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SURNAME.............................................. NAME...................................................... STUDENT I.D........................................

EUROPEAN ECONOMIC POLICY 30056-BIEMF

2nd INTERMEDIATE EXAM 12th June 2012 (Time allowed: 45 minutes)

The exam is composed of two open questions, worth 15 points each. Use only the exam papers for your answers, writing in the allocated spaces. Answers written outside the allocated spaces will not be corrected You can use the back of each sheet as scratch copy. Very important: remember to sign your exam paper, otherwise it will not be corrected Buon lavoro!

Question 1 (15 points) The latest press release (June 6th) of the ECB reads as follows:
The Governing Council of the European Central Bank (ECB) has today decided to continue conducting its main refinancing operations (MROs) as fixed rate tender procedures with full allotment for as long as necessary, and at least until the end of the 12th maintenance period of 2012 on 15 January 2013. [] The fixed rate in these special-term refinancing operations will be the same as the MRO rate prevailing at the time. Furthermore, the Governing Council has decided to conduct the three-month longer-term refinancing operations (LTROs) to be allotted on 25 July, 29 August, 26 September, 31 October, 28 November and 19 December 2012 as fixed rate tender procedures with full allotment.

a.

What is in general the main objective of the ECB and what are the tools the ECB uses to achieve its objective ? (5 points)

The main objective of the ECB (or the ESCB) is to achieve price stability (3 points) To this extent the ECB uses the conventional tools of central banking: (2 points) - interest rate (minimum bid rate for the main refinancing operations in weekly auctions) - reserve rates / open market operations (purchasing assets with different maturities) b. What are exactly the main refinancing operations of the ECB and how are the fixed rate tender procedures connected to the Rescue strategy that the ECB has endeavoured during the crisis ? Why in this context are Long Term Refinancing Operations important ? (5 points)

The main refinancing operations are the weekly operations through which the ECB controls the amount of liquidity in the inter-banking system (1 point) To provide a larger amount of liquidity during the crisis, the ECB has changed the modality of provision of the same liquidity from an auction system with a minimum bid rate to an allotment of liquidity at a fixed rate: all the liquidity requested from banks is allotted at the set policy rate, no more auctions or constraints to the total amount of allocated liquidity, until Jan 2013(2 points) Always with the idea of increasing the total amount of liquidity available to the regular operations of banks, the ECB has also extended the maturities of the refinancing operations, from weekly to monthly or even yearly operations. The LTRO of December and February allocated more than 1 trl Eur of liquidity for 3 years at the fixed rate of 1%. (2 points)
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 c. What is the no-bail out clause ? How the latter connects to the Stability Market Programme undertaken by the ECB during the crisis ? (5 points)

Under the no-bail out clause, the ECB is forbidden to monetize the debt of the Member States, ie to buy the debt when sovereign bonds are issued by a country in its refinancing auctions. (1 point) The rationale for this comes from the moral hazard situation that would be generated in a Member States management of public finance: if the Government knows that its deficits will be ultimately repaid by the central bank, why put it under control ? (1 point) However, notwithstanding the no-bail out clause, during the crisis, the ECB has started the Stability Market Programme: under the (SMP) the ECB is authorized to buy on the secondary market a sovereign bond of a distressed country, with newly printed money. In doing so, the ECB supports the price of sovereign bonds of distressed countries, therefore appeasing the potential losses (and perceived risk) of banks holding those bonds. The latter ease the access of these banks to the inter-banking market. The ECB then reverts the operation (sterilizes it) once market conditions have normalized. (3 points) Question 2 (15 points)
a.

Please explain the EU pyramid of preferences (5 points)

the complete ranking of agreements (EU membership, Association, Partnership and Cooperation agreements, GSP and CCP) and trade treatments (Acquis communautaire, CU; FTA, reduced CET, CET): 4 points the standard CET vis--vis WTO members is the MFN agreed within the WTO: 1 point

b.

Please explain why Regional Integration Agreements violate the Most Favoured Nation principle and what is the solution adopted by the GATT/WTO (5 points) If WTO members create a FTA of a CU they should extend a lowered or a zero tariff to every WTO member: 2 points Art. XXIV of GATT allows RIAs if they foster free trade among RIA members and if non-RIA members do not face trade conditions which are more restrictive than before the creation of the RIA.: 3 points

c.

Explain if and why bilateral agreements might be considered a second best of multilateralism (5 points)

Multilateralism within the WTO is beneficial since it engages 155 countries in a mutual process of trade reform. Consensus principle might be a guarantee of equity. But the same consensus led multilateralism to a failure with the Millenium Round (Seattle 1999) and the ongoing Doha Development Round is not delivering: 1 point. Bilateral agreements are capable of much deeper trade reforms since their members are fewer and often linked geographically (1 point). However this network of agreements increase complexity (1 point), big players can exploit their bargaining power (1 point) and domestic lobbies can exert their influence (1 point) jeopardizing overall welfare.