Greece fiscal crisis illustrate a fundamental weakness of the monetary union institutional design. Although the designers of the Maastricht treaty recongnised the importance of fiscal discipline to sustain the whole project, fiscal rules have a very limited effect if they are not at the same time robust to shocks and incentive compatible. The Maastricht rules are neither. In this article Daniel Gros and Thomas Mayer propose the institution of an European Monetary Fund to manage the insolvency of euro area countries. The proposal has two main components: the first component is to increase the price of using the fiscal instrument, thus internalizing at least some of the negative externalities of increasing fiscal risk, by providing transfer to the EMF in proportion of the distance of fiscal debt and deficit from the Maastricht criteria; the second component is to intervene minimizing the systemic effect of a fiscal crises of one of union members, through operations of refinancing and debt swapping with conditionality. That's certainly better than what we have now, i.e. nothing.
I like to think at this issue as the design of a bankruptcy law for sovereign states. Bankruptcy laws are designed to achieve few contemporary objectives:
- Minimize the negative spillover of failure of a firm (through orderly liquidiation)
- punish irresponsible behaviour or get rid of inefficient firms
- protect the social interest of preserving the economic value still present in the firm
When a firm goes bankrupt, the owner and management loose control of the firm and a third party, nominated by a public authority, take control of the books and start the process of liquidation or restructuring. Creditors have to wait. For the law to work both creditors and debtors have to recognize the authority of the court in taking control of the situation. In the debate about sovereign bankruptcy law the stumbling block is always the definition of the centre of sovereignty. The case of Argentina is instructive: after an external shock the policy followed by the government was not sustainable and any attempt to maintain the policy through restructuring, debt freeze and refinancing via IMF were not credible. Translate this scenario to Europe: the EMF intervenes but the cost of restructuring debt is too high to be feasible. No devaluation is possible and real devaluation is too costly and might actually increase the debt burden. If the country was a firm, the judge would intervene, the management would be replaced, creditors would be made to wait, restructuring happens, normal relationships are resumed. Who is the judge in Europe?