Eurobond (eurozone)

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Eurobonds or stability bonds were proposed government bonds to be issued in euros jointly by the 19 eurozone nations. The idea was first raised by the European Commission in 2011 during the 20092012 European sovereign debt crisis. Eurobonds would be debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to the eurozone bloc altogether, which then forwards the money to individual governments.

Euro European currency

The euro is the official currency of 19 of the 28 member states of the European Union. This group of states is known as the eurozone or euro area, and counts about 343 million citizens as of 2019. The euro is the second largest and second most traded currency in the foreign exchange market after the United States dollar. The euro is divided into 100 cents.

Eurozone Area in which the euro is the official currency

The eurozone, officially called the euro area, is a monetary union of 19 of the 28 European Union (EU) member states which have adopted the euro (€) as their common currency and sole legal tender. The monetary authority of the eurozone is the Eurosystem. The other nine members of the European Union continue to use their own national currencies, although most of them are obliged to adopt the euro in the future.

European Commission executive institution of the European Union

The European Commission (EC) is an institution of the European Union, responsible for proposing legislation, implementing decisions, upholding the EU treaties and managing the day-to-day business of the EU. Commissioners swear an oath at the European Court of Justice in Luxembourg City, pledging to respect the treaties and to be completely independent in carrying out their duties during their mandate. Unlike in the Council of the European Union, where members are directly and indirectly elected, and the European Parliament, where members are directly elected, the Commissioners are proposed by the Council of the European Union, on the basis of suggestions made by the national governments, and then appointed by the European Council after the approval of the European Parliament.

Contents

Eurobonds have been suggested as a way to tackle the 20092012 European debt crisis as the indebted states could borrow new funds at better conditions as they are supported by the rating of the non-crisis states. Because Eurobonds would allow already highly indebted states access to cheaper credit thanks to the strength of other eurozone economies, they are controversial, and may suffer from the free rider problem. [1] The proposal was generally favored by indebted governments such as Portugal, Greece, and Ireland, but encountered strong opposition from Germany, the Eurozone's strongest economy. The plan ultimately never moved forward in face of German opposition; the crisis was ultimately resolved by the ECB's declaration in 2012 that it would do "whatever it takes" to stabilize the Euro, rendering the Eurobond proposal moot.

Blue bond proposal

In May 2010 the two economists Jakob von Weizsäcker and Jacques Delpla published an article [2] proposing a mix of traditional national bonds (red bonds) and jointly issued eurobonds (blue bonds) to prevent debt crises in weaker countries, while at the same time enforcing fiscal sustainability. According to the proposal EU member states should pool up to 60 percent of gross domestic product (GDP) of their national debt under joint and several liability as senior sovereign debt (blue tranche), thereby reducing the borrowing cost for that part of the debt. Any national debt beyond a country's blue bond allocation (red tranche) should be issued as national and junior debt with sound procedures for an orderly default, thus increasing the marginal cost of public borrowing and helping to enhance fiscal discipline. Participating countries must also establish an Independent Stability Council voted on by member states parliaments to propose annually an allocation for the blue bond and to safeguard fiscal responsibility. [3]

Jakob von Weizsäcker German politician

Jakob von Weizsäcker is a German politician and currently the chief economist of the German Ministry of Finance. Before, he served as the social democratic Member of the European Parliament (MEP) from Thuringia, Germany for the 8th European Parliament (2014-2019).

Fiscal sustainability, or public finance sustainability, is the ability of a government to sustain its current spending, tax and other policies in the long run without threatening government solvency or defaulting on some of its liabilities or promised expenditures. There is no consensus among economists on a precise operational definition for fiscal sustainability, rather different studies use their own, often similar, definitions. However, the European Commission defines public finance sustainability as: the ability of a government to sustain its current spending, tax and other policies in the long run without threatening the government's solvency or without defaulting on some of the government's liabilities or promised expenditures. Many countries and research institutes have published reports which assess the sustainability of fiscal policies based on long-run projections of country's public finances. These assessments attempt to determine whether an adjustment to current fiscal policies that is required to reconcile projected revenues with projected expenditures. The size of the required adjustment is given with measures such as the Fiscal gap.

Marginal cost factor in economics

In economics, marginal cost is the change in the total cost that arises when the quantity produced is incremented by one unit; that is, it is the cost of producing one more unit of a good. Intuitively, marginal cost at each level of production includes the cost of any additional inputs required to produce the next unit. At each level of production and time period being considered, marginal costs include all costs that vary with the level of production, whereas other costs that do not vary with production are fixed and thus have no marginal cost. For example, the marginal cost of producing an automobile will generally include the costs of labor and parts needed for the additional automobile but not the fixed costs of the factory that have already been incurred. In practice, marginal analysis is segregated into short and long-run cases, so that, over the long run, all costs become marginal. Where there are economies of scale, prices set at marginal cost will fail to cover total costs, thus requiring a subsidy. Marginal cost pricing is not a matter of merely lowering the general level of prices with the aid of a subsidy; with or without subsidy it calls for a drastic restructuring of pricing practices, with opportunities for very substantial improvements in efficiency at critical points.

The authors argue that while their concept is not a quick fix, their Blue Bond proposal charts an incentive-driven and durable way out of the debt dilemma while "helping prepare the ground for the rise of the euro as an important reserve currency, which could reduce borrowing costs for everybody involved". [3] Smaller countries with relatively illiquid sovereign bonds (such as Austria and Luxembourg) could benefit most from the extra liquidity of the blue bond, although Germany's borrowing costs under the blue bond scheme would be expected to fall below current levels. Countries with high debt-to-GDP ratios (such as Italy, Greece, and Portugal) would have a strong incentive for fiscal adjustment. [3]

A reserve currency is a currency that is held in significant quantities by governments and institutions as part of their foreign exchange reserves. The reserve currency is commonly used in international transactions, international investments and all aspects of the global economy. It is often considered a hard currency or safe-haven currency. People who live in a country that issues a reserve currency can purchase imports and borrow across borders more cheaply than people in other nations because they do not need to exchange their currency to do so.

Greece republic in Southeast Europe

Greece, officially the Hellenic Republic, also known as Hellas, is a country located in Southern and Southeast Europe, with a population of approximately 11 million as of 2016. Athens is the nation's capital and largest city, followed by Thessaloniki.

Portugal Republic in Southwestern Europe

Portugal, officially the Portuguese Republic, is a country located mostly on the Iberian Peninsula in southwestern Europe. It is the westernmost sovereign state of mainland Europe, being bordered to the west and south by the Atlantic Ocean and to the north and east by Spain. Its territory also includes the Atlantic archipelagos of the Azores and Madeira, both autonomous regions with their own regional governments.

European Commission proposal

On 21 November 2011 the European Commission suggested European bonds issued jointly by the 17 euro nations as an effective way to tackle the financial crisis. On 23 November 2011 the Commission presented a Green Paper assessing the feasibility of common issuance of sovereign bonds among the EU member states of the eurozone. Sovereign issuance in the eurozone is currently conducted individually by each EU member states. The introduction of commonly issued eurobonds would mean a pooling of sovereign issuance among the member states and the sharing of associated revenue flows and debt-servicing costs. [4]

A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults. Financial crises directly result in a loss of paper wealth but do not necessarily result in significant changes in the real economy.

In the European Union, the Commonwealth countries, Hong Kong and the United States, a green paper is a tentative government report and consultation document of policy proposals for debate and discussion. A green paper represents the best that the government can propose on the given issue, but, remaining uncommitted, it is able without loss of face to leave its final decision open until it has been able to consider the public reaction to it. Green papers may result in the production of a white paper. They may be seen as grey literature.

On 29 November 2012, European Commission president Jose Manuel Barroso suggested to introduce Eurobonds step by step, first applying to short-term bonds, then two-year bonds, and later Eurobonds, based on a deeply integrated economic and fiscal governance framework. [5] [6]

Three approaches to eurobonds

The green paper lists three broad approaches for common issuance of eurobonds based on the degree of substitution of national issuance (full or partial) and the nature of the underlying guarantee (joint and several or several). [4]

  1. Full eurobonds with joint liability: This option suggests to fully replace the entire national issuance by eurobonds, each EU member being fully liable for the entire issuance. According to the European Commission "this would have strong potential positive effects on stability and integration. But at the same time, it would, by abolishing all market or interest rate pressure on Member States, pose a relatively high risk of moral hazard and it might need significant treaty changes."
  2. Partial eurobonds with joint liability: The second option would pool only a portion of borrowings, again guaranteed by all. This means EU member states would still partly issue national bonds to cover the share of their debts beyond a certain percentage of GDP not covered by eurobonds. The Commission does not state a specific volume or share of financing needs that would be covered by national bonds at the one hand and eurobonds on the other. However, the proposal is similar to that of the German Council of Economic Experts that proposed a European collective redemption fund, which would mutualise the debt in the eurozone above 60%, combined with a bold debt reduction scheme for those countries, which are not on life support from the European Financial Stability Facility. This option is expected to require an amendment of the TFEU treaty. [7]
  3. Partial eurobonds without joint guarantees: According to the third option that is similar to the blue bond proposal, eurobonds would again cover only parts of the debt (like option 2) but without joint guarantees. This could impose strict entry conditions for a smaller group of countries to pool some debt and allow for the removal of countries that do not meet their fiscal obligations. Due to "a mechanism to redistribute some of the funding advantages ... between the higher- and lower-rated" governments, this option aims to minimise the risk of moral hazard for the conduct of economic and fiscal policies. Unlike the first two approaches, this would involve "several but not joint" government guarantees and could therefore be implemented relatively quickly without having to change EU treaties.

Suggested effects

According to the European Commission proposal the introduction of eurobonds would create new means through which governments finance their debt, by offering safe and liquid investment opportunities. This "could potentially quickly alleviate the current sovereign debt crisis, as the high-yield Member States could benefit from the stronger creditworthiness of the low-yield Member States." The effect would be immediate even if the introduction of eurobonds takes some time, since changed market expectations adapt instantly, resulting in lower average and marginal funding costs, particularly to those EU member states most hit by the financial crisis. The Commission also believes that eurobonds could make the eurozone financial system more resilient to future adverse shocks and reinforce financial stability. Furthermore, they could reduce the vulnerability of banks in the eurozone to deteriorating credit ratings of individual member states by providing them with a source of more robust collateral. [4] Setting a euro-area wide integrated bond market would offer a safe and liquid investment opportunity for savers and financial institutions that matches its US$ counterpart in terms of size and liquidity, which would also strengthen the position of the euro as an international reserve currency and foster a more balanced global financial system. [4]

On the other hand, the governments of those states that most people would like to take over those debt risks do not think that this is a good idea and see other effects. They do not understand why it should help a group of states that have excessively borrowed and circumvented the EU contracts for many years should now be helped by making it even easier for them to borrow even more via Eurobonds. Germany is one of those sceptical states, [8] [9] together with Austria, [10] Finland and the Netherlands. [11]

Hans-Werner Sinn from the Munich-based Ifo Institute for Economic Research believes the cost for German tax payers to be between 33 and 47 billion Euros per year. [12] [13] Other economists such as Henrik Enderlein from the Hertie School of Governance and Gustav Horn from the Macroeconomic Policy Institute (IMK) contend these figures. Both suggest that German interest rates would only go up marginally, as Eurobonds would benefit from substantially higher liquidity and demand from around the world. [13] Again others believe German interest rates could even go down. [14] Experts from the German finance ministry expect borrowing costs to go up by 0.8%, resulting in additional borrowing costs of 2.5 billion Euros in the first year of introduction and 5 billion in the second year, reaching 20–25 billion Euros after 10 years respectively. [15] After all, Eurobond supporters argue that their introduction "would be far less expensive than the continuous increases to the emergency umbrella or even a failure of the euro." [16]

Tighter fiscal rules

Presenting the idea of "stability bonds", Jose Manuel Barroso insisted that any such plan would have to be matched by tight fiscal surveillance and economic policy co-ordination as an essential counterpart so as to avoid moral hazard and ensure sustainable public finances. [17] [18] Under the proposals, eurozone governments would have to submit their draft national budgets for the following year to the European Commission by 15 October. The Commission would then be able to ask the government to revise the budget if it believed that it was not sound enough to meet its targets for debt and deficit levels as set out in the Euro convergence criteria. [19]

On 9 December 2011 at the European Council meeting, all 17 members of the euro zone and six countries that aspire to join agreed on a new intergovernmental treaty to put strict caps on government spending and borrowing, with penalties for those countries that violate the limits. [20] All other non-eurozone countries except Great Britain are also prepared to join in, subject to parliamentary vote. [21]

Reactions

Italy and Greece have frequently spoken out in favour of eurobonds, the then Italian Minister of economy Giulio Tremonti calling it the "master solution" to the eurozone debt crisis. [22] A growing field of investors and economists share this belief, saying eurobonds would be the best way of solving the debt crisis. [7]

However, Germany remains opposed to debt that would be jointly issued and underwritten by all 17 members of the currency bloc, saying it could substantially raise the country's liabilities in the debt crisis. Barroso maintained that Germany did not oppose joint issuance in principle, but questioned the timing of it. [23] Austria, Bulgaria, Finland and the Netherlands have also raised objections over eurobond issuance. Bulgarian finance minister Simeon Djankov criticised eurobonds in Austria's Der Standard: "Cheap credit got us into the current eurozone crisis, it's naive to think it is going to get us out of it."

Counter proposals

On 28 November 2011, German newspaper Die Welt reported that Germany, France and four other AAA-rated EU members may issue common "elite bonds" (or "triple A bonds") in a bid to raise more money at low interest rates for themselves and, under strict conditions, to help also indebted euro region members. [24] Austria, Finland, Luxembourg and the Netherlands are said to be part of the plan aimed at stabilising the top-rated countries and calming financial markets. Common bonds of the six countries are expected to have an interest rate of 2 percent to 2.5 percent. [25]

Following the 2011 proposal made by the "five wise economists" from the German Council of Economic Experts, Guy Verhofstadt, leader of the liberal ALDE group in the European Parliament, suggested creating a European collective redemption fund. It would mutualise eurozone debt above 60%, combining it with a bold debt reduction scheme for countries not on life support from the EFSF. [7]

In January 2012 a working group within the European League for Economic Cooperation unveiled a blueprint for a Euro T-Bill Fund. The proposal, which elaborates further on a concept first introduced by Rabo Bank's Chief Economist Wim Boonstra, calls for a temporary fund of only four years and bonds with a maturity of a maximum of two years. [26]

In March 2012, Boston Consulting Group also followed up on the German Council proposal, agreeing that "the scope of the problem is too great to be solved by the European Stability Mechanism or the medium-term injection of liquidity by the European Central Bank" and favouring limited-scope Eurobonds. [27]

In June 2012, German chancellor Angela Merkel said no to Eurobonds. [28]

Critics

The planned introduction of Eurobonds has been criticised by economists for economic reasons such as the Free rider problem or Moral Hazard. [29] Beside economic grounds, mainly legal and political reasons are mentioned which could prohibit the introduction of Eurobonds: Article 125 of the Lisbon Treaty states explicitly that the European Union and its member states are not liable for the commitments of other members. [30] Since Eurobonds would possibly contravene Article 125, it may have to be changed prior introduction. [31]

See also

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