developing country growth assignment - group 2 - the wolfson economic prize

8/2/2019 Developing Country Growth Assignment - Group 2 - The Wolfson Economic Prize

1/21

1

The Wolfson Economic Prize:An assessment of the five finalistsMassimiliano Barone

Evren Karayel

Paolo Mentonelli

Sara Moreno Losada

Davor RogozThomas Richardson


2/21

2

Table of ContentsIntroduction ........................................................................................................ 3

The Euro Crisis and the lack of an exit plan ............................................. 4Solution? ............................................................................................................. 6

Jens Nordvig and Nick Firoozye - Planning for an orderly break-up ofthe European Monetary Union. ..................................................................... 7

Roger Bootle Leaving the euro: A practical guide ................................ 10Neil Record - If member states leave the Economic and MonetaryUnion, what is the best way for the economic process to be managedto provide the soundest foundation for the future growth andprosperity of the current membership?....................................................... 12

Jonathan Tepper - A Primer on the Euro Breakup: Default, Exit andDevaluation as the Optimal Solution........................................................... 14

Catherine Dobbs The NEWNEY approach to unscrambling the Euro . 17

Is there a winner? ........................................................................................... 19

References ........................................................................................................ 21


3/21

3

IntroductionThe Wolfson Economic PrizeThe Wolfson Economics Prize was created by Lord Wolfson to

challenge the worlds brightest economists to create a contingency

plan for the break-up of the Eurozone. On April 3rd 2012, the five

finalists were announced. They are:

1. Roger Bootle and team, Capital Economics2. Cathy Dobbs, private investor3. Jens Nordvig and Nick Firoozye, Nomura Securities4. Neil Record, Record Currency Management5. Jonathan Tepper, Variant Perception

This paper will present a short summary and a critical appraisal of

each of their proposals.


4/21

4

The Euro Crisis and the lack of an exit planIn addition to the five finalists, the Wolfson Prize also published four

other submissions that it considered worthy of note. Charles Dumas

entry (Lombard Street Research) is one that was praised for its

analysis of the Euros problems and their roots. He is also quoted by

another entrant, Edward Hugh, as having described the Euro as a form

of suicide pact.

The Euro has always been a controversial project. Hugh highlights

Marty Feldsteins view that the Euro was always a political project at

heart, hence the broad ignorance of the macroeconomic objections by

those who championed its implementation. He highlights that its

possible breakup was already forecast by Garber (1998) and Scott

(1998).

Hugh also identifies the 5 key characteristics of an optimal currency

area (Labour mobility across entire currency area; degree of economic

openness; degree of trade interconnection; risk sharing and

rebalancing framework i.e. automatic fiscal transfer mechanism; and

harmonised business cycles), noting that only the condition of a strong

degree of trade interconnection really satisfied.

Other major problems include the Euros one size fits all monetary

policy, as the work of San Francisco Federal Reserve Economist


5/21

5

Fernanda Nechio has observed: Using a simple Taylor Rule procedure

to analyse the suitability of the monetary policy decisions of the ECB

for the Eurozone core and its periphery she found that right from the

Euros inception the rate set was more in line with the needs of the

core.

Although the Euro survived its poor start (in terms of its dollar parity)

to become part of the natural and familiar furnishing of the global

financial architecture, when the global financial crisis hit in 2008 it

wasnt long until its sustainability was being questioned again.

The problem is made worse by the lack of an exit plan, because as

Stephen Deo at UBS (Deo et al, 2011) points out, referencing Hotel

California, it was intentionally set up so that once your country signed

up you could never leave.

The Europhiles and Eurosceptics have stuck resolutely to their original

positions, with the Europhiles straining to allocate all blame on the

global financial crisis and maintaining that the Euro must be saved or

there will be a global financial disaster, whilst the Europhiles, struggling

to avoid appearing smug at being proved right, are enraged further by

the fact that the mainstream politicians still ignore their warnings.


6/21

6

Solution?Of the five finalists, Catherine Dobbs best summarises what a good

exit path from the Euro must achieve, in the form of seven tests that

it should pass:

1. Does the approach provide clarity on how Euro denominatedcontracts, assets, liabilities and sovereign debts are

redenominated in the new multi currency regime?

2. How well does the approach result in matched treatment ofassets and liabilities (and supply and sales contracts) for

corporations, governments and individuals?

3. How can the migration pace and process be managed so as toprovide minimal disruption?

4. Does the migration treat individuals roughly evenly?5. How doable is the approach politically?6. What will be the impact of the exit on macroeconomic effects

including inflation, confidence and the effects of debt?

7. Does the discussion of an exit approach within the EU, in itself,result in destabilizing the Economic and Monetary Union?


7/21

7

Jens Nordvig and Nick Firoozye - Planning for an orderlybreak-up of the European Monetary Union.Norvig and Firoozye establish two possible Break up scenarios: A big-

bang Eurozone break-up where the Euro will disappear and a

sequential or onion peeling break-up process where only the strong

core European countries will remain in the Eurozone. Whichever occurs

(they see the onion peeling option as unlikely as once it got to the

stage where Italy or Spain were the next layers, the size of their

economies would make the big-bang inevitable), they see the key to

a successful break-up will be how the various debt contracts are dealt

with according to the various areas of legal jurisdiction.

1st Scenario: Individual exit of countries Obligations issued under local law, it is highly likely that

redenomination into new local currency would happen through a

mandatory currency law (regardless of the nature of the breakup).

Obligations issued under foreign law - a more complex situation.o

Unilateral withdrawal and no multilaterally agreed framework

for exit, foreign law contracts are highly likely to remain

denominated in Euro.

o Exit is multilaterally agreed, the large majority of contractsand obligations are likely to stay denominated in Euro.
http://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20jens%20nordvig.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20jens%20nordvig.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20jens%20nordvig.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20jens%20nordvig.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20jens%20nordvig.pdf


8/21

8

2nd Scenario: Full blown Eurozone break-up - contracts cannot continueto be settled in Euros. Three solutions.

1. Obligations are redenominated into new national currency.2. Existing Euro obligations are converted into a new European

Currency Unit (ECU-2). (Eliminates the currency risk that from

arbitrary conversion rates decided upon by courts.)

3. Euro denominated obligations could in theory be settled inan international foreign currency, such as GBP or USD (NY

Law contracts).

The authors outline four key steps needed to facilitate an orderly

currency redenomination process:

1. Offer guidance on the redenomination process for local and foreignlaw assets.

a. Guiding principles for redenomination oflocal law assets:Each Eurozone country should redenominate assets and

obligations in accordance with a new currency law.

b. Guiding principles for redenomination offoreign law assets(high level of legal uncertainty) specifying a role for a new

European Currency Basket (ECU-2) to settle Euro

denominated assets and obligations.


9/21

9

2. Specify the role of a new European Currency Unit (ECU-2) in theredenomination of foreign law assets and obligations.

3. The creation ofhedging market for intra-EMU currency risk, aimingto reduce intra-EMU currency risk, through the creation of non-

deliverable currency forward markets.

Allowing exchange and mitigation of the ongoing redenomination

risk would reduce systemic risk in the Eurozone banking system.

4. Adopt a new regulatory framework to reduce intra-Eurozonecurrency exposure and encouraging hedging of new FX exposures.

With the legal framework established, the key question is how would

the value of the ECU-2 be established. Their proposal would be for it

to be mechanically linked to the performance of the new currencies of

previous Eurozone countries and their equity weights in the ECB, with

the redenomination process mirroring how ECU-denominated

instruments were redenominated into Euros in 1999.

As many believe that policy makers got this wrong in the first place,

how could we guarantee that they would get it right this time?

However, the floating exchange rates of the new national currencies

should prevent any country experiencing a sustained advantage or

disadvantage.


10/21

10

Roger Bootle Leaving the euro: A practical guideRoger Bootles Practical guide focuses on the question how an

individual country can effectively leave the Euro with minimal disruption

of its own monetary system. As Bootle sees the Euro as a

malfunctioning monetary union (due mainly to its political origins) he

believes that it is better for a country with high debt burden and

stalling economy to leave the monetary union, embracing the idea of

currency depreciation as a way of becoming more competitive.

Otherwise the country faces a disaster by likely debt default and

banking collapse.

If handled well, an exit could present weak peripheral members with a

much better prospect than remaining in the Euro. Moreover, their exit

could enhance the prosperity of the rest of Europe.

Therefore his essay aims to provide a practical step-through of the

issues around Euro exit. The central focus is how to achieve a fall in

real wages and prices with the minimum practical disruption and

proposes that government debt and consumer debt be redenominated

into euros deploying the lex monetaeprinciple. Meaning that each

country determines the currency applicable under its laws with foreign

courts consequently recognizing it.
http://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20roger%20bootle.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20roger%20bootle.pdf


11/21

11

However, it proposes that corporate sector contracts be left to the

determination of legal courts (in a few cases contracts will be

interpreted in terms of national currency; in most in terms of the

Euro).

Bootle believes that there would be a large default on debt, which will

lead to reduction of the debt to GDP ratio to 60% for a country in a

similar situation to Greece, and the currency would depreciate or be

devalued.

The success of his proposal mainly depends on the success of its

execution. If the execution goes wrong, countries could face

hyperinflation and economic meltdown, which is a worse scenario than

staying in monetary union. Therefore the question is: which scenario is

more likely to happen - A Eurozone countrys default or its successful

exit from monetary union?

I think that most probable scenario for such countries e.g. Greece, is

defaulting first and then consequently exiting euro. Taking that into

consideration I think that all members should be given a chance to

use the euro until they default and then set up their own currencies

and consequently regain their monetary sovereignty.


12/21

12

Neil Record - If member states leave the Economic andMonetary Union, what is the best way for the economicprocess to be managed to provide the soundest foundationfor the future growth and prosperity of the currentmembership?Record foresees an orderly and controlled Euro abandonment with a

guarantor country, namely Germany at the forefront and possibly

France as junior partner. The execution should be led by a Task Force

responsible for deciding the precise and quick actions to take and

should be presented to the Council of Ministers. Particular emphasis is

given to the secrecy of the whole operation.

Thus, in order to control the process, the Task Force should

recommend these main actions to undertake:

The Euro should cease to exist at the time of German exit andit should be replaced by a National currency. After the

announcement, the National currency would be represented by

the Euro notes identified with the relevant country code (X for

Germany). This would mean that all the euro banknotes with a

different prefix would become foreign currencies.

Define the exchange rates on the basis of reference points thathave been stable over the past years

Preserve the EU, by not imposing custom duties or any otherheavy form of commerce restriction.
http://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20neil%20record.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20neil%20record.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20neil%20record.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20neil%20record.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20neil%20record.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20neil%20record.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20neil%20record.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20neil%20record.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20neil%20record.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20neil%20record.pdf


13/21

13

Replacing the ECB and all its functions with the National CentralBank (NCB).

The capitalization of the NCB should be done through two sources:

the shareholding proportion coming from the Balance Sheet of the

ECB and the support of the national government if the previous assets

injection would not suffice.

Overall, the issues are well developed and deeply analyzed, with useful

suggestions such as the idea of using the same Euro banknotes with

their prefix-codes as identification for the new national currencies, is

particularly helpful to solve the problem of the lack of an alternative

currency.

However, critical aspects would need to be better clarified, in

particular: the exchange rate definition, the inflation control, and the

liquidity of the banks.


14/21

14

Jonathan Tepper - A Primer on the Euro Breakup: Default,Exit and Devaluation as the Optimal SolutionI've long said that capitalism without bankruptcy is like Christianity

without hell.om

Frank Borman, Chairman of Eastern Airlines

The paper written by Jonathan Tepper suggests than an orderly

default for euro zone countries bearing an unsustainable debt like

Greece, Spain, Portugal, followed by a subsequent exit from the Euro-

zone with concomitant devaluation of their currencies is the most

rational and beneficial way to improve the economic environment in

the EU.

Tepper bases his conclusions on detailed analysis of historical

currency exists which shows little macroeconomic volatility and, in the

majority of cases, also a fast recovery and growth for the respective

countries. Tepper suggests that the previous currency exits can be

used as roadmaps for current situation.

Furthermore, the paper provides an exact manual about how the

aforementioned countries and the in the Eurozone remaining countries

should react. As Tepper correctly highlights the most challenging part

of his scenario would be the redenomination of existing debt into a
http://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20jonathan%20tepper.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20jonathan%20tepper.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20jonathan%20tepper.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20jonathan%20tepper.pdf


15/21

15

new currency. For this part he suggests redenominating the existing

debt, which was done under local law into a new currency, and

leaving the debt done under foreign law (other Euro countries) as

Euro-debt.

Unfortunately, one of the biggest weaknesses ofTeppers paper is that

he doesnt suggest any solution for private saver whose saving will

suffer the most in case of an exit from the euro-zone, as he also

correctly points out. While the rich and powerful will have already

transferred the majority of their savings abroad, the small savers will

suffer from this action and Tepper does not come up with a

suggestion to solve this problem.

Tepper highlights why a common currency is not possible for all the

European countries unlike in the US. He suggests that being in an

union where a country does not have to possibility to stamp money or

other sovereign tools to fight against crisis, leads eventually to

suffocation of weaker countries to the advantage of the stronger part

of the union. Furthermore, Tepper also demonstrates that some EU-

regulations like no deficit-runs are counterproductive in reducing the

existing debt highlighting regulatory problems in the euro-zone.


16/21

16

In summary, Teppers paper contains many insightful explanations. It

suggests that the fear from Euro-exit is unfounded and in fact that it

is the only viable path to pursue. The paper would have been more

credible if he could have elaborated a little bit more on the fact how

the Eurozone would react now, given the fact that the size of the

countries involved and their interdependencies are much stronger than

any time in the history before. With the risk and fear of financial

contagion amongst the Eurozone, one could argue that the historical

currency exits are not comparable to its situation.


17/21

17

Catherine Dobbs The NEWNEY approach to unscramblingthe EuroDobbs argues that a departure by any nation from the EMU would

result in a shock anywhere from five to ten times the size of the

shock generated by the collapse of Lehman Brothers in 2008. This

would result in another, more significant liquidity crisis and huge,

destabilizing capital flows away from the departing country(s). Dobbs

approach seeks to avert this scenario by removing the incentives for

such capital flows. The five key components of Dobbs plan are:

1) Treat all Euros as equal, regardless of location.2) Split the zone into two (or more) regions: the white zone whose

currency she calls New Euro White (NEW) and the yolk zone,

referred to as New Euro Yolk (NEY).

3) All existing Euros would be converted into a basket of NEW andNEY and an exchange rate versus the old Euro would be fixed.

4) Yolk (NEY) would slowly devalue its currency via interest rate

changes and inflation without causing a run on the currency

(inflation targets would be laid out and clearly signaled to the

market in advance).

5) Capital controls would need to be implemented and enforced toprevent movement (both electronic and physical) of assets away

from the NEY zone.
http://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20catherine%20dobbs.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20catherine%20dobbs.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20catherine%20dobbs.pdfhttp://www.policyexchange.org.uk/images/WolfsonPrize/wep%20shortlist%20essay%20-%20catherine%20dobbs.pdf


18/21

18

The primary benefits of Dobbs approach are the following:

1) Automatic redenomination of Euro assets, contracts, and

liabilities.

2) Removes incentives for destabilizing, speculative capital flows,thereby reducing the likelihood that the plan will ever need to

be implemented.

Some drawbacks to Dobbs plan:

1) Expectations of targeted/future inflation may prevent a gradualdevaluation and probably cause wages to rise, making the

sought after gain in competitiveness more difficult to achieve.

2) Could dampen economic growth as borrowers get hit more thansavers due to rising interest rates.

3) New notes and currency would need to be printed/minted,something that would be difficult to accomplish in secret.

4) Capital controls might be difficult to enforce, especially wherethere are large, porous borders.


19/21

19

Is there a winner?Catherine Dobbs highlighted an article published in the FT about the

Wolfson Prize by Tim Hartford, who described the competition as

impossible to win, but contrary to his expectations Lord Wolfson

does appear set to award the prize.

The entrants can be split into two groups: Dobbs and Nordvig focusing

on specific issues (regarding capital flight and Eurozone debt contracts

respectively), and the submissions of Bootle, Record and Tepper, who

focused on the lessons that could be learned from previous

devaluations and exits from currency unions.

Teppers faith that a Euro-exit would be just like the many previous

examples of currency devaluation is admirable, but we agree that the

unprecedented contagion risk as highlighted by Dobbs is too large to

be overlooked. Similarly the submissions of Bootle and Record depend

significantly on keeping plans secret from the markets. The chances of

this being possible are pretty small and the political ramifications once

the plans were revealed could be interesting.

Both Dobbs and Nordvig suggest creating a new currency to deal with

the issues they raise. As the judges commented when announcing the

finalists, Dobbs NEWNEY approach is beautifully clean, clear, concise

The solution is original, insightful, elegant and persuasive.
http://www.ft.com/cms/s/0/16d19598-fb2f-11e0-8756-00144feab49a.html#axzz1u6gl1VKFhttp://www.ft.com/cms/s/0/16d19598-fb2f-11e0-8756-00144feab49a.html#axzz1u6gl1VKFhttp://www.ft.com/cms/s/0/16d19598-fb2f-11e0-8756-00144feab49a.html#axzz1u6gl1VKF


20/21

20

It deals best with perhaps the most difficult of her 7 tests how

doable is it politically? It is delicately argued as being appropriate for

discussion and even being announced as the EUs official Plan B,

without causing any harm to the Euro itself. It also appeals to those

seeking the more capitalist solution as the mechanism rewards lenders

with high credit quality books gain (because there are fewer defaults)

and those with low credit quality book lose (because the defaults that

do occur involve larger haircuts).

The Nordvig solution is not as likely to be as appealing to the general

public as the mechanisms that underlie the ECU-2s valuation are more

complex and involve a hedging market, which would perhaps be a

difficult sell to the politicians and their electorate (bearing in mind the

proposal could be subjected to a referendum) in the current climate.


21/21

ReferencesNechio, Fernanda. 2011. Monetary Policy When One Size Does Not Fit

All FRBSF Economic Letter 2011-18 (June 13)

Deo, Stephane, Paul Donovan & Larry Hatheway. 2011. Euro break up

the consequences, UBS investment research

Scott, Hal S.: When the Euro Falls Apart, Intl Fin 1:2, p. 207-228,1998.

Garber, Peter (1998), Note on the Role of TARGET in a Stage III

Crisis, NBER Working Paper no. 6619.

developing country growth assignment - group 2 - the wolfson economic prize

Documents