Eurobonds, but without moral hazard

Inclusive Economy18 Feb 2016Alfred Kleinknecht

The fear of northern Eurozone members that the introduction of Eurobonds will result in their southern European companions automatically taking cheap loans again is unfounded.

This expert opinion is part of our living analysis on the Eurozone crisis

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Suppose Eurobonds, a loan issued by one country and jointly guaranteed by all Eurozone members, were issued by an EU government bond agency (GBA). This would have the advantage that countries in southern Europe would benefit from low interest rates. Many southern European countries like Spain, Portugal, Italy and France are in favour of such a system, which would allow them to more constructively handle their current indebtedness.

Although the European Commission is in favour of Eurobonds, northern Eurozone members Austria, Finland, Germany and the Netherlands are fiercely against them. They fear that already debt ridden countries in southern Europe would use the lower interest rates to obtain more loans on the international market. In 2012, at a party congress, German Chancellor Angela Merkel said no Eurobonds ‘as long as I live’. Several members of parliament allegedly responded by saying: ‘We wish you a very long life’.

But, would Eurobonds really lead to moral hazard, as many opponents of the Eurobonds suggest? If moral hazard means borrowing cheap money without limits, such moral hazard could be easily prevented. One just needs to install a clear set of rules.

The EU-GBA could be set up with strict rules for issuing new debt. The amount that a country could borrowed in a year could be dependent on the share of GDP of the country’s existing government debt. For example, countries with a government debt below 60% of GDP could issue as much debt as they wanted (as long as they did not exceed 60%), while countries with debt above 60% of GDP would be limited. The general rule could be: the higher the government debt (as a percentage of GDP), the lower the amount that the country could borrow.

The exact rules and percentages would, of course, be up for political discussion. Highly-indebted governments could be prevented from borrowing more than GBA allows on the ‘free market’ by an additional rule specifying that they can only get money from the GBA if they do not borrow additional money on the free market. By using such a clear set of rules, ‘moral hazard’ in southern Europe could be excluded.