ATHENS – Germany’s arguments against introducing Eurobonds, expanding the eurozone’s bailout fund, and instituting a comprehensive system of economic governance are transparent and easy to understand. But are they right?
The Germans fear that such innovations would lead to a rise in domestic borrowing costs, and to direct and indirect fiscal transfers to poorer countries. Moreover, they warn of the moral hazard generated by relieving over-indebted countries from the pressure to put their public finances in order. Third, they cite treaty-related and constitutional difficulties in establishing rules and procedures that would simulate a “fiscal union.” Finally, the need to move ahead with European unification in order to legitimize the inevitable infringement of over-indebted countries’ sovereignty might eventually infringe upon German sovereignty as well.
On the other hand, refusing to accept the growing consensus that fiscal union is the key to resolving the debt crisis exposes the eurozone, and Germany, to serious risks. Sticking to half-measures exacerbates markets’ impatience and provokes increasingly determined speculative attacks, not only on the weaker peripheral countries, but also on core AAA-rated countries – like France and, eventually, Germany itself – whose banking sectors hold large volumes of peripheral countries’ debt.
Indeed, weakening banking conditions are emerging as a major threat to the eurozone’s recovery and stability. In the event of sovereign defaults, moreover, the cost of bailing out the banks may far exceed the cost of issuing Eurobonds or instituting a reasonable transfer regime. Investors need to be reassured that debt-service costs are under control, and that debt volumes and deficit limits are firmly monitored in order to minimize default risks and strengthen banks’ ability to lay the groundwork for sustainable growth.