December 16, 2010
The recent proposal by Luxembourg’s prime minister Jean-Claude Juncker and the Italian finance minister, Giulio Tremonti to provide European governments with Eurobonds has sparked debate. According to this column, it will help through financing infrastructure and increasing market liquidity. But because it requires highly-indebted countries to surrender a large chunk of fiscal sovereignty, it is a good idea whose time has not yet come.
The Italian finance minister, Mr. Tremonti and his Luxembourgian counterpart, Mr. Jean-Claude Juncker, in an article which appeared in the Financial Times on 5 December, launched the proposal of establishing a European Debt Agency, which should replace the European Financial Stability Facility, when this expires in 2013. The proposal is not new. The original one goes back to Jacques Delors in the 1980s, and has been recently rejuvenated by the recent Monti Report to President Barroso (Monti 2010, see also Basevi 2006). Initially the idea was intended to provide a new debt instrument for financing pan-European infrastructures.
According to the Tremonti and Juncker version, a new European debt instrument should gradually replace national public debts. Governments should issue half of their new issues in the form of Eurobonds, until these reach 40% of the GDPs of each member country (and of the Eurozone as a whole). Countries that face serious difficulties in accessing capital markets may – in exceptional circumstances – cover 100% of their issues with European debt.
The proponents argue that the Eurobonds would achieve two important objectives:
- Creation of a bond market comparable, in size and liquidity, to the US Treasury Bill market; and
- Termination of speculative attacks against sovereign debts in the Eurozone.
Despite these proclaimed virtues, the proposal was immediately rejected by Chancellor Merkel and President Sarkozy.
The plan’s critics have argued that the new bonds would weaken the market incentives for fiscal discipline, by allowing spendthrift governments to borrow at lower costs, and would penalise virtuous countries, whose borrowing costs would likely rise.
This moral hazard problem is important, but two issues deserve far more attention – fiscal sovereignty, and default.