The years 2011 and 2012 were the most difficult for crisis countries like Portugal, Spain or Greece. Due to high spreads between refinancing costs for these countries as compared to countries like Germany or France, concrete proposals for joint debt instruments for euro member countries, such as debt redemption and eurobills, were made during that time. According to their supporters, the objective of these schemes is to restore stability in the euro area and to reduce the debt overhang of highly indebted euro countries. In July 2013, the European Commission established an “Expert group on a debt redemption fund and eurobills” to analyze the merits and risks of these schemes. The expert group was chaired by Gertrude Tumpel-Gugerell who presented the group’s results in a SAFE Policy Center Lecture on 7 May.
Debt redemption funds and eurobills
The former ECB board member presented four designs of debt redemption funds and eurobills respectively with different time-lines. For example, a debt redemption fund, as proposed by the German Council of Economic Experts, would buy government bonds of countries that exceed the Maastricht debt level of 60 percent of the country’s GDP. All countries participating in the fund would be jointly liable for these debts. As a result, interest rates for highly indebted countries would decrease which would help these countries to further reduce their public debt. According to this scheme, countries benefiting from the fund would also need to commit to debt restructuring rules once the debt overhang has been cleared to prevent new debt increases. The fund would have a lifetime of 10 to 25 years depending on the scheme.
Eurobills are defined as a joint issuance of short-term government debt by euro zone countries. They should be limited in size and in maturity, Tumpel-Gugerell explained. For example, the issuance could be limited to 10 percent of euro zone GDP and to debt with a maturity of up to one year.
Risks and side effects
The expert group concluded that both proposals would be beneficial for financial integration in Europe. However, a drawback of a debt redemption fund, that also addresses long-term debt, is that it would lead to a de facto fiscal union and, at the same time, increases funding costs for countries with good credit ratings. Introducing eurobills, on the other hand, would entail the risk of triggering a political debate about longer term joint debt instruments.
A further concern, mentioned by Tumpel-Gugerell, is moral hazard inherent to the design of the scheme. For example, participants of a debt redemption fund would enjoy immediately the benefits of transferring their debt overhang to the joint and several liability instruments. Their compliance with agreed fiscal consolidation ex post is uncertain. The expert group proposes different measures to cope with these moral hazard risks. For example, interest rates could be gradually raised for countries that do not comply with the agreed rules.
Tumpel-Gugerell stressed that the current EU Treaties do not grant sufficient competence to the EU to introduce a debt redemption fund or eurobills. On the one hand, fiscal sovereignty is still on the national level and, on the other hand, introducing such schemes would require participating countries to bear huge liabilities which violates the no-bailout clause. If EU Treaties were not changed, it would only be possible to set up a temporary eurobill scheme or a debt redemption fund that results from a purely intergovernmental construction, which would, however, raise democratic accountability issues.