In the latest issue of The Economist (20 February, Disciplinary Measures) Daniel Gros of CEPS, Brussels, and Thomas Mayer of Deutsche Bank also advocate the kind of European Monetary Fund recommended by Giuliano Amato (see our previous post).
Their EMF would mimic the IMF in "having a professional staff remote from direct political influence and a board with representatives from euro-area countries." It "would conduct regular and broad surveillance of member countries"; "its main role would be to design, monitor and fund assistance programmes for euro-area countries in difficulties, just as the IMF does on a global scale". An IMF clone - so far. The main differences between the two Funds would concern funding, disbursements and sovereign default.
For its funding the EMF would borrow "in the markets with the full and joint backing of all its member countries", but "Only those countries in breach of set limits on governments’ stocks and annual deficits would have to contribute, giving them an incentive to keep their finances in order”. “Countries could, for instance, be charged an annual contribution of 1% of their “excess debt”” over the Maastricht limits of 60% of GDP, and of their excess deficit over 3% or GDP. Gros and Mayer reckon that by these rules the EMF would have accumulated €120 bn over the last decade; in 2009 Greece would have had to contribute 0.65% of GDP. A fine way of deterring moral hazard behaviour, but an additional burden both on the profligate country in need of assistance, like Greece, and on the club of delinquent countries (like Spain Portugal Italy Ireland) that share a similar predicament. Surely if the EMF had borrowed on international markets “with the full and joint backing of all its member countries” the richer and more disciplined countries could not ignore their commitments; its creditors would see to that.
Disbursements to member countries would be made up to the amount each has contributed in the past to the EMF – i.e. would depend strictly on earlier large scale financial indiscipline – conditionally on their fiscal adjustment programmes being approved by euro-area finance ministers, with tougher conditions (including EMF status of privileged creditor) applying to withdrawals above past contributions. Further finance would be tied to specific, authorized purposes.
Finally, in case of sovereign default the EMF would “offer all holders of debt issued an exchange against new bonds issued by the EMF”, requiring creditors to take a uniform “haircut” (=loss) in order to protect taxpayers. Nothing new here, we are only replicating old-style Brady bonds. “The EMF could, for example, tie its guarantees to the 60%-of-GDP Maastricht limit on debt, so that creditors of a country with a debt stock of 120% of GDP would face a 50% haircut”: this is a very neat and ingenious disciplinary mechanism. “The EMF would only exchange debt instruments that had been registered with it beforehand”. This is to say, cosmetic derivatives traded with Goldman Sachs would not be covered.
Certainly such a European Monetary Fund would be better than “muddling through on the basis of ad hoc interventions”, as Gros and Mayer say. Ten years ago Daniel Gros used to advocate unilateral euroisation by transition economies, relying on foreign banks to provide the necessary euro liquidity at all times; the EMF scheme is more realistic.
But what is the value added of this “in house solution” with respect to what is on offer from the IMF? A duplicate set of functionaries, duplicate surveillance and monitoring and associated reports, duplicate draft stabilization plans embodying the same deflationary policies. No sovereign encroachment by outside bodies, but a lot of sovereignty encroachment by European agencies in the form of offers that cannot be refused. “A euro-zone country that refused to abide by the decisions of the EMF could choose to leave the EU, and with it the euro, under article 50 of the Lisbon Treaty. But the price of doing so would be very great”. First, the Treaty's draftsmen were so keen not to encourage the notion that dissolving EMU was a feasible option that there are no rules at all for either exiting the euro-area or expelling a member. Second, raising the stakes (tougher conditionality) may raise the probability of winning a game, but at the cost of making the loss catastrophic (EU exit) if the game is lost.
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7 comments:
I would be more positive than you seem to be about the Gros-Mayer proposal. Although, if the EMF is funded mostly by high-deficit/high-debt members, the proposal might be more acceptable to Germany than otherwise but it might be harder to establish adequate conditionality.
Are there not already penalties in force for excess deficit countries?
"Are there not already penalties in force for excess deficit countries?"
Yes, but they have never been applied and in the form presently envisaged they are probably politically inapplicable. It the excess debt countries were compelled to reduce their debts in better times there would be no such problem of sovereign risk in a period like the present when fiscal tightening may be conjucturally perverse.
Good point, Anon.
And yes, Claude, there are penalties but as Chilosi rightly says they have never been applied.
The 3% ceiling on the deficit/GDP ratio, applicable to all EU members in virtue of the so-called Growth and Stability Pact, regardless of whether or not they belong to the euro-area, can be exceeded in case of a grave recession of over 2% GDP decline or, with the Economic and Financial Committee (Ecofin) permission, of a GDP decline between 0.75% and 2%. Excess deficits must be eliminated within a year, failing which – subject to an Ecofin decision – discretionary penalties are applicable consisting in an interest-free deposit convertible into a fine in case of failure to observe the 3% constraint for two consecutive years, at the discretion of the Council. This deposit is calculated as 0.2% of GDP plus 1/10 of the excess deficit over 3%, up to a maximum fine of 0.5% of GDP.
However, the 3% constraint has been systematically violated by various recidivist EU and EMU members, without the application of any penalties. The 3% ceiling has been considerably softened by the March 2005 SGP reform, which extended the stabilisation period to two years, and made allowances for public investment and for a long list of factors that might allow a “modest, exceptional and temporary” excess deficit. These factors include expenditure on innovation,research and development; the impact of structural reforms and in particular that of pensions; contributions for international solidarity; the costs of European unification (and German unification). Low-debt countries with a high growth potential are allowed an average deficit of 1% over the cycle instead of zero.
New EU members (that joined the EU in 2004 or later) can continue to exceed the 3% deficit ceiling until a year before they wish to be considered for EMU membership – although, inexplicably, they are exposed to a much more severe maximum penalty than an interest-free deposit of 0.5% of GDP, namely the Ecofin can suspend transfers from cohesion and structural funds from the EU budget, which are subject to a ceiling of 4% of the recipients’ GDP and averages about 2% of their GDP. Such penalty has been threatened once (to Hungary) but, needless to say, has never been applied either.
So, the discipline is there formally but not in practice. A very bad precedent and an extremely poor foundation for funding a European Monetary Fund out of penalties on countries that contravene SGP or Maastricht ceilings. This is not a serious proposition.
"They are exposed to a much more severe maximum penalty than an interest-free deposit of 0.5% of GDP, namely the Ecofin can suspend transfers from cohesion and structural funds from the EU budget"
This is obviously hardly palatable politically, but still quite feasible, since, unlike the 0,5% deposit, it does not require the cooperation of the offending country, which may well be little inclined to cooperate in being sanctioned. (What is the sanction if the country does not make the deposit and does not pay the fine?)
But may I offer some ideas for a more feasible discipline?
First in a future improbable reform of the treaties the Ecofin could get closer to becoming the missing European fiscal authority by being attributed the task to set yearly with a qualified majority the limits to the admissible deficits having regard to the specific conjunctural situation.
Secondly, sanctions should not be applied discretionally, but automatically, and should not require the collaboration of the offending state. For instance the offending state should be suspended from Econfin meetings until the offense continues (unless a qualified majority of the other representatives decides to the contrary). By the way, this kind of procedure could be applied to offending states in other areas of the EU (a country such as Italy systematically offending in the area of milk quotas should be barred from the council of Agriculture Ministers). Additionally the European Central Bank should refuse to accept in open market operations and as a guarantee in refinancing operations the securities of the offending state. Some automatic measures delaying or reducing the payments from the Communities budget could be also envisaged.
On the other hand it is not always realized how much the continuance of the EU depends on abiding to the rules by any single state, and how much fragile this can be. Let us suppose, for instance, god forbids, some starts to refuse the application of the rulings of the European Court of Justice... This may be an argument for making sanctions both moderate and concretely feasible, but effective, which by no means is the case with the stability pact.
An EMF similar to IMF and its mandate is the wrong solution. We need to be original. My proposal at
http://mgiannini.blogspot.com/2010/03/stronger-case-of-eu-bonds-common.html
is simple but you have to start with common issuance of EU bonds which are legally national securities but administered at EU level with a system of cross-guarantees. Later on a EU financial transaction tax will gradually fund EU bonds issuances as a kind of EU budget own resource. As a third step the European Monetary Fund will become the agency institutionalizing the common issuance of EU bonds. Yet I do not agree that this fund be financed with penalties on countries deviating from the Stability Pact. It's a nonsense.
In other words the EMF is to be set up but not exactly for the purposes and with the objectives to deal with euro area member countries in financial difficulties, imposing IMF style conditionalities, and capable of organizing an orderly default as a measure of last resort. Do we really need that? I do not think so...
An agency "institutionalising the common issuance of EU bonds" may indeed be desirable. Of course it could not be financed with hypothetical virtual penalties on the failure to comply with the Stability Pact, and I am sceptical about a financial transaction tax, easily evaded or avoided in a global world. Such an agency would not act as bailer-out of last resort or, if it did, would have to replicate IMF conditionality.
I agree that there is no point in an EMF replicating the IMF, but I draw from this proposition the conclusion not that we should be original, but that we should not have an EMF.
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