News Analysis Assignment Follow news on topics related

News Analysis Assignment § Follow news on topics related to EU, EMU (or economic elsewhere) • Read newspapers, magazines • Search the internet • Articles do not have to be about the same topic; this time no logic required… § Based on theories/concepts learned during the course, explain the economics behind the stories - Show me that you have learned some economics during the course! - See for example group work today on news on ECB’s interest rates § Include the news as an appendix in your report § Report (excluding appendices, cover page and table of content) should be maximum 10 pages - DL Mon Nov 2 nd, send to an. chen@aalto. fi and riikkaleena. leskela@nhg. fi - INDIVIDUAL assignment – DO NOT copy text directly (not from Internet or any other source) 1

Is EMU an OCA? § In groups, collect your findings - Openness • Intra-industry trade or specialization? - Business cycle correlation • GDP changes • Inflation - Financial markets & institutions - Labor markets - … § In your opinion, is EMU above the ”OCA line”? 2

Today’s Agenda § Monetary Policy - Goals and tools - Transmission mechanism of monetary policy § The European Central Bank - Goals of ECB - Challenges 3

Monetary Policy = Actions of a central bank to control the supply of money § Goals - Stabilize economy (low inflation) - Support economic growth § Tools - Interest rate • Open market operations • Standing facilities - Minimum reserve requirements 4

Transmission Mechanism § The mechanism through which the central bank’s actions affect the economy and ultimately the price level - Complex - Time lags 5

Transmission Mechanism Illustrated OFFICIAL INTEREST RATES Expectations Money, Credit Wage & Price Setting Bank and Market Interest Rates Asset Prices Exchange Rate Supply & Demand in Goods & Labor Markets Domestic Prices Import Prices Shocks from outside the control of the central bank Changes in global economy Changes in fiscal policy Changes in commodity prices PRICE DEVELOPMENTS 6

European Central Bank § ECB, ”Eurosystem”, and ESCB § Decision-making in ECB - Governing council and executive board - General council - Independence from politics § Established in the Maastrict Treaty: - Primary objective to ”maintain price stability” - Secondary objective to ”support general economic policies in EU” • High level of employment, sustainable growth, high degree of competitiveness § Comparison to the anglo-saxon model 7

Specifying ECB’s Goals § What is meant by ”price stability”? - ECB’s definition: Inflation close but not above 2% § If inflation is bad, why not aim at 0%? - Inflation keeps economy going when wages are sticky Bias in HICP -> true inflation less Regional differences within EMU Risk of deflation 8

How Are Policy Decisions Made? § Two pillars strategy - Economic analysis - Monetary analysis § ECB takes actions to ensure price stability in the medium to long term - Due to lags, monetary policy cannot react to shocks in the short term § Accountability? ! § Transparency and communication of policy 9

Challenges for ECB § ”One policy fits all” - How to maintain price stability in all regions? - ECB follows euroarea aggregates -> large countries weigh more § Pressures from politicians and other lobbyists § Credibility and reputation - How to establish when no track record? 10

Financial Crisis 2008 § Started from the U. S. - Housing market and subprime loans turned into investment instruments - Defaults and declining prices caused huge losses for banks and investors § Problem: trust between banks disappeared - Interbank money market froze - Banks couldn’t get money so they could not lend it to firms or consumers • No invesments, low confidence => recession 11

ECB in the Financial Crisis § ECB took emergency measures - Acting as an intermediary in the interbank money market - Longer term financing guaranteed for banks - Decrease in the interest rate § New duties for the ECB: regulation of financial institutions, e. g. ”stress tests” for banks - Discussion on more regulation of the financial markets 12

Debt Crisis since 2011: Implications for ECB § Although a problem of national governments, the debt crisis affects ECB § Insolvency of one member can affect the credibility of other members - Also the credibility of the ECB is at risk: can it maintain price stability? § Problems for commercial banks - Banks use their ”low risk” investments as collateral when borrowing from ECB - When banks incur losses, their ability to gain finanancing is compromised • Potential liquidity problem similar to the financial crisis § ECB has had to purchase government bonds to calm the markets - The ECB is not supposed to purchase government bonds to maintain its independence from national governments 13

Group Work § Read the news item from September 2015 from the Wall Street Journal reporting on the outlook on FED’s monetary policy - What is the economics behind the story? • Why did ECB lower the interest rates? • What are the current challenges for the ECB? • What are the effects of the decision? 14

Pre-Lecture Assignment 1. How successful has ECB’s policy been? Evaluate the success of ECB from several view points. - Find data on the development of ECB interest rates, EMU inflation and GDP growth of EMU countries - You can read selected parts from ECB’s 10 year anniversary publication "Special edition of the Monthly Bulletin". May 2008. http: //www. ecb. int/pub/pdf/other/10 thanniver saryoftheecbmb 200806 en. pdf 2. What do you think the ECB’s challenges will be in the near future? 15