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Europe needs new fiscal governance solution

24 Apr 2015

London Business School economists propose reforms for recovery

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Europe needs a new fiscal governance solution if it is to deal with its debt issues, two leading economists from London Business School have said.

Hélène Rey and Lucrezia Reichlin, both Professors of Economics at London Business School, made the remarks at the launch of the first report in the ‘Monitoring the Eurozone’ series by the Centre for Economic Policy Research (CEPR). 

The report, titled ‘A New Start for the Eurozone: Dealing with Debt’, outlines the necessary reforms for a feasible recovery in the Eurozone. It is based on the joint work of several prominent economists of euro area countries. 

Professor Rey said: “We are proposing a number of strategies that will help ease the level of debt in Europe.  

“There are two possible debt reduction strategies. The first is a debt buyback operation via a stability fund that uses capitalised revenues from either taxes or seigniorage [economic cost of producing a currency within a given economy or country]. The second is a swap operation, through which sovereign bonds are exchanged against a combination of debt and equity. The best solution would be a combination of both.”

These strategies could be implemented quickly to boost growth in the Eurozone without threatening the stability of the financial sector, Professor Rey says.

Lucrezia Reichlin, Professor of Economics, London Business School, said: “There is no safe asset in the euro area, and this has been one of the reasons why, facing risk, banks made their balance sheet more domestic.” 

Professor Reichlin says this has led to a dangerous correlation between bank risk and sovereign risk. 

“We propose to change regulations on how government bonds are treated for banks’ liquidity and capital purposes. According to our proposal, only the senior tranche of a geographically diversified bundle of sovereign bonds would be considered safe and ECB would target that in its QE operations.”

Full report