|
|
The authors propose a simpler alternative that does not have this drawback but will still move the periphery from the bad to the good equilibrium. Countries would continue to issue bonds separately, at whatever interest rates are demanded by investors, as compensation for their perceived risk of default. The authors would compute the average of all the coupon rates weighted by the amounts issued by each country. Then, countries that paid a coupon rate lower than this weighted average would transfer the difference to countries that issued at a higher rate. They term this the euro-coupon solution.
All eurozone countries would effectively be issuing new debt at the same interest rate. In this way, we would get out of the self-fulfilling bad equilibrium since a country’s high interest rate would no longer increase its likelihood of default.
However, there would still be the possibility of default by countries with unsustainable debt levels, even at the pooled interest rate. Crucially, this risk would be fully borne by investors, not by the other countries in the union.
Illustration of the costs
As a simple illustration, imagine that all the countries in the eurozone issued the amounts expected this year at the current respective 10-year yields:
Under the authors' euro-coupon scheme:
This corresponds roughly to transfers of €5 billion from Germany, which issues 24 per cent of all the debt in the eurozone, and €3 billion to Spain, which has a share of 19 per cent of total debt.
Moral hazard
Of course this scheme does not solve the moral hazard problem of over-issuance of debt. Countries would be tempted to run up debt since they don’t have to bear the full cost of their profligacy. This means:
In this way, the euro-coupon scheme provides a large incentive to eurozone members to monitor each other’s debts, since all are affected by any member’s higher interest rates.
Finally, countries would need to coordinate their bond issuance to sell bonds with the same maturities in the same proportion at the same time. So the Treasury function would have to be centralised to some extent.
Conclusion
The euro-coupon scheme could represent a decisive step towards restoring confidence in the eurozone. Once investors realise that no country would again be dragged into a negative spiral of higher deficits driven by higher interest costs, the spreads between the different countries would narrow, making the solidarity implied in the scheme less onerous.
Regarding feasibility, remember that in the euro-coupon scheme Germany does not guarantee the capital or even the coupons of the Spanish bonds. It only commits to transfer the difference between its actual financing costs and the theoretical common costs (weighted average) of the currency union. While this would seem impossible in normal times, it may actually be Germany’s cheapest way of putting an end to the crisis. After all, the alternative may be hundreds of billions more in public loans to failing southern nations.
Euro-coupons achieve much the same benefits as eurobonds with only a fraction of the political difficulty.