Finance: Research, Policy and Anecdotes

In a recent (virtual) event at the Florence School of Banking and Finance, Pascal Donohoe, Irelands’ Minister of Finance and the head of the euro group gave a lecture at the Florence School of Banking and Finance, discussing the current agenda of the Eurogroup.  First, completion of the banking union, including the European Deposit Insurance Scheme and the regulatory treatment of sovereign exposures, two topics that many of us economists have focused on for the past decade or so. Second, the introduction of a digital euro, importantly, however, as complement not as substitute for cash; not surprisingly, this as much a question of payment efficiency, as is this a defensive move against private crypto-currencies (I would assume, this refers to Libra/Diem). Third, a strong fiscal response, including the Recovery and Resilience Facility to support the post-pandemic recovery.  Quite an agenda and we appreciated the intention of Mr. Donohoe to interact with academics on these important issues.

I was asked to give some closing remarks after the discussion and focused on three issues, using two aphorisms:

First,  the Spanish philosopher George Santayana is claimed to have coined the oft-repeated phrase: “Those who do not learn history are doomed to repeat it.” Fiscal policy choices made after the Global Financial Crisis ten years ago set the scene for the Eurozone Debt Crisis.  Withdrawing fiscal stimulus, not only in overindebted euro area periphery countries, but also in core countries, most prominently Germany, exacerbated the crisis substantially. Austerity policies in the UK between 2010 and 2016, criticised by economists both in the UK and the IMF, ultimately resulted in the Brexit referendum vote. It is thus critical for democracy and socio-economic sustainability that this mistake not be repeated and that fiscal stimulus and support not be withdrawn too quickly. The example set by the new US administration should certainly be an important signal. Mr. Donohoe was quite defensive when it comes to comparing the European and US fiscal responses to the pandemic and crisis; here I am, however, with Martin Sandbu who pointed to the risks for Europe of an insufficient stimulus.

Second, the Greek philosopher Heraclitus is claimed to have said: “No man ever steps in the same river twice, for it's not the same river and he's not the same man”. As much as we have to learn from history, it is important to realise that the current crisis is different from the previous one and the situation of the European economy is different. While in the Global Financial Crisis the financial sector was at the core of the crisis, this time the financial sector was hit as much as any other part of the economy; however, the financial sector has been critical both as a transmission channel for government support for households and firms during the pandemic and in its post-pandemic role of reallocating capital. As important, the banking sector might also be faced with a wave of corporate insolvencies as fiscal support is being withdrawn and the question arises whether the bank resolution framework as put in place over the past decade in Europe will be sufficient to address with the consequent possible bank fragility.

Finally, an appeal to my fellow social scientists to get more involved in the policy process and beyond the broad debate. My experience with the policy-making process last year at the ESRB was that there are three phases to designing policies (especially if done from a clean slate); the policy phase, when arguments in favour and against are discussed and weighed, the political phase, when the feasibility of actions has to be explored, and the technical/editorial phase, when policy is put on paper and the discussion focuses on detailed wording. Academics are mostly focused on the first phase, but I think we have to get involved in the second if not even in the third phase, where possible. Not getting involved in the second phase risks leaving the public discourse to fringe economists and charlatans; getting involved in the third phase can be an eye-opening but also humbling experience of the sausage-making process.

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