THE ACKNOWLEDGEMENT by Germany’s Finance Minister Wolfgang Schäuble of the need for a European Monetary Fund (EMF) is an important recognition of a critical deficiency in economic and monetary union. Learning from the Greek experience, the euro zone and the European Commission must now move to strengthen both economic governance and discipline, and to develop tools to deal with future potential sovereign debt defaults.
The challenge in devising a mechanism to handle default, particularly to reassure German monetary purists, lies in minimising “moral hazard”, the psychological safety net which feeds fiscal irresponsibility by allowing state policymakers the sense that their decisions will ultimately not have catastrophic consequences, that someone will come to the rescue. Strange as it may seem, that may mean making failure possible. In the case of Greece, the danger of contagion to other euro economies has resulted in rescue by fellow member-states becoming a real prospect, not to save Greece but the euro. Another case of “too big to be allowed to fail” and misconduct rewarded.
For that reason ECB chief economist Juergen Stark, an old-school German deficit hawk, yesterday vigorously defended the Lisbon treaty’s anti-bail-out prohibition and opposed the idea of an EMF, arguing that it would give perverse incentives to lax countries at the expense of states with solid finances. “Countries which have not abided by the rules, which profit unilaterally from the euro, without taking their duties seriously, should not be rewarded,” Mr Stark wrote in the paper Handelsblatt.
But it is possible to conceive of an EMF in which moral hazard is minimised and in which those “less responsible” states who breach the EU Stability Pact’s debt and deficit requirements actually pay for the fund. Such an EMF could meet even German bankers’ demands and perhaps has provided the basis for the conversion of Mr Schäuble and Chancellor Angela Merkel to the cause.
In a model proposed by economists Daniel Gros, of the Brussels think-tank CEPS, and Thomas Mayer of Deutsche Bank, euro member-states in breach of the Stability and Growth Pact would fund the EMF by contributing proportionately to the extent that their debts and deficits breach the pact targets – in effect the fund would be like an insurance policy. Such a mechanism, they argue, could have raised €120 billion since the launch of the euro, enough to bail out a moderate-sized country in default. The contribution system would itself be a disincentive to breaching the pact and discipline could be reinforced by rigorous conditionality under threat of loss of voting rights and structural funding. In the event of default, Nama-like, the EMF would buy up debt with a uniform “haircut”.
Such an EMF would make sense as a bulwark of the architecture of monetary union, or even for the whole EU, although that is politically less realistic. What may alarm Dublin most, however, with the Lisbon ratification trauma still raw, is the possibility – still unclear – that it may all require a new treaty.