The EU-Commission has recently resurfaced the idea of “Eurobonds”. The Commission’s president, Mr. Barroso, hopes that Eurobonds will reduce the bond-spreads and hence solve the current crisis in the Eurozone.
Is this just a hope? German chancellor Merkel – nicknamed “Madam No” by now – is rigorously opposed to the idea. The German coalition government stands firmly behind her. Without much debate, German politicians have decided that Eurobonds would reduce consolidation efforts and represent the ultimate evil of economic policy. Who is right?
First of all: It depends. Both the EU-Commission and the chancellor state that Eurobonds are only possible if we accept a new paradigm of European governance (that would require member states to give up substantial fiscal sovereignty). If that happens, Eurobonds could indeed be a good solution to today’s problems. But such a system of European governance does not exist at the moment – and implementing these new elements would require major changes in the European Treaty. From past experiences, the average duration of such an endeavor is estimated to last from 2 to 5 years.
In addition, unanimity would be required. No easy task with 27 countries, some of which would have to approve the measure in a popular referendum. On top, we would probably need significant changes in national constitutions, for instance in Germany. The existing German constitution does not allow giving up substantial fiscal sovereignty and sharing debt burdens across Europe. A recent judgment by the German Constitutional Court has made this point explicit: The Bundestag has a voice in fiscal debates.
Given all these hurdles, the integration process will be long and difficult in many member states. Given these challenges, the current discussion is certainly stupid.
What we need right now is a credible commitment to solve the current crisis by reestablishing a sustainable monetary union in the medium-term. There are two ways to do this: A European government or a strict rule-based system. The first path is difficult and needs significant treaty changes. Hence, it is not a realistic option in medium-run (but nevertheless possible). The second possibility is to have a strict rule-based system with enhancements of existing rules towards automatic reform processes and sanctions. This rule-based system, however, requires the loss of sovereignty only in case of violation. Accordingly, this approach would require a few treaty changes as well, but far less dramatic ones than for a European government.
When a decision about the road ahead has been reached, the most immediate task is calming the financial markets. We need four credible commitments in the short-run: First, all countries of the Eurozone must implement national debt rules – similar to the constitutional debt rule in Germany – until 2012. The ultimate and mandatory goal must be a balanced-budget in the medium-term. Second, we have to enhance the “Stability and Growth Pact” and the economic surveillance in the Eurozone. The reforms that have already been agreed upon are insufficient in this regard. We need more automatic mechanisms and not just inverse majority voting-rules. Third, we have to implement new regulations and a macro-prudential supervision to stabilize and discipline financial markets in future. Finally, the European Central Bank must primarily focus on price-stability and stop the bond purchase program immediately.
All in all, Eurobonds cannot solve the structural debt problem and thus tackle the roots of the sovereign debt crisis. Even with Eurobonds, we still face the same debt problems. They are treating the symptoms without addressing the actual crisis in the long run. And they are rather unrealistic, given today’s policy environment. If anything, Eurobonds would be a good option at the end of a long process of European reform and integration.
From an economic view, it would thus be preferable to institute a strict rule-based system with automatic mechanisms and loss of sovereignty in case of policy violation. A smart design of such a system works very well without any Eurobonds. Moreover, contrary to a European government and Eurobonds, the idea of a rule-based system is closer to national democracy and in line with the principle of subsidiarity in Europe.
Read more in this column Bodo Herzog: The False Appeal of Central Banks