European Monetary Fund (update): Beware of Germany

5 June 2017

The E.U. Commission announced on 31 May rather ambitious ideas about possible ways for deepening Europe's Economic and Monetary Union. Those reaffirm discussions about a European Monetary Fund (EMF) to help fighting Euro Area crises. Germany in particular seems eager most likely by transforming the existing European Stability Mechanism (ESM). The recent impasse on Greece's economic programme illustrates the dysfunctionality of the Euro Area's economic crisis management and urgency for institutional reforms. It would critically complement the financial architecture of the Euro Area and strengthen the euro. However, key lessons need to be learnt for the design of an EMF; above all from the International Monetary Fund (IMF). To be effective, an EMF will have to be insulated from undue German influences.

Germany is naturally a necessary but also an ambivalent supporter of an EMF. It has been an ambivalent supporter of the IMF amid a history of preventing increases in IMF financial resources and undermining its multilateral character.

Germany proclaimed in 2010: "We do not consider it appropriate to further increase the overall resources of the Fund as the crisis subsides."1 In 2007, it called into question any need for IMF resources: "[…] [T]he availability of ample private market financing to emerging markets and developing countries has overall reduced the potential need for Fund resources."2 Despite recent increases in financial resources, the IMF continues to lack adequate firepower by any economic metric.

Germany used the Troika, tying together the IMF, ECB and E.U. Commission, to amplify its weight highly disproportionately in the Euro Area IMF-supported arrangements. It degraded the IMF to a junior partner and made it rubberstamp decisions largely taken in Germany. It institutionalised political meddling.

The key lessons from the IMF are that a successful EMF needs to have ample resources, act as a technocratic institution and represent the interests of the Euro Area as a whole. The first will ensure the institution's independence and credibility as a crisis fighter. The second will allow it to be seen as a neutral broker. The third will give it legitimacy as a multilateral institution.

EMF membership could be composed similar to the ESM in proportion to the ECB's capital contributions determining both countries' financial subscriptions and voting shares.

To ensure an EMF has adequate financial resources, it would ideally obtain financing directly from the national central banks of the Eurosystem. Central banks would extend unconditional overdrafts to an EMF in proportion to their subscriptions similar to the current financing arrangement of the IMF. The current approach of the ESM of issuing debt to fund its operations is too restrictive and merely redistributes existing but does not create new resources.

To be perceived as a neutral broker, an EMF should be shielded as much as possible from undue political interferences. Its staff must be able to work independently. It must devise its own lending criteria and conditionality. Countries borrowing from an EMF should not be subject to ideological whims or political conveniences. An EMF needs to exercise its functions with authority to enforce adjustments on borrowing countries.

To foster legitimacy, an EMF would need to give member countries balanced voting shares to have a fair voice in the decisions of the institution while allowing the institution to move promptly and flexibly. No single country should have a blocking veto. Most importantly, member countries, including small ones, should not feel they are being bullied by the larger ones. All countries must abide by the same rules and be seen to advance common interests. The provisions for admitting new member countries ought to preserve the ability of the institution to act.

The IMF has for some time recognised, and taken partial remedies against, a mounting perceived lack of legitimacy amid an unbalanced distribution of voting shares among its member countries. Dynamic emerging markets in particular have increasingly felt that their economic weight is not adequately reflected in their share in decision making. It diminished ownership in the institution, undermined its effectiveness and increased perception of unrepresentativeness. It contributed to fostering a creditor-borrower divide and enhanced the stigma of IMF lending.

The Euro Area has with the ECB established a strong and independent institution that is nonetheless subject to repeated German attacks. A successful EMF must be more independent. Germany will have to be restrained and show restraint. The Euro Area warrants an EMF but it should not be a GMF in disguise.

1 Statement by Mr. Stein [Executive Director for Germany] and Ms. Meyer on Fourteenth General Review of Quotas, GRAY/10/1354, 13 April 2010, Washington, D.C.

2 IMF, Minutes of Executive Board Meeting 07/110-4, 17 December 2007, Washington, D.C.