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The ESM needs a new momentum

Point of View, 18.05.2022 Research Areas

In parallel with the competition for new leadership, the European Stability Mechanism is trying to remodel itself. The latest idea of the ESM economists to create an additional aid instrument within the institution is worth considering, say Jonas Kaiser and Paweł Tokarski.

Almost 10 years after its creation, the European Stability Mechanism (ESM) with its lending capacity of up to €500 billion is looking to reorient itself. In a discussion paper from early May, ESM economists proposed creating a “Stability Fund” that would operate within the framework of the ESM. The intention is to enable euro countries to obtain cheap loans more quickly in the event of asymmetric shocks, such as environmental disasters. Also known as the EU bailout fund, the ESM was established during the euro crisis to ensure that struggling countries had access to the financial markets. Since then, Ireland, Greece, Spain, Cyprus, and Portugal have received ESM loans. Due to the strict conditions for financial assistance, which among other things require politically damaging austerity policies, the ESM has recently fallen into disrepute. No new financial support has been requested from the rescue fund since 2015. All member states even avoided the special credit line with softened conditionality set up at the beginning of the pandemic. In early 2021, the euro countries signed a treaty amendment under which the ESM mandate was extended to strengthen the banking union. If the capital of the Single Resolution Fund is not sufficient to resolve failing banks, the ESM can step in by providing loans, and thus stabilise the financial markets. However, the institution’s core function remains to be a backstop for euro countries that experience financial difficulties. The current ESM director, Klaus Regling, is retiring in October. His successor could bring a new momentum and give the fund, which is searching for its purpose, a new direction.

Bailout fund for crises

Indeed, the proposal of the ESM economists hits a blind spot in the European financial architecture. There is general consensus that a fiscal policy instrument is needed for macroeconomic stabilisation in the Eurozone, as it is clear – especially in the current inflationary environment – that the European Central Bank’s monetary policy alone cannot guarantee favourable financing conditions for the euro countries. Furthermore, the gloomy outlook for the European economy also gives cause for pessimism. The existing SURE programme for short-time work schemes as part of the Covid-19 recovery fund “Next Generation EU” does provide an opportunity to obtain funds in order to combat unemployment. However, it is only a temporary instrument. The proposed ESM Stability Fund is expected to comprise about €250 billion. The sum is equivalent to about 2 per cent of the euro area’s economic output and is more than twice the size of the SURE short-time work instrument. This equips the crisis rescue fund with greater macroeconomic firepower. Moreover, the funds could be raised from already available ESM lending capacities, thus relying on existing institutional structures and not imposing additional costs on euro area countries. Moreover, a fiscal stabilisation capacity – which is based on loans that have to be repaid – limits moral hazard. This can be helpful in gaining political support of the so-called frugal states during implementation. Also included in the proposal are strict conditions for a euro country to access the Stability Fund. While this too is likely to be welcomed by the northern Eurozone states, it raises doubts as to whether the ESM can repair its current politically toxic image.

Integration into the EU

Overall, this is an economically sensible proposal to make the Eurozone more crisis-proof. However, the main problem lies at a more fundamental level of the ESM and its role in the European financial architecture. As an intergovernmental institution of the euro area members, the Eurozone rescue fund is presently outside the legal framework of the European Union. It is worth considering integrating the ESM into the EU. Through governance by the Commission and accountability to the EU Parliament, it would be possible to externalise the political pressure of short-term national interests and overcome the political crisis of confidence. In addition, this would simplify the institutional structure as well as provide the opportunity to integrate other credit lines and financial support programmes such as “Next Generation EU” under one roof. This would create synergies in the management of the various financial assistance programmes and contribute to a greater understanding among citizens. Nevertheless, there are still some areas that would need to be clarified if the ESM were to be integrated into EU law. For example, only Eurozone countries have paid capital into the ESM, on the basis of which the ESM can sell bonds on the financial markets and provide financial support to states as needed. However, EU countries outside the Eurozone are also represented in the Commission and the Parliament. Taking this discussion forward and providing impetus will become the main tasks of the new ESM leadership.