The potential creation of a European Monetary Fund has suddenly gained currency in the policy debate, after key German government officials have expressed explicit support for the idea. In my view, this would be an extremely counterproductive move: it would be an admission of defeat, it would give birth to a redundant regional policy institution at a time when the need for global policy coordination has been amply demonstrated, and it would distract attention from the steps needed to really enforce macroeconomic policy discipline within the eurozone. The fact that ECB and eurozone officials still protest that the Stability and Growth Pact has been working perfectly well is risible, but jumping to the conclusion that we will never be able to make it work seems extreme. The EMF proposal shows how developments in Greece have brought policymakers to realize that a fundamental overhaul of the eurozone’s institutional setup is needed. Unfortunately, the EMF is the wrong solution. The eurozone needs stronger and binding mechanisms to effectively enforce fiscal discipline and coordination, which will ultimately require a greater degree of political integration. It would be a huge step, but one that could ensure IMF-style rescues will not be needed. An EMF, instead, would be just a less experienced and likely less effective clone of the IMF, set up in the expectation that crises and rescues will become part and parcel of the eurozone’s life. It would be a needless waste of time
and of precious political resources.
Eurozone policymakers, from ECB officials to finance ministers, have reiterated over the past several weeks that Greece does not need financial help. Yet advocating an EMF implies expecting that we will in fact see periodical debt crises within the eurozone. This is an ironic contrast to the current official rhetoric, and it is a stunning admission of defeat, as it sends the message that the eurozone does not believe it will ever be able to set up binding mechanisms to enforce budget discipline. The fact that ECB and eurozone officials still protest that the Stability and Growth Pact has been working perfectly well is risible, but jumping to the conclusion that we will never be able to make it work seems extreme.
Secondly, if we expect that rescue operations will be needed, why should they not be handled by the International Monetary Fund? What is the rationale for cloning, at a smaller scale, the IMF, an institution that has accumulated decades of experience in dealing with debt crises and in designing and managing macroeconomic adjustment programs? The driving motivation, unfortunately, appears to be regional pride. IMF interventions in support of eurozone members would not be “appropriate”, as ECB President Trichet, put it, because the IMF is an international rather than a European institution, and Europe must show it can solve its problems on its own. I find this rationale completely misguided and lopsided. The eurozone’s ambition was to set up mechanisms that would prevent the insurgence of macroeconomic and financial problems of this magnitude. So far, manifestly, it has failed. Cleaning up the mess in-house may soothe the European pride, but it does not seem to bring any concrete benefits in and of itself. When Asian countries considered setting up an Asian Monetary Fund, an important reason was their dissatisfaction with the policy response imposed by the IMF during the late 1990s crisis; but if the handling of the Greek situation is any guide, the eurozone’s intention would be to impose exactly the same orthodox adjustment measures as the IMF, not to adopt different recipes.
So we have to ask, could an EMF be more effective than an IMF? It seems extremely unlikely. An institution like the IMF or the mooted EMF has two primary purposes. First, prevention: fostering the adoption of sound policies, monitoring deviations and calling for swift corrections where needed. Second, crisis resolution: stepping in to help countries in trouble with financial assistance tied to policy conditionality aimed at putting the country back on course. The IMF’s track record on prevention is admittedly disappointing, particularly as regards developed economies: the IMF has traditionally been far too timid and restrained in criticizing the policy failings of its main shareholders, its surveillance has proved largely toothless, and under its watch developed economies have accumulated the macro and financial imbalances which eventually resulted in the subprime crisis. Having said this, the eurozone has equally failed on prevention, and for some of the same reasons: the political inability to impose sanctions or even raise sufficiently harsh criticism against underperforming countries. The SGP mandates fines for serious violations of its deficit ceilings—yet these have never been imposed; leading countries like Germany and France have blatantly violated the SGP in 2002-03 and outright blocked the excessive deficit procedures which should have been launched against them at the time, showing that the rules do not apply if you are powerful enough. Setting up an EMF would do nothing to address these problems.
Would an EMF do a better job than the IMF at crisis resolution? I really do not believe so. Let us leave aside the issue of technical expertise, which the IMF already possesses and that the EMF would need to duplicate building it from scratch. The IMF enforces compliance with the agreed policy conditionality by threatening the cessation or delay of further disbursements. Political considerations sometimes come into play and can over-ride the IMF staff’s technical assessment, but the broad and diverse structure of the IMF’s Board provides some safeguard. By contrast, the board of an EMF would consist entirely of countries that would suffer from the contagion triggered by instability in one member country, exacerbating the moral hazard problem. It has been suggested that an EMF would have a wider set of “sticks”, including for example suspending the disbursement of structural funds and declaring the debt of the country not eligible as ECB collateral. But all these instruments could already be deployed to enforce compliance with the SGP. The fact that they are not shows once again that there is a lack of political commitment to establish effective enforcement mechanisms, and that fundamental underlying problem would not be addressed by creating a new institution.
A further issue is how the EMF would be funded. Daniel Gros and Thomas Mayer, in their well articulated proposed blueprint, suggest it should be funded via annual contributions proportional to each country’s excess debt and fiscal deficit over and above the SGP limits. But this system would be very similar to the fines already envisioned under the SGP, which as we know have never been imposed. Moreover, given that the 60% of GDP debt ceiling has never been enforced, not even at inception, levying a tax on excess debt at this stage would be seen as a sudden change in the rules of the game, and it seems extremely unlikely that eurozone governments would accept it. The underlying idea is that countries with weaker fiscal policies, and therefore more likely to need a rescue, should contribute more. In principle this should encourage fiscal discipline, and at the same time ensure that virtuous countries do not have to put up a significant amount of money. But this in my view raises a tricky issue of institutional design: the IMF is based on a system of quotas, which are related to GDP and which in turn determine each country’s contributions and voting rights. As a consequence, within the IMF the countries carrying the greater voting power are those which contribute the most and that tend to be the larger economies. If contributions to the EMF were proportional to debts and deficits rather than GDP, we would have two possibilities: either link voting rights to contributions, in which case however the fiscal “sinners” would carry a greater weight than the fiscal “saints”, which surely would not bode well for the strength of the conditionality; or alternatively distribute voting rights according to a different criterion, say GDP, in which case though the countries contributing more would certainly object at having less power.
This might turn out to be a moot point, however, as it is extremely implausible that contributions from high deficit/high debt countries could provide sufficient funding—which implies that stronger countries would in fact need to set money aside for potentially rescuing their weaker partners. One possibility would be to allow the EMF to raise funds by issuing its own bonds, and then park the cash in safe, highly rated eurozone government bonds, which could be liquidated when a member country seeks assistance. But again, that would still mean that the stronger countries would stand ready to underwrite the rescue. Gros and Mayer also argue that an EMF could provide a mechanism for orderly defaults in cases where a country continues to deviate from the prescribed policy conditions—indeed in their proposal this would be perhaps the strongest advantage of the new institution. To achieve this, the EMF would stand ready to exchange all defaulted debt against EMF bonds, at a substantial haircut, which could also be proportional to the country’s excess debt over the SGP ceiling. Here I have two concerns. The first is that a substantial haircut would still allow for a substantial contagion effect: if I have just lost 50% of my investment in the bonds of a highdebt country, I will quickly sell off or require a very high premium for holding bonds of other high-debt countries. The second is that to take over the entire outstanding debt stock, even at a haircut, the EMF would need to be able to acquire considerable power over the country’s future policymaking, implying a dramatic curtailment of sovereignty which seems unlikely to be accepted under any circumstances.
Bottomline: there is no doubt that the existing institutional setup of the eurozone is inadequate and needs to be overhauled; and there is no doubt that changes have to go in the direction of greater fiscal integration, which in turn requires greater political integration. These are the issues on which the policy debate should focus, to build the consensus needed to overcome the enormous and understandable resistance that governments oppose to any further curtailment of national sovereignty. If this quantum leap can be made, the eurozone could finally give teeth to the SGP and ensure effective enforcement of sound policies. There would then be no need for an EMF. If this quantum leap proves impossible, sovereign debt crises may well become a fact of life in the eurozone, but their handling should be left to the IMF, which already has the expertise, the financial resources, and probably a better incentive structure than a purely European institution would have. Setting up an EMF would distract attention from the main underlying problem—namely the lack of binding mechanisms to effectively enforce fiscal discipline, and ultimately the insufficient degree of political integration—and would constitute a needless waste of time and resources.
and of precious political resources.
Eurozone policymakers, from ECB officials to finance ministers, have reiterated over the past several weeks that Greece does not need financial help. Yet advocating an EMF implies expecting that we will in fact see periodical debt crises within the eurozone. This is an ironic contrast to the current official rhetoric, and it is a stunning admission of defeat, as it sends the message that the eurozone does not believe it will ever be able to set up binding mechanisms to enforce budget discipline. The fact that ECB and eurozone officials still protest that the Stability and Growth Pact has been working perfectly well is risible, but jumping to the conclusion that we will never be able to make it work seems extreme.
Secondly, if we expect that rescue operations will be needed, why should they not be handled by the International Monetary Fund? What is the rationale for cloning, at a smaller scale, the IMF, an institution that has accumulated decades of experience in dealing with debt crises and in designing and managing macroeconomic adjustment programs? The driving motivation, unfortunately, appears to be regional pride. IMF interventions in support of eurozone members would not be “appropriate”, as ECB President Trichet, put it, because the IMF is an international rather than a European institution, and Europe must show it can solve its problems on its own. I find this rationale completely misguided and lopsided. The eurozone’s ambition was to set up mechanisms that would prevent the insurgence of macroeconomic and financial problems of this magnitude. So far, manifestly, it has failed. Cleaning up the mess in-house may soothe the European pride, but it does not seem to bring any concrete benefits in and of itself. When Asian countries considered setting up an Asian Monetary Fund, an important reason was their dissatisfaction with the policy response imposed by the IMF during the late 1990s crisis; but if the handling of the Greek situation is any guide, the eurozone’s intention would be to impose exactly the same orthodox adjustment measures as the IMF, not to adopt different recipes.
So we have to ask, could an EMF be more effective than an IMF? It seems extremely unlikely. An institution like the IMF or the mooted EMF has two primary purposes. First, prevention: fostering the adoption of sound policies, monitoring deviations and calling for swift corrections where needed. Second, crisis resolution: stepping in to help countries in trouble with financial assistance tied to policy conditionality aimed at putting the country back on course. The IMF’s track record on prevention is admittedly disappointing, particularly as regards developed economies: the IMF has traditionally been far too timid and restrained in criticizing the policy failings of its main shareholders, its surveillance has proved largely toothless, and under its watch developed economies have accumulated the macro and financial imbalances which eventually resulted in the subprime crisis. Having said this, the eurozone has equally failed on prevention, and for some of the same reasons: the political inability to impose sanctions or even raise sufficiently harsh criticism against underperforming countries. The SGP mandates fines for serious violations of its deficit ceilings—yet these have never been imposed; leading countries like Germany and France have blatantly violated the SGP in 2002-03 and outright blocked the excessive deficit procedures which should have been launched against them at the time, showing that the rules do not apply if you are powerful enough. Setting up an EMF would do nothing to address these problems.
Would an EMF do a better job than the IMF at crisis resolution? I really do not believe so. Let us leave aside the issue of technical expertise, which the IMF already possesses and that the EMF would need to duplicate building it from scratch. The IMF enforces compliance with the agreed policy conditionality by threatening the cessation or delay of further disbursements. Political considerations sometimes come into play and can over-ride the IMF staff’s technical assessment, but the broad and diverse structure of the IMF’s Board provides some safeguard. By contrast, the board of an EMF would consist entirely of countries that would suffer from the contagion triggered by instability in one member country, exacerbating the moral hazard problem. It has been suggested that an EMF would have a wider set of “sticks”, including for example suspending the disbursement of structural funds and declaring the debt of the country not eligible as ECB collateral. But all these instruments could already be deployed to enforce compliance with the SGP. The fact that they are not shows once again that there is a lack of political commitment to establish effective enforcement mechanisms, and that fundamental underlying problem would not be addressed by creating a new institution.
A further issue is how the EMF would be funded. Daniel Gros and Thomas Mayer, in their well articulated proposed blueprint, suggest it should be funded via annual contributions proportional to each country’s excess debt and fiscal deficit over and above the SGP limits. But this system would be very similar to the fines already envisioned under the SGP, which as we know have never been imposed. Moreover, given that the 60% of GDP debt ceiling has never been enforced, not even at inception, levying a tax on excess debt at this stage would be seen as a sudden change in the rules of the game, and it seems extremely unlikely that eurozone governments would accept it. The underlying idea is that countries with weaker fiscal policies, and therefore more likely to need a rescue, should contribute more. In principle this should encourage fiscal discipline, and at the same time ensure that virtuous countries do not have to put up a significant amount of money. But this in my view raises a tricky issue of institutional design: the IMF is based on a system of quotas, which are related to GDP and which in turn determine each country’s contributions and voting rights. As a consequence, within the IMF the countries carrying the greater voting power are those which contribute the most and that tend to be the larger economies. If contributions to the EMF were proportional to debts and deficits rather than GDP, we would have two possibilities: either link voting rights to contributions, in which case however the fiscal “sinners” would carry a greater weight than the fiscal “saints”, which surely would not bode well for the strength of the conditionality; or alternatively distribute voting rights according to a different criterion, say GDP, in which case though the countries contributing more would certainly object at having less power.
This might turn out to be a moot point, however, as it is extremely implausible that contributions from high deficit/high debt countries could provide sufficient funding—which implies that stronger countries would in fact need to set money aside for potentially rescuing their weaker partners. One possibility would be to allow the EMF to raise funds by issuing its own bonds, and then park the cash in safe, highly rated eurozone government bonds, which could be liquidated when a member country seeks assistance. But again, that would still mean that the stronger countries would stand ready to underwrite the rescue. Gros and Mayer also argue that an EMF could provide a mechanism for orderly defaults in cases where a country continues to deviate from the prescribed policy conditions—indeed in their proposal this would be perhaps the strongest advantage of the new institution. To achieve this, the EMF would stand ready to exchange all defaulted debt against EMF bonds, at a substantial haircut, which could also be proportional to the country’s excess debt over the SGP ceiling. Here I have two concerns. The first is that a substantial haircut would still allow for a substantial contagion effect: if I have just lost 50% of my investment in the bonds of a highdebt country, I will quickly sell off or require a very high premium for holding bonds of other high-debt countries. The second is that to take over the entire outstanding debt stock, even at a haircut, the EMF would need to be able to acquire considerable power over the country’s future policymaking, implying a dramatic curtailment of sovereignty which seems unlikely to be accepted under any circumstances.
Bottomline: there is no doubt that the existing institutional setup of the eurozone is inadequate and needs to be overhauled; and there is no doubt that changes have to go in the direction of greater fiscal integration, which in turn requires greater political integration. These are the issues on which the policy debate should focus, to build the consensus needed to overcome the enormous and understandable resistance that governments oppose to any further curtailment of national sovereignty. If this quantum leap can be made, the eurozone could finally give teeth to the SGP and ensure effective enforcement of sound policies. There would then be no need for an EMF. If this quantum leap proves impossible, sovereign debt crises may well become a fact of life in the eurozone, but their handling should be left to the IMF, which already has the expertise, the financial resources, and probably a better incentive structure than a purely European institution would have. Setting up an EMF would distract attention from the main underlying problem—namely the lack of binding mechanisms to effectively enforce fiscal discipline, and ultimately the insufficient degree of political integration—and would constitute a needless waste of time and resources.
