conferences that are organized to present work on a specific international macro topic, but are not held on an annual basis, and I did not include these.

I list the ones I found below with links to this year’s version of the conference, organized by month, followed by the location. As you will see, many of them take place in Europe at the end of May and in June.

I am happy to consider suggestions for other conferences that should be listed. Please make your recommendation as a comment below or write me directly. If the conference meets the criteria I list above, I will be happy to include it in future editions of this list.


International Trade and Finance Association Conference (various locations)

Annual International Conference on Macroeconomic Analysis and International Finance (Greece)


INFINITI Conference on International Finance (Europe)

European Economics and Finance Society Annual Conference (Europe)

Barcelona GSE Summer Forum: International Capital Flows (Barcelona, Spain)

IF Annual Conference in International Finance (Europe)

Conference on International Economics (Spain)


NBER Summer Institute: International Finance (Cambridge, Massachusetts, US)


IMF Annual Research Conference (Washington, DC, U.S.)

Global Liquidity and U.S. Monetary Policy

The events in Greece and the Ukraine have only partially drawn attention away from the financial markets’ focus on changes in U.S. monetary policy. Federal Reserve officials seem to be split over when they will raise their Federal Funds rate target, and by how much. But while U.S. policymakers are closely monitoring domestic labor developments, the impact of their actions will have repercussions for foreign markets.

The growth of cross-border financial flows has led to research on global liquidity. Jean-Pierre Landau of SciencesPo (Paris) defines global private liquidity as the international components of liquidity, i.e., “cross-border credit and portfolio flows or lending in foreign currencies to domestic residents,” while official global liquidity is the funding available to settle claims on monetary authorities. Before the global financial crisis, global banking flows were instrumental in extending private credit across borders, while more recently portfolio flows have been important.

Eugenio Cerutti, Stijn Claessens, and Lev Ratnovski of the IMF examined the determinants of global liquidity using data on cross-border bank flows for 77 countries over the period of 1990-2012. They identified four financial centers: the U.S., the Eurozone, the U.K. and Japan. The drivers of global liquidity included factors such as the TED spread (3 month LIBOR minus 3 month government bond yield), an indicator of uncertainty that affects bank behavior. They also included measures related to monetary policy, including the real interest rate and term premium, i.e., the slope of the yield curve, defined as the difference between 10 year and 3 month government securities.

The authors first used U.S. global liquidity factors in their empirical analysis. When the U.S. term premium fell, there was a rise in international lending as banks sought higher returns. The U.S. real interest rate had a positive coefficient, which the authors saw as a sign that global banks lent less when there were favorable domestic conditions. The authors then introduced the same variables for the three other financial centers, and found that term premiums from the U.K. and the Eurozone have the same effect on cross border bank lending as did the U.S. measure. The Japanese term premium, on the other hand, had a positive coefficient, which may reflect the record of Japan’s interest rate.

When cross-border claims were broken out by lending to Asian and the Western Hemisphere countries, the TED spreads for British and European banks were significant determinants for lending to both areas. The U.S. term premium was the only term premium variable with explanatory power in lending to bank and non-banks in the two regions. The authors interpret these results as an indication that the global financial cycle is driven in part by U.S. monetary policy and British and European bank conditions. The authors also find that a borrower country can reduce its exposure to global liquidity drivers through flexible exchange rates, capital controls and stringent bank supervision.

The latest Annual Report of the Bank for International Settlements (BIS) also looks at financial flows across borders in its chapter on the international monetary and financial system. The authors of the chapter detail the growth in dollar- and euro-denominated credit through bank loans and debt securities, which can go to domestic residents in the U.S. or Eurozone, or non-residents. They point out that while U.S. households, corporations and its government account for 80% of global non-financial dollar debt at the end of 2014, the remaining one-fifth—about $9.5 trillion—of dollar credit was held outside the U.S.

These loans and securities have been growing rapidly since the global financial crisis. In particular, non-U.S. borrowers issued $1.8 trillion in bonds between 2009 and 2014. The authors of this chapter of the BIS Report attribute this growth to low lending rates and the reduction of the term premium for U.S. Treasury securities, which reflects the large scale purchase of these securities by the Federal Reserve in its Quantitative Easing (QE) programs. The European Central Bank’s bond purchases and the resulting compression of term premiums on euro-denominated bonds may lead to a similar phenomenon.

Changes in U.S. monetary policy, therefore, will influence global financial flows in both bank lending and bond issuance. If the end of QE results in higher term premiums in the U.S. as the rates on long-term securities rise, then cross-border flows could be negatively impacted. A rise in the Federal Fund Rate, on the other hand, could initially decrease the term premia, although other interest rates would likely follow. These changes take place, moreover, while the Eurozone and Japan are moving in opposite directions, which may intensify their effect. Mark Carney, Governor of the Bank of England, warned last January that the resiliency of the financial system will be tested by Federal Reserve tightening. Once again, policymakers may be forced to respond to fast-breaking developments as they occur. But this time they may not have as much flexibility to maneuver as they need. We may not know the consequences for financial stability until it is too late to avoid them.