Risk sharing plus market discipline: A new paradigm for euro area reform? A Debate

Jean Pisani-Ferry, Jeromin Zettelmeyer 18 June 2019



Euro reform seems to be an impossible topic to agree on. 

A year ago, the French president and the German chancellor agreed to “establishing a Eurozone budget within the framework of the European Union to promote competitiveness, convergence and stabilization in the euro area, starting in 2021” (emphasis added). On 13 June the Eurogroup of finance ministers agreed on a term sheet for a “budgetary instrument” deprived of any stabilisation role. Furthermore, it was unable to reach agreement on the financing of the instrument, which is now to be decided in the context of the EU’s next multi-year financial framework. 

Seven years ago, the heads of state and government of the euro area claimed that it was imperative to break the vicious circle between banks and sovereigns. But in 2018, concerns about the Italian fiscal strategy immediately reverberated on the credit market, prompting a fiscal correction. The doom loop is still alive. 

Thirty years ago, the Delors Report argued that in the Economic and Monetary Union, it would be necessary to define an overall fiscal stance for the countries participating in the currency union (Delors 1996). But such a definition does not exist yet. 

In a new VoxEU eBook (Pisani-Ferry and Zettelmeyer 2019), we argue that this history notwithstanding, pervasive disagreement is not inevitable. In fact, there is a remarkable convergence of views among economists on what a currency union really entails. While certainly not universal, this consensus is both broad and deep, and provides a basis for comprehensive reforms that would significantly improve the resilience of the euro area and would help turn it into a basis for shared prosperity. 

Download the new eBook, Risk Sharing Plus Market Discipline: A New Paradigm for Euro Area Reform? A Debate, here

As members of a group of seven French and seven German economists (the 7+7) with different opinions and political persuasions, we first endeavoured to define this consensus in a paper on euro area reform published in January 2018 (Bénassy-Quéré et al. 2018). In this paper, we argued that risk-sharing and market discipline are not antagonistic but rather complementary, and that a comprehensive package of reforms that would go far in addressing both French and German concerns had the best chance to succeed. 

Our central argument was that effective enforcement of the ‘no bailout’ principle required a credible sovereign debt restructuring option, as a last resort, without threatening euro area membership. This was impossible without better safety nets that would mitigate the financial and economic costs of debt restructuring, both for the restructuring country and other members. At the same time, stronger discipline involved the risk of an under-provision of stabilisation, which had to be addressed by creating common budgetary or liquidity mechanisms. These safety nets would have to be designed to ensure that they themselves would not distort policy incentives. In the paper, we argued that this was feasible and made some suggestions on how to do so. 

In a sense, our logic was the opposite to the one underpinning the agreement of 13 June 2019 on creating a ‘budgetary instrument’ for the euro area. We made an economic proposal which we believed would make all sides better off; and in that sense respected political red lines. At the same time, we rejected the prevailing views of both the ‘North’ and the ‘South’.  In contrast, the agreed term sheet is a compromise between who advocated a specific stabilisation budget for the euro area those (mainly France and Spain) and those who rejected the very principle of a euro area budget (mainly the Netherlands and the group of eight Northern European countries known as the ‘Hanseatic 8'). Politically, both sides can claim victory. Substantially, the proposal simply makes no difference (except in the sense that it leaves the door open for a more meaningful instrument in the future – but that option would have existed anyway).      

Having argued in our paper that the prevailing philosophies on euro area reform were wrong, we expected a great deal of pushback. We also hoped that our ideas would trigger additional, deeper work on how to reform individual pillars of the euro area architecture. We were not disappointed – as we presented our paper to various academic and policy audiences in the Spring of 2018, we were inundated with both criticism and constructive comment. To make this comment and criticism publicly accessible, Vox launched a dedicated debate in March of 2018, which we had the privilege to co-moderate. 

Over the next 12 months, we received, and for the most part published, more than 40 contributions on euro area reform. Some provided general comments on our paper, but most addressed specific points for discussion. To us as debate moderators, the most gratifying aspect was that these contributions soon began to refer to each other, rather than just to our paper or the previous literature. In other words, the collection of contributions became more than the sum of its parts. Our new eBook publishes a selection of these contributions in a way that emphasises the links between them.

The debate has helped to delineate areas of agreement and to clarify points of disagreement. Our reading of it, and conclusions from it, are as follows: 

1. If adequately priced, a common deposit insurance can be introduced even if there remains heterogeneity in banking risk across countries. There is a debate, however, on the adequate pricing scheme and on the adequacy of a waterfall structure.     

2. To protect deposits and break the doom loop, diversification of bank balance sheets requires regulation. There is less agreement on how this regulation should be designed. In addition, as developed in Guido Tabellini’s contribution to the volume, there is a minority view that argues forcefully against such regulation because it regards the very idea of decoupling banks and sovereigns as an illusion. 

3. A common safe asset would be a desirable, and perhaps essential, counterpart to regulatory incentives to bank balance sheet diversification. Several alternative schemes with different properties have been proposed. Some are better understood than others, and there is still no consensus on these alternatives. 

4. A well-functioning economic and monetary union requires facilities that reliably provide liquidity to solvent sovereigns. This is necessary in order to limit incentives to procyclical fiscal tightening and eliminate the risk of self-fulfilling debt crises. There is agreement that this requires easier access to ESM credit lines by pre-qualified countries. There is less consensus on whether it also requires changes to ECB policies.   

5. The EU fiscal rules that apply to the public finances of the member states are in need of fundamental reform. There is remarkable consensus on the principle of a primary expenditure rule that would take into account the initial debt level as well as potential output growth over the medium term. 

6. A scheme that provides fiscal stabilisation while excluding permanent transfers goes a long way towards alleviating concerns but does not command general consensus. The case for better stabilisation is hardly disputed. But it is argued by some that the need to engineer it at a central level can be lowered and possibly eliminated, either through restoring this capacity in full at the national level (which requires debt restructuring, even of currently solvent countries), or through integrating further financially so that private agents can benefit from market 

7. Whether enforcement of the no bailout rule requires considering debt restructuring as a legitimate last-resort instrument remains contentious. The logic behind the 7+7 paper that market discipline can work if the economic and financial costs of restructuring make it a viable option is disputed by some economists who see markets as inherently incapable of providing discipline at the right time. 

8. Debates on the future of Europe reverberate on the debate about euro area reform. Even technical discussions can be strongly affected by the broader framework within which they are being considered. In part, therefore, debates are of a political nature.  

No economist, however, disputed the need for significant, perhaps fundamental reforms of the euro area. The debate within the profession is dominated by a sense of urgency that is remarkably absent from public discussions and debates among national leaders.    


Bénassy-Quéré, A, M Brunnermeier, H Enderlein, E Farhi, M Fratzscher, C Fuest, P-O Gourinchas, P Martin, J Pisani-Ferry, H Rey, I Schnabel, N Véron, B Weder di Mauro, and J Zettelmeyer (2018), “Reconciling risk sharing with market discipline: A constructive approach to euro area reform”, CEPR Policy Insight No. 91. h

Delors, J (1996), Learning: The Treasure Within, report to UNESCO of the International Commission on Education for the Twenty-first Century.

Pisani-Ferry, J and J Zettelmeyer (2019), Risk Sharing Plus Market Discipline: A New Paradigm for Euro Area Reform? A Debate, A VoxEU ebook.



Topics:  EU institutions EU policies

Tags:  euro area reform, Vox debate, Risk sharing, Bailouts, European deposit insurance

European University Institute, Bruegel and PIIE

Senior Fellow, Peterson Institute for International Economics; CEPR Research Fellow

CEPR Policy Research