The dispute over a solution to the Greek sovereign debt crisis has revealed the major shortcoming of eurozone crisis management: there is no effective strategy to enforce negotiated reforms and budget cuts if a member of the European Economic and Monetary Union is not playing by the rules. Researchers from the Centre for European Economic Research (ZEW) stress that the institutional structure of the euro area is in need of reform. They also make a practical proposal on how to create a functional European Fiscal Union.

Despite the Banking Union, the European Stability Mechanism (ESM) and conditionality as a political instrument in the sovereign debt crisis, negotiations between the Eurogroup and Greece have shown that the eurozone has no long-term framework conditions for budgetary emergency situations. In the end, the European Central Bank has been left to take care of the issues at stake, which is inconsistent with the ban on monetary financing of member states. With regard to deeper fiscal integration and the corresponding institutional reforms in Europe, a current ZEW study suggests combining two instruments: a fiscal insurance mechanism without permanent redistribution, interlinked with a systematic restructuring procedure for insolvent states.

The first recommendation of the ZEW researchers is to introduce a common unemployment insurance scheme at the supranational level. Such an automatic stabiliser can help euro countries to absorb asymmetric economic shocks in the euro area. A core element of the proposal is that transfers from the European unemployment insurance only be activated in particularly severe cases of recession, and be paid to persons who have registered as unemployed for a maximum of twelve months. Moreover, unemployment benefits would have to be co-financed by the receiving states’ government budgets. ZEW calculations show that such an insurance scheme would have positive stabilisation effects, and at the same time would minimise negative incentives as well as the risk of slipping into a European transfer union.

The second recommendation consists in setting up insolvency procedures for countries that are facing the threat of national bankruptcy. ZEW has already presented a feasible concept entitled "Viable Insolvency Procedure for Sovereigns" (VIPS). To make sure the ban on monetary member-state financing will not be reduced to absurdity, insolvent countries can, as a first step, decide to draw on support from the ESM. If ESM loans cannot stabilise the country's credit standing, however, it will have to enter into negotiations on debt restructuring with its creditors and the ESM after at least three years. Throughout these negotiations, a debt moratorium should be in place. Once the VIPS concept has been implemented, ZEW experts expect that impending eurozone exits will be prevented from the outset.

"In practical terms, our proposal would lead to a binding link between stabilisation effects and budgetary discipline," says Professor Friedrich Heinemann, head of the ZEW Research Department "Corporate Taxation and Public Finance" and co-author of the study. Heinemann adds: "A fiscal insurance mechanism and an insolvency procedure for sovereigns are not mutually exclusive. To the contrary, they complement and strengthen each other. A European unemployment insurance scheme would support member states of the euro area in times of crisis. At the same time, a viable debt restructuring procedure ensures growing acceptance of automatic stabilisation at the EU level. After all, the mechanism prevents permanent transfer payments between member states.”

For more information please contact

Prof. Dr. Friedrich Heinemann, Phone +49 621/1235-149, E-mail heinemann@zew.de

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