Author: John McHale

Ronan McCrea has an op-ed in today’s Irish Times that is worth debating.    His proposal:

If we are to avoid an endless series of referendums in the coming years, we will have to give the Government a degree of authority to agree to treaty changes that have not yet been agreed.

This would require a more general amendment to the Constitution, giving the State the right to participate in a fiscal and banking union. Such an approach would allow the State to sign up to the numerous amendments that are likely in the coming years if the euro is to be saved.

Given the seriousness of the implications of fiscal union for our political system, it would be desirable that there would be a further referendum at the end of the process. Once a fiscal and banking union is fully in place, then voters could decide by referendum whether they would like to be in or out of such an arrangement.

Often lost in the recent referendum debate was recognition that developing the necessary fiscal and banking integration to underpin the euro is a two-way process.   The countries most likely to be net contributors under strengthened risk-sharing arrangements will be reluctant to agree to those arrangements without credible assurances of mutual discipline.   Given the necessity of these arrangements, it is not enough to lambast Germany for not being willing to move fast enough.   The extent of the political challenge means that there is responsibility on all countries to make the necessary changes feasible.

Willem Buiter provides another incisive analysis of the euro zone crisis is this FT article.

From the article:

The endgame for the euro area, if the political will to keep it alive is strong enough, is likely to be a 16-member area, with banking union and the minimal fiscal Europe necessary to operate a monetary union when there is no full fiscal union.

Minimal fiscal Europe will consist of a larger European Stability Mechanism, the permanent liquidity fund, and a sovereign debt restructuring mechanism (SDRM). The ESM will be given eligible counterparty status for repurchase agreements with the eurosystem, subject to joint and several guarantees by the euro area member states. There will be some ex-post mutualisation of sovereign debt. Sovereign debt restructuring through the SDRM will recur.

One question is whether vulnerable euro zone countries could ever hope to regain robust creditworthiness with the SDRM hanging over them.   Given the likely effects of threatened “bail ins”, it seems too early to give up on more ambitious efforts for ex-ante debt mutualisation along the lines of the German “wise men” proposal.  (Gavyn Davies provides a useful analysis of the proposal here.   This Bruegel blog post considers the less ambitious alternative of “eurobills”, which could be a stepping stone to more ambitious “eurobonds”.)

The proposal for a Debt Redemption Fund made by the German Council of Economic Experts seems to be gaining a bit more traction (see here).   This working paper from February provides a useful overview.   Given that this is the only “eurobonds” proposal with anything approaching momentum, it is worth debating its merits. 

Some of the basic elements:

·         Countries would be able to finance an amount of debt (as a share of GDP) equal to the difference between current levels and 60 percent of GDP through the fund.   This would occur as new funding needs (deficits/redemptions) arise

·         The fund would have joint and several guarantees

·         Repayments would be a constant share of GDP, equal to the ERF interest rate plus one percent divided by initial GDP.   The repayment schedule is designed to fully repay fund borrowings in 20 to 25 years

·         Countries would have to commit to reduce their total debt to below 60 percent of GDP.   Longer term, it doesn’t appear that there would be additional commitments beyond the revised Stability and Growth Pact and Fiscal Compact.   However, during the “roll-in” phase, countries would have EFSF-style adjustment programmes

·         Would only apply for current programme countries after they had exited their programmes. 

Karl Whelan has a very useful post on options relating to reducing the burden of banking-related debt (see here).   Of particular interest is his comparison of the present discounted cost of the current promissory notes/ELA arrangement and a low-interest (3 percent) long-term (30-year) financing deal with the ESM to immediately payoff the ELA.   This calculation shows that that ESM alternative has a lower NPV by a wide margin.  

We could perhaps quibble with some of the assumptions used in the calculation.   Karl assumes the ECB’s main refinancing rate rises to 4.5 percent by 2016, which would require a strong euro zone recovery (see Table 7 here).   Also, in a world where official financing remains available as an option over the longer term, the assumed discount rate of 7 percent (based on current secondary-market bond yields) could be considered high.   (I am also not sure from the calculations if Karl is allowing for Irish Central Bank profits on outstanding ELA.)  But Karl’s basic conclusion seems robust to reasonable relaxations of these assumptions.    

Karl notes that I am “neutral” with regard to whether the long-term refinancing via the ESM would be a good deal, waiting to see the details.   Based on his numbers, I am happy to agree that a 30-year deal at 3 percent is likely to result in a substantial reduction in the burden of this debt.

Dan O’Brien examines the grievance-based case for debt relief here.