IMF suggests ‘rainy-day fund’ to deal with crises

There is no guaranteed safe way out of the euro crisis, the IMF has cautioned but urges a ‘rainy-day fund’, common unemployment insurance and a fully-fledged euro area budget for the future.

The Washington-based body recommends a system similar to that of federal Germany and the US to avoid the kind of debacle the eurozone is trying to cope with.

But none of this will deal with the debt overhang, which it describes as a delicate issue that will require a balance of tradeoffs.

“On the one hand, relying entirely on country- adjustment could trigger debt-deflation dynamics in the periphery, dragging the entire region into a period of prolonged stagnation.

On the other hand, mutualisation of existing debt would be akin to selling insurance after the fact and could reduce incentives to restore competitiveness and fiscal sustainability,” the report warns.

It points out federations like the US, Canada or Germany manage to smooth about 80% of shocks experienced by any of their states while the euro area only manages to insulate half that amount.

“In other words, when GDP contracts by 1% in one of the euro area countries, households’ consumption in that country is depressed by as much as 0.6% as opposed to 0.2% in the US, Canada or Germany,” the report said.

It suggests that euro area countries should contribute 1.5% to 2.5% of their GDP to this rainy-day fund to ensure the same level of stabilisation found in Germany between the lander, and points out that the rescue funds — the ESM and EFSF — will amount to 7.5% of GNP — €700bn.

“Such a fund would .... make transfers to countries when they experience negative shocks. With a dedicated and guaranteed flow of revenues, the fund might even be able to borrow at low cost to smooth the impact of downturns throughout the union”, the report said.

Social protection through a common unemployment insurance should be eurozone-wide, as it is in most existing federations, even in the US where states finance part of the unemployment benefits but the role of the federal government increases when there are negative shocks.

“Such a scheme should go hand-in-hand with efforts to enhance and harmonise labour market arrangements across countries,” it said.

A euro area budget that would provide a range of centrally-provided public services such as infrastructure would allow for risk sharing through revenues and spending. Countries hit by shocks would automatically contribute less but provided they had complied with relevant rules would continue to benefit from public investment.