International Monetary Fund Managing Director Christine Lagarde delivers remarks at the U.S. Chamber of Commerce in Washington. (September 19, 2013, OIMF Staff Photograph/Stephen Jaffe).
The International Monetary Fund questions the efforts of the European Union to establish effective fiscal discipline policy instruments and a smoothly functioning banking union in the euro area. In a survey entitled “More Fiscal Integration to Boost Euro Area Resilience”, the Fund analysts observe that “Crisis exposed important gaps in architecture of the euro area”. To cure this they suggest “Strengthened fiscal governance and cross-country insurance mechanisms”, while they insist, that the Banking Union in order to be credible, needs urgently a “common fiscal backstop”. In total they have four suggestions to make, three for the long run and one for immediate application.
In detail, this IMF analysis proposes three new policy tools to secure effective fiscal discipline in the long run. They suggest that, to this end, a good start will be the timely launching of such a policy package. In the short run they insist that the Banking Union in order to be credible, apart from the Single Supervisory Mechanism and a Single Resolution Mechanism, needs “a firm and early commitment to establish an adequate backstop to anchor confidence in the banking system”. They elaborate a bit further and say, “While some of the insurance against banking accidents should be funded by the industry, a common backstop for the recapitalization, resolution, and deposit insurance would contribute to reducing the risk of contagion”. In reality they propose more taxpayers’ implication in saving failing banks. No wonder why the IMF is renowned as the best friend of banks.
IMF analysts before coming to those conclusions described accurately the unfolding of the Eurozone crisis after 2008. In this process they underlined that the “problems arising in banks raised doubts about sovereign creditworthiness and in turn sovereign stress aggravated the pressure on banks’ balance sheets”. These were the cases of Ireland and Greece respectively, while Portugal, Spain and Italy suffered of both illnesses albeit in varying degrees. Concluding its fact finding endeavour, the IMF notes that, “The approach taken so far—dealing with crises after they occur—has been costly, not only in terms of direct financial assistance, but also in terms of lost output and increased unemployment”.
The fiscal front
Focusing on the latest efforts of the European Union to cover the institutional gap of the Monetary Union with the “two pack” and the “six pack” Directives, the IMF believes they are not enough. To accomplish a well-functioning fiscal union, the Fund has four suggestions. All of them are meant to secure the long term ability of Eurozone to face crisis and accidents; the last one however is designed to cover the institutional gap of the Banking Union, as it is currently under construction and consequently, of an urgent character.
The four suggestions
The four suggestions are the following: Better oversight of national policies and enforcement of rules, increasing risk sharing with cross-country fiscal insurance mechanisms, borrowing at the centre and last but not least, a fiscal backstop for euro area banks. Of course those suggestions go beyond the current political realities in Eurozone around a possible unification. Borrowing at the centre sounds already as politically too much for Eurozone’s 17 member states. The same is true for the cross-country fiscal insurance mechanism backed with a “euro area-wide rainy day fund, a common unemployment insurance scheme, or a budget for the euro area”. In any case this is what the IMF proposes.
As for the first and the last suggestions there is more to say, than briefly abolishing them on political grounds. The first suggestion asking for better oversight and stricter enforcement of rules is not very far away, from what the Eurozone has already decided with the “six pack”. To be reminded, those six Regulations go as far as to institutionalise central approval of member states government budgets, before they are submitted to national Parliaments. The Commission’s green light is a prerequisite. In view of that, the IMF accepts that “the design of fiscal policy has improved”.
What about our beloved banks?
Now, let’s pass to the last and most urgent suggestion the IMF addresses to Eurozone’s political leadership, namely “fiscal backstop for euro area banks”. This is equivalent to suggesting that Eurozone taxpayers should accept to cover a large part of bank resolution and recapitalisation cost. Seemingly the authors of this IMF study didn’t have the time luxury to know what the President of the European Central Bank, Mario Draghi, proposed last Monday.
As the European Sting observed last Tuesday Draghi proposed the following breakthrough novelty in enacting the Banking Union, “until the resolution fund is fully financed, it should be able to borrow from other sources, including national ones, to ensure that properly-funded resolution is an option from the start”. Putting together what Draghi has said in the past and this latest statement, what he proposes here is that at an initial stage, the resolution fund should be able to borrow not only from the European Stability Mechanism, but also from those governments in the territory of which the bank accident occurs. This is a double fiscal backstop in lenders’ resolution and recapitalisation: once through the ESM and a second time directly, through national governments’ contributions.
All in all, it is obvious that this IMF study sounds as ‘laboratory’ like in suggesting a complete fiscal unification of Eurozone and common sovereign borrowing. It ignores the prevailing political mood in Eurozone, with Eurosceptic and extremist political formations gaining momentum. As for the construction of the Banking Union, the current situation is far from clear. A lot will depend on the political developments in Germany around the formation of the next government, to be presented sooner or later to the Bundestag.
There is another possibility, however, over the targets that this IMF survey is aiming at. Probably its authors, knowing the political limitations of Eurozone, are trying to exploit and pronounce them in order to undercut somewhat the global role of the euro money.
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