On Eurobonds

Eurobonds as automatic stabilizers

The fiscal position of several countries of the Euro Area (EA) has considerably deteriorated over the last decade and triggered a renewed debate about the design of new fiscal rules. In this paper, Bianchi, Melosi, and Rogantini Picco develop a two-agent New Keynesian (TANK) model of a monetary union with a high-debt country and a low-debt country to evaluate three post-pandemic scenarios for the EA.

1. Fiscal Discipline scenario: the national fiscal imbalances are expected to be entirely corrected by higher distortionary taxes and lower expenditures. Monetary policy is active.
2. Emergency Budget scenario: is a novel type of coordination between monetary and fiscal policies in which the central bank accommodates the moderate rise in inflation necessary to stabilize the amount of Eurobonds debt needed to combat the consequences of large areawide recessions. Policy authorities agree on the size of an emergency budget that will be financed by issuing Eurobonds. “This common budget clarifies that country-specific fiscal imbalances resulting from past and future decisions of national governments will be covered by the taxpayers in the respective countries.”
3. Conflict scenario: the high-debt country’s fiscal authority refuses to stabilize the debt.

The model is calibrated to two EA countries with substantially different levels of debt-to-GDP ratios: Italy and Germany. The authors find that in the Fiscal Discipline scenario, the recession is deeper and more persistent for the high-debt country due to larger fiscal adjustments. In the conflict scenario, the defiant high-debt country triggers a monetary-fiscal conflict where tighter monetary policy worsens the recession, requiring more debt issuance. Finally, the Emergency Budget scenario leads to a substantially better outcome than the two previous alternatives because it separates the issue of long-term fiscal consolidation from that of short-term need for economic stabilization. It is welfare-improving for both high and low-debt countries by mitigating ZLB episodes and the severity of recessions while maintaining national fiscal discipline.

Who Is Afraid of Eurobonds?
Authors: Francesco Bianchi, Leonardo Melosi, Anna Rogantini Picco
From: Duke University, Federal Reserve Bank of Chicago, Sveriges Riksbank

The market’s reaction to emergency-issued Eurobonds

In this commentary, Francesco Saraceno argues that the issuance of Eurobonds linked to the Next Generation EU program (expected to reach €900 billion by 2026) were initially welcomed by markets but now these EU bonds are seen as less attractive than some individual country bonds like France. Saraceno reckons that this is because there are concerns about the liquidity and future supply of EU bonds. Investors are unsure if debt issuance will continue after the NextGen EU program ends in 2026. The solution to this problem, the author suggests, is the creation of a central EU fiscal capacity that will act like an EU finance minister to raise funds and issue debt. This would provide a stable supply of EU bonds. Such central fiscal capacity would have macroeconomic benefits, help stabilize financial markets, reduce costs for member states, and consolidate the euro’s status. This solution would require treaty changes and complex checks and balances and even though Saraceno acknowledges the political challenges in establishing an EU central fiscal capacity, he argues that this is a necessary condition for European debt to be desirable.

Markets are also rooting for a European Central Fiscal Capacity
By: Francesco Saraceno – OFCE-Sciences Po