Lorenzo Bini Smaghi: Private sector involvement – from (good) theory to (bad) practice Speech by Mr Lorenzo Bini Smaghi, Member of the Executive Board of the European Central Bank, at the Reinventing Bretton Woods Committee, Berlin, 6 June 2011. *  *  *  The title of this first session of the conference is: “Policy responses within countries and inside the eurozone since 2010: an appraisal”. The topic is very broad and I cannot cover it in such a short time span unless I am selective and focus on some specific issues. I would like to consider mainly what has not gone as expected and the disappointments. This enables me to avoid talking, once again, about the ECB’s actions over the last 18 months. There are at least three things that have gone wrong. The first is that governments of the countries under stress waited too long before recognising that they needed financial assistance, and submitting their requests for support to the IMF and EU. This is true in all three cases, Greece, Ireland and Portugal. More often than not support programmes are delayed and within well integrated economic and financial regions such as the euro area these delays exacerbate market turmoil and create contagion. There is thus an externality in leaving it entirely to the country in question to turn to the IMF and EU for financial assistance.
How can we prevent taxpayers of the good performers in the euro area from being asked to foot the bill for the excesses of the bad performers? EMU is based on two pillars. The first is price stability, ensured by an independent central bank. The second is sound public finances, promoted by the Stability and Growth Pact. This second pillar has not worked properly and needs to be repaired. Including some form of automatic private sector involvement does not repair the SGP. It actually weakens it by delegating discipline to the financial markets, which we know are late and pro-cyclical. It makes debt restructuring easier and thus discourages fiscal discipline. The only way to protect taxpayers in “virtuous” countries is to avoid over-indebted countries from easily getting away with not repaying their debts; the payment of debts should be enforced, through sanctions if need be. When countries go off track they can receive financial assistance only in exchange for strict adjustment programmes, including asset sales, which allow these countries to remain solvent. Respect for contracts is the one of the key principles underlying the market economy. It is also the basis of monetary union between sovereign countries. BIS central bankers’ speeches  5