Evi Pappa
Joins the European
University Institute
in September 2011 from Universitat Autònoma de Barcelona, where she is
Associate Professor, and also Research Professor of Barcelona GSE. After
graduating from UPF, she was an assistant professor of economics at the LSE
(2001-2006), Bocconi University (2004-2005) and UAB (2005-2006). Her main
research interests are International Macroeconomics and Monetary and Fiscal
Policy. Given Evi’s interest in monetary policy analysis, she has been a
visiting researcher in many Central Banks, like the Bank of England, the
European Central Bank, the Federal Reserve Bank of Atlanta, and the Riksbank
(Sweden). She is a member of the Applied Macroeconomics Network (Amen), is a
MOVE (Markets Organizations and Voting in Economics) Research Fellow and a
Research Affiliate of the Center for Economic Policy Research (CEPR). She has
received the IGIER Scholarship for Young Researchers in 2003-2004, the
Paolo Baffi Fellowship in 2008 and the Ramon Areces scholarship in 2010. She
has published in international journals such as Journal of Monetary Economics,
International Economic Review, Journal of Public Economics and Economic Policy.
· Greece’s bankruptcy:
What are the main reasons Greece
was led to the brink of uncontrolled bankruptcy in 2010?
To start with,
Greece has never satisfied any convergence criteria for entering the EMU. At
the time of entrance, it was running a deficit much higher than 3% of its GDP.
It’s also unclear how the debt to GDP calculations were made. So, the
introduction of Greece in the Eurozone was political as now the discussion is
about Grexit.
On top of that, Greece
has never really been reformed. It has remained an uncompetitive economy, with
a huge public sector with many administrative weaknesses, and widespread tax
evasion in key sectors and corruption of both politicians and other insider
groups such as labor unions, oligopolistic sectors etc. Yet, the introduction
of Greece in the EMU guaranteed a relatively less risky investment with good
returns. The market assumed that sustainability of Greek debt would be
guaranteed by the other EU member states with more solid finances like Germany,
while the ECB would ensure that Greek debt would not become inflated in the
first place. So investors came in. The availability of cheap abundant credit
showed an increase in growth that was, however, very fragile. Given the absence
of structural changes, realized investments were inefficient and the lax credit
led to a surge in consumption, twin deficits and rent seeking.
When the financial
crisis came about in the US in 2008, Greece seemed to be the weak link in a
chain of risky investments. Many European banks had exposure to US mortgage
loans. As a result, when defaults rose, they lost a lot of money and became
reluctant to lend to other, diminishing the flows in the international banking
system and making it difficult for firms and consumers to borrow from banks.
The decline in bank lending contributed to a fall in aggregate demand. Even
countries which didn’t have any exposure to subprime lending were affected by
the global credit crunch and Greece. The sudden stop in Greece, i.e., the
sudden slowdown in private capital inflows, made the vulnerable growth in
Greece collapse. Like “Salome” Greece started taking off one by one her veils,
flashing to the financial world all her structural weaknesses.
Sovereign spreads
opened up again for Greek bonds after 8 years of low spreads with the
introduction of Greece to the EMU, reflecting perceptions of sovereign default
risk. Since September 2009, the markets have clearly perceived Greece to be in
a sovereign risk class of its own, as reflected in its sovereign default risk
spreads in both the CDS and the government bond markets.
Some political forces in our country, as
well as a minority of analysts, argued that a voluntary restructuring of its public
debt would be more beneficial for Greece than having recourse to the support
mechanism in May 2010. In other words, it would have been better –back then– if
we had declared boldly that we fail to satisfy all of our obligations to our
creditors, inviting them to negotiations over the exact payback percentage. Do
you share this view?
Definitely. The
prolonged austerity did not help Greece. The
combination of the austerity measures asked by the Troika and bad fiscal policy
and administration from the part of the domestic government, have completely
killed Greek domestic demand. Given that Greece is not exporting a lot of
goods, the real devaluation obtained with the fall in salaries did not bring a
lot of benefits, instead the cut in pensions, salaries, public and private jobs
decreased significantly domestic demand deteriorating even further the initial
recession, leading to today’ s depression.
Even the IMF
has admitted this publicly. IMF officials had severe doubts about whether
Greece's debt would be sustainable even after the first bailout. A possible
reason why this was not given as a choice to Greece could have been the fear of
contagion for the other countries in trouble at the time.
The support mechanism
has failed in all its targets: a) it has not restored market confidence; b) it
has not helped exiting the recession; c) it prolonged uncertainty; and d) led
to the political turmoil that had as a result the election of the current
populist government in power and its devastated consequences for the Greek
people and the Greek economy.
· The policies of Memoranda:
The criticism made of Memoranda focused
mainly on the over-taxation imposed on the private sector. Could the target of
the immediate primary surplus production have been achieved in any other way?
The
word “immediate” is the first thing that went wrong with Greece. European and
Greek politicians alike did not realize that the problem of Greece was
structural and hence needed to be treated with the right time profile and not
immediately. Reducing deficits and debt immediately as we have seen was
feasible but clearly inefficient and incorrect, as we have unfortunately also
seen. Cutting the deficits would not solve the
problem in the long run. The problem of Greece is structural and since it has
not been addressed correctly before entrance it should be in the top priority
list for any honest and benevolent politician, whether he is Greek or Northern
European.
Let’s
assume for a second that the word “immediate” was appropriate. As long as
demand would be sustained and the government would be able to collect correctly
the taxes with no rent seeking and corruption, an increase in taxation of the
private sector would not be the problem. Tax rates before the crisis were not
exceptionally high in Greece. The problem was that not all firms or citizens
beared equally the increases in taxation. The burden became heavier for those
unable to avoid or evade taxation.
At
the same time, there were more efficient ways to raise the primary surplus: a once-and-for-all wealth tax. A one-time wealth levy, if
introduced quickly and unexpectedly, could have solved easily and almost
painlessly the deficit reduction. If it were really possible to ensure the
public that the wealth levy would be temporary, such a tax would be much less
distortionary than imposing higher marginal tax rates on income.
Another idea could be to raise more
revenue from carbon permits, sugar products or taxes. Raising funds by taxing
negative externalities reduces distortions rather than creating them. So taxes
on cigarettes, fuel emission, unhealthy sugar products, although I understand
could be unpopular, could at least correct for distortions that individuals are
unwilling to accept.
Anyway, any of the suggestions I
provide here are no substitute for fundamental long-term reform that should
make the Greek tax system simpler, fairer, and more efficient.
What kind of measures can be implemented
in our country in order to fight tax evasion and integrate the black economy
into the formal economy?
Tax evasion and avoidance and the
black economy exist because incentives are not strong enough to discourage
them. Here is a list of a few measures one could consider to adopt in order to
reduce the black economy, tax evasion and tax avoidance:
– The obvious: Lower tax rates: reduce and simplify
taxes and tax collection. In Spain, were I have lived for many years, the
Government prepares your tax statement according to the data it collects from
private and public employers and data on property. The individuals have just to
accept the form, sign and return it, and in case of an error the tax payer can
make appointments with the tax office to correct or amend the initial declaration.
I do not know of any physical person in Spain who uses the help of an
accountant to complete his/her tax declaration. At the same time, I do not know
of any physical person in Greece who does NOT use an accountant in order to
complete his/her declaration.
– The tax system should be fairer: In Greece the payment
of taxes to the government has always been perceived as a silly thing to do.
Instead, it has always been considered a point of pride to avoid taxation. This
can be due to historical reasons (taxation under the Ottoman empire, or during
the dictatorship, especially because a big part of the current population lived
under the Papadopoulos regime), but it can also be due to the fact that people
perceive taxation to be unfair in Greece and that the social returns from
paying taxes are low. Education can of course help people realize that public
schooling, health care, police protection etc. are financed though tax
revenues. Improvements in public goods and administration, a fall in rent
seeking and corruption could make people more willing to pay their taxes. A
solution could be, for example, to let people choose between public or private
health insurance or education, and adjust accordingly the tax rates in the tax
code for the different services provided by the government.
– Minimum contribution for
self-employed, to be eligible for pension, health care or public education for
their children, with pensions and health care coverage being a function of
declared income. It is very well known that self-employed are among the groups
that evade taxes mostly. Providing incentives for these individuals to declare
their income would help. Of course, many of self-employed might result into
private insurance schemes if the public alternative implies tax compliance. In
that case, given that they are in a private insurance scheme, they will have
all incentives to declare their correct income, and insurance companies will
have by law to share the provided information with the government.
– Active labor market policies (ALMP)
and punishment for non attendance. Many young unemployed work in the black economy. ALMP should be
in place of either continuing training and education or short-term employment.
If unemployed fail to show up in those programs on specific dates, then they
are no longer entitled to unemployment.
– Subsidizing youth employment: any young person who
declares to be working, even part time, should be entitled to an employment
benefit provided by the government. It could also be favorable for the
calculation of pension years even for short-term employment spells of weeks or
months. This would be something like a negative labor income tax that would
decrease the incentives of young people to work in the underground sector and
will implicitly increase the wages in the informal sector making it more
expensive for firms to operate under black contracts.
– Loss of social security benefits
if caught working in the black economy or in case of tax evasion. Any individual caught
working in the black economy or evading taxes will lose part or his/her social
security benefits.
– Parallel existence of public and
private tax collecting companies and random assignment between the two for
every year’s taxation. Cross checking between the books of each of the two tax
collecting companies.
– Establishing Erasmus programs for
public employees within the EMU. This could potentially improve public administration, increase
efficiency within the public sector in Greece and incentivize workers to work
better and more efficiently. It would also help to fight corruption.
– Reduce the number of transactions
in cash to a minimum. Fine for firms or businesses that do not have cash machines, even
if these firms are groceries in Popular Markets (Laikes), not to mention
doctors or restaurants. Whenever I go on vacation to Greece on islands and
Athens alike, it very often happens that the cash machine of the restaurant
were we had supper or the hotel were we have stayed is broken. All tourist
shops should be equipped with payment systems that only need the credit card’s
number, expiration date and security code to make the transactions (like online payments). On the other hand,
consumers, tourists or local people should all be informed about the payment
systems.
– Impose special taxes on
representatives of offshore companies having property or operating in Greece. More than 23,000
foreign and offshore companies have developed profitable activity in Greece
over the last thirty years. At the moment, authorities have found several
people who operated as legal representatives for multiple companies. Those
legal representatives are natural persons or Greek companies that can be
charged extraordinary taxes for operating such activities, for example.
Greece ranks fifth among the EU
countries with the highest real estate taxation (2.3% of GDP in 2014 and 2015),
mainly due to the Single Property Tax (ENFIA). Do you consider the tax burden
imposed on Greek-owned property to be a necessary evil?
I
do not consider the taxes on property in Greece very high, having lived in many
other European countries, and actually the data support this claim. According
to a study by the European Commission, “Taxation trends in the European Union”
(2014), property taxes in Greece are currently high but not the highest in the
EU. The property tax rates were 2.1% of GDP in Greece compared to 4.1% in the
UK, 2.2% in Spain and 2.6% in Italy in 2012. I do not believe that the property
tax is the issue; the problem is the synchronization of increases in many taxes
and cuts in many salaries and wages. After all, the property tax is a wealth
tax and it should have positive distributional effects in favor of the weak
tale of the income distribution.
Also,
recall that our GDP has been falling, so referring to measures as a percentage
of GDP might be misleading. Looking at the ratio property taxes revenues-total
tax revenues could be a better measure.
Ηow far is still the Greek State from
making a sustainable entry into the markets;
Greek debt is highly
unsustainable, but sustainability can be restored by either a further haircut
of a substantial amount (close to 50% or even more), large interest rate
concessions, or a rescheduling of debt to longer maturities (See, Consiglio and
Zenios (2015), link http://www.voxeu.org/article/greek-debt-sustainability-devil-tails)
Consiglio and Zenios
also support, and I agree with them, for action now! Debt relief should not be
postponed to some indefinite future, but it should happen the soonest possible.
The country needs some positive news so as to improve the politics of reform.
Moreover, the much desired foreign direct investments cannot be attracted to a
country facing the uncertainty of exit from the EMU.
Debt relief can be
reached now. The refugee crisis is the best excuse. Yet, there is a lack of
trust in the current Greek government that, unfortunately, I also share with
the Northern European leaders.
A contingent contract
for debt relief could be the way out at the moment. Withholding the
disbursement of funds without prior actions is the stick that creditors exert.
Contingent debt relief is the carrot, contingent on successful structural
reforms.
· Greek Banking System:
According to data from the Bank of
Greece, almost 40 billion euros flew out of the Greek banking system in 2015 –
this is the highest amount ever compared to any other year since 2009. Do you
think that, under the certain circumstances, this money can return to the
banking system?
Under certain circumstances, no
capital is going to come back. Euros can return to Greece, but not necessarily
to Greek banks. I believe one way to further integrate and secure the banking
system in Europe is by lifting the barriers to entry into the domestic retail
banking sector of each European member country. It is really unthinkable for an
American to live in a union with no union-wide banks, I do not understand how
it’s thinkable to have Europeans living in a union with only national banks! It
makes no sense. Globalizing (Eurolizing, if you wish) commercial banks would
make deposit insurance guarantees more credible and would avoid bank runs in
the future, so capital might come back once the debt relief has been
guaranteed, and foreign investors have started investing in Greece again.
From the previous recapitalization of
Greek banks, the Greek State lost 22.5 billion euros due to the collapse of
their stock prices. Is it inevitable that the money of Greek taxpayers placed
in the last recapitalization will have the same fate, as we see today?
I am not an expert on this. Yet,
again, calling in foreign EU banks could be a solution and the non-performing
loans problem should get a suitable solution in the meanwhile.
Non-performing loans (overdue for more
than 90 days) in the Greek banking system exceed 100 billion euros, which
equals 50% of total loans – whereas the corresponding average in the developed
world is only 5%. According to your opinion, what is the most suitable solution
to cut the Gordian knot of the “red” loans?
Establishing asset management companies as independent entities to
manage and dispose of bad debt, by disposing assets removed from a bank’s
balance sheets or restructuring a corporate debt. Independence of the companies
from bank institutions is essential to avoid possible conflict of interests.
Asset management companies will be able to handle the debt while the banks have
their balance sheets strengthened by removing their non-performing loans.
Also, red loans might also present an opportunity, especially
non-performing real estate loans, allowing other investors to buy out the loans
through the asset management companies. The bank has bad loans removed from the
balance sheets, the borrowers have their debt resolved, and the investor buys
out the loan with the prospect of making the loan and/or the property
profitable.
· Economic Growth:
What are the structural changes that are
necessary in order for Greece to return to high rates of economic growth?
Structural
reforms, such as tax collection, have been considered as of immediate
importance by the Greek government. Fighting tax evasion and corruption has
been emphasized as one of the main goals of the new government. Obviously, tax
evasion deprives the government of the tax revenues required to pay for social
programs, pensions and the salaries of civil servants. Yet, increasing tax
collection would not bring growth, which is what the country needs to
experience. Fighting corruption might or might not be beneficial as
institutions remain rigid in Greece; corruption can be an antidote for growth,
so unless institutions become flexible just fighting corruption might not be
enough to recover growth.
Greece’s
lack of competitiveness is problematic. According to the global competitiveness
index the Greek economy is ranked in the 96th place compared to
Finland, for example, which ranks 3rd and Spain 35th. How
can competitiveness increase in Greece?
The structural reforms should target social infrastructure and political
institutions, fiscal policy and the business environment.
– The
government can improve the level of competition
in product markets by deregulation and by reducing barriers to entry. The
reduction of monopoly power through deregulation
and competition policy are strategies that can
be effective in creating a more dynamic and competitive micro-economy. Tax
incentives should be given to new startups to encourage new product
development.
– Privatization of industry is also likely to improve
competitiveness.
– The promotion of entrepreneurship is essential in Greece. The Greek economy does not mobilize enough knowledge, as expressed through the knowledge composition of the country's exports, relative to the rest of the world. Among 128 countries, Greece has the largest gap between its level of income and the knowledge content of its exports.
– But most importantly, competitiveness can be gained by
creating a stable macro-economic environment. As long as there is political
uncertainty, as long as there is no credible government and no fiscal rule in
Greece, investors will not come in and without investment there is no
sustainable growth.
– Improving public
administration services, making them more efficient and more
international (for example, by accepting documents in English without the need
of an official translation from the Greek ministry of foreign affairs in public
offices) would make it simpler for foreign investors to enter the Greek market.
In what areas can Greece demonstrate a
comparative advantage over other economies in order for growth not to rely on
domestic consumption funded by borrowing once again but on exports of Greek
goods and services?
– Solar
energy: An investment plan should include a part of
research and development of ways to deposit and transport (without destroying
the environment) wind and solar energy for the longer horizon.
– High
level Tourism: While labor cost indexes reflect the fall of employee
compensation in Greece, reflecting the success of the Troika policy to
internally devalue incomes, the anticipated revival of export-led growth has
never materialized. A big part of
exports is tourism. Tourism comprises on average 18% of GDP over the last 5
years. Moreover, according to the World Economic Forum, in 2013 Greece
was in the 32nd position out
of 140 countries included in the Travel and Tourism Competitiveness Index,
while, as mentioned above, it occupied the 96th position in the Global Competitiveness
Index. This data proves that Greek tourism is one of the few sectors of the
national economy that is competitive at a global level and that it may provide
potential for growth and creation of value added. Tourism is the sector on
which the Greek government has to concentrate its efforts. Greece has to
specialize in exporting “high quality” tourism. How can Greeks do that? I
have three ideas for that:
1. make Greece the
"Maldives” of the Mediterranean
2. build marinas for
sailing boats and make Greece the Mecca of sailing (see also below) by
organizing international prestigious regattas
3. promote epic trips
to international tourists (reproduce the trip of Ulysses from Troia to Ithaca,
the trip of Theseus to Minoan Crete, the trip of Jason from Volos etc.)
– Specialize
in high-quality biological and agricultural products.
· Greek Labor Market:
Besides restoring the high economic
growth rates, what other measures should be taken to reduce unemployment, which
is officially recorded at rates higher than 25% of the working force?
There are two reasons why labor
market reforms are urgently needed in Greece. The unemployment rate in Greece
is extremely high as a result of a dysfunctional labor market reacting to the
negative shock. The second reason is that medium- and long-run perspectives are
not bright because of the interactions between the debt legacy of the Crisis,
and demographic developments (the refugee crisis) and diminishing expectations
of productivity growth.
– The
government can improve labor productivity by increasing spending on education
and training to help develop skills and close the skills’ gap attributable to
long spells of unemployment.
– The
government may also promote a more flexible labor market by reducing trade
union power, encouraging part-time work, and encouraging new business
start-ups.
Do you agree with the minimum wage
reduction and the policies that enhance flexibility in the labor market?
Wages were too high in Greece
before the crisis. The fact that wages fell by 23% in the period 2009-2013 has
increased the competitiveness of the Greek economy. Also, the employment
contraction in the same period caused the wage share in the economy to fall
significantly. On the other hand, capital income, mainly comprising the gross
operating surplus of the business sector, has proved more resilient. As a
result, new hirings are more profitable at the moment, as improving business
profit margins should lead to higher investment and business expansion.
· Greek Social Security System:
Under the current EU directive,
pension spending in all EU Member States is forbidden to register an increase
of more than 2.5% of GDP compared to 2009 levels; in 2009, pension expenditure
in Greece amounted to 13.6% of GDP. What changes should be made to our pension
system so as to achieve the goal of keeping pension expenditure below 16% of
GDP in the coming years?
The pension system in
Greece was unsustainable. Apart from numbers, we should also talk about
individuals, our parents or grandparents, when we talk about pensions.
A reform reducing
pensions should account for poverty in old age, which is higher in Greece than
the EU average. This should be done by cutting mainly larger pensions. Reforms
should address the unfairness of the pension system, whereby some individuals
receive pensions that are large relative to their lifetime contributions, at
the expense of other individuals who receive much smaller pensions.
· Greek Public Debt:
In 2016, the Greek public debt will
approach a staggering 185% of GDP. Generally, a country’s public debt
sustainability depends mainly on its size to GDP or on the annual costs of
servicing to GDP?
The debt-to-GDP ratio is not a very
good metric for sustainability. A reason why the debt-to-GDP ratio has been
increasing in Greece is also because the denominator has been decreasing for
the last 8 years. Since the debt is serviced from tax revenues the ability
to repay debt should be based on tax revenues, not on the GDP. The best
measure could be the annual costs of servicing debt to tax revenues ratio.
Given that tax revenues can no
further increase in Greece, since the country has reached its fiscal limit in
the sense that it cannot generate any more increases in revenues (we are on the
right of the Laffer curve), and given the very low expectations for recovery,
from whatever angle we want to look at debt, size to GDP or annual costs of
servicing to GDP, or ratios relative to tax revenues, the picture is rather
gloomy.
Τhe Agreement signed during the Eurozone
Summit in June 12, 2015, clearly states that the nominal depreciation of our
debt (“haircut”) is impossible. To what extent can reducing interest rates and
extending the official creditors’ payback period be acceptible?
As I have mentioned before, large
interest rate concessions, or a rescheduling of debt to longer maturities,
could restore the sustainability of public debt. Yet, any relief provided
should be conditional, because debt is a variable we should think in the long
run and not in the short run. Conditional debt relief would be the best
possible solution for Greece. Greece seems to have been offered conditional
debt relief: First, in the Eurogroup Statement, November 27, 2012; then most
recently, in the Eurogroup statement of August 14, 2015. The Eurogroup
Statement on Greece, August 14, 2015, states: “The Eurogroup considers the
continued program involvement of the IMF as indispensable and welcomes the
intention of the IMF management to recommend to the Fund's Executive Board to
consider further financial support for Greece once the full specification of
fiscal, structural and financial sector reforms has been completed and once the
need for additional measures has been considered and an agreement on possible
debt relief to ensure debt sustainability has been reached.”
Is the target set in the new fiscal
adjustment program concerning our debt-servicing obligations, i.e. producing
primary surpluses of 3.5% of GDP by 2018, feasible;
No, especially with the refugee
crisis in place. According to the European Comission’s own calculations:
“General government deficit is expected to widen to 4.6 % of GDP in 2015,
reflecting the negative impact of uncertainty and economic downturn on public
finances. However, it is projected to gradually decline over the forecast
horizon to - 2.2 % of GDP in 2017, as the fiscal measures agreed under the
third adjustment program yield savings, bringing the primary balance back into
surplus.”
Why haven’t we yielded the desired
benefits from the front of making full use of the Greek State’s property yet?
If you were a foreign investor,
would you trust the current government for striking a deal for a Greek State
property? The debt crisis and the continual brinksmanship in negotiations have
created too much uncertainty, even if a Greek exit from the euro zone is
unthinkable, rapid changes in tax or other policies from the part of the
Tsipras government is not unthinkable at all, I am afraid.
· The Eurozone policies:
The Fiscal Compact signed in 2012
between the EU Member States is criticized for its obsession with austerity as
well as its lack of development policies. What do you think of its content?
I think my answers to the previous
questions clearly indicate that I disagree with blind austerity. I am a
supporter of structural reforms and I want to highlight that the Fiscal Compact
is the result mostly of agreements between politicians and not well trained
economists.
Many economists argue that the
fundamental Eurozone malfunction results from the competitive gap between the
countries of the North and the countries of the South. Would it be possible, in
the future, to set limits to the current account surplus of the Eurozone
northern countries (as was once suggested by John Maynard Keynes) or to
transfer a significant amount of resources from the North to the South,
ensuring that we recycle surpluses smoothly within the Eurozone?
While
Greece’s fiscal problems required reducing its budget deficits, a logical
accompaniment to that would have been for Germany or other Northern European
countries to expand its own economy and buy more things from the South, like
tourism, or other goods in terms of consumption or investment that could have
been taxed at low rates to ease the fiscal consolidation in Greece. That would
have given a boost to demand in the Greek economy, an increase in tax revenues
and would have helped to reduce the imbalances in both the south and the north
European current accounts.
Yes,
direct investments or consumption could transfer resources from the North to
the South, but there should be no need for explicit rules for this. The markets
should work. Rules can be distortionary. Maybe subsidies could work on this
direction until the necessary reforms will take place that will make Greece a
naturally attractive place for Northern investments.
· International Financial System:
What structural changes do we need to make to the function of the global economic system in order to bring the uncontrolled and distorted development of the financial sector under control and limit the impact of the markets on our daily lives?
The crisis has taught us that the financial system did not work efficiently and was associated with distortions that policy can come in and correct. The capital flow reversals during the fiscal crisis have shown that even advanced economies are vulnerable to the inadvertent consequences of capital account liberalization when the procyclicality inherent to capital flows is not adequately addressed.
The procyclicality of capital flows can be addressed through
coordinated global regulation and globally coordinated monetary policy. In
practice, such coordination is not always straightforward to design or
implement, even when countries have parallel interests.
Luckily, for the euro area, coordination can be an attainable
outcome through a sufficiently robust financial regulation together with
banking integration. A full banking union with a single regulator, as has been
proposed recently by the European Commission, would be an effective means to
this end. Alternatively, national banking systems that are conservatively
regulated at the national level (for instance, through macro-prudential measures
that limit banks’ reliance on short-term wholesale funding) would help moderate
capital flows that could otherwise exacerbate procyclical behavior and generate
risks.
Finally, foreign direct investment
and equity portfolio investment contribute to increased international risk
sharing and tend to be stabilizing. Instead, credit flows are not. Hence, the
current biases in favor of debt financing over equity financing in many
countries should be reduced.
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