Conditional eurobonds and the eurozone sovereign debt crisis

Abstract

This paper proposes that all new euro area sovereign borrowing be in the form of jointly guaranteed Eurobonds. To avoid classic moral hazard problems and to insure the guarantors against default, each country would pay a risk premium conditional on economic fundamentals to a joint debt management agency. This suggests that these bonds be called 'Euro-insurance-bonds'. While the sovereign debt markets have taken increasing account of the economic fundamentals, the signal to noise ratio has been weakened by huge market volatility, so undercutting incentives for appropriate reforms and obscuring economic realities for voters. This paper uses an econometric model to show that competitiveness, public and private debt to GDP, and the fall-out from housing market crises are the most relevant economic fundamentals. Formula-based risk spreads based on these fundamentals would provide clear incentives for governments to be more oriented towards economic reforms to promote long-run growth than mere fiscal contraction. Putting more weight on incentives that come from risk spreads, than on fiscal centralisation and the associated heavy bureaucratic procedures, would promote the principle of subsidiarity to which member states subscribe. The paper compares Euro-insurance-bonds incorporating these risk spreads with other policy proposals.Zampolli are gratefully acknowledged. Fabian Eser's detailed comments were particularly appreciated, but the author has sole responsibility for remaining error.

Eurozone Crisis

“…Even in the USA, which form a single nation, a member state is not liable for the fi nancial management of other states. The missing collective liability for the public debts of individual states is even the reason why the American federalism works (Muellbauer, 2013).…”

A hierarchical copula-based world-wide valuation of sovereign risk

“…In the proposed example, we highlight the impact of the systemic risk and of contagion effects on sovereign risk involved in a particular geographical area. Finally the relevance to work with an enlarged dependence structure is appreciated in the evaluation of the insurance premium and the risk contribution referred to the euroinsured-bonds (EIB for short in the following), that are products designed in the presented version by Muellbauer (2013) and whose insurance worth could represents a solution to the debt crisis of the eurozone, providing an insurance against its bankruptcy.…”

“…This kind of eurobond is then a single debt instrument issued by a group of euro-area member states backed by several and joint guarantees: each participating issuer would guarantees the totality of the obligations of the common instrument. An alternative and intermediate proposal (see Boonstra, 2010 andMuellbauer, 2013) comes instead from a sovereign bond insured by eurozone through a newly established independent fund. Basically this new kind of euro-area debt, called euro-insurancebond (EIB in the following), should be a jointly underwritten eurobond, preserving the incentives provided by risk premiums on national governments bonds, but with a part of the country's risk premiums, paid by investors to make the bond safest, thanks to the protection of the eurozone.…”

Euro-insurance-bonds: a long-term solution for the European sovereign debt problem?

“…Shocks resulting from the normalisation of monetary policy in the US may yet resurface in the Euro area 8 See Muellbauer (2013a), de Grauwe (2011) and Favero and Missale (2012).…”

“…The basic idea is that all new Euro area debt should be in the form of jointly underwritten Eurobonds trading 1 This article is based on a paper in the Oxford Review of Economic Policy, Muellbauer (2013a). Support at the same price for outside investors, but with country risk premia paid by each country, conditional on its economic circumstances.…”