A European Redemption Pact

by Peter Bofinger, Lars P. Feld, Wolfgang Franz, Christoph M. Schmidt and Beatrice Weder di Mauro

Vox
November 9, 2011

The EZ crisis has taken a turn for the worse. This column, the joint work of the five members of the ‘German Council of Economic Experts’, proposes a novel solution to the crisis – the European Redemption Pact and an associated European Redemption Fund. This would – like Eurobonds – create a joint debt vehicle, but unlike Eurobonds it would be temporary, say 25 years. Its aim would be to ease down the current unsustainable levels while implementing credible fiscal policy reforms in all EZ nations.

In the quest for a solution to the escalating European debt crisis, two equally important yet conflicting principles have led their respective proponents into an impasse that is continuously feeding this escalation, up to the point where a complete breakup of the Eurozone has become a serious threat.

• The principle of accountability demands that member countries engage into an irrevocable consolidation of their public finances and, eventually, into a reduction of public debt back into the realm of universally acknowledged fiscal sustainability.
• The principle of solidarity, on the other hand, requires the stronger member countries to support the weaker ones in times of severe crisis, thereby weakening the incentives among the recipients of any aid to display sufficient fiscal discipline once the climax of the crisis has passed.

The respective positions appear almost impossible to reconcile. Proponents of solidarity are stunned that their Eurozone peers let them stand in the rain even at the risk of their own peril, while proponents of accountability maintain that they have been disappointed by empty promises once too often.

In order to de-escalate the situation a mechanism is needed that allows for combining these two principles.

• It should be able to calm markets by demonstrating convincingly that solidarity will prevail. This can only be reached by strong countries lending their reputation, ie their low risk premia in the bonds market, to member countries facing a liquidity crisis.
• At the same time a credible commitment is required to ascertain accountability, with all member countries adhering to the European Stability and Growth Pact at least in the long run. It would then be possible to discuss suitable avenues to design the future governance structure of the Eurozone in calmer weather, without the gun-to-the-head urgency of the current situation.

More