Eurozone is on its way to fiscal union

Europe’s leaders may still harbour secret hopes that the European Central Bank will come to their rescue, but at least they seem to have understood that the surest way to make that happen is to deliver on what they have responsibility for, starting with budgets. Fiscal union is now officially on the European agenda.

For some, this is all about strengthening sanctions for budgetary slippages through more automatic decision procedures and granting the power to veto national budgets to a European body. Angela Merkel, the German chancellor has spoken along these lines recently and Mark Rutte, the Dutch prime minister, is on a similar page. However, this plan alone is not likely to deliver much more than another layer of half-effective measures.

The principle underpinning budgetary surveillance is that each country is solely responsible for its own debt, but that it can be sanctioned ex post for misbehaviour. Alternatively, countries participating in the eurozone could have joint responsibility over at least part of their public debt, but they would also agree to give their partners the right to veto their budgets before they are implemented. To be clear, this would imply that eurozone members agree to provide a guarantee to the holders of, say, Italian debt and have the right to prevent the issuance of Italian debt.

Both principles are logically consistent. The choice today is whether to move towards adopting the latter instead of the former. But the idea of establishing an ex ante veto procedure without a quid pro quo is a dream. The unilateral surrender of budgetary sovereignty – a fundamental parliamentary right – is not something democratic countries will easily agree to if they do not get anything in exchange.

This is why, if serious, the debate on fiscal union is bound to involve discussion about the issuance of eurozone bonds. However, these come in many different shapes and colours. The European Commission presented a number of proposals earlier this week. The German Council of Economic Experts also suggested its own version.

Ideally, the scheme for issuing eurozone bonds would ensure that in order to be attractive to overseas investors they are at least as safe as and more liquid than existing high-quality government bonds. It should also involve incentives to fiscal discipline so that participating governments contribute to keeping the new bonds on a sound footing. In view of these criteria, the incentives-focused ‘blue bond’ proposal by Jacques Delpla and Jakob von Weizsäcker remains the best on offer.

However, recent developments at the German constitutional court complicate matters. The court has ruled that Germany cannot enter into unlimited, open-ended commitments vis-à-vis partners.

The German experts’ proposal addresses these concerns by proposing a temporary guarantee scheme covering current debt in excess of 60 per cent of gross domestic product. They envisage the creation of a temporary redemption fund that would benefit from joint and several liability and through which participating countries could issue debt in the next few years until they have reached their quota (namely, their current debt less 60 per cent). This debt would be paid off and gradually extinguished over time. To this end, each participating country would be required to earmark specific tax revenues.

There are shortcomings in this proposal. One may wonder what would be the attractiveness of temporary eurozone bonds. Countries with high debt, such as Italy, would benefit from it more than those with low debt, such as Spain, though the scheme could be tweaked to correct this imbalance. It would also lack the permanent incentive property of the blue bond scheme. But it has two advantages. First, the temporary possibility to issue new debt under joint and several liability would give breathing space to countries in trouble, leaving them time to adjust. Second, it would be an instrument to rebuild trust. For these two reasons, it deserves serious consideration.

A version of this commentary was also published in the Financial Times A-List