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a blog from young economists at Nova SBE

The Portuguese Health Insurance, accessible to everyone and truly beneficial?

There are several types of health insurance systems being applied worldwide, and its differences are important to be known. Those can be found in the article below entitled “Health Systems Classification” by my colleague Jorge Moreira dos Santos. Portugal, as the same article describes, uses the so called National Health Service (NHS) which consists on a tax-based funding and public provision with relationships between agents being determined by the state. This basically means most people working discount to be able to ask for the health care treatment for free or at a reduced price, but then there are some others that privately contract it or benefit from some subsystems (some public, some private) depending on their professional work.

But is this accessible to everyone? How? Well, there are some differences on what it covers and how it is accessible. Let me take the students example, someone with no income. If I am Portuguese, the most common situation is to be covered by my parent’s discounts and whenever needed be able to take health care for free. If I am an international student from within the European Union, the health care system and plan from my home country make my access to the Portuguese NHS easier as according to the European Union rules the right is extended. Finally, the third option is if I am an international student from outside the European Union but studying in Portugal. In this case I am covered by the NHS with free medicines and doctor appointments. To have more than those basics, a contract should be done (usually Universities help with those). Overall, the system covers quite well all the possible situations in which students can be, but does that mean it is efficient and truly beneficial?

Taking my personal experience from the system, I cannot say I am unsatisfied. I am not a frequent user of the NHS but due to some breathing difficulties that sometimes appear when the season changes, I have felt already the need of benefit from it and apart from the time spent taking the treatments I cannot complain, for me it has been working quite well. Moreover, last week for instance I had a problem which cared for medical attention and two days after I was well again.

To conclude my brief comment, independently from your situation, the Portuguese NHS is quite easily accessible for all and the results derived from it – taking my own experience as example, are good and truly beneficial. Have you also the same idea of easy accessibility and good treatment? What has been your experience?


José Miguel Filipe
#1586 Masters in Management


Welfare Losses in Market of pharmaceutical Products in Germany

The expenditures for pharmaceutical products of health insurances in Germany increased in 2009 again about 4.8% to an amount of 32.4 billion Euro. This is much more than in other European countries. In 2010 the “Arzneiverordnungsreport” pointed out that prices of drugs in Germany are from 50% to 100% more expensive than prices in Sweden. Already in 2008 some Italian authors showed that Germany has the highest price level of seven European countries. An adoption of the Swedish price level would imply savings of 9.4 billion Euro.

A reason for this is that enterprises could set prices for their pharmaceutical products freely. This is also the case in Europe only in Denmark and Malta. When a drug is licensed, the statutory health insurances have to pay the dictated price. 19 other European countries dictate the prices of drugs by observing prices in reference markets (often Germany) and setting a discount up to 30%. Other 4 countries in Europe negotiate with pharmaceutical producers.

In the past several approaches of German government took occur to reduce the high costs for customers of drugs and statutory health insurances (18% of total expenditures). Most of them failed because the lobby of pharmaceutical industry threatened to reduce a fraction of their 100,000 workplaces in case of higher regulation.

During a reform in health sector in 2004 the “Institute of Quality and Economic Efficiency in Health Sector” was established. This institute is assigned by a committee of government and should work as a neutral controller and evaluator of pharmaceutical products with respect to prices and utility. But this evaluation doesn’t take place at the introduction of a new product, first after three months. After six months the price of the products become fixed if there is no additional utility compared with other recent products. After 12 months the prices of drugs are negotiated between the producer and statutory health insurances, where the neutral institute acts as a conciliator.

Negotiations between Ministry of Health and pharmaceutical producers in 2013 about this topic leads to selling of indulgences. The pharmaceutical industry is willing to pay 1.5 billion Euro per year by increasing the time of two years of given discounts to statutory health insurances and the price regulation of old drugs stops. Since 2010 these discounts are fixed by government by 16%. Critics of this decision mentioned that potential savings are much higher by negotiating and conforming to prices from other countries.

We can observe in Germany a typical case of welfare losses in cause of price settings from producers. The efficiency of a market with respect to prices doesn’t function in this case because statutory health insurances are committed to accept the price. In case of market failure the government has to intervene and to creep over influences of lobbies to create welfare gains. Different approaches for this can be adopted by other countries by fixing prices. A more efficient way would be an increased transparency and a higher competition among suppliers of drugs.


Alexander Max #1575



Recently released, the OECD Health Data states that Portugal spent 2,2% less in health care between 2009 and 2011, against the previous trend of growth at 1,8% from 2000 to 2009. According to this document, health care public expenses represent now only 0,2% of PIB. The portuguese Minister of Health finds the OECD data “globally positive”, as refered by tv channel RTP. However, he recognizes that there’s still much to invest in continuos care program – a ministerial iniciative that promotes the permanent social and health support to citizens in need, especially to those in such cases as complete dependece of others.
Although it sounds like goods news for Portugal to have less expenses in the health sector and, as a consequence, to persue the goal of reducing public expenditure as a whole, it is still to be proved if this apparently more efficient management of the health care system and the consequent lower threshold for health-related expenses, have the desired reflex in terms of health standards for the portuguese citizens. This reduction of expenses may be explained by several factors. One of the most important ones is the progressive reduction of per capita income in the latest years, since it has a direct effect in the reduction of health expenses, being its demand-on-interest elasticity next to one. The more adequate use of primare care heatlh services is another possible cause for this finding. Furthermore, political decisions like the reduction of salaries for health sector professionals or even the scarcity of some resources in hospitals and other health centers, certainly have some marginal effects on the public expense, even though their weight on total expense is not very clear. Curiosly, the demographic evidence of having an aging population has not been systematically linked with growing expenses in healt care in the literature, although it is the commom perception that elderly people tend to consume more health care products.
In conclusion, it is apropriate to stress out that, even though it is current practice to take OECD Health Data as a good way to compare Health Care systems from different countries with similar development status, it might also be a deceiving way of judging their performance on the contributing factors for the increase or decrese of expenses that are being evaluated.
Raquel Paixão

Aid: A new strain of the “Dutch”

With the recent discussion of Dutch Disease and how it is affecting (or not) the Canadian economy, we thought this was an opportune time to review the effects of this “curse” on developing countries. In this post we will relate the consequences of Dutch Disease to large aid flows, present some solutions and, in the process also shed some light on a, personally, important and intriguing Development Economics issue.

The term Dutch Disease was first mentioned in a 1977 edition of The Economist and it was used to describe the problems afflicting the Dutch manufacturing sector. Generally, it is related to the effects of shifts in production patterns – namely between tradable and non-tradable goods – that arise due to large changes in wealth. The latter can be caused by the discovery of natural resources, a drastic change in its world price or when large aid inflows take place.

To illustrate this concept, imagine a country that neither has natural resources nor receives aid. The only way for its citizens to buy imports is through exports, hence exporters generate foreign exchange and importers buy the foreign exchange off them. Thus, for the export producing country, exports’ value results from the need of paying for imports. Now, let natural resource exports – aid in our case – come into place. As resources are sources of foreign exchange, exports lose their value domestically. Id est, non-tradables become more expensive and so resources get rechanneled into producing them. As you can infer the problem lies with the inflow of foreign exchange; and aid, in its most basic form, is nothing more than an inflow of foreign currency. Therefore, the large shift in domestic demand caused by foreign aid leads to a consumption boom, expanding the non-tradable sector and squeezing the tradable one, damaging precisely the economic sector most in need for development[1]. Empirically, this topic is being studied by Raghuram Rajan (2005)[2], in which he shows that aid tends to retard the growth of labour-intensive exports activities needed for diversification.

Some solutions have been proposed by the academia and no consensus has been reached. For instance Paul Collier[3], the author of The Bottom Billion[4], suggests that countries should use their aid in creating import demand – aid automatically creates import supply – through technical assistance, this is, importing skills, which decreases the likelihood of Dutch Disease. Moreover, Collier argues that aid spent in developing the export sector may avoid infection, because, after an infrastructure improvement at ports, aid is scaled back and there is no further Dutch Disease, just a better port, for example. Nonetheless, William Easterly[5], the author of The Elusive Quest for Growth[6], puts forward the idea of “conditional adjustment lending”, where aid should be conditioned on policies with very specific stringent targets concerning indicators such as inflation, exchange rates and average black market premium, reforms on the public sector, budget deficit as a percentage of GDP, real interest rates and corruption levels.

In summary, Dutch Disease on developing countries appears to have a harmful effect, undermining growth. Basic forms of aid do not relief the problem and, instead, can be considered as a Dutch Disease catalyst. As Easterly put it “The operation [aid] was a success for everyone except the patient […] much lending, little adjustment, little growth (…).” On the other hand, Canada, a developed country, states that it is healed due to its diversified economy (and, personally, good institutions). Thus, developing countries must aim to diversify their economies and improve the foundation of their institutions (if they want to be cured).

Mariana Tavares no 64

Miguel Vian no 634

[1] This reasoning is in par with the concepts behind the TNT model as non-tradables have to be produced internally and tradables can be imported to satisfy changes in domestic demand.

[2] Rajan , Raghuram G. and Arvind Subramanian, 2005, What Undermines Aid’s Impact on Growth?, IMF Working Paper No. 05/126

[3] Professor Collier is the Director for the Centre for the Study of African Economies at The University of Oxford

[4] Collier, Paul, 2007, The Bottom Billion, Oxford

[5] Professor of Economics at New York University specialized in economic growth and foreign aid.

[6] Easterly, William, 2001, The Elusive Quest for Growth, MIT Press

Failing the adaptation to the Savings Glut

It has been a while since the worst financial crisis occurred (2007/2008), yet the economists still seem to not have reached a consensus on its causes. Explanations for the crises seem to focus on two main branches of reasons: subprime mortgage crisis and global imbalances. Bernanke, in 2005, address this matter in a speech entitled “Global Savings Glut” where he argued that excess savings in China (as well as oil exporting countries and developing Asia) were the main cause for USA trade deficits and low long-run interest rates.  As he stated, “during the past few years, the key asset-price effects of the global saving glut appear to have occurred in the market for residential investment, as low mortgage rates have supported record levels of home construction and strong gains in housing prices”, which seems to make a bridge between the two sources of reasons economists fight about. This seemed to be a warning for the western world of what was about to coming. In this post we will argue about the failure of adaptation by the Western countries to China’s massive saving glut.

In the past, China’s savings accounted for less than 1 percent of total global savings. Nowadays, China holds a quarter of the world’s savings. Moreover, large economies conventionally generate gross savings of about 15/20 per cent, while China owns now around 50 per cent. At the moment, Western economies are suffering great distortions given the large scale of savings.

Bernanke used this idea when explaining the United States current deficit. Some Asian countries, especially China, save more than what they invest. This has led to the generation of current account surpluses, which could not be absorbed by investing only in their own countries. Thus, this created the glut to lend abroad to countries in deficit, like the US and other Western countries. A large amount of these foreign savings were channelized mainly at the US government bonds and, like in June of 2013, China was holding US government bonds worth about $1.3 trillion. As a result of this capital inflow, interest rates became lower, which over time generated higher investment and excessive risk-taking, creating the asset price bubble in the US, which end up being the fuel of the crisis.

Aside from creating the framework for the financial crisis, there are other effects that can be pointed out as regards to China’s savings glut, mainly because western governments made mistakes. There was a belief that this glut permitted them to spend more in boom periods and then to count on deficits and taxes from expanding financial services, but as it turns out the results were drastic, leaving governments with high and still rising ratios of debt to GDP. Moreover, it is likely that there will be a settlement of the global assets that China holds close to its share of worlds GDP, as China’s growth slows down. This means that half of this country’s assets will be outside the country itself (given that its savings ratio is twice as large that the world average).

However, it is noticeable that the global savings glut hypothesis suffers from two obvious flaws. First of all, the reduction in USA’s current account deficit only occurred after the collapsing of the housing bubble. And usually the collapse of booms is caused after a sudden stop, not before. But China continued to have huge dollar reserves until 2011. Moreover, the house market prices and current account deficit were not particularly well synchronized. While the prices went down, the deficits reached their peak, at which time it was hopped that the foreign capital were doing some pressure for prices to rise. Second, the imminent focus on net capital flows rather than gross forms misperception. According to Treasury data, the higher source of foreign capital in the US was not Asia but European banks. The main problem for the US was that financial outflows to the rest of the world declined drastically, generating the same current account deficit in 2007 and 2008 even with the different flows exhibit in those years.

With this, we can conclude that saving countries like China are not to be blamed for saving what they have earned. Indeed, it was the failure of adaptation from western countries that caused the problem. Central banks must also be responsible for this, since they are the true originators of the crises because they are printing money, handling their currencies and corrupting the global economy.

Andreia Parreira 646
Rita Azevedo 625


Stunning Similarities

While Germany won’t ever forget about the hyperinflation disaster of the early 20’s – something The Economist recently referred to as Germany’s hyperinflation phobia[1] – the German debt crisis right before the Nazis seized power surprisingly seems to have widely faded away from collective memory. Specifically when observing the German debate on to which degree the ECB shall be allowed to financially support the crisis-stricken, indebted south European countries, it seems odd that this part of German history remains almost unmentioned.  In contrast, though, German opinion makers seem to never tire of emphasizing the bitter experience made by hyperinflation when debating on potential instruments of the ECB’s crisis management.

After World War I and the accompanying hyperinflation Germany borrowed heavily from the US in order to finance the war reparation payments but also used debt to boost economic growth. Thus, it was basically a credit bubble that financed Germany’s Golden 20’s, a situation very similar to the economic boost experienced by South European countries before the arise of the financial crisis in 2008. Then, in 1929 the Great Depression erupted in the US causing the German bubble to burst. At once there was a sudden stop as US banks started withdrawing funds from Germany and suspended new lending. In the course of the increasing pressure of debt repayment Germany’s US $ reserves were shrinking which forced Germany to build up a trade account surplus in order to earn the US dollars needed to settle its debt. But as Germany’s currency was tied to the gold standard the possibility of devaluation was not given, while the defense of the exchange rate was further accumulating the decline of US $ reserves. Furthermore, due to the Great Depression the US demand for imports was plummeting, and so did German exports. Thus, the only way to pay back debt and regain trust from international investors was strict fiscal tightening. However, this was resulting in a banking crisis including bank panics, bank socialization and a credit crunch paralyzing the economy and consequently leading to rising unemployment up followed by mass demonstrations and violent clashes of political opponents. When foreign reserves were finally exhausted, so that the exchange rate was not anymore defendable, Germany was forced to abandon the gold standard and to devaluate its currency. But the effect did not sufficiently boost exports in order to earn the dollars needed to keep up with the debt payments. Between 1929 and 1932 the German GNP declined by 25 %, culminating in an unemployment rate of 30 % in 1932. The disastrous economic situation represented fertile ground for the radical political fringes and accompanied by the debt default in 1933 the Nazis seized power[2].

If one imagine, how the course of history may have gone if debt would have been restructured in a way to better avoid such a deflationary economic development it gives cause for thought. Something the US – being the major creditor – had learned from, which gave rise to the Marshall Plan after the disaster of WW2. Of course, in the awakening of the cold war, complemented by the importance of European export markets for the US economy, there was much political calculation involved, however, it gave Germany the possibility to rebuild the economy by creating an efficient institutional framework, that led to the impressive economic growth during the 60ies and finally to the full repayment of the loans granted by the Marshall Plan.

Today’s political circumstances are different; still, the similarities of economic pattern are stunning. Since the awake of the crisis Greek GDP was constantly shrinking and in 2013 unemployment reached a new record high of 27 %[3]; and with economic change inevitably comes political change. Today’s disastrous economic situation again is leading to the empowerment of radical political fringes – from both the left and the right extremes. A recent survey showed a 15 % public support for the Greek neo-Nazi party “Golden Dawn” and violent clashes between political opponents are increasingly reported.[4]

This time Germany plays a main part as being a main creditor and the long-term level of reimbursement depends on an economic comeback of the high indebted economies. Furthermore, Germany’s industries strongly depend on its export potential, which in turn is positively affected by the Euro that makes exports cheap, something that would not be the case without the Euro zone (an own German currency would highly appreciate). The allowance of the Target2 transfers, which remain relatively unnoticed by the public, show that German officials are aware of these facts, however, their political leeway is constrained by the voter’s opinion and still; the key aspect of how the German public widely perceives the financial aid is to pay for mistakes made by others rather than the economic and historical based moral rationales behind the support.  To extent the debate by German’s own history of deflation could help to shift the inner German discussion from the question of if to support to the question of how to best support to enable struggling countries to build the right institutional and economic frameworks to get back on track. But this of course would require further investments, which obviously is not feasible without sufficient financial support in the form of debt reliefs.

Hans Kaufmann and Svenja Telle
Macroeconomic Analysis – Fall semester 2013

[1] Cf.: The Economist (2013, November 15): “Germany’s hyperinflation-phobia” retrieved from

[2] Cf.: Ritschl, Albrecht and Sarferaz, Samad (2006): “Currency vs. Banking in the German debt crisis of 1931”; Humboldt University of Berlin

[3] Statista (2013): “Greece: Unemployment rate from 2003 to 2013”; retrieved from

Deindustrialization and the current account

A range of factors have contributed to the deindustrialization of the US economy – that is, the relative decline of the tradable sector relative to the non-tradable sector. Much of this shift can be explained by the changes in the structure of production catalysed by capital inflows. In addition to this effect, economists such as Baumol have hypothesised that economies tend toward deindustrialization due to the inherent characteristics of tradable and non-tradable sector. This decline in manufacturing leads to a deterioration of the current account and makes it increasingly difficult to recover.

As noted by Bernake in 2005[i], an increase in global savings led to an increase in capital inflows to the USA. One of the key push factors that led to the “global savings glut” was the fact that from the mid 90s onwards, developing countries went from being net capital importers to being net capital exporters. This was a strategic choice adopted by developing countries that had been negatively affected by the instability of capital flows and the exchange rate, and therefore began to build up large quantities of foreign-exchange reserves to protect themselves. Furthermore, the sharp rise in oil prices led oil-exporting countries to greatly increase their savings, leading many developing countries to become net lenders rather than net borrowers. 

But why did the capital flows end up in the USA? A pivotal pull factor was the technology boom of the 1990s that made the country an attractive investment destination. Furthermore, the importance of the dollar as a currency to which others are pegged and as a leading international reserve currency ensured that savings from the developing world were translated into dollar-denominated assets. In addition to this, stock market wealth led to an increase in consumption, and therefore demand for capital.

This accumulation of capital inflows has pernicious effects on an economy. Firstly, it can lead to what is called immiseration, which is incentivizing the wrong sectors of an economy thus leading growth to make the country worse off. There is also the issue of Macroeconomic Overheating in which the excess inflow overstimulates the economy, creating bubbles. Another typical issue is the vulnerability of the country to a sudden stop in the capital inflows which would enforce a steep adjustment to the economy. Due to the pivotal role of the U.S. in the world economy, however, it can be held that it is not subjected to sudden stops. Nonetheless, empirical evidence shows that capital inflows have led to the relative decline of the non-tradable sector, ultimately leading to a deterioration of the current account. 

The increase in house prices in the early 2000s is symptomatic of this. According to data from the US census, house prices rose 11% from 2003 to 2004 (with inflation at 3.3%). On the other hand, the manufacturing sector’s contribution to GDP declined 2.46% from 1999 to 2009[ii]. While part of this change can be explained by capital inflows, Baumol’s unbalanced growth theory[iii] also provides some rationale. The theory departs from the fact that the tradable sector experiences growth in productivity whilst the non-tradable sector doesn’t. This leads the non-tradable sector to absorb more labour, ultimately decreasing the relative weight of the tradable sector. This effect is compounded by the fact that increased demand due to capital inflows leads to a rise in the relative prices of non-tradable goods (because domestic demand changes the price of non-tradables while tradables obey the law of one price).

This change in the economic structure of the country leads to an uncompetitive tradable sector and an overblown non-tradable market. Since the capital inflows, and the current account, are paid with the tradable sector, it gets increasingly hard for a country to pay its debts (you can’t pay Japanese investors with houses in Arizona). If this growth of the non-competitive sector does not stop, the country will eventually have difficulties in paying its obligations and it may run into a current account crisis. Additionally, the more the change is postponed, the harder it is to implement it. The U.S. may still be far from having to face a current account crisis but the readjustment it needs is still large and it is getting larger as time passes.


Macroeconomic Analysis

Manuel Costa Reis

Margarida Madaleno


[i] Bernake, B. (2005). The Global Saving Glut and the U.S. Current Account Deficit. Sandridge Lecture. Richmond, Virginia.


[ii] Hunt, B. (2009). The Declining Importance of Tradable Goods Manufacturing in Australia and New Zealand: How Much Can Growth Theory Explain? IMF Working Paper .


[iii] Baumol, W. (1967). Macroeconomics of Unbalanced Growth: The Anatomy of Urban Crisis. American Economic Review , 415-426.


Liquidity Crises in a Monetary Union

One of the economic drawbacks of a monetary union is the vulnerability it imposes on its members. By losing control over their currency and over the Central Bank operations, member-countries find themselves prone to insolvency and liquidity crises.

The concepts of liquidity and solvency rely on market perceptions. In general, liquidity will depend on how investors perceive the risk of insolvency for a given country. A country is solvent if it is perceived as able to repay its debt. This will happen if its future budget surpluses are expected to be over a given threshold, which depends on the current level of debt and the present value of future issuing, as well as on the interest, growth and inflation rates. The perception of solvency by the investors will also depend on whether or not the country is in a monetary union.

De Grauwe (2011) argues that, everything else constant, a country in a monetary union will be perceived as having a higher risk of default. This is due to the lack of a Central Bank that acts as a lender of last resort in order to avoid liquidity crises. If the risk of default is significant for a given country, investors holding its bonds will want to sell them, leading to an increase in their interest rate that decreases the liquidity of the country. While in general the Central Bank can provide liquidity by buying government debt, this is not the case in a monetary union, where the Central Bank is not directly controlled by the member countries. Additionally, an increase in the risk of default by a country will make holders of its currency more willing to sell it: this excess supply leads to a depreciation that helps the economy to grow. In a monetary union, this is not necessarily the case, since the value of the currency does not depend on the behaviour of a single country. These two effects mean that monetary union countries are more vulnerable to variations in market behaviour that can lead to a sudden stop. This framework is used to compare the Spanish situation with that of the UK, focusing on the Eurozone crisis that started in 2009. After the crisis the pound depreciated against the euro, namely due to a higher inflation in the UK, which helps to explain a higher growth rate for this country. Since the primary surplus needed to stabilize debt decreases with both inflation and the growth rate, the author estimated it to be higher for Spain (2,30% of GDP) than for the UK (-1,21%), even taking into account that the UK had a higher debt.

One important application of this result is that countries in a monetary union lose part of their capacity to deal with economic crisis, namely the ability to implement counter-cyclical fiscal policies: this kind of policies aims at smoothing the effects of a downturn by means of an increased government spending, leading to higher budget deficits. The higher the primary surplus required for solvency, the smaller is the deficit the country can incur to avoid a default. Thus, the need for a higher primary budget surplus impairs the country’s ability to use counter-cyclical measures.

While there are benefits associated with the implementation of a monetary union, such as reduced uncertainty associated with exchange rate fluctuations within their members, it is important to acknowledge for the problems it may pose. In particular, as discussed, the loss of independent monetary policy can make a country more vulnerable to market fluctuations, leading to limitations in the use of its other main macroeconomic instrument, fiscal policy.


De Grauwe, P. (2011), “The Governance of a Fragile Eurozone”, Economic Policy, CEPS Working Documents.

Carla Ferreira, 636

João Araújo, 638

Cyprus: A tale full with economic lessons

Cyprus is a small Mediterranean economy with a population of 800 m that entered in EU in 2004 and joined the Euro Currency in 2008. It grew steadily in the beginning of the new millennium, and currently its GDPpc is at 92% of the EU. The composition of Cyprus GDP is based on services, reaching 81.2% of GDP, while industry 16% and agriculture is rounding 2%. Banking and tourism are the core services of Cyprus.


In order to understand the crisis that drove Cyprus close to bankrupt, it is important to highlight that the island had few natural resources (gas in the Mediterranean will only be available to extract 2-5 years from now). To push national wealth up and attract capital inflows, legislation was made to the banking sector one major industry of the country. Low tax rates and the regulation attracted foreign depositors (37% of the total are from non-Euro countries), and the size of the banks reach 7.5 times the size of the island´s economy.

Since 2008, the year of the financial meltdown, the government deficit rose and with it the level of debt. The housing market started to show the signals of recession, and the banks see their balance sheets worsen due to non-performing loans. Private debt is at record levels, and deleveraging process made the recovery weaker.

Cyprus starts 2012 indebted, with a financial sector near collapse, and a need to finance its deficit of 6.4%. They first turn into Russia, which provides them a €2,5 bn  loan with an annual interest rate of 4.5% and maturity of 4.5 years, which helps the country survive 6 more months without much media attention, in spite of the increasing borrowing costs. Lesson 1 – If the size of the financial sector is relatively large to the size of the economy, sound fiscal policies are required since the burden of the financial sector failure will ultimately rely on it.

However, Greek debt restructuring gave a final death sentence to Cyprus financial sector. Cyprus’s two biggest banks, the Bank of Cyprus and Laiki Bank, held large amounts of Greek government debt and took a major hit in the partial default. The solvency itself was at stake. Russia is seen as another way out, but its Government denies providing with another €5 bn, even with economic opportunities attached. EU and IMF are the last standing. Cypriot Government knows that attached to the European financial aid comes strong conditionally regarding public finances and financial regulation. Lesson 2 – There is a permanent need to evaluate the contagious effects of measures taken by a country in a monetary union, because those will affect the other members.

(Beginning of) Resolution

June 2012 marks the beginning of a lengthy negotiation process that reached dramatic conclusions 10 months after. For the first time a Euro country imposes capital controls and heavy losses on uninsured depositors of troubled banks. Laiki Bank was divided in two: good bank and a bad bank (with all the toxic assets). Lesson 3 – Although belonging to a monetary union , capital controls can help avoid the self-fulfilling prophecy of the insolvency of a financial sector and can help a country to perform damage controls and eventually aid its recovery, by avoiding massive capital outflows.

A National Fund was created that included public and church assets. With this, Cyprus is able to self-finance a share of the €10 bn bailout (also called bail-in) that was agreed officially in 16th March 2013. The €10bn bailout comprise €4.1bn spend on debt liabilities (refinancing and amortization), 3.4bn to cover fiscal deficits, and €2.5bn for the bank recapitalization.

Advantages/ Disadvantages of the policy choices

Cyprus was the 5th country to ask a formal bailout to EU within the Euro zone, 5 years after the hit of the subprime crisis and 3 years after the beginning of the sovereign debt crisis.

The EU faced unprecedented challenges, but a monetary union with 17 democratic sovereign countries has a different response time. Nevertheless new measures (unimaginable a few years ago) come into ground – an European Fund to insure stressed countries  (ESM), a new Treaty regarding fiscal policies was signed and a new monetary policy by the ECB targeting  member states public debt in the secondary market with soaring yields.

In this torturous path that EU have gone through, Cyprus crisis was a decisive moment, for good and bad reasons. This was the moment when Europe decided to start input losses to junior bondholders and shareholders of troubled banks (which eventually would transform the way euro countries deal with troubled banks). But this was also the moment when Europe consider as an hypothesis to input losses on insured depositors, which lead to several hard days to stock exchanges, with banking shares taking a hit and also to worsen the confidence levels on the banking system. In spite of giving up on this solution, this was seen by the European people as a real possibility and economists fear that the next time a similar situation happen and a clear regulatory framework is not known to people, bank runs can happen again. Lesson 4 – Uncertainty brings unexpected costs to the economy.

Cyprus has to reduce the size of its banking system to the EU average of 3.5 times GDP, and this indicator was introduced in the Macroeconomic Imbalance Procedure (MIP) Scoreboard (collected by the Eurostat). Lesson 5 – This indicator is now present when European Comission evaluated the macroeconomic imbalances of a country, and it may help avoid future banking crisis in the euro. A wide range of indicators needs to be considered when evaluation the macroeconomic performance of a member state.


EU rules compliance before the crisis was not enough…


A high leverage economy together with a fall in the housing market did not help the economy in a presence of adverse shocks.


Unemployment soared with the burst of the bubble…

Bruno Dias                      Nº 670

José Campelo Ribeiro     Nº 645

This gallery contains 4 photos

The implications of Secular Stagnation


Secular Stagnation has been the word of order in major economic gatherings, as developed countries struggle to overcome their low growth rates. As the name says, they stagnated and to overcome this and boost prosperity, especially after the recent economic crisis, the greatest economic minds have gathered in the IMF Research Conference to discuss this issue. Contextualizing the reader, the argument of secular stagnation is that the equilibrium real rate of interest in the global economy has been significantly negative (around -2 to -3 per cent) since at least the mid-2000s, while the actual real rate (at least on bonds) has consistently been much higher than this, despite the efforts of the central banks to reduce it. The consequence is a prolonged period of under-investment in the developed economies, with GDP falling behind its underlying long run potential. The central banks, in order to try and tackle this, have created asset price bubbles (technology stocks in the late 1990s, housing in the mid 2000s and possibly credit today), since this has been the only means available to boost demand. See graph bellow.


The gap between the trend and the Actual GDP lines has led think tanks to suggest that potential output has not actually followed the red trend line, but has instead followed a path sketched by the dotted orange line, reflecting the damage done to the capital stock and the effective supply of labor by the recession.

Recent research tells us that it is unlikely that GPD is still below the orange line and as such central banks have kept their monetary policies aggressively easy (policy makers believe that asset prices are not in bubble territory) and further still, that given the “right” policies, potential GDP can be increased to the red line. One of such Researchers is the Fed’s David Wilcox, who claims that “demand might create its own supply by boosting capital investment and raising labour participation”. Our own ECB stands by the creation and/or acceleration of structural reforms able to increase the growth rate of potential GDP (which have averaged 0.5% per annum).

What secular stagnationists add to this debate is that the problem of under-performance of GDP will last for a very long time, and will not solve itself through flexibility in prices and interest rates, which is what happens in classical economic models (rapidly), and in new Keynesian models (more slowly). The reason for this is presumably that the zero lower bound prevents nominal interest rates from falling, and also prevents prices and wages from adjusting downwards. Further they defend that the normal route through which monetary policy works, by bringing forward consumption from the future into the present, is unlikely to be successful. If the secular stagnationists are right, there will still be a shortage of demand when the future comes around, so there will be a need for ever-greater injections of monetary stimulus (presumably through quantitative easing) in order to avoid an ever-worsening recession. Finally, they say that calls for fiscal action are bound to intensify. Ben Bernanke commented that secular stagnation was unlikely to occur, because there would always be capital projects with a positive rate of return that would be undertaken by the public sector. These projects could be financed by raising public debt at zero or negative real rates of interest, so the debt would be sustainable and the net worth of the government would actually improve. Therefore, in a rational world, public investment would always be used to end the secular stagnation.

Therefore what can we conclude? The low inflation and bond yields appear to lean the battlefield towards the Sec Stag side, but they may be wrong if the real GDP doesn’t correct to either the red or orange (bad case scenario) lines. Attempts to get there would then be followed not only by asset bubbles, but also by rising inflation, and then a massive economic correction. So apparently and essentially, this comes down to the oldest macro-economic question of all: where do policy makers want to take risks, with higher inflation or lost output and employment?

Manuel Piedade #609
Sérgio Rocheteau #620

“De Gato p’ra Lebre”

It was in 13th October of 1987 that Portuguese people listened from their Prime Minister, Aníbal Cavaco Silva, that investors would be buying “gato por lebre” (“Pig in a poke”).

Emerging from a revolution, Portugal was a new player in the European team and had recently received foreign aid throughout two adjustment programs to solve the problem of external imbalance.

The crisis passed, the stock reacted and Portuguese economic situation steadied during a decade of growth.  Being able to recognize the mistakes made since then we find ourselves today in a situation that is no less serious, hovering over the whole economy a question: will we be “gato ou lebre”?

Between Portugal’s entry in EU and the euro membership it was witnessed a period of economic growth, with a strong inflow of EU capital, launching major public investments in infrastructures and a national effort to catch up with other member states. With the euro started a period of stagnation that came to result in the crisis recently faced.

Without its own currency and no autonomy in monetary or exchange rate policy, since 2000 Portugal went through a period called “the lost decade” marked by an artificial enrichment resulting from a large inflow of foreign capital with desirable interest rates.

Excess liquidity and easy credit access resulted in a strong expansion of aggregate demand and also in a progressive external debt due to a permanent trade balance deficit. At the same time, the real exchange rate appreciated, resulting in a huge loss of competitiveness of Portuguese exports and an allocation of resources in favour of the non-tradable sector.

The country, itself not athletic, then settled down in its basket as a big fat cat, sedentary, domesticated and oblivious of the difficulties that would follow.

As Guillermo Calvo and coauthors document for the Latin American economies in the 1990s, large capital inflows typically come with increases in the real exchange rate, that is, increases in the domestic prices relatively to prices abroad. Therefore, this Portuguese crisis can be analyzed through the Salter & Swan approach, observing the tradable and non-tradable sector dynamics.

According to Ricardo Reis, an explanation for the Portuguese slump is the large capital inflows that were misallocated across sectors, causing a strong fall in the domestic productivity growth. This misallocation caused a strong increase in the non-tradable prices and the country ran successive current account deficits until we reached this situation. Additionally, the government amounted to an excessive annual deficit which caused an unsustainable level of public debt, i.e. becoming more and more dependent from abroad.

After the sudden stop, the Portuguese government was forced to sign the Memorandum of Understanding which established, beyond other goals, the commitment of supporting “the reallocation of resources towards the tradable sector.” Figuratively speaking, the country committed on ceasing to be “the gato” and start being “the lebre”, capable of becoming positive the animal spirit in order to achieve economic stability, growth and development.

Have we been successful?

preços copy

emprego copy2

Despite the difficulties associated with nominal rigidities in prices and wages and a huge lack of ability to attract international investment, prices of non-tradables have decreased in contrast to the perceived inflation in tradables.

Although, the pricing system is not promoting an efficient allocation in the labor market, and consequently we can see that until the first quarter of 2013 the employment reduction felt more in the non-tradable sector (more subject to international competition). This is not a good indicator of success.

aula copyEven though, Portugal has managed to generate trade balance surpluses because of a massive contraction in domestic demand. Considering the graph, Portugal was producing at A and it’s now at C, which is clearly ineficient.

However, according to Eurostat, it is estimated that in the 2nd and 3rd quarters of the year Portugal was the EU country where employment grew most, a factor which is due to the recovery of markets and investors confidence and a clear support in the export sector.

Fortunatelly, the signs of this adjustment process are starting to be noticed and soon our production level will be able to return to the Production Possibilities Frontier (at B) with a strong, competitive and sustainable economy.

The effort has been tremendous but the optimists say that if, even after the end of the adjustment program, these reforms continue to be undertaken with the same determination, the “gato” will become “lebre”.


Dino Alves #607

Sara Simões #643

Macroeconomic Analysis

[Graphs on Tradables and Non-Tradables – Prices and Employment – from Equilibria nº 1 and 2]

1 Comment

Europe… Dynamite?

After entering the European Union in 1986, the Portuguese economy has experienced one of the highest economic growth in its history. This historical landmark meant, initially, alongside with the underlying policies, increased credibility and improved perspectives on the Portuguese economy and a big widening of a soon-to-be free market for Portuguese potentially exporting firms. In a second stage, we should not forget the creation of the European Economic and Monetary Union, which was divided in three phases:

1. Starting from July 1990, there was the liberalization of capital movements between Member States.

2. Creation of the European Monetary Institute with the main aim of preparing the establishment of the European Central Bank.

3. Introduction of the single currency in the 1st of January, 1999.

The combination of national policies, the direct effects of EU entry and decisions at European level (such as the creation of a single market and a single currency) led to a rapid economic growth, fueled mainly by transfers from the European Union and the massive inflow of capital. The evolution of capital inflows is well described in the chart below where it is easily seen that Portugal experienced a huge capital inflow in this period: the net transactions with the Rest of the World increased from 0.186 milliard euros (1986) to 1.721233 milliard euros. (1992).

We propose a short analysis of this period under the TNT model framework. An increase in capital inflows such as the one Portugal has experienced probably means a higher level of absorption. With prices unchanged, the economy would produce the same amount of goods (since the price to producers remains the same) but consumers would want to consume more of both tradable and non-tradable goods. As the non-tradable goods cannot be imported, the excess demand for this type of goods will translate into a rise in their prices relatively to the price of tradable goods.

The increase in the relative price of non-tradable goods will lead to a second round of effects because entrepreneurs will perceive the opportunity to invest more in on-tradables and consumers will substitute more towards tradables. In the end, we should expect an equilibrium in which there is again an internal balance but the economy has a (higher) external deficit (the consumption exceeds the production of tradable goods).

Did this happen to the Portuguese economy? The figure below describes the evolution of employment in services (which is used as a proxy for non-tradable goods) and in manufacturing industry (tradable sector).  As expected, the huge capital inflow and the consequent real exchange rate appreciation were accompanied by a reduction in employment in the tradables sector and by a rise in employment in the non-tradables sector. We can see that employment in services in 2012 represented about 65% of total employment while in 1986 this value was only about 44%. Moreover, in 1986, manufacturing accounted for about 30% of total employment, while in the last year the same value was around 15%. Thus, the empirical data is very consistent with the results predicted by the theory: the data may suggest that the huge capital inflow caused a move toward the non-tradable sector. Data on the real exchange rate (measured by AMECO as the real value of the domestic currency relative to the remaining former 15-EU countries; an increase in the index means an exchange rate appreciation) is also consistent: throughout the majority of the period, Portugal has been experiencing an exchange rate appreciation.


The last two or three years provide hence a fairly good explanation for what has been happening in Portugal: since 2009 and mainly from 2011 hence, there has been an attempt to devalue the Portuguese production (in real terms, of course) in order to pay for the immense external debt the country has been accumulating. We are now in the beginning of the repayment phase, during which employment is expected to be redirected towards tradable goods as this sector’s production gets relatively more expensive.

The TNT model also predicts what could happen to the economy should the repayment phase be not as smooth as what is depicted in a diagram: in case production fails to adjust to prices (due to lost learning economies during the illusory boom phase) or if prices (namely, that of non-tradables) resists falling, there will be unemployment in this sector as a consequence of excess supply of the goods.

Entering the EU and the EMU proved to be explosive to the Portuguese economy, which sat vulnerable to massive Push factors and to the binding European rules regarding the abolishment of any type of capital controls. The next big challenge is to stop the climbing markup of the main players in the non-trabable sector so that prices can reflect wages and the adjustment can proceed.


Filipe Silvério, 617

João Garcia, 618

All to the rescue – Moral Hazard within Eurozone countries

The European Union was dreamed as an economic and political integration of countries, where through a democratic system, all countries would move together towards a more prosperous economic region. With the creation of the euro, the European Union embarked on a grand experiment.

From the starting point, there were wide differences in degrees of budget, or fiscal transparency. As an attempt to control this, convergence requirements were established and all countries should maintain deficit lower than 3% and government debt lower than 60% of GDP, subject to a sanction otherwise.

Nevertheless, early predictions about the potential of moral hazard in public finances as a consequence of asymmetric information about fiscal decisions were not taken seriously and on top of that, there was no concrete mechanism that restricted governments from overspending.


Euro-zone members became tightly intertwined meaning that banks, insurance companies and pension funds in every euro-zone economy became the biggest investors in the bonds issued by governments of other euro countries mostly because there was no currency risk. That meant that if one government defaulted, it would have severe effects on the health of all financial intermediates. This overall risk elevated even small European economies to the “too big to fail” category.


The current conflict existing between the weak economies of Southern Europe, such as Greece and Portugal, with the rest of the euro-zone countries has become a serious moral hazard problem. The point is whether the fact of being bailed out in case of default, causes a country to misbehave. Would bailing out an indebted country encourage that and other countries to live beyond its means in the future?

This ill-fated setup allows governments to maintain uncompetitive economic structures such as inflexible labor markets, huge welfare systems, and huge public sectors for a long time. Moreover, the system causes the over-indebtedness and lack of competitiveness typical of the recent sovereign-debt crisis.


One of the key criticisms of the bailout of Greece is that it rewards the country for its mistakes and for breaking the rules of the Eurozone project. Also, in the five years after the single currency being launched, the two biggest economies in the Eurozone, Germany and France, had broken the debt rules for three years in a row with no punishment, violating the convergence requirements mentioned above. Not wishing to harm the most important countries in the project, Eurocrats quietly ignored the rule breaking. These two cases show how non-credible the Eurozone agreements are, allowing a misbehaving conduct. If things go wrong, Eurocrats will come to the rescue for their own good, in other words, a check will be sent for the sake of everyone as fears of contagion spreads. EU’s leaders said that they would do “whatever it takes” to protect the integrity of the Eurozone.

The solution for economic stability must then start with imposing a good behavior long before the profligacy becomes acute; it is needed to cut incentives that lead to bad situations and not act only when the worst happens. More specific measures have been discussed such as a policy tool that denies profligate countries to vote in any euro decisions. These measures show that the EU intentions for efficiency and punishment are becoming more credible making weak countries to think twice when relying on others strengths to bail them out.


Francisca Pereira dos Santos 680

Margarida Ortigão 647

Macroeconomic analysis



The liberalization of the capital account of the balance of payments was one of the main reasons of the increasing amount of capital flows that came in into many emerging economies. In the last decades the restrictions on these capital movements have been eliminated and the world has witnessed the creation of a liberalized environment. Whether it was driven by “push” or “pull” factors (originated in the lending and borrowing countries respectively), the inflowing of capitals brought many positive welfare implications for the borrowing countries and for their economies. However, there are some potential problems too and this article is going to focus on one of them: the sudden stops, and mostly about the ones that occurred in the Euro Area.

Sudden stops are an abrupt slowdown of private capital inflows into an economy, due to new information about the capability of a country to honor its financial obligations. It is usually very disruptive to an economy, since it forces an almost immediate reversal in the current account from an external deficit to a surplus one (unless the country benefits from significant balance of payments assistance). Therefore, policy challenges arise.

When it comes to the Euro Area case in particular, there have been countries like Portugal, Spain, Ireland, Greece and Italy that, right after the creation of the Economic and Monetary Union, started to see a large amount of capital to flow to their economies. They offered attractive investment opportunities and there was no longer the risk associated with the exchange rate. Everything was being  seen as part of a well-functioning monetary union which was designed to make a balance of payment crisis (inability of country to pay for essential imports and/or service its debt repayment) impossible to happen. So, the current account imbalances that arose through time were disregarded. Nevertheless, macroeconomic imbalances occurred in the form of large and persistent current account deficits which had increase the accumulation of external debt and deteriorated the competitiveness of these countries when compared to the other euro zone ones.

Not much later, there were three main episodes of sudden stops: one by the time of the outbreak of the global financial crisis, another one by the time of the launch of the Greek programme, and the last in the second half of 2011. They suggest that has been contagion across countries and from what it has been discussed in class, is easy to point out that one of the biggest problems here is that a sudden stop requires a real exchange rate appreciation, which is difficult to achieve in this case.



  1.Sudden stop episodes in southern euro-area countries, 2009-11               

A special feature of the Euro area crisis is that even though the capital outflows have been impressive, the current account of deficit countries’ have only adjusted partially given the important role of Eurosystem financing. When compared to other countries outside the monetary union (The Baltics for example), data shows the adjustment when facing a sudden stop is much faster and sharper in the last ones. Even though different choices of fiscal policy and different patterns of bank ownership did also contribute to a delayed fiscal and external adjustment, the Eusosystem played a much crucial role. Its injection of liquidity has helped accommodate persistent current-account adjustments and also protect countries by minimizing the immediate effects of a sudden stop in private capital flows (it’s important to remember that they can no longer rely on adjusting their exchange rates).


2.Current account turnaround BELL= Baltic States (Estonia, Latvia and Lithuania)  GIIPS= Greece, Ireland, Italy, Portugal and Spain

So basically, we can conclude that the effects of a sudden stop have been soften by a smooth functioning of the payment system and if it was not the case, the Euro currency could become unsustainable. It is important to act keeping in mind that the level of integration of the euro-area financial markets requires policies that should preserve it from the risk of further attacks.

However, welfare analysis suggests that a short and sharp adjustment path, like the one followed by the EU Member States outside the euro area actually had two advantages: less debt was accumulated and the macroeconomic performance was better if measured over time.

Catarina Coelho #640
Maria Dentinho#615


Notes from the Professor

Financial Repression and Exports – the South Korean Experience

Financial repression is defined as the use by official institutions, either the legislative body, the central bank or the government, of policies aimed at increasing available credit to government at the expense of private sector. So, funds that would otherwise be destined to private borrowers are directed to the government, often at below market rates.

Through these low interest rates, government reduces its debt servicing costs and, when financial repression is combined with inflation existing debt denominated in domestic currency is eroded. Typical financial repression policies include: caps on interest rates, controls on cross border capital movements, increased reserve requirements, allocation of captive funds (such as social security and pension funds, domestic banks) to government financing and tighter relations between government and banks (i.e. public ownership of banks). The concept is frequently employed to describe the situations in the period after World War II and in the years since the financial crisis of 2008.

However, the term also applies to the South Korean economic panorama in the 60s and 70s. Financial repression tools constituted a key feature of President Park Chung-hee rule from 1961-79; although they were adopted for different reasons: the purpose of the government was not to reduce its debt but to direct available funds to target industries. These were essentially firms in sectors with exportable profile and growth prospects and infant industries’ firms.

Soon after Park Chung-hee took power, a set of circumstances, namely the dramatic reduction of aid remittances by the USA, shifted South Korea’s economic policy orientation from an import-substitution to an export-substitution strategy. The country was the first among the “gang of four” to bring exports to the center of economic concerns, ahead of Singapore, Taiwan and Hong Kong1. In short, the logic and the subsequent success of the shift are due to a number of factors: Korea lacked in natural resources but had an abundant labor force, education was increasing both in its spread and in quality, the USA were willing to provide trade advice and access to a broad market, and advanced industrial countries were going through a boom.

Government began promoting an “Export-Oriented Industrialization”, conducting the production factors towards exportable goods. These were effective as one can observe through the growth in exports to GNI ratio (see graph). It implemented 5 year indicative economic plans that explicitly presented the reforms to be undertaken and the industries to be promoted2. Because the government settled export targets accomplishment as the country’s mission, it needed to protect exporting industries so they could face international competition and benefit from learning-by-doing effects, hence the implementation of high subsidies to firms, tax exemptions, restraints on import and cheap funding for the required investments.


Focusing on the financial sector, under the highly centralized rule Park Chung-Hee installed, all banks were nationalized as government took control of all forms of credit distribution. For this reason, capital movements were restricted (government was the sole entity able to borrow money from abroad). This full control over commercial banks and other institutional credit suppliers allowed the government to manipulate interest rates. Additionally, Bank of Korea, the country’s central bank, was naturally under fiscal dominance and therefore government also influenced monetary policy.

Because government wanted not only to direct investment towards exporting firms but also to provide them with cheap loans; eventually, the banking sector turned into a “non-profit public agency”. Banks entered in a scheme of strong credit rationing: as they lent money at extremely low rates, the demand for funds was much larger than supply and, naturally, target industries businesses were prioritized. The consequent distortion in the financial market produced a huge informal, unorganized and unsecure parallel credit market , “the kerb market”, that at its peak in 1964/65, was equal in volume of lending to around 40% of total regular bank loans. The poorer population, attracted by the higher returns, opted to put their savings in these schemes and those in need of loans, but rejected by regular banks, were forced to pay nominal interests rates that reached as high as 60%.

Simultaneously, from 1960 until 1981, South Korea had, the highest inflation rate among Asian NICs: around 18,8% annual. The inflationary pressures arose from the economy’s overheating, resulting from the aggressive export promotion that forced businesses into overly ambitious investments. Furthermore, as mentioned, high inflation rate translate into negative real interest rates, which was verified for 11 years during the period of 1960–1981.


This financial market distortion left deep impressions in the country’s economy. Thanks to the state-controlled credit allocation, a large share of funds was allocated to increasingly bigger and more powerful corporations, the chaebol, that undermined free-market system due to the monopolies attributed over time. Furthermore, when government eventually started to liberalize the financial market in the early 80s, the challenge of dismantling the centralized credit market, the controlled capital movements and the fixed exchange rate policy proved to be too hard of challenge to cope with. To cut a long a story short, inconsistent and unbalanced deregulation (prompted by the hurry to get OCDE membership in 1996), culminated in a major currency and banking crisis that put an end to the so called “Korean miracle” and justified the IMF arrival in 1997 with a bail-out package.

1. “Gang of Four”, Jagdishi Bhagwati 1972

2. For example, in the first plan (1962-1966), “trade policy’s aim was to expand exports as much as possible by providing exporting firms with cheap loans, tax benefits, export compensation schemes and various administrative supports”, on the second plan “major reforms included a financial reform, an exchange rate reform and a trade reform allowing imports of parts and machinery used in the production of exports goods”

Other References

The rise of the Korean Economy, Byung-Nak Song


Francisco Delerue 635 Matilde Varela 666