The op-ed was first published on FT.com on August 9, 2017.
The gains would outweigh the costs and help chart a path for the continent’s future
As Germany heads towards its general election one of the debates in Berlin and elsewhere is what course the next government will pursue on Europe. In particular there is much speculation about a possible “grand bargain” between France and Germany that would see Berlin re-engage in reforming Europe.
At the centre of such a bargain could be a macroeconomic stabilisation mechanism for the euro area that balances the demand for stricter rules and more solidarity. Call it a “European Monetary Fund”, or EMF.
In a recent analysis the European Commission said that such a mechanism was necessary for dealing with economic crises and for supporting further integration. This is music to the ears of the French government and all those who want more solidarity and abhor austerity. But the commission is equally right that a functioning monetary union requires credible rules, and does not need either a transfer union or a political union. This pleases the German side, which fears moral hazard and suspects behind almost every reform proposal an attempt to get at its money.
Transforming the European Stability Mechanism, the eurozone’s bailout fund, into an EMF could constitute the “grand bargain”. The EMF would have to strike a balance across three dimensions. First between crisis prevention and crisis resolution — the EMF should have a common budget derived from national taxes, and a debt-issuing capacity, not only for emergency loans during crises, but also for supporting reforms and for dealing with recessions.
Potential instruments are structural adjustment programmes, a joint unemployment insurance scheme, and funds for common infrastructure, energy or digital projects. The common budget should not be seen as a substitute, but as a complement to sensible rules on national budgets. The overarching objective should be to ensure economic convergence to make the euro viable and European Central Bank monetary policy more symmetrical. This would be a gain for all member states as it will ultimately result in higher growth and less malign crises.
The EMF also needs to strike a balance between European solidarity and national sovereignty. France likes to emphasise the need for risk-sharing, while Germany stresses the importance of common rules and risk-reduction. The euro area needs both. Hence EMF instruments should be linked to strict conditionality. It could and should create an actuarially fair insurance union, while ruling out a larger transfer union.
The third balancing act is between the state and the market. In addition to completing banking union and capital market union, markets should be used as a disciplining device. Making EMF financing in crisis times conditional on private sector involvement, as well as risk-weighting and capping banks’ holdings of domestic government debt, would discipline governments to pursue sound policies in good times.
The tricky issue is governance. For its conditionality to be credible, the EMF should be a technocratic institution, similar to the IMF. Members’ votes could match their relative financial contributions, yet there should neither be unanimity nor a veto right for individual members. And it could be accountable to a euro area chamber of the European Parliament. A strong EMF would not have to weaken the EU commission, which should closely co-operate with the ESM on surveillance and on programme implementation.
Such a grand bargain would require tough compromises. But the gains would outweigh the costs for everyone. Paris would succeed in strengthening solidarity and economic convergence; Berlin would get more credible mechanisms to reduce risks and liabilities for having to bail out its neighbours. Most important of all, such a deal would help make the euro sustainable and chart a path for Europe’s future.