Chapter 18: The financial markets and the euro

Introduction
- adoption of the euro: expected to encourage further integration of Europe’s capital markets
o savers and borrowers with better opportunities
o improve the overall productivity of European economy
- but: sovereign crisis / however: single currency is reshaping the financial sector
- this chapter:
1. overview of the role and characteristics of financial markets
2. existence of the euro = integrate national financial markets
3. difficulties of Eurozone’s sovereign debt crisis
4. focus on banking (part of the financial markets) / presents the newly adopted Banking
Union (designed to remedy shortcomings of the original union)
5. supremacy of the US dollar vs. possibility of the euro issuing a challenge to this

1. Essentials of financial markets

1.1. The macroeconomic role of financial markets: behind the IS and MP schedules
- financial markets: where changes in the central bank interest rate trigger a wave of reactions
that eventually determine all the other interest rates / they have a life on their own
- interest rate (set by a central bank): ultimate cost at which banks borrow the resources that
they need to lend to their customers
- banks and other financial institutions constantly asses the prevailing economic conditions and
their own situations to decide on how much they lend and at what interest rates (this may
change)
- reason why the crisis on Wall Street (2008) triggered a strong recession:
o banks become worried: the perceive higher risks ahead
o the charge a higher interest rate
o even though the central bank has not changed its policy, the individual’s schedule
shifts
o the perception of heightened financial risks exerts a contractionary impact

1.2. What are financial institutions and markets?

- financial markets are central to long-term growth / task: make savers and borrowers meet to
achieve the best possible mutual deals
o banks borrow from some customers and lend to others
o individual lenders, often using as intermediaries a variety of collective funds:
 bond markets: where borrowers issue debt instruments (bonds) that savers
acquire
 stock markets: where borrowers are private corporations that raise money by
offering ownership in the form of shares or stocks
- challenge for financial markets: to cater to every single need in the most efficient and
cheapest way / they perform 3 main functions:
o intermediation: savers deposit their funds in financial institutions, which re-lend them
to borrowers
o maturity transformation: savers like better assets with short maturities / borrowers
prefer to obtain stable resources / financial intermediaries stand in between
 o risk taking and diversification: financial markets deal with risks in many ways, including
offering baskets of instruments collectively less risky than individual components
1.3. Types of financial institutions and markets
- Banks, funds, insurance companies
o banks receive deposits, offer loans, provide assistance with managing wealth
o investment banks specialize in managing portfolios
o fund management firms offer “wholesale” services to banks and insurance companies
o insurance companies take “deposits” (insurance premia paid by their customers) that
they use to “make loans” as they invest in financial assets
o some financial conglomerates combine classic universal banking, investment banking
and insurance
- Markets
o designed to collect savings and lend them back to borrowers (users -lenders and
borrowers - “meet” one another on the markets)
o Bonds: debts issued by firms and governments for a set maturity at an explicit interest
rate
o Stocks (or “shares”): ownership titles to firms / they last as long as the firm itself
o When bonds and shares are created, they are initially sold on the primary market /
they can endlessly change hands on the secondary market
o ability to promptly buy and sell bonds or shares results from the depth of the market
(relies on the continuing presence of a very large number of investors)
o Depth and breadth are the essential qualities of a financial market
o Lenders ( or “investors”) usually operate through intermediaries, whom they instruct
to buy or sell assets on the markets on their behalf
o Financial institutions come in all shapes and sizes

1.4. What do financial markets do?

- Matching lending and borrowing needs: maturity
o term deposits offer more attractive interest, which grows with maturity
o banks encourages its customers to choose longer-term deposits because the bank will
re-lend the deposit to another customer who will be ready to pay a higher interest
rate for loans of longer maturity
o the saver could by bonds (with various maturities) or stocks (unlimited duration)
o stocks returns will be higher than bank deposits of the same maturity because these
bonds and stocks are typically riskier than bank deposits
- Matching lending and borrowing needs: risk
o Governments, banks and firms issue bonds as a counterpart to borrowing (their
maturities range from the very short term to the very long term)
o Bonds and shares are risky:
 at best: they are worth a fraction of their face value if issuer goes bankrupt
 at worst: they are worth nothing
o When the investment is made, there is usually no way of knowing for certain whether
the project will yield profits
o Customer tastes, exchange rates, prices and the level of competition can change
unexpectedly, altering profits
o Two projects may have the same expected return but the profit flow may be more
variable (riskier) for one than for the other
 o people tend to value less risky projects more
o Markets put a price on risk: the risk premium
o Savers obviously prefer no or little risk, but they may be attracted by a higher return
o The interest offered on each asset typically rises with the risk of the asset
o Different savers will pick different points on the risk-return trade off schedule because
they have different degrees of aversion to risk
o Financial markets allow every saver to find an asset that meets her preference and
every borrower to find the resources that he needs
o interest rate can be interpreted as the sum of two prices: the maturity premium and
the risk premium
o the longer and the riskier is the loan, the higher is the interest rate
o The anchor of all interest rates is the policy rate set by the central bank, which
concerns the shortest and safest loans
o financial system does not react mechanically
- Diversification
o Not only do markets price risk, they also allow for risk diversification
o the risk of a particular project must not be evaluated in isolation; it must be looked
upon in conjunction with the investor’s total portfolio of projects
o Financial markets can offer almost unbounded possibilities for diversification; the
more so the bigger they are
o because well-diversified portfolios bear little risk, the risk premium is reduced and this
reduction is shared between savers (who receive higher returns) and borrowers (who
face lower borrowing costs)

1.5. Characteristics of financial markets

- Scale economies
o Matching the needs of borrowers and lenders and risk diversification are both easier
when there are a large number of borrowers and lenders
o The existence of different currencies is one such barrier
o The creation of a single currency removes this particular barrier to competition
- Networks
o Financial institutions and markets can be seen as a network of borrowers and lenders
o When a financial firm receives funds from a saver, it needs to re-lend these funds as
soon as possible because “time is money”
o solution: to re-lend the saver’s money to another financial firm that may have spotted
a borrower or identified another financial firm that may have spotted a borrower
o money passes quickly from financial firm to financial firm until it finds a suitable
borrower somewhere in the network
- Asymmetric information
o borrower always knows more about his own riskiness than the lender
o lenders may simple refuse to lend rather than take unknown risks / they may set the
price of risk very high (ask for very large risk premia)
o this discourage low-risk borrowers who cannot convincingly signal their true riskiness
o only bad risks are present in the market / lenders withdraw
o Asymmetric information is a fact of life, unavoidable and widespread / tends to
undermine the development of financial institutions and markets
 o general response to that is regulation: legislative measures that aim at reducing the
overall riskiness of financial markets and institutions

2. Effects of a monetary union

2.1. EU policy on capital market integration
- Until the 1986 Single European Act and a 1988 directive that ruled out any remaining
restriction on capital movements among EU residents, EU capital markets were not integrated
- several loopholes allowed EU member countries to impede capital mobility / reasons:
o they wanted to protect their financial institutions from foreign competition
o many EU nations just did not believe that unrestricted capital mobility was a good idea
(saw capital flows as responsible for repeated balance-of-payment and banking crises)
- 1960: European Commission promoted a partial liberalization but included numerous opt-out
and safeguard clauses, extensively used by EU members
- Single European Act 1986 established the principle that all forms of assets should be allowed
to move freely inside the EU
- adoption of the euro eliminates the currency risk within the Eurozone:
o savers don’t have to worry about where the asset is issued as long as it’s denominated
in euros
o borrowers can tap the hole area by taking an euro-denominated debt

2.2. Effects of the single currency on banks

- Banks compete to attract deposits and make loans
- market for bank services is segmented along national lines for several reasons:
1. before the adoption of the euro, different currencies tended to make national markets
distinct (by adopting the euro, that source of fragmentation has been eliminated)
2. customers do not change banks easily
3. banks often develop personal relationships with their customers to better know their
needs and means and to develop loyalty
4. proximity is important, although less so with the spread of internet banking and of
automatic teller machines
5. being national, regulations have long implied that using the services of a foreign bank
may result in lower legal protection
- Bank loans by Eurozone banks to households and corporations from other Eurozone countries
more than quintupled between September 1997 and September 2008 (the global financial
crisis erupted)
- As people took out loans from banks abroad, they were encouraged to move their business, at
least part of it, to these banks
- loans by German banks to Spanish borrowers and, mostly perhaps, to German residents
buying properties in Spain as the housing market was booming
- Banks did not only expand their customership beyond their initial borders, the also increased
their relationships with one another
- banks are predominantly acquired by domestic banks (banks supervision is still domestic /
going abroad requires getting familiar with the fine prints of local legal practices

2.3. Effects of the single currency on bond markets

- interest parity principle: when markets are well integrated, interest rates between two assets
issued in different currencies differ by:
o the expected change in the exchange rate
o a premium reflecting different risks
- up until the crisis all EU governments were believed to be highly trustworthy
- with the adoption of the common currency the currency risk was eliminated and financial
integration should have resulted in identical rates across the Eurozone
- For decades, interest rates had been lower in German bonds because of the strong currency
status of the Deutschmark and the credibility of the government

2.4. Effects of the single currency on stock markets

- The stock market is where large firms raise the financial resources they need to develop their
activities
- They issue shares, many of which are held by individuals or by large institutional investors,
such as pension funds and insurance companies
- Increasingly, individuals buy shares from collective funds designed to offer good risk-return
trade-offs through extensive diversification
- stock market are characterized by a strong “home bias”: borrowers and savers alike tend to
deal mostly on domestic markets and to hold domestic assets / reasons:
o information asymmetry: investors believe that they know more about domestic firms
 individual investors increasingly rely on financial intermediaries to manage
their wealth
 financial intermediaries are becoming increasingly global
o currency risk (eliminated within the Eurozone)
- The proportion of home shares is declining, while the proportion of shares issued in other
Eurozone countries has risen, as did the proportion issued elsewhere in the world
- most European countries have one stock exchange each, or more (natural when currency risk
was segmenting the various national markets)
- In comparison to the USA, Eurozone exchanges remain small, and therefore likely to suffer
from limited scale economies
- In the Eurozone, each country seems to insist on having its own exchange but the
harmonization of rules within the Eurozone has led to a wave of mergers

2.5. Overall effects of the single currency

- There are clear signs that the creation of the euro was accompanied by further integration of
all financial market components until 2008
- faster integration has been the tendency within the Eurozone
- The global financial crisis has put a (temporary?) stop to financial globalization
- The Eurozone sovereign debt crisis has had a particularly strong adverse effect on financial
integration within the Eurozone

3. Fragmentation during the crisis

- The Eurozone has faced 2 crisis:
o the global financial crisis in 2007 in USA
o home-made sovereign debt crisis
- these crises have led to a significant reduction in financial integration (challenge to one of the
key benefits expected from the monetary union)
- financial markets become fragmented during crisis (response: creation of the Banking Union)
3.1. Bank and the interbank market
- commercial banks grant loans while their customers make deposits or withdraw Money from
their accounts / banks are alternately flush with and short of cash
- the central bank is active on the interbank market, seeing to it that the interest rate stays
close to the announced policy rate
- the central bank provides money as needed to enforce the policy rate
- the interbank market is the heart of the banking system (its interest rate 1s the basis for all
other interest rates)
- 2007: interbank transactions started to slow down in many developed countries (Eurozone)
- Banks became concerned about lending to one another because each one was concerned that
the others might fail to pay back their borrowings
- Being risky, unsecured lending (lending without requiring collateral as a guarantee) declined
markedly and has not yet recovered
- banks became increasingly unable to fulfil a key task: lending to firms and households
- Even though the ECB provided them with huge amounts of cash, banks faced very different
situations (distressed countries were hit and this fragmentation affected fragile borrowers)
- Banks usually charge a higher interest rate on smaller loans, largely because the information
asymmetry is more important for loans to small borrowers
- spreads returned to normal in non-distressed countries / remained in the distressed countries
- Loan applications have been rejected at a much higher rate in the distressed countries.
- How can firms compete if they face such different conditions?
- a euro held in one bank in one country stopped being the same as in another country
- Depositors went on transferring money away from banks in distressed countries

3.2. Bond markets

- private issuers of bonds offer a higher interest rate than the one applied to government bonds
(hard-pressed governments can transfer the debt burden on to the private sector)
- public debt = the safest debt many country
- interest rates on several Eurozone governments debts started to diverge when the global
financial crisis began and bounced back when the sovereign debt crisis got under way
- creation of the euro have unified the government bond markets / the crisis fragmented them
- divergence between public bond rates reflects 2 risks:
1. the fear that some governments could default, introducing a risk premium
2. the fear that some countries could leave the Eurozone (restore their own currencies) /
implies that the expected depreciation has to be factored in

3.3. Stock markets

- Except for a brief episode in 2008, the returns in the non-distressed countries have been more
dispersed than in normal years
- distressed countries: dispersion has increased during the sovereign debt crisis

3.4. Monetary conditions in Eurozone countries

- monetary policy works through the cost and availability of credit to households and firms, and
the exchange rate
- regarding credits conditions, bank lending has been very different across the Eurozone, and
monetary policy has had very different effects across the Eurozone
- in the presence of an asymmetric shock the common monetary policy cannot be adequate for
every member country (well-understood implication of a monetary union)
- countries not affected by the sovereign debt crisis have been growing quasi-normally while a
historically deep recession has afflicted the crisis-hit countries
- common monetary policy was too lax for the first group and far too tight for the second group
4. The Eurozone and its banks
4.1. What is special about banking?
- presence of scale economies implies that a few large banks eventually dominate the market
- the tendency for competition to become monopolistic challenges the perfect competition
assumption (economies are vulnerable to difficulties suffered by important players)
- banks are continuously dealing with one another (If one fails, the others may be pulled down)
- presence of information asymmetries: banks routinely take risks (prone to panics and crises)
- bank outsiders (other banks, banking authorities) do not know how healthy each bank is
- most people and firms have deposited significant parts of their wealth in banks
- A bank failure can have dramatic implications for the whole country with disproportional
effects on a majority of the population (bank can’t just go bankrupt like any other corporation)
- moral hazard: protection from risk results in more risk taking (vicious cycle)
- in every country, banks are tightly regulated and closely supervised / authorities intervene

4.2. Regulation, supervision and resolution

- to reduce the incidence and consequences of catastrophic events: banks are regulated
- ensure that financial institutions adopt prudent strategies, and are able to withstand shocks
- regulation requires supervision, and make sure that they are respected
- supervisors must be as sophisticated as the financier themselves
- 2007-2008: supervisors were ill-informed, ill-prepared or technically unable to cope with crisis
- Even with perfect regulation and supervision, there will always be bank failures
- In order to avoid depositor panic, failing banks are usually dealt with over a weekend, when
only ATMs can be emptied (bank resolution
- failing bank has been active in different counties: different resolution authorities are involved,
each of which is subject to national legislation and likely to face national interest groups
- core principles of regulation are agreed within the framework of the Basel Committee of Bank
Supervision (brings together regulators from countries with significant banking systems)
o Regulation:
 the rules are largely designed at the EU level, based on the “4 freedoms”,
which rest on strong externalities and returns to scale: free mobility of goods,
services, assets, and people
 For financial services to be freely traded, financial institutions need to be
allowed to operate throughout the EU
 If national regulations differed too much, financial institutions would have to
register in each and every country in which they wished to operate
 Savers, unsure about the quality of foreign regulations, would prefer to keep
their money in domestic institutions
o Supervision:
 One argument for keeping supervision at the national level is the existence of
another kind of information asymmetry (between supervisor and supervisee)
 Most banks wish to hide their difficulties, especially if disclosure would lead to
fines or even outright closure of the bank
 information asymmetries are lower at the national than at the union level
  decentralized supervision : unless proven impossible or inefficient, supervision
should remain at the national level

 centralized supervision:
 returns to scale imply that banks are likely to become multinational /
they cannot be subject to supervisors that operate differently /
supervisors cannot avoid making subjective judgments
 closeness between supervisor and supervisee is beneficial in terms of
reducing information asymmetries, but can lead to capture
 a level playing field requires equally of treatment
 the EBC is bound to be involved when a trouble bank requires quasi-
instantaneously large amounts of money
o Resolution:
 decisions made when a bank fails include:
 the type and amount of bank liabilities that will be protected and who
will benefit from such protection
 how large losses will be imposed and on whom
 whether management will be discharged and, if so, who will take over
 *in some case, the bank can even be nationalized
 in a democracy, only elected officials have a mandate to take such decisions
 these 3 arguments work on the opposite direction:
 banks are powerful: often exercise strong influence on their
governments (taxpayers may not be well protected)
 many governments like to def end their national champions a form of
protectionism that runs against the spirit of the single market
 the amounts can be such that the ECB may have to provide resources
- When the euro was created: combine common regulation with decentralized supervision and
national resolution authorities (financial crisis showed that this was not adequate)
- countries ended up temporarily offering unlimited guarantees to deposits at their own banks
- Larosiere Report (2009):
o national supervisors did not share information with one another, leaving governments
in the dark when emergency decisions had to be made
o the ECB was not better informed regarding the true situation of stressed banks and
therefore enabled to even consider acting as lender in last resort
- Following those proposals, the European System of Financial Supervision (ESFS) was created,
including 5 new institutions:
o The European Banking Authority (EBA), collects detailed information on all EU banks
o The European Securities and Market Authority (ESMA): brings together all EU bond
and stock market regulators and supervisors
o The European Systemic Risk Board (ESRB): looks at the overall picture, especially the
crossborder links among unknown financial institutions
o The European Insurance and Occupational Pensions Authority (EIOP A): like the ESRB
but with a focus on insurance companies and pension funds
o The Joint Committee of the European Supervisory Authorities (ESA): brings the
national supervisors together with a view to improving transparency
- The second step was the creation of a banking union in 2014

4.3. The Baking Union

- involves 3 building blocks:
1. The Single Rule Book (common regulations)
2. The Single Supervision Mechanism
3. The Single Resolution Mechanism
- Membership is compulsory for all Eurozone member states and open to the EU countries
- Regulation (in 2013 the EU adopted key requirements):
o Bank capital:
 Banks must have an amount of capital equal to 8% of “risk weighted assets”
 capital is the amount of shares issued by the bank and represents the value of
the bank to its owners
 A bank stands to suffer losses if some of Its assets lose value
 If the losses exceed the capital, the bank is technically bankrupt
 regulation: enough capital to serve as a buffer. Resilient banks in case of losses
o Leverage ratio:
 a bank often borrows to invest
 the more It borrows and invests, the larger are the profits.
 relates borrowing to capital
 will be monitored and the authorities can require that it be reduced
o Liquidity ratio:
 assets that can be promptly and safely sold to obtain cash as a proportion of
payments that a bank expects to make
 will have to be progressively raised to 100%, starting at 60% in 2015
o Because important banks cannot be allowed to fail, and are extremely costly to rescue
or resolve, they are subject to higher requirements for the above ratios
o Macro-prudential policies:
 When banks face large losses, their capital can be depleted
 banks can be required to raise the capital ratio above the minimum in good
times to accumulate an additional buffer
- Supervision:
o Supervision of the 119 largest banks of the Eurozone is centralized and under the
authority of the ECB (Single Supervisory Mechanism - SSM)
o The smaller banks remain subject to national supervision
o The ECB is an independent institution with considerable credibility
o Critics worry about the ECB facing a conflict of interest between its monetary policy
and bank supervision duties
o while part of the ECB, the SSM operates independently of the monetary policy wing
o in-depth ECB’s analysis of financial health of each bank includes 2 steps:
1. the Asset Quality Review (AQR): designed to challenge Banks on their own
evaluation of the risk that they bear
2. stress tests that simulate hypothetical financial and economic shocks to
determine the bank's resilience
 o The SSM may request banks that fail the tests to take precautionary measures

- Resolution:
o the second pillar of the Banking Union: Supervisory Resolution Mechanism (SRM)
o it operates under the authority of a Single Resolution Board (SRB)
o The SRB is responsible for all large banks of the countries that have signed up to the
Banking Union
o Its mission involves the following principles:
 Resolution of a bank is decided by the SRB and carried out by the relevant
national resolution authority
 Funding for any cash injection is provided by a new resolution fund to which
banks contribute
 The SSM (supervision) and the SRM (resolution) are independent institutions.
 The creation of the SRM is one part of the Bank Resolution and Recovery
Directive, which applies to all EU countries (minimize the costs of a bank
failure borne by the taxpayers)
 All bank deposits by households and SMEs are fully protected up to € 100,000.
This guarantee is to be provided by each country. The Commission has
proposed establishing a European Deposit Insurance Scheme (EDIS) that
would provide a collective guarantee (meeting strong resistance from
countries that worry that they would end up paying for other countries that
have not yet cleaned up their banking systems)
o This organization is unwieldy (requires merging national institutions into collective
ones, with considerable interests at stake)

4.4. The Capital Markets Union Initiative

- Compared to the USA, in Europe Banks play a much larger role than the financial markets in
financing the needs of households and firms
- capital markets exist in every European countries, but they are relatively small
- key advantage over banks: bank crises are more lethal governments must protect small
depositors who are unaware of the riskiness of bank d posits an often unable to absorb losses
- another advantage: it is sometimes easier for startup firms to find resources in capital markets
- largest European capital market is in London, from where it has served all other EU countries
- the European Commission is sponsoring the Capital Markets Union Initiative, with the aim of
increasing the role of capital markets and of promoting a truly integrated market

5. The international role of the euro

- Today: the US dollar is of universal use
- 19 century: sterling was the international currency, having displaced gold and silver
- only large economies can expect their currency to achieve an international status (a condition
that the Eurozone fulfils)
- The Eurosystem's commitment to price stability further enhances the euro's potential
- An international currency must fulfill the same conditions as a national currency.
- The classic attributes of money are:
 o A medium of exchange used for commercial transactions
o A unit of account
o A store of value
- Domestically, these attributes are underpinned by the legal status of money
- Internationally, they cannot be imposed, they have to be earned on merit

5.1. The Capital Markets Union Initiative

- For every export, an agreement must be reached on the currency that will be used to set the
price and then carry out payment
- the Eurozone stands to benefit from a wider acceptance of its currency
- The euro is more often used for exports than for imports, reflecting the fact that the seller
usually decides its own currency
- bulk of primary commodities (oil, gas, raw materials): priced in USD$ in specialized markets
- dollar: currency of choice among countries that are neither the USA nor euro currency areas

5.2. Unit of account: vehicle currencies on foreign exchange markets

- the foreign exchange market is a network of financial institutions that trade currencies among
themselves
- The bulk of transactions involve a vehicle currency
- The share of the euro after its creation in 2001 was much smaller than the sum of the former
share of its constituent currencies, but this simply reflects the elimination of exchange rate
transactions among the currencies that joined the Eurozone
- the euro is a distant second to the dollar and its role has declined after the crisis
- the pre-eminence of the dollar remains unchallenged
- the rise of the Chinese yuan i noteworthy

5.3. Store of value: bond markets

- Large firms and governments borrow on the international markets by issuing long-term debt
(bonds) / this is an enormous market
- following the launch of the euro, the share of bonds issued in that currency rose
- Given the recent turmoil, the share of euro-denominated bonds has now declined
- the share of the dollar has kept rising, in spite of the global financial crisis

5.4. Store of value: international reserves

- All national central banks hold foreign exchange reserves to underpin trust in their currencies
and, if need be, to intervene on foreign exchange markets
- Currencies appropriate for this store of value role must be widely traded and be perceived as
having long-term stability
- European countries at the periphery of the Eurozone are gradually replacing dollars with euros
- Besides politics, central banks are traditionally unwilling to change the currency composition
of their reserves
- large-scale sale of dollars could precipitate its depreciation, with 2 adverse effects
1. cheap dollar would alter international competition in trade, favouring the US economy
2. it would create losses for dollar-holders, including for the central banks themselves
- major shift would require a serious deterioration in the dollar's own quality as a store of value

5.5. The euro as an anchor

- When a country does not let its exchange rate float freely, it must adopt an anchor, a foreign
currency to which its own currency is more or less rigidly tied
- The link can be deliberately vague (managed float) or quite explicit (from wide crawling bands
to the wholesale adoption of a foreign currency)
- A number of countries use the euro as an anchor for their currencies in one way or another
- Most are geographically close to the Eurozone (central and eastern Europe, northern Africa) or
have historical ties to one of its constituent legacy currencies (French-speaking Africa)
5.6. Does it matter?
- The wish to displace the dollar is no doubt driven by political sentiment
- When international trade is invoiced in a foreign currency, importers and exporters face an
exchange risk
- US firms, which mostly carry out international transactions in dollars, enjoy some advantage
- Paper money is costless to produce, but is being exchanged against goods, services or assets
- The profit earned by the central bank (seigniorage) is a form of tax
o when levied on residents: a form of domestic taxation
o when levied on foreigners: represents a real transfer of resources
- the economic benefits resulting from having a world currency are quite modest
- ECB considers that a possible intemational role for the euro is something that it should neither
encourage nor discourage

6. Summary
- The financial markets operate as a channel of transmission of monetary policy
- The interest rates that they charge to their customers tend to follow closely the policy rate set
by the central bank, but the transmission is affected by financial market participants' views of
economic and financial conditions
- financial markets are subject to economies of scale, operate as networks and face important
information asymmetries, are prone to systemic instability
- financial systems are regulated and supervised
- the adoption of a common currency has contributed to the further integration of the various
components of the financial market
- 2007’s crisis have led to a fragmentation of these markets, affecting banks (undermines the
single monetary policy)
- Eurozone was inadequately equipped to deal with turmoil in the banking system
- this had led to a host of new Eurozone institutions, culminating in the establishment of a
Banking Union, which goes some way towards centralizing bank supervision and resolution
- The euro has some potential to challenge the USD$ as an international currency
- dollar’s supremacy has not been seriously challenged
- at the periphery of the Eurozone, it plays a dominant role as an anchor for local currencies