From the site LAVOICE.INFO
Complete the crisis management system in the euro area
After the summer hurricanes, and while perhaps others are preparing for the autumn, we can try to take stock of the crisis management system in the Eurozone. Two aspects stand out: first, on all major fronts eurozone governments have moved in the right direction, albeit often too little too late (Wyplosz 2011); secondly, there is some consensus among experts on what should be done to stabilize financial markets and secure the eurozone.
Remove the root causes of financial instability
The eurozone sovereign debt crisis originates in the real economy. In its conclusions of March 2011, the European Council decided on a radical overhaul of economic governance and new economic policy guidelines for the euro area which in principle would be able not only to strengthen budgetary discipline, but also to gradually remove economic rigidities underlying assets and divergences in costs and wages. It is true that the Council has not been very effective in enforcing common policies by member states in the past, but in the future financial markets can be expected to play an important role in keeping states on the straight and narrow with the threat of penalizing spreads on their titles. Furthermore, in the recent letter to van Rompuy, Merkel and Sarkozy propose new measures useful for strengthening fiscal discipline at the national level, including constitutional rules on balanced budgets such as in Germany (France, Italy and Spain have already indicated their intention to adopt them ), the recommendation to link the structural funds to the necessary economic reforms with explicit conditionality. If national safeguards are strengthened, a supranational tax authority is unnecessary – although some enhanced transparency mechanisms at EU level, as suggested by Burda and Gerlach (2010), would help.
The new European procedure, with legal force, to prevent excessive imbalances and the European Systemic Risk Board should in the future prevent the accumulation of excessive private debt. To this end, the Board or the ECB should be empowered to selectively impose increases on banks' reserve requirements or capital when credit accelerates excessively in some member states. Current mechanisms leave this responsibility to national authorities, which is too weak a solution.
Debt sustainability also requires decisive support for growth, which is dramatically decelerating and which will not come simply from better public finances and cost convergence, things which indeed initially tend to depress economic activity, worsening debt sustainability (Wyplosz 2011 ). Therefore, at its October meeting, the European Council would do well to focus attention on growth strategies (see Amato et al. 2010): including measures to open services markets and accelerate investment in the EU in energy, transport and communications networks in the internal market, to be adopted with accelerated procedures.
Stabilize expectations
Solving the economic problems at the root of the eurozone debt crisis will not be enough if financial markets fear that sovereign debts will not be serviced: the problem is how to break the vicious circle of self-reinforcing expectations following increasingly bailouts large – essentially fueled by the fear that at some point Germany will no longer be willing to shoulder the burden of residual guarantor of eurozone sovereign debt obligations (De Grauwe 2011a). In order to do this, the eurozone must collectively be much more willing to use the euro to stabilize government debt markets and to issue union bonds, through the Common Stability Facility, as needed to ensure that stressed sovereign debts can be renewed in an orderly manner while stabilization measures are implemented (De Grauwe 2011b, Eichengreen 2010, Gros and Mayer 2011, Micossi 2011b, Wyplosz 2011).
The role of the ECB…
In this respect, the ECB already has, according to Article 18.1 of its statute, all the necessary powers to be able to act as lender of last resort to stabilize the banking system and the government bond markets, but has been rather reluctant to use these powers to buy the bonds of countries in crisis – also due to the firm opposition of some members of its governing council. But when the collapse of the markets appeared possible again, for example in November 2010 and in recent weeks, the interventions of the ECB were effective in averting it. These interventions are regularly sterilised, so as to avoid unwanted easing of monetary policy; nor do they imply any direct granting of credit to debtors in crisis, given that the purchases of securities take place on the secondary market.
However, the ECB does not want to remain trapped with large quantities of debt securities of crisis countries that could one day be subject to a restructuring, eroding their capital and jeopardizing their independence. But the problem would be solved if the EFSF, which would become the European Stability Mechanism (ESM), had the power to acquire these bonds and offer the ECB Union bonds in exchange, supported by the collective guarantee of the member states. The bonds of countries in difficulty would be acquired by the EFSF as part of the financial assistance program for countries in crisis that issued them, and could be returned to them with buy-back mechanisms. Thus the EFSF would not bear any additional risk on these securities beyond that already implicit in the financial assistance loans. An alternative option would be to transform the EFSF (and the ESM) into a bank and allow it to carry out open market operations directly, drawing on an unlimited credit line from the ECB, as proposed by Gros and Mayer (2011); however, it is probably preferable for the ECB to handle all open market operations.
A separate question is whether the ECB should abandon its obsession with price stability and expand liquidity more aggressively – even, if necessary, with quantitative easing (Valiante 2011).
… and the EFSF
As regards the EFSF, important decisions have already been taken by the Council of Heads of State and Government of the Eurozone on 11 March to increase its resources (up to an effective amount of €440bn, later €500bn when the Stability Fund is made permanent), and on 21 July, with the extension of the operational powers of the EFSF to various secondary market and financing operations. After the customary initial confusion and divergent public statements, member states pledged to put those decisions into effect by the end of this month – and the news helped calm financial markets.
Two issues remain which require the Council's attention. First, even after recent increases, the resources available to the EFSF are insufficient to produce a convincing deterrent against market attacks on a large eurozone member state (Gros and Giovannini 2011). One possible approach to bolster its ammunition would be to transform current member states' commitments into permanent (on call) capital of the EFSF, and amend its statute to allow it to issue debt securities on the market up to three times its capital . A firepower of 2008 trillion euros should be enough to convince financial markets that the eurozone will not fall apart. With its own capital, the EFSF would also be able, under most foreseeable circumstances, to directly bear all the risks associated with its lending activity, the guarantee of which by the member states would only represent a last resort, to which it is unlikely that an appeal will ever have to be made. The direct link between individual EFSF funding operations and national budgets would effectively be severed. Member states' sovereign debt ratings would in all likelihood remain unaffected. De facto, a European Monetary Fund would be born, as proposed for the first time by Gros and Micossi (XNUMX).
The second problem facing the Council concerns the governance of the EFSF (De la Dehesa 2011, Micossi 2011a). According to the provisions in force, the decision to grant financial assistance to a member state in difficulty requires the unanimity of the "governors" of the EFSF, ie the finance ministers of the member states of the eurozone. Naturally, decisions on the EFSF's lending policies must remain with the governors, but implementation should be left to the executive body, as in the IMF. This aspect is particularly important not only to remove decisions on financial assistance from the whims of national politics, but also to ensure the speed of action necessary in an emergency.
What about Eurobonds?
Eurobonds are a good idea but have turned into a diversion. Most proponents of Eurobonds understand them as a scheme to replace large-scale national government bonds with jointly issued (and guaranteed) Union (or Eurozone) bonds (Gros 2011, Micossi 2011a). The underlying rationale is that in this way all national government bonds would end up having the same quality – presumably closer to that of better rated government bonds – and any fear of sovereign default would vanish.
It is clear, however, that no such scheme will ever be acceptable to public opinion in Germany and Northern Europe without a full political union and complete centralization of budgetary policies (De Grauwe 2011a). In this regard, Gros (2011) has drawn attention to the enormous differences not only in fiscal conditions, but also in the quality of public sector governance mechanisms as insurmountable obstacles to rapid progress in this direction. Therefore, the many discussions on the benefits of liquidity and the costs of financing in the various innumerable schemes that have been proposed seem underproductive, because initiatives of this type are politically unthinkable. Indeed, they can be counterproductive, because they mobilize public opinion in the creditor countries of the eurozone against the bailout operations.
However, many of the benefits associated with issuing Eurobonds can also be obtained without transferring sovereign liabilities from one member state to another. This would be precisely the case in the scheme discussed above, with the EFSF endowed with its own capital and able to issue large-scale co-collateralised bonds to offer financial assistance, recapitalize banks and swap debt securities (at market prices) for preserve the stability of the eurozone. By strengthening the eurozone's ability to resist speculative attacks, bonds would make the latter much less likely.
REFERENCES
Amato G., Baldwin R., Gros D., Micossi S. and Padoan PC (2010), A new political deal for Eurozone sustainable growth: An open letter to the President of the European Council, Voxeu.org, 7 December.
Burda M. and Gerlach S. (2010), A credible stability and growth pact: raising the bar for budgetary transparency, Voxeu.org, 17 June.
Council of the European Union, Statement by the heads of state or government of the euro area and EU institutions, 21 July 2011.
De Grauwe P. (2011a), Governance of a Fragile Eurozone, CEPS Working Documents, 4 May 2011.
De Grauwe P. (2011b), The European Central Bank as a lender of last resort, Voxeu.org, 18 August.
De la Dehesa G. (2011), Eurozone design and management failures, Voxeu.org, 18 May.
Eichengreen B. (2010), Drawing a line under Europe's crisis, Voxeu.org, 17 June.
European Council (2011), Conclusions of the 24/25 March meeting.
Gros D. (2011), Eurobonds: wrong solution for legal, political and economic reasons, Voxeu.org, 24 August.
Gros D. and Giovannini A. (2011), The EFSF as a European Monetary Fund: does it have sufficient resources?, CEPS Commentary, 22 July.
Gros D. and Mayer T. (2011), What to do when the euro crisis reaches the core, CEPS Commentary, 18 August.
Gros D. and Micossi S. (2008), A call for a European Monetary Fund, Voxeu.org, 30 October.
Merkel A. and Sarkozy N. (2011), Letter to President van Rompuy, 16 August.
Micossi S. (2011a), On the tasks of the European Stability Mechanism, 15 March.
Micossi S. (2011b), Eurozone crisis: are we losing the patient?, Voxeu.org, 18 August.
Valiante D. (2011), The Eurozone debt crisis: from its origins to a way forward, CEPS Policy Brief No. 251, August 2011.
Wyplosz C. (2011), They still don't get it, Voxeu.org, 22 August.
