First-Hand Information on Economic Policy - ZEW President Clemens Fuest: "The Weak Budgetary Restrictions in the Eurozone Undermine Fiscal Discipline."

The eurozone member states are currently facing a critical decision, one which will be decisive in determining their future. "The weak budgetary restrictions in the eurozone undermine any fiscal discipline", said Professor Clemens Fuest, President of the Centre for European Economic Research (ZEW). "We are running the risk that debt will be financed through the money printing press," claimed Fuest, as he summarised the urgent economic problems which the euro area is now facing. In his lecture, titled "The European Monetary Union at a Crossroads", which he delivered as part of the lecture series "First-Hand Information on Economic Policy" at ZEW in Mannheim on October 29, 2015, Fuest made clear that joint liability for debt in the eurozone could be an option only if controls were also shared. In the short term at least, it is inconceivable that such a situation will be achieved.

Is there even an alternative to buying up an unlimited number of government bonds, the policy currently pursued by the European Central Bank (ECB)? The policy favoured by Europe's politicians in the "Five Presidents' Report", argued Fuest, is in no way a viable alternative. The plan does foresee more political coordination and greater control of national policies by Brussels, as well as an increased degree of shared liability for government debt and financial transfers in the case of financial crisis – policies which, in theory, cannot be faulted. The plan, however, has several weaknesses, the ZEW President argued.

According to Fuest, its implementation would bear the risk of massive distributional conflicts between the member states of the eurozone. Furthermore, Brussels lacks the political power and democratic legitimation required if it is to control and coordinate national fiscal policies.  "Is there a reason to be sure that the committees in Brussels always come up with the best economic policy for a given country?" the economist asked. Fuest argued that nations should have the freedom to pursue the economic policies they prefer, but they should also be responsible for any subsequent risks.

ZEW proposes European fiscal union

ZEW proposes a European fiscal union as a sustainable alternative to the measures proposed in the "Five President's Report". Concrete measures in the proposal include effective coordination of national fiscal and economic policies within Europe, the implementation of an insolvency procedure for sovereigns in the eurozone, including liability for private creditors, as well as a European bank union and, finally, a fiscal stabilisation mechanism designed to absorb the impact of economic shocks in the euro area. From a political perspective, however, the implementation of such comprehensive changes would be extremely difficult, said Fuest.

By contrast, the introduction of "accountability bonds" - a concept developed by Fuest and his colleagues at ZEW - would be a "minimally invasive intervention", making this proposal more realistic, as the ZEW President noted. In the case of a financial crisis, such junior bonds would first cease to be serviced. In addition, banks would be permitted to purchase accountability bonds only if they are able to guarantee sufficient equity capital. They would also be completely excluded from government bond purchases made by the ECB, explained Fuest.

Government bonds and accountability bonds should coexist

States would be obliged to issue such junior bonds if their deficit exceeds the level required to ensure a roughly balanced national budget in the medium-term, and if their national debt is greater than 60 per cent of their gross domestic product. Pre-existing debts would continue to be financed with regular government bonds. "This would ensure that the costs of excessive debt are borne by those who cause them," said the ZEW President. Accountability bonds would mean higher interest rates for states in debt, and greater risks for investors. Fuest, however, remains optimistic that there would be sufficient demand for junior bonds. "It may take some fiscal incentives to persuade countries which currently have high levels of debt to accept the model." In the long-term, Fuest said, accountability bonds would ensure greater stability in the eurozone.