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Lender of Last Resort

I never thought I would live to see a serving European Commissioner suggest that it was "reckless" to launch the euro without a lender-of-last resort or fiscal union to back it up.
Or that EMU policies have led to a vicious cycle and a catastrophic double-dip recession that is entirely due to the dysfunctional character of the project.
Or that the Greek debt crisis was botched because Germany’s leaders were playing politics with the North-Rhine Westphalia elections.
Or that that the internal devaluation policies forced on the victim states are cruel and inherently self defeating.
Or that EMU's stabilisation regime has not come close to putting monetary union on a viable footing, able to command political consent over time.
But we have one today from László Andor, and it is a corker, delivered in Berlin of all places. The European Commissioner for Employment and Social Affairs is very close to outright revolt, not surprisingly since his job is to deal with the terrible consequences of these policies.
Ambrose Evans-Pritchard, June 13th, 2014

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László Andor

Social dimension of the Economic and Monetary Union:
what lessons to draw from the European elections?
Lecture at Hertie School of Governance, Berlin, 13 June 2014

Interndevalvering (Ådals-metoden)

EU:s bankunion har ingen backstop.
Backstop? De är en Lender of Last resort, helt enkelt.
Rolf Englund blog 24 mars 2014

The Federal Reserve final rule requiring higher capital levels from non-US banks,
including Deutsche Bank, Barclays and Credit Suisse,
with the aim of avoiding a US government bailout if their New York operations run into trouble.
FT February 19, 2014

RE: Det förefaller som om det var Fed och inte ECB som ställde upp som Lender of Last Resort för de europeiska bankerna
som professor Pelotard har viskat i mitt öra.

Can the European Central Bank legally act as lender of last resort to ensure the survival of the euro?
This question is of fundamental importance for the sustainability of the monetary union. Recently, the German Constitutional Court ruled that it cannot.
In the court’s view the ECB has the power to conduct monetary policy,
but not to support member states in financial distress even if necessary to ensure the survival of the common currency.
Katharina Pistor, Vox, 26 February 2014

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German Constitutional Court

The real reason for lenders of last resort
the rare but critical instances when one or more banks go bust.
There is absolutely nothing new here. The definitive statement on the issue was made by Bagehot (1873).
Even if the ESM resources ever grow to €500 billion, they will be massively insufficient to deal with the major banks in the Eurozone.
Deutsche Bank, for example, has assets of over €2 trillion – about 80% of Germany GDP (Deutsche Bank 2011).
Charles Wyplosz, Vox, 17 September 2012

The massive rescues that we have witnessed since 2008 in the US, UK, EZ, and Switzerland have now removed the fig leaf.
Central banks are lenders of last resort, whether they want it or not.

They need a deal with the relevant government to make sure that the costs will be borne ultimately by the government, not by the central bank, but they cannot and should not refuse to act when an emergency arises.

This logic was ignored when the single currency was under preparation. The ‘oversight’ however was deliberate, resulting from pressure by both banks and national supervisors each acting for their own shameful reasons.

EZ banking union
Non-EZ countries are revolting because they are dragged into this business. They are right. They have their own central banks that can act as lender in last resort and therefore have no need for ECB intervention.
The commission is making a grave mistake when it proposed an EU solution for a EZ problem.

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Martin Wolf och Rolf Englund om att
den som har en sedelpress går inte i konkurs.
Ganska självklart, men vänta till Wolf har förklarat det vetenskapligt
Rolf Englund 23 maj 2012

Måste Spanien upprepa Irlands misstag?
I Irland fick oron till följd att regeringen införde en bankgaranti.
När Irlands banker fick problem med hotande bankrusning fanns ingen "lender of last resort".
Hur kunde eurons konstruktörer glömma att förse valutaunionen med en fungerande centralbank
Danne Nordling 2 juni 2012

As Ben Bernanke, chairman of the Federal Reserve, explained in an important speech on April 13,
central banks have expanded their balance sheets because those of the private financial sector collapsed.
That is what a lender of last resort is supposed to do during a severe panic. We have known this since the 19th century
Martin Wolf, Financial Times, 1 May 2012

The biggest danger is Greece
Greece has a €14.4 billion bond due on March 20th.
The country’s slow-motion bank run has continued
The Economist print, 14 January 2012

ECB remains adamant that it cannot intervene as the lender of last resort to euro-zone sovereigns.
The Economist print, Dec 17th 2011

Skuldkrisen är i första hand en ekonomisk kris. Därför bör inte EU springa iväg med stora, komplicerade ändringar av regler, institutioner eller av EU-fördraget.
Inte heller är euroobligationer eller utvidgade möjligheter för ECB att ge finansiellt stöd en lösning.
Det sade statsminister Fredrik Reinfeldt vid en presskonferens på tisdagen efter att ha träffat EU-ordföranden Herman Van Rompuy.
SvD nyhetsplats, 22 november 2011

The notion that “fiscal union” of some kind is workable, and that Germany wants it, has gained ground
because that is the only way certain financial analysts can keep predicting that “Merkel will print” and the end-of-year market rally will come.
Liam Halligan, DT 26 Nov 2011

The ECB lowered its benchmark interest rate from 1.25% to 1% to try to mitigate the coming recession.
It agreed to provide unlimited cash to commercial banks for up to three years, at its main interest rate,
to replace the medium-term funding that private investors are unwilling to extend.
The Economist print, Dec 17th 2011

The central bank will now accept higher-risk asset-backed bonds as well as loans as security for cash, and it has lowered its reserve requirements for banks to ease their funding pressures.

Such measures will help to address a shortage of liquidity in the euro-zone banking system. But they are unlikely to avert a nasty credit crunch, because banks are inclined to shed assets, rather than make new loans, as they strive to comply with new capital rules by next June.

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Slutet för den nuvarande valutaunionen. Inte det mest sannolika, men ändå inget orealistiskt perspektiv.
Euroländerna kan bli tvungna att bryta mot reglerna för att valuta­unionen ska överleva.
EU-fördraget gör klart att Europeiska centralbanken, ECB, inte får låna ut pengar till medlemsstater.
I en verklig nödsituation är ändå detta vad som måste göras.
Johan Schück, DN 25/11 2011

Spåren från hyperinflationen i 1920-talets Tyskland förskräcker. När pengar totalt förlorar sitt värde blir följden att tilliten i ett samhälle försvinner. Detta undergrävde demokratin och beredde väg för nazismen.

Euroobligationer – som nu föreslås av EU-kommissionen – skulle hjälpa skuldtyngda länder att låna, med hjälp av Tysklands kreditvärdighet. Men detta kan ligga i framtiden och är inte till hjälp om läget för Italien eller Spanien snart skulle förvärras. I en verklig nödsituation finns ingen annan utväg än att ECB köper statspapper i stor skala, direkt från ländernas regeringar.

Syftet är i så fall att undvika en krasch som drar med sig hela eurosystemet och betyder slutet för den nuvarande valutaunionen. Det är för dagen inte det mest sannolika, men ändå inget orealistiskt perspektiv.

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The financial crisis has exposed the weaknesses in any currency union among otherwise sovereign countries,
particularly the difficulty of adjustment and the lack of a proper central bank.
It has also exposed the weaknesses of the actual design of the eurozone.
Martin Wolf, Financial Times, April 24, 2012

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The eurozone sovereigns lack a true lender of last resort.
They are what Charles Goodhart of the London School of Economics calls "subsidiary sovereigns".
Martin Wolf, FT 2011-11-23

Their debt bears a risk of outright default rather than mere monetisation. Fearing default, investors create illiquidity, which turns into insolvency.

The greater the proportion of foreign creditors, the more plausible default becomes: investors know that politicians are more unwilling to default to their own citizens than foreigners. But, as a result of the currency union, foreigners hold a higher proportion of sovereign debt than before: half of Italian public debt is held abroad.

The third explanation is that there is break-up risk. No currency union is irrevocable. Even countries do not survive forever. But a currency union among discordant states is far more fragile than a country.

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Konstruktionen kring euron har inte varit fel
Jan Björklund, Birgitta Ohlsson, Carl B Hamilton och Olle Schmidt, SvD Brännpunkt, 9 september 2011


Martin Wolf

After almost two years in which the focal point of the euro-zone debt crisis has shifted from one European capital to another,
it has finally arrived where it belongs: in the bloc's headquarters in Brussels
Simon Nixon, Wall Street Journal, 22 November 2011

The crisis has only ever been partly about the sustainability of the sovereign debts of Greece, Ireland, Portugal, Italy and Spain.

More crucially, it has always been a political crisis, an institutional crisis, a crisis of governance. It has been about the failure of the euro zone to develop the necessary mechanisms to ensure financial discipline among its member states and to come to the aid of countries when they ran into financial trouble, thereby ensuring that a debt problem in one of its smallest members should become an existential threat to the currency itself.

There can be no solution to the euro-zone crisis that doesn't first address this governance crisis.

Two myths have until now sustained the hopes of those betting the euro zone could exit the crisis.

The first was the belief that rising government bond yields simply reflected the loss of credibility by some governments — for which the solution was an even-greater commitment to austerity and structural reform and, if necessary, its replacement by technocrats.

The second myth was the view that if the survival of the euro zone were threatened, the European Central Bank would ride to the rescue of cash-strapped governments, deploying its all-powerful "bazooka" to prevent a collapse into chaos.

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More by Simon Nixon at Wall Street Journal


Konstruktionen kring euron har inte varit fel
Jan Björklund, Birgitta Ohlsson, Carl B Hamilton och Olle Schmidt, SvD Brännpunkt, 9 september 2011

Krisen hösten 2011 handlar inte om inflation utan om att upprätthålla finansiell, social och politisk stabilitet i Europa.
Peter Wolodarski, DN 21 november 2011

Historien visar att det bara finns en institution – centralbanken – som har verktygen för att avvärja den panik som så lätt blir självuppfyllande.
Blotta vetskapen om att ECB (som alltid kan trycka nya pengar) garanterar krisländernas betalningsförmåga skulle kunna avvärja spekulationen.

Frågan i dag är hur länge politikerna i Berlin ska låta eurokrisen fördjupas innan de ger centralbanken de befogenheter som behövs i ett nödläge.

On Friday, Mario Draghi said “no”.
The president of ECB declared that the eurozone crisis was a crisis in need of a political solution and the ECB would not bail out anybody.
To underline the message, the ECB’s governing council had earlier in the day put up a ceiling of €20bn on its weekly bond purchases.
Wolfgang Münchau, FT 20 Nov 2011

There is no political solution in sight. Angela Merkel, the German chancellor, rejects a eurozone bond. The European financial stability facility is too small to handle countries the size of Italy or Spain, let alone both.

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If Germany genuinely wishes to save Spain and Italy, it must allow EMU-wide reflation and
mobilize the ECB as a lender of last resort to halt the bond crisis, since the EFSF rescue fund does not exist.
To create a currency without such a backstop is criminally irresponsible.
Ambrose Evans-Pritchard, DT, 20 Nov 2011

If this role is illegal under EU treaty law – and that is arguable – then EU treaties must be changed immediately.

If Germany cannot accept this for understandable reasons of sovereignty or ideology, it should accept the implications and prepare an orderly break-up of monetary union.

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Spain and Italy


The euro is a macro-economic weapon of mass destruction - it simply must be defused.
Should Germany sanction the European Central Bank to guarantee the sovereign debts of all ?
These are the questions that the cheer-leaders of “fiscal union” need to answer.
Liam Halligan, DT, 19 Nov 2011

The gathering storm in Italy has a growing number of policy makers calling on the ECB
to use its most powerful tool—its printing press—to shore up debt markets by buying unlimited amounts
of euro-zone bonds, becoming the lender of last resort.
So far, the bank has resisted, arguing this wouldn't be legal under European law.
Wall Street Journal, 18 November 2011

Safety nets encourage loose behaviour.
But when the whole eurozone is in peril and the future of the European Union is at stake,
it is no time to be quibbling about morally hazardous niceties.

John Plender, FT 8 Nov 2011

That, after all, is why central banking developed the tradition of last resort lending, starting with the Bank of England’s intervention in the financial crisis of 1825-26.

Instead we have the European financial stability facility, a curious off-balance sheet lender of last resort. Despite recent frenetic summitry, the politicians have failed to convince markets that this rescue fund will ever be adequately resourced.

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A German veto and EU treaty constraints stop ECB intervening with overwhelming force as a genuine lender of last resort.
The bank is itself at risk of massive over-extension without an EU treasury and single sovereign entity to back it up.
This lack of a back-stop guarantor is an unforgivable failing in the institutional structure of monetary union.
Ambrose Evans-Pritchard, 6 Nov 2011

As Berkeley professor Brad DeLong argues in a new paper, such “utter disregard for financial stability – much less for the welfare of the workers and businesses that make up the economy – is a radical departure from the central-banking tradition.”

German lawmakers had days earlier stipulated that the ECB must withdraw from its existing purchases of bonds as a condition for Bundestag approval of the revamped bail-out fund EFSF.

Yet Europe’s fiscal rescue machinery remains a fiction, a fund designed for Greece, Ireland, and Portugal that is now being stretched by every disreputable artifice of structured credit to shore up the whole EMU edifice on the cheap.

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Krugman och Münchau är eniga om att ECB bör får obegränsade möjligheter att agera ”lender of last resort” för medlemsstaterna.
Detta för att försöka förhindra en självförstärkande och för hela eurozonen katastrofal ”run” mot Italien och Spanien.
Per Lindvall, e24, 12 seotember 2011

ECB har kunnat förhindra en katastrof genom att just göra sådana stödköp de senaste månaderna.
Den nödvändiga politiska uppbackningen för detta har emellertid minskat rejält.
I helgen hoppade den tyska ECB-ledamoten, och inofficiell ”chefsekonom”, Jürgen Stark av sitt uppdrag.

Krugman hämtar mycket stöd frånen analys av den belgiske professorn Paul de Grauwe.

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Början på sidan


Euro Crisis Makes Fed Lender of Only Resort
Bloomberg, Sept 28, 2011

U.S. prime money-market funds cut their exposure to euro-zone bank deposits and commercial paper, or short-term IOUs, to $214 billion in August from $391 billion at the end of last year, according to JPMorgan Chase & Co. data.

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A lecture by Paul de Grauwe in Spain, on the Euro crisis as a morality play,
delivered in acceptance of an honorary doctorate by the University of Valencia.
Eurointelligence 3 December 2012

De Grauwe's central argument is that the Euro crisis cannot be solved as long as it is narrated in the surplus countries as a 'morality play' as this leads to the misdiagnosis that the crisis stems from 'irresponsible' behaviour by the deficit countries, and thus to the misguided prescription that 'punishment' is necessary so that the deficit countries learn to not 'sin' again.

The reported content is very close to this Editorial by de Grauwe on Intereconomics, the journal of the Centre for European Policy Studies.

As Paul De Grauwe, professor of economics at the University of Leuven, has put it in a defining paper on the difficulties of the eurozone,
“a monetary union can only function if there is a collective mechanism of mutual support and control.
Such a collective mechanism exists in a political union.
In the absence of a political union, the member countries of the eurozone are condemned to fill in the necessary pieces.
What has been achieved, however, is still far from sufficient to guarantee the survival of the eurozone”.

Jeremy Warner, DT, 14 Sep 2011

The problem is that Germany is determined not to go further. Indeed, it has now been told by its constitutional court that it mustn’t, never mind the concerns of ordinary Germans about being made liable for other people’s debts.

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We have learned from the history of banking that a necessary condition to stabilize the banking system
consists in providing for a lender of last resort.

National governments in a monetary union issue debt in a "foreign" currency, i.e. one over which they have no control.
Paul de Grauwe, Eurointelligence 28 July 2011

As a result, they cannot guarantee to the bondholders that they will always have the necessary liquidity to pay out the bond at maturity. This contrasts with "stand alone" countries that issue sovereign bonds in their own currencies. This feature allows these countries to guarantee that the cash will always be available to pay out the bondholders.

The absence of a guarantee that cash will always be available makes the sovereign bond markets in a monetary union prone to forces of contagion, very much like banking systems that lack a lender of last resort are prone to contagion.

In such banking systems, banks cannot guarantee that cash will always be at hand to pay out deposit holders. As a result, solvency problems in one bank quickly lead deposit holders of other banks to withdraw their deposits, setting in motion a generalized crisis.

The same risk exists in a monetary union when solvency problems in one country (Greece) lead bondholders to fear the worst in other bond markets and to sell the bonds there.

We have learned from the history of banking that a necessary condition to stabilize the banking system consists in providing for a lender of last resort.

This gives a guarantee to deposit holders that the cash will always be available, and pacifies them most of the time.

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Riksbankens roll som lender of last resort

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“This crisis has the potential to be a lot worse than Lehman Brothers,” said George Soros,
the hedge fund investor, citing the lack of an authoritative pan-European body to handle a banking crisis of this severity.
“That is why the problem is so serious. You need a crisis to create the political will for Europe to create such an authority, but there is still no understanding as to what the authority will do.”
New York Times, 7 september 2011

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One can sympathise with Berlin. But sharing debts with Italy and Spain was implicit when they agreed to launch the euro.
Ambrose Evans-Pritchard, Daily Telegraph 08 October 2008
Very Important Article

Den franska storbanken BNP Paribas har en exponering mot grekiska
statsobligationer på 5 miljarder euro (49 miljarder kronor).

E24 6/5 2010

The crucial problem on this side of the Atlantic is that the largest European banks have become not only too big to fail, but also too big to be saved.
The total liabilities of Deutsche Bank (leverage ratio over 50!) amount to about €2,000bn (more than Fannie Mae) or more than 80 per cent of the gross domestic product of Germany.
This is simply too much for the Bundesbank or even the German state, given that the German budget is bound by the rules of the European Union’s stability pact
Daniel Gros and Stefano Micossi, Financial Times, September 23 2008

European banks harder hit by credit crunch
Of the $387bn in credit losses $200bn was suffered by European groups and $166bn by US banks,
Gillian Tett, FT June 5 2008

Riksbanken om Krisberedskap och Lender of Last Resort-funktionen
Klicka här

Bank of England about Lender of Last Resort
Click here

Fed NY about Last Resort
Click here

Remarks by Chairman Alan Greenspan
More fundamentally, we should recognize that if we choose to enjoy the advantages of a system of leveraged financial intermediaries, the burden of managing risk in the financial system will not lie with the private sector alone. Leveraging always carries with it the remote possibility of a chain reaction, a cascading sequence of defaults that will culminate in financial implosion if it proceeds unchecked. Only a central bank, with its unlimited power to create money, can with a high probability thwart such a process before it becomes destructive. Hence, central banks have, of necessity, been drawn into becoming lenders of last resort.
September 25, 2002

Axel Weber, president of Germany’s Bundesbank, may rue his choice of words eight days ago.
The bail-out of IKB, a previously little-known listed bank that had been caught in the fallout from the US subprime mortgage crisis earlier in August, was an “isolated, institution-specific incident”, he said.
By late last Friday night, it had happened again.
Financial Times 22/8 2007

Med nödkrediter på nästan 900 miljarder kronor,
mer än man pumpade ut efter terrorattackerna den 11 september 2001,
lyckades Europeiska centralbanken avvärja en allmän panik på Europas finansmarknader.

Gunnar Örn, Dagens Industri 8/10 - den 10 augusti - 2007

Den svenska riksbanken har nämligen blivit en något stympad ”lender of last resort”. Den kan kanske inte längre i tillräcklig kvantitet tillhandahålla de nationella betalningsmedlen?
Ur Margit Gennser: EMU - en kritisk analys, Fischer & Co 1997

Det visas att man i Sverige helt felbedömde den Europeiska centralbankens (ECB) roll inom Eurosystemet.
ECB är varken systemets gemensamma centralbank eller ens en sann centralbank.
Den har därför varken förmågan att utjämna inflationsskillnader inom EMU, som Lindahl ansåg vara den centrala uppgiften för huvudcentralbanken, eller att verka som ”lender of last resort”.
Denna viktiga institution saknas helt inom Eurosystemet
Otto Steiger, Ekonomisk Debatt nr 2/2007

J. Pierpont Morgan, stemmed the Panic of 1907, Acting, in effect, as lender of last resort from his Wall Street office, he was briefly feted before Americans realised the danger of having such power vested in one man.
After his death in 1913 the Federal Reserve was set up.

The Economist 17/5 2007

At least since 1823, when Byron's Don Juan described “Jew Rothschild, and his fellow Christian Baring” as the “true Lords of Europe”, investment bankers have inspired awe, envy and, rightly or wrongly, a measure of disdain. Exactly 100 years ago the undisputed patriarch of the modern industry, J. Pierpont Morgan, stemmed the Panic of 1907, a financial crisis caused by unregulated trusts (the hedge funds of their day). Acting, in effect, as lender of last resort from his Wall Street office, he was briefly feted before Americans realised the danger of having such power vested in one man. Cartoonists then mercilessly mocked him. After his death in 1913 the Federal Reserve was set up.

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The European Commission ran an exercise in which it pretended a commercial insolvency was threatening to bring down two banks

In April last year the European Commission ran an exercise in which it pretended a commercial insolvency was threatening to bring down two banks, one of them big.
The Economist print 18/1 2007

In May the European Central Bank rehearsed the collapse of a large European institution. The British financial authorities also had two drills in the past year, one of which examined the impact on a British clearing bank of the failure in London of a foreign banking subsidiary.

Putting some doubt into bankers' minds—“constructive ambiguity”, as the regulators put it—is a guard against moral hazard. If commercial lenders assume the central bank will always bail them out when things go wrong, they may be tempted to lend recklessly.

The biggest banks, to which regulators apply the ungainly term Large and Complex Financial Institutions (LCFIs), straddle so many markets, in so many countries, that a national authority cannot act alone.

Nordic regulators are the keenest on financial war games, but so far even they have not included the banks themselves as active participants. “We are moving in that direction,” says Göran Lind, an adviser to the Sveriges Riksbank, the Swedish central bank.

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Cross-border banks require a single regulator
Wolfgang Munchau, FT 1/4 2007

With the arrival of the euro, responsibility for monetary policy was transferred from national central banks to the European Central Bank. But this did not apply to banking supervision, which remained under national control – either within the central banks themselves or with independent supervisory agencies.

As long as there is no crisis, the system can obviously be made to work. But at some point, supervisors have to take tough decisions – such as whether a bank should be bailed out or closed. It may well be that one supervisor wants to bail out a bank and another does not; or that both back a bail-out but cannot agree on how to split the costs.

Financial Integration in Europe, Strengthening the EU Framework for Cross-border Banks, p.33ff, ECB, March 2007,

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Every nation state has a system of supervision and control of its financial sector, including a lender of last resort, to guarantee the soundness and stability of the financial system.
Presently, such a pan-European set of institutions is lacking.
Lars Jonung, CNN

The Lender of Last Resort in the European Single Financial Market
Garry J. Schinasi and Pedro Gustavo Teixeira, IMF Working paper

A Symposium Sponsored By The Federal Reserve Bank of Kansas City
Very impressive pdf 9 MB