23 January 2018
The prospects for a European Monetary Fund (EMF) are good. The agreement of last Sunday to initiate formal talks between the SPD and CDU to form a government in Germany made an EMF significantly more likely. An EMF has been promoted by the CDU and pushed by the SPD and may be one of the first European measures of the new government. However, an EMF is unlikely to address monetary issues or become a fund. The misnomer obfuscates what an EMF should and likely will be doing. European Fiscal and Financial Support Bank would be more fitting.
The idea to establish an EMF is undoubtedly welcome. It should have been part of the Euro Area financial architecture form the beginning. The concept naturally stems from the International Monetary Fund (IMF). Yet, in a monetary union with a convertible and readily accepted currency, an EMF faces very different tasks than the IMF.
The IMF was established in 1944 to serve as a permanent mechanism for exchange rate policy coordination. Part of its remit was to support countries that face temporary balance of payments problems, that is, that ran out of foreign exchange to meet their foreign currency denominated obligations. The IMF was set-up as a fund, where IMF member countries lend their own foreign exchange to the IMF to allow the IMF to lend to IMF member countries in need. For that purpose, the IMF has unconditional access to IMF member countries foreign exchange accounts up to the amounts of the member countries’ subscriptions or quotas with the IMF. This means the IMF can only lend in the amount of its subscriptions (though those have been topped-up by bilateral official lending) but by using currencies expands on existing resources.
The term monetary fund was coined with the Join Statement by Experts on the Establishment of an International Monetary Fund of April 1944 of the U.K. and U.S. that laid the foundation for negotiating an international monetary fund in July 1944 in Bretton Woods, New Hampshire. The plan was a merger of the ideas for a clearing union advanced by John Maynard Keynes for the U.K. and the idea of an international stabilisation fund advanced by Harry Dexter White for the U.S. The latter dominated the final proposal. Both proposals addressed the same problem of providing a lending mechanism to help countries address balance of payments shortfalls. However, while the stabilisation fund sought adjustment for balance of payments problems mostly from debtors, the clearing union introduced provisions to put pressure on both creditor and debtor countries to share the responsibility for balanced international payments.
An EMF would face rather different challenges. It is not the main mechanism for monetary cooperation in the Euro Area, that is the remit of the European Central Bank (ECB). It will not support balance of payments problems from a monetary point of view because within a monetary union, there are no foreign exchange shortfalls. It may help address balance of payments problems with third non-Euro Area countries, but because EMF member countries have the euro and can readily convert it in the foreign exchange market, there is no foreign exchange need. An EMF will likely be able to lend to banks directly, something the IMF cannot do and hereby play a critical role to address bank failures. An EMF will most probably lend to governments in distress that face insolvency. Since governments in the Euro Area predominantly borrow in euros, an EMF would address outright fiscal problems, something the IMF is not supposed to do but does.
If an EMF adopts the same funding mechanism as the existing European Stability Mechanism (ESM) than it will not be a fund but more like a bank. Critically, issuing bonds in capital markets to raise money merely redistributes existing resources and will be more constrained in attaining needed levels of fire power.
An EMF would be a critical achievement to strengthen the Euro Area. Yet, it needs to be clear of how it aims to achieve its objectives. The right name for a start matters. Setting-up an EMF would also represent a unique opportunity to revisit Keynes’ clearing union, building on the successful European Payments Union of 1950-58, and whether this mechanism may not serve better to fulfil the European ideals of distributing the burden of adjustment between debtors and creditors. At the time of setting-up the IMF, the largest credit country, the U.S., thought it would rather be inconvenient. Germany, as the biggest creditor in the Euro Area may feel the same today. Nonetheless, European Clearing Union would also sound much better.