The challenge is formidable. How do you keep up – in Italy's case, step up – the pressure on foot-dragging European governments to undertake vital, growth-enhancing social and economic reforms; shore up a tottering European banking system; rescue Greece; and lay stable, democratically legitimate foundations for a more deeply integrated eurozone economy?
In July, Lagarde's call for massive capital injections into EU banks was angrily dismissed by European Union officials as unnecessary and inflammatory. Today, Merkel and Sarkozy no longer dispute their banks' need for capital. Injecting loss-absorbing capital into banks is seen as a vital part of a wider, confidence-building exercise.
Last week, Jean-Claude Trichet, the president of the ECB, bluntly rejected the idea that the ECB can continue indefinitely to be the key participant in the ongoing efforts to support an economy as big as Italy's and head off contagion. “We expect governments to be responsible for restoring financial stability”, he said. He forcefully rejected the idea that the ECB should directly boost the firepower of Europe's specialist but temporary bail-out mechanism, the European Financial Stability Facility (EFSF). “The governing council (of the ECB) considered that it would not be appropriate that the central bank would leverage the EFSF”, Trichet said.
If the ECB won't help, what next? Back to Lagarde. Last month, former IMF chief economist Raghuram Rajan argued that it is time for the IMF to take over the lead role in tackling Europe's sovereign-debt crisis. He is right, and not only because of the IMF's long-established expertise in handling sovereign debt bail-outs. But Lagarde has pointed out that the IMF is also financially constrained, with only around $400 billion (€294 billion) of funds available to be deployed. So a first step would have to be to negotiate an increase in IMF resources.
Rajan's model calls for a special financing vehicle to be set up in the IMF. It could tap not only the bulging, $3 trillion (€2.2 trillion) financial reserves of China and the tens of billions held by Middle East oil exporters, but also private markets. It would operate alongside the EFSF. And countries such as Italy and Spain would be required to submit to IMF conditionality in return for support.
Announce all this as a package in Cannes – a revised bail-out package for Greece; a strengthened EFSF; the recapitalisation of vulnerable European banks; a new financing vehicle located within the IMF with the financial firepower to impress both the bond market vigilantes and irresponsible governments – and you have a European sovereign-debt strategy that might just work.
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