On 3-5 January the American Economic Association (AEA) held its annual meeting in San Francisco. Marco Buti, Director General of the Direcrorate General Economic and Financial Affairs, chaired a panel on the first ten years of EMU
Charles Wyplosz focused on the persistence of intra-area imbalances, revisiting the well-known 'Walters critique' that in a monetary union real interest rates tend to behave pro-cyclically, thus exacerbating cross-country differences in cyclical positions. He found that the Walters critique indeed proved valid in EMU, but not quite in the way as initially expected: it operated via capital inflows rather than via low real interest rates in booming countries, as inflation differentials had remained limited.
Lucas Papademos dealt with the crisis, in particular with the interaction between economic contraction and financial stability risks, the continued tensions in money markets and the weakening of monetary policy transmission in the face of de-leveraging. He warned that the euro cannot shield countries that have built up imbalances in their external or fiscal positions against credit and growth risks. He called for a stronger role for the ECB in supervising large cross-border financial institutions, but thought an evolutionary approach would be inevitable.
Barry Eichengreen discussed the likelihood of a break-up of the euro area in the face of the crisis, which he saw as close to nil as an announced euro-area exit would unavoidably result in bank runs and capital flight in the country concerned. To address the crisis he saw several routes, including the coordination of bank bailouts, resorting to debt-equity swaps, re-capitalising financial institutions over the budget and the creation of an EU stability fund.
Simon Johnson underscored the widening yield spreads within the euro area, and wondered how, and if, a major risk of default of a major euro area country could be managed. He also drew attention to the challenge of coordinating fiscal stimulus in the face of spillover effects and hoped that the current crisis could be conducive to the establishment of a genuine fiscal authority at the EU center.
There was a broad agreement in the subsequent discussion that the widening yield spreads in the euro area should be seen as related more to sovereign risk than to liquidity, and that this issue may become more acute once rising debt and rollover needs kick in the years ahead. There was also broad agreement that EU/euro area financial markets are in need of a more coordinated supervisory system, but there was less clarity as concerns the modalities and time frame for achieving this.