EUR-bonds in the corona crisis and beyond
by Thomas Theobald
and Silke Tober on 10th April 2020 @IMKFlash
Eurobonds are needed to anchor
macroeconomic stability and offer a safe path out of the coronavirus storm.
The abrupt increase in
sovereign-yield differentials amid the escalating Covid-19 crisis in mid-March
served as a stark reminder of the vulnerabilities of the euro area. Within just
a few days, the spread between ten-year Italian and German sovereign bonds
climbed to 2.8 percentage points, while the Greek spread jumped to 4.1 points.
In crisis times like these,
sovereign debt is of pivotal importance as safe assets. Due to their
countercyclical price movement, safe sovereign bonds serve as an anchor of
macroeconomic stability. In an economic downturn or after an exogenous shock, a
flight to safety increases the price of these bonds, simultaneously lowering
their yield. The lower financing costs increase the fiscal space, while the
higher price improves the banking system’s balance sheets.
If, however, government bonds are
not perceived as safe assets—because investors expect payment difficulties or
even default down the road—an exogenous shock such as the coronavirus may lead
to capital flight from the respective sovereign debt, thereby increasing
financing costs and feeding the financial ‘doom loop’ between the banks and the
state.
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It is debatable whether the
president of the European Central Bank, Christine Lagarde, acted wisely
when she said that ‘we are not here to close
spreads … there are other actors to actually deal with those issues’. Yet,
despite the unfortunate timing, she raised a valid point: it was the
responsibility of governments in 2010 to dispel fears of a Greek default and it
is their responsibility to have each other’s back in today’s crisis. In the
same vein, Lagarde called upon euro-area governments to act and issue eurobonds, a demand also formulated by groups
of economists on March 20th and March 21st, as well as by nine of the 19
euro-area governments on March 26th.
Signal of determination
By implementing the €750 billion
Pandemic Emergency Purchase Programme—capable of being enlarged and free of the
conditionality attached to outright monetary transactions—the ECB once again
rose to the task and eliminated the immediate need for governments to act. The
crisis is dramatic, however, and governments rapidly need to announce stimulus
packages to stabilise expectations, in addition to financing the immediate
ongoing expenses. Issuing mutually guaranteed bonds would signal their
determination to overcome this crisis together and dissuade expectations of
austerity, once the immediate problems of lockdown have unwound.
Unfortunately, the window of
opportunity to deal constructively with the twin problem of high public debt in
some euro countries and a lack of safe assets in the euro area as a whole
has closed for the time being. Nonetheless, the
proposals for sovereign-bond-backed securities (from the ESRB, Bénassy-Quéré et al and Theobald and Tober), capitalised e-bonds, purple bonds and a debt-redemption fund
(earlier from the German Council of Economic Experts and Parello and Visco) provide useful pointers for
issuing mutual euro-area sovereign bonds.
In the current emergency, we
recommend that the ECB play an important role as the institution that has
proved to be most functional at the European level and already holds a
substantial portfolio of sovereign bonds which can be transformed into
euro-area bonds. At all events, conditionality in the form of procyclical austerity measures must be avoided.
This flaw of programmes of the
European Stability Mechanism (ESM) in the euro crisis is again looming large.
The proposals currently being discussed only envisage a waiver of
conditionality for a very limited volume of ESM loans.
EUR-bonds
Our proposal calls for the
introduction of EUR-bonds (‘your bonds’) and EUR-bills in the amount of 20 per
cent of euro-area gross domestic product, in the following manner. The
Eurosystem—the ECB and the national central banks of the euro area—uses its
existing portfolio of sovereign bonds to create sovereign-bond-based securities
(EUR-bonds). It would do so at the behest of the euro-area governments and in
its capacity as a fiscal agent, much as the Federal Reserve Bank of New York
assists the United States government in issuing and auctioning its treasury
bills and bonds.
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At the same time, the governments
issue national bonds up to the amount of 20 per cent of domestic GDP. The ECB
then issues EUR-bonds and buys national sovereign debt on the secondary market
to replace the EUR-securities sold, as it would when securities mature.
Unlike sovereign-bond-backed
securities or European Safe Bonds, EUR-bonds are not issued
in different tranches with varying risk characteristics. There is no formal
guarantee, albeit an implicit one, and lengthy treaty change is not required.
The governments simply agree, in
this time of crisis, to ask the ECB to package their bonds into EUR-bonds as a
signal and an instrument of solidarity, unity and determination. The ECB could
even buy these bonds on the secondary market as part of its purchase programme.
Ideally, however, EUR-bonds would be purchased by banks and other investors as
safe assets, whereas the ECB would focus its purchasing programmes on
eliminating any sovereign-yield differentials which may persist—despite the
signals sent out by euro governments in issuing debt together.
Same proportion
EUR-bonds are created by combining
euro-area sovereign bonds in the same proportion as the national subscriptions
to the ECB’s capital. Accordingly, a EUR-bond with the nominal value of €1,000
is backed by €264 of German sovereign debt, €204 of French, €170 of Italian,
€120 of Spanish and so forth.
The risks of default—and thus of
moral hazard—will be higher the longer euro-area governments wait to act in
unison and present a common front to financial markets, as well as unity to citizens. Taking Italy as an example,
even a sovereign yield spread of only 2 percentage points would in itself add
€7 billion per year to Italy’s financial burden if the debt ratio rose by 20
percentage points.
In the medium term, the debt ratios
of all euro-area countries need to converge to allow for a large market of safe
assets, which stabilises the area and reinforces the international role of the
euro. Countries with the highest government-debt ratios need stronger growth
supported by active European policy instruments, such as a European unemployment reinsurance scheme,
revenue-side consolidation in the form of capital levies and more transparent,
stringent and growth-friendly fiscal rules.
In the short run, decisive measures
are required to allow the economy in all parts of the euro area to recover from
the virus shock—and, in so far as possible, foster the structural transformation required to
stop global warming.
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