A Third Weapon to Save the Euro

http://www.nytimes.com/2012/10/13/business/global/a-third-weapon-to-save-the-euro.html

Version 0 of 1.

BRUSSELS — In an indication that union in Europe is still very much a work in progress, its top official on Friday suggested assembling yet another big gun to save the bloc’s troubled common currency.

The European Central Bank has already promised to use its financial armory to buy unlimited quantities of bonds, and euro zone governments have pledged to fund a bailout “bazooka” worth €500 billion, or $650 billion.

On Friday, Herman Van Rompuy, the president of the European Council, made formal proposals for a third weapon to save the euro — a separate budget for the euro zone, perhaps equipped with a central treasury with borrowing capabilities, to combat sudden economic shocks and promote structural overhauls.

Mr. Van Rompuy did not say how much money such a treasury should manage, and no agreement on that figure is expected when E.U. leaders gather for a two-day summit meeting in Brussels in the coming week to consider his proposals.

The new weapon would differ in important ways from the European Stability Mechanism — the “bazooka” fund that held its first board meeting during the past week — as it would facilitate direct aid, rather than loans, to countries in acute difficulty, said Guntram B. Wolff, the deputy director of Bruegel, a research organization.

“If the money flows from participating countries to a single country in need,” Mr. Wolff said, “then I don’t think this fund needs the capacity to borrow.”

Helping a country like Spain overcome an economic shock might require a sum equal to 5 percent of its annual output, or €50 billion, to support programs like unemployment insurance or subsidies for new infrastructure, Mr. Wolff said.

“But to pay for larger, regional shocks, such a fund would almost certainly need to bulk up its ammunition by going to the markets,” he said.

For Germany, the budget could represent a step toward pooling euro zone finances that does not stir the fears of unlimited liability that poisoned an earlier discussion of so-called euro bonds, which would make euro zone countries jointly responsible for debt.

Mr. Van Rompuy did not rule out euro bonds in his report. But he sounded cautious about the prospects, writing that “the pooling of some short-term sovereign funding instruments” like treasury bills “could be examined further.”

Mr. Van Rompuy also sketched out a separate but related plan to offer countries money or other assistance in exchange for meeting economic targets, the kind of conditionality designed to appeal to Germany.

One “idea to be explored is for the euro area member states to enter into individual arrangements of a contractual nature with the E.U. institutions on the reforms promoting growth and jobs these countries commit to undertake and their implementation,” Mr. Van Rompuy wrote.

“This could include supporting reform efforts through limited, temporary, flexible and targeted financial incentives,” he wrote.

For governments like Spain’s, trying to stave off deepening economic problems, and for France, where many officials are generally in favor of new tools to support the single currency, the creation of a budget, and perhaps a treasury, could be another channel of financial support in the event of a sudden shock.

Mr. Van Rompuy was careful to emphasize the system should “not lead to permanent transfers across countries.”

But Mr. Wolff of Bruegel cautioned that it would be “very difficult to design such a system where such aid transfers do not last for long periods, like five or 10 years, because once money starts flowing, the incentive for countries to carry out reforms does risk being diluted.”