Blog post

Why we should listen to Tim Geithner

Publishing date
18 September 2011

In this op-ed, Guntram Wolff comments on Tim Geithner's encouragement to eurozone leaders to collaborate in order to avoid a financial melt-down and his proposal to use EFSF guarantees and capital more efficiently by leveraging it with ECB money.

In his visit to Poland, Tim Geithner has urged eurozone leaders to collaborate and avoid a financial melt-down. He urged to use EFSF guarantees and capital more efficiently by leveraging it with ECB money, thereby increasing the firing power of the EFSF for buying government bonds. This mechanism would immediately ease the crisis and may even be cheaper than all the other options currently followed. It also does not amount to a monetary financing of government debt. Here is how and why.

The mechanism would essentially give the EFSF access to ECB liquidity[1]. The ECB would immediately stop its bond purchasing program and transfer this task to the EFSF. This will help increase ECB independence and separate clearly monetary policy from fiscal policy. The EFSF would start buying government bonds of countries with significant spreads and would repo the bonds with the ECB. The ECB would not increase its overall liquidity provisioning as it would fully sterilize the liquidity provided by providing less liquidity to the banking system directly. The ECB would set a haircut that is in line the fundamental solvency risk of the country. By doing so, the solvency risk would remain with the EFSF. A ten percent haircut would allow the EFSF to leverage its resources by a factor of ten. Its firing power could thereby increase to up to 3500 billion euros.

In the face of such a large fund, markets would immediately stop speculating against the euro area sovereigns under stress. Indeed, investors that were speculating against peripheral bonds would quickly lose a lot of money. This outcome was recently confirmed in a simulation with real market participants organized by Bruegel and the Peterson Institute (download event summary). In fact, market participants in the simulation reacted positively to the new mechanism when it was proposed in the simulation. Spreads to Germany narrowed strongly and overall market stress was reduced. In addition, the ECB could stop its costly securities markets program.

In the discussions among participants after the simulation, market participants agreed that the new mechanism would immediately ease problems. It was argued that the mechanism would probably not be tested for quite some time. However, many players warned that even while the short-term financing and budget problems of Greece were eased, all the debtor countries needed to continue on a path of fiscal consolidation and structural reform in the years ahead. The new mechanism would leave unresolved the issue of how structural reforms could be fostered and conditionality imposed. Ultimately, it would therefore risk being tested again by the market. The proposed mechanism should therefore be seen as a way of buying time only. But the mechanism is more compatible with incentives for reform than the current mechanism that relies on the ECB stepping-in to avoid a financial meltdown. Since it relies on the EFSF where every government has a veto right, its introduction would increase the incentives for structural reforms as the countries participating in the EFSF could at any stage decide to discontinue their support in case of severe misbehavior of a country. At the same time, given the size of the fund, market speculation could be ended thereby giving the time to move forward with a new economic governance framework that would allow much stronger control of public budgets and structural reform progress.

[1] This proposal was already made by Gros and Meyer (2011).

About the authors

  • Guntram B. Wolff

    Guntram Wolff was the Director of Bruegel. Over his career, he has contributed to research on European political economy and governance, fiscal, monetary and financial policy, climate change and geoeconomics. Under his leadership, Bruegel has been regularly ranked among the top global think tanks and has grown in influence and impact with a team of now almost 40 recognized scholars and around 65 total staff. Bruegel is also recognized for its outstanding transparency.

    A recognized thought leader and academic, he regularly testifies at the European Finance Ministers' ECOFIN meeting, the European Parliament, the German Parliament (Bundestag) and the French Parliament (Assemblée Nationale). From 2012-16, he was a member of the French prime minister's Conseil d'Analyse Economique. In 2018, then IMF managing director Christine Lagarde appointed him to the external advisory group on surveillance to review the Fund’s priorities. In 2021, he was appointed to the G20 high level independent panel on pandemic prevention, preparedness and response. He is also a professor (part-time) at the Solvay Brussels School of Université Libre de Bruxelles, where he teaches economics of European integration.

    He joined Bruegel from the European Commission, where he worked on the macroeconomics of the euro area and the reform of euro area governance. Prior to joining the Commission, he was coordinating the research team on fiscal policy at Deutsche Bundesbank. He also worked as an external adviser to the International Monetary Fund.

    He holds a PhD in economics from the University of Bonn and studied in Bonn, Toulouse, Pittsburgh and Passau. He taught economics at the University of Pittsburgh and at Université libre de Bruxelles. He has published numerous papers in leading academic journals. His columns and policy work are published and cited in leading international media and policy outlets. Guntram is fluent in German, English, French and has good notions of Bulgarian and Spanish.

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Greeniums in sovereign bond markets

In this paper, we analyse whether green sovereign bonds are systematically priced differently to conventional sovereign bonds in the secondary markets

Monika Grzegorczyk and Guntram B. Wolff