Implications of Negative Interest rate

Assessing the implications of negative interest rates

Speech by Benoît Cœuré, Member of the Executive Board of the ECB, at the Yale Financial Crisis Forum, Yale School of Management, New Haven, 28 July 2016

Introduction^[1]

I would like to thank Glenn Schepens and Skander Van den Heuvel for their assistance in preparing this speech. All views expressed herein remain mine.

Interest rates have been low across all major advanced economies for some time now. The decline in interest rates – both nominal and real – has been a persistent trend since the 1990s and is visible in the long-term interest rates on government bonds . A range of structural factors have been proposed for this secular decline in the rate of return on safe assets, including demographic changes, a slowdown in the rate of technological progress, and a high demand for safe assets relative to their supply.^[2]

See Bean C., C. Broda, T. Ito and R. Kroszner, “Low for Long? Causes and Consequences of Persistently Low Interest Rates” Geneva Reports on the World Economy 17, 2015.

This decline in long-run interest rates has consequences for monetary policy. Monetary policymakers often think in terms of a concept known as the real equilibrium rate or the “natural” rate of interest.^[3]

This equilibrium rate is the interest rate that is consistent with stable inflation and output at its potential level. Setting short-term interest rates above this rate puts downward pressure on activity and inflation. Setting them below this rate of course has the opposite effect. While this real equilibrium interest rate is difficult to estimate precisely, and while there are competing explanations for it, there is a broad consensus that it has declined in advanced economies over the past two decades. By some estimates it is currently negative in the euro area.^[4]

Since the global financial crisis, inflation has been low worldwide, and growth subdued. Central bankers are responding to this low inflation and output below potential by conducting accommodative policies. Both these cyclical factors and the longer-term decline in the equilibrium real rate of interest have required policy rates to be set at record low levels in advanced economies. As short-term policy rates approached zero, central banks carried out further loosening by providing forward guidance about the expected future path of interest rates and by lowering term premia through large-scale asset purchase programmes.

In June 2014, following in the footsteps of the Danish National Bank, the European Central Bank (ECB) became the first major central bank to lower one of its key policy rates to negative territory. The rate of interest on our deposit facility is now -0.4% while the rate on our main refinancing operations is zero.^[5]

The ECB’s deposit facility rate has become its most important policy rate in an environment of very ample excess liquidity. The overnight money market rate, which was previously driven by the rate on the ECB’s main refinancing operations, is now close to the deposit facility rate.

At the same time, we launched an asset purchase programme (APP) covering a broad range of investment grade securities.
These various policy measures are complementary instruments and are necessary to ensure that sufficient stimulus is provided to the economy to return inflation to the ECB’s objective. Failure to take into account the downward trend in real equilibrium interest rates would have resulted in downward pressure on inflation and activity, pushing real interest rates up and driving the economy further away from full employment.
It is difficult to know how long these low interest rates will persist, but it seems possible that they will be low for quite some time. That certainly is the view of financial markets, where the return on government bonds is negative for a range of countries, even at long maturities.
While low or negative rates and the asset purchase programmes are needed to provide sufficient monetary stimulus, a number of observers have voiced concern about their impact on the behaviour of economic agents, on the resilience of financial intermediaries and, ultimately, on financial stability.^[6]

Today, I will offer some thoughts on these issues, focusing on the banking sector, which plays a key role in the transmission of monetary policy in the euro area.

The specialness of negative nominal interest rates

So what makes negative rates special?  The first answer is cash. Since cash (i.e. paper money and coins) offers a zero nominal return, at some point it will dominate holding assets with negative nominal yields.^[7]

For an early discussion from an ECB perspective, see Cœuré B., “Central banks and the challenge of the zero lower bound”, intervention at the “Meeting on the Financial Crisis” organised by the University of Chicago Booth School of Business, Miami, 19 February 2012.

For example, if banks were to charge significantly negative rates on deposits, then the higher return on cash could lead households and businesses to withdraw their deposits. And this disintermediation would be likely to pose risks to financial stability.
Of course, holding cash is not entirely convenient or costless. It would be cumbersome (not to mention risky) to buy a car or a house in cash, and storing a large amount of cash requires high-security storage as well as insurance. These costs of holding and insuring cash explain why the effective lower bound on interest rates is below zero.^[8]

The literature on substitution between cash and deposits at the lower bound, and on technical devices which can push the “physical” lower bound down, starts with the proposal by Gesell (1911) to attach stamps to banknotes to accelerate their demurrage. It was revived by Goodfriend (2000) and Buiter and Panigirtzoglou (2001) and more recently by Agarwal and Kimball (2015).

The academic discussion of negative rates has centred around cash, but in public debate other issues have recently emerged.One issue is associated with money illusion, i.e. the tendency of people to value assets and goods in nominal rather than in real terms.^[9]This led to the notion that negative nominal rates are unnatural, which has become a popular theme in the public debate.^[10]

“Imagine a world in which tax offices harry people who file their returns promptly; where big supermarket chains pay their suppliers before the goods fly off the shelves and not months afterwards; and where a pre-paid annual gym membership is more costly than paying month by month. It sounds fanciful, absurd even.”, in The Economist, op. cit.

In contrast, we have been through episodes of negative real rates in the past without having such debates. Indeed, as the Bundesbank has noted, negative real rates of interest on deposits have been the norm rather than the exception in Germany in recent decades.^[11]

 People may gradually understand the rationale behind negative nominal rates and adapt to this new situation. For instance, the popular assumption that the negative income effect on household consumption dominates the positive substitution effect when nominal yields are very low is not in line with the evidence. In fact, the average net interest income of euro area households has been largely unaffected, thanks to lower interest payments. Low interest rates have mainly redistributed resources from net savers to net borrowers. As the latter typically have a higher marginal propensity to consume than the former, this has further supported consumption.^[12]

But one cannot rule out that negative nominal interest rates raise broader cognitive issues as they challenge the rules of thumb used by economic agents in their everyday decisions.

Finally, negative rates may be special due to institutional features embedded in the financial system, such as legal restrictions on the application of negative rates or at least uncertainty regarding the legal standing of such an arrangement,^[13]

For example, some financial contracts (e.g. money market funds or floating rate notes) may not foresee the possibility of payments from the lender to the borrower and in any case the logistics of collecting interest payments from holders of securities can be complex.

or the tax treatment of negative interest rate income, which is often not symmetric with the treatment of positive interest rate income. In addition, some IT systems may not be able to cope with negative rates.
In the euro area, however, these scenarios have not yet materialised. Thanks to intensive technical cooperation between the ECB and market participants ahead of the introduction of negative rates, our experience has been very smooth, allowing large parts of the government bond and secured and unsecured money markets to operate at negative rates without any disruption.^[14]

The introduction of negative rates has been smooth also in other jurisdictions outside of the euro area.^[15]

How low and for how long?

There are two key questions for central bankers . First, how much lower can we go? Second, does the persistence of low and/or negative interest rates pose particular challenges to the stability of the financial system?
Answering the first question appears to be simple. As I said earlier, the “physical lower bound” of nominal interest rates, at which disintermediation risk will materialise, is imposed by the opportunity cost of holding cash.
But is there an “economic lower bound”, different from the physical one, where further rate cuts cease to provide aggregate stimulus to the economy? This economic lower bound could then potentially but not necessarily impose an earlier binding constraint for monetary policy.
Indeed, in the current discussion, it has been suggested that at some point the level of rates can become low to the extent that the detrimental effects on the banking sector outweigh the benefits of lower rates. In a recent paper, Brunnermeier and Koby refer to this rate as the “reversal rate”.^[16]

At the reversal rate, bank profitability will fall, reducing capital generation via retained earnings, which is an important source of capital accumulation, and thereby eventually restricting lending. The risk that low rates might cause short-term dislocation in financial markets was already identified by Bernanke and Reinhart in their 2004 paper on the implications of very low rates.^[17]

Low (and negative rates) have both a one-off short-term impact and more persistent effects on a bank’s profitability and capital. And bank capital matters for credit provision and for financial stability, as low bank capital means high leverage.

The short-term impact partly stems from one-off capital gains on the outstanding fixed-income portfolio of a bank. When rates are falling, the value of fixed-income securities on a bank’s balance sheet goes up, leading to higher profits. A decline in the level of interest rates can also boost net interest margins in the short run. Banks carry out maturity transformation by borrowing short term and lending long term. As short-term interest rates fall, funds become cheaper. Since existing fixed-rate loans take some time to reprice to lower rates, the initial impact of lower rates on net interest margins could be positive.
Other things being equal, lower rates will decrease net interest income over the long term. If the decline in rates is accompanied by a flattening of the yield curve, the margin between lending and borrowing eventually compresses, reducing net interest income. Such a flattening may result from expectations of a prolonged period of low short-term rates, and it may be compounded by a compression of the term premium if the central bank also operates a large-scale asset purchase programme.
Even for a given slope of the yield curve, a low level of interest rates can also compress net interest margins for banks reliant on retail deposits. The reason is that retail deposits tend to have low and sticky interest rates, and banks are reluctant to charge negative rates on them. As market rates decline, the yield on bank assets will eventually drop, but this funding source will still cost the same to banks, resulting in a decline in net interest margins. The decline in present and future net interest margin reduces the forward-looking measure of bank capital, hence the risk-bearing capacity of the bank, and its supply of credit. This is turning upside down Adrian and Shin’s “credit supply channel” of transmission of monetary policy.^[18]

See Adrian, T., and H.S. Shin (2011), “Financial Intermediaries and Monetary Economics”, in B. Friedman and M. Woodford (Eds.), Handbook of Monetary Economics, Volume 3, Chapter 12, pp. 601-650.

The exact magnitude of the effect of negative interest rates on aggregate bank profitability is uncertain, since it has to be put in the context of what would happen in the absence of monetary policy action. First of all, servicing floating-rate loans and mortgages becomes more affordable as interest rates fall. Borrowers who are struggling in the adverse economic climate are therefore less likely to default. Second, and more importantly, accommodative monetary policy should create a more favourable macroeconomic environment, which ought to improve the financial situation of bank borrowers. Indeed, empirical research shows a clear negative relation between economic growth rates and non-performing loans.^[19]

These positive effects are present at all rate levels and are likely to dominate when rates are moderately negative.

Also, the economic lower bound is not uniquely determined at the aggregate level, since it will vary across banks and markets. The larger the share of floating-rate lending in the stock of loans, the faster the negative impact on interest margins will be. Banks with large fixed-income holdings and holdings of bonds which benefited the most from spread compression will be better able to offset decreases in interest margins, due to the revaluation effect I mentioned earlier. The reversal rate is also likely to be lower for those banks that are more reliant on wholesale rather than retail funding. Market-based funding suffers less from this zero lower bound, meaning that these banks will be better able to protect their interest margin. Similarly, banks with greater market power will be better able to avoid passing on the lower rates to borrowers, which will shield their interest margin.
In the euro area, this translates into geographic differences based on national banking structures, implying that the negative interest rate policy has distributional consequences across banks located in different jurisdictions.
The second important question for central bankers is whether the persistence of low and/or negative interest rates poses other challenges to the stability of the financial system.
Challenges to financial stability could potentially materialise if banks were to increase their exposure to lower quality counterparties in order to boost returns.^[20]

This could reflect a portfolio rebalancing towards riskier assets when yields on safe assets are low, or a greater concentration of lending to small and medium-sized enterprises (SMEs), which generate higher returns but have historically exhibited higher default risk.

The effect is similar to the “search for yield” by managers targeting a minimum return on assets.^[21]

Note that this mechanism may as well apply to shadow banks insofar as they rely on short-term funding. Financial stability risks could also materialise outside of banks, through excessively inflated financial asset prices and if zero or negative rates encourage asset price volatility.

Existing empirical evidence, mainly relying on periods with low, but positive rates before the global financial crisis, indicates that periods of lower interest rates are indeed associated with lower bank lending standards and with a shift of credit towards borrowers with a lower credit quality.^[22]

Additionally, the latest ECB Survey on the Access to Finance of Enterprises in the Euro Area (SAFE) shows an improvement in the availability of bank loans for SMEs between October 2014 (shortly after negative rates were introduced) and March 2016.^[23]

This could indicate that one way that banks are taking on more risk is by lending more to smaller, and typically riskier, firms.Of course, promoting lending, including to risky borrowers, is one of the goals of accommodative monetary policy.

But the main question, however, is whether negative rates can also lead to excessive risk-taking by banks. If accommodative monetary policy works as intended, then more investment projects will gain a positive net present value and will be financed – including some riskier ones. That’s the “good” risk-taking. However, banks may be tempted to finance risky but negative net present value loans – that is excessive or “bad” risk-taking. The theory suggests that this possibility is more likely when interest rates are low, if banks are highly leveraged or if they can easily adjust their capital structure.^[24]

Empirical evidence

While theoretically appealing, a precise estimate of the point where accommodative monetary policy becomes contractionary and/or an issue for financial stability is extremely challenging.
What I can offer you today is an overview of the situation of financial intermediaries in the euro area, in order to see whether there are signs that we have reached or are reaching a reversal rate.
But let me start by referring to the most recent data on monetary developments in the euro area. They show no signs of cash substitution, indicating that we are still far from the physical lower bound for nominal interest rates.^[25]

The annual growth rate of the narrower aggregate, including currency in circulation and overnight deposits (M1), decreased to 8.6% in June, from 9.1% in May. See ECB, “Monetary developments in the euro area: June 2016,” https://www.ecb.europa.eu/press/pdf/md/md1606.pdf.

In a second step, let me focus on bank income and profitability. Slide 8 shows the main sources of operating income for banks in the euro area, based on aggregate numbers. [ Slide 8: Euro-area banks: Income sources ] In recent years, the distribution of these sources has been fairly stable, with approximately 60% of income coming from net interest income, 25% from fees and commissions and 15% from other income sources.
Given its large share, net interest income thus plays an important role in bank profitability. As I mentioned, a reduction in interest rates could harm interest margins, and this could be even more pronounced when rates enter negative territory, due to a potential zero lower bound for retail deposit rates.
Slide 9 illustrates average loan and deposit rates for both non-financial corporations and households in the euro area.^[26]

See English W., J. Skander Van den Heuvel, and E. Zakrajsek, “Interest Rate Risk and Bank Equity Valuations”, Finance and Economics Discussion Series 2012-26, Board of Governors of the Federal Reserve System, for evidence on the reaction of net interest margins of US banks to changes in rates.

 The vertical red line indicates June 2014, the first time deposit facility rates became negative in the euro area. The gap between loan rates and deposit rates narrows because declining rates are passed on more strongly to loan rates than to deposit rates, indicating that there indeed seems to be a zero lower bound for deposits. While average deposit rates only decreased by around 0.2 percentage point between June 2014 and May 2016, loan rates decreased by around 0.8 percentage point, effectively reducing the interest margin. This is also shown on slide 10, using profit and loss data of a group of large euro area banks, which on average indeed have seen a reduction of their net interest margins – defined here as net interest income over total assets – since mid-2014.
But what about overall income? ECB staff estimates show that the overall impact on bank profitability of recent monetary policy actions is net positive, compared with a scenario without any monetary policy action^[27]

See Rostagno M. et al., “Breaking through the zero line: The ECB’s Negative Interest Rate Policy”, Brookings Institution, Washington DC, 6 June 2016. Presentation available on the Brookings website.

. Decreasing net interest income and charges on excess liquidity do put pressure on bank profitability. But there are also two strong positive effects of lower rates. First, the positive impact of lower rates on the macro environment reduces firm default risk and lowers the debt servicing cost of borrowers, which should improve credit quality. Second, lower rates will lead to capital gains on the bond portfolio of banks.
The ECB’s latest Financial Stability Review^[28]broadly confirms these model-based estimates. As slide 12 shows, the net income of euro area significant banking groups actually increased between 2014 and 2015. This was mainly driven by lower impairments and higher non-interest income. Even net interest income made a positive contribution, despite a small decline in interest margins. This reflects an increase in volumes, which is of course an intended consequence of accommodative monetary policy. As discussed earlier, however, interest margins are likely to stay low and might even further decline, while profits from one-off capital gains will fade away. Indeed, analysts forecast a decline in bank profitability in 2016 and 2017, mainly due to lower net interest income. And the recent decline in euro area bank share prices can be at least partially ascribed to market concerns over future banks profitability.

As such, if very low or negative rates are here for a prolonged period of time due to the structural drivers highlighted above, banks might have to rethink their business models. The revenue structure of euro area banks was stable for a long time but it has recently begun to change and there is at least some evidence of banks tending to offer fee-based products to clients as substitutes for interest-based products.^[29]

Another way forward is to improve cost efficiency. Although a number of banks have reduced their operating costs over the last couple of years, overall cost efficiency has remained low in the euro area, with aggregate cost-income ratios between 63% and 65% over the last five years.^[30]

Consolidated ECB banking data for domestic banks in the euro area.

Action taken by euro-area banks to remedy this situation will also help them cope with a prolonged period of very low rates. Action to dispose of their stocks of legacy non-performing loans, which has been identified by ECB Banking Supervision as one of its priorities for 2016, will also safeguard their profitability.
Moving away from profitability, deposit growth rates for euro area banks show that there is no sign of disintermediation risk at the moment. Deposits of both households and non-financial corporations have been growing over the past two years, at a similar pace to the period before we entered negative interest rate territory . This risk is not materialising mainly because rates on retail deposit seem to have a zero lower bound, as shown earlier.
With regard to bank lending, it is clear that we have not yet reached the reversal rate for the euro area. Bank lending has improved since mid-2014, both for non-financial corporations and households.  Similarly, results from the ECB’s July 2016 euro area bank lending survey clearly indicate that loan supply conditions for enterprises in the area are continuing to improve.
Finally, what about the risks to financial stability? The ongoing economic recovery should help bolster the income and earnings position of euro area households and non-financial corporations, thereby mitigating the risks associated with a continued debt overhang which persists in some countries. At the same time, the recovery of euro area real estate markets has gained further momentum. While overall residential property valuations remain contained, prime commercial property valuations have moved above long-term averages. Against this backdrop, as highlighted in the ECB’s latest Financial Stability Review, the best way to counter any potentially emerging risk in any market segment is targeted action by the macroprudential authorities.

Conclusions

Let me conclude. As is well known from the academic literature, the “physical lower bound” of short-term nominal interest rates is equal to the opportunity costs of holding cash. Monetary developments in the euro area show no signs of cash substitution, indicating that we are still far away from the physical lower bound. Central bankers should however be mindful of a potential “economic lower bound”, at which the detrimental effects of low rates on the banking sector outweigh their benefits, and further rate cuts risk reversing the expansionary monetary policy stance.
The ECB is mindful of these risks. In the euro area, the potential adverse impact on bank profitability, if it materialises, would be compounded by low growth prospects and a legacy of high non-performing loans.^[31]

See Constâncio V., “Challenges for the European banking industry”, lecture at the conference on “European Banking Industry: what’s next?”, University of Navarra, Madrid, 7 July 2016.

The current conditions of financial intermediation suggest, however, that the economic lower bound is safely below the current level of the deposit facility rate and that the impact of negative rates, combined with the APP and forward guidance, has clearly been net positive. Indeed, we should not look at the implications of negative interest rates in isolation. Negative nominal rates have reinforced forward guidance in the euro area, sped up the process of portfolio rebalancing associated with the APP and supported the effectiveness of the recent targeted longer-term refinancing operations.
But there can be cumulative effects on financial intermediation and financial stability if rates remain very low for a very long time. One might argue that disintermediation may have benign effects if non-bank entities are equally capable of collecting and channelling savings, while being less vulnerable to the adverse effects of negative interest rates. The shift towards a more market-based financial structure, as promoted by the European Union’s capital markets union project, would then help our economy cope with a longer period of very low or negative rates. But there is a limit to this argument. Non-banks are also affected by very low rates: for example, fixed net asset value money market funds may not be able to maintain the value of their shares close to par, while asset managers and insurance companies face the same shrinking margins as banks. Regardless of the entities that originate and distribute, household savings will be collected and long-term assets will sit on a balance sheet.
So what can be done to address this situation? The ECB’s monetary policy measures, including the deposit facility rate set at its current negative level, are proving to be effective in lifting inflation towards its medium-term objective and reducing the overall level of risk in the economy. Fiscal and structural policies should act more decisively to support aggregate demand and productivity, thereby preventing the economy from falling into a low interest rate trap. And banks should adapt continually to the changing environment by adjusting their business models, cutting their operating costs and reducing their non-performing loans. In doing so, they will also improve their resilience to a prolonged period of very low rates.

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^[1]I would like to thank Glenn Schepens and Skander Van den Heuvel for their assistance in preparing this speech. All views expressed herein remain mine.

^[2]See Bean C., C. Broda, T. Ito and R. Kroszner, “Low for Long? Causes and Consequences of Persistently Low Interest Rates” Geneva Reports on the World Economy 17, 2015.

^[3]See Cœuré B., “The economic consequences of low interest rates”, lecture at the International Center for Monetary and Banking Studies, Geneva, 9 October 2013. The natural starting point for an economist is K. Wicksell, Interest and Prices, Royal Economic Society, 1936. For a definition of the natural rate of interest in the context of dynamic economic models, see Woodford M., Interest and Prices: Foundations of a Theory of Monetary Policy, Princeton University Press, 2003.

^[4]See Laubach T. and J. Williams, “Measuring the Natural Rate of Interest Redux”, Federal Reserve Bank of San Francisco, Working Paper, No. 2015-16, October 2015, and V. Constâncio, “The challenge of low interest rates for monetary policy”, lecture at the Macroeconomics Symposium, Utrecht School of Economics, 15 June 2016.

^[5]The ECB’s deposit facility rate has become its most important policy rate in an environment of very ample excess liquidity. The overnight money market rate, which was previously driven by the rate on the ECB’s main refinancing operations, is now close to the deposit facility rate.

^[6]See, for example, The Economist, “Negative creep”, 6 February 2016.

^[7]For an early discussion from an ECB perspective, see Cœuré B., “Central banks and the challenge of the zero lower bound”, intervention at the “Meeting on the Financial Crisis” organised by the University of Chicago Booth School of Business, Miami, 19 February 2012.

^[8]The literature on substitution between cash and deposits at the lower bound, and on technical devices which can push the “physical” lower bound down, starts with the proposal by Gesell (1911) to attach stamps to banknotes to accelerate their demurrage. It was revived by Goodfriend (2000) and Buiter and Panigirtzoglou (2001) and more recently by Agarwal and Kimball (2015). See Gesell S., Die Natürliche Wirtschaftsordnung, 1911, published by Rudolf Zitzman Verlag, 1949; Fisher, I. “Stamp scrip”, Adelphi Company, 1933; Buiter W. and N. Panigirtzoglou, “Liquidity traps: How to avoid them and how to escape them,” in W. Vanthoor and J. Mooij (Eds.), Reflections on Economics and Econometrics, Essays in Honour of Martin Fase, De Nederlandsche Bank, 2001, pp. 13–58; Goodfriend M., “Overcoming the Zero Bound on Interest Rate Policy”, Journal of Money, Credit and Banking, Vol. 32, No. 4, pp. 1007-1035, 2000; and R. Agarwal and M. Kimball, “Breaking Through the Zero Lower Bound,” IMF Working Paper, No. 15/224, 2015.

^[9]On money illusion, see Shafir E., P. Diamond and A. Tversky, “Money Illusion”, The Quarterly Journal of Economics, Vol. 112, Issue 2, 1997, pp. 341-374. On the interaction between negative rates and money illusion, see Borio C. and A. Zabai, 2016 “Unconventional monetary policies: a re-appraisal”, BIS Working Paper No 570, 2016.

^[10]“Imagine a world in which tax offices harry people who file their returns promptly; where big supermarket chains pay their suppliers before the goods fly off the shelves and not months afterwards; and where a pre-paid annual gym membership is more costly than paying month by month. It sounds fanciful, absurd even.”, in The Economist, op. cit.

^[11]See Deutsche Bundesbank, “Nothing new about real interest rates on deposits”, 30 June 2014, https://www.bundesbank.de/Redaktion/EN/Topics/2014/2014_06_30_nothing_new_negative_interest_rates.html.

^[12]See European Central Bank, “Low interest rates and households net interest income”, ECB Economic Bulletin, Issue 4 / 2016, Box 3.

^[13]See McAndrews J., “Negative Nominal Central Bank Policy Rates: Where Is the Lower Bound?”, remarks at the University of Wisconsin, 8 May 2015. For example, some financial contracts (e.g. money market funds or floating rate notes) may not foresee the possibility of payments from the lender to the borrower and in any case the logistics of collecting interest payments from holders of securities can be complex.

^[14]See Cœuré B., “Life below zero: learning about negative interest rates”, presentation at the annual dinner of the ECB’s Money Market Contact Group, 9 September 2014.

^[15]Jackson, H. "The international experience with negative policy rates", Bank of Canada Staff Discussion Paper, No. 2015-13, November 2015.

^[16]See Brunnermeier M. and Y. Koby, “The “Reversal Rate”: Effective Lower Bound on Monetary Policy”, presented at the BIS research network meeting, 14 March 2016. See https://www.bis.org/events/confresearchnetwork1603/brunnermeier.pdf

^[17]See Bernanke B. and V. Reinhart, “Conducting Monetary policy at Very Low Short-Term Interest Rates”, American Economic Association Papers and Proceedings, Vol. 94, No. 2, pp. 85, May 2004.

^[18]See Adrian, T., and H.S. Shin (2011), “Financial Intermediaries and Monetary Economics”, in B. Friedman and M. Woodford (Eds.), Handbook of Monetary Economics, Volume 3, Chapter 12, pp. 601-650.

^[19]See Beck, R., P. Jakubik and A. Piloiu, “Non-performing loans: What matters in addition to the economic cycle?” ECB Working Paper, No. 1515, February 2013

^[20]See Borio, C. and H. Zhu, “Capital regulation, risk-taking and monetary policy: a missing link in the transmission mechanism?”, Journal of Financial Stability, Vol. 8, 2012, pp. 238-251, and Caballero R., Hoshi T. and A. Kashyap, “Zombie Lending and Depressed Restructuring in Japan,” American Economic Review, Vol. 98, 2008, pp. 1943–77.

^[21]See Rajan R., “Has financial development made the world riskier?”, European Financial Management, 12(4), 2006, pp. 499–533.

^[22]See, for example, Ioannidou V., S. Ongena, and J.-L. Peydrò, “Monetary policy and subprime lending: a tall tale of low federal funds rates, hazardous loans and reduced loan spreads”, European Banking Centre Discussion Paper, No. 45, 2009; Maddaloni A. and J.-L. Peydrò, “Bank Risk-Taking, Securitization, Supervision and Low Interest Rates: Evidence from the Euro Area and U.S. Lending Standards”, Review of Financial Studies, Vol. 24, No. 6, pp. 2121-165, 2011; Jiménez G., S. Ongena, J.-L. Peydrò and J. Saurina, “Hazardous Times for Monetary Policy: What Do Twenty-Three Million Bank Loans Say About the Effects of Monetary Policy on Credit Risk-Taking?”, Econometrica, Vol. 82, No. 2, pp. 463-505, 2014; and Dell'Ariccia G., L. Laeven, and G. Suarez, “Bank Leverage and Monetary Policy’s Risk-Taking Channel: Evidence from the United States”, Journal of Finance, forthcoming.

^[23]See the October 2014 – March 2015, April 2015 – September 2015 and October 2015 – March 2016 SAFE surveys.

^[24]See Dell’Ariccia G., L. Laeven, R. Marquez, “Real interest rates, leverage, and bank risk-taking,” Journal of Economic Theory, 149, 2014.

^[25]The annual growth rate of the narrower aggregate, including currency in circulation and overnight deposits (M1), decreased to 8.6% in June, from 9.1% in May. See ECB, “Monetary developments in the euro area: June 2016,” https://www.ecb.europa.eu/press/pdf/md/md1606.pdf.

^[26]See English W., J. Skander Van den Heuvel, and E. Zakrajsek, “Interest Rate Risk and Bank Equity Valuations”, Finance and Economics Discussion Series 2012-26, Board of Governors of the Federal Reserve System, for evidence on the reaction of net interest margins of US banks to changes in rates.

^[27]See Rostagno M. et al., “Breaking through the zero line: The ECB’s Negative Interest Rate Policy”, Brookings Institution, Washington DC, 6 June 2016. Presentation available on the Brookings website.

^[28]See the May 2016 ECB Financial Stability Review, p. 60, Chart 3.4.

^[29]See Nouy D., “Risks and resilience – the European banking sector in 2016”, speech at the Bank Capital Forum, London, 23 February 2016.

^[30]Consolidated ECB banking data for domestic banks in the euro area.

^[31]See Constâncio V., “Challenges for the European banking industry”, lecture at the conference on “European Banking Industry: what’s next?”, University of Navarra, Madrid, 7 July 2016.

Global female unemployment:An econometric study

This journal is the outcome of 15-16 July conference in Vijaywada by IMRF in which 55 research papers were presented and published relating to mainly gender studies that were contributed by several social scientists.

I have a paper in it entitled "Global female unemployment:An econometric study"

Here is an Abstract

  Global Female Unemployment: An Econometric Study

Dr.Debesh Bhowmik (Ex.Principal and Associate Editor-Arthabeekshan)

Abstract

The paper studied that world unemployment has been increasing at the rate of 1.335% per year during 1991-2018 in which male and female unemployment have been stipulating at the rates of 1.28% and 1.42% per year respectively during the same period.All are significant.The global female unemployment has been significantly increasing exponentially at the rate of 0.0158% per year in the study period.AR(2) process of the global female unemployment is nonstationary and significant.On the other hand ARIMA(1,1,1) model of the global female unemployment is also nonstationary.It follows random walk hypothesis and also satisfied the random walk with a drift conditions.This series showed a good fit of minimizing cycles under the Hodrick-Prescott-Filter model.

In showing the nexus between global growth rate and global female unemployment,the paper concludes that it follows the Okun’s law and one percent increase in global growth rate per year led to 0.00562% decrease in global female unemployment per year during 1991-2018 which is statistically insignificant.The nexus between the two showed bi-directional causality and cointegration in the order of one cointegrating vector.The VAR model is not quite good fit but showed stable and divergent as had been confirmed by unit root circle and impulse response functions respectively.

Key words- Global female unemployment, world unemployment, world growth, cointegration, causality, VAR

JEL- J01, C68

 I.Introduction

Female labor force participation rates vary among countries and vary with time, and it is widely believed and witnessed that female labor force participation rates are relatively high in developed countries. That rapid change of female labor force participation rates in developing and developed countries has contributed economists to pursuit of analyzing the evolution of female labor force participation in cross-countries. U-shaped hypothesis, simply, exhibits the relationship between economic development and female labor force participation and it is suggested that female labor force participation rates first decline, and then rise as the country develops. Apart from that, it is suggested that, other conditions, such as labor market conditions and household characteristics also affect the female labor force participation. Among these, educational attainment, unemployment rate, urbanization rate and industrial mix are the remarkable determinants of female labor force participation. During the process of development, especially, at the initial stages of economic development, home-based production pattern changes to market oriented production pattern. Market oriented activities dominate home-based production, henceforth, the expansion of market oriented activities or introduction of new technologies lead to a decrease in female labor force participation. After a certain point, economic development requires more female labor, and demand for female workers will increase.  Hence, female labor force participation will increase. Almost all of the studies about female labor force participation exhibit the existence of U-shaped female in the cross-country analyses. It is suggested that less developed countries have high level of female labor force participation rates. Since agricultural activities play important role, women in these countries employed as unpaid family workers, therefore female labor force participation is relatively high in less-developed countries. On the other hand, developing countries have the lowest female labor force participation rates. In an extreme example, developed countries have the highest female labor force participation rate. According to econometric results, all unemployment variables have negative effects on female labor force participation, but female

unemployment rate has, roughly, more impact than others. These results are in accordance with

“discouraged-worker effect” hypothesis, theoretically, when the unemployment rates are

relatively high, it will be more difficult for females to enter labor market, and probability of not

being employed increases. The effects of urbanization rate and total fertility rate are found to be as expected in all models; both variables have hinder female labor force participation. It should not be missed out that total fertility rate has more impact on female labor force participation rates than urban population rate; that is, when fertility rate is high, females devote themselves as a responsible for household activities. Population employed in agriculture and population employed in industry are other determinants of female labor force participation and they have positive and negative coefficient respectively.

This paper has endeavoured to analyse the global female unemployment patterns and its nexus with global growth rate during 1991-2018.

....................Please read from the Journal page 52-60.

EU without UK

EU without UK

 Tim Oliver

INTRODUCTION

Britain’s membership of the European Union has long been overshadowed by doubts about its commitment and whether it may one day leave, also known as a ‘Brexit’. The election of a majority Conservative government in May 2015, David Cameron’s January 2013 commitment to seeking a renegotiated UK-EU relationship and in/out referendum, and developments elsewhere in the EU have increased the possibility of a withdrawal.¹ This has led to a wealth of analysis and comment about what this could mean for Britain, adding to an already substantial literature on UK-EU relations. Despite this, the Brexit debate has long been a parochial one, focused largely on the implications for Britain. When in November 2015 David Cameron set out Britain’s aims for a renegotiated relationship, he did so at Chatham House. The location helped convey his message that part of the European question in UK politics was one of national security, something that had until that point been largely overlooked.² The wider implications of such a move — for the EU, Europe, transatlantic relations, NATO, and wider international relations — have often been ignored except for debates in a small international relations community of diplomats and scholars. Even Britain’s debate has its limits; Ed Miliband, former leader of Britain’s Labour party, once warned that the UK risks sleepwalking out of the EU.³ The EU itself has been asleep, oblivious to what a Brexit could mean for it. The withdrawal of one of the EU’s largest member states would almost certainly be a defining moment in the history of the EU with wider knock-on effects for NATO, European security and international relations.

This presents a problem for all concerned. Until the election of a majority Conservative government at the May 2015 General Election, most in the rest of the EU (and to some extent the UK) had refused to contemplate a renegotiation of Britain’s membership because it seemed a distant possibility. Cameron’s renegotiation and referendum have not been easy, often denounced as a step towards an EU ‘a la carte’. But if an EU ‘a la carte’ is not acceptable then this increases the risk of an EU ‘sans la Grande Bretagne’. Without being able to weigh up the pros and cons of losing Britain, the EU cannot know how far it should go in negotiating, refusing or appeasing the UK. An EU without Britain might be a more united union that functions better. It might also become more divided, with a Brexit unleashing centrifugal forces that unravel the EU.

British supporters of withdrawal or renegotiation also need to reflect on how the rest of the EU and others might respond, and how much leverage is gained from the threat of Brexit.⁴ Britain could be undermining its chance to lead Europe. As Cameron himself made clear in his speech at Chatham House, on current projections, by the middle of the century the UK will have the largest population, economy and military in the EU. Sidelining itself or withdrawing now means any deal or relationship will be determined not by what the best deal is for the UK, but what is in the much larger collective interests of the EU and Europe. This will be shaped by the outlook of the remaining EU, an outlook that Britain’s departure could change into one much less hospitable to British interests.⁵ Undoubtedly, Britain and the EU will continue cooperating, with some cooperation undertaken through forums such as NATO or bilaterally through relations with Germany or France. However, beyond military and some issues of high politics, most other cooperation and what means this is facilitated through, is likely to be decided through relations where the EU will be the predominant actor or a defining factor in the thinking of other European states.

A Brexit could also have significant implications for NATO, wider European politics, transatlantic relations and Europe’s position in the international system. It is concerns over such implications that will shape the way countries such as the USA, Russia or emerging powers will view a Brexit. A Brexit that added to Europe’s divisions and security weaknesses, or turned it inwards would be of serious concern to Washington D.C. A focus in UK political debate on US-UK relations distracts from how geopolitical thinking about a wider transatlantic relationship will shape the response of the USA to a Brexit.

Any Brexit will not happen in isolation from other events, not least of which are ongoing efforts to manage the ongoing problems in the Eurozone and Schengen.⁶ In writing about the direction the EU could go as it recovers from the Eurozone crisis, Tom Wright of Brookings sketches out three scenarios: an EU that takes a leap forward to become more united, functioning more effectively; a muddling through with the EU largely stagnating; and further divisions, possibly leading to the collapse of the EU.⁷ Understanding a Brexit requires us to take into account these wider changes in which a Brexit could play an influential — perhaps, defining — role. By taking these into account we can see more clearly that the concerns of states such as Germany or the EU’s institutions will not be about the UK or simply economic links with it, something British Eurosceptics have argued will ensure relations between the UK and the EU remain cordial and in line with the UK’s needs. We also need to keep in mind the role of ideas in European integration and relationships; supranational, intergovernmental, multilateral and bilateral links that connect Europe; global and European political and economic pressures such as the Eurozone or emerging powers; and the outlook of the political elites across the EU that will define how Europe responds to a Brexit.

HOW LIKELY IS A BREXIT?

The question of Britain’s continued membership of the EU has slowly risen up the list of concerns for other EU member states, in no small part thanks to other problems such as Russia, migration and the Eurozone being of larger concern. There is also a sense by the rest of the EU of having been here before, both with a similar referendum in 1975 and in repeated complaints and bust-ups with the UK over the following 40 years of membership. Added to this is a sense that David Cameron’s aim has not been to secure a reformed EU or UK-EU relationship, but instead has been about his holding onto power in the face of opposition from the Eurosceptic backbench members of his own party. Such an approach runs the risk of overlooking the tensions that define the European issue in UK politics. ‘To be or not to be in Europe: is that the question?’⁸ In short: no that is not the question. The question — or issues that fuel it — have been building for some time. It is not entirely surprising that a referendum has finally been called. The issue of holding an in/out referendum became an accepted norm of UK politics such that at the 2015 General Election all the main UK parties — Conservatives, Labour, Liberal Democrats and UKIP — were committed to holding an in/out referendum, albeit under different conditions.

Opinion polling shows that the British public can appear split over the issue of EU membership. There can be little doubt that they are amongst the most Eurosceptic in the EU. However, it is important to note that opinion polling has shown the British people are not overwhelmingly sold on voting for the unknowns of a Brexit. Indeed, look more closely at opinion amongst the public and political elite and we find it is more nuanced than often assumed with Eurosceptic opinion being something of a minority, albeit still a substantial one.⁹ The surge in support for UKIP is not simply about the EU. Its support is also about anti-politics, anti-immigration and anti-London.¹⁰ As a result of the UK’s majoritarian electoral system, UKIP has struggled to turn votes into MPs, buts it has succeeded in taking votes from all of the other UK parties.

As a result, UKIP is unlikely to fade away anytime soon, support for it has pushed the other parties into responding to its agendas, and it draws on unease with the EU that has long been present in British politics. Britain’s long history of strained relations with the EU will not disappear. Even if there were a referendum, and it produced a vote to stay in the EU, it would unlikely settle what David Cameron called ‘the European question’ in British politics. The European Question is not simply about whether to be or not to be in the EU; it is more about tensions within the UK’s party politics, changing constitution, identity politics, political economy, responses to globalization and place in a changing Europe.¹¹ A variety of polls have shown a willingness to back withdrawal. Scotland’s 2014 referendum result serves as a reminder that political arrangements, even those that have been set for hundreds of years, could change. Inaccurate polling over the Scottish referendum and the 2015 General Election also serve as a reminder of how unpredictable these votes can be.

The EU’s own crises — with the Eurozone, Russia and migration — have not helped to sell itself to a British electorate that like many across Europe have shown a growing weariness at European integration.¹² When contrasted with the economic opportunities from emerging markets the EU can appear to be the past, not the future it once was. The EU’s appeal in the UK rests largely on economics and trade. Declines in the trading link will add to questions about what Britain gains from EU membership. We should also be careful not to overlook the capacity for the EU itself to bring about or shape the likelihood of a Brexit. A refusal to agree to any renegotiated relationship, another Eurozone crisis or failure to grapple with another immigration crisis could make it more likely that the referendum result will be for a withdrawal.

IMPLICATIONS FOR EUROPEAN UNITY AND INTEGRATION

The first problem the EU would face from a Brexit is the unprecedented experience of negotiating the withdrawal of a member state. The very idea of withdrawal is a taboo, representing a reversal and challenge to the idea of European integration as a process that moves forwards not backwards. That said, withdrawal is not strictly unprecedented with two overseas territories of member states having left: Greenland in 1985, and Algeria in 1962. The EU also has a procedure for withdrawal as set down in Article 50 of the EU’s Treaty.¹³ It provides a withdrawal timeframe of two years, possibly longer if both sides agree this is necessary. Negotiating for the EU would be a team nominated by the Commission and approved by the Council. Article 50 requires any withdrawal agreement contain both a deal for the withdrawal of the member state and a framework for a post-withdrawal relationship with it. This whole deal would have to satisfy the remaining EU member states through a vote in the European Council, and receive the support of the European Parliament. In the case of the UK any deal would also require the support of the UK Government, British Parliament, and possibly the British people if there was pressure for the deal to be subject to approval by another referendum. The possibility of the European Court of Justice becoming involved should not be overlooked, it providing an avenue through which private individuals and/or companies challenge the withdrawal deal. Any such negotiations could also be set against the backdrop of ongoing negotiations to deal with the problems in the Eurozoen and Schengen. The context within which a UK withdrawal takes place could therefore be another period of considerable EU institutional change, naval-gazing and tense relations between individual leaders and national elites.

Any institutional naval-gazing would also be the result of the EU needing to make changes to its own institutions and procedures to fill the gap left by Britain. The EU would face the never-easy task of negotiating changes to the voting system used for making decisions in the European Council, a reallocation of seats in the European Parliament, changes to staffing quotas, and increases in budgetary payments to make up for the loss of the UK’s large net contribution (£8.5 billion in 2015).¹⁴ When combined with possible changes to the Eurozone, a Brexit could add to shifts to the EU’s balance of power and changes to the EU’s policies and outlook.

Perhaps the most dramatic consequences of a Brexit would be one that put the unity of the EU under pressure. The EU’s unity has come under considerable pressure during the Eurozone and migration crises. While they have so far held together, and the response has if anything been to push for further integration, the Eurozone and Schengen remain vulnerable and future tests of their unity cannot be ruled out. If the UK and other non- EU members thrived and the Eurozone continued to struggle, then Britain’s withdrawal could trigger centrifugal forces leading other member states to question their membership and commitment to integration, in turn stalling integration and beginning a process that unravels the EU. The key here is likely to be Germany. In writing about the potential for the EU to disintegrate, Douglas Webber notes that the EU has never faced a ‘crisis made in Germany’, the EU’s driver, paymaster and indispensable nation.¹⁵ What that crisis might be is not clear, but a Brexit that combined with another crisis in the Eurozone or Schengen could strike deep into the EU’s heart leading both Germany and other members to question their membership. Any such ‘domino theory’ by which a Brexit makes other EU members states question and abandon their membership or commitment to integration, has to be set against the likelihood of another domino effect within the EU should the UK secure a renegotiated relationship that provokes envy elsewhere. Other states could then demand concessions, creating the aforementioned EU ‘a la carte’. Whichever way is taken, Britain’s behavior could appeal to far left and right wing groups, especially in some Southern and Eastern European member states, adding to the problems the Eurozone crisis has caused for anchoring these states into the European mainstream. It could also have some appeal to groups in Northern and Western Europe, such as France’s Front National. At the same time, if the UK struggles outside the EU then its appeal and decisions would be limited, strengthening the EU’s position. Losing a member noted for being ‘an awkward partner’ could allow the EU to work together more effectively.¹⁶ That said, Britain is not the only member of the EU who can be awkward. Both the Eurozone and Schengen, neither of which Britain is a member of, have struggled to find the necessary unity and leadership in the face of ongoing problems.

The centre of power in the EU could also shift. Germany’s already strong position could be further strengthened with implications for the Franco-German axis. Britain has sometimes played a role in this bilateral relationship. France could be left facing an EU where the centre of gravity has shifted further eastwards and where Germany’s ‘culture of restraint’ and preference for geoeconomic thinking over the geopolitical, comes to shape the EU’s international standing.¹⁷ However, Germany might also be left feeling uneasy at the withdrawal of an ally that has helped it push an economically liberal, free-market agenda. The political and geographical centre of the EU could shift eastwards and southwards. Some member states may gain from a withdrawal, seeing it as a chance to enhance their position within the EU. Some such as the Irish Republic, more heavily linked to the UK than others, may face significant challenges.¹⁸

The EU’s place in Europe could also be changed. A Brexit could change the EU’s relationship with countries such as Norway and Switzerland who are connected to the EU through either membership of the European Free Trade Area (EFTA) and/or the European Economic Area (EEA). These were intended as conveyor belts towards eventual EU membership. A Brexit has the potential to throw them into reverse. A Brexit would also remove from the EU a member that has been more willing than many to contemplate Turkish membership of the EU. While such membership has long been in doubt, a Brexit would more than likely end any remaining hopes. For countries such as France, who have already made clear their unease at Turkish membership, losing a large Western, developed and largely Christian state such as Britain would make it more likely they would block enlargement to a large, developing, South Eastern European and largely Muslim state such as Turkey. At the same time, Britain’s exit and new external relationship with the EU could open new possibilities for the EU’s relations with states such as Turkey.¹⁹

How the EU’s relations with these non-EU European states develop could be shaped by whatever post-withdrawal relationship is established with Britain. The EU will be compelled by geography, economics (including the power of the City of London), law (Article 50 TEU requires it — but not the departing member state — to attempt to negotiate a post-withdrawal relationship), demographic links — indeed, by sheer realpolitik — to develop a working relationship for managing common problems and a deeply interconnected relationship. A variety of proposals have been put forward for a post-Brexit UK-EU relationship. These range from special trade deals through to membership of the European Free Trade Area and/or the European Economic Area. Each has been discussed in great detail, even been the subject of €100,000 prizes.²⁰ The focus is almost always on what would be good or bad for the UK. What would be good or bad for the EU is rarely assessed despite the EU having to agree to any such deal, and therefore likely to be in the driving seat of any negotiations.²¹ What the EU agrees to will depend on what is in its economic, social and security interests, which ideas define the political debate, institutional links, international events and the outlook of individual leaders.²²

Should a Brexit weaken the EU then Britain could try to use this as an opportunity to redraw the economic and political relationships of Europe, moving away from the more supranational political setup of the EU towards more intergovernmental arrangements focusing largely on trade. The British government and political class may also expect Britain to be treated in some special way. This does not simply reflect some high self-opinion of Britain’s place in the world. It reflects the UK’s much larger demographic, economic, social and military size compared to other non-EU European countries such as Norway and Switzerland, who also have their own unique arrangements with the EU. It is also a reflection of Britain’s future position. Britain’s economy is predicted to overtake that of France by 2020, and London looks set to continue powering ahead as Europe’s most international city.²³ Sometime in the 2040s Britain’s growing population looks set to overtake that of a declining Germany.²⁴ By mid-century Britain could therefore be the largest member of the EU. Any expectation of special treatment also reflects forty years of membership. A UK outside the EU would move from decision maker to decision shaper, but it will be the best placed country outside the EU to shape decisions through bilateral or multilateral governmental links, or through networks involving civil society or the business community. One of the biggest tests of a Brexit for the EU will therefore be whether it can present a united front to the UK. Given the mutual interests in areas such as foreign, security and defence matters, and the global power of the financial institutions of the City of London, the EU could engage the UK through forums such as an EU+1 arrangement, an EU2+1 involving France, Germany and the UK, or a modified version of the EU’s current G6.²⁵ While the ability of the UK to divide and rule should not be overplayed, it should not be underestimated either. The EU has struggled to act in a united way in dealings with a range of other non-EU states such as Russia, the USA, Turkey and Israel. To what extent then can it be expected to manage a united front to the UK? However, we should not overlook the possibility that should the EU become more united then its relationship with the UK might come to resemble that of the USA’s relationship with the UK: a one-sided ‘special relationship’.

GEOECONOMIC IMPLICATIONS

Any compilation of national views from around Europe and the world looking at what a Brexit might mean for these states soon reveals concerns about the economic costs of a withdrawal.²⁶ The UK’s economic place in the EU is substantial. Britain constitutes 14.8% of the EU’s economic area, with 12.5% of its population.²⁷ British exports are 19.4% of the EU’s total exports (excluding intra-EU trade).²⁸ Within the EU Britain runs a large trade deficit with the rest in goods and services, around £28 billion a year in 2012 and as high as £61.6 billion in 2014.²⁹ What impact a Brexit would have on Britain’s trade with the EU is hotly contested within the UK. That Britain runs a trade deficit with the rest of the EU leads some to argue the EU needs Britain more than Britain needs the EU. This is questionable given roughly half of Britain’s trade is with the rest of the EU, leaving the UK in the position where it could potentially damage more of its overall trade than the rest of the EU. Nevertheless, neither side has an interest in allowing a situation in which their economic links are damaged. As mentioned earlier, a plethora of proposals have been put forward ranging from free trade deals, membership of EFTA/EEA (or an adapted version of them), or some special membership of the EU’s Single Market. These focus almost entirely on what might be best for Britain. Yet the final agreed arrangement will also be one shaped by what is best for the EU and Europe. Few if any member states will see anything to be gained from allowing a deal whereby the UK can undercut the EU by having access to the EU’s Single Market without any of the costs of membership. Some states have already made clear they expect to attract investment at Britain’s expense, France’s foreign minister saying his country would ‘roll out the red carpet’ for investors looking elsewhere.³⁰ The City of London, already something of a target for some within the EU, could become an even clearer target for hostile acts should the UK withdraw. To what extent the EU can pursue acts that either punish or limit Britain’s behavior is debatable, but it should come as no surprise if some in the EU seek this following a Brexit.

Longer-term concerns about a Brexit focus on whether the EU that emerges (or a more fragmented Europe if the EU were to break up) becomes more inward looking and less inclined towards liberal, free-market economics. Britain has been a long-standing supporter of the EU’s Single Market and has repeatedly pushed for it to be more open and deregulated.³¹ This has led to uneasy talk elsewhere in the EU of Europe being subject to an ‘Anglo-Saxon’ agenda, or even the ‘Britishisation’ of the EU.³² However, Britain’s role in the EU’s economic thinking is already limited by its exclusion from the Eurozone. Without the UK the Eurozone and EU could more neatly align, leaving the members of the Eurozone as the undisputed heart of the EU both politically and economically. It is also questionable to what extent countries such as Germany or even France would allow the EU, or the Eurozone, to become more inward looking and protectionist. Even the European Commission, often lambasted by British Eurosceptics as a bastion of state-socialism, just as often finds itself accused of pursuing harsh neoliberal, deregulatory and free-trade agendas.³³ Reforms to the Eurozone might have struggled to overcome its problems, but the intention has been to ensure the Eurozone is more open and competitive.³⁴ The UK is also not alone in seeing the potential and feeling the draw of emerging markets, something some British politicians accuse the EU of holding Britain back from. Germany’s interests in markets such as China and Brazil dwarf those of the UK, with many other EU members also pursuing links. Pressure from the USA or China and international trade negotiations, may not leave the EU many options but to continue embracing an outward looking economic agenda. Britain itself would likely use its influence from the outside to try to ensure the EU remains open and competitive. Granted, models of state-capitalism in Russia or China may grow in appeal. But the EU would come under incredible global pressure to remain open, as would the UK. Should the EU integrate further and feel more confident then it may even begin to espouse its own models for managing globalisation.³⁵

Possible economic implications of a Brexit could be seen first with the Transatlantic Trade and Investment Partnership (TTIP), a development Britain has been at the forefront of efforts to create.³⁶ TTIP negotiations have progressed, but questions remain as to whether EU member states or the US Congress might become problematic in ratifying it. Slowed TTIP approval could see it caught up in the Brexit debate. While a TTIP without the UK would not be impossible — indeed, the USA and EU have warned this could happen — Britain’s large economic and political relations with the USA (larger than any other EU member states) mean it would be more difficult and a lesser deal if secured, and potentially a more difficult sell to the US Congress.³⁷ Given the aim of TTIP is to expand to include other states such as Canada, a UK outside the EU could secure some form of partnership. However, what this partnership with other countries might entail is not yet clear. Nor is it clear whether the EU would allow the UK anything less than a backseat role. For the EU the partnership would be a bilateral one between Washington and Brussels.

EUROPEAN SECURITY, TRANSATLANTIC RELATIONS AND NATO

A Brexit would remove from the EU one of its two military powers capable of operating and thinking on a global scale. Britain’s military capabilities might be much reduced, but they along with its diplomatic, intelligence, international aid and soft power remain considerable.³⁸ The UK has long been one of the mainstays of EU efforts at cooperation in security, defence and foreign policy, with UK-French defence cooperation being extensive. Both countries have felt frustrated with the slow progress in EU defence and security cooperation. Without the UK, France would be left as the only major military power in the EU. Perhaps France would then abandon bilateral cooperation with the UK in favour of renewed efforts at EU led cooperation, opening up opportunities for Germany to develop its own and the EU’s military capabilities and geostrategic thinking. France, Germany and Poland — the Weimar Group — could develop into the heart of EU cooperation on such matters. However, whether Germany would be willing or able to engage in such a role is open to doubt.³⁹

A great deal of how a Brexit might change European security will hang on the reaction of the USA. Focusing on what a Brexit might mean for the UK-US ‘Special Relationship’ or accusing Britain of being an ‘American Trojan Horse’ set to weaken the EU or make it serve the USA, deflects attention from the close relations the USA has with any number of other European states such as Ireland or Germany. The sheer economic size of the EU — which without the UK would have a collective GDP of $13.5 trillion compared to Britain’s $2.4 trillion — means collective US-EU economic relations would overshadow those with Britain. The USA could therefore face a double loss from a Brexit if this led to a more awkward relationship with the EU (combined with more complex EU-NATO relations) and a reduced standing of the UK in the world.⁴⁰ There would be no shortage of applicants to fill the position of claiming to be the USA’s closest friend inside the EU. While such applicants might not offer a relationship that could claim to be as ‘special’ and intimate as that with the UK, for the USA they will be of increased importance thanks to Europe, and the EU, being an area of the world in which it will retain considerable interests. Despite some high profile spats, as President Obama made clear in his state visit to the UK in 2011, Europe remains the cornerstone for US global engagement and the greatest catalyst for global action in the world today.⁴¹ As President Obama made clear in 2015, UK membership of the EU:

“gives us much greater confidence about the strength of the transatlantic union and is part of the cornerstone of institutions built after World War II that has made the world safer and more prosperous…the values that we share are the right ones, not just for ourselves, but for Europe as a whole and the world as a whole”.⁴²

Should the UK absent itself from the predominant political and economic organisation of Europe, then it would be disengaging from a partner the USA will continue to work with on shared ideas, interests and through a variety of multilateral institutions. The extra effort the US would put into other European relationships would in part stem from a desire to ensure the EU does not change to the detriment of US interests. A British withdrawal would likely add to US worries that Europe lacks the unity or political energy to think geostrategically about the rise of powers such as China and Brazil.⁴³ These concerns have been fuelled in recent years by the EU’s focus on its internal problems such as the Eurozone crisis.

The USA will also view a Brexit in the light of long-running fears that Europe will continue to free-ride on a US security guarantee provided through NATO. The result could be more frustration for the USA at Europe’s inability to deal with security issues in its near-abroad, for example in the Middle East, North Africa (the Libyan War being a clear example of Europe’s divisions and military weaknesses) and with Russia over developments surrounding Ukraine. If developments in Ukraine mean Europe once again becomes a security importer, changes to the configuration of US defence capabilities mean the USA is likely to provide at best a minimum contribution while continuing — likely in vain — to shift some of the burden of dealing with issues in Europe’s near-abroad towards Europe. For the foreseeable future the US will continue to work through NATO or through coalitions of the willing on key issues. But in the longer-term, the United States will likely need a strong and coherent European Union to advance common interests in the face of emerging powers. This is especially so given mounting pressures within the USA to leave Europeans to fend for themselves.⁴⁴ A successful TTIP would provide some balance to the part of NATO in the transatlantic relationship, and thus a powerful geoeconomic tool.⁴⁵ It would be wrong therefore to assume a Brexit would have no impact on NATO or not weaken it in anyway. While the shared links between the US and EU mean the two are likely to work around a Brexit, the disappearance from the EU of one of its major military powers could further strain efforts at Europe-wide defence cooperation, whether through the EU or NATO. Nobody should cheer the failure of the EU, Europe’s predominant economic and political organisation, to shift the grounds for better cooperation on defence spending and businesses. If the EU continues to struggle to provide a way for doing this, then Washington may well wonder what hope remains for Europe ever organising itself better on defence.

Countries such as Canada, Australia, New Zealand, Singapore and Japan — allies of the UK, the USA and the rest of the EU — are likely to be just as uneasy as the USA at an EU without the UK.⁴⁶ They would prefer a UK inside the EU, fighting for reform and standing as a reliable ally. But a Brexit would not make them give up on the EU, their relations with it being substantially larger than that with the UK alone. They too will fear the prospect of an EU that becomes more inward looking or divided, seeing in it a weakening of Europe’s position in the world and in turn a weakening of the Western alliance. The outcome could make more likely a scenario, as outlined by Jan Techau, of a Europe that, ‘is not a pillar of world affairs but a territory that risks being pulled asunder between the United States and Asia’.⁴⁷

However, there is a paradox in EU defence cooperation: Britain’s contribution has been important, but so too has it been a key obstruction.⁴⁸ Fears of jeopardising NATO, or of crossing some sovereignty line in the sand by agreeing to cooperation on defence matters has held the UK, and in turn the EU back. A Brexit could therefore remove an obstruction, allowing the EU to move forward in this area. We should remember that the EU’s international relations are varied and widespread. Its civilian, economic and soft powers remain considerable, even if they are not wielded as effectively as they could be. Its military operations, although small, should not be overlooked.⁴⁹ Even Germany, with is culture of restraint, is a leading actor on the international stage, if perhaps one that remains more reluctant to employ force than other powers.

Hopes the EU might develop a serious military capability would likely prove very difficult without the UK’s military, but this is already difficult enough. And the EU already finds itself in a Europe that is being torn in different direction, what has been termed a ‘multipolar Europe’ with Turkey and Russia as the other two European poles.⁵⁰ A Brexit would add — or perhaps make clearer — another pole. Should the EU continue to develop then these three poles would surround the larger pole of the EU. This EU pole could develop into a more robust European arm for NATO, or, as some fear, an alternative to it.

CONCLUSION

A British exit from the EU is not something to be casually overlooked. Developments in Britain and the EU have increased the possibility of the referendum leading to a vote to withdraw. Britain’s difficulties with the EU long pre-date the current government and reflect deeper problems in Britain’s party politics, identity, constitution, political economy and place in the world. A changing EU and Eurozone could also push the UK to the margins — or out — of the EU. Despite this, the implications for the EU of a Brexit remain under-researched in public. To be fair, the entire topic of EU disintegration is marginal to the large body of literature that offers theories of European integration. Further research is necessary to take the debate beyond the narrow British-focus that has so far characterized the debate.

A Brexit could confront the EU with significant and unprecedented practical and philosophical challenges. The withdrawal of any member state would be a defining moment for the EU, to lose as large a state as the UK even more so. This is especially so given Britain will remain a growing European power, even if a Brexit encapsulates the decline and end of Britain’s position as an EU power. UK-EU relations will remain an important relationship for understanding European politics. The EU’s development — whether it unites, disintegrates or muddles through — will be shaped by a myriad of factors, one of which will be its relations with the UK. The EU therefore has a calculation to make about Britain’s utility and how damaging or beneficial a Brexit could be. To borrow from US President Lyndon Johnson: is it better to have Britain inside the EU tent pissing out, or outside the tent pissing in?

It is not only the EU that needs to take this into account. Other European countries such as Norway, Switzerland and Turkey need to consider what a Brexit could mean for their relations with the EU. For the USA, a Brexit would not be seen in a narrow sense of being about the UK and UK-US relations. The USA’s concerns will revolve around how a Brexit might change the EU, European politics, transatlantic relations, NATO, European security and the EU/Europe’s place in the wider international system.

The debate in Britain also needs to take better into account the wider international dimensions of the Brexit question. The final decision to stay or leave the EU is, of course, for the people of Britain alone to make. But a full debate of such a decision requires an assessment of the likely implications for the EU and internationally. Without this the British people would be making a decision without fully appreciating what this could mean for their allies and the wider geopolitical system in which their country plays a role. Focusing exclusively on the pros and cons for the UK, or on what ideal post-withdrawal relationship Britain should secure, creates a debate that is blind to dealing with the wider implications of such a decision