Review of Theories of Financial Crises: Currency Crises

1
Review of Theories of Financial Crises Currency
Crises

• By Itay Goldstein and Assaf Razin
• June 2013

2
Scope

• The last few years have been characterized by a
  great turmoil in the worlds financial markets
• These events exhibit ingredients from all types
  of financial crises in recent history
• Banking crises
• National currency and single currency area crises
• Credit frictions
• Market freezes
• Asset bubbles booms and Busts
• Sovereign Debt Crises cum Eurocrisis

3
Financial and Monetary institutions

• --Enable the efficient transmission of resources
  from savers to the best investment opportunities.
• --Provide risk sharing possibilities, so that
  investors
• can take more risk and advance the economy.
• --Enable aggregation of information that provides
  guidance for more efficient investment decisions.
  
• --Monetary arrangements, such as the European
  Monetary Union (EMU) are created to facilitate
  free trade and financial transactions among
  countries, thereby improving real efficiency.

4
Financial Crisis

• A financial crisis marks a severe disruption of
  these normal functions of financial and monetary
  systems, thereby hurting the normal functioning
  of the real economy.

5
Financial Fragility

• The models reviewed here describe situations in
  which financial systems are fragile and prone to
  crises.
• Main problems
• Agency problems
• Those who are making the decisions
  might not fully reflect the interests of those
  on whose behalf they were supposed to be acting.
• Coordination failures
• e.g., Banks rely on the fact that only
  forecastable fraction of depositors will have
  short term liquidity needs. But there is self
  fulfilling equilibrium where all depositors
  demand early withdrawal.
• Strategic Complementarities
• E.g., When more depositors withdraw their
  money the bank is more likely to fail and so
  other depositors have a stronger incentive to
  withdraw.

6

• Principal-Agent moral hazard
• e.g., The borrower has the ability to divert
  resources to himself at the expense of the
  creditor. This creates a limit on credit. The
  limit can get tightens when economic conditions
  worsen.
• Risk Shifting
• e.g., An investor who borrow to buy assets
  benefits from the upside while having limited
  exposure to the downside risk.
• Heterogeneous beliefs and leverage
• e.g., where the optimists-pessimists
  composition in the investor population shifts
  endogenously leverage bubbles are created and
  burst.
• Fragile institutional of monetary and exchange
  rate arrangements
• E.g. European Monetary System

7
Currency Crises

• Governments/central banks try to maintain certain
  financial and monetary arrangements, most notably
  a fixed-exchange rate regime, or more recently, a
  regional monetary union. Their goal is to
  stabilize the economy or the region.
• At times, these arrangements become unstable and
  collapse leading to debt crises and banking
  crises
• The strand of the literature analyzes currency
  crises characterized by a speculative attack on a
  fixed exchange rate regime. The newer strand
  emphasizes banking and fiscal union as a backstop
  to single currency area crises.

8
The International-Finance Tri-Lemma

• A tri-lemma is a situation in which someone faces
  the choice among three options, each of which
  comes with some inevitable choices because not
  all the three can be simultaneously accomplished.

9
Monetary Policy Options

• First, make the countrys economy open to
  international capital flows, because by doing so
  they let investors diversify their portfolios
  overseas and achieve risk sharing. They also
  benefit from the expertise brought to the country
  by foreign investors.
• Second, use an independent monetary policy as a
  tool to help stabilize inflation, output, and the
  financial sector in the economy. This is achieved
  as the central bank can increase the money supply
  and reduce interest rates when the economy is
  depressed, and reduce money growth and raise
  interest rates when it is overheated. Moreover,
  it can serve as a lender of last resort in case
  of financial panic.

10
Options

• Third, maintain stability in the exchange rate.
  This is because a volatile exchange rate, at
  times driven by speculation, can be a source of
  broader financial volatility, and makes it harder
  for households and businesses to trade in the
  world economy and for investors to plan for the
  future.

11
Fixed exchange rate and capital mobility

• By attempting to maintain a fixed exchange rate
  and capital mobility, the central bank loses its
  ability to control the interest rate or
  equivalently the monetary base its policy
  instruments as the interest rate becomes
  anchored to the world interest rate by the
  interest rate parity and the monetary base is
  automatically adjusted. This is the case of
  individual members of the EMU.

12
Monetary Control and Capital Mobility

• In order to keep control over the interest rate
  or equivalently the money supply, the central
  bank has to let the exchange rate float freely,
  as in the case of the US.

13
Exchange Rate Stability and Monetary Control

• If the central bank wishes to maintain both
  exchange rate stability and control over the
  monetary policy, the only way to do it is by
  imposing domestic credit controls and
  international capital controls, as in the case of
  China.

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Currency Crises and the Tri-Lemma

• Currency crises occur when the country is trying
  to maintain a fixed exchange rate regime with
  capital mobility, but faces conflicting policy
  needs, such as fiscal imbalances or fragile
  financial sector, that need to be resolved by
  independent monetary policy, and effectively
  shift the regime from the first solution of the
  tri-lemma described above to the second solution
  and the tri-lemma.

15
First-Generation Models of Currency Crises

• This branch of models, the so-called first
  generation models of currency attacks was
  motivated by a series of events where fixed
  exchange rate regimes collapsed following
  speculative attacks, for example, the early
  1970s breakdown of the Bretton Wood global
  system.
• The first paper here is the one by Krugman
  (1979).
• He describes a government that tries to maintain
  a fixed exchange rate regime, but is subject to a
  constant loss of reserves, due to the need to
  monetize government budget deficits.

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First-Generation Model of Currency Crises

• These two features of the policy are
  inconsistent with each other, and lead to an
  eventual attack on the reserves of the central
  bank, that culminate in a collapse of the fixed
  exchange rate regime.
• Flood and Garber (1984) extended and clarified
  the basic mechanism, suggested by Krugman (1979),
  generating the formulation that was widely used
  since then.

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A First-Generation Model of Currency Crises

• Recall that the asset-side of the central banks
  balance sheet at time t is composed of domestic
  assets BH,t
• the domestic-currency value of foreign assets
  StBF,t
• where St denotes the exchange rate, i.e., the
  value of foreign currency in terms of domestic
  currency.
• The total assets have to equal the total
  liabilities of the central bank, which are, by
  definition, the monetary base, denoted as Mt.

18
Currency Crises First-Generation Model of
Currency Crises
.

• Due to fiscal imbalances, the domestic assets
  grow in a fixed and exogenous rate
• Because of perfect capital mobility, the domestic
  interest rate is determined through the interest
  rate parity, as follows
• Where it denotes the domestic interest rate at
  time t and it denotes the foreign interest rate
  at time t.

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Currency Crises First-Generation Model of
Currency Crises

• The supply of money, i.e., the monetary base, has
  to be equal to the demand for money, which is
  denoted as L(it), a decreasing function of the
  domestic interest rate.
• The inconsistency between a fixed exchange rate
  regime
• with capital mobility, and the fiscal
  imbalances, comes due to the fact that the
  domestic assets of the central bank keep growing,
  but the total assets cannot change since the
  monetary base is pinned down by the demand for
  money, L(it), which is determined by the foreign
  interest rate it

20
Currency Crises First-Generation Model of
Currency Crises

• Hence, the obligation of the central bank to keep
  financing the fiscal needs, puts downward
  pressure on the domestic interest rate, which, in
  turn, puts upward pressure on the exchange rate.
• In order to prevent depreciation, the central
  bank has to intervene by reducing the inventory
  of foreign reserves.
• Overall, decreases by the same amount as
  BH,t increases, so the monetary base remains the
  same.

21
Currency Crises First-Generation Model of
Currency Crises

• The problem is that this process cannot continue
  forever, since the reserves of foreign currency
  have a lower bound.
• Eventually, the central bank will have to abandon
  the solution of the tri-lemma through a fixed
  exchange rate regime and perfect capital mobility
  to a solution through flexible exchange rate with
  flexible monetary policy (i.e., flexible monetary
  base or equivalently domestic interest rate) and
  perfect capital mobility.

22
Currency Crises First-Generation Model of
Currency Crises

• The analytical question is what is the critical
  level of domestic assets BH,T , and the
  corresponding period of time T, at which the
  fixed-exchange rate regime collapses.
• This happens when the (conditionally) expected
  shadow exchange rate -defined as the flexible
  exchange rate under the assumption that the
  central banks foreign reserves reached their
  lower bound while the central bank keeps
  increasing the domestic assets to accommodate the
  fiscal needs -is equal to the pegged exchange
  rate.

23
Second-Generation Model of Currency Crises

• Following the collapse of the ERM in the early
  1990s, which was characterized by the tradeoff
  between the declining activity level and
  abandoning the exchange rate management system,
  the so-called first-generation model of currency
  attacks did not seem suitable any more to explain
  the ongoing crisis phenomena.
• This led to the development of the so-called
  second generation model of currency attacks,
  pioneered by Obstfeld (1994, 1996).

24
Currency Crises Second-Generation Model of
Currency Crises

• A basic idea here is that the governments policy
  is not just on automatic pilot like in Krugman
  (1979) above, but rather that the government is
  setting the policy endogenously, trying to
  maximize a well-specified objective function,
  without being able to fully commit to a given
  policy.
• In this group of models, there are usually
  self-fulfilling multiple equilibria, where the
  expectation of a collapse of the fixed exchange
  rate regime leads the government to abandon the
  regime.
• This is related to the Diamond and Dybvig (1983)
  model of bank runs, creating a link between these
  two strands of the literature.

25
Currency Crises Second-Generation Model of
Currency Crises

• Obstfeld (1996) discusses various mechanisms that
  can create the multiplicity of equilibria in a
  currency-crisis model. Let us describe one of
  them, which is inspired by Barro and Gordon
  (1983).
• Suppose that the government minimizes a loss
  function of the following type
• Here, y is the level of output, y is the target
  level of output, and e is the rate of
  depreciation, which in the model is equal to the
  inflation rate.

26
Currency Crises Second-Generation Model of
Currency Crises

• Hence, the interpretation is that the government
  is in a regime of zero depreciation (a fixed
  exchange rate regime). Deviating from this regime
  has two costs.
• The first one is captured by the index function
  in the third term above, which says that there is
  a fixed cost in case the government depreciates
  the currency.
• The second one is captured by the second term
  above, saying that there are costs to the economy
  in case of inflation.

27
Currency Crises Second-Generation Model of
Currency Crises

• But, there is also a benefit the government
  wishes to reduce deviations from the target level
  of output, and increasing the depreciation rate
  above the expected level serves to boost output,
  via the Philips Curve.
• This can be seen in the following expression,
  specifying how output is determined
• Here, is the natural output, u is a random
  shock, and is the expected level of
  depreciation/inflation that is set endogenously
  in the model by wage setters based on rational
  expectations

28
Currency Crises Second-Generation Model of
Currency Crises

• The idea is that an unexpected inflationary shock
  boosts output by reducing real wages and
  increasing production.
• Importantly, the government cannot commit to a
  fixed exchange rate. Otherwise, it would achieve
  minimum loss by committing to e0.
• However, due to lack of commitment, a sizable
  shock u will lead the government to depreciate
  and achieve the increase in output bearing the
  loss of credibility.

29
Currency Crises Second-Generation Model of
Currency Crises

• Going back to the tri-lemma discussed above, a
  fixed exchange rate regime prevents the
  government from using monetary policy to boost
  output, and a large enough shock will cause the
  government to deviate from the fixed exchange
  rate regime.
• It can be shown that the above model generates
  multiplicity of equilibria. If wage setters
  coordinate on a high level of expected
  depreciation/inflation, then the government will
  validate this expectation with its policy by
  depreciating more often.

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Currency Crises Second-Generation Model of
Currency Crises

• If they coordinate on a low level of expected
  depreciation, then the government will have a
  weaker incentive to deviate from the fixed
  exchange rate regime.
• Hence, a depreciation becomes a self-fulfilling
  expectation.
• Similarly, one can describe mechanisms where
  speculators may force the government to abandon
  an existing fixed-exchange rate regime by
  attacking its foreign currency reserves and
  making the maintenance of the regime too costly.
  If many speculators attack, the government will
  lose many reserves, and will be more likely to
  abandon the regime.

31
Currency Crises Second-Generation Model of
Currency Crises

• A self-fulfilling speculative attack is
  profitable only if many speculators join it.
• Consequently, there is one equilibrium with a
  speculative attack and a collapse of the regime,
  and there is another equilibrium, where these
  things do not happen.
• Similarly, speculators can attack government
  bonds demanding higher rates due to expected
  sovereign-debt default, creating an incentive for
  the central bank to abandon a currency regime and
  reduce the value of the debt.

32
Currency Crises Second-Generation Model of
Currency Crises

• As argued by Paul De Grauwe (2011), the problem
  can become more severe for countries that
  participate in a currency union since their
  governments do not have the independent monetary
  tools to reduce the cost of the debt.
• Morris and Shin (1998) applied global games
  methods to tackle the problem of multiplicity of
  equilibrium in the second-generation models of
  speculative attacks.

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Currency Crises Second-Generation Model of
Currency Crises

• Using the global-game methodology, pioneered by
  Carlsson and van Damme (1993), they are able to
  derive a unique equilibrium, where the
  fundamentals of the economy uniquely determine
  whether a crisis occurs or not. This enabled them
  to ask questions as to the effect of policy
  tools on the probability of a currency attack.

34
Third generation Currency Crises models

• While the 1st and 2nd generation currency crisis
  literature focused on the government alone, the
  Third-generation models connect currency crises
  to models of banking crises and credit frictions.

35
Twin Crises

• In the late 1990s, a wave of crises hit the
  emerging economies in Asia, including Thailand,
  South Korea, Indonesia, Philippines, and
  Malaysia. A clear feature of these crises was the
  combination of the collapse of fixed exchange
  rate regimes, capital flows, financial
  institutions, and credit This led to extensive
  research on the interplay between currency and
  banking crises, sometimes referred to as the twin
  crises, and balance sheet effects of
  depreciations For a broad description of the
  events around the crisis, see Radelet and Sachs
  (1998). The importance of capital flows was
  anticipated by Calvo (1995).

36
Currency mismatch between their assets and
liabilities

• One of the first models to capture this joint
  problem was presented in Krugman (1999).
• In his model, firms suffer from a currency
  mismatch between their assets and liabilities
  their assets are denominated in domestic goods
  and their liabilities are denominated in foreign
  goods.
• Then, a real exchange rate depreciation increases
  the value of liabilities relative to assets,
  leading to deterioration in firms balance
  sheets.

37
Add Credit Frictions

• Because of credit frictions as in Holmstrom and
  Tirole (1997), described in the next section,
  this deterioration in firms balance sheets
  implies that they can borrow less and invest
  less.
• The novelty in Krugmans paper is that the
  decrease in investment validates the real
  depreciation in the general- equilibrium setup.
• This is because the decreased investment by
  foreigners in the domestic market implies that
  there will be a decrease in demand for local
  goods relative to foreign goods, leading to real
  depreciation.

38
Multiple Equilibrium

• Hence, the system has a multiple equilibrium with
  high economic activity, appreciated exchange
  rate, and strong balance sheets in one
  equilibrium, and low economic activity,
  depreciated exchange rate, and weak balance
  sheets in the other equilibrium.
• Other models that extended and continued this
  line of research include Aghion, Bacchetta, and
  Banerjee (2001), Caballero and Krishnamurthy
  (2001), and Schneider and Tornell (2004). The
  latter fully endogeneize the currency mismatch
  between firms assets and liabilities.

39
Third-Generation Model of Currency Crises

• The global-game methodology, relying on
  heterogeneous information across speculators,
  also brought to the forefront the issue of
  information in currency-attack episodes, leading
  to analysis of the effect that transparency,
  signaling, and learning can have on such episodes
  (e.g., Angeletos, Hellwig, and Pavan (2006)).

40
Bank Runs and Currency Crises

• Chang and Velasco (2001) and Goldstein (2004)
  model the vicious circle between bank runs and
  speculative attacks on the currency.
• On the one hand, the expected collapse of the
  currency worsens banks prospects, as they have
  foreign liabilities and domestic assets, and thus
  generates bank runs, as described in the previous
  section. Bank runs are more likely in a currency
  union without a single-currency-wide bank union,
  or the ability of the central bank to act as a
  lender of last resort for sovereign debt.

41
Circular relationship between currency crises and
banking crises

• On the other hand, the collapse of the banks
  leads to capital outflows that deplete the
  reserves of the government, encouraging
  speculative attacks against the currency.
• Accounting for the circular relationship between
  currency crises and banking crises complicates
  policy analysis. For example, a
  lender-of-last-resort policy or other
  expansionary policies during a banking crisis
  might backfire as it depletes the reserves
  available to the government, making a currency
  crisis more likely, which in turn might further
  hurt the banking sector that is exposed to a
  currency mismatch.

42
Contagion of Currency Crises

• The forceful transmission of crises across
  countries generated a large literature of
  international financial contagion.
• Kaminsky, Reinhart, and Vegh (2003) provide a
  nice review of the theories behind such
  contagion. They define contagion as an immediate
  reaction in one country to a crisis in another
  country.
• There are several theories that link such
  contagion to fundamental explanations.

43
Contagion of Currency Crises

• The clearest one would be that there is common
  information about the different countries, and so
  the collapse in one country leads investors to
  withdraw out of other countries. For a broader
  review, see the collection of articles in
  Claessens and Forbes (2001).
• Calvo and Mendoza (2000) present a model where
  contagion is a result of learning from the events
  in one country about the fundamentals in another
  country.

44
Contagion of Currency Crises

• They argue that such learning is likely to occur
  when there is vast diversification of portfolios,
  since then the cost of gathering information
  about each country in the portfolio becomes
  prohibitively large, encouraging investors to
  herd.
• Another explanation is based on trade links (see
  e.g., Gerlach and Smets (1995)).
• If two countries compete in export markets, the
  devaluation of ones currency hurts the
  competitiveness of the other, leading it to
  devalue the currency as well. A third explanation
  is the presence of financial links between the
  countries.

45
Currency CrisesContagion

• In Kodres and Pritsker (2002), investors optimize
  their portfolio allocation.
• A decrease in the share of their portfolio held
  in one country due to a crisis, leads them to
  rebalance by reducing their holding in another
  country, and hence causes co-movement in prices.
• In Allen and Gale (2000), different regions
  insure each other against excessive liquidity
  shocks, but this implies that a shock in one
  region is transmitted to the other region via the
  insurance linkage.

46
Currency CrisesContagion of Currency Crises

• Empirical evidence has followed the above
  theories of contagion.
• The common information explanation has vast
  support in the data.
• Several of the clearest examples of contagion
  involve countries that appear very similar.
  Examples include the contagion that spread across
  East Asia in the late 1990s and the one in Latin
  America in the early 1980s. A vast empirical
  literature provides evidence that trade links can
  account for contagion to some extent.

47
Currency CrisesContagion of Currency Crises

• These include Eichengreen, Rose, and Wyplosz
  (1996) and Glick and Rose (1999).
• Others have shown that financial linkages are
  also empirically important in explaining
  contagion. For example, Kaminsky, Lyons, and
  Schmukler (2004) have shown that US-based mutual
  funds contribute to contagion by selling shares
  in one country when prices of shares decrease in
  another country.
• Caramazza, Ricci, and Salgado (2004), Kaminsky
  and Reinhart (2000) and Van Rijckeghem and Weder
  (2003) show similar results for common commercial
  banks.

48
Single Currency Area Theory

• In the 1960s, a new concept emerged in
  international macroeconomics
• optimum currency area theory.
• The question it sought to answer when should
  countries adopt a common
• currency?
• Recall that by adopting a common currency,
  countries would give up much of their policy
  independence the question was how costly that
  would be, and how large are the benefits.
• One variant, pushed by Ronald McKinnon, stressed
  the amount of trade the more two countries
  trade, the bigger the advantages of not having to
  change currencies, and arguably, also, the less
  adjustment is needed to correct trade imbalances.
  Another (actually the first paper on the
  subject), by Robert Mundell, stressed labor
  mobility you dont need as much policy
  independence if unemployed workers can move to
  where the jobs are. A third, stressed by my late
  colleague Peter Kenen, stressed fiscal
  integration if countries or regions share common
  budgets for major programs, there will be a lot
  of automatic compensation for
• asymmetric shocks.

49
Public debt denominated in own, or in foreign,
currency

• Paul De Grauwe notes that the benefits of
  retaining a currency on ones own manifest in the
  post-crisis interest rates paid on long-term
  public debt
• The ratio of net public debt to gross domestic
  product of the UK and Spain are essentially
  identical. (IMF forecasts that in 2017, the ratio
  is 93 per cent for the UK and 95 per cent for
  Spain.)
• Yet the yield on UK 10-year bonds is firmly under
  2 per cent among the lowest in UK history, and
  not much above Germanys but the yield on
  Spanish 10-year bonds, meanwhile, is about 5 per
  cent.

50
Lender of last resort

• The ability and desire of the Bank of England to
  prevent outright default is more credible than
  that of the ECB an independent, supranational
  central bank.
• The BoE, as lender of last resort, also promises
  market liquidity. If the market for public debt
  is subject to self-fulfilling prophecies of good
  or bad outcomes, this should guarantee more
  stability at favorable rates.

51
Banks and Governments

• Central Banks were given double task
• ?Lender of last resort for banks
• backstop to counter panic and run on banks.
• ?Lender of last resort to governments
• to counter run on government bond markets

52
Banks and Governments

• Banks and governments face similar problem
  unbalanced maturity structure of assets and
  liabilities
• ?Making both banks and governments vulnerable for
  movements of distrust, which will lead to
  liquidity crisis, and can degenerate into
  solvency crisis.
• When banks collapse sovereign is in trouble
• When government collapses banks are in trouble

53
A Need for Fiscal Union

• The fiscal union aspect comes in because of the
  need to have government budget as shock absorber
  based on Keynes savings paradox paradox
• ?When after crash private sector has to
  de-leverage. It does two things
• ?It tries to save more.
• ?It sells assets.
• ?Private sector can only save more if government
  sector borrows more (i.e. higher budget deficit)
• ?But, if government also tries to save more,
  attempts to save more by private sector are
  self-defeating. The economy is pulled into
  deflationary spiral.

54
Eurozone Stabilizers are organized at national
levels

• These stabilizing features relatively well
  organized at the level of countries (US, UK,
  France, Germany), but, not at international level
  nor at the level of a monetary union like the
  Eurozone
• ?These EMU design failures were only recognized
  after the financial crisis, also because Optimum
  Currency Area Theory was pre-occupied with
  exogenous shocks, but not with an endogenous
  dynamics
• ?And even then in many countries, especially in
  Northern Europe the point is still not recognized
  because of dramatic diagnostic failure, focusing
  on government profligacy giving rise to
  austerity policy during the de-leveraging period.
  

55
Features that magnify private- and public-sector
financial fragility within the euro zone

• Financial integration undermines the ability of
  individual member governments credibly to
  backstop their
• national banking systems through purely fiscal
  means.
• Within the euro zone the key functions of bank
  regulations, depositor insurance, bank
  resolutions and fiscal policy remained national.
• In the absence of national discretion over
  last-resort lending, money creation, and the
• exchange rate.

56
A Fiscal Tri-lemma

• Obstfeld proposes a fiscal trilemma for the euro
  zone
• One cannot simultaneously maintain all three (1)
  Cross-border financial integration
• (2) Financial stability
• (3) National fiscal independence.

57
Financial integration and financial stability
with external fiscal support

• If countries are financially integrated,
• they simply cannot credibly backstop their
  financial systems without the certainty of
  external fiscal support, either directly (from
  partner country treasuries) or indirectly
  (through monetary financing from the union-wide
  central bank) thus sacrificing national fiscal
  independence .

58
Alternatively, a country reliant mainly on its
own fiscal resources will likely sacrifice
financial integration as well as stability,
because markets will then assess financial risks
along national lines.
59
Financial repression to minimize financial
fragility

• Voluntary withdrawal from the single financial
  market might allow a country with limited
• fiscal space to control and insulate its
  financial sector enough to minimize fragility.

60
Fragility of government bond market in a
monetary union

• Governments of member states cannot guarantee to
  bond holders that cash would always be there to
  pay them out at maturity in contrast with
  stand-alone countries that give this implicit
  guarantee, because they can and will force
  central bank to provide liquidity
• (There is no limit to money creating capacity)

61
Self-fulfilling Sovereign Debt crises

• This lack of implicit guarantee to government
  debt can trigger liquidity crises.
• Because,
• (1) distrust by market leads to bond sales, and
  interest rate increases.
• (2) Liquidity is withdrawn from national markets,
  moving to safe havens.
• Government, unable to rollover debt, is forced to
  introduce immediate and intense austerity,
  producing deep recession and Government Debt to
  GDP ratio increases.

62
In 2012 ECB has acted

• On September 6, 2012 ECB announced it will buy
  unlimited amounts of government bonds.
• ?Program is called Outright Monetary
  Transactions (OMT)
• ?Large parts of the euro area were in a bad
  equilibrium in which self-fulfilling expectations
  were feeding on themselves.

63
Outright Monetary Transactions

• European Central Banks promises to intervene via
  a program called outright monetary transactions
  (OMT). But, OMT is still less credible than
  lending of last resort by national central bank
  because in the context of supranational EMU
  institution there is no similar institution which
  provides a Eurozone fiscal backing.

64
Concluding Remarks
65
Far From a Fiscal Union Austerity in the
periphery to offset by stimulus in the core?

• Source IMF
•  

66
Thank you