The optimal size of the European Stability Mechanism: a cost–benefit analysis

Abstract

This study presents a core-periphery model to determine the optimal size of the European Stability Mechanism (ESM), building on Jeanne and Ranciere [2011. "The Optimal Level of International Reserves for Emerging Market Countries: A New Formula and Some Applications." The Economic Journal 121: 905-930]. While the periphery is subject to a probability of losing access to external credit, the core's incentive for setting up an ESM stems exclusively from the spillover effects present in the case of periphery default. The model develops regional best response functions, determining a set of feasible ranges for the total ESM size, given optimal regional contributions. The model is then calibrated to the European Economic and Monetary Union. If costs from default are reasonably high, the probability of the periphery not having access to external credit is sufficiently large, and spillover effects to the core are present, both the core and the periphery have an interest in contributing to the ESM. Calibration and sensitivity analysis suggest that the optimal ESM size is between the current and twice the size of the agreed-upon ESM.

Public Debt Amidst Low Interest Rates: The Magic Pentagon and Its Significance for Economic and Social Policy

“…As regards deficit budgets as the cause of the increase in debt, these are mainly the result of an expansionary fiscal policy aimed at satisfying the demands of the population (which cannot be underestimated, but should be moderated), and also of the fall in public revenues during the economic crisis, when tax revenues fell out, especially from companies and banks (if they reduced profits or even made a loss because of the crisis), but also from the population, due to the increase in unemployment and the reduction in consumption. These principles are behind many of the steps that we have seen in practical economic policy in recent years (Hermitte, 2017), including the construction of the European Stability Mechanism (ESM), which increases the lending capacity available to European countries and makes its use conditional on country-specific stabilisation programmes (Kapp, 2014;Atik, 2016). They also explain why there is so much pressure for fiscal consolidation on "problematic EU member states" such as Greece, Italy or Portugal -there is a fear that they may not be able to keep their considerable relative debt under control over time and, if they are members of the eurozone, this threatens the euro itself.…”

Southern Europe and the Eurozone Crisis Negotiations: Preference Formation and Contested Issues

“…In July 2011 the need for a permanent financial assistance mechanism pushed the eurozone member states to sign an intergovernmental treaty establishing the European Stability Mechanism (ESM), whose lending capacity was set at 500 billion euros. Its paymentscrucially subject to conditionalitywere meant to operate as a 'liquidity bridge' (Kapp 2014) to support countries until they reacquired capital market access. In order to address the shortcomings of the institutional framework underpinning the process of financial integration within the EU (Jones 2015), after the introduction of the ESM further steps were also taken toward the creation of a European banking union.…”

A Theory of Bazookas; or, 'When (and When Not) to Use Large-Scale Official Sector Support'

“…Yet when a panic hits, providing support will often cost public sector creditors a factor of magnitude less than not intervening. 6 These considerations were illustrated starkly in the debates around TARP (Berger and Roman, 2014) and the ESM (Blundell-Wignall, 2012;Kapp, 2012). 7 Both the mechanism of the "bazooka effect" and these controversies are similar for support to both sovereigns and financial institutions, by international organizations, governments and central banks.…”

“…Meanwhile, the creditor will choose , and in period = 1. While the creditor's objective function is not explicitly given, it can be assumed that the creditor is willing to provide support because of the potential contagion from a default by the borrower (Kapp, 2012).…”