ignazio visco : the new eu economic governance and market discipline remarks by mr ignazio visco, deputy director general and member of the governing board of the bank of italy, at the brussels economic forum 2011, “ rethinking economic policy in europe – a new era of eu economic governance ”, session ii : “ eu economic governance framework in practice – ensuring its robustness ”, brussels, 18 may 2011. * * * the economic and monetary union has been a success in many respects. it has enhanced internal trade and delivered a credible monetary policy that has anchored inflation expectations and fostered a culture of price stability. the euro rapidly attained the status of a strong international currency. however, the functioning of emu has been hampered by some very serious pitfalls in its institutional design. we now clearly see an asymmetry between the strength of the “ monetary ” pillar and the weakness of the institutional framework. the architects of emu understood that fiscal discipline was necessary for the functioning of a monetary union in which the single monetary authority would be confronted by multiple national fiscal policy - makers. to achieve fiscal discipline they relied on a multilateral surveillance mechanism based on fiscal rules. the european sovereign debt crisis has shown that the surveillance mechanism has not been effective. european rules were not sufficient to induce countries to adopt prudent fiscal policies in good times. the result was that many euro area countries faced the crisis with relatively high deficit ratios, still far from their medium term objectives ; those objectives, equal to a balanced budget for most member states, would have allowed countries to let automatic stabilizers operate in unfavourable circumstances without exceeding the 3 per cent threshold. in several countries the debt - to - gdp ratio was above the 60 per cent ceiling, in some cases still by a large margin. fiscal rules and procedures failed on more than one occasion. in 2003 a trade - off of short - term interests within the european council stopped the rules from being applied to germany and france. this reflected the lack of an independent enforcer. the sustained fiscal profligacy in greece was not timely reflected in official fiscal data ( the estimate for 2009 deficit, which in april of the same year was 5. 1 per cent, was progressively revised upwards to 15 per cent ). this case exemplifies problems of the statistical monitoring framework. there is a wide consensus that fiscal rules should be broader ( encompassing debt dynamics ) and more effective ( via new voting procedures ). the crisis has also highlighted

- sector solutions ( including recapitalizations, ownership transfers, purchases & assumptions ), ahead of any other source of support and certainly before taxpayer money is tapped. however, as these options may prove insufficient or unviable in particularly serious cases, we must also prepare valid alternatives. various mechanisms are being discussed, including : haircuts haircuts on creditors or “ bail in ” instruments have been recently proposed as one of the most promising tools for increasing the loss absorbing capacity of financial firms, beyond the capital base. statutory bail - in would allow authorities in a going concern situation to wipe - out creditors, before the collapse of the firm. however, it would entail harmonizing global rules on creditor preferences and imposing bail - in conditions on pre - existing contracts. contractual bail - in, on the other hand, would force institutions to issue a portion of senior debt, to be determined by regulation, that could be either written down or converted into equity in a public intervention procedure. there are also potential drawbacks in this option as it would introduce a distinction between “ investors ” and “ customers ”, with the latter being less concerned about a careful monitoring of the bank. nevertheless, it is clear that this is a route to be further explored. private resolution funds a privately - financed european recovery fund has also been proposed. this would be designed to facilitate emergency medium - term funding when liquidity shocks, in distressed capital markets, threaten banks that are otherwise solvent and profitable. it would be financed by voluntary contribution of the top twenty european banks. although private, the fund would only intervene when european authorities determine that a bank needs support, providing guarantees at market conditions. this could be an important resource for overcoming difficulties in certain situations, but it is essential for authorities to consider the capacity of the banking system to finance both a resolution fund and an insurance scheme ; an additional question is whether a private resolution fund would duplicate dgs that act as “ beyond pay box ” instruments. ex - ante resolution funds in addition, the eu commission has recently proposed establishing a system of euharmonized resolution funds ( com 2010 / 254 ), aimed to facilitate the resolution of failing institutions. the funds would be financed by imposing levies on banks. to avoid moral hazard, these funds should be activated only as instruments of last resource, after exhausting all private sources of financing. within a clear resolution framework, it could provide a useful instrument to help authorities liquidate banks in an orderly manner, by covering