John Muellbauer
Nuffield College, Oxford and Institute for New Economic Thinking, Oxford Martin School, University of Oxford, UK.
Abstract
This paper proposes that all new euro area sovereign borrowing be in the form of jointly guaranteed Eurobonds. To avoid classic moral hazard problems and to insure the guarantors against default, each country would pay a risk premium conditional on economic fundamentals to a joint debt management agency. This suggests that these bonds be called 'Euro-insurance-bonds'. While the sovereign debt markets have taken increasing account of the economic fundamentals, the signal to noise ratio has been weakened by huge market volatility, so undercutting incentives for appropriate reforms and obscuring economic realities for voters. This paper uses a new econometric model with a transition from inattention to attention and varying degrees of over-reaction to analyse 10-year sovereign yield spreads vs Germany. This suggests that competitiveness, public and private debt to GDP, and the fall-out from housing market crises are the most relevant economic fundamentals. Formula-based risk spreads based on these fundamentals would provide clear incentives for governments to be more oriented towards economic reforms to promote long-run growth than mere fiscal contraction. Putting more weight on incentives that come from risk spreads, than on fiscal centralisation and the associated heavy bureaucratic procedures, would promote the principle of subsidiarity to which member states subscribe. The paper compares Euro-insurance-bonds incorporating these risk spreads with other policy proposals.
This paper proposes that all new euro area sovereign borrowing be in the form of jointly guaranteed Eurobonds. To avoid classic moral hazard problems and to insure the guarantors against default, each country would pay a risk premium conditional on economic fundamentals to a joint debt management agency. This suggests that these bonds be called 'Euro-insurance-bonds'. While the sovereign debt markets have taken increasing account of the economic fundamentals, the signal to noise ratio has been weakened by huge market volatility, so undercutting incentives for appropriate reforms and obscuring economic realities for voters. This paper uses a new econometric model with a transition from inattention to attention and varying degrees of over-reaction to analyse 10-year sovereign yield spreads vs Germany. This suggests that competitiveness, public and private debt to GDP, and the fall-out from housing market crises are the most relevant economic fundamentals. Formula-based risk spreads based on these fundamentals would provide clear incentives for governments to be more oriented towards economic reforms to promote long-run growth than mere fiscal contraction. Putting more weight on incentives that come from risk spreads, than on fiscal centralisation and the associated heavy bureaucratic procedures, would promote the principle of subsidiarity to which member states subscribe. The paper compares Euro-insurance-bonds incorporating these risk spreads with other policy proposals.