Modest proposal in Berlin 2012

The Modest Proposal in Berlin – INET Conference, 13th April 2012

Currently, Europe is caught in a savage dilemma between the present policy of bailouts-with-austerity (which no one seriously expects to work) and the idea of resolving the Crisis through federal moves (e.g. a transfer union, jointly and severally guaranteed eurobonds) that Europe is not ready for and which would, in any case, be outpaced by the galloping Crisis.

Thankfully, this is a false dilemma. Below I present three policies that would swiftly ringfence Europe without debt monetisation by the ECB, without a Federal Treasury, without having the surplus countries guaranteeing the debt of the periphery, without further loss of sovereignty, without Treaty changes, and with only a rational re-assignment of Europe’s existing institutions.

Policy 1: Dealing with the Debt Crisis

The ECB announces its Debt Conversion Program for any member-state that chooses to participate: It will service (as opposed to purchase) a portion of every maturing government bond corresponding to the member-state’s Maastricht-Compliant (or blue) public debt (MCD hereafter).

To fund these redemptions, the ECB will issue its own bonds (ECB-bonds) in its own name, guaranteed solely by the ECB but repaid, in full, by the member-states (on whose behalf the ECB will have issued them). This is how: Upon the issue of ECB bonds, the ECB will simultaneously open a debit account per participating member-state into which the latter is legally bound to make deposits (to cover the ECB-bonds’ coupons and principal).

Who will stand behind the ECB-bonds in the case of a defaulting member-state? First, the ECB debit accounts of each member-state shall enjoy super-seniority status vis-à-vis all its other debts. Secondly, the ESM-EFSF will insure, against a hard default, the repayments by each participating member-state into its ECB debit account. [3]

In summary, member-states will enjoy large-scale interest rate reductions (having refinanced their MCD at low rates secured by the ECB) while the ECB terminates both its government bond purchasing program and the LTRO. Instead of monetising debt, the ECB will have played the role of a go-between member-states and money markets, insured by the ESM-EFSF. Additionally, the ECB-bond issues will help create a large liquid market for European paper that advances the euro’s reserve currency status.

Policy 2: Redressing low aggregate investment and internal imbalances

Europe is in urgent need of (a) higher aggregate investment and (b) investment flows that ameliorate its internal imbalance of payments. Both can be achieved through an Investment and Internal Imbalances Amelioration Program involving the European Investment Bank (EIB), the European Investment Fund (EIF) and the ECB: The EIB will focus on infrastructural projects (with an emphasis on green technologies), the EIF on start-ups and SMEs (with an emphasis on new technologies) and the ECB will be a funding partner via its ECB-bond program.

The Program’s first task will be to untie the EIB-EIF’s hands to invest more in aggregate by allowing for the national contribution to projects (currently set, by convention, to 50% of total funding) to be funded by a net-issue of ECB-bonds (following agreement between the EIB-EIF and ECB), rather than through national borrowing which is, currently, severely circumscribed.[4] Upon completion of such projects, resulting from the EIB-EIF-ECB collaboration, all net revenues are to be repaid directly 50% to the EIB-EIF and 50% to the ECB.

Concerning the second task, dealing with the Eurozone’s internal imbalance of payments crisis, the distribution of investments among the Eurozone’s regions (as opposed to member-states) may be calibrated, by means of a pre-agreed formula, in proportion to each region’s balance of payments deficit within the Eurozone.

Policy 3: Dealing with the banking crisis

The Eurozone must be turned into a single banking area with a single authority that supervises directly and recapitalises the area’s banks. To this purpose, existing national boundaries are to be dismantled, together with national supervisory authorities. The currently confederate European Banking Authority (EBA) is to be re-configured as a unitary agency with a board comprising officials drawn from member-states, plus representatives from the ECB and the ESM-EFSF.

With the ESM-EFSF now relieved of its task to fund the public debt of insolvent member-states (courtesy of Policy 1), the largest share of its capital is to be used for the purposes of direct bank recapitalisations.[5] These capital injections shall flow directly from the ESM-EFSF, under the supervision of the EBA and the ECB, to the banks but without mediation from the national governments and without these capital injections counting as part of national debt. In exchange, equity in the recapitalised banks is passed on to the ESM-EFSF which is then re-sold to the private sector when the EBA and ECB judge that banks have been sufficiently recapitalised.


Three crises, three policies for addressing them, each involving existing institutions and requiring no Treaty changes. In their totality, the three programs sketched above constitute nothing less than a New Deal for Europe, shifting idle savings into productive investments, dealing with the debt crisis, addressing the banking malaise and ameliorating the Eurozone’s crippling internal imbalance of payments.

[1] A variant of a Policy Paper jointly authored with Stuart Holland, and entitled A Modest Proposal for Overcoming the Euro Crisis, Levy Institute, May 2011

[2] Department of Economics, University of Athens & Lyndon B. Johnson Graduate School of Public Affairs, University of Texas, Austin

[3] This idea is borrowed from George Soros’ recent proposal. “How to pull Italy and Spain back from the edge”, The Financial Times, 25th January 2012.

[4] The remaining 50% is funded via the normal issue of the EIB’s own bonds.

[5] With another part dedicated to insuring the ECB’s debt conversion program (see Policy 1) against the hard default of some member-state.


Yanis Varoufakis

Professor of Economic Theory at the University of Athens. Finance Minister of Greece