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We pause the series analysing the project to rebuild macroeconomic theory to cover a very interesting contribution by a group of 14 French and German economists, many of the best policy-oriented thinkers of both countries. Not all natural intellectual bedfellows, they have come together to create a consensus road map on eurozone reforms that they think would best serve Europe’s monetary union.
There are three very good things to say about their paper. The first is that, whether one agrees or disagrees, it synthesises virtually all the aspects of the past few years’ debate on eurozone reform in two dozen pages — admittedly dense ones, but a shorter summary is eminently accessible. An interested observer could read this one article and be reassured that they have not missed any of the important recent reform proposals.
Featuring here, for example, are the need to perfect the bail-in aspect of banking union, the importance of cross-border financial integration as a means of improving macroeconomic stabilisation through private financial links, more sensible fiscal rules, a pan-European deposit insurance scheme, a sovereign debt restructuring mechanism, a pooling of national unemployment benefit schemes as a mechanism for sharing risk through government budgets, a synthetic euro-wide bond to serve as a safe asset for banks, and an institutional redesign of the rescue fund for sovereigns and the monitoring function of the European Commission.
The second is that, while the group takes as a starting point the current political stalemate between “risk reduction” (typically cast as a German priority) and “risk sharing” (similarly, the stereotypical French imperative), they quickly argue — rightly — that this is somewhat of a false dichotomy.
Economically speaking, risk sharing is a way to increase market discipline and therefore less risky policies within each eurozone member. This is at least true — and here the authors could have been much clearer — if the risk sharing happens through private channels. If private investors know that they will suffer the losses when something goes wrong, and not be saved by taxpayer bailouts, they will monitor national policies more assiduously and charge more for their credit when risks are higher.
Politically, too, the only way to move forward is to pursue policies for risk reduction and risk sharing simultaneously.
Third, and most important, this previous point allows the authors to demonstrate that the recipe for reform is pretty much there for the taking. All the ingredients are on the table, well described and understood through thinking they and others have engaged in over the past few years. The crucial point to understand is that they need to be applied together: both politically and economically. The well-rehearsed solutions they outline will only work best (and sometimes only) if they are adopted as a package. This is an intelligent type of incrementalism — no single great leap to, say, fiscal union, but many small improvements that together make a big qualitative difference. Much of this can be realised without difficult treaty changes.
Billed as a synthesis to overcome a political deadlock between France and Germany, albeit not explicitly stated as such, it looks like a package Berlin should find easier than Paris to endorse. In particular, the authors are paragons of moderation when it comes to deep political integration and build their vision much more on improved functioning of private financial markets than on fiscal integration. They are noticeably cool on the idea of an ambitious eurozone budget or a common borrowing capacity.
Stating that implication more explicitly suggests that the group may not even need all the components of their package to an equal extent — this is a belt-and-braces approach. In my view, for example, they remain overly pessimistic about the disruptions and orderly and predictable practice that sovereign debt restructuring would bring, especially in the presence of well-established restructuring (bail-in) rules for banks. They also do not acknowledge that a world where banks were regularly bailed in as a matter of course would have less need for fiscal backing for bank insolvencies or deposit insurance (besides there are appealing alternatives to conventional deposit insurance).
But belts and braces together are a lot better than having neither. Decision makers in all eurozone countries should place this contribution prominently on their policy drawing boards.
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