SWP Research Paper 2011/RP 11, October 2011, 38 Pages
The euro area is still negotiating its future framework for sovereign
debt crisis management and prevention. This study suggests what such a
framework should look like. As a basic rule, it should distinguish
between liquidity problems and solvency problems. In cases of liquidity
problems, emergency loans at a low interest rate should be made
available. In cases of insolvency, an orderly restructuring of debt
should be chosen.
However, this is easier said than done as the volumes
needed for liquidity support might be very large. Increasing the volume
of the European Stability Mechanism (ESM) might endanger France’s credit
rating. Meanwhile, even an orderly default of a state could trigger a
banking crisis.
Hence, a five-pillar solution is proposed: First, a
permanent liquidity fund with a sufficiently large volume should provide
loans to euro area members experiencing acute payment difficulties,
with clear conditions and strict budget monitoring. Second, a bank
recapitalisation fund should be able to directly inject capital into
banks and allow for a restructuring of public debt of one of the euro
area countries without having to fear a systemic banking crisis. Third, a
debt restructuring mechanism should be introduced for the euro area.
Fourth, a euro-bond for up to 60 percent of GDP should make sure that
the ESM can remain within a reasonable size and still be able to prevent
liquidity support also to large member states. Fifth, substantially
strengthened macro-economic and budgetary policy coordination on the EU
level based on sound democratic legitimacy would complement the
framework. Six case studies show that macroeconomic imbalances are a key
factor when assessing solvency and liquidity and hence need to be
tackled to ensure the long-term sustainability of the euro area.
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