The Trouble with Eurobonds

MUNICH – German Chancellor Angela Merkel has withstood the pressure from southern Europe: there will be no Eurobonds. For the markets, this is a disappointment, but there is no other way for these countries to rebuild themselves than to insist patiently on a phase of debt discipline and an end to lax budget constraints.

Investors in Europe’s troubled economies are already getting enough as it is. Eurozone leaders’ decision on July 21 to allow the European Financial Stability Facility to buy back old debts – limited only by the EFSF’s capacity – already amounts to a type of Eurobond. And the European Central Bank will also blithely continue its bailout policy in terms of giving loans to the eurozone’s troubled members and purchasing their government bonds.

Southern Europe, however, is pushing hard for a complete changeover to Eurobonds to get rid of the interest-rate premiums relative to Germany that markets are demanding of them. This is understandable, given that the hope of interest-rate convergence was a decisive reason for these countries to join the euro in the first place. And, for a little more than a decade, from 1997-2007, this hope was realized.

For the Italian state, interest-rate convergence brought a medium-term reduction in debt-service payments of up to 6% of GDP. That would have been sufficient to pay back the entire Italian national debt over about a decade and a half. Italy, however, chose to squander that interest-rate advantage. Italy’s debt-to-GDP ratio today, at 120%, is as high as it was when the country entered the eurozone in the mid-1990’s.