Towards a Stable Monetary Union: What Role for Eurobonds?

33 Pages Posted: 25 May 2013

See all articles by Niels D. Gilbert

Niels D. Gilbert

De Nederlandsche Bank

Jeroen Hessel

De Nederlandsche Bank

Silvie Verkaart

De Nederlandsche Bank

Date Written: May 22, 2013

Abstract

This paper investigates the role that Eurobonds could play in making EMU stable in the long run. We establish that EMU’s budgetary problems are not only caused by lack of budgetary discipline, but also by the large and sudden fiscal deterioration during the financial crisis. This type of shock can never be fully ruled out. EMU member states appear more vulnerable in this situation than countries with their own currency, and risk getting caught in a self-fulfilling spiral of increasing interest rates. This presents a strong case for some type of rescue mechanism. We establish that neither the EFSF/ESM nor the ECB form the ideal backstop, and that Eurobonds potentially offer a more stable solution, but at the price of important moral hazard problems. All existing Eurobond proposals therefore seek a balance between stabilisation and moral hazard, typically through retaining some degree of market discipline. Our Eurobond proposal improves the trade-off between stabilisation and moral hazard by using Eurobonds themselves to further enforce budgetary discipline. Even then, however, EMU governance has to be strengthened substantially and debt levels have to converge before Eurobonds can be introduced. Therefore, our Eurobond proposal could only serve as the capstone of EMU.

Keywords: Eurobonds, sovereign bond spreads, fiscal risk-sharing, Economic and Monetary Union

JEL Classification: E44, E61, H63, H77, F33, F36

Suggested Citation

Gilbert, Niels D. and Hessel, Jeroen and Verkaart, Silvie, Towards a Stable Monetary Union: What Role for Eurobonds? (May 22, 2013). De Nederlandsche Bank Working Paper No. 379, Available at SSRN: https://ssrn.com/abstract=2269538 or http://dx.doi.org/10.2139/ssrn.2269538

Niels D. Gilbert (Contact Author)

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Jeroen Hessel

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Silvie Verkaart

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

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