22 May 2018

„Purple Bonds“ for Strengthening the Euro Area Architecture

SAFE Policy Lecture: Lorenzo Bini Smaghi presents an alternative to Eurobonds

Lorenzo Bini Smaghi, Chairman of the Board of Société Générale and of Italgas, has put forward his idea of “Purple Bonds” at a SAFE Policy Lecture last Wednesday. This idea is a response to the experience of the European Financial crisis and aims at protecting national bond stock from disruption, encouraging fiscal discipline, and lowering funding costs for the periphery. Its goal also is to strengthen bank balance sheets, maintain market access under a program of the European Stability Mechanism (ESM), reduce the eventual burden on ESM funds, and potentially increase the effectiveness of the European Central Bank (ECB) in the implementation of monetary policy.

Essentially, the idea behind “Purple Bonds” is that the Fiscal Compact requires that member states reduce general government debt over 60% of GDP by 1/20 every year. Any refinancing needs that would incur debt in excess of this limit would be done in “Red bonds” that would carry a high risk premium. Conversely, the debt at or below the yearly limit of the Fiscal Compact would be “Purple” and protected from any debt restructuring that could otherwise be required as part of an eventual ESM Programme. The no restructuring guarantee would not apply if a member state were to leave the euro area. Starting from today, all existing government debt would be labelled “Purple”, declining to 60% of GDP by the end of the 20-year period.

For Bini Smaghi, “Purple Bonds” have several advantages. “They could give national governments an incentive for more fiscal discipline,” he said. Also, this idea would increase the market for safe assets in Europe.

Before coming to his proposal, he talked about the causes for the eurozone crisis. He pointed out that the crisis was triggered by financial contagion from the Greek debt restructuring. This turned into an economic crisis mainly due to the weak bank position in some countries that lead to a credit crunch, Bini Smaghi said. This threatened fiscal positions because of the impact of lower growth on budget deficits and potential bail-outs of banks. The result was a doom-loop between sovereign and bank risk, he explained. The crisis also induced further fiscal tightening to restore budgetary soundness.

Bini Smaghi analyzed the measures already taken in order to break contagion which are the ECB´s OMT-Program (Outright Monetary Transactions), the start of a banking union, the adoption of the Fiscal Compact and the creation of the ESM. Nevertheless, according to Bini Smaghi, there are still objectives which need to be addressed. Firstly, the shock absorption capacity needs to be improved. Secondly, contagion has to be minimized and finally, self-inflicting shocks have to be reduced. In many ways, there are areas for improvement, for instance monetary policy, the capital market union and the banking union. For the latter, Bini Smaghi called for a completion and argued that rules should be fully harmonized and the role of the SSM (Single Supervisory Mechanism) needs to be strengthened. He also said that an European Deposit Insurance Scheme (EDIS) should be implemented over a clear time horizon. “EDIS would minimize contagion and create conditions for a pan-European banking system,” he said.

From June 2005 to December 2011 Bini Smaghi was a Member of the Executive Board of the ECB. During that period he acted as G7 and G20 Deputy for the euro area. He is author of numerous articles and several books on international and European monetary and financial issues.