Council on the Euro Zone Crisis - 23-7-12

7/31/2019 Council on the Euro Zone Crisis - 23-7-12

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New Economic Thinking

3. Solvingthecurrentcrisisisnotazero-sumgame.Instead,itisawin-winchoiceforbothcreditoranddebtorcountries.

1Theeconomicandpoliticallossesthataeurobreakupwillbringabout

arelikelytobeanorderofmagnitudelargerthanthepotentialtransfersrequiredtosolvethe

legacyproblems.However,lackoftrustbetweencreditorsanddebtorsisstoppingthemfrom

arrivingatmutuallybeneficialsolutions.Forexample,ifthedeficitcountriescouldcredibly

committofiscalrulesthatbringtheratioofnationaldebttoGDPdowntoreasonablelevelsin

thelongrun,thenthesurpluscountrieswouldhavelittleobjectiontonewdebtissuesinthe

shortruntosupportcountercyclicalfiscalpoliciesinthedeficitcountries,sincetheseadditional

debtswouldbetemporaryandcouldberepaid.Theproblemisthatitisdifficultforthedeficit

countriestomakeacrediblelong-termcommitmenttofiscalprudencesincethatwouldbind

futurevoters.Whatisneededarecreativewaystosolvethisproblembymakingsupport

availableinsufficientamounts,butalsoundersafeguardsandconditionsthatareboth

perceivedasfairbydebtorcountryvotersandcrediblebycreditorcountryvotersandthe

financialmarkets.

4. Althoughtheycontainedstepsintherightdirection,themeasuresannouncedbyeurozonepolicymakersonJune29andagainonJuly9didnotmeetthisthreshold.Agreeingona

timetableforcreatingasingleeuroareabankingsupervisorybodyandsubsequentlyallowing

directbankrecapitalisationfromtheESMwouldhelptoaddresscriticalshortcomingsofthe

eurozonedesignandthecrisisresponsesofar.However,thesummitdidnotpresenta

convincingplantostopthedownwardeconomicspiralinthedeficitcountries.Stabilisingbond

yieldsbasedonlyonexistingESMresourcesandinvestmentprojectsfinancedmainlybyexisting

E.U.structuralfundsandtheEIBdonotadduptoaconvincingpackage.Furthermore,the

summitofferednosharedvisionforthelongrunbeyondtheagreementoncommonEuropean

bankingsupervision.Butsuchavisionisneededtorestorethecredibilityofthecurrencyunionintheeyesofbothinvestorsandthegeneralpublic,andhencetorestoreconfidencein

governmentbondmarketsandstopcapitalflightfromthedeficitcountries.

II. Anewstrategywhichrecognizeslargecommongains

5. Acomprehensiveactionplanmustmeetfourobjectives. ItmustrestorefaithintheeuroareaandtheEuropeanUnionthroughacrediblepromiseof

abettertomorrowthatholdstheprospectforgreaterwelfareandmorestability

Itmuststabiliseinterestcostsandreversethedeclineofoutputandemploymentinthedeficitcountries;

ItmustbeconducivetoareductionindebtlevelsoverthemediumtermincludingpublicdebtinItalyandprivatedebtinSpain,butalsoelsewhereandsupportthecontinued

reductionofbalanceofpaymentimbalanceswithintheeurozone;

1Thisnoteusesthetermssurpluscountries,creditorcountries,ornorthinterchangeablytorefertocountriessuch

asAustria,Finland,Germany,Netherlands,andtheSlovakRepublic;anddeficitcountries,debtorcountries,crisis

countriesorsouthtoreferprimarilytoItalyandSpain.Ireland,Portugal,Greece,andCypruscouldalsobeconsideredto

beinthisgroup,buttheirsituationissomewhatdifferentbecausetheyareinIMF-EUsupportedadjustmentprogrammes.Weavoidthecentreversusperipheryterminologythathasbecomeengrainedinthelastyearbecauseacountrysuch

asItalyistoocentraltoEuropegeographically,economically,andhistoricallytobeconsideredpartoftheperiphery.


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Itmustaddressthefundamentalstructuralflawsinthecurrencyunion,bothtomakethesinglecurrencycredibleagainasalong-termpropositionandtomakeitmuchlesslikelythat

acrisisaswearewitnessingtodaywilleverrecurintheeurozone.

6. Thechallengeofcomingupwithsuchaplanrelatesinparttoactualorperceivedconflictsbetweentheseobjectives.Stabilisingoutputandemploymentintherecession-struckdeficit

countriesisimpossiblewithoutdelayingsomeoftheon-goingfiscaladjustmentandchannelling

moresupporttothedeficitcountries.Fromtheperspectiveofthesurpluscountriesthisraises

twoconcerns:howtoprovidesupportwithoutoverstretchingthefiscalresourcesinthesurplus

countriesthemselves,andhowmaintainincentivesforadjustmentintheeventthatstabilisation

succeeds.Arelatedconcerniswhetherthecurrencyunionisworkablewithoutpermanent

transfersinthefuture.ExceptinthecontextofaEuropeansuper-stateinwhichfinancingand

controlofspendingaretightlylinked,amajorityofthepopulationinthesurpluscountries

believesthatapermanenttransferunionistoohighapricetopayforthepreservationofthe

singlecurrency,evenifthealternativeisacatastrophiccrisis.Theresistancetoscaled-up

supportasameansofgettingoutofthecurrentcrisisisinpartduetothefactthatitisviewed

asthefirststeptowardsuchatransferunion.

7. Hence,theCouncilbelievesthatthecriticalrequirementfortacklingthecrisisistoseparatethesolutionofthelegacyproblemstoppingtheon-goingrecessions,reducingdebtlevels,and

loweringcurrentaccountsurplusesanddeficitswithinthecurrencyunionfromtheproblemof

fixingthestructuralflawsoftheeurozoneforthelongterm.Theformerrequiressignificant

burdensharing.Butitdoesnotfollowthatthelatterrequirespermanenttransfersorjointlyand

severallyissueddebt.

8. Asfarasthelegacycostsareconcerned,Europeanpolicymakersinthesurpluscountriesmustmakeanefforttoconvincetheirvotersthatsignificantburden-sharingisnotonlynecessaryto

stopthecrisis,butalsojust,andthatitcanbereconciledwithandindeedisnecessaryfor

goodincentives.

Itisnecessarybecausedeficitcountrieswillotherwiseremainstuckinaspiralwherefiscaladjustmentdepressesoutputintheshortrun,makingitharderfor

theprivatesectortorepayitsdebts,puttingpressureonassetpricesandasset

qualityofbanks,constrainingcredit,andfurtherdepressingoutputandrevenue,

whichunderminesfiscaladjustment.Thisleadstoabreakupoftheeurozone,

whichimposeslargelyavoidablebutveryhigheconomicandothercostsonboth

surplusanddeficitcountries.

Itisjustbecausetheproblemsthatthedeficitcountriesarestrugglingwithwerenotcausedbythesecountriesinisolation,butweretheresultofaflawedeuro

zonedesignthatencouragedbothrecklessborrowing(inthedeficitcountries)

andrecklesslending(inthesurpluscountries).Hence,allcountriesthatsigned

uptothisdesign,andtookpartinthelendingandborrowingboom,bear

responsibilityforthecrisis.

Itisconsistentwithgoodincentivesaslongas(1)theburdenofpayingforfinancialsystemlossesisinthefirstinstancetakennotonlybytheequity


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holdersbutalsothecreditorsofthebanksthatwereengagedinover-lending

(bothinsurplusanddeficitcountries),andonlyinthesecondinstancebythe

taxpayersstandingbehindthebanksandbankcreditors;(2)ittakesamedium

termview,inwhichhighdebtcountriescommittoadjustmentpathsandreceive

supportconditionaloncontinuedadjustment.

9. Asfarasthelong-termvisionisconcerned,wedonotbelievethateurozonebonds,orafullfiscalunion,arenecessarytoensureafunctioningeconomicandmonetaryunion.Instead,the

extentoffiscalunionmustbedeterminedbytheneedsofthe financialunion(particularlythe

institutionsgoverningtheintegratedEMUbankingsector)thatisthenecessarycomplementto

theEMUasameanstofostereconomicprosperity.WhilemanyCouncilmembersbelievethat

furtherfiscalandpoliticalintegrationInEuropeisdesirable,wedonobelievethattheyare

necessarytomakeaneconomicsystemwithasinglecurrencyviable.Thus,ourproposalaimsto

buildtheminimumsetofinstitutionsnecessarytoexitthecurrentcrisis, andestablishasolid

futurefoundationfortheeuro.

10.Consistentwiththeviewthatanyplantoovercomethecrisismustbeginbyrestoringthecredibilityofaneconomicallyprosperoussystemthatembodiesasinglecurrency,theremainder

ofthisnotebeginswithalong-runvision.ThisrepresentstheCouncilsviewonthe minimal

institutionalframeworktoensurethatthecurrencyunionfunctionsasoriginallyintended:that

is,asafinanciallystableareathatpromotesthesingleEuropeanmarketandlong-rungrowth

andcanfunctionwithoutpersistenttransfersfromsurplustodeficitcountries.Theshort-run

visionisaboutcreatingtheconditionstorecoveroutputandemploymentgrowthwhile

maintainingincentivesforadjustmentandreformtoenhancefiscalsolvency,reduceexcessive

debt,andnarrowcurrentaccountimbalances.

III. Along-runsolutionthatlimitsmutualisationisachievableandsufficient

11.Althoughthereisdisagreementonwhichspecificdeficienciesaremosttobeblamedforthecurrentcrisis,thereisbroadagreementwithintheCouncil(andoutside)onthreecategoriesof

problemsthatareinherenttothecurrencyunionasitispresentlysetup.

Raisingmonetarypolicytoasupranationallevelwhilemaintainingfiscalpolicyandbankingsupervisionatthenationallevelcancreatedistortionsthatencourageover-borrowingand

over-lending,bothprivateandpublic.Membershipinacurrencyunionimpliesautomatic

accesstoofficialbalanceofpaymentsfinancing.Thismitigatestheimpactofasuddenreversalofcapitalflows,whateveritstrigger,andhencethecountry-levelcostsofcrises.At

thesametime,currencyunionsleadtoclosereconomicandfinanciallinkages,whichimply

thatcountry-levelcriseshavelargercross-countryrepercussions.Thisarguesforstronger

centralisedcontroloverbothfiscalpolicyandbankingsupervision;andpossiblyalso

coordinationonstructuralmeasurestopreventbalanceofpaymentimbalancesfrom

becomingchronic.

Givingupnational-levelcontroloverthemoneysupplyexposesmembersofacurrencyunionparticularlyonewherethecentralbanksmandateprohibitsmonetaryfinancingof

publicdebtissuancetorollovercriseswithrespecttotheirpublicdebt.Withnorecoursetotheprintingpressinanemergency,thesecouldinduceself-fulfillingfiscalcrises.


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ContagionfromGreecetoothereurozonememberslikeSpainandItalyisofteninterpreted

inthislight.

Givingupexchangerateadjustmentexposesmembersofthecurrencyuniontopainfulandlongadjustmentprocessesinthecaseofrealovervaluation(induced,forexample,byover-

lendingintherealestatesector).

Thelessonsfromthisarethree-fold.First,thatmoreeuro-arealevelfiscalpolicyadjustmentsmaybeneededtocountertheimpactofamonetarypolicydesignedforan

averagethatistootightforsomecountriesandtoolooseforothers.Second,thatsound

financialregulation,especiallythemacro-prudentialvariety,isevenmoreimportantwithin

theeuroareathanoutsideit.Andthird,thattheexerciseofmonetarypolicywithintheeuro

areamaybenefitfromtheuseofadditionalpolicytoolssuchasdifferentiatedcreditreserve

ratiosandcountercyclicalrealestatetaxesthatcouldhelpdesignpolicysoitismore

customizedtoprevailingeconomiccircumstancesindifferentmemberstates

12.ThecreatorsofEuropescurrencyunionrecognisedtheriskoffiscalfreeriding,whichtheysoughttodiscouragebyimposingasetofdeficitanddebtrules.However,theremainingrisks

werenotfullyappreciated,andnoinstrumentswereputinplacetocontainthem.Theresult

wasexcessiveprivateborrowingandlendinginIreland,Spain,andothercountrieswhose

currencyriskhadbeensharplyreducedbyEMUmembership,fuelledbycapitalinflowsfromthe

surpluscountries.Atthesametime,fiscalrulesfailedtoconstrainpublicborrowinginseveral

countries(includingFranceandGermany),andallowedatleastonecountry,Greece,to

accumulateunsustainablepublicdebt.Theseborrowingspreeswerecutshortbythe2008-2009

crisisandrecession,triggeringprivateinsolvenciesandputtingpressureonpublicfinancesasa

resultofbothrevenuecollapses,automaticstabilizers,andthesocialisationofbankinglosses.

Fiscaladjustmentwasalsocomplicatedbysharprisesinpublicborrowingcoststhatarguably

incorporatedaself-fulfillingelement.TheclearestexampleforthisisItaly,acountrythat

avoidedbothpublicandprivateborrowingspreesbutwasnonethelessvulnerablebecauseofits

highpublicdebtlevel.Finally,deficitcountriessufferedarealappreciationthatwasverycostly

tocorrectsinceonlyreal(andnotnominal)variableswereavailabletorectifyitbyindividual

memberstatesintheabsenceofflexibleexchangerates.

13. Inlightofthisdiagnosis,financialresilienceinthecurrencyunionrequiresreformsinfiveareas.Thesecanbuildonon-going,butstillincompletereformsundertakenintherecentpast.

Bankingunion.Financialintegrationiscriticaltoastableunion.Thediabolicalloopbetweenbanksandsovereignsisdraggingbothdownaseachrescuestheother,mostnotablyinSpain

andIreland,andcoulddothesameelsewhere.Asconfidencedisappearsandinvestorsrun

away,onlythestatesfinancethebanksandonlythebanksfundthestate.Breakingthisnexus

requiresmakingthestabilityofthebankstheconcernoftheentireunion.AcommonE.U.or

eurozone-levelfinancialsupervisionandresolutionagencymustbeestablished,eitherinthe

ECBorbothintheECBandintheformofanewagencywithauthorityovernationalsupervisors.

Nationalresolutionregimeswouldneedtobeunifiedinasystemthatensuresthewrite-offofall

bankdebtorbailin(exceptdepositsuptotheinsuredlimit)beforetaxpayersareaskedfor

funds.AEuropeandepositinsurancemechanism,basedonindustrypremiums,shouldeither

replaceorreinsuretheexistingnational-levelmechanismsafterthesehavebeenreviewed(and


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ifnecessary,replenished)toofferconsistentlevelsofinitialprotection.Anadditionalfundfor

theresolutionofsystemicallyimportantinstitutionsshouldbeestablished,financedbya

systemicrisklevy.Residualfiscalriskwouldbesharedbetweenthecountrylevelandtheeuro

zonelevel,inrecognitionofthefactthatsomepolicyandsupervisoryresponsibilitywould

remainatthenationallevel.TheE.U.-levelbackstopwouldtaketheformofcatastrophicloss

insuranceincasefiscalcostsofabankingcrisisexceedaspecifiedlevel(e.g.20%ofGDP).There

areseveralwaysofstructuringthisbackstop,forexampleviatheESM.

FinancialReform.Many,thoughnotall,oftheproblemsencounteredintheeurocrisiscanbeattributeddirectlyorindirectlytoamalfunctioningofthefinancialsector.TheEuropeanUnion

hasembarkedonasubstantialprogramoffinancialreformthatseekstomakethefinancial

systemmorestable,moretransparent,andlessrent-seeking.Butmuchmoreneedstobedone

onthisfront.Thereisanurgentneedtoaskandanswerthequestion:Whatsortoffinancial

systembestservestheneedsoftherealeconomy?Onlybyimplementingfar-reachingreforms

thatwillnecessarilyincludestructuralchangestothefinancialsystemcantheE.U.hopetotackletheproblemsofchroniclowgrowthratesandfinancialinstability.Thesereformsarea

prerequisiteforanyformofafinancialuniontobepoliticallyacceptabletocitizens.

Fiscalcontrols .AsignificantsteptowarddiscouragingfiscalfreeridingistheMarch2012fiscalcompact,whichseekstoanchorE.U.fiscalrulesinnationallegislationwhilemaintainingsome

scopeforcountercyclicalpolicy.However,inthecontextofnationaldemocracies,fiscalrulescan

neverbe100%crediblesincenationallegislationcanalwaysbechangedthroughanactof

parliamentthisistheessenceofdemocracy.Thefiscalcompacthasgoneasfaraspossiblein

ensuringcommitmenttotheruleandcredibilityoftherulewithinthedemocraticcontextof

eachsovereignstate.Thesetensionswouldbediminished,ifnoteliminatedentirely,withinthecontextofafederalpoliticalunion.SomemembersoftheCouncilseeamovetowardafederal

politicalunionasanecessarydevelopmentoftheeuroarea.Intheshortrun,theexternalities

associatedwithdeviationsfromnationallyapprovedfiscalruleshavetobecontainedviaeuro

area-levelautomaticadjustmentlevels.Forexample,someVATratescouldbeautomatically

alteredtoprovideatleastapartialcorrectivemechanism,oralternativelylimitstogovernment

expenditurescouldbeimposed.TheCouncilbelievesthefiscalcompactmustallowforalarger

scopeforcountercyclicalfiscalpolicy:providedthateuroarealevelautomaticadjustmentsare

inplace,therecanbelittleobjectiontoallowingcountriesindeeprecessiontheopportunityto

providegreaterfiscalstimulusthanthatallowedbythecurrentfiscalcompact.Toensure

democraticaccountability,theinstitutioninchargeofthefiscalsurveillanceshouldbe

accountabletotheEuropeanParliament.

Aeurozone-levellenderoflastresorttogovernmentsthatrespectthefiscalcompact.Ideally,thiswouldbetheECB.TheESMwillalsobeabletoplaythisrole,notwithstandingitslimited

volumeinthesteadystate,once publicdebtlevelsarereducedsignificantlyfromthecurrent

size,andonceflightsofcapitalacrosscountriesaremitigatedviaacommonrisk-freeasset(see

below).AllowingtheESMtohaveenoughfirepowertoachievethisaimrequiresthatitbe

givenabankinglicensesothatitcanaccesstheECBsdiscountwindow.

Adebt-restructuringregimeforcountriesthatarenoteligibleforESMfinancing.Unlessthereisaregimethatprovidesanorderlyalternativetochaoticdefaultwithintheeurozone,exclusionof


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crisiscountriesthatviolatethefiscalcompactfromtheESMwillbecircumventedthroughad-

hocbailoutsbytheofficialsector.Itispreciselythisfearthatisfuellingthebottomlesspit

theoryofthecurrencyunioninsomeofthecreditorcountries.

Acommonrisk-freeassetnottiedtoorissuedbyaspecificcountry.Thiswouldensurethatpurepanicssuddendropsinriskappetiteofinvestorstaketheformofflightstosafetyfrom

betweenassetclasses,ratherthanbetweencountries.Moreover,suchassetsareessentialin

modernfinancialsystems,bothascollateralforderivativetransactionsandforprudentbank

regulationpurposes.Asubstantialpartofanybank'sbalancesheetmustbeinsafeassets,as

definedbythefinancialregulators,andhavingitinaeuroarea-assetwouldhelpcutthelink

betweenthesovereignanditsbankingsystem.Also,theconductofmonetarypolicyrequires

thecentralbanktoexchangemoneyforsafebonds.Finally,theprovisionofsuchasafeasset

wouldalloweurozonememberstheabilitytocapturetheliquiditypremiumthatcomeswith

theprovisionofthissafeasset,andthuswouldrepresentasignificantsourceofnewincome.

Suchassetscouldbecreatedwithoutjointandseveralliabilitiesacrosscountries.2

14.Whilethesereformswouldtakeeurozoneinstitutionssignificantlybeyondthestatusquo(particularlythebankingunionandthedebtrestructuringregime)itisimportanttonotewhatis

notintheproposal:apermanentmechanismforcommoneurozonedebtissuanceanda

mechanismforcountercyclicalfiscaltransfers.3Indeed,thereisnocommonliabilityinanyof

ourlong-termproposalsbeyondthosenecessarytoestablishandbackstopthebankingunion

andtheESM,andbotharesubjecttostrictsafeguards.WhilesomeCouncilmembersfavoured

goingbeyondthisminimalleveloffiscalunion(forexample,throughapermanentjointand

severalguaranteeonaportionofmembercountriesdebt,orviacommonEuropean

unemploymentinsurance),otherCouncilmembersfeltthatthiswouldbepracticallyand/or

politicallyextremelydifficult,particularlyatthepresentjuncture.

IV. Urgentshort-runmeasures

15.Theinstitutionalreformsdescribedabovewouldbesufficienttoputtheeurozoneonafirmfootingonlyiftheyareaccompaniedbyasuccessfuladjustmentprocessthatunwindsthehigh

debtlevelsandlossesincompetitivenessaccumulatedduringthepre-crisisandcrisisperiodsin

anumberofcountries.Thedilemmaishowtodothisinthemiddleofrecessionsthatare

beginningtostrainsomesocietiestothebreakingpoint,andinlightoftheoverwhelmingsize,

power,and(sofar)scepticismoffinancialmarkets.Theanswermustinvolveacombinationof

extraordinarymeasures,whichincludefiscal-structuralreformsaimedatminimisingthe

immediateoutputcostofrealexchangerateandfiscaladjustment,supportfromexistingfunds

(theEFSFandESM),additionalsupportfromsurpluscountries,voluntarydebtrestructuring,an

exceptionalrolefortheECB,andexceptionalemergencymacroeconomicandmonetarypolicy

measures.

Partialandtemporarymutualisationoflegacydebt. Thelegacydebtispartlytheresultofthebaddesignoftheeuro,aswellofbadpoliciesofthememberstatescombinedwiththe

2SeeBrunnermeieretal.EuropeanSafeBonds(ESBies),Euro-nomicsgroup,September2011.

3Forarecentproposalthatcontainsbothoftheseelements,seeEnderleinetal.,CompletingtheEuro,Reportofthe

TommasoPadoa-SchioppaGroup,June2012.


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powerfulpressuresbroughtonbytheglobalfinancialcrisisof2007-2008.Ourgroup

rejectedtheneedforlarge-scalepermanentmutualisationofgovernmentdebtasa

necessaryfeatureoftheeurozone.However,dealingwiththelegacyproblemrequires

officialsupportforcountriespursuingadequatefiscaladjustment.OurCouncilendorsesthe

proposalsoftheGermanCouncilofEconomicExpertstoprovideprogressivelyaguarantee

onthelegacydebtforcountriespursingadequatefiscaladjustmentundertheE.U.excessive

deficitprocedure.Toprovidetherightincentivesthiswouldtaketheformofaguaranteeon

newdebtissuanceuptoapre-agreedthreshold.Theagencyinitiallyexecutingthese

purchasescouldbetheEFSF/ESM,backedbyanE.U.-levelcommitmenttoalarger

redemptionfundbackedbyeitheradditionalcapitalorthepowertoissuebillsundera

jointandseveralguaranteeifthisweretoprovenecessary.TheESMcouldalsoreceivea

bankinglicensetoensurethatithadadequatefirepower,orifititsdirectborrowingfrom

theECBwereconsideredinviolationofthetreaty,itsdebtcouldbetheprimarytoolinthe

secondarypurchasesoftheECB.

Voluntarydebtrestructuringcouldtaketheformofofferingtoexchangeexistingbondsfornewbondswiththesamefacevalueandcouponsbutlongermaturities(say,theoriginal

paymentdatesplus5years).Whilesuchanoperationwouldnotaffectheadlinedebt-to-

GDPratios,itcouldreducethepresentvalueofthedebtburdenandcreatecashflowrelief

intheshort-andmedium-term(possiblybeyondthehorizonenvisagedforofficialsupportof

newdebtissues).Tocreateincentivesforprivatesectorstoaccepttheexchangeoffer,the

newdebtwouldbeissuedunderforeignlaw.Inaddition,ashort-termsweetenercouldbe

offered(cashorESMbills),particularlytobondholderswithshorterresidualmaturity,which

couldbefinancedbylong-termgovernmentborrowingfromtheESM.Asafurther

incentive,thenewdebtcouldbetreated paripassuwiththeESM;whiletheexistingdebtwouldremainsubordinatedtoESMloansusedtofinancethesweetener.

Fiscal-structuralreformsthatfocuson:i. reformsaimedatrestoringsolvencywithoutcreatingadirectoutputcost(e.g.

raisingthepensionage);

ii. reformsthatmayhaveoutputcostsand/orfiscalcostsintheshort-runbut createlastingimprovementsinfiscalsolvencyandcompetitiveness(e.g.staffreductionsin

bloatedpublicadministrations,labourmarketreform);and

iii. fiscaldevaluationsthatusefinancialinstrumentstolowerlabourcostsinafiscallyneutralway(essentially,bysubstitutingpayrolltaxeswithindirecttaxes).

Thesecondgroupofmeasurescouldbefinanced(andtheircontractionaryimpactblunted)

throughacombinationofoutrighttransfersfromtheE.U.budgetandlowinterestloans

fromtheEFSF/ESM.

AtemporaryrolefortheECBinthecrisis.Puttinginplacealloftheabovemechanismswilltaketime.Convincingstepstowardabankingunionandamedium-termdebtreductionplan

backedbytemporaryguaranteesshouldgivetheECBroomtoactmoreforcefullyinthe

marketforsovereigndebtandalsoforcommunicatingtothemarketthatthistoolwillbe

usedactively.Inparticular,giventhatthefiscalcompacthasgonefarinensuring


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commitmenttoafiscalruleandcredibilitywithinthedemocraticcontextofeachsovereign

state,andgiventhatforSpainandItalywearedealingwithselffulfillingfiscalcrises,we

believethattheECBcouldandshouldbecommittingtomuchlargerinterventionsinthe

marketfordebtofsovereignswhoaremeetingtheirobligations.Webelievethatthis

interventionisaconditionformakingthetransmissionmechanismofmonetarypolicywork

inallmemberstates,anditisthereforeinlinewithitsmandate.

Emergencymacroeconomicandmonetarypolicymeasures:Thelast10yearshavebequeathedtheeurozonewithalegacyeconomiccrisisaswellaslegacyfinancialproblems,

andasstatedabovesolvingthiscrisisisthefirstpriorityofpolicymakers.Indeed,without

solvingtheeconomiccrisis,theeurozonewilleventuallycollapse.TheCouncilnotesthat

eventhegoldstandardembodiedimplicitemergencyclausesallowingthenormalrulesto

besuspendedduringtimesofcrisis,andthisisatimeofexistentialcrisisfortheeurozone.

Thedeficiencyofaggregatedemandatpresentleavesmanyresourcesunnecessarilyidle,

narrowsthetaxbaseatatimeoffiscalstress,andisonthecuspofrenderingtheeurozone

systemsociallyunsustainable.Inaddition,theeurozonemustmeetthechallengeof

reducingthelargecumulativedivergenceincompetitivenessbetweenmembercountries.

Anyplantoachieveadjustmentofrelativepricesofthismagnitudemustavoidabsolute

deflationinanycountry,whichwillaggravatedebtburdens.Thuspricelevelgrowthin

surpluscountriescannotbesoslowastoforcedeflationuponabroadarrayofdeficit

countriesalreadyonthecuspofdepression.TheECBmustusealltools(conventionaland

nonconventional)toensureamorehomogeneoustransmissionofmonetarypolicy.Asthe

IMFhassuggested,monetarypolicyshouldbeaccommodativeduringthisemergency

period,usingbothconventionalandnon-conventionalpoliciestosupportnominalGDPand

facilitatetherealexchangerateadjustmentsneeded.Surpluscountrieswithfiscalspaceshouldusethatspacetohelpmaintainaggregatedemandintheeurozoneasawhole.And

eurozonememberstatesshouldexploreasamatterofurgencywhetherthereisgreater

scopeforE.U.institutionstopromoteE.U.-widegrowth.

16.Thetimehorizonenvisagedfortheseextraordinarymeasurescouldencompassaboutfiveyears.Followingthisinitialphase,publicdebtreductioninlinewithagreedEUfiscalruleswouldneed

tocontinueinsomeofthepresenthigh-debtcountries,suchasItaly.However,thepresumption

isthatwiththebenefitofeconomicrecoveryandfiscal-structuralmeasuresalreadyundertaken,

continueddebtreductioncouldtakeplacewithoutexternalfinancialsupport.Hence,toreassure

thepublicinthecreditorcountriesthatfinancialsupportparticularly,withregardtosupportingthepricesofnewdebtissuesinthedeficitcountrieswillnotturnintoa

bottomlesspittherecouldbeanagreedcaponsuchsupportguidedbytheexpectationthat

pricesupportwillnotcontinuebeyondfiveyears.

17.Acomplicatingfactorintheadjustmentprocessdescribedaboveisuncertaintyontheextentofhousingpricedeclines,andhencethequalityofthemortgageloanportfolio,inthebanking

systemsofcountriessuchasSpain.Indealingwiththisuncertainty,itisnecessarytostrikea

balancebetweentheprinciplethatunrecoverablebankingsystemlossesthatwereincurred

undertheauspicesofnationalsupervisorsshouldinthefirstinstancebeabsorbedatthe

nationallevel,andthefactthattherearelimitstothenationalcapacitytoabsorbsuchlosseswithoutendangeringtheentireadjustmentandreformprocess.Inlinewiththelogicof


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proposedinParagraph7forafuturebankingunion,itisproposedtodealwiththistensionby

settinganationalfirstlosslimit,andallowingtheESMtoundertakedirectcapitalinjections

intonationalbankingsystemwhennationalrecapitalisationcostsexceedthatlimit.This

commitmenttocatastrophiclossinsuranceattheeurozone-levelshouldbemadeconditional

oneurozone-levelconditionalitytothenationalresolutionprocessfromtheoutset.Itshould

alsoretroactivelyapplytoothercountries,suchasIreland.

Non Consensual Views

18.AmajorityofCouncilmemberstaketheviewthatfiscaldevaluationsinthedeficitcountriesshouldbesupportedbyfiscalrevaluationsinGermanyandsomeoftheothersurpluscountries

(e.g.toequaliserealeffectiveexchangeratesinFrance,GermanyandItaly).

19.AminorityofCouncilmembersbelievethatavoidingfuturecrisesrequireschangingthestatuteoftheECBtowardadualmandatethatincludesoutputandemploymentobjectives,andthat

thepricestabilityobjectiveshouldberevisedtotargetnominalGDPgrowth.

Signatories1

PatrickArtus

GlobalChiefEconomist,NATIXIS-BanquedeFinancementetdInvestissement

ErikBerglof

ChiefEconomistandSpecialAdvisertothePresident,EuropeanBankforReconstructionand

Development

PeterBofinger

Professor,UniversittWrzburg

GiancarloCorsetti

Professor,UniversityofCambridge

PaulDeGrauwe

Professor,LondonSchoolofEconomicsandPoliticalScience

GuillermodelaDehesaChairman,CentreforEconomicPolicyResearch(CEPR)

LarsFeld

ProfessorforEconomicPolicy,UniversityofFreiburg

Jean-PaulFitoussi

ProfessorEmeritus,Institutd'EtudesPolitiquesdeParis

LuisGaricano

ProfessorofEconomicsandStrategy,LondonSchoolofEconomics


11/11


INETeconomics.org 11

Institute For


DanielGros

Director,CentreforEuropeanPolicyStudies(CEPS)

KevinO'Rourke

ProfessorofEconomicHistory,UniversityofOxford

LucreziaReichlin

ProfessorofEconomics,LondonBusinessSchool

HlneRey

ProfessorofEconomics,LondonBusinessSchool

AndreSapir

SeniorFellow,Bruegel

DennisSnower

President,KielInstitutefortheWorldEconomy

Hans-JoachimVoth

ICREAResearchProfessor,UniversitatPompeuFabra

BeatriceWederdiMauro

ProfessorofEconomics,JohannesGutenbergUniversityofMainz

Endnote

1.StatementbasedonJune26-27BrusselsconstituentmeetingoftheCouncilandsubsequentdiscussions,whichincluded

CouncilmembersErikBerglf,PeterBofinger,GiancarloCorsetti,PaulDeGrauwe,GuillermodelaDehesa,LarsFeld,Jean-

PaulFitoussi,LuisGaricano,DanielGros,KevinORourke,LucreziaReichlin,HlneRey,AndrSapir,DennisSnower,Hans-

JoachimVoth,andBeatriceWederdiMauro;advisorsSergeiGuriev,HaroldJames,RobJohnson,LeifPargrotsky,Adam

Posen,GeorgeSoros;andHeatherGrabbe,PeterJungen,OlliRehn,GuntramWolff,PhilippeLegrainandAndrWilkens,

SonyKapoorandJerominZettelmeyerasguestsorrapporteurs.ThisdocumentwaswrittenbyLuisGaricanoandJeromin

ZettelmeyerandreflectscommentsfromCouncilmembers.

Documents

Council on the Euro Zone Crisis - 23-7-12