Wolfson Euro Prize: A Private Sector Incentive to Save Europe

If member states leave Economic and Monetary Union, what is the best way for the process to be managed to provide the soundest foundation for the future growth and prosperity of the current membership?

To stimulate and assist the debate on the future of EMU, the Wolfson Economics Prize, worth £250,000, has been launched in Britain with the hope and expectation that it will attract entrants from all over the world who are asked to answer the following question:

"If member states leave Economic and Monetary Union, what is the best way for the process to be managed to provide the soundest foundation for the future growth and prosperity of the current membership?"

Some people in Germany may think this a very British question which ignores the political determination to keep EMU together. To paraphrase president Sarkozy and chancellor Merkel "it cannot happen so it will not happen." However, it is impossible to ignore that the present configuration of EMU may not survive - even its political leaders have accepted that a country might leave EMU.

Clearly a break-up of the EMU might take many forms and all of them would create their own problems - political as well as economic and financial - for both countries deciding to leave as well as those (who might) chose to remain in some form of currency bloc.

Perhaps the most obvious concern is that as soon as one country departed there would be bank runs in countries deemed to be in similar positions. Capital controls would become inevitable.

Unless it was Germany that left, the least bad but least likely outcome, the currency (or currencies) of the country (or countries) leaving would depreciate against the rump and more "Germanic" euro.

This might be very dramatic and there is a potential role for the IMF in trying to ameliorate this problem with some chance (given improved prospects for growth outside EMU) that any additional loans might be actually be repaid.

It seems unlikely that a country leaving EMU would need to embark on any additional "austerity" as it would benefit from depreciation and in these circumstances a country would be able to benefit from economic reforms in away not possible within EMU.

Inflation might at some stage become a problem for countries leaving EMU, but this threat is probably exaggerated (as were those associated with Britain's exit from the ERM) given the scale of spare capacity in the countries concerned.

European banks, including German banks, are of course very exposed to developments in the peripheral countries, not just in terms of sovereign debt but also through lending to companies affected by economic developments, and their problems will be compounded if at the same time they are put under further pressure to recapitalize.

The position of sovereign debt is probably reasonably straightforward; if the government decides to redenominate in the new currency it can do so. Private debt is more complicated and much will depend on the jurisdiction in which contracts are drawn. Lawyers will do very well out of this!

Similarly, interbank borrowing in euros between Greek banks borrowing is pretty straightforward, borrowing will be redenominated in the new currency; but the position of a Greek bank borrowing from a German bank is more difficult and clearly if these were redenominated the German banks would take a very bit hit.

The main concern for the man or woman in the street may be what happens to their deposits.

This is quite complicated too. For example a deposit held by a citizen of Greece (or any other country leaving EMU) who is a resident in Greece in a Greek-owned bank located in Greece will find deposits denominated in new currency. However, if any of the four implied dimensions (citizenship of depositor, residence of depositor, ownership of the bank taking the deposits and the location of the bank taking the deposits) the outcome is much less certain, for example a German citizen resident in Greece with a deposit in Greek bank.

All in all, a break-up will likely be messy and certainly costly, but exit at least offers the prospect of resumed growth for the peripheral countries while the economic and political costs of attempting maintain the present configuration will only increase with time.

Governments and central banks are, one assumes, giving their full attention to the growing crisis, but their deliberations will invariably be private.

The Wolfson Prize can be considered a private sector initiative to search out through market incentive ideas that it is hoped will reinforce and reinvigorate policy makers in the decisions that will have to be made, if Europe and the wider world are to get out of the current mess.


What's Hot