29 October 2015

Completing Economic and Monetary Union: the Role of Eurobills

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 Five Presidents’ Report laid out a two-stage process to completing EMU, and the Commission’s October Communication spelt out some detailed principles.These include that “the European Parliament should organise itself to assume its role in matters pertaining especially to the euro area... However, as the euro area evolves towards a genuine EMU, some decisions will increasingly need to be made collectively while ensuring democratic accountability and legitimacy… A future euro area treasury could be the place for such collective decision-making.”

It also proposed a fiscal stabilisation function for the euro area with guiding principles “It should not lead to permanent transfers between countries… should not undermine the incentives for sound fiscal policy-making … be tightly linked to compliance with the broad EU governance framework… should not be an instrument for crisis management and should help to prevent crises - making future interventions by the ESM less likely.

The Temporary Eurobill Fund could be operational quickly and the political governance could reflect the Community method so that its European Treasury function could indeed become the locus of European “collective decision-making” between the European Parliament and Eurogroup. The revamped European Semester process could readily provide a mechanism to manage some of the `European’ liabilities created by the TEF. So accountability to the European peoples and corresponding liability for `moral hazard’ would both be at the European level.

What is `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’. Greece has epitomised this dilemma as the euro area has wondered how much of its total public sector exposure – around €250 billion – might 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’ if the ECB’s QE programme winds down in late 2016 and interest rates normalise.

This note summarises how a Temporary Eurobill Fund could achieve these goals.

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© Graham Bishop