MUTUALIZING EURO AREA DEBT WITHOUT A FISCAL UNION.
| Autor | Montalbert, Stefan Krause |
| Páginas | 23(21) |
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INTRODUCTION
Policymakers across the globe responded to the most recent financial crisis and ensuing worldwide recession with a policy mix designed to better withstand the potentially nefarious effects expected by experts and markets alike. This series of unprecedented phenomena since WWII resulted in a combination of active fiscal policy and accommodative monetary policy (Reinhart & Rogoff, 2010). Yet, a twin crisis soon emerged in the Euro Area: the sovereign debt crisis. It entailed substantive risks to the monetary union, partly due to commitment and coordination issues, and also to heterogeneities across countries.
For starters, Greece had a debt-to-GDP ratio which had been growing long before the onset of the financial crisis, which made it a special case. Ireland was disproportionally hit by the financial crisis on account of its large exposure to the American and British banking systems. Furthermore, other countries (notably Italy, Portugal, Slovenia and Spain) were also paying high premia for their sovereign bonds, especially between 2011 and 2012. While the short-term interest rate spikes during this period may have been partly explained by rising public debts in each individual country, much of the volatility was the result of fears of contagion among some Euro Area countries, as well as a general rise in uncertainty with regards to the future of the common currency.
While at the time of writing, most interest rates on sovereign debt had decreased to more reasonable levels--mainly as a result of the actions undertaken by the European Central Bank (ECB) and the fiscal programs established in each country--a return to a period of increased uncertainty and contagion fears is not completely out of the question (Ehrmann & Fratzcher, 2015). With this in mind, the main objective of this paper is to design a mechanism that "pools" Euro Area debt together, in order to lower short-term interest rates, and limits the risk of contagion. This design --which draws from existing proposals for jointly issued bonds in the Euro Area--contains features that would make it acceptable for participants (such as no ex-ante fiscal transfers across countries, and widespread benefits from lower debt-service payments), while placing a reasonable cap on potential losses from default by other participants through limited liability.
The remainder of the paper is organized as follows: Section 2 provides an overview of the European sovereign debt crisis and the subsequent response in the Euro Area. Section 3 describes the four main proposals for issuing joint Euro Area debt instruments, which were circulated between May 2011 and January 2012. Section 4 introduces a new proposal for jointly issued bonds that does not require the need for a fiscal union in the Euro Area, or any ex-ante net transfers between participating countries. Section 5 further studies this proposal and how the fund could evolve over time. Section 6 provides some conclusions and further extensions.
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THE EURO AREA SOVEREIGN DEBT CRISIS: SOME STYLIZED FACTS
2.1 Key facts and posible spiraling effects
As of 2015, there are 19 sovereign country members in the Euro Area. Interestingly enough, at the end of 2013, only six of them (Estonia, Finland, Latvia, Lithuania, Luxembourg, and Slovakia) would have been in compliance with the "below 60% debt-to-GDP ratio" rule set by the Stability and Growth Pact, as depicted in Appendix Figure 1. Furthermore, almost all New Member Countries--with the exceptions of Hungary (77%) and Croatia (66%)--were maintaining debt-to-GDP ratios below the 60% threshold (see Appendix Figure 2).
Nevertheless, the documented fiscal imbalances did not directly translated into price pressures. Since the mid-2008 inflation in the Euro Area has hovered around and below 2% on average, while inflation expectations have remained firmly anchored. In recent years, despite record-low policy rates, deflation has been more of a concern. Furthermore, there exists evidence of a disconnect between fiscal sustainability and the level of the debt-GDP ratio (Polito & Wickens, 2011), which may help explain why Spain and Slovenia (for example) had been paying higher interest rates on their newly-issued debt in 2011, despite having a lower debt-to-GDP ratio in comparison to countries like France and Germany.
At the end of 2011, interest rate differentials between countries of the Euro Area reached record levels since the inception of the Euro in many cases: For Portugal, the yield surpassed 13%; while for Ireland, Italy, Slovenia and Spain rates were on average at levels between 6%-9%. This at a time when the ECB main refinancing rate had been persistently near the 1% level. Even Belgium and Austria were paying relatively high premia on their newly issued debt, hovering around 3.5%-5% yields.
2.2 Euro area responses and aftermath
In order to re-establish the proper functioning of the monetary transmission mechanism, the ECB began open market purchases of government and private debt securities in May 2010 (European Central Bank, ECB, 2010). This program was expanded in September 2012 with additional financial support in the form of selected yield-lowering bond purchases, through the Outright Monetary Transactions program (Draghi & Constâncio, 2012). Another key measure was implemented in December 2011 with the introduction of Long Term Refinancing Operations, through which ECB loans supplemented inter-bank lending (Draghi & Constâncio, 2011).
From the fiscal perspective, in January 2011 the European Council created the European Financial Stability Facility, an emergency funding program guaranteed by the European Commission using the budget of the European Union as collateral, which was replaced by the European Stability Mechanism (ESM) between September and October 2012 (European Commission, 2018). Also, on December 9th, 2011, the Euro Area Heads of State or Government issued a joint statement in which they indicated their willingness to establish new fiscal rules and reinforce existing ones(European Council, 2011).
Finally, individual countries adopted fiscal austerity plans to different degrees. In the particular situation of Greece, the Public Debt Relief Programme attributable to the debt restructuring in 2012 represented over 50% of GDP. Estimates suggest that the present value haircut of the Greek debt exchange ended up in the range of 59-65 percent (Zettelmeyer, Trebesch & Gulati, 2013). This parameter will be useful for the calibration exercises performed in Sections 4 and 5.
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POTENTIAL EURO AREA RESPONSE TO THE CRISIS: PROPOSAL FOR JOINTLY ISSUED BONDS
While the return to high interest rate differentials across countries constitutes (as of February 2015) at most a latent concern, the increased speculation over the future of the Euro Area over the past 6-to-9 months, coupled with recent developments in Greece, provides fertile ground for examining additional options. In this spirit, this paper revisits several proposals for issuing joint Euro Area bonds. I focus specifically on four such proposals that were circulated between May 2011 and January 2012: I.
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The Blue Bond proposal, originally published by Jacques Delpla and Jakob von Weizsacker in May 2010 (Depla & Weizsaker, 2010).
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The European Redemption Pact, originally published by the German Council of Economic Experts in November 2011, with a 25 January 2012 addendum (German Council of Economic Experts, 2011).
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The Stability Bonds, published by the European Commission on 23 November 2011 (European Commission, 2011).
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Eurobills, published by Christian Hellwig and Thomas Philippon on 2 December 2011 (Hellwig, & Philippon, 2011).
The common objectives of these and other proposals were, in the short term, to "pool" Euro Area debt together, in order to lower short-term interest rates of countries paying a high premium (Italy, Spain, Portugal, others). In the long term, jointly issued bonds could lead up to creating a liquid market for Euro Area debt instruments, which could aid towards preventing future crises. Over the next few subsections I briefly describe the features of each of the plans, as well as some considerations for the design of Euro Area-wide bonds.
3.1 The blue bond proposal
The main idea put forth by Delpla and von Weizsacker (2010) was for Euro Area governments to pool up to 60% of their sovereign debt "in the form of a common European government bond." These supra-national debt instruments, named Blue Bonds, would be jointly issued through a Euro Area-wide agency: The Independent Stability Council (ISC). The ISC would be in charge of the allocation of said bonds under the approval of the participating countries' parliaments.
Any government debt surpassing the 60% ceiling would continue to be issued by individual countries in the form of Red Bonds. While Blue Bonds, through their senior status and joint and several (JS) issuance, may become eligible to ECB refinancing operations, the junior Red Bonds without JS issuance would continue return to being ineligible for monetary open market operations. Finally, Blue Bonds would correspond to the operational equivalent of plain national sovereign debt, which is why tax revenues would be required to be transferred directly to the ISC.
3.2 European redemption pact
According to the German Council of Economic Experts (2011), the ECB had been "damaging its reputation [by continuing] its programme of buying Italian and Spanish debt." Furthermore, they claim that this constitutes a "blur" of the line that separates fiscal and monetary policy. The interventions in the sovereign debt market were thus "jeopardizing the credibility" of the ECB and the Eurosystem as a whole.
The European Redemption Pact proposal set forth by the Council, in a way, is by the design the exact opposite to the Blue Bond / Red Bond proposal: while individual countries would continue to issue sovereign debt instruments for up to 60% of their GDP, all...
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