German Chancellor Angela Merkel successfully stood up to pressure from southern Europe and there will be no Eurobonds. This is a disappointment for markets, but for indebted countries the only way to rebuild is to patiently pursue policies of debt discipline and an end to lax budget constraints, argues Hans-Werner Sinn.
Hans-Werner Sinn is professor of economics and public finance at the University of Munich and president of the Ifo Institute, a think-tank.
"Investors in Europe's troubled economies are already getting enough as it is. Eurozone leaders' decision on 21 July 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 euro zone'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 realised.
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 euro zone in the mid-1990s.
Now that interest-rate spreads are increasing again, the pain is considerable, prompting calls for Eurobonds. When other countries guarantee repayment, it is hoped, low interest rates will return.
But who is to make these guarantees? The debt-to-GDP ratios of France and Germany are well above 80%, which isn't all that far below Italy's – and far above Spain's. Pooling debts doesn't make them go away. Everybody and every country must service their own debts; there is no way around that.
And, incidentally, the current agitation about interest rates is a bit over the top. The interest rates that countries like Italy and Spain have to pay today are only half as high as they were in 1995, before the conversion rates within the euro zone were set; likewise, interest-rate spreads vis-à-vis Germany today are only two-thirds of their size then.
There is no indication that the markets are dysfunctional and overstating the differences between countries' creditworthiness.
The spreads are necessary to keep capital flows within the euro zone in check. Before the introduction of the euro, capital flows had been limited by uncertainty about exchange rates. This saved Europe from overly large external imbalances. Now, without exchange-rate risk, interest-rate spreads based on debtor countries’ credit ratings are the only remaining defence against excessive capital movements and the resulting external imbalances.
If investors are given unlimited protection, with no risk of bearing their share of possible losses, capital will continue to flow unimpeded from one corner of the euro zone to the other, prolonging these imbalances."
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Published in partnership with Project Syndicate.