by Peter Bofinger, Claudia M. Buch, Lars P. Feld, Wolfgang Franz, Christoph M. Schmidt
July 25, 2012
EZ leaders have failed to tame the crisis. This column presents the English language version of the new plan by the German Council of Experts to resolve the crisis via “redemption bonds” and accompanying institutional reforms.
Since the beginning of this year, the Eurozone crisis has worsened. Despite notable efforts, the June European summit has not succeeded in restoring confidence in the euro. Fearing the restructuring of public debt in EZ countries, investors have turned their back on sovereigns in the Eurozone, and even on the Eurozone as a whole.
This distinctly systemic nature of the crisis originates from the implicit sovereign default risk. In contrast to the central banks of the US, the UK and Japan, the ECB is not allowed to finance treasuries in the member states. It cannot therefore act as a lender of last resort for governments. This dividing line between monetary and fiscal policy was drawn by the Maastricht Treaty to ensure price stability and, given the experience with monetisation of fiscal deficits in Europe’s history, should remain in place. But it induces an implicit insolvency risk for investors financing sovereign debt of EZ countries which, in the current situation, induces investors to either avoid the countries in trouble or even the Eurozone as a whole. The Eurozone thus faces the threat of breakup.
This situation requires a new governance structure for the Eurozone in order to regain investors’ confidence. The crisis has become so gridlocked, however, that the new governance cannot be established easily. The European Redemption Pact (ERP) proposed by the German Council of Economic Experts (GCEE) in November 2011 allows for breaking this deadlock. The GCEE therefore proposes a revised and extended ERP which addresses both the exacerbation of the crisis during the last months and a number of concerns induced by the original proposal.
We view this as a device for solving the current crisis whose time has come.