Yesterday the European commission released a series of reports outlining different schemes under which the Eurozone’s government might release the much-rumored Eurobonds. This is a welcome move to my way of thinking, but it’s worth asking what problem Eurobonds are supposed to solve at this point. At an earlier point in the crisis, the point of Eurobonds was perfectly clear to me—it would have been one of a series of tools to prevent “contagion” from a Greek default from adversely impacting Spain and Italy. Today we’re already seeing problems in Italy have an adverse impact on France, Austria, the Netherlands, and Finland so we’re well beyond talking about contagion.
To see what’s wrong with this idea, consider another potential solution to the crisis. French President Nicholas Sarkozy could announce that in the event of an Italian default, he’s going to use France’s nuclear arsenal to destroy Frankfurt, Berlin, Munich, and Hamburg. He could further clarify that a common sense standard will be employed here, meaning no loopholes à la the “voluntary” restructuring of Greek debt that prevented Credit Default Swaps from triggering.
How does that solve the problem? Well, presumably the threat of being vaporized will cause officials at the European Central Bank and in the German government to reconsider their aversion to making the kind of firm monetary commitments that could get Italy out of its current jam.
But this is just a long-winded way of saying that to get out of its current jam Italy needs to keep running a primary budget surplus, and get a firm monetary commitment from the European Central Bank that as long as Italy maintains a healthy primary surplus the ECB will provide the monetary support it needs to roll its outstanding debts over. A primary surplus plus that kind of commitment should lead private market participants to reduce the interest rates they demand for Italian debt, which should leave Italy in the clear. With Italy in the clear, there’ll be no more rumors of the Eurozone breaking up, and Austria, the Netherlands, and Finland will get the relief they need. The nuclear weapons are playing no meaningful role in offering a solution here, it’s just a crude way to get Germans to do stuff they don’t want to do because they feel they shouldn’t pay the price for Italian policy error.
A Eurobond seems similar. Under current ECB policy, a Eurobond would no more have a monetary guarantee from the ECB than do Italian bonds. So the same basic problem that we have today would recur. Eurobonds might make a difference because it would be crazy for the ECB to refuse to intervene to keep them safe. But it’s pretty crazy for the ECB to be doing what it’s currently doing and that doesn’t seem to be dissuading them.