Yanis Varoufakis on “fiscal water-boarding” and ECB bonds

Yanis Varoufakis at the INET conference in Berlin

Yanis Varoufakis has been covering the Euro Crisis for quite some time and wrote a “Modest Proposal” to solve the crisis early on,  that he updates regularly. I have been following his writings and also recommended him in my recommended economics blogs list (in German). I fully agree with Yanis, and have written it over and over, that a ruthless recapitalization of European banks is one important part of a solution to this crisis. His other proposals I find less convincing.

Let’s have a look at his recent post “Fiscal Waterboarding versus Eurobonds: Misrepresenting the latter to effect the former”. In essence, Yanis says that jointly and severally guaranteed Eurobonds are not the answer because they involve transfers from core to periphery taxpayers. He claims that he has found a way around this, by having the ECB issue bonds on the member states’ behalf, have the states pay off their debt at the ECB, and have the EFSF/ESM guarantee the losses of the ECB “in the remote case that some members do not redeem its bonds in the distant future”.

How is this different from a jointly and severally guaranteed Eurobond? Let’s leave out the political mess and just focus on the economics. The ECB’s role ensures that interest rates on the these bonds are very low. This lowers the debt burden of, say, Italy. However, there is no guarantee that Italy will be able to service its debt in the future. Who is standing behind these ECB bonds? Either the ECB itself, which means that it needs to be recapitalized (= will transfer lower profits to the governments). Or the insurance by the EFSF/ESM will cover losses. Either way, the other European governments pay. So there is not a big difference here: ECB bonds transfer risks.

Where I can see a difference is in interest rates: Eurobonds will have yields above German rates (some weighted average of all Eurozone yields), whereas ECB bonds will probably have German rates, so Germany won’t pay more than before. Fair enough. But the problem here is that ECB bonds might increase the yield on other bonds. Sounds silly? It is not.

If the states have to recapitalize or insure the ECB, these countries’ risks increase. The ECB bond is just a Eurobond with a higher seniority, if you want: the loss-absorbing capacity of the ECB is around 2,000 – 3,000 billion euros, but this capacity is directly related to government revenues. ECB bonds will therefore be repaid first, at the expense of the government revenues that are available for other bonds. This leads de facto to a lower seniority of the normal bonds, which as we all know leads to a higher yield on these junior bonds. So by giving out ECB bonds, the yields on other bonds are likely to increase.

Yanis would have to make a more convincing case that by having the ECB issue bonds, some risk is taken out of the market, and are not just redistributed like in the case of Eurobonds. But where? There might be a safety and liquidity premium for ECB bonds that lowers yields overall, which the Eurobonds do not have to the same extent (as they are by no means perfectly safe). There might be other reasons, but in my view ECB bonds are not a silver bullet, and very close to the commonly proposed Eurobonds.

His conclusion is that Germany refuses his proposal…

… [f]irst, because Germany does not really want interest rate relief for the struggling Periphery. For some reason, which I shall not elaborate on here, Mrs Merkel feels that fiscal waterboarding is what the Periphery needs more of these days.

Secondly, because such a scheme would mean that Germany would lose its capacity to leave the eurozone as a common debt external to the European System of Central Banks will be born by the ECB, thus making it impossible for any member-state to up stumps and leave the euro. Such a loss of its ‘exit card’ (that only Germany truly owns) will reduce the German chancellor’s bargaining power, within the eurozone, inordinately.

I think both is incorrect. The pressure on the countries in the periphery has certainly helped to change their domestic policies, and I am sure Yanis agrees. More pressure is surely not in Germany’s interest, as it threatens to break up the Eurozone, which would be very costly by almost any calculation I have seen.

The second aspect sounds very weird to me: a German exit is surely not the main reason why Germany has bargaining power. A German exit would be extremely complex, legally nigh impossible, and threatening Germany’s industry that just recovered from several negative shocks (reunification, globalization, EU enlargement, higher financing costs).

Yanis writings on the Euro Crisis are important for me because they challenge my thinking, and I like that. But except for the banking aspect, I am having trouble with some of his views. Besides the above on ECB bonds, I diagree with…

  • … his tendency to blame Germany for economically exploiting Europe. That is a very one-sided view of what Germany’s economic development is about, and why it developed the way it did. So far, Germany has not gained from being in the euro (contrary to what is written again and again), and it is likely to foot a massive bill when this whole mess is over (partly self-inflicted, I know, but almost surely not the major part of it).
  • … his tendency to make this Euro Crisis look like an easy-to-solve problem which is not backed-up by any theory or evidence from the past, as far as I know. It is a full-blown mess (on a continent with legally mandated free capital movement) that is and always was very difficult to solve – including the question what a “fair” distribution of the burden looks like, irrespective of the usual moralizations.
  • …  his diagnosis that Europe suffers from an under-investment crisis. That is a strange view given that Greece, Ireland and Spain received massive EU and capital market help to over-invest in infrastructure and real estate in the past. Europe suffers from a lack of smart investment and even more importantly, from a lack of efficient, growth-promoting institutions. If he meant to say that the periphery (and the Eurozone as a whole) suffers from a lack of aggregate demand (AD), I fully agree with him. But again, there are problems with dividing up AD in the Eurozone, and above all, a problem with getting the ECB to stabilize aggregate demand, and not headline inflation.

PS: I do recommend you have a look at his blog, though, and read his views for yourself. Also, check out his Modest Proposal. You might also be interested to buy one of his books, for instance his recent “The Global Minotaur”.


  1. genau11 schreibt:


    Der Typ ist einfach nur ein abgefeimter Lügner.

    “Varoufakis had been arguing for two years that Greece was insolvent and the country should default while staying in the euro region”

    Aber sein “Modest Proposal 1.0 ist von Nov 2010, also 1.5 Jahre her.

    Er ist von mir und von anderen, z.B. Kastner mehrmals aufgefordert worden, auf seinem blog, doch über seine immer neuen Ideen hinaus, wie er weiterhin Geld von anderen bekommen kann,
    irgendwelche Vorschläge zu machen, wie sie ihre Economy wieder ans laufen bekommen.

    Da ist absolut gar nichts, nur Ideen wie man mit wie immer genannten bonds noch eine Weile Cash abziehen kann, während man mit anderen schon den Komplett bankrott plant.

    wie Hkaspar in bezug auf den Bofinger gesagt hat,
    all diese Leute die angeblich die US Hauspreis krise schon 2005 vorhergesagt haben,

    das ist ein sehr sicheres Zeichen das diese Leute sich mit dreistem Lügen wichtig machen wollen.

    Entweder sie haben Belege, wie z.B. “The Economist”

    oder auch ein Warren Brussee, de das ganze schon auf US consumer data bis 2003 als Buch 2005 veröffentlicht hat
    “The Second Great Depression (2007-2020)”

    Auch in anderen Foren wird von Griechen nur noch über die eigene strategische Wichtigkeit gefaselt.

    Ich habe das schon mal erlebt, wie eine frühere Firma, bei der ich beschäftig war, in den Bankrott schlitterte.
    Dieser hemmungslose Realitätsverlust.

    Wer am lautesten schreit, will sich hübsch machen für den nächsten Gig.

    Ganz allgemein, alle diese Vorschläge für “joint bonds” oder “joint Bank insurance” sind nur noch Schemas,
    wie man an deutsches Geld herankommt. Nichts anderes mehr.

    Ich hatte hier ja auch mal empfohlen, sich den Typen und auch die Iren (http://www.irisheconomy.ie/) anzugucken, gerade so als Kontrast.

    Die Iren diskutieren ihre Optionen systematisch und quantitativ, strategisch durch.

    • kantoos schreibt:

      @ genau11

      Ich bitte Dich, mit Vorwürfen wie “Lügner” etwas vorsichtiger zu sein. Yanis hat seine Sicht auf die Eurokrise, mit der möchte ich mich auseinander setzen.

    • skom schreibt:

      Einfaches “googeln” liefert eine Publikation im Monthly Review . Das scheint aber ziemlich genau nach “two years” zu sein. Im uebrigen ist das Modest Proposal sicherlich im November 2010 in Varoufakis blog erschienen . Wenn man in 2012 ueber eine Meinung die 2010 schon geauessert wurde sagt, dass man sie nicht schon seit zwei Jahren vortragt, na dann ….
      Dann haette ich gern mal gehoert wie Sue ueber die Ausserungen Frau Merkels bezueglich des langen Urlaubs der Suedlaender urteilen.

  2. Craig Willy schreibt:

    “First, because Germany does not really want interest rate relief for the struggling Periphery. For some reason, which I shall not elaborate on here, Mrs Merkel feels that fiscal waterboarding is what the Periphery needs more of these days.”
    Merkel, Hans-Werner Sinn, Weidmann and Bundesbank officials have all argued precisely this at one time or another: That they don’t *want* low interest rates for the periphery because that would reduce pressure for austerity/”reform”.

    Here is Sinn for example on the results of LTRO: “Yes, of course, and the markets have calmed themselves. But should we calm the markets? I am not of that opinion. A certain excitement of the markets is appropriate with regard to over-indebted countries.” He then cited Berlusconi reneging on certain reforms/cuts last year due to a drop in rates. http://www.euractiv.com/euro-finance/economist-market-instability-appropriate-indebted-countries-news-512325 (Also in German: http://www.euractiv.de/finanzen-und-wachstum/artikel/sinn-geldgeschenke-zerstren-die-wettbewerbsfahigkeit-006222)

    This strategy of brinksmanship (or blackmail) has been completely integral to Germany’s approach to the crisis. One can think it distasteful or undemocratic or economically disastrous or, perhaps, inevitable from Berlin’s perspective (because of supposedly unchangeable EU/German legal constraints), but there’s no sense being coy about it.

    • kantoos schreibt:

      @ CW

      I think it is correct to argue that market rates should be higher for countries that represent higher risks. This is the argument behind Sinn et al. What is more, they know that political pressure cannot make these countries reform. Only market pressure can. So yes, market pressure is good and necessary. But Greece is way beyond “market pressure”, that was my point. This amount of pressure is dangerous and not in Germany’s interest.

  3. nicholbrummer schreibt:

    Having various types of bonds denominated in Euro is inherently unstable. It is a classical multiple-equilibrium problem. As long as the risk of default isn’t considered serious, the alternative with the highest interest will be simply the most attractive, as all other things are equal. Once risk of default looms, anywhere, there will be a stampede for the lowest risk alternative.

    Providing new alternative(s), like Eurobonds, red, blue, ECB, in addition to the existing menu, cannot solve this dynamic. The only thing that may help, is if the spreads can be managed actively by the ECB or some central authority. But how to do this fairly by a bunch of technocrats without democratic authority? The only simple rule I can see is if politicians can agree on the ECB keeping the spreads within some maximum, decided on democratically. And we know how tricky that is .. as this has been tried, somewhat.

  4. “Either the ECB itself, which means that it needs to be recapitalized”

    Do we have any historical examples of states recapitalizing their central banks? Where is it written that a state or the Euro Zone as a whole is required to cover losses inflicted on the ECB?

    “Eurobonds will have yields above German rates (some weighted average of all Eurozone yields)”

    What evidence do we have on that? What do you mean by “weighted average”?

    “The pressure on the countries in the periphery has certainly helped to change their domestic policies, and I am sure Yanis agrees. More pressure is surely not in Germany’s interest, as it threatens to break up the Eurozone”

    Mrs. Merkel and her subordinates have repeatedly argued that “the pressure from the markets has to be uphold”. That’s exactly one of the main reasons why they refuse eurobonds.

    source: http://www.spiegel.de/politik/deutschland/streit-um-euro-bonds-fdp-chef-roesler-lehnt-euro-bonds-strikt-ab-a-834688.html

    “So far, Germany has not gained from being in the euro (contrary to what is written again and again)”

    Could you develop this argument?

    • kantoos schreibt:

      @ SgF

      - ECB has recently raised its capital, and if it does not, its profits (that belong to the taxpayers) will be lower, which is an implicit recapitalization.

      - Eurobonds will have a yield somewhere between German (the lowest) and Greek (the highest). Where exactly it will end up is unknown, but it will be somewhere in between (=weighted average)

      - Exactly, but too high pressure (!) is certainly not in Germany’s interest, if it leads to a break-up.

      - Germany’s gains or losses from the Euro are a difficult topic. But there are good arguments for both sides (gains and losses), which on average makes me conclude that they roughly balance.

    • @ Kantoos

      “- ECB has recently raised its capital, and if it does not, its profits (that belong to the taxpayers) will be lower, which is an implicit recapitalization.”

      Not really. It’s quite some difference if the ECB is directly recapitalized by the member states because it suffered a loss of around 50 to 200 billion or if it simply reduces its profits for the next 20 to 30 years. But you basically confirmed what I was thinking. That there is absolutely no legal mechanism that would force the taxpayers to cover up ECB losses.

      “Where exactly it will end up is unknown, but it will be somewhere in between (=weighted average)”

      Of course, it’s totally unknown. That’s why I wouldn’t call it “weighted average”. Greece’s rates are just ridicilously high and Germany’s ridiculously low. A good estimate could be the rates that the EFSF has to pay for its bonds (after all, these bonds are guaranteed by all EZ members, can thus be considered a form of eurobonds).


      “Exactly, but too high pressure (!) is certainly not in Germany’s interest, if it leads to a break-up.”

      I agree. But I don’t see that Germany acts against this pressure. See Spain for instance. It’s clear that the country cannot live forever (not even until the end of 2013) with risk premiums above 6%. And Berlin should know that the ESM is financially too weak to “save” Spain for any period longer than a year – let alone Italy. The only advice coming from Germany is to restore market confidence through austerity. This works well until the newest GDP and unemployment figures are published, which will lead to even more market uncertainty. Spain is clearly in a dead end, and Germany opposes everything that is unconventional. This is a recipe for desaster. In my eyes, at least.

      So far, Germany has never done anything to ease the pressure. If the ECB hadn’t acted in a quite unconventional way at the end of 2011 (LTRO), the Euro Zone could have been already exploded.

    • kantoos schreibt:

      @ SgF

      Um…, no. It does not make a big difference: lower profits in the future mean higher debt burden, borrowed from the future.

      “Greek rates are ridiculously high”, I have heard that before, from Bofinger and company, when was that…? Wait, that was in the spring 2010, evil financial markets attacking the euro etc.! I think the yield then was 14%… Greece might exit the euro, in which case, they will pay zero back. The yield is reflecting that fear. Nobody knows what the “correct” yield is, so I wouldn’t use word like “ridiculously high”. But the EFSF might be a good starting points for yields — although Eurobonds would be larger in scale and scope, so the yields might be higher.

      Pressure: well, 6% on Spain is unsustaniable, but not an immediate threat. I think this is the amount of pressure that Germany wants to have on these countries. Whether that is a good idea is another question. But reforming a country is very painful, and Germany wants to make sure that these countries are ready for the 21st century before they agree to something like Eurobonds (that immediately takes almost all pressure away (please don’t say “political pressure”, the only country that was ever impressed by “political pressure” in Europe was Germany).

      I think the pressure should be on the reform side, not the austerity side. I guess that is point where we can agree?

  5. Positroll schreibt:

    ” the loss-absorbing capacity of the ECB is around 2,000 – 3,000 billion euros”
    I really don’t get this part. It’s the same kind of argument one reads on some US blogs claiming that “judging the Fed by normal standards it’s long bankrupt”, Um, no. The Fed and the ECB CANNOT be judged by normal standards. Why? Because US and European debt is denominated in US$ and EUR respectively. And the Fed and the ECB got something other banks don’t: the right to create legal tender by printing ink on paper or by changing some numbers in an electronic account.
    The Fed and the ECB aren’t restricted by the amount of debt – they are restricted by the danger of inflation. And since, on both sides of the Atlanctic, we are in a liquidity trap, inflation isn’t really an issue.

    Hence my (updated) proposal to approach the problem head on:
    (Kantoos, I promise this is the last time I clog your blog with it. OTOH, not mentioning it in the post above merits some retribution imO … ;-) )

    How to save the Eurozone

    Step 0 – to be discussed later

    Step 1: Print central bank money
    ECB creates an amount X of central bank money out of the blue. IMO 2 trillion EUR should suffice, but I am open for change in this respect (alternatively: 3 trillion).

    Step 2: How to use the money
    a) 70%: based on capita / member state (MS). Credited to ECB accounts that will be held in trust by the ECB for those Euro-countries who implement the stability pact (and thereby limit their future debts). The money on these accounts can only be used to pay for government bonds coming due within the next 10 years.
    Germany (pop 82 mio = 26% of the Eurozone) receives 26% x 70% x 2000 billion = 364 billion EUR. (546 billion EUR in the 3 trillion variant)
    Spain (pop 47 mio = 15% of the Eurozone) receives 15% x 70% x 2000 billion = 210 billion EUR.
    Greece (pop 11 mio = 3,5% of the Eurozone) receives 3,5% x 70% x 2000 billion = 49 billion EUR.

    In order to reduce the impact on inflation, the claims by the MS against the ECB come due in YEARLY INTERVALS , depending on the financial situation of the MS. That is, Greece, Portugal and Ireland can access the money at once. Spain, Italy and Belgium in years 2-5, later France and Germany only in years 9-10.
    The ECB makes clear that (1) this is a one-time occurrence, due to the great recession, and won’t be repeated, (2) it will accept higher inflation for a few years (say 3-3,5%, anything else would be shot down by Germany), but would return to 2-2,5% afterwards..
    b) 15-20% (ca.300- 400 billion) go directly to the ESF, to be used before and in addition to the guarantees of the MS; also to be used to bail out banks.
    c) 5-10% (100-200 billion) go to a special fund (or one of the existing European ones?) to finance Pan-European infrastructure (e.g. the HSR link between Spain and Portugal) and massive reforestation in the GIPS countries (ecologically useful and as a means to boost employment during the slump).
    d) 3% for countries whose currencies are pegged to the EUR and who might suffer from the plan.
    e) 2% to mitigate contingencies

    Step 3: Measures by the MS (cf. addendum below)
    Those MS; which now do have again some financial leeway (e.g. Germany, Netherlands, Austria, Finland, maybe France) will use it to step up their own (infrastructure) investments and to reduce the impact of inflation. E.g. in Germany, taxes on life insurance could be abolished, consumption taxes could be reduced, and basic income / stipends (for pensioners, students) could be raised. In addition, Germany could grant an income tax rebate to anyone travelling to the PIGS (say 50% of the hotel bill up to 300 EUR / year – a nice gift to German voters which won’t drive up German inflation and help reduce the trade imbalances).

    Step 0: Before announcing the plan
    Before announcing the plan, the ECB buys up sovereign bonds of MS that are traded below value, up to the amount as defined by Step 1. This increases “bang for the buck” – hopefully a lot. Since the ECB is in effect only using money that is earmarked for the SM in question anyway, there can’t be any complaints that the ECB is violating the treaties.

    – The financial pressure on most MS is reduced a lot, making it very likely that especially Spain and Italy will be able to get out of the hole, and improving chances for Portugal and Greece,* too. This avoids speculation against them, making it again easier to finance their remaining debt needs. Still, they will have to continue to go to the markets for money, so the pressure to keep up systemic reforms remains.
    *If Greece leaves the Euro, the money (50 billion) can either help them to a better starting position – or it can be used to plug the hole in the ESF …
    - ESF looks a lot stronger considering that its first line of defense now is financed via ECB means, i.e. if Greece goes down, Spain and Italy don’t have to scramble too hard to find the money to finance their part of the bailout. Which in turn improves the outlook for Spain and Italy – and the interest they have to pay ….
    – Better outlook for Spanish and Italian bonds equals better outlook for their banks who will need less recapitalization from the ESF
    – More money in the North for investment and consummation, creating growth at a time we really need it.
    – Yes, M0 incresaes, but in a manageable amount (only 200 billion central bank money more / year), while we are in a liquidity trap, and structured in a way that allows Germany to fight of its social impact while profiting from growth opportunities + creating better financial stability (making sure that pensions can be paid in the future). For German politicians this will be a lot less difficult to sell than a break up of the Euro and a bank bailout.
    – The ECB does not have to take on a political role, but simply does its job: regulating the amount of money in the system. The job of forcing Greece etc to reform is left with the political players, including the ESF (which is bolstered with money that can be used before the MS have to pay up themselves.
    - As far as the external value of the EUR is concerned, the stabilization achieved by this plan should more than counter any negative effects of increased inflation fears. The “imported inflation” factor therefore would be positively influenced (though a positive outlook for the Eurozone might lead to higher oil prices again).

    Addendum: What Germany could do unilaterally:

    Short term:
    - raise the tax on acquiring real estate (Grunderwerbssteuer), with an excemption for people who will be living in one / two family houses themselves for at least 5 years.
    - as a one-time measure: grant an income tax rebate to anyone buying a house / flat in the GIPS countries** in 2013+2014 (announcing the plan should help to stabilze prices in Spain in 2012 also)
    - grant a (permanent) income tax rebate to anyone travelling to the GIPS countries** (say 50% of the hotel bill up to 300 EUR / year – a nice gift to German voters which won’t drive up German inflation and help reduce the trade imbalances. Measure might be limited to off-season travel only.

    Mid term: Invest in rail projects that link Germany’s current industrial heart (BW+ Bawaria) better to Italy via Switzerland (Rhine valley – Basel + Stuttgart-Zurich, cf. http://en.wikipedia.org/wiki/AlpTransit) and Austria.

    Long term: Help the GIPS countries to limit the amount of energy they need to import by Europe financing more research on renewable energies (esp energy storage http://www.economist.com/node/21548495 ) and by financing the implementation.

    ** Since Germany would do this to help OTHER EU countries and not specific enterprises, one can make a very good case that this “discrimatory” treatment is justified under EU law, based on the solidarity principle of Art. 3 (3) EU treaty: “It [=the EU] shall promote economic, social and territorial cohesion, and solidarity among Member States” and the fact that in theory, the Euro is the currency of the WHOLE of the EU, Art. 3 (4) EU treaty (“The Union shall establish an economic and monetary union whose currency is the euro.”).
    Of course, the tax law would have to say not Greece, Spain etc… but “a Eurozone country that has a negative trade balance with Germany, as declared each year in January by a regulation (Rechtsverordnung).”
    The ECJ surely would want to punish Germany for helping out the GIPS countries …
    As far as the WTO is concerned – don’t think anybody will sue: All countries around the Med are interested in saving Europe and want other goodies from Europe. Other countires aren’T significantly affected.

    • kantoos schreibt:

      @ P

      You are misrepresenting my post. My argument about the loss-absorbing capacity of the ECB is very (!) different from “standard” principles. If you don’t see why, have a look here:


  6. Positroll schreibt:

    Sorry, I should have phrased that differently. The piece you linked to is more precise than either of us: “The total NON-INFLATIONARY loss absorption capacity (NILAC) of the ECB is very large – we provide estimates that put it at €3.4trn. … The ECB’s loss absorption capacity in euros, unconstrained by an inflation limit, is infinite.”
    I guess, we basically agree. To the extent the ECB is ready to increase M0,there is no limit to its LAC.
    And the current 2% inflation limit is just a figment of the ECBs imagination, anyway: Art.127 (1) TFEU only requires stable prices – if one doesn’t define 0% as stable but takes general economic factors into account to arrive at 2%, it’s just as easy to argue that 3% is stable under the current circumstances than saying 2% is stable under normal circumstances …

  7. genau11 schreibt:


    the ECB has ZERO loss absorption capacity.
    They already got 2 warning letters from Weidemann. Three strikes and they are out. The ECB is on probation.

    In the moment Weidemann must pull the plug, based on the Maastricht treaty and the German constitution, the ECB has 0 cents in its coffers, but a target 2 debt of 600 billion to be repaid.

    If Weidemann pulls the plug on this Friday 10 pm, You will pay with deutschmarks tuesday morning.
    maybe one day later and we celebrate independence day in the future “Pfingstdienstag”.

    Of course, citi group, goldman sachs, soros, el erian, etc, WSJ, the GIPSIs dont like this view.

    • kantoos schreibt:


      Sorry, but there are so many things wrong with your comment… Weidman cannot pull any plug, the ECB has exactly zero Target “debt” (which is a wrong term to begin with), a German exit from the Euro is ridiculously unlikely, complex and costly, etc etc.

  8. genau11 schreibt:

    nobody will discuss the details in public.
    Lets just say, there is a good reason, why the ECB is in Frankfurt.
    It is like Schroedingers cat. In the moment you open the box, the cat is dead.

    • Positroll schreibt:

      Nope. Because that (German exit from the EURO) isn’t a decision for the Bundesbank to make. If anybody could make such a decision (ignoring the EU treaty in the process), it would be parliament (BTag + BRat). And to some degree the BVerfG. But surely NOT the Bundesbank (the only thing they could do is not accepting Greek bonds any longer). The DM only was legal tender, because a German law -since repealed – said so.

  9. hkaspar schreibt:

    My view:

    1) The Varoufakis proposal is in effect joint and several liability just as eurobonds. I don’t think there can be serious debate about this.

    2) The difference is the institutional setup. Instead of direclty guaranteeing once anothers’ liabilities, euro area states guarantee the liabilities of a joint instituion whose capital they own. The advantage is (i) if the institution goes broke, euro area states recapitalize it once, write off the losses and move on, rather than being stuck in dysfunctional mutual guarantees forever, and (ii) in the default case they have claims against the joint institution, not against one another. It would be a political nightmare if Germany or France would one day have to collect claims from a defaulting Greece or Portugal – but far less so if they have claims against a joint European institution.

    This is why I also prefer direct bond purchases by the ECB over eurobonds.

    3) For eurobonds, at least permanent ones, Europe would need a much stronger governance structure than it has today (even with the fiscal compound). At a minimum, there would need to be credible sanctions against governments not complying with their obligations to run sustainable budgets, such as taking over these governments’ taxing powers. There also would need to be a functioning framework of macroprudential regulation, to prevent the built up of private sector liabilities that, in crisis, tend to end up with the sovereign.

    In short, open-ended eurobonds have to be the endgame of fiscal integration, not the opening salvo. We are decades away from anyting like that. In the basence of a sufficient governance structure, however, open-ended eurobonds – such as the (in my view rather dumb) blue-red-purple-pink bond proposal by Brueghel – would create moral hazard left and right, and are a sure receipe to break up Europe, both economically and politically. The crisis we have today is small fish compared to what we would have once governments start defaulting on eurobonds.

    4) This is different though if joint and several liability is limited and temporary (as it would also be in the case of ECB bod purchases). The European collective redemption fund proposed by the German council of economic advisors, for example, would introduce eurobonds only to cope with the existing debt overhang, this is very much worth considering (the proposal has been endorsed by the Economist this week). This is a one-off crisis combating instrument, however, and not part of deeper, permanent fiscal intergration. Also the Hellwig/Philippon proposal of euro t-bills is much better and eurobonds, for the short maturity and therefore limited duration of the joint obligation. This would seem the right instrument to combat a liquidity (rather than sovency) crisis.


    • Very Serious Sam schreibt:

      “he European collective redemption fund proposed by the German council of economic advisors, for example, would introduce eurobonds only to cope with the existing debt overhang”

      I rather believe that once introduced, it would be used for a lot of other things. As can be seen from the demands to use the ESFS/ESM to directly recapitalize banks, the political ‘elite’ tends to not to stick to he contracts and promises they made.

    • kantoos schreibt:

      @ VSS

      Very valid point. But what HK meant was I think more in the direction of “limited size and duration”. Any extension beyond that would have to be agreed to by the Bundestag, for instance, and that is probably impossible. A redemption fund would be the ultimate limit for the German public, I guess.

    • kantoos schreibt:

      @ HK

      I agree, the political aspect of owing a European institution rather than Germany money is a good point.

    • hkaspar schreibt:

      @ VSS

      I agree of course. At the same time, some degree of flexibility is necessary when combating a crisis, during the course of which circumstances change and new challenges present themselves. One can box oneself in with a too rigid “up to here and no further”.

      As for the size of a redemption fund, I would include, for example, the costs of recapitalizing Spain’s banks, for example, and thee may increase going forward. At the same time, the coste are contingent fiscal liabilities that result from the built-up of excessive private debt prior to the crisis, and are a one-off, i.e not grounded in inherently unsustainable fiscal behavior (such as Greece). The risk of moral hazard is relatively modest in this case.

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