Ademu at the European Parliament, 27 March 2018

A Dynamic Economic and Monetary Union
(ADEMU)
Ramon Marimon
ADEMU Scientific Coordinator
European University Institute and UPF – Barcelona GSE
Research and Innovation Action
Horizon 2020 (Call H2020-EURO-SOCIETY-2014)
EU Contribution of €2,499,999.00 for 36m (Grant # 649396)

The consortium
European University Institute
University of Cambridge
University of Bonn
Toulouse School of Economics
University College London
Catholic University of Portugal
Barcelona Graduate School of Economics

In the aftermath of the euro crisisIn the aftermath of the euro crisis

In the aftermath of the euro crisisIn the aftermath of the euro crisis
The need to strengthen the resilience of the EA

Agreeing to an Unemployment Insurance
System for the Euro Area?
Based on joint work with Árpád Ábrahám,
João Brogueira de Sousa and Lukas Mayr
European University Institute

A European Unemployment Insurance System?
• Several policy proposals then and now:
◦ The Marjolin Report (1975),
◦ Dullien (2014), Beblav´y et al. (2015), Beblav´y and
Lenaerts (2017), Dullien et al. (2018).
• High unemployment + low deficit requirements: costly
delivery of unemployment insurance during recessions.
• Business cycles are not perfectly correlated across EU
countries: risk sharing.
◦ Social and political cohesion, labour market
integration, worker mobility.
• Large differences in unemployment rates and labour
market flows: cross-country transfers.

Unemployment in Europe (2010Q1-2017Q3)

Three questions
• What could be the benefits of developing a European
Unemployment Insurance System (EUIS)?
• Can all the EU countries involved benefit from a common
and simple change to their current UI systems?
• Can unanimous agreement for this change be achieved
without needing permanent transfers across countries?
The answers depend on how the EUIS is designed.

A step back
We first develop a flexible framework to
Describe the observed heterogeneity of labour markets in
the EU (job creation and destruction, search costs, and av.
wage differentials).
Evaluate the impact of different types of EUIS’s.
− On individual consumption, labour supply, private
savings, insurance.
− Government budget: taxes and UB expenditures.
− Political support and welfare of different groups in the
population (employed, unemployed, inactive).

Map of EU Labour Markets
0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.18
Job finding rate: Non-Active
0
0.05
0.1
0.15
0.2
0.25
Jobfindingrate:Unemployed
Labour Market Institutions (model)
Austria
Belgium Germany
EstoniaSpain
Finland
France
Greece
Ireland
Italy
Luxemburg
Latvia
Netherlands
Portugal
Slovenia
Slovakia

Map of EU Labor Markets
0.06 0.08 0.1 0.12 0.14 0.16 0.18 0.2
Average Job finding rate: Non-Employed
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
JobSeparationrate:Employed
Labour Market Institutions (model)
Austria
Belgium
Germany
Estonia
Spain
Finland
France
Greece
IrelandItaly
Luxemburg
Latvia
Netherlands
Portugal
Slovenia
Slovakia

Map of EU national UB policies
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7
Replacement rate
0
1
2
3
4
5
6
7
8
9
10
Maximumduration,quarters
Unemployment benefit policy (data)
Germany
Austria
Estonia
Spain
Finland
France
GreeceIreland
Italy
Luxemburg
Latvia
Netherlands
Portugal
SloveniaSlovakia

An EUIS for large asymmetric negative shocks
Consider the following scenario:
• Member states keep the existing national UB systems.
• EUIS provides support when large negative shock
increases unemployment.
• A Member State enters unemployment recession alone
(the rest of the Union not affected).
• Two scenarios:
◦ Without a EUIS: the country facing the
unemployment crisis must balance the budget;
◦ Under the EUIS: government receives a transfer
equivalent to the increase in national UB expenditures
during the recession.

France’s employment during a recession

France’s unemployment during a recession

France’s taxes during a recession, without and
with an EUIS

The benefits of sharing risk through an EUIS?
Employed Unemployed Un. Eligible. Un. Non-Elig. Non-Active Total
Austria 0.02 0.01 0.01 0.01 0.00 0.02
Belgium 0.07 0.04 0.04 0.04 0.02 0.06
Germany 0.01 0.00 0.00 0.00 0.00 0.01
Spain 0.11 0.05 0.05 0.06 0.02 0.09
Finland 0.09 0.05 0.05 0.07 0.04 0.08
France 0.06 0.02 0.01 0.02 0.00 0.05
Ireland 0.05 0.02 0.02 0.02 0.01 0.04
Italy 0.01 0.01 0.00 0.01 0.00 0.01
Luxembourg 0.00 0.00 0.00 0.00 0.00 0.00
Netherlands 0.02 0.01 0.00 0.01 0.00 0.02
Table: EUIS for large shocks: welfare gains in CEV% (Cons. Equiv. Value)

10 EA countries’ employment during a
recession

10 EA countries’ unemployment during a
recession

10 EA countries’ taxes during a recession

10 EA countries’ taxes during a recession
with EUIS insurance

What could be the benefits of sharing risk
through an EUIS?
Employed Unemployed Un. Eligible. Un. Non-Elig. Non-Active Total
Austria 0.02 0.01 0.01 0.01 0.00 0.02
Belgium 0.07 0.04 0.04 0.04 0.02 0.06
Germany 0.01 0.00 0.00 0.00 0.00 0.01
Spain 0.11 0.05 0.05 0.06 0.02 0.09
Finland 0.09 0.05 0.05 0.07 0.04 0.08
France 0.06 0.02 0.01 0.02 0.00 0.05
Ireland 0.05 0.02 0.02 0.02 0.01 0.04
Italy 0.01 0.01 0.00 0.01 0.00 0.01
Luxembourg 0.00 0.00 0.00 0.00 0.00 0.00
Netherlands 0.02 0.01 0.00 0.01 0.00 0.02
Table: EUIS for large shocks: welfare gains in CEV% (Cons. Equiv. Value)

What role for an EUIS?
• Welfare gains of insuring large shocks are small, but
positive for all Members.
• An interesting finding:
◦ All EA UB systems defined by: the replacement rate
and the duration of eligibility.
• We asked: What would be the optimal UB policy for
each Member state, given its existing labour market
institutions?
• Remarkably similar across countries:
◦ UB Replacement rate 10%-25% and very long duration
of eligibility.

An EUIS with a common minimal coverage
• Replacement rate (15%) and unlimited duration of benefits.
• Financed with a common EUIS wage tax.
Employed Unemp. Inactive Total Tax rate Transfer
Austria -0.31 -0.05 -0.28 -0.29 1.47 -0.51
Belgium 0.36 -1.01 0.18 0.25 1.47 -0.71
Germany 0.16 0.79 0.14 0.20 1.47 -0.14
Spain 1.51 1.42 1.31 1.45 1.47 0.74
Finland 1.11 0.63 0.92 1.04 1.47 -0.87
France -0.06 -0.02 -0.08 -0.06 1.47 -0.16
Ireland 0.66 1.07 0.63 0.68 1.47 -0.09
Italy 0.75 2.13 0.76 0.87 1.47 0.29
Luxemb. -0.43 -0.20 -0.34 -0.40 1.47 -0.64
Netherlds. 0.14 0.55 0.12 0.17 1.47 0.07
Table: Welfare gains (in % CEV), tax rate (in %) and transfers (in % of GDP)

Can all countries benefit from an EUIS,
without crosscountry transfers?
• Common replacement rate (15%) and unlimited duration of benefits.
• Country-specific tax rates, that neutralize transfers.
Employed Unemp. Inactive Total Tax Rate Cur. Tax
Austria 0.21 0.51 0.24 0.23 0.73 0.99
Belgium 1.05 -0.24 0.81 0.92 0.45 2.14
Germany 0.34 0.44 0.28 0.38 1.27 0.45
Spain 0.65 0.65 0.58 0.62 2.53 4.33
Finland 2.09 1.83 1.90 2.03 0.22 3.75
France 0.11 0.18 0.09 0.11 1.23 1.90
Ireland 0.77 1.31 0.73 0.79 1.34 1.97
Italy 0.48 1.58 0.51 0.60 1.90 0.25
Luxembourg 0.30 0.51 0.33 0.32 0.55 0.53
Netherlands 0.06 0.13 0.03 0.08 1.57 1.01
Table: Welfare gains (in % CEV) and tax rates (in %)
• Member States can top-up, increasing their replacement rates.

Wrapping up on EUIS
• With an EUIS for large asymmetric negative shocks
◦ Risk Sharing benefits are small and benefit the employed more if
there are no UB cuts without EUIS
• Substantial gains to be made with
an EUIS with a common minimal coverage. How?
◦ With national systems, if National EUIS Funds have enough
borrowing capacity!?
◦ With a centralized EUIS Fund absorbing deviations from
steady-state beyond certain threshold (| ˆUi − ¯Ui| ≥ tr; ¯Ui =
steady-state unem. rate of country i; tr = 0 → full centralization)
◦ With central funding there is a need for monitoring, periodic risk
assessments, and a proper contract between each participating
country and the EUIS Fund (more on this later).

Wrapping up on EUIS
• With an EUIS for large asymmetric negative shocks
◦ Risk Sharing benefits are small, although in times of crisis even
small gains count!
• Substantial gains to be made with
an EUIS with a common minimal coverage.
• “Experience rating taxes” provide incentives for higher tax
countries to improve their labour markets.
• An EUIS can also enhance labour cohesion and mobility across
EU participating countries, and social identity with the EU!

A European Stability Fund
as a Constrained Efficient Mechanism
Based on joint work with Árpád Ábrahám,
Eva Carceles-Poveda and Yan Liu∗
∗
European University Institute, UPF - Barcelona GSE & CEPR; European University Institute; SUNY at
Stony Brook, and Wuhan University.

Strengthening the EA: 4 related themes
I. Risk-sharing and stabilization policies in normal times.
II. Dealing with severe crises (“a robust crisis management
mechanism”).
III. Resolving a debt crisis (the euro ‘debt overhang’).
IV. Developing ‘safe assets’.

Strengthening the EA:
A “Stabilisation Function” (EC) & “Risk-sharing” once we
get more convergence (Presidents’ Reports)
II. Dealing with severe crises.
Transforming the ESM into a European Monetary Fund (EC)

Strengthening the EA: Our approach
Concentrate on

Strengthening the EA: Our approach
Interesting ﬁnding: Solving for a
I. Stability Fund as a ‘constrained eﬃcient risk-sharing
mechanism’ also helps to:
II. deal with severe crises,
III. resolve a debt crisis, and
IV. develop ‘safe assets’.

A basic principle:
The EU is a long-term self-enforcing partnership!

A basic principle:
The EU is a long-term self-enforcing partnership,
but not a Federal State!

Designing a European Stability Fund
• The EMU is a long-term self-enforcing partnership.
• The ECB to address the problem of time-inconsistency
in monetary policy (mainly: ‘competitive devaluations’).
• The ESF to address the problem of time-inconsistency
in fiscal policy (to follow pro-cyclical fiscal policies, i.e.
primary surplus/GDP not sufficiently procyclical).

Designing a Stability Fund – say, the ESF –
• The ESF long-term contract between the ESF and an EU
country is the key element: it is based on a risk-assessment
of the country.
• The ESF long-term contract deﬁnes state-contingent
transfers, in contrast to unconditional debt contracts.
• A ESF contract induces countercyclical ﬁscal (primary
debt) policies (it is not a crisis resolution debt contract)

Designing a Stability Fund – say, the ESF –
• Long-term contracts can provide risk-sharing and enhance
borrowing & lending and investment opportunities.
• Contingency is ex-post, in contrast with ex-ante eligibility
conditions (e.g. MoU ‘austerity programme’conditions).
• Normal-times-transfers ‘build trust’, in contrast to crisis-
relief-transfers which tend to create ‘stigma & resentment’.

Designing the Fund accounting for 3+2 constraints:
The sovereignty constraint: The country is sovereign and
can always ‘exit’ (although it may be costly)
The redistribution constraint: risk-sharing transfers should
not become ex-post persistent, or permanent, transfers
(Hayek’s problem).
The moral hazard constraint: the severity of shocks may
depend on which policies and reforms are implemented.

Designing the Fund accounting for 3+2 constraints:
The asymmetry constraint: there is no ex-ante ‘veil of
ignorance’ and countries may start with large (debt)
liabilities.
The funding constraint: the fund should be (mostly) self-
funded.

The ESF as a ‘constrained eﬃcient
risk-sharing mechanism’ means
its contracts are optimal, subject to the 3+2 constraints!

Comparing two alternative borrowing & lending regimes
Incomplete markets with default (IMD) and a risk-free
rate r: 1/(1 + r) ≥ β
• countries smooth shocks, and borrow and lend, with long-
term non-contingent debt;
• there can be default (full, in our case);
• default is costly and the country has no access to
international ﬁnancial markets, temporarily.

Comparing two alternative borrowing & lending regimes
Financial Stability Fund (Fund) as a risk-neutral agent
with discount 1/(1 + r) ≥ β.
• a country could leave the Fund at any time, in which case it
is like a country which defaults in an IMD regime;
• persistent transfers are limited by the amount of
redistribution that is mutually accepted;
• there are incentives for countries to apply policies which
reduce risks.

The ESF contract has the following 5 properties:
Consumption smoothing: consumption is less volatile and
less procyclical.
Countercyclical ﬁscal policies: primary surpluses are highly
procyclical.
Government bond spreads are very low (& negative): the
real spreads of ESF contracts (debts) are very low (&
negative).

The ESF contract has the following 5 properties:
High capacity to absorb severe shocks (& existing debts):
in a severe shock (a rare event) a country with an ESF
contract disposes of a large line of credit.
Conditional transfers, not just ex-ante: credit in times of
crisis is not given with ex-ante (austerity plan) conditionality,
but conditionality is a persistent feature.

An ESF contract for the 5 EA ‘stressed’ countries
(1980 - 2015)
1st
Moments Data IMD Fund
Mean
Debt to GDP ratio 77.29% 76.56% 186.65%
Real bond spread 3.88% 3.76% −0.02%
G to GDP ratio 20.18% 19.62% 19.31%
Primary surplus to GDP ratio −0.78% 1.30% 3.57%
Fraction of working hours 36.74% 37.28% 38.09%
Maturity 5.38 5.38 5.38

2nd
Moments Data IMD Fund
Volatility
σ(C)/σ(Y ) 1.49 1.47 0.35
σ(N)/σ(Y ) 0.92 0.69 0.62
σ(G)/σ(Y ) 0.91 0.86 0.53
σ(P S/Y )/σ(Y ) 0.65 0.80 0.94
σ(real spread) 1.53% 0.93% 0.21%
Correlation
ρ(C, Y ) 0.88 0.76 0.57
ρ(N, Y ) 0.67 −0.13 0.94
ρ(P S/Y, Y ) −0.29 0.11 0.95
ρ(G, Y ) 0.35 0.07 0.03
ρ(real spread, Y ) −0.35 −0.29 −0.05
ρ(Gt, Gt−1) 0.94 0.94 0.94

Comparing the economies in normal times

IMD vs. Fund Business Cycle Paths: shocks and allocations
0 100 200 300
0.1
0.2
0.3
0.4
Productivity & G shock
3
g
0 100 200 300
0.1
0.15
0.2
0.25
Output
0 100 200 300
0.1
0.15
0.2
Consumption
0 100 200 300
0.25
0.3
0.35
0.4
Labor
Fund
IMD

IMD vs. Fund Business Cycle Paths: shocks and assets
0 100 200 300
0.1
0.2
0.3
0.4
3
g
0 100 200 300
-0.05
0
0.05
Primary surplus
0 100 200 300
-3
-2
-1
0
Debt/Output
0 100 200 300
0
0.05
0.1
Bond spread
Fund
IMD

Contrasting paths...
• Repeated defaults [in grey] in the IMD economy, no quits with the Fund.
• Positive spreads ‘anticipating’ default when debt is relatively high, and just small
episodes of negative spreads.
• Default episodes mostly driven by productivity shocks: productivity drops + (relatively)
large debt levels.
• Larger amount of ‘borrowing’ with the Fund.
• Fiscal policies (primary deﬁcits) are more counter-cyclical with the Fund.
• Smoother consumption and, correspondingly, more volatile asset holdings and primary
deﬁcits with the Fund.

Comparing the economies in times of crisis

IMD vs. Fund: combined shock impulse-responses: allocations
0 100 200 300
0
0.1
0.2
0.3
0.4
3
g
0 100 200 300
0.05
0.1
0.15
0.2
Output
0 100 200 300
0.05
0.1
0.15
Consumption
0 100 200 300
0.3
0.35
0.4
0.45
Labor
Fund
IMD

IMD vs. Fund: combined shock impulse-responses: assets
0 100 200 300
0
0.1
0.2
0.3
0.4
3
g
0 100 200 300
-0.04
-0.02
0
0.02
Primary surplus
0 100 200 300
-2
-1
0
1
Debt/Output
0 100 200 300
-0.05
0
0.05
0.1
0.15
Bond spread
Fund
IMD

Contrasting severe crises...
• With an unexpected ‘one-period’ worst (θ, G) shock the Fund clearly dominates:
– With a relatively large asset position (implicit insurance) the country can aﬀord
higher consumption with lower labour at the beginning (recall that the borrower is
relatively more impatient),
– even if at ﬁrst there is a drop of output (larger than in the IMD economy) and later
the asset position becomes negative (debt).
• In contrast, there is a a severe crisis with large spreads in the IMD economy!

Welfare gains and absorbing capacity

Welfare gains and absorbing capacity
Shocks (θ, Gc) Welfare Gain (b /y)max: M (b /y)max: F
(θl, Gh) = (0.148, 0.038) 8.90 1.71 97.42
(θm, Gh) = (0.299, 0.038) 7.03 107.55 187.16
(θh, Gh) = (0.456, 0.038) 4.68 217.43 336.77
(θl, Gl) = (0.148, 0.025) 7.87 1.84 101.89
(θm, Gl) = (0.299, 0.025) 6.56 111.40 187.93
(θh, Gl) = (0.456, 0.025) 4.46 217.80 334.47
Average 6.53
• Welfare gains are expressed in consumption equivalent terms at b = 0 (%).
• bmax
is the maximum level of country indebtedness expressed as the percentage of
GDP in a given ﬁnancial environment (Markets or Fund).

Strengthening the EA: as we have seen...
Solving for a
I. Stability Fund as a ‘constrained eﬃcient risk-sharing
mechanism’ also helps to:
II. deal with severe crises,
III. resolve a debt crisis, and
IV. develop ‘safe assets’.

Implementing the ESF
Light version
• ESM implements ESF contingent contract on crisis resolution
contracts (existent and new)
• ESF conditionality becomes ex-post
• ESF is allowed to provide risk-sharing contracts (e.g.
countries that may fail GSP conditions)

Implementing the ESF
Full version
• Full risk-sharing, stabilization, capacity integrated to its
crisis-resolution capacity
• ESF contracts become ‘safe assets’ in the ESF balance sheet
• ESF becomes a proper Fund that can accommodate other
EMU needs (Backstop for SRM, EUIS Fund,...?)
• ESF allowed to issue a safe bond backed by its safe assets

In the aftermath of the euro crisis
&
The key role that EA institutions have played:

the ECB & the ESM

In the aftermath of the euro crisis
&
The key role that EA institutions have played:

the ECB & the ESM

on the ECB known & discussed

(Draghi’s pledge in 2012)

on the ESM…

some ADEMU research…

by Giancarlo Corsetti, Aitor Erce and Timothy Uy

Ademu at the European Parliament, 27 March 2018

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Ademu at the European Parliament, 27 March 2018