ADEMU: The final report of the advisory committee

By Thomas Cooley (chair), Charles Bean, Jean Pierre Danthine, Lars Feld, Jose Manuel Campa, Fernandez, Lucrezia Reichlin, René Smits and Thomas Sargent.

The ADEMU Project was initiated in June of 2015 with a network of research economists and legal scholars from leading European Universities. They were organized into eight research groups with the ambitious goal of finding with concrete ways to make the European Monetary Union more resilient and less prone to crises. We have submitted two interim reports on the progress of this research project.

On May 9-11, 2018 there was a final conference at The European University Institute where we discussed the accomplishments of the project, summarized the research findings, and described some concrete proposals to make the European monetary union more robust for the long run.

The final stage of the project was also marked by the publication, in co-operation with VoxEu, of an e-book summarizing the major research themes of the project and describing many concrete policy proposals. The sheer volume of the research and intellectual activity generated by the project are impressive. There have been 13 conferences, 16 workshops, 4 seminars and 1 summer school where research on the project was presented to a broader audience and presentations in the main European Union institutions (ECB, ESM, European Commission, European Parliament and Central Banks of Germany, France, Spain, Portugal and Denmark), as
well as in many international conferences.

There have been 13 ADEMU lectures throughout Europe delivered by distinguished researchers on topics relevant to the ADEMU goals. There have been 135 ADEMU Working Papers published and available on the ADEMU website along with multiple datasets connected to ADEMU research. In addition the ADEMU project has sponsored the research and theses of  26 graduate students throughout Europe, as well as given support to six postdoctoral fellows. In sum, the project has involved a large number of researchers and policy makers. There has been an effort to disseminate the research very broadly.

The accomplishments of the ADEMU project have been many. Importantly the project underscores the critical role of innovative research focused intensely on the underlying issues of the Eurozone and the compelling policy issues they create.

The solution to the EMU’s initial design flaws and inherent time consistency problems are not likely to be resolved by a re-drafting of the basic treaties. As a consequence the remedies must be somewhat piecemeal. But should we just muddle along with improvised solutions or are there pro-active policies that can make the system more resilient? The ADEMU project has addressed these issues.

We cannot summarize the many contributions of the ADEMU project in this brief report but we can offer a few illustrative examples.

Some ADEMU highlights

A European Stability Fund
ADEMU researcher Giancarlo Corsetti has carefully documented how the flaws in the design of the EMU and more importantly the asymmetric endowment of initial risks has made the response to shocks and crises more costly because of wider misallocation of resources. The weakest economies and the weakest banking systems have suffered disproportionately which has perpetuated the asymmetries of the economies.

At the same time the ECB has been adept at recognizing these flaws and has acted with authority to stabilize the economies and banking systems. In response to the crisis and the flaws it revealed, many of the member states have called for greater stabilization and risk sharing in the Union. The European Stability Mechanism is seen as imperfect and insufficiently powerful body to help countries through their crises, while democratic legitimacy and review of its decisions are not enmbedded in the EU framework.

But there is another view – that the problems of the most vulnerable economies stem from inadequate domestic fiscal policies and banking oversight. In this view more robust stabilization and risk sharing facilities within the EMU would be counterproductive and would exacerbate the inherent moral hazard problems. On this view what is needed is more enforcement of fiscal
rules and market discipline.

A European Stability Fund as a Constrained Efficient Mechanism
One of the key contributions of ADEMU research is the design of a European Stability Fund that reconciles these views. It is essentially a long-term contract that defines state contingent transfers between the stability fund and an EMU Sovereign.

The state contingency is meant to induce countercyclical behavior in goods times. The design of the fund is meant to induce sound fiscal behavior in better times, it is not designed solely as a crisis tool but it can be useful in a crisis. More importantly Stability Fund Contracts can function as safe assets on the balance sheet of the European Stability Mechanism. Because of that, “safe” bonds can be issued against them and serve as an anchor of the financial system.

European Unemployment Insurance
Should there be a common unemployment insurance system – possibly one that is complementary to national unemployment insurance schemes? What form should it take to avoid the usual moral hazard problems or the appearance that it is just a transfer from well functioning economies to poorer ones.

The ADEMU researchers devised a scheme that includes a common replacement rate and country specific tax rates based on local labor market characteristics.

An insurance scheme based on these principles would not only promote labor market reform and increase welfare it could also have another valuable side effect. It could strengthen the public acceptance of a common European interest. Policies that originate with the EU and improve welfare for all and promote good institutions have at least the possibility of reinforcing the argument that there is value beyond the dreams of politicians to being part of a common enterprise.

Without a constitution Europe suffers from a bit of an identity problem and can be easily undermined by populists sentiments. Having common beneficial policies may be an antidote to that.

Improving The Financial Architecture
The optimal contracting theory that underlies the design of optimal risk sharing mechanisms can be extended to finding a solution to one of the remaining elements of banking union – deposit insurance. Existing proposals to create a common deposit insurance scheme have failed because the banking systems are very different with different inherent risks, Italy for example is fragmented and risky with a legacy of non-performing loans. Germany is very different. Any successful deposit insurance proposal must address these differences. The principles of incentive compatibility put to work in the proposals for a European Stability Fund
and a European unemployment insurance have the potential to do so in this case as well.

Concluding comments

It would be impossible to summarize the vast quantity of research and the wealth of ideas that have emerged from the ADEMU project. The book makes an attempt to summarize a good deal of it and the project’s webpage provides thorough and accessible account of the work done. This is research that offers a path forward for the Eurozone and it is impressive in its scope. Our assessment is that the ADEMU project has delivered on its promise.

Follow-up research to accompany the current debate on implementing the various EMU reform
proposals on the table (Commission, President Macron, Chancellor Merkel) would
be welcome.