Image via WikipediaEurope again faces serious market uncertainty. The debate on crisis resolution initiated at last month’s meeting of national and European Union leaders in Brussels has unfortunately failed to restore confidence; instead, fears are growing over high debt and deficit levels in certain vulnerable states. Irish and Portuguese bond spreads have increased markedly in recent weeks and governments across the EU are watching nervously for signs of contagion.
What we now need is to create the conditions for stability with a long-term plan for EU crisis resolution. To restore credibility, the affected member states must take measures to front-load their consolidation efforts, making savings at the earliest possible opportunity.
The European Council agreed last month that EU member states should establish a crisis mechanism to safeguard stability in the euro area. Given the state of Europe’s public finances, I believe such a mechanism must promote sound fiscal policies and a return to sustainable debt levels. To this end, I have sent a letter to Olli Rehn, the EU’s economic and monetary affairs commissioner, Herman Van Rompuy, the president of the European Council, my colleagues in the Ecofin council and Jean-Claude Trichet, the president of the European Central Bank, detailing a Swedish proposal on how to fund the mechanism in a way that reflects risk and provides the right incentives. I look forward to discussing this at Wednesday’s Ecofin council meeting in Brussels.
A crisis mechanism needs resources to lend to member states that have run into trouble. An important question is how to mobilise these resources in a way that minimises moral hazard. The existing EU crisis lending facilities are the European financial stability facility and the European financial stability mechanism for euro countries, and balance of payment support for non-euro area countries. All are financed in a way that neither reflects risk nor provides incentives for sound fiscal policies.
This is most unfortunate, since experience has shown that irresponsible fiscal behaviour has adverse effects not only on the sinner but also on the euro area and the EU as a whole. The costs of this externality should be borne, to a much higher degree than is the case today, by those members that act irresponsibly.
We could draw a parallel with the “polluter pays principle” in environmental economics. In this case, however, it is risky fiscal behaviour that should be made more costly.
Another way to make the point is to look at a crisis resolution arrangement as an insurance system. Those who are more likely to draw on the insurance should also pay higher fees. Looking at the future permanent mechanism from this perspective, contributions should be differentiated according to risk. Otherwise a disproportionate burden is carried by countries with high credibility, which are unlikely to use the mechanism for their own financing needs.
A mechanism could consist of both guarantees based on gross domestic product levels and paid-in funds that are differentiated according to risk. Paid-in contributions could be differentiated with regard to the public debt of member states. This is a simple and straightforward way of measuring risk, which is well recognised by the Lisbon treaty through the Maastricht debt criterion and the excessive deficit procedure.
One could envisage a progressive fee with a zero rate for countries with very low debt levels (less than 30 per cent of GDP), a low fee for debts between 30 and 60 per cent of GDP and then a higher rate for countries that exceed these debt levels. The fee would differ between countries, which of course is the purpose. Some countries would pay in nothing at all, while those with high debt levels would pay a higher fee. A “stability fee” along these lines would thus be an additional incentive to pursue sustainable fiscal policies.
What I have set out above is one of a number of building blocks for a European crisis framework. We also need to look at private-sector involvement, economic policy conditionality and the role of the International Monetary Fund.
Europe must build a culture of stability-oriented economic policies. We should ensure that the rules of the economic governance system we are now renewing and strengthening provide the right incentives.
The writer is Sweden’s finance minister
Copyright The Financial Times Limited 2010.