There are both incentives and disincentives for the provision of liquidity support across the euro area. Indeed, combined, these factors represent an important component in our rating analysis for EU countries, and have so far prevented any member country from being rated at non-investment-grade levels.

 

Taking the disincentives first, the risk is that liquidity assistance turns into an ongoing fiscal transfer, or is perceived as one. This would generate moral hazard, but it would also cast a deeper shadow on the framework of fiscal responsibility (the Stability and Growth Pact) that has amply demonstrated its shortcomings and is already well dented. Anyway, a permanent transfer of this kind outside the normal channels is never likely to win support from taxpayers in potential donor/creditor countries as they are not likely to take kindly to being asked to compensate for the profligacy of others.

 

There also exist, however, powerful incentives to intervene. The first of these is the risk of contagion, which is effectively already materializing. As mentioned already, this situation is reminiscent of the contagion that prevailed at the times of ERM currency crises in the early 1990s. It speaks to a de facto solidarity that arises between European governments.

 

It is difficult to imagine that the governments that extended widespread support to their banks in order to contain contagion risks, and that provided support to Latvia or Hungary for more or less similar reasons, would withhold liquidity support to a fellow EMU member state, given the risk that this may generate to their own funding plans and costs. This is especially true if the member state in question is actively pursuing a responsible fiscal reform strategy, even if belatedly so.

 

In addition, it is in the interest of the EU that member states put public finances on a clearly sustainable path. This cannot happen if (i) their cost of funding spirals uncontrollably or (ii) they cannot fund their borrowing requirement during the adjustment process.

 

In sum, the balance of costs, risks and benefits appears considerably skewed in favour of the EU and its more robust member states providing, if required, emergency liquidity assistance to the more exposed governments.

 

The Treaties that helped to create the EU foresee in various articles the possibility for the Union or its members to grant assistance to others. This does not mean that assistance has to take place through one of the schemes that are explicitly mentioned, some of which have restrictions that may not apply in the current context. Governments are sovereign, and the assistance they grant each other is – in the ultimate analysis – a sovereign decision.

 

Moreover, Article 308 of the Lisbon Treaty states: “If action by the Community should prove necessary, within the framework of the policies defined in the Treaties, to attain one of the objectives set out in the Treaties, and the Treaties have not provided for the necessary powers, the Council, acting unanimously on a proposal from the Commission and after obtaining consent from the European Parliament, shall adopt the appropriate measures.” This article makes explicit that the EU has broad flexibility to do almost anything that it has not been explicitly prohibited from doing. 

  

 

Neither of these is an obstacle to liquidity support, which could take several forms, both direct and indirect. Direct support would involve the EU or individual member states granting loans to another member state. Indirect support could take the form, for instance, of requiring an EU agency – such as the European Investment Bank – to provide budgetary support loans to member states. (Note that the African Development Bank did make budget support loans available to its member governments during the crisis.) While the EIB has ruled out such a move, its shareholders may have different views.