Euro area countries should be prepared to lose some degree of control over their budget, pool resources to set up an insurance program and do common borrowing, economists at the International Monetary Fund said.
To avoid a repeat of the debt crisis that led to bailouts from Ireland to Cyprus, the 17 nations that share the euro need to toughen rules enforcing fiscal discipline and set up fund transfers before crises develop, according to a report released by the Washington-based fund’s staff.
“Although the first step to dealing with country-level fiscal problems must be larger national fiscal buffers, the size of shocks and their capacity to freeze up markets suggest a role for a zone-wide insurance mechanism,” IMF economists wrote. “Fiscal integration can be that mechanism.”
The most urgent task is to set up a backstop for banks, according to the report. After agreeing to build a banking union to help restore confidence in Europe’s lenders, policy makers are now divided over a proposal to centralize control of failing institutions. While a fiscal union is a further step away, spelling out the measures to get there would help boost investors’ confidence, according to the report.
To make such a plan viable, Europeans should agree to give up more sovereignty over their budgets, according to the paper.
“The euro area cannot afford a repeat of the imprudent fiscal and financial policies undertaken by some countries,” the economists wrote. “To ensure that the agreed fiscal rules are implemented, countries need to be provided with the proper incentives to comply, but also with a credible threat in case they do not.”
Discipline would enable them to pool resources toward an insurance fund or even a full-fledged euro-area budget, the economists suggested.
Once that’s in place, the euro-area could have its own debt instrument, staff suggested. That could help finance the temporary transfers to members facing shocks or even be a backstop to the banking union, they wrote.
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