Baby steps to the future
Full mutualisation of euro zone government debt looks like a pipe dream for now. But pooling together short-term debt could help weak countries, without incurring the risk of moral hazard and potential losses of full-blown euro bonds.
Euro bonds raise two main problems; they would involve a vast transfer of risk from southern Europe to northern Europe, and by removing the discipline of markets, they could incite governments to misbehave.
Enter Eurobills, conceived by Christian Hellwig at Toulouse School of Economics and Thomas Philippon of New York University, and recently included in a European Parliament proposal as a possible near-term crisis measure. The basic idea is for each euro zone country to issue short-term debt, fully mutualised, up to a limit of 10 percent of their gross domestic product. That would amount to a market of about 900 billion euros. The potential losses borne by taxpayers in northern Europe would shrink, since short-term debt rolls off before default.
Eurobills would have a three-fold effect. Weak economies would get a shot in the arm – Italy’s short-term funding rate could come down perhaps as much as four percentage points from the level in December, according to estimates by Hellwig and Philippon. Banks would be able to buy a new form of low-risk debt, reducing their exposure to weak sovereigns. And markets would get a signal that integration is the way ahead.
It would not totally remove the danger of moral hazard. But this can be reduced. Countries would still need to issue long-term debt, exposing them to market discipline. Those that breach Stability and Growth Pact targets could pay a surcharge, and face the ultimate threat of being thrown off the programme if they repeatedly misbehave.
There is a risk that Europe shies away from enforcing the nuclear option, since throwing a member state off the programme might force them into default. But an alternative way to discipline miscreants would be to use a sliding scale of penalties, where a country failing to reform or cut spending would lose a portion of its Eurobill quota.
For Germany it would mean funding at a higher cost – but Berlin currently pays almost nothing to borrow for a year. Normality will come at a price.