- ‘Re-assessing Fragmentation of the Euro Area Banking System. Offshore Channels for Cross-Border Banking Activities’ (with Iñaki Aldasoro and Torsten Ehlers)
It is an established assessment that since the Eurocrisis, the Euro area banking system has been fragmented. Representing the Eurozone’s monetary architecture as a web of interlocking balance sheets, we carve out four different types of fragmentation that pertain to different parts of banks’ balance sheets and a different set of counterparties. The first type affects the size, scope, and business model of EA banks; the second the cross-border interbank lending among EA banks; the third the monetary policy transmission via EA banks; and the fourth the harmonization of public backstops for EA banks. We argue that the first two types of fragmentation can in principle be mitigated by using ‘offshore channels’ for cross-border banking activities. Euro area banks are not restricted to using EUR-denominated instruments inside the Eurozone monetary jurisdiction but may carry out cross-border activities in other units of account than the EUR (notably the USD) and in other booking locations (notably via their branches in the United Kingdom and the United States). Using data derived from the BIS’s international debt securities and locational banking statistics, we analyse whether the use of these offshore channels warrants a re-assessment of established findings on the fragmentation of the Euro area banking system.
Presentations at the workshop “Offshore Finance in International Political Economy” at Freie Universität Berlin (09/2023) and the workshop “Continuity and Transformation in the (Shadow) Banking System since the Global Financial Crisis” at the European University Institute (10/2023).
- ‘Primary Dealers in the Offshore US-Dollar System. Intermediating Treasury and Central Bank Balance Sheets’ (with Will Bateman)
This study analyzes the Primary Dealer model for the issuance and distribution of sovereign debt as a distinctive feature of today’s international monetary system, the Offshore US-Dollar System. Primary dealers are a group of private banks who have an oligopoly for purchasing sovereign debt on the primary market. Hence, not only do they form a transmission belt between central banks and treasuries, but they also control the distribution of sovereign debt within and across monetary jurisdictions, which is particularly relevant for sovereign debt with safe asset status that is in high demand, such as US and German bills and bonds. We argue that the Primary Dealer model is a historically specific and idiosyncratic institutional solution that originated in the US and by now has been adopted with only limited variation by most monetary jurisdictions around the globe. Combining institutionalist, legal and quantitative analysis of sovereign bond issuance, this study presents an in-depth analysis of the triangular structure between primary dealers, treasuries and central banks that exists in four quintessential cases: the United States, the United Kingdom, Japan, as well as Germany and the Eurozone.
Will Bateman, Australian National University
- ‘Encumbered Security. Conceptualizing Vertical and Horizontal Repos in the Euro Area’ (with Alexandru-Stefan Goghie and Matteo Giordano)
Despite the paramount centrality of repurchase agreements (repos) in today’s market-based finance regime, both conceptual and empirical questions about European repo markets are insufficiently explored as contradictory legal and accounting treatments make their on-balance-sheet representation intricate. Drawing on the literature on monetary hierarchy, we make three connected conceptual arguments: First, we argue that the balance sheet mechanics of repos vary if the counterparties involved are on hierarchically different levels (“vertical repos”) or on the same hierarchical level (“horizontal repos”). While the vertical repo mechanism implies money creation, the horizontal repo mechanism only lends on pre-existing money. Second, we provide a coherent representation of the security posted as repo collateral, which—as to contemporary regulations—does not leave the balance sheet of the repo borrower but changes its status from being held outright to being “encumbered”. Third, we introduce an on-balance-sheet notation of the collateral framework as a means of the repo lender to alter the elasticity of the funding provided. Applying our methodology on two cases—vertical repos created by the Eurosystem for monetary policy implementation and horizontal repos used in the European interbank market—offers an innovative and consistent way to represent changes in the collateral frameworks that affect the elasticity space in the Euro area’s monetary architecture. Our analysis yields two main contributions: We offer an innovative understanding of different mechanisms for repo creation based on monetary hierarchy, and we put forth a data-driven empirical analysis of repos in Europe aimed at supporting our conceptual elaborations.
Presentations at the Third Money View Symposium (01/2023) and the Financial Market Infrastructure workshop at Goethe Universität, Frankfurt am Main (06/2023).
Alexandru-Stefan Goghie, Freie Universität Berlin
Matteo Giordano, School of Oriental and African Studies (SOAS)
- ‘Transformation of the Eurozone Architecture. On Crises and Institutional Change in the Offshore US-Dollar System’ (with Alexandru-Stefan Goghie, Matteo Giordano and Ludwig Schulze)
The Eurocrisis was a make-it-or-break-it moment for the EMU with a profound impact on the transformation of the Eurozone architecture. However, its underlying macro-financial causes remain insufficiently understood. While dominant narratives emphasize excessive sovereign debt issuance, weaknesses of the Stability and Growth Pact, or lacking supranational supervision, they cannot convincingly explain how and why the US-centric run on shadow money spilled over to some EMU treasuries and disregard the critical role of EMU repo markets and the Eurosystem’s collateral framework. Drawing on the macro-financial model developed in Murau (2020), this paper analyses the crisis-driven transformation of the Eurozone architecture from the Global Financial Crisis to the Asset Purchase Programmes in 2014. We argue that the contagion dynamics across private and public balance sheets of the Eurozone and US monetary architectures should be understood as “endogenous forces” that critically determined the EMU’s transformation towards its contemporary shape. We operationalize it with a novel methodology that combines structured process-tracing with balance sheet visualization of crisis dynamics. Drawing on primary and secondary sources as well as private and public sector data, we apply an analytical scheme that starts with on-balance-sheet contractions, followed by the activation of inbuilt elasticity provision mechanisms; where these fail, innovation occurs which can materialize via enhanced elasticity space, new instruments, or even new institutions. As a result, we provide a novel perspective on the process of financial integration in the EMU and derive hypotheses for a theory on the endogeneity of crisis-driven change in modern monetary architectures.
Presentations at the symposium “Crises Capitalism. Shadow Banking, Central Banks, and New Configurations of State-Financial Market Entanglements” in Hannover (06/2023), the workshop “Money in Open Economies” at Leeds Business School (09/2023), and at the Annual Conference of the Political Economy Section of the German Association for Political Science (09/2023).
Alexandru-Stefan Goghie, Freie Universität Berlin
Matteo Giordano, School of Oriental and African Studies (SOAS)
Ludwig Schulze, European University Institute
- ‘Euro Internationalization and the Future of the Offshore US-Dollar System’ (with Jens van ‘t Klooster)
A key objective of President von der Leyen’s “geopolitical” EU Commission is improving the international role of the euro. The Juncker Commission had put this old idea back on the agenda, motivated by crumbling transatlantic relations during the Trump Presidency and the desire to challenge the global USD hegemony. Geopolitics re-appeared stronger than anyone could have wished for in February 2022 when Russia attacked Ukraine and the West passed unprecedented financial sanctions—including the freezing of Russian FX reserves held at Western central banks. To assess what these changes imply for euro internationalization and concomitantly USD hegemony, we develop a theory of currency internationalization that—drawing on the conceptual framework of Murau and van ‘t Klooster (2022)—places the use and creation of private offshore credit money center-stage. In our view, euro internationalization must imply the political promotion of the use and creation of offshore euro rather than offshore USDs. We discuss the potential of an EU “monetary foreign policy” which focuses on the euro’s use as vehicle currency in global value chains; the denomination of key commodities (chiefly oil); the integration in central bank payment systems (notably TARGET2); and the availability of international lender of last resort facilities (notably EUR swap lines).
Presentations at the Annual Convention of the International Studies Association (ISA) in Montreal (03/2023) and the Annual Conference of the Political Economy Section of the German Association for Political Science in Witten (09/2023).
Jens van ‘t Klooster, University of Amsterdam
- ‘Financing the Green Transition in the European Monetary Architecture’ (with Armin Haas and Andrei Guter-Sandu)
Most scholars agree that debates on how to finance the Green Transition have not yet yielded definitive answers. We use the framework of ‘monetary architecture’ to analyze the Eurozone monetary and financial system as a constantly evolving hierarchical web of interlocking balance sheets. We frame the Green Transition as a challenge to provide large-scale financing by expanding the balance sheets and creating new credit money that can be used for investments in capital stock. This has a systemic dimension as the entire monetary architecture must be mobilized, and a procedural dimension as it also affects long-term funding and final repayment. The established approaches of the market-failure paradigm, which calls for a Pigou tax, and the ‘triad’ framework of taxation, treasury borrowing, and central bank money creation seem insufficient to provide the apparent financing need. We explore how financing the Green Transition in the European monetary architecture translates at the balance sheet level, and outline a four-step plan for ensuring that a green initial expansion can be triggered at sufficient scale, that it can be funded over the long term by crowding in balance sheets able and willing to sustain the expansion of credit money in the system, that the system has sufficient firefighting mechanisms to safeguard against disorderly contraction, and that it can provide channels for a orderly contraction when the objective of financing the Green Transition is reached.
Presentations at the workshop “Off-Balance-Sheet Fiscal Agencies and the Role of the State in Financing the Green Transition” (09/2023) and the 35th Annual Conference of the European Association for Evolutionary Political Economy (EAEPE), University of Leeds (09/2023).
- ‘Towards a Public Sustainable Finance Paradigm for the Green Transition’ (with Philipp Golka and Jan-Erik Thie)
Sustainable finance is often discussed as a solution to the climate crisis, but its impacts are limited. We introduce the concept of “public sustainable finance,” in which the state has a central role to play for maximum transformational impact. To date, sustainable finance focuses on mobilizing private capital by “de-risking” private investments through public funds without considering direct government action. This is due to an implicit reference to mainstream economic theory: according to the New Consensus model, an overly active state leads to time inconsistency problems and crowding-out effects. The theoretical assumptions are also reflected in the current institutional framework in the form of the EU’s Maastricht Treaty and national debt brakes. However, these assumptions based on the loanable funds theory have been sufficiently refuted in recent years. Loans arise out of thin air and can provide additional public investments, which in turn lead to increased private investment (crowding in). Using the case of Germany, we show how public sustainable finance can be introduced despite tight fiscal regimes. We propose that the Klima- und Transformationsfonds (KTF) be given its own borrowing powers. By borrowing 162 billion euros by 2030, the existing financing gap can be closed and important investments in the future can be made.
- ‘Macro-Financial Innovation in Times of Crisis: The Role of the Recovery and Resilience Facility in Transforming the Eurozone’s Monetary Architecture’ (with Friederike Reimer, Andrei Guter-Sandu, and Armin Haas)
The Recovery and Resilience Facility (RRF), introduced as EU’s main macro-financial response to the Covid-19 pandemic, has been hailed as Europe’s Hamiltonian moment and raised great expectations for future fiscal integration. Despite its promised radicality, the actual status of the RRF in the Eurozone architecture remains ambiguous. On the one hand, it is integrated into the EU budget and therefore can be understood as the biggest joint debt-financed program on the EU ‘Treasury’ balance sheet. On the other hand, the RRF’s status as a temporary extra-budgetary fund allows it to be read as yet another off-balance-sheet fiscal agency (OBFA) that allows policymakers to eschew fundamental questions about the EU’s future as a common fiscal space. Building on the emerging critical macro-finance literature, we scrutinise the radicality of the RRF and investigate how it transforms the Eurozone’s monetary architecture. First, we clarify the position of the RRF as an ‘institution’ within the Eurozone’s web of interlocking balance sheets. Second, we discuss the conceptualisation of RRF debt as ‘instruments’, looking at similarities and differences with sovereign bonds and their implications for the emergent EU Primary Dealer System. Finally, we look at the intersection with the central banking segment, discussing their potential to function as European safe asset and implications for TARGET2 balances. We argue that given the EU’s propensity for governing through OBFAs, the RRF can be read as auguring a form of ‘quiet radicality’ in the EU’s evolution.
Friederike Reimer, Global Climate Forum
Andrei Guter-Sandu, University of Bath
Armin Haas, Global Climate Forum