Ifo Viewpoint No. 113: How to Save the Euro
Munich, 29 April 2010
The euro’s Greece-triggered crisis has taught Europe a bitter lesson in economics.
If a nation wishes to raise its standard of living by bringing in imports, it can try to earn the necessary cash by producing and selling more of its goods. But then again, it could also sell bonds or assets. If it has its own currency, its attempt to sell bonds will eventually come up against investors’ skepticism. For this reason, in their pre-euro days, many European Union countries had to devalue their currencies now and then in order to sell more merchandise and real assets and thus raise the necessary funds. Admittedly, only rarely were whole islands flogged on the market, but quite a bit of real estate was indeed sold at the time by such countries as Greece, Italy, Spain and Portugal.
Today, some of these countries, foremost Greece, interpret their membership in the European monetary union as having the right to pay for their imports with bonds rather than real resources. They are neither willing to offer investors higher yields, nor to render themselves somewhat cheaper, and thus more competitive, producers of commodities and tourist services. Putting to use the political power that the EU accords them, they now demand contingency loans from other euro state, which the market is not ready to grant them. Meanwhile, some of these countries secretly speculate that their debts could be forgiven entirely in the future. In the end, instead of doing something to reciprocate for all their imported smartphones, airplanes, and cars, they want to receive part of these goods as some sort of donation.
Drawing on the experiences of the past few years, such expectations can be foiled only with a new Stability and Growth Pact, one that would be formulated to impose ironclad debt discipline. What is needed are modified debt rules, hefty sanctions, and, most of all, a system of rules that automates the levying of penalties, leaving no room for political meddling. Concretely, the EU should agree on the following:
- The permitted maximum for the deficit-to-GDP ratio should be inversely proportional to the debt-to-GDP ratio, in order to establish an early incentive to apply debt discipline. For instance, it could be established that for every 10 percentage points that the debt-to-GDP ratio deviates from the 60% stipulated in the Maastricht Treaty, the upper limit of the deficit ratio inversely deviates one percentage point from the 3% limit established by the Stability and Growth Pact. As an example: Germany, with a 73% debt-to-GDP ratio at the end of 2009, would have to keep its budget deficit below 1.7%; while Denmark, with a debt-to-GDP ratio of 34%, would be allowed a budget deficit of up to 5.6%. This notwithstanding, the member countries should not relent in their commitment to keep their debt-to-GDP ratio below 60%.
- A tax, proportional to the breach of the deficit and indebtedness rules, should be levied on euro-zone members’ national debt. The level of the tax would be set for each country based on the spread charged by the markets in the days before the euro. The tax should be high enough to ensure that it is not possible for a given country, when compared to the bloc’s most stable country, to acquire excessive debt more cheaply than they would have been able to prior to the introduction of the euro. The euro’s advantage of reducing the interest cost of public debt should accrue to the group of euro-zone countries as a whole, and not in particular to the more profligate countries.
- In order to avoid pushing sanctioned countries into a debt trap, sanctions should take the form of long-maturity covered bonds, bearing interest at current market rates and collateralized with privatizable state assets. These covered bonds would not be tallied with the remaining debt with regard to the new indebtedness rules proposed here.
- The rules should be defined so unambiguously that the task of calculating the sanctions could be left to the European statistical office (Eurostat). This office should enjoy direct control and executive authority over the respective national statistical offices when it comes to obtaining the necessary data. The “deliberate” falsifying of data, a charge levied by Eurostat on Greece’s audit office, should be utterly unacceptable.
- A European Public Prosecution Service should be established that is obliged to take legal action independently against breaches of duty by the respective national statistical offices or EU bodies and bring the cases before the European Court of Justice.
- If a country cannot raise debt in the market without sharply rising yields, the rest of the member countries should provide it through standby loans whose accumulated value, including compound interest, does not exceed 10% of the borrowing country’s GDP. These loans should also take the form of covered bonds collateralized with privatizable state assets, and be endowed with the rate of interest normal for such bonds. The low rate of interest for covered bonds will not imply subsidies, because such bonds would be safe debt instruments even when issued by the countries in question – assuming of course that the EU finds a way to legally secure the collateral against a unilateral debt moratorium on the part of a debtor country.
- A country that, despite such credit facility, still defaults on its debt or breaches the indebtedness rules five or more times in 10 years should be expelled from the monetary union.
Although the new rules would require changing the European treaties, they can already be put to practice in the case of Greece, because the country’s neediness will have to be stated unanimously by all euro countries, and the conditions for the provision of credit are yet to be defined. The EU should use the time until that “ultima ratio” to press ahead with the treaty negotiations so that these conditions for standby credit can be applied to Greece.
Paper doesn’t blush. Only by making an example can the EU hope that the new rules for indebtedness will be adhered to.
Professor for Economics and Public Finance
President of the Ifo Institute
Published as "How to Save the Euro", in The Wall Street Journal, 20 April 2010; additionally printed in Wirtschaftswoche, No. 15, 12 April 2010, p. 43.