CEPS Working Document No. 2017/11, December 2017

As early as 2010, at the outset of the sovereign debt crisis, Daniel Gros and Thomas Mayer argued that Europe needed a European Monetary Fund (EMF). In the meantime, the European Stability Mechanism (ESM) has been created, which performs the function of an EMF. It was critical in containing the cost of the crisis and four of its five country programmes have been a success. But the case of Greece shows that one needs to be prepared for failure as well. They propose in this paper to keep the ESM essentially as it is, but would empower it to set conditions on countries receiving its financial support. Such support would have a limit, however, to prevent situations in which the ESM would ‘own’ a country.

The authors conceive of the ESM/EMF literally as a financial stability mechanism, whose main function is to ensure that a bailout is no longer “alternativlos”, as Chancellor Angela Merkel used to say. In 2010, the rescue of Greece was presented as TINA (There Is No Alternative) because the stability of the financial system of the entire euro area appeared to be in danger. With financial stability guaranteed by the ESM/EMF in combination with the Banking Union, default becomes an alternative that should be considered dispassionately. Whether the debt of a country is sustainable is rarely known with certainty beforehand. Accordingly, they argue that it is proper that the Union, in the ‘spirit of solidarity’, initially gives a country the benefit of the doubt and provides financial support for an adjustment programme, but caution that the exposure should be limited. If the programme goes awry, the ESM/EMF could be of great help, as it could provide bridge financing to soften the cost of default.

Daniel Gros is Director of CEPS, and Thomas Mayer is Founding Director of the Flossbach von Storch Research Institute.

Keywords: European Monetary Fund; European Stability Mechanism; EMU reform; debt restructuring in EMU; EMU exit