27 May 2015

Is the time `ripe’ for Eurobills?

The Four Presidents will report to June’s European Council on “Preparations for Next Steps on Better Economic Governance in the Euro Area” – following the February “Analytical Note”.

The Introduction to that Note stated: “The Euro Summit of 24 October 2014 concluded that “closer coordination of economic policies is essential to ensure the smooth functioning of the Economic and Monetary Union”. It called for work to continue “to develop concrete mechanisms for stronger economic policy coordination, convergence and solidarity"; and it invited the President of the European Commission, in close cooperation with the President of the Euro Summit, the President of the Eurogroup and the President of the European Central Bank, “to prepare next steps on better economic governance in the euro area.”

My detailed plan for a Temporary Eurobill Fund (TEF) explicitly provides such a “concrete mechanism for stronger economic policy coordination, convergence and solidarity”. It would provide a platform to ensure continuing financial integration and stability once the ECB’s non-standard monetary policy measures expire. However, it can be initiated as a small step towards  financial integration; be scaled up to become a de facto European Treasury and even provide a modest `fiscal capacity’; but it can be reversed easily – even to extinction within two years. The plan would contribute to answering most of the eleven questions posed in the February Analytical Note.

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The euro area’s struggle to develop a robust governance structure flows inexorably from its need to control the `moral hazard’ that is inherent in the creation of an economic and monetary union. During the original design process, few thought that the government of a Member State would ever actually behave in the way that Greek governments have now done repeatedly. The nightmare has turned into reality – and it cannot be allowed to happen again as that might be on a scale to put the very existence of the euro in doubt. Chancellor Merkel stated very plainly ahead of the March European Council, "If the euro fails, Europe fails." The euro is far more than just a currency. Alongside the European institutions, it is "the strongest expression of our will to bring the people of Europe together in friendship and in peace".

What is this `moral hazard’? The US economist Paul Krugman defined it rather pithily as ‘any situation in which one person makes the decision about how much risk to take while someone else bears the cost if things go badly’. The Greek situation now epitomises this dilemma as the euro area wonders how much of its total public sector exposure – around €250 billion – will be at risk if `things go badly’.

Beyond the direct benefits to financial integration and stability, a properly designed Eurobill system can provide a concrete mechanism state-by-state: (i) to reward good economic `homework’ (ii) penalise lack of effort (iii) operate with the grain of the markets to graduate the carrot and stick incentives for each state and (iv) minimise the eventual costs if a state insists on pursuing economic policies that are likely to end `badly’.  It could be operational in time to take over euro area `solidarity’ as the ECB’s QE programme winds down after September 2016 and interest rates normalise.

The full, 10-page article is avaibale via the link below to the PDF

© Graham Bishop