"Which Eurobonds?" by Jeffrey Frankel | Project Syndicate - 0 views
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Any solution to the eurozone crisis must meet a short-run objective and a long-run goal. Unfortunately, the two tend to conflict.Illustration by Paul LachineCommentsView/Create comment on this paragraphThe short-run objective is to return Greece, Portugal, and other troubled countries to a sustainable debt path (that is, a declining debt/GDP ratio). Austerity has raised debt/GDP ratios, but a debt write-down or bigger bailouts would undermine the long-term goal of minimizing the risk of similar debt crises in the future.CommentsView/Create comment on this paragraph
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it is hard to commit today to practice fiscal rectitude tomorrow. Official debt caps, such as the Maastricht fiscal criteria and the Stability and Growth Pact (SGP), failed because they were unenforceable.
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The introduction of Eurobonds – joint, aggregate eurozone liabilities – could be part of the solution, if designed properly. There is certainly demand for them in China and other major emerging countries, which are desperate for an alternative to low-yielding US government securities.
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But Germany remains opposed on moral-hazard grounds: a joint guarantee of Eurozone members’ liabilities would strengthen individual national governments’ incentive to spend beyond their means.
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The German Council of Economic Experts has proposed a European Redemption Fund (ERF). The plan would convert into de facto 25-year Eurobonds the existing sovereign debt of member countries in excess of 60% of GDP, the threshold specified by the Maastricht criteria and the SGP.
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it offers absolution precisely on the 60%-of-GDP margin where countries will have the most trouble resisting temptation.
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the main explanation for the absence of US moral hazard is that the right precedent was set in 1841, when the federal government let eight states and the Territory of Florida default.
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Ever since 1841, the market requires that US states running up questionable levels of debt pay an interest-rate premium to compensate for the default risk.
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Had the ECB operated from the outset under a rule prohibiting it from accepting SGP-noncompliant countries’ debt as collateral, the entire eurozone sovereign-debt problem might have been avoided.
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the expansion in the US took place at the federal level, where spending today amounts to 24% of GDP, compared to just 1.2% of GDP for the European Union budget.
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The version of Eurobonds that might work as the missing long-term enforcement mechanism is almost the reverse of the Germans’ ERF proposal: the “blue bonds” proposed two years ago by Jacques Delpla and Jakob von Weizsäcker. Under this plan, only debt issued by national authorities below the 60%-of-GDP threshold could receive eurozone backing and seniority. When a country issued debt above the threshold, the resulting “red bonds” would lose this status.
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The point is that the enforcement mechanism would be truly automatic: market interest rates would provide the discipline that bureaucrats in Brussels cannot.
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Of course, the eurozone cannot establish a blue-bond regime without first solving the problems of debt overhang and troubled banks. Otherwise, the plan itself would be destabilizing, because almost all countries would immediately be in the red.
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But one thing seems clear. German taxpayers, whose longstanding suspicion of profligate Mediterranean euro members has been vindicated, will not be happy when asked to pay still more for the cause of European integration. At a minimum, they will need some credible reason to believe that 20 years of false assurances have come to an end – that this is the last bailout.