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Franco-German proposal for a reform of the European monetary union: building a euro area with more risk-sharing and more discipline

Press Release of January 17, 2018

Joint press release of the German Institute for Economic Research (DIW Berlin) and ifo Institute – Leibniz Institute for Economic Research at the University of Munich

Fourteen economists from France and Germany, including Marcel Fratzscher (DIW Berlin) and Clemens Fuest (ifo), are presenting a reform package aimed at making the euro area more robust and more resilient to crises as well as allow for sound public finances and stronger economic growth.

After nearly a decade of stagnation, the euro area is finally experiencing a robust economic recovery. At the same time, it remains financially vulnerable, economically and politically divided, and seemingly unable to deliver its full growth potential. A reform of the financial, fiscal, and institutional architecture of the monetary union is urgently called for.


Agnès Bénassy-Quéré (Paris School of Economics and Université Paris 1), Markus Brunnermeier (Princeton University), Henrik Enderlein (Hertie School of Governance and Jacques Delors Institute Berlin), Emmanuel Farhi (Harvard University), Marcel Fratzscher (DIW and Humboldt University Berlin), Clemens Fuest (Ifo Institute and University of Munich), Pierre-Olivier Gourinchas (University of California at Berkeley), Philippe Martin (Sciences Po and Conseil d'Analyse Économique), Jean Pisani-Ferry (Bruegel, EUI, Hertie School of Governance and Sciences Po), Hélène Rey (London Business School), Isabel Schnabel (University of Bonn and German Council of Economic Experts), Nicolas Véron (Bruegel and Peterson Institute for International Economics), Beatrice Weder di Mauro (INSEAD and University of Mainz) and Jeromin Zettelmeyer (Peterson Institute for International Economics).

The proposals by 14 economists from France and Germany are very concrete and address the flaws in the fiscal and financial design of the monetary union. They would achieve a great deal while not altering the nature of the European project nor requiring any major political shift.

“We are in urgent need of reforms if the monetary union wants to live up to its promises and if we want it to be more resilient to future crises,” said Marcel Fratzscher. “At the same time, we know that in Europe, political reform processes take a long time. We economists don’t want everything to be done differently. Rather, we propose realistic reforms that nevertheless have the potential to be game-changing.”

Compromise between France and Germany

The proposed reforms combine more risk-sharing among member states with more fiscal discipline. The antagonism between these two positions—often seen as a “French” position and a “German” position—is thought to be unbridgeable and has stood in the way of reforms in Europe.

 “France and Germany play a key role in the European reform process,” said Clemens Fuest. “They have to develop a join concept and move on to convince their partners. This will work only if both countries make compromises and move towards each other. France should accept more market discipline and Germany be ready for more risk-sharing. At the same time, both the moral hazard stemming from risk-sharing and the destabilization possibility originating in market discipline should be kept in check.The reforms we propose would, however, not make the euro area the ‘union of transfers’ rejected by many in Germany.”

Concrete proposals in six areas

The following proposals should be viewed as a package that largely requires joint implementation.

1) Completion of the banking union and the capital markets union. This implies, among other things, the introduction of a common deposit insurance, as has been discussed for a while. We also advocate the introduction of a sovereign concentration charge. Should the balance sheet of a bank entail more than a certain proportion of debt by a single issuer (its home country, for instance), it would be required to increase its capital. That mechanism is aimed at breaking the “doom-loop” between banks and sovereign debt of their home country.

2) Introduction of a new expenditure rule in lieu and place of the Maastricht deficit rule. The current deficit rule, stating that a member country’s public deficit cannot exceed three percent of GDP in a given year, is in need of reforming. We propose a new rule according to which government expenditure should not grow faster than long-term nominal output. National fiscal watchdogs, supervised by an independent euro area institution, would monitor compliance with this rule.

3) Strengthening the no-bail-out rule. We interpret this as prohibiting official loans to insolvent countries unless their debt to private creditors are restructured. The ESM needs to ensure that countries with unsustainable debt cannot be financed through new credit programmes.

4) Creation of a new fiscal capacity to help member countries cope with large economic disturbance. This fund would be fed with national contributions, whereby countries that are more likely to draw on it would make proportionally higher contributions. Should unemployment rise above a pre-set threshold, a participating country would be entitled to a payout from the fund.

5) Initiative to create a new type of euro area asset as an alternative to sovereign bonds. This new synthetic asset, which is explicitly not a Eurobond, would achieve a high degree of safety thanks to a combination of diversification and seniority.  

6) Institutional reform. Currently the Eurogroup and its president are both watchdog (“prosecutor”) and political decision-maker (“judge”). We propose to separate these two functions by creating an independent fiscal watchdog (“prosecutor”) within or without the European Commission. The president of the Eurogroup (“judge”) would be assigned to the Commission, similar to the High Representative of the Union for Foreign Affairs.