Economists' action plan for a strong euro zone

French and German economists have been touring Europe’s capitals urging the EU’s leaders to take action now to strengthen the banking sector to fend off another financial crisis and put in place measures to minimise the impact if one occurs.

Today, while the situation is relatively stable, is the right time to grasp the nettle and put the right reforms in place, says one of the experts Paris School of Economics economist Agnès Bénassy-Quéré.

She said the following are some of the crucial measures the experts believe should be taken up, which have been outlined in detail in a report published by the Centre for Economic Policy Research (CEPR) at this link.

Concentration charges

There should be ‘concentration charges’ on banks that hold too many government bonds from one country (usually the one they are located in) encouraging them instead to diversify their portfolios. The aim would to be to make banks less closely linked to one country and less vulnerable to economic problems occurring there.

Deposit insurance

Another area where banks are often closely tied to the home country is in national deposit insurance schemes (where the government promises to compensate bank customers’ losses up to a certain level if the bank goes bust). Instead, a common deposit insurance should be created for the EU ensuring all euro zone bank customers are protected equally.

More authority to ESMA and creating a capital markets union

More authority should be given to the European Securities and Markets Authority (ESMA), to ensure harmonisation of financial regulations – that they are implemented in the same way everywhere. A ‘capital markets union’ should be developed, simplifying ways for euro zone businesses to attract investment from would-be investors in other member states, as opposed to relying on loans from banks.

Spending rule

At present governments spending is too ‘cyclical’ – they tend to spend more in times of economic upturn (and accumulate debt) and make cuts in times of difficulty. Instead there should be a rule that spending should not grow faster than potential growth of GDP. In times of downturn a larger deficit (between spending and tax income) is acceptable and spending should stay on track; but in an upturn the spending rule would represent a break on increased spending.

Spending should grow more slowly in countries which have a high debt compared to GDP and who therefore need to reduce this ratio.

This should be monitored by independent national fiscal watchdogs, supervised by an independent euro area body.

Governments that break the rule would have to finance excess spending by issuing ‘junior bonds’ with a much higher interest rate than ordinary government bonds, which would act as a disincentive and be more effective than sanctions.

Euro area fiscal capacity

In normal times countries would rely on their own national fiscal policies, but if there is a major crisis they could receive a one-off transfer from a fund created from national contributions; for example if there is a sudden leap in the unemployment rate above a certain level.

It would not be a loan, but would be conditional on spending the money according to guidelines – eg. if the crisis related to unemployment it would be used on unemployment benefit or used to maintain investment.

ESM (European Stability Mechanism)

This is a Luxembourg-based organisation established to bail out euro zone member states in financial difficulty. We should introduce new precautionary measures: only countries that in the past have complied with the fiscal rules will automatically get money from the ESM with very limited conditions if they have an urgent need of liquid funds.

Euro area safe assets

There has been a lot of discussion about the viability of creating a new kind of euro zone safe asset based on government bonds from the member areas. We should carry out a small-scale experiment.

Role of institutions

The ESM should be directly accountable to the European Parliament.

Regarding fiscal matters, within the European Commission, the roles of making political decisions and checking that countries comply with rules should be more clearly separated (eg. Chinese walls – no internal information sharing – with different commissioners in charge of each), or the watchdog role should instead be done by another institution such as the European Fiscal Board.

Ms Bénassy-Quéré said: “The general idea is that all of these ideas fit together. If you do only one of them then you can introduce more hazards and financial instability.

“Or if not all of them, then at least a balanced package must be worked out.

“The important thing is to fix the banking sector first and then in case there is a crisis, to have other tools to make the crisis less detrimental.”