Euro bonds – halfway between solidarity and self-responsibility
The rules of the eurozone state that every country must take responsibility for its own debt. The no bail-out clause in the Maastricht Treaty excludes the possibility of a Member State assuming liability for the sovereign debt of other Member States. The aim of this ban was to avoid some Member States ‘freeloading’ off others by pursuing an irresponsible fiscal policy.
In the current debt crisis, the no bail-out clause has been scrapped and replaced by a huge safety net for countries hit by crisis. The reasons such a strategy was adopted in May 2010 are twofold. First, there were grave concerns that Greece’s going bankrupt would lead weaker countries in the eurozone, and especially European banks, to go under, thereby running the risk of causing a fresh banking crisis. Second, providing support to countries in crisis speaks to our deep-rooted sense of ourselves as a Europe founded on solidarity.
Given that Greece and Ireland, not to mention other countries (the next is likely to be Portugal), will probably also be asking soon for help with their debt management, plans are afoot to further extend the safety net over the coming months. Yet, in the face of such massive support for crisis-hit countries, the question arises as to how to avoid situations where countries, burdened by debt as a result of the foolhardy fiscal policies they had adopted, are given a free ride by the others.
One possibility lies in amending the rules and standards underpinning the current Stability and Growth Pact to include strong rules that would compensate for jettisoning the no bail-out clause. This is the approach presently adopted by Germany and France. However, it would be a risky business to rely on tough rules alone. After all, Greece was able to flout the existing fiscal rules for years.
For this reason, we should also avail ourselves of a second possibility, that is to say, enhancing fiscal discipline through market signals. This is the goal of the euro bond proposal, which Giulio Tremonti and Jean-Claude Juncker are now advocating, following a proposal submitted by Jacques Delpla and myself.
Our proposal envisages countries in the eurozone dividing their sovereign debt into ‘senior’ and ‘junior’ tranches. This would, for one thing, lower the interest burden for sovereign debt as a whole in the eurozone. For another, incentives for fiscal sustainability in the eurozone would be markedly improved.
The senior tranche, with debts up to the Maastricht limit of 60 % of the GDP of the country in question, would be pooled across Europe under joint liability as ‘Blue Bonds’. This euro bond would be an extremely secure state bond with similar liquidity to that of the US government bond, which is the global leader today. This would make the euro more attractive as a reserve currency and bring down interest rates on the Blue Bond as a result.
However, debts in excess of 60 % of GDP would have to be issued as junior ‘Red Bonds’, to be dealt with on a purely national basis. The Red Bonds would therefore work in a similar way to an ‘excess’ in car insurance. Without this, the euro bond could indeed lead to a ‘partial comprehensive insurance fiscal mentality’ in the eurozone – about which critics are right to sound a note of caution. With the Red Bonds as ‘excess’, any additional debt above the 60 % threshold is considerably more expensive, thus increasing the incentives for sound fiscal discipline.
Moreover, in the event of a crisis, the creation of Red Bonds would simultaneously set in place a kind of ‘predetermined breaking point’ by minimising the systemic risks should default on the Red Bonds occur. In particular, ‘Red Bonds’ ought, to a large extent, to be kept out of the banking systems. In order to achieve this, the ECB should refuse to accept Red Bonds as security. At the same time, banking authorities should ask for a high own-capital deposit for Red Bonds, thus making them comparatively unattractive.
Making such provisions would make an orderly default on Red Bonds possible. The Red Bond interest rates would correspondingly react to any fiscal policy which flouted the sustainability imperative. This additional market discipline could contribute significantly towards improving peoples’ faith in the Stability and Growth Pact in the wake of the euro crisis.
Jakob von Weizsäcker
Director General for Economic Policy and Tourism, Economics Ministry of Thuringia
Reference: Jacques Delpla and Jakob von Weizsäcker (2010), The Blue Bond Proposal, Bruegel Policy Brief