1.
Safety Nets and
Market Discipline
Beatrice Weder di Mauro
Roma, 8 December 2018

2.
Overview
What needs solving?
How to fix it ? (7+7) and the debate
Why is it so hard to agree?

3.
Diagnosis 7+7
1. Underdeveloped private and public risk-sharing (for a
currency union)
 Limited financial integration, lack of fiscal stabilization tools,
2. Amplification during crisis
 Doom loop, runs for safe havens, procyclical fiscal
3. (An inefficient and politically divisive approach to maintaining
fiscal discipline)
 Based on fiscal rules that are error-prone, require micromanagement
from Brussels, and are hard to enforce.

4.
More market discipline REQUIRES more
safety nets
1. More and better risk sharing:
 Uniform deposit insurance (EDIS)
 Liquidity line at ESM for pre-qualified countries
 “Safe asset” based on diversified sovereign debt portfolio
2. Greater role for market discipline
 More credible no-bail-out rule
 Breaking doom loop – disincentives for home bias
 Incentives for fiscal discipline

5.
Three Types of critics
Type A : accept basic proposition but prefer a different design
Type B: Reject basic proposition – want much on more risk sharing, only
Type C: Reject basic proposition – oppose any type of market discipline
Type D: Kind of accept the basic proposition but NOT NOW -

6.
Critics of type C/D: Too much market discipline
On debt restructuring
– Principled opposition against debt restructuring (Type C)
– Debt restructuring is seen as dangerous,
• always (Type C),
• in high debt countries (Type D)
On banking
– Don’t change regulation, we need for banks as safety valves ,
• always (Type C)
– Don’t change regulation, NOW,
• we need for banks, since there are not other safety valves (Type D)
On fiscal discipline
– Don’t like Junior bonds (don’t like ESBIEs either) because they increase
sovereign borrowing cost (Type C and D?)

7.
Debt restructuring - the rational
• Diagnosis :
– Debt restructuring it too costly (distributionally, politically, doom loops,
contagion, redenomination)
– Debt restructuring happens too little, too late (gambling for resurrection
and too costly adjustment)
– Therefore the private sector correctly (!) first does not price risk
correctly and then panics
• Ex ante : Preventive
• Ex post : Curative

8.
Debt restructuring – some misunderstanding
• We are Not saying
– Automatically restructure
– Fixed thresholds
– Introduce in a situation of high vulnerability
• What we are saying
– Make restructuring manageable without sinking the banking system,
the economy and the government
– Make restructuring manageable by sweeping in hold outs
+ Safety net
– Create a european safe asset to prevent runs
– Create fire walls to reduce contagion

9.
Why is it so difficult to agree?
The battle of interests vs. ideas
• Interest Theory: problems are distributional
– creditors against debtors, high-debt against low- debt states, stable against
crisis-prone countries, or global banks against local banks.
– Zero sum game, easy to understand analytically
• Ideas Theory : problems are cognitive
– disagreements because actors do not share the same representation of reality,
but rather work with different implicit or explicit models of it
– Reasoning with different models is harder to “solve”

10.
Thank you