(Bloomberg Opinion) -- The Covid-19 epidemic has reopened old wounds in the euro zone. A group of countries, led by Spain and Italy, is asking for some form of debt mutualization as a show of European unity. Others, including Germany, are opposed to the idea, since they fear so-called “euro bonds” would be too difficult to set up in a crisis.
Germany has a point: The legal, practical and political hurdles to issuing joint and several liabilities right now are immense. However, there’s a risk that countries with fragile public finances will emerge from this crisis with too much debt to manage. It would make sense, therefore, for the euro zone to commit to a more limited path of debt mutualization than the one promised by euro bonds — or coronabonds as they’re now referred to.
This could be done through a joint debt reduction fund, an idea that has been explored before and which would amount to a pledge from the euro zone to take over a portion of each country’s sovereign debt after the crisis. That would offer the weaker member the prospect of some future debt relief, without forcing the monetary union to implement something too ambitious now.
The euro zone response to the latest crisis has relied on a mix of fiscal and monetary policy. The European Commission has suspended its fiscal rules, letting member states borrow as much as they need to fund a large-scale fiscal stimulus. The European Central Bank has launched a temporary asset-purchase scheme, worth 750 billion euros ($815 billion), which will provide a safety net to ensure that governments don’t face excessively high interest rates. The ECB has also said there are “no limits” to its commitment to support the euro zone, a hint that this program could be expended further.
As I’ve argued previously, this combination will go a long way to making sure governments can fund their health-care systems and support their economies. Were investors to turn against an individual country, it would be able to access additional funds from the European Stability Mechanism, the euro zone rescue fund. The ESM usually demands austerity and structural reforms in exchange for its help, but it should go easier if a member gets in trouble this time — the coronavirus is hardly anyone’s fault.
Unfortunately, there’s a missing part to Europe’s rescue package. At the end of the crisis, those countries with already fragile public finances — including Italy, Spain and Portugal — would have perilously high debt. A new proposal from the Commission to issue debt to fund cheap loans to support the most vulnerable countries’s labor markets is important symbolically, but it doesn’t solve the debt problem.
The affected member states have therefore been calling on the monetary union to issue euro bonds (or coronabonds). These debt issues could be limited in size and targeted at specific needs, such as funding the bloc’s health-care systems. Their supporters argue that such “solidarity” is fully justified given that Covid-19 is everybody’s problem.
The difficulty with coronabonds is three-fold. First, it’s not clear what institution would issue them and how it would pay for them. Ideally, the euro zone needs a treasury with a federal budget, but this would be hard to set up now and would require governments to give up some of their tax revenues at a time of great financial stress. Second, the EU treaties include a clause that prevents countries from bailing each other out. Euro bonds would require a change to the treaties, which in turn would need parliamentary votes and referendums. This isn’t the swift action you need in a pandemic. Third, a federal treasury would demand checks on how member states spend their money, to avoid governments getting a free ride.
Germany is right that euro bonds are impractical.
Still, the problem of future debt is real, which brings me back to that possible interim solution, where the euro zone’s leaders would commit to creating a fund in the future that could take over and retire some of each country’s sovereign debt. The fund would take on the same proportion of debt from each member state, say 20% of gross domestic product. It would issue bonds to pay for the purchases and governments would assign some of their future tax revenues to cover the cost.
This plan would replicate a solution designed a few years ago by a group of academics, including Philip Lane, now the chief economist of the European Central Bank. It would also draw on elements in a proposal from the German Council of Economic Experts drafted at the height of the euro zone debt crisis. Weaker member states would be reassured about not having to shoulder the extra debt from managing the pandemic on their own. And the euro area would send out a strong political signal on its common purpose, while deferring the important legal and practical questions until after the crisis.
Skeptics will argue that Germany and other northern European countries with strong public finances might renege on this commitment once the crisis is over. However, those nations have an interest in ensuring the likes of Italy and Spain have manageable debt levels. The ECB won’t be able to increase interest rates and reduce its balance sheet unless this problem is solved. Berlin will have to choose between a fully functioning central bank and a limited degree of debt mutualization.
The best long-term solution is for the euro zone to become a proper fiscal and political union, with a centralized treasury and stronger institutional and parliamentary checks on how its money is spent. Until that happens, the bloc must find a workable fix. Committing to a joint debt reduction fund might go a long way.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
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