Vox
May 11, 2012Eurobonds have been proposed as a solution to the crisis, but Germany is wary of guaranteeing the entire debt of EZ countries. This column suggests the more politically feasible Euro-coupon solution. EZ countries would issue bonds at market interest rates and transfers between countries would harmonise the effective interest rates.
Whether a country is solvent depends on the interest rate it is charged. There are two possible equilibriums. In the good equilibrium, investors believe the country will pay its debt and demand a low interest rate, which makes the solvency self-fulfilling. In the bad equilibrium, however, investor suspicion drives up interest rates, which in turn makes default (or a bailout) unavoidable due to the high cost of servicing the debt. The periphery of Europe is now stuck in the bad equilibrium.
On the other hand, Germany’s ability to finance its debt has actually benefited from the crisis (Dullien and Schieritz 2012). Since it is perceived as a safe haven, investors have bid its interest rates to record lows, significantly improving the country’s fiscal position. However, even Germany would not remain solvent for long if it had to pay Spanish interest rates.
Jointly issued Eurobonds have been proposed as a solution to the crisis. But Germany is understandably wary of guaranteeing the entire stock of debt of other Eurozone countries.
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