31 August 2015

VoxEU: The state of the monetary union

Concluding remarks and the way forward

What I take away from the previous sections is:

• On one hand, the structural problems of the eurozone are more severe than the ones facing the US, but that the differences are not nearly as large as what is commonly argued.
• On the other hand, political risk and distrust (in a broad sense) will persist for a long time.

They will not dissipate simply because unemployment comes down. It is, therefore, important to plan for several years of political instability.

So what should be done?

• Keep cool and continue building the banking union

[...] The interesting question is: What does it take to have a stable currency area? In my view, the traditional approach missed the most important piece –the banking union. Forget labour mobility, a common language, or even a federal budget. A banking union is the one piece of financial architecture that should have been built before the crisis. [...]

• Reforming the eurozone.

The Greek crisis has exposed deep flaws in the functioning of the eurozone. It needs to become more accountable, more transparent, and more efficient.

A possible solution is to merge the position of ECFIN commissioner with that of president of the Eurozone. At the same time, the enforcement of fiscal discipline should be entrusted to an independent division within ECFIN. We also need a eurozone chamber within the European parliament where eurozone issues would be discussed and where the President of the eurozone would be confirmed and heard on a regular basis.

• More markets, less politics.

The externalities that exist in a currency union create the need for strict fiscal discipline among member states. The difficult issue is how to impose this discipline effectively. [...]

We need instead to bring back market discipline. [...]

• Markets, however, have one fundamental advantage over politicians – they punish but they do not humiliate. [...]

The fundamental challenge, then, is to revive market discipline without creating the risk of sudden stops (Merler and Pisani-Ferry 2012). This is why we need to reopen the eurobonds debate.

• Eurobonds, or at least Eurobills.

Eurobonds were widely discussed in 2010 and 2011 but they were not implemented, probably because they were not the right choice as a crisis management tool.

The combination of ESM and OMT did the job. But the lively debates that took place at the time were nonetheless insightful. Here is a quick summary of what most participants agreed on:

• A currency union needs a shared safe asset. That safe asset should not be the bonds of one particular member because this could trigger episodes of sudden stops and flight to safety. [...]

• A shared safe asset would be very useful for banking regulation and for the conduct of monetary policy. [...]The solution is to treat individual sovereign debt as risky and to introduce new safe assets at the same time.

• Avoiding moral hazard is a priority but we should recognise that moral hazard is already present in the current system and we should look for an improvement, not a first-best solution. I would also argue that providing some insurance (as in the form of eurobonds quotas) is likely to reduce moral hazard by making the no-bailout option more credible. [...]

I view the blue/red bond proposal of Delpla and von Weizsäcker (2010) as the most elegant solution. [...] A less ambitious proposal is to introduce eurobills, as proposed by Hellwig and Philippon (2011). The idea is to mutualise the short end of the yield curve – to avoid fragmentation of the money markets – but not the long end – to maintain market discipline. That same logic that was later applied to the OMT, and it worked exactly as predicted. I would therefore propose the introduction of eurobills together with the gradual strengthening of the no-bail-out clause by adjusting the prudential requirements on sovereign debt. In the long run, we would move to a blue/red debt market where markets would help enforce fiscal discipline.

Full article on VoxEU

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