Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday 25 October 2017

A European Monetary Fund

Sapir and Schoenmaker at Bruegel have a discussion of what a European version of the IMF might look like and do. Here are my thoughts on the sovereign debt (not banking) side, which I am sure will be regarded once again as radical and will therefore be ignored.

I think some new Eurozone institution is necessary, but not for the reason that most people might think. The idea that the Eurozone might have a common fund that lends to Eurozone countries in fiscal difficulties with associated conditionality, as the IMF does, is a terrible idea. We know it is a terrible idea because of Greece.

Think of the following scenario. A country getting into difficulties is lent some money by the EMF. That sum increases as existing private investors take fright. For whatever reason the ‘recovery plan’ imposed by the EMF goes wrong, and it becomes clear to all neutral observers that the country needs to default on its debts, including those to the EMF. As the EMF loan is regarded as ‘our money’ by a good part of the EZ electorate, this default is resisted and punitive austerity is imposed on the country so that the EMF can get its money back. This does not happen to the IMF because the electorate in any individual country do not think of their loans as ‘their money’, but it is naive to believe that wouldn’t happen with an EMF. It is exactly what happened in Greece, and it is also why moves to a political union are far too premature..

This raises an obvious question: why have an EMF, when we have an IMF? The wrong way of thinking about that question is that the Eurozone needed to supplement the IMF during the last crisis. The last crisis is not a good example because the ECB did not operate OMT until September 2012. The right way to think about the past is what would have happened if OMT had been operating from the start.

The ECB is (rightly) only prepared to operate OMT for a country that is returning its financing to some sustainable level. For some countries that may not be possible, or desirable, without default. That was the case for Greece. For others that will be possible without default, as Ireland and Portugal have shown. You need somebody, or some institution, to decide which category a country finds itself in. But whether default is needed or not, a recovery plan (austerity) has to be put in place to return the public finances to sustainability and once that plan is in place OMT then operates.

Once that happens, I think any lending should be done by the IMF for the reason I have already given [1]. However it may well be that as long as the austerity is sensibly mild and drawn out [2], private sector lending will resume because of OMT.

I think a new institution to do both the job of initially deciding about default and to create the recovery plan would be a good idea. But both decisions have to be kept as far away from politicians as possible. The reason again comes from history: the loans to the government that may require default are likely to be from banks or institutions in other EZ countries. That creates a serious bias towards ‘lend and pretend’, as we saw with Greece. 

How can you achieve such independence in the EMF? In addition, how do you justify giving an institution staff and resources when it hopefully will be hardly ever needed? One answer could be to use the IMF, although at the moment the IMF is not sufficiently independent of EZ politicians. Another is to utilise the network of independent fiscal institutions or fiscal councils that every EZ country now has. If those institutions live up to their name, they should be independent of politicians. In addition, they have exactly the expertise to decide on any default and to put together a recovery plan.

Now the great thing about this set-up is that it allows fiscal autonomy in countries that have not got into fiscal difficulties. Fiscal discipline through the market is restored, because there is a clear default risk (but not the self-fulfilling default risk that operated before OMT). There would be less of a feeling in countries like Germany that they had to worry about fiscal policy in other EZ countries because they will pick up the tab because there will not be any tab to pick up. In that sense the no bail out rule is restored. 

What would the Brussels machinery that currently monitors each EZ country do? Am I proposing to put some Brussels bureaucrats out of a job? Not necessarily. A potential problem with the system I suggest is that fiscal councils will be captured by their governments. Brussels could ensure that the fiscal councils are independent, which would involve checking their assessments and forecasts (or even supplying them with forecasts).

I can predict with almost certainty that some comments will be that I am taking crucial decisions away from democratically elected politicians and giving them to technocrats. We have enough of that in the Eurozone as it is they will say. There are two simple responses. First, in the absence of the Eurozone, governments that were no longer able to borrow would face the technocrats at the IMF. Second, we have tried the democratic route and it has failed spectacularly for reasons that will not go away in a hurry. 

There you have it. A feasible plan to increase sovereignty in the Eurozone and mitigate another Eurozone crisis and avoid another Greece. Now tell me why we have to move to fiscal and political union.

[1] Obviously in that case the IMF would also have to approve the recovery plan.

[2] A short sharp shock will almost inevitably lead to damaging negative feedback on output, perhaps creating another Greece.


  1. re: I think any lending should be done by the IMF. Problem is IMF have not and cannot critizise basic euro model, thus cannot reccomend usual adjustment mechanism, incl. FX adjustment. Logical step then is intra euro transfers = solidarity, but since that’s not there, they will be designing and enforcing second best program. This failed in Greece and they don’t want to do that over again. So the Europeans will have to find a solution themselves

    1. «intra euro transfers = solidarity, but since that’s not there,»

      Greece for example gets 4% of their GDP as intra-EU fiscal transfers, regional development funds, year after year, even if Greece is a rich country and greek income per head is four time (300% higher) than that of Bulgaria and Romania, which are also EU members.

      «This failed in Greece and they don’t want to do that over again.»

      The USA and the UK refused to lend a cent or a penny to Greece; the UK even put a veto on using EU funds to help Greece. The IMF, in which the USA and the UK have a share, did lend a small amount, but offered, as usual, zero fiscal transfers and zero discounts -- repayment in full.
      Conversely the greek government, despite having run a borrowing fraud (confessed by the greek PM in the greek parliament, so indisputable) for around 15-25% per year of greek GDP, got more than 60% write-off of their debts held by private lenders, mostly french and some german banks, and the rest were turned into government debt and restructured by the eurozone governments to reduce their value by 60%. Plus the 4% fiscal transfers continued.
      But people like Y Varoufakis and their admirers continued to demand fiscal indefinite fiscal transfers for 20-25% of greek GDP.

  2. I agree with everything said above. Just two points: maybe I have missed something, but imo the need for a fiscal union comes from the fact that we have situations (such as 2012-2015) where fiscal policy coordination fails to achieve the optimal policy mix in terms of the whole EZ - the countries that can do more, do not need to, while the countries that need to do stimulus cannot. So the central fiscal stabilization function is crucial here to intervene and lead to the better equilibrium under the ZLB. It is this central stabilization function that requires a fiscal and political union imo, not the country rescue mechanisms.
    As for the other part - well to anybody that says, that the fiscal councils will be giving more power to the technocrats, as we know, the "technocrats" on fiscal policy had a much more realistic and fact-based view on the need for fiscal policy stimulus and its beneficial effects at the ZLB in comparison to the politicians in some countries...

  3. «this default is resisted and punitive austerity is imposed on the country so that the EMF can get its money back. This does not happen to the IMF because the electorate in any individual country do not think of their loans as ‘their money’»

    Pull the other one too pleasem it tickles so good: every IMF loan in its entire history has been repaid in full, regardless of the cost to the debtor; "punitive austerity" and "IMF" are pretty much synonyms.
    Because the USA and UK governments don't want to explain to their voters that they need to raise taxes to recapitalize the IMF because "scrounger country X" have not repaid their IMF loan.

  4. «would face the technocrats at the IMF»

    I think that it is widely understood that the "technocrats" are there to follow whatever policy the USA government gives them, with a small degree of influence by the UK and by the Eurozone (“at the moment the IMF is not sufficiently independent of EZ politicians”, a few lines earlier), and maybe a tiny bit by Japan, that is they are independent only from the members that don't matter...

  5. Very relevant. It all comes down to assuming the need of a LoLR. However the complexity of solutions discussed results from the complexity of current financial "acqui communautaire" and its political consequences. Solutions sought are incremental

  6. i don't think we are ever going to get any of these situations under control until we tackle runaway inequality

    this started around 1980

    after the stagflation period when we started to focus on preventing excess inflation

    excess inflation requires two elements

    A degree of monopoly power of the employers

    workers getting bargaining power

    since 1980 we have controlled workers wages, so real wages stay flat
    so we don't get excess inflation

    but economic rents have skyrocketed

    causing extreme inequality

    no fund structure will ever work if we don't tackle inequality

  7. Why would/how could the IMF take responsibility for refinancing an EZ state if that state was seen to fail because it has broken EMU (fiscal) rules? Surely an EMU institution should do that? Catch and kill your own. If an EZ state fails, the other EZ states have failed to keep it in line. On top of that, markets repeatedly finance recalcitant states - they can't help themselves - the history on this is extensive. Moral hazard has to be delt with in some more effective manner - the markets have to share in the pain. But the fear is that this will end even more badly.

    The more you run this around in your head the more the problem seems intractable and eternal. Plus ca change, ne plus ca change.


  8. Ok. California runs chronic tax surplus; pays more than it receives from fiscal/monetary authority. Arizona opposite; chronic tax deficit. Thus feds tax Cal to build fighter jets in Arizona or better blows more deficit dollars by spending in Arizona. Thus zeroing out imbalance which would otherwise balloon (integrate up) forever. Think Germany vs Greece. That’s why you need fiscal/monetary central authority.

  9. I have to admit I find this post rather bizarre.

    The whole thrust seems to be to find a way of saving governments from the consequences of their bad decisions but your absolute priority is to keep (other) governments away from influencing the rescue process.

    It sems odd to say that "... both decisions have to be kept as far away from politicians as possible" when these decisions are (I think) about the allocation of real resources between different groups. Do we really have so much trust in "Fiscal Councils" and even "Brussels" (and I write as a former Brussels technocrat) that we are willing to hand these decisions over to such bodies - appointed by who?

    In these troubled times, two remarks often attributed to Winston Churchill come to mind: "Democracy is the worst system of government except for all the others" and "You can count on the US (but read EU and other large governments) to do the right thing when all alternatives have been exhausted".

    Many - most - experts want to do the right thing but do we really trust Mervyn King, let alone Montague Norman, to take these decisions?

  10. Deeply disappointed by your comment. You are still clinging to the mainstream narrative that Euro Area countries have suffered from budget indiscipline leading to sovereign debt crisises. Despite the fact that interest rates on sovereign debt are now lower in most countries while public debt to GDP is higher and often much higher than in 2008. The Euro Area crisis is mainly two things: 3 successive monetary contractions (2008-9, 2011, 2012) + monetary contractions which are strongly geographically differentiated in function of international net financial position. Real estate crashes, bank troubles, sovereign debt crisises, inefficient austerity can all be explained properly with monetary approach. Euro Area problems need monetary solutions, not bandaid like EFM.

  11. 'ECJ made its final ruling of the case in June 2015, declaring the conditional "OMT program" to be legal, as it due to its attached conditions "does not exceed the powers of the ECB in relation to monetary policy and does not contravene the prohibition of monetary financing of EU nations'
    See also Lisbon Article 123.

  12. I am a Greek. I think the reason for the completion of the eurozone is that Greek or Italian economic policy has failed to keep up with competitive pressures so it needs to be centralised so the tax collection is handled by Frankfurt or Paris for the whole of the eurozone and also the spending of these taxes.

    However the formula and the target must be German living standards for all in the eurozone.
    The current arrangement is keeping some regions undeveloped and keeping failed politicians with their hands on budgets.

    This is what we want but the Germans seem to just want to export and keep the eurozone lopsided.

    This makes us immigrants to Germany and is idiotic. It's not even efficient.

    Btw stop inviting people from the middle East to be cheap labour when careers are disappearing.
    Automation will create more surplus labour.


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