Before the end of the year, the European Commission plans to publish its first proposals for the establishment of a European Monetary Fund (EMF). The idea of a new vehicle to deal with eurozone debt crises has been floated since 2010, when it was proposed by the German government. At the time, it was kicked into the long grass, on the argument that it might require changing EU treaties.
Now, the proposal is back at the top of the agenda after being endorsed, in principle, by French President Emmanuel Macron, German Chancellor Angela Merkel, EC President Jean-Claude Juncker and even Klaus Regling, the managing director of the European Stability Mechanism (ESM), which might be replaced by a future EMF. However, beyond political agreement on the need of something like it, there are big differences in the visions of what the EMF should accomplish and how it should be run.
From an economic point of view, the need for an EMF is questionable. There is already an International Monetary Fund (IMF) to deal with such crises. A recent paper commissioned by the European Parliament concludes that the “only fundamental reason” to create an EMF is political and symbolic: “to be able to make do without the IMF.” It is not true, the paper argues, that the IMF would not have enough resources to deal with eurozone emergencies, if it follows its standard practice of collecting additional credit from affected nations. This is a role the ESM (and its precursor, the EFSF) has played rather effectively so far, handing out a total of 260 billion euros to eurozone members in distress.
It is true that the eurozone’s crisis management governance structure is overly complex, slow and politicized. The EC is in charge of crisis prevention, monitoring and management; it is also part of the “Troika” (along with the European Central Bank and the IMF) or, since 2015, the “Quadriga” (also including the ESM) of institutions negotiating the bailouts. Lending decisions, in turn, require unanimity within the Eurogroup (composed of the eurozone finance ministers) and the prior approval of several parliaments, such as the German Bundestag.
Some tasks could be combined and coordinated in a European Monetary Fund. However, this would require dramatic changes to EU governance in a delicate area: the sovereignty of nation states.
A full-blown EMF
A full-blown EMF, based on the model of the IMF, would involve setting up a large and powerful institution (the IMF employs around 2,700 staff; the ESM around 122) capable of monitoring the economic and financial policies of its member countries, as well as of being entrusted to prevent and resolve sovereign and financial debt crises. It would have a high degree of political independence (at the IMF most powers are delegated to the executive board) and use a complex system of majority voting based on shares in the fund.
Powers in Brussels, Berlin and Paris are certain to find only some parts of such an EMF attractive, each fighting for different elements to be included in the final version.
The German view: avoiding ‘moral hazard’
Why has the German government put the EMF on the agenda in the first place? And what kind of EMF does it want to see? After all, Berlin has always insisted that the IMF be an integral part of all bailout negotiations. It worries that the other parts of the Troika, especially the Commission, would be too dependent on the countries they are meant to represent and monitor. However, it became clear that the IMF is unwilling to pay its share of the third bailout for Greece as long as there is no agreement on substantial debt relief.
Germany, therefore, wants the EMF to solve this problem. If the new institution can avoid becoming too politicized, it could take over for the Commission in monitoring structural reforms and enforcing fiscal rules.
The key element of the German position is “moral hazard,” of which there are two types: borrower moral hazard and lender moral hazard. The former is the temptation to borrow excessively in the anticipation that a bailout will come. The latter is when there is an incentive to grant loans that are too big, anticipating that the borrower will be bailed out (with little or no cost to the lender).
A “German-style EMF” would reduce moral hazard and enhance risk avoidance. It would focus on crisis prevention, for example by strengthening instruments to keep public finances under control (such as the Fiscal Compact) and limit sovereign-bank “doom loops.” It would also hand out loans only if debt sustainability (solvency) can be ensured and after applying clear rules for orderly debt restructuring, prioritizing the “bail-in” of creditors. Finally, it would apply strict conditionality – demands for fiscal and structural reforms in the receiving countries.
The French view: ‘solidarity’ and ‘risk sharing’
At his speech on the future of Europe in September, President Macron did not directly refer to his plans for an EMF. But his overall approach, confirmed by his finance minister, is to use the EMF as a eurozone stabilization – and transfer – mechanism.
The French vision of the future of the EU has always been about “solidarity,” “protection” and “risk sharing.” Paris believes that fiscal, social and economic policies should be harmonized – at French levels. It also wants the eurozone to have its own budget (around three times as large as the current EU budget), fed by eurozone-wide taxes, managed by a powerful European minister of economy and finance, and controlled by a eurozone parliament.
It is still unclear whether France wants to see these powers blended within those of a traditional bailout organization like an EMF or given to some different fiscal capacity. In both cases, Paris wants much more money to be raised at the EU level and handed out for public spending. Such spending would be rather discretionary, bypassing demands for austerity or conditionality. Understandably, France wants to end Germany’s de facto veto power over raising funds. Instead, it wants the mandate of a eurozone parliament in which a “Club Med” majority could quite easily be gathered.
The EC view: ‘competence’ and power
How will the EC’s proposal for a future EMF balance these seemingly opposing visions? Most likely, it will restate the established ESM principle of making access to bailouts contingent on participation in the Fiscal Compact and other existing EU rules under Commission supervision.
The proposal will see to it that the EC will be in the driver’s seat, assisted by the European Parliament (but not, as Mr. Juncker made clear, a separate eurozone parliament). In his State of the Union speech, President Juncker also insisted that a future EMF must be firmly “anchored in the European Union’s rules and competences.”
This can mean many things, but probably Mr. Juncker’s proposed EC vice president would not only assume the role of economy and finance minister and preside over the Eurogroup, but also run the EMF and “coordinate all EU financial instruments that can be deployed if a Member State is in a recession or hit by a fundamental crisis.” Consequently, the EMF would no longer be organized as an intergovernmental treaty among the eurozone states as shareholders of the fund; it would be controlled by the Commission.
So far, there is no regional alternative to the IMF. In 1997, in the early phase of the Southeast Asian crisis, Japan proposed creating an Asian Monetary Fund to escape the IMF and the “Washington Consensus” on principles like opening trade, competitiveness-enhancing reforms, fiscal discipline and price stability. It ultimately failed, not least because it was too prone to moral hazard problems and because China refused to join a Japanese project.
Today, the EU can reform the ESM into a more robust but streamlined institution and simply call it a “European Monetary Fund.” Creating a full-blown EMF would have far-reaching legal, political and economic consequences. This is true for the suggestions from Berlin, Paris or Brussels outlined above. All of them, in their purest form, would require changes to EU treaties – and none of them would find agreement among the EU member states or the eurozone. So, there is likely to be a “European Monetary Fund” in name soon, but it will not amount to much more than a somewhat reformed ESM.
At the same time, a new institution with a larger budget, a bigger staff and more power could easily drift in a direction that its creators did not foresee. The future ESM will have to find its place. It will be a key element in the European transfer union, managing bailouts and risk-sharing, even as it seeks to introduce new European rules and mutual commitments to avoid moral hazard.