15 April 2015

CEPR: A New Start for the Eurozone - Dealing with Debt

The Eurozone’s problems of poor growth and the threat of financial instability are rooted in its very foundation. The authors of the inaugural Monitoring the Eurozone report consider three means by which the Eurozone can protect itself from structural failure.

Their recommendations, which do not require Treaty changes, are crucial in offsetting the major risks a repetition of the recent Crisis would present.

For a while, the storm seemed to have passed and the Eurozone entered a welcome tranquil period. Now, Greece has once again triggered the alarm and, while the financial and economic resilience of many member countries has improved, their political resilience has not. Greece is special in many ways and will have to be dealt with in a different way from the other member countries, but the renewed turbulence it has caused once again has highlighted that the construction of the monetary union remains incomplete.

In the inaugural report in CEPR’s new Monitoring the Eurozone series (Corsetti et al. 2015), the authors call for a reconsideration of the Eurozone’s architecture. The report is available to download here.

Important institutional steps have certainly been taken, but the weight of crisis-fighting has fallen heavily on the ECB, which increasingly faces the danger of becoming overburdened – while being criticised simultaneously by those who think it is doing too much and those who wish for more.

While the ECB is not the only central bank in danger of being overburdened, the political and institutional structure of the Eurozone makes the problem more complex and potentially divisive. Meanwhile, reforms at the European level have come to a standstill and all debates on increasing fiscal and political integration have remained moot. Some countries have implemented significant fiscal consolidation and structural reforms, but others have lagged.

Three proposals

The report, A New Start for the Eurozone: Dealing with Debt, focus on three issues because they are important and they can be addressed without a fully-fledged fiscal federation or changes to the Treaty:

• A one-time debt stock operation to rapidly reduce sovereign debt, particularly in the highly indebted peripheral countries. The authors offer a menu of options, one of which is a debt buyback through the commitment of future revenues, which could include seigniorage, VAT or a wealth (transfer) tax. This does not involve any redistribution across members of the currency union, but it would not be sufficient to eliminate the overhang. Therefore, they discuss a number of other choices, including a European solidarity tax with some limited redistribution across countries and ‘debt-equity’ exchange with GDP-indexed bonds.


• A strengthened sovereign lending framework for the ESM, which both creates strong market-based incentives to avoid excessive debt levels in the future and makes future debt restructuring – should it become necessary – less painful than is currently the case.


• A set of regulatory changes that discourage and limit the exposure of banks to sovereign debt, particularly that of their own sovereign. This should be complemented by the creation of a European synthetic bond that does not require mutualisation, but would constitute a safe asset and could facilitate unconventional monetary policies by the ECB.

Certainly, the goal is ambitious. The proposals aim to kill, with one stone, the three birds of enforcing long-run fiscal discipline, dealing with the legacy debt overhang and breaking the sovereign bank loop.

This would require a concerted effort and significant investment of political capital, which may only become available if the fragility of the present situation becomes apparent. However, the solutions to these three problems are strongly complementary and would generate large welfare improvements for Eurozone citizens if implemented jointly. Indeed, the authors stress that the package proposed should not be unbundled and nor should the implementation be partial.

Full article on Vox EU

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