Issue Report: European Monetary Fund

Is a European Monetary Fund a good idea?

As Greece’s 2010 fiscal problems escalated, the European Commission endorsed a German proposal for a European Monetary Fund to prevent future debt crises. A European Monetary Fund (EMF) would act in many ways like the International Monetary Fund (IMF), acting as the watchdog of the monetary zone and apply the strong measures usually needed to reign in fiscal deviants like Greece, but only for Eurozone countries. The new Eurozone organization would probably be annexed to the European Central Bank (ECB,) and would have the power to bailout and restructure failing national financial systems through massive aid and low-interest loans. Indeed, the idea is for EU countries to have a similarly powerful institution as the IMF to respond to major economic crises in the EU like the Greek default crisis. More broadly, it could open a two-tiered system with the IMF acting globally and smaller EMF-like institutions acting regionally. But, some countries and leaders have resisted the idea, raising concerns about having to bailout other EU countries due to their own reckless financial behavior. Others wonder whether an EMF is repetitive, needlessly overlapping with the function of the IMF. These and other arguments are presented below.

Vs IMF: Is an EMF necessary beyond role of International Monetary Fund?

European Monetary Fund creates global AND regional system

Simon Johnson. "European Monetary Fund, Arriving Soon." The Baseline Scenario. March 8th, 2010

“[The EMF] would represent a major reshaping of global financial architecture […] The main point is that it makes sense to have a two tier system – at the regional level (or for countries grouped in some other way, like “emerging markets”) and at the global level, meaning the IMF. […] The regional entities would be like your family doctor; the IMF runs the big hospital. If you go in with chest pains, your friendly physician will try to get you to change your diet, exercise more – and may also provide some relatively harmless pills. If you have a heart attack, however, you need to go to the emergency room – where their bedside manner may be less than ideal, but they can actually save your life.”

Other IMF-like regional funds have been created outside Euro

Ban on oil drilling in Bristol Bay, Alaska

"European Monetary Fund debate: the main points." EU Business. March 11th, 2010:

“The leading economies among the 16 countries forming the eurozone, with Germany to the fore, do not want the Washington-based International Monetary Fund poking its nose into their affairs.”

IMF bailout would humiliate EU, undermine its legitimacy

"An IMF for Europe." Economist, Free Exchange Blog. Mar 9th 2010:

“An EMF would address a sticky situation within the European fold—the IMF is typically the source of emergency funding for countries looking to avoid debt crises, but IMF involvement in Europe would seriously undermine the image of the euro zone as a functioning entity.”

EU needs European Monetary Fund with equal power as IMF.

German Finance Minister Wolfgang Schaeuble said at the weekend that “for the internal stability of the eurozone, we need an institution that has the experience and power of the IMF.”[1]

The EMF was specially designed for the Euro Bloc.

The European Monetary Fund is slightly different from the IMF. The IMF’s range is worldwide. Therefore, it has to bailout more general countries at a lower loan. However, the EMF was specially designed for the Euro Bloc and uses the Euro as its currency. Also, it was specially adapted for European economies. That would make bailout of European countries easier. Therefore, the EMF is here to stay.

The IMF was not designed for developed Euro countries

"Yes to the European Monetary Fund." New Europe. March 14th, 2010:

“This was the standard case for Third World countries and the solution was provided by the International Monetary Fund (IMF,) which intervened and straightened up the big spender with a strong diet that, however, was never applied to a “First” World countries such as Greece, Spain or Italy.”

European Monetary Fund is repetitive of IMF functions

Desmond Lachman wrote in an Economist magazine EMF roundtable: “What is even less clear is why Gros and Mayer would want to reinvent the wheel by creating a European Monetary Fund, when one has the International Monetary Fund that already has the expertise to impose the appropriate conditionality on lending to wayward countries like Greece.”[2]

EMF would not be big enough to save entire EU countries

Roberto Perotti argued in the Economist magazine roundtable on this topic: “(B)y the authors’ calculations this facility would today give Greece access to something like .65 percent of its GDP … plus any additional discretionary fund from the pool of all accumulated savings. However, .65 percent of GDP would make no difference to Greece today; and … the intervention needed would eat up the whole fund just for a small country like Greece. The key problem country, Spain, with a public debt just above the Maastricht level this year, would have made virtually no contribution to the EMF. In the end, effective intervention, especially when the risk of contagion is high, is likely to depend on the discretion of Germany and other non-problem countries, just as it does now.”[3]

The IMF has neutral bargaining power

"The EMF as camel’s nose." Crooked Timber. March 2010:

“The IMF usually has maximal bargaining power at a country’s moment of crisis – it typically cares far less about whether the country makes it through than the country itself does, and hence can extract harsh conditions in return for aid. But – as we have seen with the Greek crisis – EU member states are far less able to simulate indifference when one of their own is in real trouble, both because member states are clubby, involved in iterated bargains etc, and because any real crisis is likely to be highly contagious (especially within the eurozone). In other words, the bargaining power of other EU member states (and of any purported EMF) is quite limited.”

If EMF is more strict, countries will go to the IMF

Edwin Truman said in the Economist magazine roundtable on the European Monetary Fund: “if the EMF were tougher than the IMF is on average in terms of its economic and financial conditions, then Euro area countries would prefer to go to the IMF for assistance.”[4]

Calling IMF is not humiliating, but sensible during crisis.

Despite the fact that the IMF is (in the EU) seen as “Washington”, the truth is that the IMF is an international body “crammed with clever economists and technocrats from around the world.”, according to the Charlemagne column of the Economist.[5] Therefore, at the time of crisis it is rather sensible to call for such an organization.

Efficacy: Would EMF be able to deal with crises effectively?

EMF would improve EU fiscal federalism/coherence

Mark Thoma. "EMF roundtable: Try a European Fiscal Fund." Economist magazine roundtable. February 18th, 2010

“The fact that individual countries within the euro area cannot use monetary policy to stabilise their economies means they must rely upon fiscal policy as their main stabilisation tool. However, fiscal policy alone is not as effective at stabilisation as fiscal policy used in combination with monetary policy. Fiscal federalism is one way to improve stability. […] if the goal is to provide more economic stability within the euro area, both a European Monetary Fund and a European Fiscal Fund would be helpful.” An EMF can act in this way, regulating and disbursing common resources for the collective financial health of the EU.

EMF would allow orderly sovereign default.

Daniel Gros and Thomas Mayer’s proposed a European Monetary Fund (EMF) in an Economist guest column, arguing that the status quo in the EU was “a failure to allow for an orderly sovereign default.” An EMF, they argued, was essential to enabling such an orderly default.[6]

The EMF could impose tougher sanctions

"Proposed European Monetary Fund Advances." The New York Times. March 2010:

“Lack of sanctions allowed Greece to run up a budget deficit equivalent to 12.7 percent of gross domestic product — the limit for euro members is 3 percent — provoking a crisis that threatens to spread to Spain, Portugal and other countries.”

The EMF could enhance transparency of public finances

EMF is not a short-term solution to immediate crisis

Matthew Saltmarsh. "Proposal for European Monetary Fund Meets Resistance." New York Times. March 2010:

“‘It does not appear to me to be the absolute priority in the short term,’ Ms. Lagarde said on the sidelines of a banking event here. ‘If it is simply meant to strengthen the European mechanisms already in place to govern finances, then it is not helpful, in my opinion, to stir up the polemic.’ That sentiment was echoed by Axel A. Weber, the chief of the Bundesbank, or German central bank. ‘It’s not helpful to talk about ways to institutionalize help when the question is how to implement the budget reforms,’ he said, according to a Reuters report from Frankfurt.”

EMF will not solve EU structural fiscal problems

Tyler Cowen argued that the “underlying problems of European multilateral governance” are unlikely to “be solved by creating an entirely new and different institution.”[7]

The EMF siphons off capital, increases national borrowing costs

Joseph Gokhale. "Forget The European Monetary Fund." Forbes. March 2010

The “EMF borrowing on financial markets would immediately siphon off investible capital and increase interest rates. If the EMF is sizable, it would make public borrowing by national treasuries more costly, directly and immediately.”

Strictly enforcing budgets is better than creating EMF

Germany’s Jürgen Stark, a member of the European Central Bank’s executive committee, said in March of 2010: “Instead of a European monetary fund, budget rules must be strengthened and strictly enforced through a stringent surveillance mechanism.”[8]

Feasibility: Is creating an EMF feasible?

The EMF could be financed effectively

"Disciplinary measures." The Economist. February 18th 2010:

“Countries could, for instance, be charged an annual contribution of 1% of their “excess debt”, the difference between their actual level of public debt and the limit of 60% of GDP agreed on as one of the Maastricht criteria for euro entry. A similar charge could be levied on governments’ excess deficits, the amount exceeding the Maastricht limit of 3% of GDP. Under these parameters the EMF would have accumulated about €120 billion ($163 billion) over the past decade, enough to cover the likely costs of rescuing Greece. These levies are not so big that they make it impossible for offenders to get to grips with their finances.”

The EMF could work like the IMF.

The IMF was effective at pulling irresponsible countries with debt, like South Korea and recently Greece. The worry and speculation among investors on a Greece bankruptcy sent shockwaves through the international market and even reached South Korea, a remote country which has only limited contact with Greece. If South Korea can be shook by even a small fear of bankruptcy, then imagine how bankruptcy can affect the world market. After Greece, there are more jittery European countries like Hungary, Portugal, Spain, and even Italy, the fourth largest economy in the Euro Bloc. To save these countries and the world economy, the EMF should exist. The EMF would work much like the effective IMF which stopped enormous bankruptcies to ensure the world economy’s safety. The only difference is the the EMF’s protection would only reach to Europe

The EMF cannot be set up without a new treaty

Creation of the Fund faces many legal impediments. [9] Angela Merkel: “Without treaty changes we cannot found such a fund. So we will need a treaty change.”

"European Monetary Fund debate: the main points." EU Business. March 11th, 2010:

“German Chancellor Angela Merkel says EU treaties, which currently forbid eurozone countries from coming to the financial rescue of another, must be changed. That could prove laborious in the extreme, going by the years of referendums and special exemptions required to ratify the Lisbon Treaty, which took effect only in December. France has little appetite for new treaty negotiations.”

Investing EMF assets abroad could cause consternation

Joseph Gokhale. "Forget The European Monetary Fund." Forbes. March 2010:

“To ensure a credible commitment to crisis avoidance, the fund should be invested in non-European financial securities. But that would remove investible resources from Europe–something member nations are unlikely to support.”

European Monetary Fund undermines stability/unity of EU

Joseph Gokhale. "Forget The European Monetary Fund." Forbes. March 2010:

“The debt crisis in Greece has European economists befuddled–and clutching at ideas like establishing a European Monetary Fund, which is likely to undermine, not enhance, the stability of the European Union.” The reasons provided are that it would siphon off capital and increase borrowing costs, and that it would create a morale hazard that encourages further reckless spending. All of this, he argues, would ultimately burden, stress, and jeopardize the EU, rather than strengthen it.

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