Is the ‘Euro Bond’ the Answer to the Euro Sovereign Debt Crisis? What Outcome Can Investors Expect Out of Europe?

Abstract:     
This paper analyzes the causes of the sovereign debt crisis in the eurozone and examines the policy alternatives confronting euro area governments. It suggests that pooling fiscal risks, creating an EU Treasury and issuing jointly-backed euro bonds is an optimal solution and the inevitable conclusion of the economic integration project in Europe. It examines the advantages and disadvantages of euro bonds and concludes that issuing euro bonds can transform a market that is fragmented along national lines into a single unified European government bond (EGB) market that can have the depth, breadth and liquidity to match the US Treasury market. By enhancing the size and liquidity of the EGB market it can become possible for global investors and wealth managers to use euro bond instruments as a tool for payment or transactions needs as well as short-term precautionary and investment balances that can increase the demand for them and lower their yields. This development can enhance the euro’s ‘safe haven’ status and enable the Euro area to extract seigniorage benefits similar to those that the US has enjoyed in the post war period that should reduce funding costs even for fiscally strong euro area countries. It can also consolidate the euro as one of the world’s two principal reserve currencies. The risk that fiscally weak area countries might take advantage of low borrowing costs to increase debt can be easily and effectively mitigated by agreeing on a formula that will establish an escalating rate in the sharing of interest costs that will be proportional to their debt-GDP ratio. Thus moral hazard is mitigated, the disciplining role of the markets is internalized and incentives are created to reduce debt and increase income.

Number of Pages in PDF File: 28

Keywords: Europe, euro, sovereign debt, crisis, seigniorage, ECB, EMU, EU, Greece, Eurozone, economic integration, EFSF, euro bonds, moral hazard, fiscal integration, bank leverage, European banks, Italy, Germany, stability and growth pact, ESM

JEL Classification: E42, E44, E58, E61, F02, F15, F33, F34, F36, F55, F59, G01, G12, G15, H12, H63, N24

Accepted Paper Series