Preparing for the December 9 Summit
Merkel and Sarkozy agreed to automatic sanctions and a fiscal balanced budget rule with a 3% deficit limit written in the national legislation/constitution of each EZ country. In order not to infringe sovereignty too much, the European Court of Justice would receive powers to determine whether the fiscal rule is implemented properly, but it would not have the authority to refuse a national budget. Eurobonds are taboo for now. Importantly, the launch of the ESM will be brought forward to 2012 instead of 2013 and its decisions will follow an 85% majority rule instead of unanimity. The focus on private sector involvement (PSI) at the ESM will be toned down to highlight standard IMF principles and procedures and without raising the ESM’s seniority status, i.e. there would be no “Lex Europa” that would treat investors in Europe worse than investors elsewhere in the world, according to Merkel. Greece’s PSI is explicitly to remain a unique case. Merkozy vowed that if such treaty change could not be agreed to by all 27 members it will be implemented separately by the EZ 17 plus whichever country wants to join. Separately, Mario Monti suggested that a fiscal compact, a larger EFSF fund in addition to IMF involvement could meet the conditions for the ECB to adopt a more aggressive crisis fighting role. With respect to the IMF involvement, the German press speculates that the 17 national central banks stand ready to lend the IMF a “three digit billion sum” on behalf of a special bailout fund – the figure of €100-200 billion is making the rounds which would be added to the €440 billion in EFSF guarantees.
Are these elements enough to put an end to the crisis? In our view these are necessary but not yet sufficient first steps toward a more stable framework. A temporary positive effect on risk premiums is warranted as the tail risk of an EZ implosion is removed in the immediate term. Ultimately, however, what is needed is a growth strategy to make public and private debt levels sustainable. Sterilized SMP purchases are not the same as countercyclical monetary policy a la QE. So far the latter was regarded as out of the question with a view to the price stability mandate (and with the no bailout clause) even if secondary market purchases are legally allowed. We note that Chancellor Merkel has recently again reiterated that any treaty change will not involve any amendment to the ECB’s mandate to include the role of lender of last resort. Thus, even if the economy deteriorates further and the ECB chose eventually to embark in unsterilized asset purchases (e.g. by buying bonds across the board rather than targeted towards a particular country), we note that the still binding treaty constraints and the lack of a wholehearted adoption of the lender of last resort role would keep uncertainty –and risk premiums—elevated. We also note that the path towards a fiscal union ultimately entails more than just a fiscal rule and big bazookas – S&P’s mass downgrade threat serves as a reminder that in the EZ the fate of one country has repercussions on the others even in the absence of any formal cross-burden sharing or joint liability. The question about an automatic cross-EZ stabilization mechanism and/or a jointly guaranteed financing mechanism a la Eurobonds needs to be sorted out.
3 Responses to “Preparing for the December 9 Summit”
"S&P’s mass downgrade threat serves as a reminder that in the EZ the fate of one country has repercussions on the others": not to forget repercussions on the rest of the world including the US.
As posted at pragcap.com, this is the latest as of 6:40 EST:
If this is finalizes the preview of what is coming this Friday (I.e., the S-M Monday meeting plus this); then, markets worldwide should start showing the beginning of the BiG disappointment as early as tomorrow:
December 6, 2011 7:19 pm
EU talks on doubling financial firewall http://www.ft.com/cms/s/0/839e6eac-202e-11e1-9878…
The whole thing is under a trillion €.
Reply12/06/2011 at 6:37 PM
The 9th of December is going to be a two days late Pearl Harbor.