Seeking Alpha
May 16, 2011
My preceding blog post identified three mistakes made by leaders of the European Economic and Monetary Union in dealing with Greece. But what is done is done. The mistakes now lie in the past. How can Europe’s fiscal regime be reformed to avoid future repeats of this crisis?
The reforms that are now underway are not credible. (”We are going to make the fiscal rules more explicit and make sure to monitor them more tightly next time.”) Similarly, most proposals for how to put teeth into the rules are not credible — penalties such as monetary fines or loss of voting privileges.
But it is not too late to apply the lesson of mistake number two: To adjust the ECB policy of accepting the debt of all member states as collateral. This is the policy that short-circuited warning signals that the private markets would otherwise have sent via interest rates during 2002-07.
My proposal: The euro zone should adopt a rule that whenever a country violates the fiscal criterion of the Stability and Growth Pact (say, a budget deficit in excess of 3% of GDP, structurally adjusted), the ECB must stop accepting that government’s debt as collateral. This system would achieve the elusive objective of true automaticity. If a country exceeded the threshold for justifiable reasons, such as natural disaster, the private markets could perceive that and impose little or no default risk premium. No judgment of the merits by bureaucrats or politicians would be required.
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