European monetary fund will not help Greece

The plans for a European Monetary Fund come too late to solve Greece's problems. Setting it up could take years and the question remains how much authority it would have.

When the European Monetary System was in the works in 1978, the agreement called for a European Monetary Fund (EMF) to be set up within two years. For political reasons, that fund never saw the light of day.

Now the EMF plan has been taken from the shelf again as a possible solution for the current debt crisis in many European countries using the euro. But like in 1978, the main question remains: do the eurozone governments really have the political will to improve economic cooperation? After all, the plan is at odds with the idea of retaining national sovereignty.

In February, Daniel Gros of the Centre for European Policy Studies in Brussels and Thomas Mayer of Deutsche Bank relaunched the old EMF plan by distributing a policy paper in the European capital. Last weekend, German finance minister Wolfgang Schäuble was the first politician to openly support the idea. He said an EMF, a European version of the International Monetary Fund (IMF) which would lend money to euro-countries in financial distress, was "worth considering".

Only one place to turn to

But a European IMF would come too late to solve the Greek problems. Getting all eurozone government leaders to agree to it could take years. On paper, though, it offers excellent solutions to the types of problems currently plaguing Greece and the eurozone.

European treaties prohibit direct financial support to the 16 euro countries. Citizens in rich countries like Germany and Netherlands, which have been frugal in years of prosperity, don't even want to lend money to those that weren't. Hence, if the problems in Greece escalate despite fierce austerity measures, the country has only one place to turn to: the IMF.

The Washington-based IMF grants emergency loans to countries in exchange for far-reaching undertakings to clean up their public finances. Some of the bigger euro countries have problems with the IMF playing such a dominant role in euro territory. "Allowing the IMF to step in would be to admit that euro countries can't solve their own problems," Schäuble said.

Not just advantages

The EMF treasury would be filled with the fines paid by euro countries that break the rules of the Stability and Growth Pact. This way, the ones who behave best would not need to contribute. This appeals to the northern countries that feel those who have made a mess of their public finances shouldn't be rewarded as this would be a ‘moral hazard’. Gros and Mayer proposed that a country should never be allowed to borrow more than it has contributed. Had the EMF been set up when the euro currency was adopted in 1999, they estimated, the fund would now have 120 billion euros.

But there are not just advantages to an EMF. Political complications begin with the question what the fund can demand in return for supplying a loan. Can it put a country under economic surveillance? Can it force countries to change labour laws, halt all military expenses or raise the national pension age in exchange for its loans? Can it influence monetary decisions now taken by the European Central Bank? This conditionality is the tricky part.

"A EMF has to be very tough, or it will be a bottomless pit," said Charles Wyplosz, professor of International Economics at the Graduate Institute in Geneva. "I myself advocated an EMF for years. But I have come to the conclusion the eurozone can never be as hard against its own member states as the IMF, which comes from outside. Why set up a clone when you can have the real thing, especially when the real thing is better?"

Open Pandora's box?

German chancellor Angela Merkel, who knew about Schäuble's plan, has voiced cautious support. She believes the idea of the EMF is "good and interesting", but pointed out that setting it up would probably involve amending the European Treaty

It took EU members years to negotiate and ratify the Lisbon treaty and nobody wants to open Pandora's box again. This alone was reason for the Italian finance minister to oppose the EMF.

Jürgen Stark, board member at the ECB in Frankfurt, is against it as well. Whichever mechanism you establish, he said, it is crucial that countries start behaving better. Preventing a situation like the current one in Greece is key. The EMF could only be successful if it could set budgetary demands in stone and enforce those.

Such demands are already part of the Stability and Growth Pact, but they are not enforced because the signatories don't want them to be. As long as the sanctions stipulated by the pact are not put into practice, countries like Greece can keep doing what they want. No new institution is going to change that. Stark is against a powerless EMF that is more political than it is technical, and could even interfere with ECB politics. "The euro could pay dearly for it," he said.