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ADEMU Report Summary

Project ID: 649396
Funded under: H2020-EU.3.6.

Periodic Reporting for period 1 - ADEMU (A Dynamic Economic and Monetary Union)

Reporting period: 2015-06-01 to 2016-05-31

Summary of the context and overall objectives of the project

The successive financial and sovereign debt crises that affected large parts of the world economy between 2008 and 2013, together with the deep recession they brought about, have generated a number of new challenges in the design of appropriate macroeconomic policies. Such challenges have been particularly striking in the Euro area, as the crises clashed with the Economic and Monetary Union (EMU) substantially weak institutional architecture, the deficiencies of which became apparent with the start of the Greek debt crisis. Since 2010, on the one hand, there have been significant advances in the development of the EMU oriented to overcome these deficiencies – in particular the ‘fiscal compact’, the European Stability Mechanism (ESM), the SSM and the SRM of the Banking Union.On the other hand, due to the recession and accompanying austerity measures, wide popular discontent, and mistrust regarding existing and new economic policies and institutions, have erupted . The recent Brexit result is the most dramatic example of how European institutions are being questioned, underlining the urgent need to learn from these experiences and to provide credible and sustainable answers as to how the EMU (and EU) architecture should work.

The Four and Five Presidents’ Reports (2012 -also known as the Van Rompuy Report -and 2015) provide a roadmap of how EMU should be completed with five components: Monetary Union, Economic Union, Fiscal Union, Financial Union and Political Union. Unfortunately, in spite of the progress being made, the roadmap is as yet incomplete, its theoretical foundation is still weak and its implementation, beyond Monetary Union, needs to be developed. Fortunately, there is a large body of research in the field of dynamic macroeconomic theory which one can build upon, and further develop, to reassess the EMU fiscal and monetary framework and provide insights into how to reform and complete it. At the same time, new theories and applied work will also need to be developed. The fulfillment of these needs is the aim of the ADEMU project A Dynamic Economic and Monetary Union - a joint research effort involving eight leading European Universities engaged in the rigorous investigation of risks to the long-run sustainability of EMU, and how to design credible EMU policies and institutions, taking into account the political and legal constraints within the framework of which the EMU project is being developed.

ADEMU research is divided into four objectives, or main areas of investigation:

1) Long-term sustainability of monetary and fiscal union, in particular the sustainability of sovereign debt, and of union-wide burden-sharing mechanisms.
2) Stabilization policy in currency unions, for the improvement of resilience to macroeconomic shocks.
3) Macroeconomic and financial interdependencies, with a main focus on international spillovers associated with fiscal policies and macroeconomic and financial imbalances.
4) Implementation of institutional reforms for the better management of fiscal policy within the EU, with a particular focus on the legal, political and behavioural constraints that the current and the alternative, future EMU fiscal institutional structures may face.

The ADEMU project was officially launched in June 2015 and in one year progress has been made towards fulfilling its objectives, while fully acknowledging that further progress must, and will, be made.

Work performed from the beginning of the project to the end of the period covered by the report and main results achieved so far

The work carried out can be summarized as it follows:

- October 8-9, 2015. Cambridge. ADEMU Kick-off conference, “Reassessing the EU Monetary and Fiscal Framework”.

- October 22-23, 2015. Florence. Workshop on “Legal and Institutional Dimensions of EMU”.
- December 11, 2015. Florence. Presentation of the results of the workshop on Legal and Institutional Dimensions of EMU.
- April 29-30, 2016. Prague. Workshop on “Macroeconomic Imbalances and Spillovers”.
- May 20-21, 2016. Florence. Workshop on “Risk-Sharing Mechanisms for the European Union”.

- April 19, 2016. “Macroeconomics of financial frictions”. With Nicolas Crouzet, Simon Gilchrist and Nobu Kiyotaki, held at the University of Cambridge. LEAD BENEFICIARY: University of Cambridge
- May 10, 2016. “Heterogeneous Agents and Macroeconomic modeling” with Gianluca Violante, Mark Hugget and Nezih Guner, held at the University of Cambridge. LEAD BENEFICIARY: University of Cambridge.

- March 15, 2016. Cambridge. Lecture on “Fiscal Sustainability: What Makes the Euro-Area Different?”, by Eric Leeper (Indiana University).
- March 21, 2016. Florence. Lecture on “Growth and the Industrial Revolution”, by Robert E. Lucas Jr (University of Chicago).

- March 14, 2016. Webinar on “Learning from the Euro Crisis in order to avoid new ones”, with Thomas F. Cooley (Stern School of Business, NYU; ADEMU Advisory Committee), Giancarlo Corsetti (University of Cambridge, ADEMU Steering Committee), René Smits (University of Amsterdam, ADEMU AC). Moderated by Ramon Marimon.
- July 1, 2016. Webinar on “After Brexit: What next for the EMU, EU and UK?”, with Joaquín Almunia (Former Vice-President of the European Commission);
Ramon Marimon (European University Institute and UPF – Barcelona GSE; ADEMU Scientific Coordinator); Giorgio Monti (European University Institute; ADEMU Steering Committee); Morten Ravn (University College London; ADEMU Steering Committee).

- March 14, 2016. London. Masterclass on “The Macroeconomics of Uncertainty Shocks: Evidence, Models and Methods”, by Jesus Fernandez Villaverde.

g. ADEMU SESSIONS in the framework of other major events
- March 22, 2016. University of Sussex, Brighton. ADEMU special session on Sovereign Debt and Austerity at the Meetings of the Royal Economic Society (in collaboration with the Centre for Macroeconomics).
- April 21-22, 2016. University of Cambridge. ADEMU special session on Sovereign Debt at the CEPR Annual International Macroeconomics and Finance Programme Meeting (CEPR Spring Meeting).

In order to further extend the scope of the research carried out in the framework of the ADEMU project and with the additional aim of contributing to a relevant dissemination of the objectives and the outcomes of the project, a number of outstanding economics scholars and policy-makers have been invited to join the project as associated researchers. As such, associated researchers are regularly informed about ADEMU events and can publish their research related to ADEMU in the ADEMU Working Paper Series. At the end of May 2016, a total of 74 economists have joined the ADEMU project as associated researchers.

During the first year of the project, several working groups composed by PhD and PostDoc researchers have started to actively contribute to the research topics of the ADEMU agenda, regularly meeting in the respective affiliation institutions (European University Institute, CERGE-EI, University College London, Barcelona GSE) and sharing the outcomes of their work across the different working groups. In particular, the aims of the working groups are: identifying puzzles and gaps in the literature related to the ADEMU project; contributing to policy surveys as well as data collection and analysis; informing each other about new (and old) research findings; discussing policy proposals and developing new views; finding ideas for research projects. For example, the Working Group at the European University Institute organized a total of 21 weekly meetings with an average attendance of 20 PhD and PostDoc students every week; at UCL a weekly 2 hours Reading Group with junior faculty and PhD students was organized counting on the participation from 10-15 PhD students and from 4 members of the faculty.

The realization of all of the activities above has contributed (and is contributing) to reinforce the most immediate scientific outcome of the project, that is the production of working papers or of first draft of papers that will be further developed and finalized over the coming months. More specifically, the following papers have been/will be soon published in the Series:

- “Disclosure of Corporate Tax Reports, Tax Enforcement, and Insider Trading”, by J.Caballe, A. Dumitrescu

- “Tax Reform with Endogenous Borrowing Limits and Incomplete Asset Markets”, by Á.Abrahám, E.Carceles-Poveda

- “Risk-sharing and contagion in networks”, by A.Cabrales, P.Gottardi, F.Vega Redondo

- “Fiscal Unions Redux, by P.Kehoe”, E.Pastorino

- “Rethinking Optimal Currency Areas”, by V. V. Chari, P.Kehoe, A.Dovis

- “Capital Taxation and Globalization”, by I.Correia

- “Exit expectations and debt crises in currency unions”, by A.Kriwoluzky, G. J. Müller, M.Wolf

- “The Case for Flexible Exchange Rates in a Great Recession”, by G.Corsetti, K.Kuester, G.J. Müller

- “Fiscal Consolidation in a Disinflationary Environment: Price- vs. Quantity-Based Measures”, by E.Pappa, R.Sajedi, E.Vella

- “Persistent Government Spending and Fiscal Multipliers: the Investment-Channel”, by M.Dupaigne, P.Féve

- “The effects of government spending endogeneity on estimated multipliers in the U.S.”, by A.Moura

- “Does Austerity Pay Off?”, by B. Born, G.J. Müller, J.Pfeifer

- “Understanding Differences in European Household Finance”, by T.Hintermaier, W.Koeniger

- “Unemployment (Fears) and Deflationary Spirals”, by W.Den Haan, P.Rendahl and M.Riegler

- “The Dark Corners of the Labor Market”, by V.Sterk

- “The Changing Nature of Gender Selection into Employment: Europe over the Great Recession”, by J.J. Dolado, C. Garcia-Peñalosa, L.Tarasonis

- “Policy Spillovers and Synergies in a Monetary Union”, by O.Arce, S.Hurtado, C.Thomas

- “Asymmetric Trade Liberalizations and Current Account Dynamics”, by A. Barattieri

- “Breaking the spell with credit easing”, by G.Gaballo, R.Marimon

- “Bank Opacity and Financial Crises”, by J.Jungherr

- “The new Economic component of EMU: A Lawful and Effective Design”, by C. Kilpatrick

- “The Single Supervisory Mechanism: legal fragilities and possible solutions”, by C.A. Petit, G.Monti

- “Size, fungibility and the Strength of Lobbying Organizations”, by D.K.Levine, S.Modica

- “Collusion constrained equilibrium”, by R.Dutta, D.K.Levine, S.Modica

- “Voter Participation with Collusive Parties”, by D.K.Levine, A.Mattozzi

- “On the asset prices and leverage requirements – An experimental analysis”, by T. P. Gehrig, R.Levínský

All of the research outcomes and the activities of the project have been thoroughly disseminated within different types of audiences (e.g. academia, policy makers, general public) thanks to specific actions aimed at providing the project with a strong visibility. Such actions included the launch and the continuous update of a dedicated website; the creation of the ADEMU Working Paper Series; and the release of a monthly newsletter (shared with over 800 among economists, academics, researchers and policy makers).

Progress beyond the state of the art and expected potential impact (including the socio-economic impact and the wider societal implications of the project so far)

The ADEMU Project will provide a coherent reassessment of the fiscal and monetary framework of the EMU, having as a benchmark the roadmap laid out in the Four and Five Presidents’ Reports, and the EU experience through the debt and Brexit crises. And, as theoretical guidance, the understanding that the EMU is a joint-commitment institution operating within the global economy, limited by the extent to which national policies are delegated to - or coordinated by – the EMU. More specifically, the ongoing work of ADEMU addresses issues of general interest such as:

1. A reassessment of the debt overhang problem.
2. Risk-assessment as a continuous screening device.
3. ‘Risk-sharing mechanisms’ as a complement/alternative to ‘crisis resolution mechanisms’ (ESM and ECB interventions): design, strengths and limitations of risk-sharing mechanisms in a heterogeneous EMU, with special attention to European Unemployment Insurance.
4. The scope of the EMU Fiscal Union when fiscal capacity must be constrained by the capacity to commit to joint fiscal responsibility without unwanted fiscal transfers.
5. Capital taxation and fiscal policy coordination and spillovers across the euro area, and in and out of the euro area.
6. Reassessing the Fiscal Compact in the light of the new findings on fiscal multipliers and the experience with the austerity programmes.
7. An EMU without convergence: labour and other national social policies, their spillovers and possible need of screening and coordination, and more generally, macro imbalances and their indicators (e.g. reassessing the Macroeconomic Imbalance Procedure)
8. Mitigating and sharing financial risks: the link between the Fiscal-Economic Union and Financial-Banking Union, as well as the link with ECB policies (e.g. debt and QE asset policies, BU supervision).
9. Mitigating rent-seeking and capture, through collusion, of regulatory agencies.
10. The legal weaknesses of the current EMU and the legal implications of the ADEMU proposals.

And, as a final synthesis:
• The political economy of EMU as a joint commitment institutional design.

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