New eBook: Risk Sharing Plus Market Discipline: A New Paradigm for Euro Area Reform? A Debate

Tuesday, June 18, 2019

There is a remarkable convergence of views among economists on what a currency union really entails, according to the editors of a new CEPR volume that brings together key contributions to the debate about the future of the euro area. This consensus provides a basis for comprehensive reforms that would significantly improve the resilience of the euro area and help to turn it into a basis for shared prosperity.

Risk Sharing Plus Market Discipline: A New Paradigm for Euro Area Reform? A Debate focuses on potential reforms to the financial architecture of the currency union in four specific areas: deposit insurance, a common safe asset, liquidity provision to governments, and EU fiscal rules.

Jean Pisani-Ferry and Jeromin Zettelmeyer, members of the 7 +7 group of French and German economists and who have led the debate and edited the volume, lay out the main conclusions and clarify remaining points of disagreement on the way forward:

  1. If adequately priced, a common deposit insurance can be introduced even if there remains a heterogeneity of banking risks across countries. There is a debate, however, on the adequate pricing scheme and on the adequacy of a waterfall structure.
  2. To protect deposits and break the doom loop, diversification of bank balance sheets requires regulation. There is less agreement on how this regulation should be designed. In addition, there is a minority view that argues forcefully against such regulation because it regards the very idea of decoupling banks and sovereigns as an illusion.
  3. A common safe asset would be a desirable, and perhaps essential, counterpart to regulatory incentives to bank balance sheet diversification. Several alternative schemes with different properties have been proposed. Some are better understood than others, and there is still no consensus on these alternatives.
  4. A well-functioning economic and monetary union requires facilities that reliably provide liquidity to solvent sovereigns. This is necessary to limit incentives to procyclical fiscal tightening and eliminate the risk of self-fulfilling debt crises. There is agreement that this requires easier access to European Stability Mechanism credit lines by pre-qualified countries. There is less consensus on whether it also requires changes to the policies of the European Central Bank.
  5. The EU fiscal rules that apply to the public finances of the member states are in need of fundamental reform. There is remarkable consensus on the principle of a primary expenditure rule that would take into account the initial debt level as well as potential output growth over the medium term.
  6. A scheme that provides fiscal stabilisation while excluding permanent transfers goes a long way towards alleviating concerns but does not command general consensus. The case for better stabilisation is hardly disputed. But it is argued by some that the need to engineer it at central level can be lowered and possibly eliminated, either through restoring this capacity in full at national level (which requires debt restructuring, even of currently solvent countries), or through integrating further financially so that private agents can benefit from market stabilisation.
  7. Whether enforcement of the no bail-out rule requires considering debt restructuring as a legitimate last-resort instrument remains contentious. The logic behind the 7 + 7 report that market discipline can work if the economic and financial cost of restructuring make it a viable option is disputed by some economists who see markets as inherently incapable of providing discipline at the right time.
  8. Debates on the future of Europe reverberate on the debate about euro area reform. Even technical discussions can be strongly affected by the broader framework within which they are being considered. In part therefore, debates are of a political nature.

The editors conclude:

‘No economist disputes the need for significant, perhaps fundamental reforms of the euro area. The debate within the profession is dominated by a sense of urgency that is remarkably absent from public discussions and debates among national leaders.’


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