A Modest Proposal for Resolving the Euro Crisis: an abridged version as published by the Financial Times On Line

17/08/2012 by

by Yanis Varoufakis[1] and Stuart Holland[2] (click here for the full version of our Modest Proposal)

The Eurozone is disintegrating under the weight of three intertwined crises unfolding in the realms of banking, public debt and under-investment & internal imbalances.

For two years each and every response by Europe’s leadership to the crisis proved consistently underwhelming. The reason was Europe’s steadfast denial that this is a systemic crisis, as opposed to just a failure of fiscal discipline in some of its member-states. And when, more recently, the systemic aspect of the crisis could no longer be denied, Europe got entangled in a debilitating dilemma between the present policy of bailouts-with-austerity (which no one seriously expects to work) and the idea of resolving the crisis through moves toward federal solutions (which Europeans are not ready for).

Can this deadlock be broken swiftly and effectively? We think that it can with three policies which resolve the three intertwined crises by re-configuring Europe’s existing institutions.

Policy 1: Ending the disintegration of the Eurozone’s banking system

For a while now, the expected value of a euro in a bank account in Madrid or Rome has been lower than that of a euro in a German or Dutch bank account. This is so because stricken banks in Spain and Italy must rely for capital injections from the respective states which find their own re-financing unsustainable. The capital flight that follows pushes these banks and the states that are supposed to stand behind them into a death spiral that is only made worse by the combination of austerity and loans from the European Financial Stability Facility (EFSF). To break the deadly embrace between insolvent member-states and bankrupt banks, the task of recapitalising Europe’s banks must be shifted directly to the EFSF, under the supervision of the ECB. Such a Euro-TARP can be created immediately and with no Treaty changes whatsoever.

Policy 2: Dealing with the Debt Crisis

The ECB could announce tomorrow morning that, henceforth, it will be undertaking a Debt Conversion Program for any member-state that wishes to participate: It will service (as opposed to purchase) a portion of every maturing government bond corresponding to the percentage of the member-state’s public debt that is allowed by the Maastricht Treaty.[3]

To fund these redemptions on behalf of some member-state, the ECB will issue bonds in its own name, guaranteed solely by the ECB but repaid, in full, by the member-state: Upon the issue of ECB bonds, the ECB will simultaneously open a debit account per participating member-state into which the latter is legally bound to make deposits to cover the ECB-bonds’ coupons and principal. These debts of member-states to the ECB shall enjoy super-seniority status and be insured by the EFSF against the risk of a hard default.

This Debt Conversion Program, which involves no debt monetisation, will instantly engender large interest rate reductions for fiscally-stricken states without any concomitant rise in the long term interest rates that Germany pays (since Germany is not guaranteeing the Program).

Policy 3: Redressing low aggregate investment and internal imbalances

Having allowed this Crisis to fester for so long, the Eurozone fell unnecessarily into a fresh recession which exacerbates its internal imbalances. Europe is now in urgent need of its own New Deal; i.e. a policy for shifting the mountains of idle savings into profitable investments, especially in the deficit regions.

Remarkably, Europe can achieve this without Keynesian stimuli. The European Investment Bank (EIB) has a sterling record in financing, through its own bond issues, profitable investments and has a long list of shovel-ready potentially lucrative projects that could realise Europe’s New Deal. What we need is that the EIB’s hands are untied by allowing for the national contribution to projects (currently set, by convention, to 50% of total funding) to be funded by a net-issue of either ECB-bonds or of bonds by the EIB’s sister organisation, the European Investment Fund (EIF).

Neither Treaty changes nor unanimity are necessary

Three crises, three policies for addressing them, each involving existing institutions and requiring no Treaty changes, no German guarantees of other nations’ debts, no Keynesian stimuli, no Central Bank monetisation.

Alas, Europe, deeper in self-doubt than in debt, is dithering while the Eurozone crumbles. Many blame the requirement of unanimity for this. Only it is not true: unanimity is unnecessary! Nine member-states or more can call for these policies to apply to them on the established (but never used) principle of ‘enhanced cooperation’ and ‘qualified majority voting’. (Click here for our letter to the Financial Times on this issue.)

The institutions are in place and the solution is within reach. All that is missing is the will.


[1] Professor of Economics at University of Athens and the Lyndon B. Johnson Graduate School of Public Affairs, University of Texas, at Austin; Economist-in-Residence with Valve Corporation, Seattle

[2] Visiting Professor of Economics, Coimbra University; formerly a Member of the House of Commons, UK, and advisor to Jacques Delors.

[3] The proposal here is that the ECB will be servicing 100[(D-E)/D% of each maturing bond, where D is the national government’s debt-to-GDP ratio (in %) and E is the difference between D and 60% (the Maastricht-compliant level). E.g. in the case of Italian and Spanish debt-toGDP ratios tthat are in the region of 120% and 90% respectively, then the ECB would be servicing 50% of each Italian government maturing bond and 66.7% of each Spanish government maturing bond.


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