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501. The quickly fading memory of why and when bank capital is important

Author:
Jesper Berg, Nicolas Boivin, and Hans Geeroms
Publication Date:
04-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Less than fifteen years after the global financial crisis of 2007-2008, banks and policymakers are calling for deregulation and lower capital requirements in the financial sector. They dispute that the Basel framework, the global standards for regulating large international banks, should be implemented fully in the European Union. One concern is that stricter capital regulation will affect the competitiveness of European banks compared to those in the United States and will restrict loan provision in the EU, despite Europe’s significant investment gap. However, deregulation should not be confused with reducing capital requirements for banks. On balance, there is only limited empirical evidence that respecting the capital requirements necessary to support financial stability hampers credit to the economy, investment or economic growth in the long term. Only well-capitalised banks can continue financing the economy during economic setbacks, and weakening the implementation of the Basel standards increases the risks of a new financial crisis. Bank lending and access to financing surveys also show there is no credit crunch in the euro area at present and that capital requirements are not the primary constraint on credit provision. A detailed look at current banking regulation does not support the conclusion that European banks are more strictly regulated overall than US banks. A direct comparison suggests rather the opposite. However, the compliance cost incurred by EU banks from current banking regulation can be reduced by simplifying EU rules.
Topic:
Markets, Financial Crisis, European Union, Regulation, Capital, and Banking
Political Geography:
Europe

502. Lessons for the European Central Bank from the 2021-2023 inflationary episode

Author:
Pablo Hernández de Cos
Publication Date:
05-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Since mid-2021, the euro-area economy has gone through several shocks, leading to the highest inflation since the creation of the European Monetary Union. A forceful and persistent response from the European Central Bank, grounded in the monetary policy framework it agreed in 2021 ahead of the inflationary episode, has succeeded in bringing inflation down and delivering on the central bank’s price-stability mandate. The framework will be reviewed in 2025 and it might conclude that there is no need for a drastic change. Nevertheless, this assessment should be compatible with identifying some areas for improvement. In particular, the 2021 review was primarily focused on the effective lower bound. The recent inflationary episode, together with high ongoing uncertainty, indicate that the articulation of monetary policy strategy frameworks should be robust to very different scenarios. Likely persistence of high levels of uncertainty over the next few years will also require an emphasis on flexibility to adapt to the magnitude, origin and persistence of shocks. Unconditional forward guidance should be avoided. In addition, there might be a need to more clearly distinguish in the future, when possible, between quantitative easing for market functioning versus monetary stimulus, which could incentivise a careful assessment of the amount, duration and structure of any asset purchase programme. Communication also needs to be improved in relation to the level of uncertainty and its consequences for monetary policy making with, for instance, greater use of scenarios and sensitivity analyses as appropriate. Improving forecasting/modelling tools, in particular when dealing with large supply shocks, and understanding the roles of different measures of inflation expectations should also be priorities.
Topic:
Monetary Policy, Governance, European Union, Central Bank, and Macroeconomics
Political Geography:
Europe

503. Sovereigns on thinning ice: debt sustainability, climate impacts and adaptation

Author:
Matteo Calcaterra, Andrea Consiglio, Vincenzo Martorana, Massimo Tavoni, and Stavros Zenios
Publication Date:
05-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
A fundamental problem for sovereigns enacting climate policies is whether they can manage increasing debts as their economies suffer from adverse climate impacts. We develop stochastic debt sustainability analysis integrating a coupled climate-economy model with debt financing scenario optimisation, and stress test sovereign debt for representative countries globally under the Intergovernmental Panel on Climate Change marker narrative scenarios of climate change. The stress test combines socioeconomic and climate pathways with calibrated aleatory scenario trees of economic, fiscal and financial variables to generate forward-looking debt projections over the century. These projections incorporate climate-induced damages to economic growth, spanning the broad spectrum of impact functions from the literature. Our findings reveal significant risks to sovereign debt sustainability, particularly under high climate damages, that are large from mid-century. Expected costs increase by up to 3 percent of GDP under high climate impact in a world of regional rivalries, or 0.25 percent under low impact in a middle-of-the-road narrative, with considerable variation between countries. The long-run debts of highly impacted countries are unsustainable. We assess whether adaptation investments or fiscal consolidation can mitigate potential climate-debt crises. Public financing of reactive adaptation is a justified expenditure that breaks even but does not fully restore the debt sustainability of highly impacted high-debt countries. Maintaining public spending while ensuring debt sustainability appears infeasible under climate impacts.
Topic:
Climate Change, Governance, Macroeconomics, Fiscal Policy, Public Debt, and Decarbonization
Political Geography:
Global Focus

504. Radical novelties in critical technologies and spillovers: how do China, the US and the EU fare?

Author:
Alicia Garcia-Herrero, Michal Krystyanczuk, and Robin Schindowski
Publication Date:
05-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Critical technologies including artificial intelligence, semiconductors and quantum computing are attracting attention because of their indispensable nature and their role in national security strategies. We compare China, the United States and the European Union in these technologies and their subfields. We use large language models (LLMs) to identify which patents in these technologies can be considered most groundbreaking (not patented before) and worth replicating. These are ‘radical novelties.’ We find that the US clearly dominates quantum. Chinese and EU progress is similar. The US does slightly better than China in AI with clear dominance in generative AI, but China stands out in some important subfields, such as aerial vehicle technology. China dominates in a larger number of semiconductor fields but not in the highest value added, which is related to design. In a second step we assess how quickly radical novelties in these three technologies are transferred from one economic area to another and within each economic area. We find that the fastest transmission overall is for AI. The EU is by far the slowest in replicating radical novelties from the US and China, while the US and China tend to replicate European novel patents relatively quickly. Radical novelties are also replicated quickly between China and the US which is surprising given US controls on exports of critical technologies to China. Our findings are concerning for Europe because it does not produce enough critical patents in these technologies and because it is slower in replicating patents from the US and China.
Topic:
Science and Technology, Economy, Trade, and Artificial Intelligence
Political Geography:
China, Asia, and United States of America

505. Which companies are ahead in frontier innovation on critical technologies? Comparing China, the European Union and the United States

Author:
Alicia Garcia-Herrero, Michal Krystyanczuk, and Robin Schindowski
Publication Date:
05-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Competition in critical technologies is attracting increasing attention not only because of the foundational nature of these technologies for other types of innovation, but also because of their role in the United States national security strategy. In this paper, we look into which entities in China, the European Union and the US innovate at the technology frontier in the three most important critical technologies – artificial intelligence, quantum computing and semiconductors – based on identification of the most radical novel patents in these technologies and their subsectors. Working with these pathbreaking patents, we look into the origin of the companies that file the largest numbers of them. US innovators dominate the innovation frontier for quantum computing and, to a lesser extent, AI, with Chinese innovators doing better in semiconductors. European innovators lag in all, but perform relatively better in quantum computing, in which they rank similarly to Chinese innovators. Furthermore, the innovation ecosystem is quite different across geographies. In the US, tech companies top the rankings of critical novelties and are highly concentrated: as many as three companies are in the top rankings of all of the three critical technologies. Frontier innovators in the field in which the EU competes most equally – quantum – are mostly research centres and not companies. China lies somewhat in between in all three domains.
Topic:
Science and Technology, European Union, Innovation, Artificial Intelligence, Semiconductors, and Quantum Computing
Political Geography:
China, Europe, Asia, and United States of America

506. India-China rapprochement: what are the long-term prospects?

Author:
Nayanima Basu and Alicia Garcia-Herrero
Publication Date:
05-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
China-India relations, which have long been fraught, were further complicated by the 2020 military standoff on the Himalayan border. The political disruption had a significant impact on Chinese companies’ presence in India. And yet, India’s dependence on Chinese imports has increased since. The Indian economy is decelerating at a challenging time for Prime Minister Modi, who governs in a coalition. China could offer a partial solution to India’s economic woes by providing manufacturing FDI and creating jobs. The Modi-Xi ‘rapprochement’ after their encounter at the October 2024 BRICS summit signals that relations could improve. India may be willing to accept targeted investment from China, but relations are unlikely to fully normalise, particularly since the 2025 India-Pakistan military stand-off. There are three main reasons for this. First, the Indian army remains cautious about the situation at the border and security risks relating to China. Second, the United States under President Trump will exert pressure on Modi not to depend further on China. This is even more relevant in the context of Trump’s threat to impose tariffs on India. Third, Indian public opinion on China and the Belt and Road Initiative remains negative. India is predicted to experience greater growth than China in the coming decades, meaning China could lose its upper hand in economic relations between the two countries. This, however, will depend on how dependent India might have become on China for imports or for jobs through FDI and other channels. The militarised border, India’s asymmetric economic dependence on China and China’s leadership in the Global South will still shape the relationship even if the Indian economy grows to a similar size to China’s. India-China ‘rapprochement’ is possible but will remain fragile and unlikely to be maintained in the long run.
Topic:
Bilateral Relations, Governance, Economy, Economic Growth, Investment, and Trade
Political Geography:
China, India, and Asia

507. Intra-Western Balkans dynamics: stocktaking and ways ahead

Author:
Armin Steinbach, Nina Vujanović, and Anna Fiore
Publication Date:
05-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
In the context of the push by the European Union for regional integration in the Western Balkans, this paper explores the barriers to, and prospects for, deeper intra-Western Balkan economic relationships. First, it addresses the pronounced bilateral economic relationships between Western Balkan countries associated with historical path-dependencies. Second, by comparing the Central European Free Trade Agreement with Stabilisation and Association Agreements that the EU has with Western Balkan countries, it identifies areas of less economic integration under the former. Third, it focuses on intra-Western Balkan trade barriers and how the associated costs influence regional integration. Finally, the paper describes the structures of Western Balkan economies and how much they contribute to regional exports through domestic value added. The paper emphasises the importance of regulatory alignment for reducing trade barriers and the role of funds under the EU Growth Plan for the Western Balkans for investment in transport infrastructure within the region. It finds that the Central European Free Trade Agreement and Common Regional Market should focus on untapped potential, especially in the liberalisation of capital, services and movement for employment. Infrastructure issues, trade logistics and the tackling of technical barriers to trade should feature prominently on the policy agenda.
Topic:
Governance, Macroeconomics, Trade, and Trade Policy
Political Geography:
Europe and Western Balkans

508. Implementing the EU Nature Restoration Law: exploring pathways for member states

Author:
Heather Grabbe, Bas Heerma van Voss, Camille Mehlbaum, and Sjoerd van der Zwaag
Publication Date:
06-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
The European Union Nature Restoration Law (NRL) entered into force in 2024. The NRL sets quantitative restoration targets aimed at improving natural habitats that are currently in poor condition, with substantial leeway for countries to choose implementation pathways that fit their priorities. This Working Paper examines three pathways: (1) evenly spreading restoration efforts across all ecosystems; (2) prioritising cost-efficiency; and (3) maximising carbon sequestration. Each approach yields vastly different outcomes. This paper provides insights into the trade-offs. For countries seeking to minimise costs in the short run, an 81 percent reduction in costs over the period 2025-2030 is possible compared to a baseline scenario of an even restoration of all ecosystems. Countries that aim to maximise carbon sequestration benefits can achieve a 54 percent increase in climate impact over the same period. However, the different pathways converge after 2040. Prioritising cost minimisation in the early years could lead to higher costs later if delays in investment in the more costly restoration projects allow habitats to continue to degrade. Maximising cost-efficient carbon sequestration is possible, allowing relatively low investment costs and high sequestration. Countries should adopt a holistic approach to pathway selection, considering the full spectrum of ecological and societal gains alongside climate mitigation. Land ownership is an important factor that shapes feasible and effective pathways. In countries such as Spain and Germany, where private entities own substantial shares of agricultural and forest lands, policies should incentivise private investment, including through norms, subsidies or pricing mechanisms. Countries with substantial public landholdings, such as the Netherlands, may find it easier to implement direct restoration projects. These structural differences will influence the cost and pace of restoration and also the design of policies and governance mechanisms to ensure compliance with NRL targets.
Topic:
Climate Change, European Union, Decarbonization, Green Deal, Energy, and Carbon Sequestration
Political Geography:
Europe

509. European export finance needs a reboot

Author:
Conor McCaffrey and Niclas Poitiers
Publication Date:
06-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Export credit agencies (ECAs) play an important role in international trade by providing derisking instruments that function as public assistance to companies engaging in international commerce. As the geopolitical environment has become more fraught, this support has become ever more important. In recent years, the role of ECAs has evolved from a purely commercial one to include the pursuit of strategic goals, such as fighting climate change, shaping trade relations with key partners and securing access to critical raw materials. However, the system of European export credit agencies is not well equipped to deal with these challenges. ECAs are national with a variety of models and not all European Union countries have one. There is little transparency on their operations, very limited steering at the EU level and, beyond a small pilot project in Ukraine, no EU-level funding for European public goods. Non-EU ECAs have increasingly used funding instruments not available to EU ones, partly because of competition from countries not subject to the OECD Arrangement on Officially Supported Export Credits and state aid constraints. This makes the lack of coordination not only a strategic oversight but a potential competitive disadvantage. For these reasons, we argue that reform of the European ECA sector is necessary. We advocate for improved transparency and EU-level steering to ensure European strategic objectives are met. More complex is the question of how European public goods could be adequately supported by ECAs. Several models are possible, with the most promising option being EU level funding for projects implemented by national ECAs coupled with some form of EU level oversight.
Topic:
Governance, Regulation, Exports, Macroeconomics, and Financial Literacy
Political Geography:
Europe

510. How can Europe’s nuclear deterrence trilemma be resolved?

Author:
Andrea Gilli and Francesco Nicoli
Publication Date:
06-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
The United States under President Donald Trump has adopted an ambiguous position on European security. Although no immediate risk of abandonment is apparent, European countries are rethinking their defence strategies in case the US declines to support them, or provides only partial support, in a crisis. This discussion is particularly sensitive in relation to nuclear weapons, the ultimate deterrent, for which European countries depend extensively on the United States. We argue that a possible future US withdrawal from European nuclear security will force European countries to face a policy trilemma. If they stick to the existing policy framework of no proliferation and no joint deterrence, they expose themselves to nuclear blackmail, should the US withdraw its external guarantee. If they want to protect themselves from nuclear blackmail, they must choose how to provide nuclear security: either collective nuclear security, which would compromise some national sovereignty, or independent provision by individual countries, leading to nuclear proliferation in Europe. Having established that uncontrolled proliferation is an inferior outcome to some form of joint deterrence, we identify four main alternatives: an extension of the Franco-British nuclear deterrent; an extension complemented by a jointly financed expansion of existing deterrence; the absorption of the French (and perhaps British) nuclear arsenals into a European arsenal; and the construction of a separate European submarine deterrent (with Europe using French or British technology or developing new technology). We also discuss briefly forms of non-nuclear deterrence, which however would likely be a complementary rather than a substitute for a nuclear deterrent. We compare these options using a set of parameters: strategic autonomy and credibility, changes to treaties (including non-proliferation), costs, capabilities and readiness. Our analysis shows that all options have advantages and disadvantages, but some are politically, financially and militarily more feasible.
Topic:
Security, Arms Control and Proliferation, Industrial Policy, Nuclear Weapons, Geopolitics, Macroeconomics, Deterrence, Transatlantic Relations, and Vulnerability
Political Geography:
Europe, North America, and United States of America