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This war-like shock will require very large fiscal support. Its financing cost should be distributed over several generations. This can be achieved by issuing irredeemable or very long maturity Eurobonds. They should be backed by the ECB to keep the financing burden low.
No one knows yet how large the economic damage of this pandemic will be. But under plausible scenarios, government support to the economy will be in the double digits as a percentage of national incomes. How can such amounts be financed, without sparking a second sovereign debt crisis in the weaker euro area countries?
The ECB’s new Pandemic Emergency Purchase Programme (PEPP), launched last week, has bought precious time. But PEPP is mainly designed to reduce liquidity strains and avoid an immediate run on the debt of highly indebted euro area countries. Some of the financing needs will be absorbed by the monetary expansion implied by PEPP. But allowing for only temporary deviations from the capital keys in the ECB asset purchases could limit the extent of the monetary support to the highly indebted countries. More needs to be done. There is need to find alternative financial arrangements that shield the euro area against a return to 2011-like crises.
Authors propose that countries issue 50-year or 100-year bonds, or even perpetuities (also known as perpetual bonds or ‘consols’, i.e. a fixed-income security with no maturity date). The ECB should stand ready to buy them to keep the interest burden low enough to avoid adding to debt sustainability concerns. There are clear economic rationales for this:
Member states should jointly issue a large amount of very long maturity COVID Eurobonds backed by their joint tax capacity. Each country would issue its own bonds, but the bonds would otherwise be identical. Their common rating would be the result of all bonds being guaranteed by the joint tax capacity of the countries participating in the joint issues.
The financing arrangement for Perpetual Eurobonds should be enacted immediately. Postponing it would be counterproductive, for two reasons. First, because an immediate response would be much more effective in preventing economic collapse. Second, because it is now clear that all countries have been hit by a common exogenous shock; in one or two years, there will be more recriminations about moral hazard and policy mistakes, and a coordinated response would be politically even more difficult.