HEIGHTENED GREEK TURMOIL
Repeated "last chance." Pressure is mounting on reaching an agreement for the Greek bailout plan, after the country announced it would pull together its four June payments to the IMF into one €1.6bn payment due on June 30th—the second time this mechanism is used, after Zambia in the 1980s (Open Europe). According to Gabriele Steinhauser and Viktoria Dendrinoou (Real Time Brussels), a third bailout deal needs to be sealed before winter to avoid default. Reform plans are presented in quick succession (e.g., a Greek "Reforms Draft Plan" on June 1st (Keep Talking Greece), with new amendments on June 9th (Keep Talking Greece and EuroIntelligence)). The main issues are debt relief and primary surplus targets. Grexit is no longer ruled out, as suggested by recent speeches by Christine Lagarde and Angela Merkel (EuroIntelligence).
Diverging opinions on austerity measures. Joseph Stiglitz (Project Syndicate) questions the efficiency of the Brussels Group’s drastic austerity stance in light of Greece’s willingness to engage in continued reforms, and fears economic and political risks attached to a Grexit are "significantly underestimated" by EU leaders. Florian Schui (EUROPP) points out that a Grexit would have a “controllable” economic impact but would harm European solidarity. Elias Papaioannou, Richard Portes and Lucrezia Reichlin (VOXEU) argue that an agreement on the completion of the second programme for Greece will not restore confidence and call for "an efficient, realistic and truly reforming new program."
Quoting an IMF paper, Simon Wren-Lewis (Mainly Macro) highlights that the shock of the financial crisis and Great Recession led to a large increase in debt levels in nearly all OECD countries, and calls for slow public debt adjustment “until interest rates rise, so that monetary policy can offset the impact of any subsequent fiscal consolidation”. Andreas Müller, Kjetil Storesletten, and Fabrizio Zilibotti (VOXEU) stress that well-designed assistance programs deliver large welfare gains and help lift a country out of recession and vicious debt circles. They argue that repeated renegotiations are more efficient than program withdrawals.
More broadly, the issue of debt reduction is on the table. The IMF paper on the efficiency of debt reduction calls into question the governance of the Eurozone. The authors suggest that indebted countries with significant fiscal space should not necessarily engage in extensive debt reduction. Free Exchange further highlights that previous IMF research has shown the trajectory of the debt-to-GDP ratio can matter more than its overall level. Benedicta Marzinotto points out in Project Syndicate the need to shift the policy focus from short-term goals (nominal deficit targets) towards fiscal sustainability, i.e., providing for more flexible fiscal rules. André Sapir and Guntram B. Wolff (Bruegel) highlight five priorities for Euro area governance reforms to achieve tighter fiscal governance at European level. They recommend the creation of a Eurosystem of Fiscal Policy (EFP) comparable to the Eurosystem of Central Banks, with approval powers given to a Euro area Chamber of the European Parliament.
Missing parts of the Banking Union
In a new report, Nicolas Veron (Bruegel) assesses the state of play of the Banking Union after the transfer of the supervisory authority over Euro Area banks to the ECB last November, with a few concerns:
The legislative agenda remains unfinished—capital regulation harmonization is still incomplete, and the Basel III accord imperfectly transposed, while insolvency regimes for banks, accounting and auditing frameworks differ across Member States. EuroIntelligence expressed concerns about key measures still missing in Basel IV and recognized the need for a full implementation of Basel III. Viktoria Dendrinou (Wall Street Journal) points out that Germany is pushing to provide Governments with a veto power over banks’ resolution.
The geographical discrepancy between the Banking Union area and the EU, especially with regards to the special status of the UK. Alex Barker (Financial Times) notes that France is leading an assault on Britain’s prized carve-out, which protects its national banking structure reforms from being overwritten by a EU-wide initiative. Other Member States expressed worries about the cross-border impact of allowing a different UK regime.
A Banking Union without a Fiscal Union is an inherently incomplete and potentially unstable combination—as regulation is federalized but risk is not mutualised (Nicolas Veron and Simon Tilford). Keeping deposit insurance in the national bosom is fundamentally at odds with the very concept of a Banking Union, and can only be changed with the implicit or explicit backing of a pan-European treasury, which currently does not exist. Peter Spiegel argues that a fiscal union is highly improbable following the Franco-German paper issued following the May 26th Brussels meeting of EU “sherpas”.
What impact? A VoxEU post highlights how regulatory changes have contributed to a sizeable decline in cross-border claims to GDP, which reduces the exposure to global shocks. However, more regulations will not necessarily prevent future crises, as it is difficult to differentiate illiquid from insolvent assets. According to John Cochrane, preventing crises and bailouts requires all fixed-value demandable assets to be backed 100% by abundant supply of short-term Treasuries. The ECB Financial Stability Review draws attention to the risks posed by an inflating shadow banking sector, which circumvents regulation. Increases in bonds and real estate funds are most likely to amplify shocks and impose externalities on the system.
