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22 February 2011

Axel Weber: Europe's reforms may come at a high price


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The FT published an article written by Weber whose key message is that the cornerstones of the monetary union are subsidiarity, responsibility of individual member countries, and the no-bailout rule. In other words, this is a monetary union only.


In the coming weeks, European policymakers will have to decide on an overhaul of governance of the European monetary union. As a guiding principle the European Council has clearly – and, in my view, rightly – stated that the main foundations of EMU and the European Union Treaty have to be respected. This means the principles of subsidiarity, responsibility of individual member countries and no-bail-out remain essential for the EU. In this context, what cornerstones are to be considered in the matter of reforming EMU governance?

First and foremost, it is up to the member countries themselves to consolidate their public budgets and to initiate comprehensive economic reforms. Financial assistance is a supplement to buy some time and to smooth this process. Against this backdrop the existing instruments for short-term crisis resolution are adequate and, despite repeated demands to the contrary, should not undergo significant adjustment.

In terms of future crisis prevention, it will be essential to set the correct incentives for stability-oriented policies in member countries. Additionally, financial market regulation and surveillance have to be improved in order to significantly increase the financial system’s capacity to absorb shocks. Finally, in the event of a crisis nevertheless occurring, there is a need for a resolution mechanism which does not diminish the individual responsibility of member states and market participants.

With this in mind, the decisions taken by the European Council represent a step in the right direction: the Stability and Growth Pact is to be strengthened, although I fear that the proposals currently on the table fall short of what is required and run the risk of being weakened further in the political process. Macroeconomic surveillance will be enhanced in order to detect structural developments within Member States that might be harmful for the rest of the monetary union. In this context, it is vital that the process remains focused on major imbalances and that any unproductive macroeconomic fine-tuning be avoided. 

Furthermore, if such preventive measures turn out to be insufficient, the European stability mechanism (ESM) will be available as a means of crisis resolution if there is a risk to the stability of the eurozone as a whole. The properties of this mechanism, as endorsed by the European Council in December 2010, are derived from the current design of the European financial stability facility. In particular, financial support will be granted at non-concessional rates only, and will be conditional on a tough adjustment programme.

Going beyond the EFSF, collective action clauses should allow for an easier restructuring of debt in the event of insolvency. Further, taxpayers in other member states will be protected by a preferred creditor status. These basic features should allow a prompt response to crises without undermining the incentives for sustainable economic policy in member states or exposing taxpayers in other member states to undue risks.

Against this background I am rather sceptical about some proposals to broaden the scope or to soften the conditions of the agreed framework. If implemented, these would result in a weakening of the responsibility of financial market participants and member states, diminished incentives for sound fiscal policies, and again a shifting of risks to the taxpayers of other Member States. I therefore perceive a danger in reducing the interest rates of ESM borrowing significantly below the conditions of the EFSF, thereby introducing eurobonds more or less through the back door.

As I see it, bond purchases on secondary markets should not be incorporated into the ESM. First, the conduct of such purchases would run into significant operational governance problems regarding their volume, timing and conditions. Second, given the direct support of the ESM, Member States in distress would already be protected from high market interest rates.

Third, secondary market purchases with the aim of a debt buy-back would not only be a very inefficient way of reducing the debt burden, requiring very large volumes to achieve a sizeable effect, but they would also constitute a transfer from other Member States − a transfer that would be all the higher, the lower the interest rate charged for ESM buyback loans.

Fourth, proponents of secondary market purchases argue that these would stabilise bond prices and, as a result, financial markets, too. While that may be true, I doubt whether purchases would be an efficient way of achieving that goal. We should not forget our experience of setting up banking stabilisation tools in several member states at the height of the financial crisis.

At that time, asset purchases were regarded as costly instruments that were not well targeted given the problems at hand. Such considerations are all the more relevant in a more complex European context. Finally, secondary market purchases combined with the well-justified and necessary preferred-creditor status of ESM loans might even jeopardise financial market stability as the risks of the remaining private bondholders would increase sharply, thereby significantly heightening the pressure to sell.

The current crisis has challenged the founding principles of EMU. Still, EMU can emerge stronger and more resilient than before. To that end, the decisions on EMU governance have to reinvigorate rather than circumvent the basic principles of subsidiarity, responsibility of individual member countries, and no-bail-out, as laid down at the launch of monetary union. This is an opportunity that must not be lost.

Full article (FT subscription needed)



© Financial Times


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