As the European Stability Mechanism (ESM) has been pushing into global headlines again after yesterday’s conditional go-ahead from Germany’s constitutional court, here are some questions and answers about what will be a key tool for policymakers to keep the Euro crisis under control – today with a chart and decent contents input from our team member Franziska Schmidt!
What is the ESM?
The European Stability Mechanism is an institution for the containment of financial crises in the Euro area, to be launched shortly by the members of the Euro area. It will be equipped with EUR700 billion (USD880 billion), of which EUR500 billion (USD630 billion) are available for lending. Worth noting three things: A, the term ‘mechanism’ is probably a bit misleading, as the ESM has very few automated processes, contrary to what ‘mechanism’ might suggest to many. B, it is a formal and permanent institution, rather than just an abstract mechanism. And C, the ESM has been designed as an intergovernmental institution outside the formal EU framework, despite being an amendment to the Treaty of Lisbon and despite being accessible to Euro area members only.
What is the ESM there for?
The ESM will be used to support the Euro area as economic problems in the periphery states continue to threaten its stability. Euro area member states with severe economic problems (e.g. with difficulties to attract primary market financing) and unable to help themselves can apply for support. In return, they will have to commit to restructuring and adjustment programmes. The latter can be painful, which is to make sure the ESM is not used as an easy way around unpleasant policy decisions for national governments. From a wider perspective, the ESM should strengthen the monetary union institutionally while helping to restore trust within the financial markets – which governments depend on with their financing needs.
Who is filling the EUR700 billion pot?
The ESM money will be made available through a combination of cash deposits (worth EUR80 billion) and guarantees (worth EUR620 billion) from the 17 Euro area member states. Member state contributions will be weighted by economic power – for example, Germany as the largest member will account for 27% of the amount (EUR190 billion), with France backing 20.4%, Italy 17.9% and Spain 11.9%. The four countries alone will contribute around 77% of the total – however, should one of the countries need ESM support and become unable to contribute, the burden of the other Euro area members will increase accordingly, as stated by the ESM treaty.
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What are the implications of yesterday’s court ruling in Germany?
This last point about liquid Euro area members paying extra contributions to compensate for defaults elsewhere will have to be looked at again, after Germany’s constitutional court yesterday declared that Germany must not exceed its EUR190 billion threshold unless the national parliament gives its explicit go-ahead. The decision essentially means that German parliament must always remain in control of amounts guaranteed by the German taxpayer, rather than agreeing to an uncontrollable automated process. This creates uncertainty, given that a potential need for Spain and Italy to seek financial support could drastically reduce the ESM volumes available if the German parliament refuses to increase contributions – with the potential of triggering a new forceful escalation of the Euro crisis. This in turn means: the financial markets will sleep better for now, but only as long as Spain and Italy are doing fine.
Will the ESM finally end the Euro crisis?
No, the ESM alone definitely won’t. The ESM, as a crisis management institution, is merely a tool that will help to extinguish a fairly limited number of fires, but the underlying structural problems in the periphery economy (budget deficits, lack of competitiveness, unemployment) will still have to be tackled by national governments. This will be painful and the crises in the affected states can be expected to drag on for years. In other words, ESM does not mean ‘there will be no homework’.
What does the ESM mean for retailers?
The mere existence of the ESM, when it comes on-stream as early as next month, will contribute to calming down the financial markets, which in turn should have a positive impact on business and consumer confidence. However, once a country needs to seek shelter under the ESM, restructuring and adjustment policies are very likely to intensify with damaging short and medium-term effects to economic output, the job market and consumer confidence.
Simultaneously, should the ESM burden of contributors (such as Germany) increase as a result of defaults elsewhere in the Euro area (e.g. in Spain), and should the higher guaranteed amounts actually be collected by the ESM, this will negatively impact on government spending and tax burdens in the contributor states. As the ESM helps to limit moments of escalation, it spreads the problems more evenly across member states, with potentially negative effects on retailers across the whole Euro area (albeit to varying degrees).